STATEMENT OF ADDITIONAL INFORMATION
1301 Avenue of the Americas (6th Avenue), 35th Floor New York, New York 10019 866-476-7523
Direxion Zacks MLP High Income Shares (ZMLP)
The Direxion Shares ETF Trust
(Trust) is an investment company that offers shares of a variety of exchange-traded funds, including the Direxion Zacks MLP High Income Shares (the Fund), to the public. The shares of the Fund (Shares) offered in
this Statement of Additional Information (SAI) trade, or upon commencement of operations will trade, on the NYSE Arca, Inc.
This
SAI, dated September 16, 2013, is not a prospectus. It should be read in conjunction with the Funds prospectus dated September 16, 2013 (Prospectus). This SAI is incorporated by reference into the Prospectus. In other words, it is
legally part of the Prospectus. To receive a copy of the Prospectus, without charge, write or call the Trust at the address or telephone number listed above.
September 16, 2013
TABLE OF CONTENTS
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THE DIREXION SHARES ETF TRUST
The Trust is a Delaware statutory trust organized on April 23, 2008 and is registered with the Securities and Exchange Commission (SEC)
as an open-end management investment company under the Investment Company Act of 1940, as amended (1940 Act). The Trust currently consists of 125 separate series, including the Fund.
The Fund seeks to provide investment results, before fees and expenses, which correspond to the performance of the Zacks MLP Index (the
Index).
The Fund issues and redeems Shares only in large blocks of Shares called Creation Units. Most investors will
buy and sell Shares of the Fund in secondary market transactions through brokers. Shares of the Fund, upon commencement of operations, will be listed for trading on the secondary market on the NYSE Arca, Inc (the Exchange). Shares can be
bought and sold throughout the trading day like other publicly traded shares. There is no minimum investment. Although Shares are generally purchased and sold in round lots of 100 Shares, brokerage firms typically permit investors to
purchase or sell Shares in smaller odd lots, at no per-share price differential. Investors may acquire Shares directly from the Fund, and shareholders may tender their Shares for redemption directly to the Fund, only in Creation Units of
50,000 Shares, as discussed in the Purchases and Redemptions section below.
CLASSIFICATION OF THE FUND
The Fund is a non-diversified series of the Trust pursuant to the 1940 Act. The Fund is considered non-diversified because a relatively high percentage of its assets may be
invested in the securities of a limited number of issuers. To the extent that the Fund assumes large positions in the securities of a small number of issuers, the Funds net asset value (NAV) may fluctuate to a greater extent than
that of a diversified company as a result of changes in the financial condition or in the markets assessment of the issuers, and the Fund may be more susceptible to any single economic, political or regulatory occurrence than a diversified
company.
The Funds classification as a non-diversified investment company means that the proportion of its assets that may
be invested in the securities of a single issuer is not limited by the 1940 Act.
EXCHANGE LISTING
AND TRADING
Upon commencement of operations of the Fund, Shares will be listed on the Exchange and may trade at prices that 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 will continue to be met. The Exchange may, but is not required to, remove the Shares from listing if
(i) following the initial 12-month period beginning at the commencement of trading of the Fund, there are fewer than 50 beneficial owners of the Shares for 30 or more consecutive trading days; (ii) the value of the Index is no longer
calculated or available; or (iii) such other event shall occur or condition exist that, in the opinion of the Exchange, makes further dealings on the Exchange inadvisable. The Exchange will remove the Shares from listing and trading upon
termination of the Fund.
As is the case of other stocks traded on the Exchange, brokers commissions on transactions will be based on
negotiated commission rates at customary levels. The Trust reserves the right to adjust the price levels of the 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.
The trading prices of the Shares in the secondary market
generally differ from the Funds daily NAV per share and are affected by market forces such as supply and demand, economic conditions and other factors. Rafferty Asset Management, LLC (Rafferty or Adviser) may, from time
to time, make payments to certain market makers in the Trusts shares. Information regarding the intraday value of shares of the Fund, also known as the intraday indicative value (IIV), is disseminated every 15 seconds
throughout the trading day by the Exchange or by market data vendors or other information providers. The IIV is based on the current market value of the securities and cash required to be deposited in exchange for a Creation Unit. The IIV does not
necessarily reflect the precise composition of the current portfolio of securities held by the Fund as a particular point in time, nor the best possible
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valuation of the current portfolio. Therefore, the IIV should not be viewed as a real-time update of the NAV, which is computed only once a day. The IIV is generally determined by
using both current market quotations and/or price quotations obtained from broker-dealers that may trade in the portfolio securities held by the Fund. The quotations of certain Fund holdings may not be updated during U.S. trading hours is such
holdings do not trade in the U.S. The Fund is not involved in, nor responsible for, the calculation or dissemination of the IIV and make no representations or warranty as to its accuracy.
INVESTMENT POLICIES AND TECHNIQUES
The Fund generally invests at least 80% of its net assets (plus any borrowings for investment purposes) in the securities of the Index and/or: investments that have economic characteristics that are
substantially identical to the economic characteristics of the securities of the Index. The Fund may also invest up to 20% of its assets in financial instruments that provide exposure to the Index, which include: futures contracts; options on
securities, indices and futures contracts; equity caps collars and floors; swap agreements; forward contracts; short positions; reverse purchase agreements and other financial instruments. The Fund also generally holds short-term debt instruments
that have terms-to-maturity of less than 397 days and exhibit high quality credit profiles, including U.S. government securities and repurchase agreements.
With the exception of limitations described in the Investment Restrictions section below, the Fund may engage in the investment strategies discussed below. There is no assurance that any of
these strategies or any other strategies and methods of investment available to the Fund will result in the achievement of the Funds objective.
This section provides a description of the securities in which the Fund may invest to achieve its investment objective, the strategies it may employ and the corresponding risks of such securities and
strategies. The greatest risk of investing in an exchange-traded fund (ETF) is that its returns will fluctuate and you could lose money. Recent events in the financial sector have resulted, and may continue to result, in an unusually
high degree of volatility in the financial markets. Both domestic and foreign equity markets could experience increased volatility and turmoil, with issuers that have exposure to the real estate, mortgage and credit markets particularly affected,
and it is uncertain whether or for how long these conditions could continue. The U.S. government has already taken a number of unprecedented actions designed to support certain financial institutions and segments of the financial markets that have
experienced extreme volatility, and in some cases a lack of liquidity.
Reduced liquidity in equity, credit and fixed-income markets may
adversely affect many issuers worldwide. This reduced liquidity may result in less money being available to purchase raw materials, goods and services from emerging markets, which may, in turn, bring down the prices of these economic staples. It may
also result in emerging market issuers having more difficulty obtaining financing, which may, in turn, cause a decline in their stock prices. These events and possible continued market turbulence may have an adverse effect on the Fund.
Bank Obligations
Money Market Instruments
. The Fund may invest in bankers acceptances, certificates of deposit, demand and time deposits, savings shares and commercial paper of domestic banks and savings and
loans that have assets of at least $1 billion and capital, surplus, and undivided profits of over $100 million as of the close of their most recent fiscal year, or instruments that are insured by the Bank Insurance Fund or the Savings Institution
Insurance Fund of the Federal Deposit Insurance Corporation (FDIC). The Fund also may invest in high quality,
short-term,
corporate debt obligations, including variable rate demand notes, having a
maturity of one year or less. Because there is no secondary trading market in demand notes, the inability of the issuer to make required payments could impact adversely the Funds ability to resell when it deems advisable to do so.
The Fund may invest in foreign money market instruments, which typically involve more risk that investing in U.S. money market instruments. See
Foreign Securities below. These risks include, among others, higher brokerage commissions, less public information, and less liquid markets in which to sell and meet large shareholder redemption requests.
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Bankers Acceptances
. Bankers acceptances generally are negotiable instruments (time
drafts) drawn to finance the export, import, domestic shipment or storage of goods. They are termed accepted when a bank writes on the draft its agreement to pay it at maturity, using the word accepted. The bank is, in
effect, unconditionally guaranteeing to pay the face value of the instrument on its maturity date. The acceptance may then be held by the accepting bank as an asset, or it may be sold in the secondary market at the going rate of interest for a
specified maturity.
Certificates of Deposit (CDs)
. The FDIC is an agency of the U.S. government that insures the deposits
of certain banks and savings and loan associations up to $100,000 per deposit. The interest on such deposits may not be insured to the extent this limit is exceeded. Current federal regulations also permit such institutions to issue insured
negotiable CDs in amounts of $100,000 or more without regard to the interest rate ceilings on other deposits. To remain fully insured, these investments must be limited to $100,000 per insured bank or savings and loan association.
Commercial Paper
. Commercial paper includes notes, drafts or similar instruments payable on demand or having a maturity at
the time of issuance not exceeding nine months, exclusive of days of grace or any renewal thereof. The Fund may invest in commercial paper rated
A-l
or
A-2
by
Standard & Poors
®
Ratings Services
(S&P
®
) or
Prime-1
or
Prime-2
by Moodys Investors Service
®
, Inc.
(Moodys), and in other lower quality commercial paper.
Caps, Floors and Collars
The Fund may enter into caps, floors and collars relating to securities, interest rates or currencies. In a cap or floor, the buyer
pays a premium (which is generally, but not always a single up-front amount) for the right to receive payments from the other party if, on specified payment dates, the applicable rate, index or asset is greater than (in the case of a cap) or less
than (in the case of a floor) an agreed level, for the period involved and the applicable notional amount. A collar is a combination instrument in which the same party buys a cap and sells a floor. Depending upon the terms of the cap and floor
comprising the collar, the premiums will partially or entirely offset each other. The notional amount of a cap, collar or floor is used to calculate payments, but is not itself exchanged. The Fund may be both buyers and sellers of these instruments.
In addition, the Fund may engage in combinations of put and call options on securities (also commonly known as collars), which may involve physical delivery of securities. Like swaps, caps, floors and collars are very flexible products. The terms of
the transactions entered by the Fund may vary from the typical examples described here.
Corporate Debt
Securities
The Fund may invest in investment grade corporate debt securities of any rating or maturity.
Investment grade corporate bonds are those rated BBB or better by S&P
®
or Baa or better by Moodys.
Securities rated BBB by S&P
®
are considered investment grade, but Moodys considers securities rated
Baa to have speculative characteristics. See Appendix A for a description of corporate bond ratings. The Fund may also invest in unrated securities.
Corporate debt securities are fixed-income securities issued by businesses to finance their operations, although corporate debt instruments may also include bank loans to companies. Notes, bonds,
debentures and commercial paper are the most common types of corporate debt securities, with the primary difference being their maturities and secured or un-secured status. Commercial paper has the shortest term and is usually unsecured.
The broad category of corporate debt securities includes debt issued by domestic or foreign companies of all kinds, including those with small-, mid- and
large-capitalizations. Corporate debt may be rated investment-grade or below investment-grade and may carry variable or floating rates of interest.
Because of the wide range of types, and maturities, of corporate debt securities, as well as the range of creditworthiness of its issuers, corporate debt securities have widely varying potentials for
return and risk profiles. For example, commercial paper issued by a large established domestic corporation that is rated investment-grade may have a modest return on principal, but carries relatively limited risk. On the other hand, a long-term
corporate note issued by a small foreign corporation from an emerging market country that has not been rated may have the potential for relatively large returns on principal, but carries a relatively high degree of risk.
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Corporate debt securities carry both credit risk and interest rate risk. Credit risk is the risk that the
Fund could lose money if the issuer of a corporate debt security is unable to pay interest or repay principal when it is due. Some corporate debt securities that are rated below investment-grade are generally considered speculative because they
present a greater risk of loss, including default, than higher quality debt securities. The credit risk of a particular issuers debt security may vary based on its priority for repayment. For example, higher ranking (senior) debt securities
have a higher priority than lower ranking (subordinated) securities. This means that the issuer might not make payments on subordinated securities while continuing to make payments on senior securities. In addition, in the event of bankruptcy,
holders of higher-ranking senior securities may receive amounts otherwise payable to the holders of more junior securities. Interest rate risk is the risk that the value of certain corporate debt securities will tend to fall when interest rates
rise. In general, corporate debt securities with longer terms tend to fall more in value when interest rates rise than corporate debt securities with shorter terms.
Depositary Receipts
To the extent the Fund invests in
stocks of foreign corporations, the Funds investment in such stocks may also be in the form of depositary receipts or other securities convertible into securities of foreign issuers. Depositary receipts may not necessarily be denominated in
the same currency as the underlying securities into which they may be converted. American Depositary Receipts (ADRs) are receipts typically issued by an American bank or trust company that evidence ownership of underlying securities
issued by a foreign corporation. European Depositary Receipts (EDRs) are receipts issued in Europe that evidence a similar ownership arrangement. Global Depositary Receipts (GDRs) are receipts issued throughout the world that
evidence a similar arrangement. Generally, ADRs, in registered form, are designed for use in the U.S. securities markets, and EDRs, in bearer form, are designed for use in European securities markets. GDRs are tradable both in the United States and
in Europe and are designed for use throughout the world. Depositary receipts will not necessarily be denominated in the same currency as their underlying securities.
Depositary receipts may be purchased through sponsored or unsponsored facilities. A sponsored facility is established jointly by the issuer of the underlying security and a
depositary, whereas a depositary may establish an unsponsored facility without participation by the issuer of the depositary security. Holders of unsponsored depositary receipts generally bear all the costs of such facilities and the depositary of
an unsponsored facility frequently is under no obligation to distribute shareholder communications received from the issuer of the deposited security or to pass through voting rights to the holders of such receipts of the deposited securities.
Fund investments in depositary receipts, which include ADRs, GDRs and EDRs, are deemed to be investments in foreign securities for purposes
of the Funds investment strategy.
Energy Infrastructure Industry Risk
The MLPs in which the Fund invests are engaged in the: (i) gathering, transporting, processing, treating, terminalling, storing, refining,
distributing, mining or marketing of natural gas, natural gas liquids, crude oil, refined products or coal, (ii) the acquisition, exploitation and development of crude oil, natural gas and natural gas liquids, (iii) processing, treating,
and refining of natural gas liquids and crude oil, and (iv) owning, managing and transporting alternative energy infrastructure assets, including alternative fuels such as ethanol, hydrogen and biodiesel. These MLPs are subject to many of the
risks associated with investments in the energy infrastructure companies, including the following:
Commodity Risks
.
The return
on the Funds investments will depend on the margins received by MLPs and energy infrastructure companies for the exploration, development, production, gathering, transportation, processing, storing, refining, distribution, mining or marketing
of natural gas, natural gas liquids, crude oil, refined petroleum products or coal. These margins may fluctuate widely in response to a variety of factors including global and domestic economic conditions, weather conditions, natural disasters, the
supply and price of imported energy commodities, the production and storage levels of energy commodities in certain regions or in the world, political instability, terrorist activities, transportation facilities, energy conservation, domestic and
foreign governmental regulation and taxation and the availability of local, intrastate and interstate transportation systems. Volatility of commodity prices also may make it more difficult for MLPs and energy infrastructure companies to raise
capital to the extent the market perceives that their performance may be directly or indirectly tied to commodity prices.
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Supply and Demand Risks
.
A decrease in the production of natural gas, natural gas liquids,
crude oil, coal or other energy commodities, a reduction in the volume of such commodities available for transportation, mining, processing, storage or distribution, or a sustained decline in demand for such commodities, may adversely affect the
financial performance or prospects of MLPs and energy infrastructure companies. MLPs and energy infrastructure companies are subject to supply and demand fluctuations in the markets they serve which will be impacted by a wide range of factors,
including fluctuating commodity prices, weather, increased conservation or use of alternative fuel sources, increased governmental or environmental regulation, depletion, growing interest rates, declines in domestic or foreign production, accidents
or catastrophic events, and economic conditions, among others.
Operational Risks
.
MLPs and energy infrastructure companies are
subject to various operational risks, such as disruption of operations, inability to timely and effectively integrate newly acquired assets, unanticipated operation and maintenance expenses, lack of proper asset integrity, underestimated cost
projections, inability to renew or increased costs of rights of way, failure to obtain the necessary permits to operate and failure of third-party contractors to perform their contractual obligations. Thus, some MLPs and energy infrastructure
companies may be subject to construction risk, acquisition risk or other risks arising from their specific business strategies.
Acquisition Risks
.
The ability of MLPs and energy infrastructure companies to grow and, where applicable, to increase dividends or
distributions to their equity holders can be highly dependent on their ability to make acquisitions of energy businesses that result in an increase in free cash flow. In the event that such companies are unable to make such accretive acquisitions
because they are unable to identify attractive acquisition candidates or negotiate acceptable purchase contracts, because they are unable to raise financing for such acquisitions on economically acceptable terms, or because they are outbid by
competitors, their future growth and ability to make or raise dividends or distributions will be limited and their ability to repay their debt and make payments to preferred equity holders may be weakened. Furthermore, even if these companies do
consummate acquisitions that they believe will be accretive, the acquisitions may instead result in a decrease in free cash flow.
Regulatory Risks
.
MLPs and energy infrastructure companies are subject to significant federal, state and local government regulation in
virtually every aspect of their operations, including how facilities are constructed, maintained and operated, environmental and safety controls, and the prices they may charge for the products and services they provide. Various governmental
authorities have the power to enforce compliance with these regulations and the permits issued under them, and violators are subject to administrative, civil and criminal penalties, including civil fines, injunctions or both.
For example, many state and federal environmental laws provide for civil penalties as well as regulatory remediation, thus adding to the potential
liability an MLP or energy infrastructure company may face. More extensive laws, regulations or enforcement policies could be enacted in the future which would likely increase compliance costs and may adversely affect the financial performance of
MLPs and energy infrastructure companies.
Rising Interest Rate Risks
.
The values of securities of MLPs and energy
infrastructure companies in the Funds portfolio are susceptible to decline when interest rates rise. Accordingly, the market price of the Funds common stock may decline when interest rates rise. Rising interest rates could adversely
impact the financial performance of these companies by increasing their costs of capital. This may reduce an MLPs ability to execute acquisitions or expansion projects in a cost-effective manner.
Terrorism Risks
.
The terrorist attacks in the United States on September 11, 2001 had a disruptive effect on the economy and the
securities markets. United States military and related action in the Middle East could have significant adverse effects on the U.S. economy and the stock market. Uncertainty surrounding military strikes or actions or a sustained military campaign
may affect an MLPs or energy infrastructure companys operations in unpredictable ways, including disruptions of fuel supplies and markets, and transmission and distribution facilities could be direct targets, or indirect casualties, of
an act of terror. The U.S. government has issued warnings that energy assets, specifically the United States pipeline infrastructure, may be the future target of terrorist organizations. In addition, changes in the insurance markets have made
certain types of insurance more difficult, if not impossible, to obtain and have generally resulted in increased premium costs.
Weather
Risks
.
Extreme weather patterns, such as Hurricane Ivan in 2004 and Hurricane Katrina in 2005, or environmental hazards, such as the BP oil spill in 2010, could result in significant volatility in the supply of energy and power and could
adversely impact the value of the debt and equity securities of the MLPs and energy infrastructure industry in which the Fund invests. This volatility may create fluctuations in commodity prices and earnings of MLPs and energy infrastructure
companies.
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Catastrophe Risk
.
The operations of MLPs and energy infrastructure companies are subject to
many hazards inherent in the transporting, processing, storing, distributing, mining or marketing of natural gas, natural gas liquids, crude oil, coal, refined petroleum products or other hydrocarbons, or in the exploring, managing or producing of
such commodities, including: damage to pipelines, storage tanks or related equipment and surrounding properties caused by hurricanes, tornadoes, floods, fires and other natural disasters; inadvertent damage from construction or other equipment;
leaks of natural gas, natural gas liquids, crude oil, refined petroleum products or other hydrocarbons; and fires and explosions. These risks could result in substantial losses due to personal injury or loss of life, severe damage to and destruction
of property and equipment and pollution or other environmental damage and may result in the curtailment or suspension of their related operations. Not all MLPs and energy infrastructure companies are fully insured against all risks inherent to their
businesses. If a significant accident or event occurs that is not fully insured, it could adversely affect an MLPs or energy infrastructure companys operations and financial condition and the securities issued by the company.
Competition Risk
.
The MLPs and energy infrastructure companies may face substantial competition in acquiring assets, expanding or
constructing assets and facilities, obtaining and retaining customers and contracts, securing trained personnel and operating their assets. Many of their competitors, including major oil companies, independent exploration and production companies,
MLPs and other diversified energy companies, will have superior financial and other resources.
Depletion and Exploration Risk
.
Energy reserves naturally deplete as they are produced over time. Many energy companies are either engaged in the production of natural gas, natural gas liquids, crude oil, or coal, or are engaged in transporting, storing, distributing and
processing these items or their derivatives on behalf of shippers. To maintain or grow their revenues, these companies or their customers need to maintain or expand their reserves through exploration of new sources of supply, through the development
of existing sources or, through acquisitions. The financial performance of MLPs and energy infrastructure companies may be adversely affected if they, or the companies to whom they provide the service, are unable to cost-effectively acquire
additional reserves sufficient to replace the depleted reserves. If an MLP or energy infrastructure company fails to add reserves by acquiring or developing them, its reserves and production will decline over time as the reserves are produced. If an
MLP or energy infrastructure company is not able to raise capital on favorable terms, it may not be able to add to or maintain its reserves.
Financing Risk
.
Some MLPs and energy infrastructure companies may rely on capital markets to raise money to pay their existing obligations.
Their ability to access the capital markets on attractive terms or at all may be affected by any of the risk factors associated with MLPs and energy infrastructure companies described above, by general economic and market conditions or by other
factors. This may in turn affect their ability to satisfy their obligations to us. In addition, certain MLPs and energy infrastructure companies are dependent on their parents or sponsors for a majority of their revenues.
Equity Securities
Common Stocks
. The Fund may invest in common stocks. Common stocks represent the residual ownership interest in the issuer and are entitled to the income and increase in the value of the assets and
business of the entity after all of its obligations and preferred stock are satisfied. Common stocks generally have voting rights. Common stocks fluctuate in price in response to many factors including historical and prospective earnings of the
issuer, the value of its assets, general economic conditions, interest rates, investor perceptions and market liquidity.
Convertible
Securities
. The Fund may invest in convertible securities that may be considered high yield securities. Convertible securities include corporate bonds, notes and preferred stock that can be converted into or exchanged for a prescribed amount of
common stock of the same or a different issue within a particular period of time at a specified price or formula. A convertible security entitles the holder to receive interest paid or accrued on debt or dividends paid on preferred stock until the
convertible stock matures or is redeemed, converted or exchanged. While no securities investment is without some risk, investments in convertible securities generally entail less risk than the issuers common stock, although the extent to which
such risk is reduced depends in large measure upon the degree to which the convertible security sells above its value as a fixed income security. The market value of convertible securities tends to
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decline as interest rates increase and, conversely, to increase as interest rates decline. While convertible securities generally offer lower interest or dividend yields than nonconvertible debt
securities of similar quality, they do enable the investor to benefit from increases in the market price of the underlying common stock. When investing in convertible securities, the Fund may invest in the lowest credit rating category.
Preferred Stock
. The Fund may invest in preferred stock. A preferred stock blends the characteristics of a bond and common stock. It can offer the
higher yield of a bond and has priority over common stock in equity ownership, but does not have the seniority of a bond and its participation in the issuers growth may be limited. Preferred stock has preference over common stock in the
receipt of dividends and in any residual assets after payment to creditors if the issuer is dissolved. Although the dividend is set at a fixed annual rate, in some circumstances it can be changed or omitted by the issuer. When investing in preferred
stocks, the Fund may invest in the lowest credit rating category.
Warrants and Rights
. The Fund may purchase warrants and rights,
which are instruments that permit the Fund to acquire, by subscription, the capital stock of a corporation at a set price, regardless of the market price for such stock. Warrants may be either perpetual or of limited duration, but they usually do
not have voting rights or pay dividends. The market price of warrants is usually significantly less than the current price of the underlying stock. Thus, there is a greater risk that warrants might drop in value at a faster rate than the underlying
stock.
Foreign Currencies
The Fund may invest directly and indirectly in foreign currencies. Investments in foreign currencies are subject to numerous risks not least being the fluctuation of foreign currency exchange rates with
respect to the U.S. dollar. Exchange rates fluctuate for a number of reasons.
Inflation
.
Exchange rates change to reflect
changes in a currencys buying power. Different countries experience different inflation rates due to different monetary and fiscal policies, different product and labor market conditions, and a host of other factors.
Trade Deficits.
Countries with trade deficits tend to experience a depreciating currency. Inflation may be the cause of a trade deficit,
making a countrys goods more expensive and less competitive and so reducing demand for its currency.
Interest Rates.
High
interest rates may raise currency values in the short term by making such currencies more attractive to investors. However, since high interest rates are often the result of high inflation, long-term results may be the opposite.
Budget Deficits and Low Savings Rates.
Countries that run large budget deficits and save little of their national income tend to suffer a
depreciating currency because they are forced to borrow abroad to finance their deficits. Payments of interest on this debt can inundate the currency markets with the currency of the debtor nation. Budget deficits also can indirectly contribute to
currency depreciation if a government chooses inflationary measure to cope with its deficits and debt.
Political Factors.
Political instability in a country can cause a currency to depreciate. Demand for a certain currency may fall if a country appears a less desirable place in which to invest and do business.
Government Control.
Through their own buying and selling of currencies, the worlds central banks sometimes manipulate exchange rate movements. In addition, governments occasionally
issue statements to influence peoples expectations about the direction of exchange rates, or they may instigate policies with an exchange rate target as the goal.
The value of the Funds investments is calculated in U.S. dollars each day that the New York Stock Exchange is open for business. As a result, to the extent that the Funds assets are invested
in instruments denominated in foreign currencies and the currencies appreciate relative to the U.S. dollar, the Funds NAV per share as expressed in U.S. dollars (and, therefore, the value of your investment) should increase. If the U.S. dollar
appreciates relative to the other currencies, the opposite should occur.
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The currency-related gains and losses experienced by the Fund will be based on changes in the value of
portfolio securities attributable to currency fluctuations only in relation to the original purchase price of such securities as stated in U.S. dollars. Gains or losses on shares of the Fund will be based on changes attributable to fluctuations in
the NAV of such shares, expressed in U.S. dollars, in relation to the original U.S. dollar purchase price of the shares. The amount of appreciation or depreciation in the Funds assets also will be affected by the net investment income
generated by the money market instruments in which the Fund invests and by changes in the value of the securities that are unrelated to changes in currency exchange rates.
The Fund may incur currency exchange costs when it sells instruments denominated in one currency and buy instruments denominated in another.
Currency Transactions.
The Fund conducts currency exchange transactions on a spot basis. Currency transactions made on a spot basis are for cash at the spot rate prevailing in the currency
exchange market for buying or selling currency. The Fund also enters into forward currency contracts. See Options, Futures and Other Strategies below. A forward currency contract is an obligation to buy or sell a specific currency at a
future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. These contracts are entered into on the interbank market conducted directly between currency
traders (usually large commercial banks) and their customers.
The Fund may invest in a combination of forward currency contracts and U.S.
dollar-denominated market instruments in an attempt to obtain an investment result that is substantially the same as a direct investment in a foreign currency-denominated instrument. This investment technique creates a synthetic position
in the particular foreign-currency instrument whose performance the Adviser is trying to duplicate. For example, the combination of U.S. dollar-denominated instruments with long forward currency exchange contracts creates a position
economically equivalent to a money market instrument denominated in the foreign currency itself. Such combined positions are sometimes necessary when the money market in a particular foreign currency is small or relatively illiquid.
The Fund may invest in forward currency contracts to hedge either specific transactions (transaction hedging) or portfolio positions (position hedging).
Transaction hedging is the purchase or sale of forward currency contracts with respect to specific receivables or payables of the Fund in connection with the purchase and sale of portfolio securities. Position hedging is the sale of a forward
currency contract on a particular currency with respect to portfolio positions denominated or quoted in that currency.
The Fund may use
forward currency contracts for position hedging if consistent with its policy of trying to expose its net assets to foreign currencies. The Fund is not required to enter into forward currency contracts for hedging purposes and it is possible that
the Fund may not be able to hedge against a currency devaluation that is so generally anticipated that the Fund is unable to contract to sell the currency at a price above the devaluation level it anticipates.
The Fund currently does not intend to enter into a forward currency contract with a term of more than one year, or to engage in position hedging with
respect to the currency of a particular country to more than the aggregate market value (at the time the hedging transaction is entered into) of its portfolio securities denominated in (or quoted in or currently convertible into or directly related
through the use of forward currency contracts in conjunction with money market instruments to) that particular currency.
At or before the
maturity of a forward currency contract, the Fund may either sell a portfolio security and make delivery of the currency, or retain the security and terminate its contractual obligation to deliver the currency by buying an offsetting
contract obligating it to buy, on the same maturity date, the same amount of the currency. If the Fund engages in an offsetting transaction, it may later enter into a new forward currency contract to sell the currency.
If the Fund engages in an offsetting transaction, it will incur a gain or loss to the extent that there has been movement in forward currency contract
prices. If forward prices go down during the period between the date the Fund enters into a forward currency contract for the sale of a currency and the date it enters into an offsetting contract for the purchase of the currency, the Fund will
realize a gain to the extent that the price of the currency it has agreed to sell exceeds the price of the currency it has agreed to buy. If forward prices go up, the Fund will suffer a loss to the extent the price of the currency it has agreed to
buy exceeds the price of the currency it has agreed to sell.
8
Since the Fund invests in money market instruments denominated in foreign currencies, it may hold foreign
currencies pending investment or conversion into U.S. dollars. Although the Fund values its assets daily in U.S. dollars, it does not convert its holdings of foreign currencies into U.S. dollars on a daily basis. The Fund will convert its holdings
from time to time, however, and incur the costs of currency conversion. Foreign exchange dealers do not charge a fee for conversion, but they do realize a profit based on the difference between the prices at which they buy and sell various
currencies. Thus, a dealer may offer to sell a foreign currency to the Fund at one rate, and offer to buy the currency at a lower rate if the Fund tries to resell the currency to the dealer.
Foreign Currency Options.
The Fund may invest in foreign currency-denominated securities and may buy or sell put and call options on foreign currencies. The Fund may buy or sell put and call
options on foreign currencies either on exchanges or in the over-the-counter (OTC) market. A put option on a foreign currency gives the purchaser of the option the right to sell a foreign currency at the exercise price until the option
expires. A call option on a foreign currency gives the purchaser of the option the right to purchase the currency at the exercise price until the option expires. Currency options traded on U.S. or other exchanges may be subject to position limits
which may limit the ability of the Fund to reduce foreign currency risk using such options. OTC options differ from traded options in that they are two-party contracts with price and other terms negotiated between buyer and seller, and generally do
not have as much market liquidity as exchange-traded options.
Foreign Currency Exchange-Related Securities.
Foreign currency warrants
. Foreign currency warrants such as Currency Exchange Warrants
SM
(CEWs
SM
) are warrants which entitle the holder
to receive from their issuer an amount of cash (generally, for warrants issued in the United States, in U.S. dollars) which is calculated pursuant to a predetermined formula and based on the exchange rate between a specified foreign currency and the
U.S. dollar as of the exercise date of the warrant. Foreign currency warrants generally are exercisable upon their issuance and expire as of a specified date and time. Foreign currency warrants have been issued in connection with U.S.
dollar-denominated debt offerings by major corporate issuers in an attempt to reduce the foreign currency exchange risk which, from the point of view of prospective purchasers of the securities, is inherent in the international fixed-income
marketplace. Foreign currency warrants may attempt to reduce the foreign exchange risk assumed by purchasers of a security by, for example, providing for a supplemental payment in the event that the U.S. dollar depreciates against the value of a
major foreign currency such as the Japanese yen or the Euro. The formula used to determine the amount payable upon exercise of a foreign currency warrant may make the warrant worthless unless the applicable foreign currency exchange rate moves in a
particular direction (
e.g.,
unless the U.S. dollar appreciates or depreciates against the particular foreign currency to which the warrant is linked or indexed). Foreign currency warrants are severable from the debt obligations with which
they may be offered, and may be listed on exchanges. Foreign currency warrants may be exercisable only in certain minimum amounts, and an investor wishing to exercise warrants who possesses less than the minimum number required for exercise may be
required either to sell the warrants or to purchase additional warrants, thereby incurring additional transaction costs. In the case of any exercise of warrants, there may be a time delay between the time a holder of warrants gives instructions to
exercise and the time the exchange rate relating to exercise is determined, during which time the exchange rate could change significantly, thereby affecting both the market and cash settlement values of the warrants being exercised. The expiration
date of the warrants may be accelerated if the warrants should be delisted from an exchange or if their trading should be suspended permanently, which would result in the loss of any remaining time value of the warrants (
i.e.,
the
difference between the current market value and the exercise value of the warrants), and, in the case the warrants were out-of-the-money, in a total loss of the purchase price of the warrants.
Warrants are generally unsecured obligations of their issuers and are not standardized foreign currency options issued by the Options Clearing
Corporation (OCC). Unlike foreign currency options issued by OCC, the terms of foreign exchange warrants generally will not be amended in the event of governmental or regulatory actions affecting exchange rates or in the event of the
imposition of other regulatory controls affecting the international currency markets. The initial public offering price of foreign currency warrants is generally considerably in excess of the price that a commercial user of foreign currencies might
pay in the interbank market for a comparable option involving significantly larger amounts of foreign currencies. Foreign currency warrants are subject to significant foreign exchange risk, including risks arising from complex political or economic
factors.
9
Principal exchange rate linked securities
. Principal exchange rate linked
securities (PERLs
SM
) are debt obligations the
principal on which is payable at maturity in an amount that may vary based on the exchange rate between the U.S. dollar and a particular foreign currency at or about that time. The return on standard principal exchange rate linked
securities is enhanced if the foreign currency to which the security is linked appreciates against the U.S. dollar, and is adversely affected by increases in the foreign exchange value of the U.S. dollar; reverse principal exchange rate
linked securities are like the standard securities, except that their return is enhanced by increases in the value of the U.S. dollar and adversely impacted by increases in the value of foreign currency. Interest payments on the
securities are generally made in U.S. dollars at rates that reflect the degree of foreign currency risk assumed or given up by the purchaser of the notes (
i.e.,
at relatively higher interest rates if the purchaser has assumed some of the
foreign exchange risk, or relatively lower interest rates if the issuer has assumed some of the foreign exchange risk, based on the expectations of the current market). Principal exchange rate linked securities may in limited cases be subject to
acceleration of maturity (generally, not without the consent of the holders of the securities), which may have an adverse impact on the value of the principal payment to be made at maturity.
Performance indexed paper
. Performance indexed paper (PIPs
SM
) is U.S. dollar-denominated commercial paper the yield of which is linked to certain foreign exchange rate
movements. The yield to the investor on performance indexed paper is established at maturity as a function of spot exchange rates between the U.S. dollar and a designated currency as of or about that time (generally, the index maturity two days
prior to maturity). The yield to the investor will be within a range stipulated at the time of purchase of the obligation, generally with a guaranteed minimum rate of return that is below, and a potential maximum rate of return that is above, market
yields on U.S. dollar-denominated commercial paper, with both the minimum and maximum rates of return on the investment corresponding to the minimum and maximum values of the spot exchange rate two business days prior to maturity.
Foreign Securities
The Fund may have both direct and indirect exposure through investments in stock index futures contracts, options on stock index futures contracts and options on securities and on stock indices to foreign
securities. In most cases, the best available market for foreign securities will be on exchanges or in OTC markets located outside the United States.
Investing in foreign securities carries political and economic risks distinct from those associated with investing in the United States. Investments in foreign securities also involve the risk of possible
adverse changes in investment or exchange control regulations, expropriation or confiscatory taxation, limitation on or delays in the removal of funds or other assets of a fund, political or financial instability or diplomatic and other developments
that could affect such investments. Foreign investments may be affected by actions of foreign governments adverse to the interests of U.S. investors, including the possibility of expropriation or nationalization of assets, confiscatory taxation,
restrictions on U.S. 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. Investments in foreign
countries also involve a risk of local political, economic or social instability, military action or unrest or adverse diplomatic developments.
Developing and Emerging Markets.
Emerging and developing markets abroad may offer special opportunities for investing but may have greater
risks than more developed foreign markets, such as those in Europe, Canada, Australia, New Zealand and Japan. There may be even less liquidity in their securities markets, and settlements of purchases and sales of securities may be subject to
additional delays. They are subject to greater risks of limitations on the repatriation of income and profits because of currency restrictions imposed by local governments. Those countries may also be subject to the risk of greater political and
economic instability, which can greatly affect the volatility of prices of securities in those countries.
Investing in emerging market
securities imposes risks different from, or greater than, risks of investing in foreign developed countries. These risks include: smaller market capitalization of securities markets, which may suffer periods of relative illiquidity; significant
price volatility; restrictions on foreign investment; possible repatriation of investment income and capital. In addition, foreign investors may be required to register the proceeds of sales;
10
future economic or political crises could lead to price controls, forced mergers, expropriation or confiscatory taxation, seizure, nationalization, or creation of government monopolies. The
currencies of emerging market countries may experience significant declines against the U.S. dollar. Inflation and rapid fluctuations in inflation rates have had, and may continue to have, negative effects on the economies and securities markets of
certain emerging market countries. Additional risks of emerging markets securities may include: greater social, economic and political uncertainty and instability; more substantial governmental involvement in the economy; less governmental
supervision and regulation; unavailability of currency hedging techniques; companies that are newly organized and small; differences in auditing and financial reporting standards, which may result in unavailability of material information about
issuers; and less developed legal systems. In addition, emerging securities markets may have different clearance and settlement procedures, which may be unable to keep pace with the volume of securities transactions or otherwise make it difficult to
engage in such transactions.
Hybrid Instruments
The Fund may invest in hybrid instruments. A hybrid instrument is a type of potentially high-risk derivative that combines a traditional stock, bond, or
commodity with an option or forward contract. Generally, the principal amount, amount payable upon maturity or redemption, or interest rate of a hybrid is tied (positively or negatively) to the price of some commodity, currency or securities index
or another interest rate or some other economic factor (each a benchmark). The interest rate or (unlike most fixed income securities) the principal amount payable at maturity of a hybrid security may be increased or decreased, depending
on changes in the value of the benchmark. A hybrid could be, for example, a bond issued by an oil company that pays a small base level of interest, in addition to interest that accrues when oil prices exceed a certain predetermined level. Such a
hybrid instrument would be a combination of a bond and a call option on oil.
Hybrids can be used as an efficient means of pursuing a variety
of investment goals, including currency hedging, and increased total return. Hybrids may not bear interest or pay dividends. The value of a hybrid or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up
or down) more steeply and rapidly than the benchmark. These benchmarks may be sensitive to economic and political events, such as commodity shortages and currency devaluations, which cannot be readily foreseen by the purchaser of a hybrid. Under
certain conditions, the redemption value of a hybrid could be zero. Thus, an investment in a hybrid may entail significant market risks that are not associated with a similar investment in a traditional, U.S. dollar-denominated bond that has a fixed
principal amount and pays a fixed rate or floating rate of interest. The purchase of hybrids also exposes the Fund to the credit risk of the issuer of the hybrids. These risks may cause significant fluctuations in the NAV of the Fund.
Certain issuers of structured products such as hybrid instruments may be deemed to be investment companies as defined in the 1940 Act. As a result, the
Funds investment in these products may be subject to limits applicable to investments in investment companies and may be subject to restrictions contained in the 1940 Act.
Illiquid Investments and Restricted Securities
The Fund
may purchase and hold illiquid investments. The Fund will not purchase or otherwise acquire any security if, as a result, more than 15% of its net assets (taken at current value) would be invested in investments that are illiquid by virtue of the
absence of a readily available market or legal or contractual restrictions on resale. This policy does not include restricted securities eligible for resale pursuant to Rule 144A under the Securities Act of 1933, as amended (1933 Act),
which the Board of Trustees (Board or Trustees) or Rafferty has determined under Board-approved guidelines are liquid. The Fund, however, currently does not anticipate investing in such restricted securities.
The term illiquid investments for this purpose means investments that cannot be disposed of within seven days in the ordinary course of
business at approximately the amount at which the Fund has valued the investments. Investments currently considered to be illiquid include: (1) repurchase agreements not terminable within seven days; (2) securities for which market
quotations are not readily available; (3) OTC options and their underlying collateral; (4) bank deposits, unless they are payable at principal amount plus accrued interest on demand or within seven days after demand; (5) restricted
securities not determined to be liquid pursuant to guidelines established by the Board; and (6) in certain circumstances, securities involved in swap, cap, floor or collar transactions. The assets
11
used as cover for OTC options written by the Fund will be considered illiquid unless the OTC options are sold to qualified dealers who agree that the Fund may repurchase any OTC option it writes
at a maximum price to be calculated by a formula set forth in the option agreement. The cover for an OTC option written subject to this procedure would be considered illiquid only to the extent that the maximum repurchase price under the formula
exceeds the intrinsic value of the option.
The Fund may not be able to sell illiquid investments when Rafferty considers it desirable to do
so or may have to sell such investments at a price that is lower than the price that could be obtained if the investments were liquid. In addition, the sale of illiquid investments may require more time and result in higher dealer discounts and
other selling expenses than does the sale of investments that are not illiquid. Illiquid investments also may be more difficult to value due to the unavailability of reliable market quotations for such investments, and investment in illiquid
investments may have an adverse impact on NAV.
Rule 144A establishes a safe harbor from the registration requirements of the 1933
Act for resales of certain securities to qualified institutional buyers. Institutional markets for restricted securities that have developed as a result of Rule 144A provide both readily ascertainable values for certain restricted securities and the
ability to liquidate an investment to satisfy share redemption orders. An insufficient number of qualified institutional buyers interested in purchasing Rule 144A-eligible securities held by the Fund, however, could affect adversely the
marketability of such portfolio securities, and the Fund may be unable to dispose of such securities promptly or at reasonable prices.
Indexed Securities
The Fund may purchase indexed securities, which are securities, the value of which varies positively or
negatively in relation to the value of other securities, securities indices or other financial indicators, consistent with its investment objective. Indexed securities may be debt securities or deposits whose value at maturity or coupon rate is
determined by reference to a specific instrument or statistic. Recent issuers of indexed securities have included banks, corporations and certain U.S. government agencies.
The performance of indexed securities depends to a great extent on the performance of the security or other instrument to which they are indexed and also may be influenced by interest rate changes in the
United States and abroad. At the same time, indexed securities are subject to the credit risks associated with the issuer of the security, and their values may decline substantially if the issuers creditworthiness deteriorates. Indexed
securities may be more volatile than the underlying instruments. Certain indexed securities that are not traded on an established market may be deemed illiquid. See Illiquid Investments and Restricted Securities above.
Total Return Swaps
The Fund may enter into total return swaps for hedging purposes and non-hedging purposes. Since swaps are entered into for good faith hedging purposes or are offset by a segregated account maintained by
an approved custodian, Rafferty believes that swaps do not constitute senior securities as defined in the 1940 Act and, accordingly, will not treat them as being subject to the Funds borrowing restrictions. The net amount of the excess, if
any, of the Funds obligations over its entitlement with respect to each total return swap will be accrued on a daily basis and an amount of cash or other liquid securities having an aggregate NAV at least equal to such accrued excess will be
maintained in a segregated account by the Funds custodian. The Fund will not enter into any total return swap unless Rafferty believes that the other party to the transaction is creditworthy. If there is a default by the other party to such a
transaction, the Fund will have contractual remedies pursuant to the agreement. 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. In addition, some total return swaps are, and more in the future may be, centrally cleared. As a result, the swap market has become relatively liquid in comparison with the markets for other similar instruments which
are traded in the interbank market.
Options, Futures and Other Strategies
General
.
The Fund may use certain options (traded on an exchange or OTC, or otherwise), futures contracts (sometimes referred to as
futures) and options on futures contracts (collectively, Financial Instruments) as a substitute for a comparable market position in the underlying security, to attempt to hedge or limit the exposure of the Funds
position, to create a synthetic money market position, for certain tax-related purposes or to effect closing transactions.
12
The use of Financial Instruments is subject to applicable regulations of the SEC, the several exchanges upon
which they are traded and the Commodity Futures Trading Commission (the CFTC). In addition, the Funds ability to use Financial Instruments will be limited by tax considerations. See Dividends, Other Distributions and
Taxes. Pursuant to a claim for exemption filed with the National Futures Association on behalf of the Fund, the Fund is not deemed to be a commodity pool operator or a commodity pool under the Commodity Exchange Act (the CEA) and
is not subject to registration or regulation as such under the CEA. However, the registration exclusion was amended in February 2012, and such amendments took effect on April 24, 2012.
Under current CFTC regulations, if the Fund uses commodity interests (such as futures contracts, options on futures contracts and swaps) other than for
bona fide
hedging purposes (as defined by the
CFTC) the aggregate initial margin and premiums required to establish these positions (after taking into account unrealized profits and unrealized losses on any such positions and excluding the amount by which options that are
in-the-money at the time of purchase) may not exceed 5% of a funds NAV, or alternatively, the aggregate net notional value of those positions, as determined at the time the most recent position was established, may not exceed 100%
of the funds NAV (after taking into account unrealized profits and unrealized losses on any such positions). Accordingly, the Fund will register, prior to commencement of operations, as a commodity pool, and the Adviser has registered as a
commodity pool operator with the National Futures Association. The Fund is subject to the risk that a change in U.S. law and related regulations will impact the way the Fund operates, increase the particular costs of the Funds operation and/or
change the competitive landscape. In this regard, any further amendment to the CEA or its related regulations that subject the Fund to additional regulation may have adverse impacts on the Funds operations and expenses.
In addition to the instruments, strategies and risks described below and in the Prospectus, Rafferty may discover additional opportunities in connection
with Financial Instruments and other similar or related techniques. These new opportunities may become available as Rafferty develops new techniques, as regulatory authorities broaden the range of permitted transactions and as new Financial
Instruments or other techniques are developed. Rafferty may utilize these opportunities to the extent that they are consistent with the Funds investment objective and permitted by the Funds investment limitations and applicable
regulatory authorities. The Funds Prospectus or this SAI will be supplemented to the extent that new products or techniques involve materially different risks than those described below or in the Prospectus.
Special Risks
.
The use of Financial Instruments involves special considerations and risks, certain of which are described below. Risks
pertaining to particular Financial Instruments are described in the sections that follow.
(1) Successful use of most Financial Instruments
depends upon Raffertys ability to predict movements of the overall securities markets, which requires different skills than predicting changes in the prices of individual securities. The ordinary spreads between prices in the cash and futures
markets, due to the differences in the natures of those markets, are subject to distortion. Due to the possibility of distortion, a correct forecast of stock market trends by Rafferty may still not result in a successful transaction. Rafferty may be
incorrect in its expectations as to the extent of market movements or the time span within which the movements take place, which, thus, may result in the strategy being unsuccessful.
(2) Options and futures prices can diverge from the prices of their underlying instruments. Options and futures prices are affected by such factors as current and anticipated short-term interest rates,
changes in volatility of the underlying instrument and the time remaining until expiration of the contract, which may not affect security prices the same way. Imperfect or no correlation also may result from differing levels of demand in the options
and futures markets and the securities markets, from structural differences in how options and futures and securities are traded, and from imposition of daily price fluctuation limits or trading halts.
(3) As described below, the Fund might be required to maintain assets as cover, maintain segregated accounts or make margin payments when it
takes positions in Financial Instruments involving obligations to third parties (
e.g.
, Financial Instruments other than purchased options). If the Fund were unable to close out its positions in such
13
Financial Instruments, it might be required to continue to maintain such assets or accounts or make such payments until the position expired or matured. These requirements might impair the
Funds ability to sell a portfolio security or make an investment when it would otherwise be favorable to do so or require that the Fund sell a portfolio security at a disadvantageous time. The Funds ability to close out a position in a
Financial Instrument prior to expiration or maturity depends on the existence of a liquid secondary market or, in the absence of such a market, the ability and willingness of the other party to the transaction (the counterparty) to enter
into a transaction closing out the position. Therefore, there is no assurance that any position can be closed out at a time and price that is favorable to the Fund.
(4) Losses may arise due to unanticipated market price movements, lack of a liquid secondary market for any particular instrument at a particular time or due to losses from premiums paid by the Fund on
options transactions.
Cover
.
Transactions using Financial Instruments, other than purchased options, expose the Fund to an
obligation to another party. The Fund will not enter into any such transactions unless it owns either (1) an offsetting (covered) position in securities or other options or futures contracts or (2) cash and liquid assets with a
value, marked-to-market daily, sufficient to cover its potential obligations to the extent not covered as provided in (1) above. The Fund will comply with SEC guidelines regarding cover for these instruments and will, if the guidelines so
require, set aside cash or liquid assets in an account with its custodian, the U.S. Bancorp Fund Services, LLC (USBFS), in the prescribed amount as determined daily.
Assets used as cover or held in an account cannot be sold while the position in the corresponding Financial Instrument is open, unless they are replaced with other appropriate assets. As a result, the
commitment of a large portion of the Funds assets to cover or accounts could impede portfolio management or the Funds ability to meet redemption requests or other current obligations.
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
®
(CBOE
®
), the 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 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 whom 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.
14
The Funds 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.
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 Funds 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 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 AMEX
®
Major Market Index or on a narrower index such as the Philadelphia Stock Exchange Over-the-Counter Index.
The Exchange 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 Rafferty 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 positions 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 times a specified multiple (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.
15
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 Funds 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 underlying 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.
Forward Contracts
. The Fund may enter into equity, equity index or interest rate forward contracts for purposes of attempting to gain
exposure to an index or group of securities without actually purchasing these securities, or to hedge a position. Forward contracts are two-party contracts pursuant to which one party agrees to pay the counterparty a fixed price for an agreed upon
amount of commodities, securities, or the cash value of the commodities, securities or the securities index, at an agreed upon date. Because they are two-party contracts and because they may have terms greater than seven days, forward contracts may
be considered to be illiquid for the Funds illiquid investment limitations. The Fund will not enter into any forward contract unless Rafferty 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 forward contract in the event of the default or bankruptcy of a counterparty. If such a default occurs, the Fund will have contractual remedies pursuant to the forward contract, but such remedies may be
subject to bankruptcy and insolvency laws which could affect the Funds rights as a creditor.
Futures Contracts and Options on
Futures Contracts
.
A futures contract obligates the seller to deliver (and the purchaser to take delivery of) the specified security on the expiration date of the contract. An index futures contract obligates the seller to deliver (and the
purchaser to take) an amount of cash equal to a specific dollar amount times the difference between the value of a specific index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery
of the underlying securities in the index is made.
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 Funds loss from an unhedged short position in futures contracts or from writing unhedged call options on futures contracts is potentially unlimited. The Fund only purchases and sells futures contracts and options on futures contracts
that are traded on a U.S. exchange or board of trade.
No price is paid upon entering into a futures contract. Instead, at the inception of a
futures contract the Fund is required to deposit initial margin in an amount generally equal to 10% or less of the contract value. Margin also must be deposited when writing a call or put option on a futures contract, in accordance with
applicable exchange rules. Unlike margin in securities transactions, initial margin does not represent a borrowing, but rather is in the nature of a performance bond or good-faith deposit that is returned to the Fund at the termination of the
transaction if all contractual obligations have been satisfied. Under certain circumstances, such as periods of high volatility, the Fund may be required by an exchange to increase the level of its initial margin payment, and initial margin
requirements might be increased generally in the future by regulatory action.
16
Subsequent variation margin payments are made to and from the futures commission merchant daily
as the value of the futures position varies, a process known as marking-to-market. Variation margin does not involve borrowing, but rather represents a daily settlement of the Funds obligations to or from a futures commission
merchant. When the Fund purchases an option on a futures contract, the premium paid plus transaction costs is all that is at risk. In contrast, when the Fund purchases or sells a futures contract or writes a call or put option thereon, it is subject
to daily variation margin calls that could be substantial in the event of adverse price movements. If the Fund has insufficient cash to meet daily variation margin requirements, it might need to sell securities at a time when such sales are
disadvantageous.
Purchasers and sellers of futures contracts and 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 futures and 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 a futures contract or an option on
a futures contract can vary from the previous days 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 a futures contract or 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 Futures Contracts and Options Thereon
.
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.
Risks Associated with Commodity Futures Contracts.
There are several additional risks
associated with transactions in commodity futures contracts.
Storage.
Unlike the financial futures markets, in the commodity
futures markets there are costs of physical storage associated with purchasing the underlying commodity. The price of the commodity futures contract will reflect the storage costs of purchasing the physical commodity, including the time value of
money invested in the physical commodity. To the extent that the storage costs for an underlying commodity change while the Fund is invested in futures contracts on that commodity, the value of the futures contract may change proportionately.
Reinvestment.
In the commodity futures markets, producers of the underlying commodity may decide to hedge the price risk of
selling the commodity by selling futures contracts today to lock in the price of the commodity at delivery tomorrow. In order to induce speculators to purchase the other side of the same futures contract, the commodity producer generally must sell
the futures contract at a lower price than the expected future spot price.
17
Conversely, if most hedgers in the futures market are purchasing futures contracts to hedge against a rise in prices, then speculators will only sell the other side of the futures contract at a
higher futures price than the expected future spot price of the commodity. The changing nature of the hedgers and speculators in the commodity markets will influence whether futures prices are above or below the expected future spot price, which can
have significant implications for the Fund. If the nature of hedgers and speculators in futures markets has shifted when it is time for the Fund to reinvest the proceeds of a maturing contract in a new futures contract, the Fund might reinvest at
higher or lower futures prices, or choose to pursue other investments.
Other Economic Factors.
The commodities which underlie
commodity futures contracts may be subject to additional economic and non-economic variables, such as drought, floods, weather, livestock disease, embargoes, tariffs, and international economic, political and regulatory developments. These factors
may have a larger impact on commodity prices and commodity-linked instruments, including futures contracts, than on traditional securities. Certain commodities are also subject to limited pricing flexibility because of supply and demand factors.
Others are subject to broad price fluctuations as a result of the volatility of the prices for certain raw materials and the instability of supplies of other materials. These additional variables may create additional investment risks which subject
the Funds investments to greater volatility than investments in traditional securities.
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.
Other Investment Companies
Open-End and Closed-End
Investment Companies
.
The Fund may invest in shares of open-end and closed-end investment companies in accordance with the investment restrictions in the 1940 Act. Shares of an ETF that has received exemptive relief from the SEC to permit
other funds to invest in the shares without these limitations are excluded from such restrictions to the extent that the Fund has complied with the requirements of such orders. The Fund, as a shareholder of another investment company, will bear its
pro-rata portion of the other investment companys advisory fee and other expenses, in addition to its own expenses and will be exposed to the investment risks associated with the other investment company. To the extent that the Fund invests in
open-end or closed-end investment companies that invest primarily in the securities of companies located outside the United States, see the risks related to foreign securities set forth above.
Exchange-Traded Products
.
The Fund may invest in ETFs, which are registered investment companies, partnerships or trusts that are bought
and sold on a securities exchange. The Fund may also invest in exchange-traded notes (ETN), which are structured debt securities. Additionally, the Fund may invest in swap agreements referencing ETFs. Whereas ETFs liabilities are
secured by their portfolio securities, ETNs liabilities are unsecured general obligations of the issuer. Most ETFs and ETNs are designed to track a particular market segment or index. ETFs and ETNs share expenses associated with their
operation, typically including, with respect to ETFs, advisory fees. When the Fund invests in an ETF or ETN, in addition to directly bearing expenses associated with its own operations, it will bear its pro rata portion of the ETFs or
ETNs expenses. The risks of owning an ETF or ETN generally reflect the risks of owning the underlying securities the ETF or ETN is designed to track, although lack of liquidity in an ETF or ETN could result in it being more volatile than the
underlying portfolio of securities. If the Fund invests in ETFs or swap agreements referencing ETFs, the underlying ETFs may not necessarily track the same index as the Fund. In addition, because of ETF or ETN expenses, compared to owning the
underlying securities directly, it may be more costly to own an ETF or ETN. The value of an ETN security should also be expected to fluctuate with the credit rating of the issuer.
18
Payment-In-Kind Securities and Strips
The Fund may invest in payment-in-kind securities and strips of any rating or maturity. Payment-in-kind securities allow the issuer, at its option, to
make current interest payments on the bonds either in cash or in bonds. Both zero-coupon securities and payment-in-kind securities allow an issuer to avoid the need to generate cash to meet current interest payments. Even though such securities do
not pay current interest in cash, the Fund nonetheless is required to accrue interest income on these investments and to distribute the interest income at least annually to shareholders.
The Fund may also invest in strips, which are debt securities whose interest coupons are taken out and traded separately after the securities are issued but otherwise are comparable to zero-coupon
securities. Like zero-coupon securities and payment-in-kind securities, strips are generally more sensitive to interest rate fluctuations than interest paying securities of comparable term and quality.
Repurchase Agreements
The Fund may enter into repurchase agreements with banks that are members of the Federal Reserve System or securities dealers who are members of a national securities exchange or are primary dealers in
U.S. government securities. Repurchase agreements generally are for a short period of time, usually less than a week. Under a repurchase agreement, the Fund purchases a U.S. government security and simultaneously agrees to sell the security back to
the seller at a mutually agreed-upon future price and date, normally one day or a few days later. The resale price is greater than the purchase price, reflecting an agreed-upon market interest rate during the Funds holding period. While the
maturities of the underlying securities in repurchase agreement transactions may be more than one year, the term of each repurchase agreement always will be less than one year. Repurchase agreements with a maturity of more than seven days are
considered to be illiquid investments. No Fund may enter into such a repurchase agreement if, as a result, more than 15% of the value of its net assets would then be invested in such repurchase agreements and other illiquid investments. See
Illiquid Investments and Restricted Securities above.
The Fund will always receive, as collateral, securities whose market value,
including accrued interest, at all times will be at least equal to 100% of the dollar amount invested by the Fund in each repurchase agreement. In the event of default or bankruptcy by the seller, the Fund will liquidate those securities (whose
market value, including accrued interest, must be at least 100% of the amount invested by the Fund) held under the applicable repurchase agreement, which securities constitute collateral for the sellers obligation to repurchase the security.
If the seller defaults, the Fund might incur a loss if the value of the collateral securing the repurchase agreement declines and might incur disposition costs in connection with liquidating the collateral. In addition, if bankruptcy or similar
proceedings are commenced with respect to the seller of the security, realization upon the collateral by the Fund may be delayed or limited.
Reverse Repurchase Agreements
The Fund may borrow by entering into reverse repurchase agreements with the same parties with whom it may enter into repurchase agreements. Under a reverse repurchase agreement, the Fund sells securities
and agrees to repurchase them at a mutually agreed to price. At the time the Fund enters into a reverse repurchase agreement, it will establish and maintain a segregated account with an approved custodian containing liquid high-grade securities,
marked-to-market daily, having a value not less than the repurchase price (including accrued interest). Reverse repurchase agreements involve the risk that the market value of securities retained in lieu of sale by the Fund may decline below the
price of the securities the Fund has sold but is obliged to repurchase. If the buyer of securities under a reverse repurchase agreement files for bankruptcy or becomes insolvent, such buyer or its trustee or receiver may receive an extension of time
to determine whether to enforce the Funds obligation to repurchase the securities. During that time, the Funds use of the proceeds of the reverse repurchase agreement effectively may be restricted. Reverse repurchase agreements create
leverage, a speculative factor, and are considered borrowings for the purpose of the Funds limitation on borrowing.
19
Short Sales
The Fund may engage in short sale transactions under which the Fund sells a security it does not own. To complete such a transaction, the Fund must borrow
the security to make delivery to the buyer. The Fund then is obligated to replace the security borrowed by purchasing the security at the market price at the time of replacement. The price at such time may be more or less than the price at which the
security was sold by the Fund. Until the security is replaced, the Fund is required to pay to the lender amounts equal to any dividends that accrue during the period of the loan. The proceeds of the short sale will be retained by the broker, to the
extent necessary to meet the margin requirements, until the short position is closed out.
Until the Fund closes its short position or
replaces the borrowed stock, the Fund will: (1) maintain an account containing cash or liquid assets at such a level that (a) the amount deposited in the account plus the amount deposited with the broker as collateral will equal the
current value of the stock sold short and (b) the amount deposited in the account plus the amount deposited with the broker as collateral will not be less than the market value of the stock at the time the stock was sold short; or
(2) otherwise cover the Funds short position.
Swap Agreements
The Fund may enter into swap agreements. Swap agreements are generally 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. Some swaps are, and more in the future will be, centrally cleared. Swaps that are centrally-cleared are subject to the creditworthiness of the clearing organizations involved in the transaction. For
example, an investor could lose margin payments it has deposited with the clearing organization as well as the net amount of gains not yet paid by the clearing organization if it breaches its agreement with the investor or becomes insolvent or goes
into bankruptcy. In the event of bankruptcy of the clearing organization, the investor may be entitled to the net amount of gains the investor is entitled to receive plus the return of margin owed to it only in proportion to the amount received by
the clearing organizations other customers, potentially resulting in losses to the investor.
Most swap agreements entered into by the
Fund calculate the obligations of the parties to the agreement on a net basis. Consequently, the Funds current obligations (or rights) under a swap agreement generally will be equal to the net amount to be paid or received under
the agreement based on the relative values of the positions held by each party to the agreement (the net amount). Payments may be made at the conclusion of a swap agreement or periodically during its term.
Swap agreements do not involve the delivery of securities or other underlying assets. Accordingly, if a swap is entered into on a net basis, if the other
party to a swap agreement defaults, the Funds risk of loss consists of the net amount of payments that such Fund is contractually entitled to receive, if any.
The net amount of the excess, if any, of the Funds obligations over its entitlements with respect to a swap agreement entered into on a net basis will be accrued daily and an amount of cash or
liquid asset having an aggregate NAV at least equal to the accrued excess will be maintained in an account with the Custodian that satisfies the 1940 Act. The Fund also will establish and maintain such accounts with respect to its total obligations
under any swaps that are not entered into on a net basis. Obligations under swap agreements so covered will not be construed to be senior securities for purposes of the Funds investment restriction concerning senior securities.
Because they are generally two-party contracts and because they may have terms of greater than seven days, swap agreements may be considered
to be illiquid for the Funds illiquid investment limitations. The Fund will not enter into any swap agreement unless Rafferty 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.
20
The Fund may enter into a swap agreement with respect to an equity market index in circumstances where
Rafferty believes that it may be more cost effective or practical than buying the securities represented by such index or a futures contract or an option on such index. 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 represented in
the index, 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.
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. In addition, as discussed above, some swaps currently are, and more in the future will be, centrally cleared, which affects how swaps are transacted. As a result, the swap
market has become relatively liquid in comparison with the markets for other similar instruments that are traded in the OTC market. Rafferty, under the supervision of the Board, is responsible for determining and monitoring the liquidity of Fund
transactions in swap agreements.
The use of equity swaps is a highly specialized activity that involves investment techniques and risks
different from those associated with ordinary portfolio securities transactions.
U.S. Government Sponsored
Enterprises (GSE)
GSE securities are securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities. Some obligations issued by GSEs and instrumentalities are supported by the full faith and credit of the U.S. Treasury; others by the right of the issuer to borrow from the U.S. Treasury; others by discretionary authority of the
U.S. government to purchase certain obligations of the agency or instrumentality; and others only by the credit of the agency or instrumentality. Those securities bear fixed, floating or variable rates of interest. Interest may fluctuate based on
generally recognized reference rates or the relationship of rates. While the U.S. government currently provides financial support to such GSEs or instrumentalities, no assurance can be given that it will always do so, since it is not so obligated by
law.
Certain U.S. government debt securities, such as securities of the Federal Home Loan Banks, are supported by the
right of the issuer to borrow from the U.S. Treasury. Others, such as securities issued by the Federal National Mortgage Association (Fannie Mae
®
) and the Federal Home Loan Mortgage Corporation (Freddie Mac
©
), are supported only by the credit of the corporation. In the case of securities not backed by the full faith and credit of the United States, the Fund must
look principally to the agency issuing or guaranteeing the obligation in the event the agency or instrumentality does not meet its commitments. The U.S. government may choose not to provide financial support to GSEs or instrumentalities if it is not
legally obligated to do so. The Fund will invest in securities of such instrumentalities only when Rafferty is satisfied that the credit risk with respect to any such instrumentality is comparatively minimal.
U.S. Government Securities
The Fund may invest in securities issued or guaranteed by the U.S. government or its agencies or instrumentalities (U.S. government securities) in pursuit of its investment objective, in order
to deposit such securities as initial or variation margin, as cover for the investment techniques it employs, as part of a cash reserve or for liquidity purposes.
U.S. government securities are high-quality instruments issued or guaranteed as to principal or interest by the U.S. Treasury or by an agency or instrumentality of the U.S. government. Not all U.S.
government securities are backed by the full faith and credit of the United States. Some are backed by the right of the issuer to borrow from the U.S. Treasury; others are backed by discretionary authority of the U.S. government to purchase the
agencies obligations; while others are supported only by the credit of the instrumentality. In the case of securities not backed by the full faith and credit of the United States, the investor must look principally to the agency issuing or
guaranteeing the obligation for ultimate repayment.
21
U.S. government securities include U.S. Treasury Bills (which mature within one year of the date they are
issued), U.S. Treasury Notes (which have maturities of one to ten years) and U.S. Treasury Bonds (which generally have maturities of more than 10 years). All such U.S. Treasury securities are backed by the full faith and credit of the United States.
U.S. government agencies and instrumentalities that issue or guarantee securities include the Federal Housing
Administration, Fannie Mae
®
, the Farmers Home Administration, the Export-Import Bank of the United States, the
Small Business Administration, the Government National Mortgage Association (Ginnie Mae
®
), the
General Services Administration, the Central Bank for Cooperatives, the Federal Home Loan Banks, Freddie Mac
©
,
the Farm Credit Banks, the Maritime Administration, the Tennessee Valley Authority, the Resolution Funding Corporation and the Student Loan Marketing Association (Sallie Mae
®
).
In September 2008, the
U.S. Treasury and the Federal Housing Finance Agency (FHFA) announced that Fannie Mae
®
and Freddie
Mac
®
had been placed in conservatorship. Since that time, Fannie Mae
®
and Freddie Mac
®
have received significant capital support through U.S. Treasury preferred stock purchases, as well as Treasury and Federal Reserve purchases of their mortgage backed
securities (MBS). The FHFA and the U.S. Treasury (through its agreement to purchase Freddie Mac
®
and
Fannie Mae
®
preferred stock) have imposed strict limits on the size of their mortgage portfolios. While the
mortgage-backed securities purchase programs ended in 2010, the U.S. Treasury continued its support for the entities capital as necessary to prevent a negative net worth through at least 2012. From the end of 2007 through the third quarter of
2012, Fannie Mae
®
and Freddie Mac
®
required U.S. Treasury support of approximately $187.5 billion through draws under the preferred stock purchase agreements. However, they have repaid approximately
$46 billion in dividends. Fannie Mae
®
and Freddie Mac
®
ended the third quarter of 2012 with positive net worth and, as a result, neither required a draw from the U.S. Treasury. (Freddie Mac
®
also has reported positive net worth as of the fourth quarter of 2012.) While the U.S. Treasury committed to offset
negative equity at Fannie Mae
®
and Freddie Mac
®
through its preferred stock purchases through 2012, FHFA has made projections for those purchases through 2015, predicting that cumulative U.S. Treasury draws
(including dividends) at the end of 2015 could range from $191 billion to $209 billion. Nonetheless, no assurance can be given that the Federal Reserve or the U.S. Treasury will ensure that Fannie
Mae
®
and Freddie Mac
®
remain successful in meeting their obligations with respect to the debt and mortgage-backed securities that they issue.
In addition, the problems faced by Fannie Mae
®
and Freddie Mac
®
, resulting
in their being placed into federal conservatorship and receiving significant U.S. Government support, have sparked serious debate among federal policy makers regarding the continued role of the U.S. Government in providing liquidity for mortgage
loans. The Obama Administration produced a report to Congress on February 11, 2011, outlining a proposal to wind down Fannie
Mae
®
and Freddie Mac
®
by increasing their guarantee fees, reducing their conforming loan limits (the maximum amount of each loan they are authorized to purchase), and continuing
progressive limits on the size of their investment portfolio. In December 2011, Congress enacted the Temporary Payroll Tax Cut Continuation Act (TCCA) of 2011 which, among other provisions, requires that Fannie Mae
®
and Freddie Mac
®
increase their single-family guaranty fees by at least 10 basis points and remit this increase to Treasury with respect to all loans acquired by Fannie Mae
®
or Freddie Mac
®
on or after April 1, 2012 and before January 1, 2022. Serious discussions among policymakers continue, however, as to whether Freddie Mac
®
and Fannie Mae
®
should be nationalized, privatized, restructured, or eliminated altogether. Fannie Mae
®
and Freddie Mac
®
also are the
subject of several continuing legal actions and investigations over certain accounting, disclosure or corporate governance matters, which (along with any resulting financial restatements) may continue to have an adverse effect on the guaranteeing
entities. Importantly, the future of Freddie Mac
®
and Fannie
Mae
®
is in serious question as the U.S. Government considers multiple options.
Yields on short-, intermediate- and long-term U.S. government securities are dependent on a variety of factors, including the general conditions of the
money and bond markets, the size of a particular offering and the maturity of the obligation. Debt securities with longer maturities tend to produce higher capital appreciation and depreciation than obligations with shorter maturities and lower
yields. The market value of U.S. government securities generally varies inversely with changes in the market interest rates. An increase in interest rates, therefore, generally would reduce the market value of the Funds portfolio investments
in U.S. government securities, while a decline in interest rates generally would increase the market value of the Funds portfolio investments in these securities.
When-Issued Securities
The Fund may enter into firm
commitment agreements for the purchase of securities on a specified future date. The Fund may purchase, for example, new issues of fixed-income instruments on a when-issued basis, whereby the payment obligation, or yield to maturity, or coupon rate
on the instruments may not be fixed at the time of transaction. The Fund will not purchase securities on a when-issued basis if, as a result, more than 15% of its net
22
assets would be so invested. If the Fund enters into a firm commitment agreement, liability for the purchase price and the rights and risks of ownership of the security accrue to the Fund at the
time it becomes obligated to purchase such security, although delivery and payment occur at a later date. Accordingly, if the market price of the security should decline, the effect of such an agreement would be to obligate the Fund to purchase the
security at a price above the current market price on the date of delivery and payment. During the time the Fund is obligated to purchase such a security, it will be required to segregate assets with an approved custodian in an amount sufficient to
settle the transaction.
Other Investment Risks and Practices
Borrowing
. The Fund may borrow money for investment purposes, which is a form of leveraging. Leveraging investments, by purchasing securities with
borrowed money, is a speculative technique that increases investment risk while increasing investment opportunity. Leverage will magnify changes in the Funds NAV and on the Funds investments. Although the principal of such borrowings
will be fixed, the Funds assets may change in value during the time the borrowing is outstanding. Leverage also creates interest expenses for the Fund. To the extent the income derived from securities purchased with borrowed funds exceeds the
interest the Fund will have to pay, that Funds net income will be greater than it would be if leverage were not used. Conversely, if the income from the assets obtained with borrowed funds is not sufficient to cover the cost of leveraging, the
net income of the Fund will be less than it would be if leverage were not used, and therefore the amount available for distribution to shareholders as dividends will be reduced. The use of derivatives in connection with leverage creates the
potential for significant loss.
The Fund may borrow money to facilitate management of the Funds portfolio by enabling the Fund to meet
redemption requests when the liquidation of portfolio instruments would be inconvenient or disadvantageous. Such borrowing is not for investment purposes and will be repaid by the borrowing Fund promptly.
As required by the 1940 Act, the Fund must maintain continuous asset coverage (total assets, including assets acquired with borrowed funds, less
liabilities exclusive of borrowings) of 300% of all amounts borrowed. If at any time the value of the required asset coverage declines as a result of market fluctuations or other reasons, the Fund may be required to sell some of its portfolio
investments within three days to reduce the amount of its borrowings and restore the 300% asset coverage, even though it may be disadvantageous from an investment standpoint to sell portfolio instruments at that time.
Lending Portfolio Securities.
The Fund may lend portfolio securities with a value not exceeding 33 1/3% of its total assets to brokers, dealers, and financial institutions. Borrowers
are required continuously to secure their obligations to return securities on loan from the Fund by depositing any combination of short-term government securities, shares of registered and unregistered money market funds and cash as collateral with
the Fund. The collateral must be equal to at least 100% of the market value of the loaned securities, which will be marked to market daily. The value of this collateral could decline, causing the Fund to experience a loss. While the Funds
portfolio securities are on loan, the Fund continues to receive interest on the securities loaned and simultaneously earns either interest on the investment of the collateral or fee income if the loan is otherwise collateralized. The Fund may invest
the interest received and the collateral, thereby earning additional income. Loans would be subject to termination by the lending Fund on a four-business days notice or by the borrower on a one-day notice. Borrowed securities must be returned when
the loan is terminated. Any gain or loss in the market price of the borrowed securities that occurs during the term of the loan inures to the lending Fund and that Funds shareholders. A lending Fund may pay reasonable finders, borrowers,
administrative and custodial fees in connection with a loan. The Fund could lose money from securities lending if, for example, it is delayed or prevented from selling the collateral after a loan is made, in recovering the securities loaned or if
the Fund incurs losses on the reinvestment of cash collateral. The Fund currently has no intention of lending its portfolio securities.
23
Portfolio Turnover
. The Trust anticipates that the Funds annual portfolio turnover will
vary. The Funds portfolio turnover rate is calculated by the value of the securities purchased or securities sold, excluding all securities whose maturities at the time of acquisition were one year or less, divided by the average monthly value
of such securities owned during the year. Based on this calculation, instruments with remaining maturities of less than one year are excluded from the portfolio turnover rate. Such instruments generally would include futures contracts and options,
since such contracts generally have a remaining maturity of less than one year. In any given period, all of the Funds investments may have a remaining maturity of less than one year; in that case, the portfolio turnover rate for that period
would be equal to zero. However, the Funds portfolio turnover rate calculated with all securities whose maturities were one year or less is anticipated to be unusually high.
High portfolio turnover involves correspondingly greater expenses to the Fund, including brokerage commissions or dealer mark-ups and other transaction costs on the sale of securities and reinvestments in
other securities. Such sales also may result in adverse tax consequences to the Funds shareholders resulting from its distributions of increased net capital gains, if any, recognized as a result of the sales. The trading costs and tax effects
associated with portfolio turnover may adversely affect the Funds performance.
Risk of Tracking Error
Several factors may affect the Funds ability to track the performance of its applicable index. Among these factors are:
(1) Fund expenses, including brokerage expenses and commissions (which may be increased by high portfolio turnover); (2) less than all of the securities in the target index being held by the Fund and securities not included in the target
index being held by the Fund; (3) an imperfect correlation between the performance of instruments held by the Fund, such as 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; and (6) the need to conform the Funds portfolio holdings to comply with that Funds investment restrictions
or policies, or regulatory or tax law requirements.
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 Funds short-term performance will reflect such deviation from its target index.
Potential Substantial After-Tax Tracking Error Risk
The Fund will be subject to taxation on its taxable income. The Funds NAV will also be reduced by the accrual of any deferred tax liabilities. The Index, however, is calculated without any
deductions for taxes. As a result, the Funds after tax performance could differ significantly from the Index, even if the pretax performance of the Fund and the performance of the Index are closely correlated. The performance of the Fund may
diverge from that of the Index.
INVESTMENT RESTRICTIONS
The Trust, on behalf of the Fund, has adopted the following investment policies which are fundamental policies that may not be changed without the
affirmative vote of a majority of the outstanding voting securities of the Fund, as defined by the 1940 Act. As defined by the 1940 Act, a vote of a majority of the outstanding voting securities of the Fund means the affirmative vote of
the lesser of (1) more than 50% of the outstanding shares of the Fund or (2) 67% or more of the shares present at a meeting, if more than 50% of the outstanding shares are represented at the meeting in person or by proxy.
The Funds investment objective is a non-fundamental policy of the Fund. Non-fundamental policies may be changed by the Board without shareholder
approval.
For purposes of the following limitations, all percentage limitations apply immediately after a purchase or initial investment.
Except with respect to borrowing money, if a percentage limitation is adhered to at the time of the investment, a later increase or decrease in the percentage resulting from any change in value or net assets will not result in a violation of such
restrictions. If at any time the Funds borrowings exceed its limitations due to a decline in net assets, such borrowings will be reduced promptly to the extent necessary to comply with the limitation.
24
The Fund may not:
1.
|
Borrow money, except to the extent permitted by the 1940 Act, the rules and regulations thereunder and any applicable exemptive relief.
|
2.
|
Issue senior securities, except to the extent permitted by the 1940 Act, the rules and regulations thereunder and any applicable exemptive relief.
|
3.
|
Make loans, except to the extent permitted by the 1940 Act, the rules and regulations thereunder and any applicable exemptive relief.
|
4.
|
Purchase the securities of any issuer (other than securities issued or guaranteed by the U.S. Government or any of its agencies or instrumentalities) if, as a result,
25% or more of the Funds total assets would be invested in the securities of companies whose principal business activities are in the same industry. However, the Fund, which tracks an underlying index, will only concentrate its investment in a
particular industry or group of industries to approximately the same extent that its underlying index is so concentrated.
|
5.
|
Purchase or sell real estate, except that, to the extent permitted by applicable law, the Fund may (a) invest in securities or other instruments directly secured
by real estate, and (b) invest in securities or other instruments issued by issuers that invest in real estate.
|
6.
|
Purchase or sell commodities or commodity contracts unless acquired as a result of ownership of securities or other instruments issued by persons that purchase or sell
commodities or commodities contracts; but this shall not prevent the Fund from purchasing, selling and entering into financial futures contracts (including futures contracts on indices of securities, interest rates and currencies), and options on
financial futures contracts (including futures contracts on indices of securities, interest rates and currencies), warrants, swaps, forward contracts, foreign currency spot and forward contracts and other financial instruments.
|
7.
|
Underwrite securities issued by others, except to the extent that the Fund may be considered an underwriter within the meaning of the 1933 Act in the disposition of
restricted securities or other investment company securities.
|
PORTFOLIO
TRANSACTIONS AND BROKERAGE
Subject to the general supervision by the Trustees, Rafferty is responsible for decisions to buy and sell
securities for the Fund, the selection of broker-dealers to effect the transactions, and the negotiation of brokerage commissions, if any. Rafferty expects that the Fund may execute brokerage or other agency transactions through registered
broker-dealers, for a commission, in conformity with the 1940 Act, the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder.
When selecting a broker or dealer to execute portfolio transactions, Rafferty considers many factors, including the rate of commission or the size of the broker-dealers spread, the size
and difficulty of the order, the nature of the market for the security, operational capabilities of the broker-dealer and the research, statistical and economic data furnished by the broker-dealer to Rafferty.
In effecting portfolio transactions for the Fund, Rafferty seeks to receive the closing prices of securities that are in line with those of the
securities included in the applicable index and seeks to execute trades of such securities at the lowest commission rate reasonably available. With respect to agency transactions, Rafferty may execute trades at a higher rate of commission if
reasonable in relation to brokerage and research services provided to the Fund or Rafferty. Such services may include the following: information as to the availability of securities for purchase or sale; statistical or factual information or
opinions pertaining to investment; wire services; and appraisals or evaluations of portfolio securities. The Fund believes that the requirement always to seek the lowest possible
25
commission cost could impede effective portfolio management and preclude the Fund and Rafferty from obtaining a high quality of brokerage and research services. In seeking to determine the
reasonableness of brokerage commissions paid in any transaction, Rafferty relies 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.
Rafferty may use research and services provided to it by brokers in servicing all series
of the Trust; however, not all such services may be used by Rafferty in connection with the Fund. While the receipt of such information and services is useful in varying degrees and generally would reduce the amount of research or services otherwise
performed by Rafferty, this information and these services are of indeterminable value and would not reduce Raffertys investment advisory fee to be paid by the Fund.
Purchases and sales of U.S. government securities normally are transacted through issuers, underwriters or major dealers in U.S. government securities acting as principals. Such transactions are made on a
net basis and do not involve payment of brokerage commissions. The cost of securities purchased from an underwriter usually includes a commission paid by the issuer to the underwriters; transactions with dealers normally reflect the spread between
bid and asked prices.
No brokerage commissions are provided for the Fund because it had not commenced operations prior to the date of this
SAI.
PORTFOLIO HOLDINGS INFORMATION
Disclosure of the Funds complete holdings is required to be made quarterly within 60 days of the end of each fiscal quarter in the Annual Report
and Semi-Annual Report to Fund shareholders and in the quarterly holdings report on Form N-Q. These reports are available, free of charge, on the EDGAR database on the SECs website at www.sec.gov. In addition, the Funds portfolio
holdings will be made available on the Funds website at www.direxionfunds.com each day the Fund is open for business.
The portfolio
composition file (PCF) and the IIV, which contain portfolio holdings information, is made available daily, including to the Funds service providers to facilitate the provision of services to the Fund and to certain other entities
as necessary for transactions in Creation Units. Such entities may be limited to National Securities Clearing Corporation (NSCC) members, subscribers to various fee-based services, investors that have entered into an authorized
participant agreement with the Distributor and the transfer agent or purchase Creation Units through a dealer that has entered into such an agreement (Authorized Participants), and other institutional market participants that provide
information services. Each business day, Fund portfolio holdings information will be provided to the Distributor or other agent for dissemination through the facilities of the NSCC and/or through other fee-based services to NSCC members and/or
subscribers to the fee-based 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 Fund in the
secondary market.
Daily access to the PCF file and IIV is permitted to: (i) certain personnel of service providers that are involved in
portfolio management and providing administrative, operational, or other support to portfolio management; (ii) Authorized Participants through NSCC, and (iii) other personnel of the Adviser and the Funds distributor, administrator,
custodian and fund accountant who are involved in functions which may require such information to conduct business in the ordinary course.
From time to time, rating and ranking organizations such as Standard & Poors
®
and Morningstar
®
, Inc. may
request complete portfolio holdings information in connection with rating the Fund. To prevent such parties from potentially misusing the complete portfolio holdings information, the Fund will generally only disclose such information no earlier than
one business day following the date of the information. Portfolio holdings information made available in connection with the creation/redemption process may be provided to other entities that provide additional services to the Fund in the ordinary
course of business after it has been disseminated to the NSCC.
26
In addition, the Funds President may grant exceptions to permit additional disclosure of the complete
portfolio holdings information at differing times and with differing lag times to rating agencies and to the parties noted above, provided that (1) the Fund has a legitimate business purpose for doing so; (2) it is in the best interests of
shareholders; (3) the recipient is subject to a confidentiality agreement; and (4) the recipient is subject to a duty not to trade on the nonpublic information. The Chief Compliance Officer shall report any disclosures made pursuant to
this exception to the Board.
MANAGEMENT OF THE TRUST
The Board of Trustees
The Trust is governed by its Board. The Board is responsible for and oversees the overall management and operations of the Trust and the Fund, which includes the general oversight and review of the
Funds investment activities, in accordance with federal law and the law of the State of Delaware, as well as the stated policies of the Fund. The Board oversees the Trusts officers and service providers, including Rafferty, which is
responsible for the management of the day-to-day operations of the Fund based on policies and agreements reviewed and approved by the Board. In carrying out these responsibilities, the Board regularly interacts with and receives reports from senior
personnel of service providers, including personnel from Rafferty, USBFS, Alaric Compliance Services, LLC (Alaric) and the Trusts Chief Compliance Officer (CCO). The Board also is assisted by the Trusts
independent auditor (who reports directly to the Trusts Audit Committee), independent counsel and other professionals as appropriate.
Risk Oversight
Consistent with its responsibility for oversight of the Trust and the Fund, the Board oversees the management of risks relating to the administration and operation of the Trust and the Fund. Rafferty, as
part of its responsibilities for the day-to-day operations of the Fund, is responsible for day-to-day risk management for the Fund. The Board, in the exercise of its reasonable business judgment performs its risk management oversight directly and,
as to certain matters, through its committees (described below) and through the Independent Trustees. The following provides an overview of the principal, but not all, aspects of the Boards oversight of risk management for the Trust and the
Fund.
The Board has adopted, and periodically reviews, policies and procedures designed to address risks to the Trust and the Fund. In
addition, under the general oversight of the Board, Rafferty and other service providers to the Fund have themselves adopted a variety of policies, procedures and controls designed to address particular risks to the Fund. Different processes,
procedures and controls are employed with respect to different types of risks.
The Board also oversees risk management for the Trust and the
Fund through review of regular reports, presentations and other information from officers of the Trust and other persons. The CCO and senior officers of Rafferty, and USBFS regularly report to the Board on a range of matters, including those
relating to risk management. The Board also regularly receives reports from Rafferty and USBFS with respect to the Funds investments. In addition to regular reports from these parties, the Board also receives reports regarding other service
providers to the Trust, either directly or through Rafferty, USBFS, Alaric or the CCO, on a periodic or regular basis. At least annually, the Board receives a report from the CCO regarding the effectiveness of the Funds compliance program.
Also, on an annual basis, the Board receives reports, presentations and other information from Rafferty in connection with the Boards consideration of the renewal of each of the Trusts agreements with Rafferty and the Trusts
distribution plan under Rule 12b-1 under the 1940 Act.
The CCO reports regularly to the Board on Fund valuation matters. The Audit Committee
receives regular reports from the Trusts independent registered public accounting firm on internal control and financial reporting matters. On at least a quarterly basis, the Independent Trustees meet with the CCO to discuss matters relating
to the Funds compliance program.
27
Board Structure and Related Matters
Board members who are not interested persons of the Fund as defined in Section 2(a)(19) of the 1940 Act (Independent
Trustees) constitute two-thirds of the Board. The Trustees discharge their responsibilities collectively as a Board, as well as through Board committees, each of which operates pursuant to a charter approved by the Board that delineates the
specific responsibilities of that committee. The Board has established three standing committees: the Audit Committee, the Nominating Committee and the Qualified Legal Compliance Committee. For example, the Audit Committee is responsible for
specific matters related to oversight of the Funds independent auditors, subject to approval of the Audit Committees recommendations by the Board. The members and responsibilities of each Board committee are summarized below.
The Board periodically evaluates its structure and composition as well as various aspects of its operations. The Chairman of the Board is not an
Independent Trustee and the Board has chosen not to have a lead Independent Trustee. However, the Board believes that its leadership structure, including its Independent Trustees and Board committees, is appropriate for the Trust in light of, among
other factors, the asset size and nature of the Fund, the number of series of the Trust overseen by the Board, the arrangements for the conduct of the Funds operations, the number of Trustees, and the Boards responsibilities. On an
annual basis, the Board conducts a self-evaluation that considers, among other matters, whether the Board and its committees are functioning effectively and whether, given the size and composition of the Board and each of its committees, the
Trustees are able to oversee effectively the number of portfolios in the complex.
The Trust is part of the Direxion Family of Investment
Companies, which is comprised of the 125 portfolios within the Trust, 18 portfolios within the Direxion Funds and 1 portfolio within Direxion Insurance Trust. The Independent Trustees constitute two-thirds of the Board of Trustees of Trust.
The Board holds four regularly scheduled in-person meetings each year. The Board may hold special meetings, as needed, either in person or by
telephone, to address matters arising between regular meetings. During a portion of each in-person meeting, the Independent Trustees meet outside of managements presence. The Independent Trustees may hold special meetings, as needed, either in
person or by telephone.
The Trustees of the Trust are identified in the tables below, which provide information regarding their age, business
address and principal occupation during the past five years including any affiliation with Rafferty, the length of service to the Trust, and the position, if any, that they hold on the board of directors of companies other than the Trust as of
December 31, 2012. Each of the non-interested Trustees of the Trust also serve on the Board of the Direxion Funds and Direxion Insurance Trust, the other registered investment companies in the Direxion mutual fund complex. Unless otherwise
noted, an individuals business address is 1301 Avenue of the Americas (6th Avenue), 35th Floor, New York, New York 10019.
Interested Trustees
|
|
|
|
|
|
|
|
|
|
|
Name, Address and Age
|
|
Position(s) Held with
Fund
|
|
Term of Office and
Length of Time Served
|
|
Principal Occupation(s)
During Past Five Years
|
|
# of
Portfolios in
Direxion
Family of
Investment
Companies
Overseen by
Trustee
(2)
|
|
Other Trusteeships/
Directorships
Held by Trustee
During Past Five
Years
|
Daniel D. ONeill
(1)
Age:
45
|
|
Chairman of the Board of Trustees
|
|
Lifetime of Trust until removal or resignation; Since 2008
|
|
Managing Director of
Rafferty, 1999-present.
|
|
125
|
|
None.
|
28
Non-Interested Trustees
|
|
|
|
|
|
|
|
|
|
|
Name, Address and Age
|
|
Position(s) Held with
Fund
|
|
Term of Office and
Length of Time
Served
|
|
Principal Occupation(s)
During Past Five Years
|
|
# of
Portfolios in
Direxion
Family of
Investment
Companies
Overseen by
Trustee
(2)
|
|
Other Trusteeships/
Directorships
Held by Trustee
During Past Five Years
|
Gerald E. Shanley III
Age: 70
|
|
Trustee
|
|
Lifetime of Trust until removal or resignation; Since 2008
|
|
Retired, Since 2002;
Business Consultant,
1985-present; Trustee of
Trust Under Will of
Charles S.
Payson,
1987-present; C.P.A.,
1979-present.
|
|
144
|
|
None.
|
John Weisser
Age: 71
|
|
Trustee
|
|
Lifetime of Trust until removal or resignation; Since 2008
|
|
Retired, Since 1995;
Salomon Brothers, Inc,
1971-1995, most
recently as Managing
Director.
|
|
144
|
|
Director, Eclipse
Funds, Inc.
(2 Funds); Director,
The MainStay
Funds Trust
(28 Funds), The
MainStay Funds
(12
Funds),
MainStay VP Fund
Series (28 Funds);
Mainstay Defined
Term Municipal
Opportunities Fund
(1 Fund); Private
Advisers
Alternative
Strategy Fund
(1 Fund).
|
(1)
|
Mr. ONeill is affiliated with Rafferty. Mr. ONeill is the Managing Director of Rafferty and owns a beneficial interest in
Rafferty.
|
(2)
|
The Direxion Family of Investment Companies consists of the Direxion Funds which, as of the date of this SAI, offers for sale to the public 18
portfolios, the Direxion Insurance Trust which, as of the date of this SAI, offers for sale 1 portfolio and the Direxion Shares ETF Trust which, as of the date of this SAI, offers for sale to the public 50 of the 125 funds registered with the SEC.
|
In addition to the information set forth in the tables above and other relevant qualifications, experience, attributes or
skills applicable to a particular Trustee, the following provides further information about the qualifications and experience of each Trustee.
Daniel D. ONeill: Mr. ONeill has extensive experience in the investment management business, including as managing director of Rafferty.
Gerald E. Shanley III: Mr. Shanley has audit experience and spent ten years in the tax practice of an international public accounting
firm. He is a certified public accountant and has a JD degree. He has extensive business experience as the president of a closely held manufacturing company, a director of several closely held companies, a business and tax consultant and a trustee
of a private investment trust. He has served on the boards of several charitable and not for profit organizations. He also has multiple years of service as a Trustee.
29
John Weisser: Mr. Weisser has extensive experience in the investment management business, including as
managing director of an investment bank and a director of other registered investment companies. He also has multiple years of service as a Trustee.
Board Committees
The Trust has an Audit Committee,
consisting of Messrs. Weisser and Shanley. The members of the Audit Committee are not interested persons of the Trust (as defined in the 1940 Act). The primary responsibilities of the Trusts Audit Committee are, as set forth in its
charter, to make recommendations to the Board Members as to: the engagement or discharge of the Trusts independent registered public accounting firm (including the audit fees charged by the accounting firm); the supervision of investigations
into matters relating to audit matters; the review with the independent registered public accounting firm of the results of audits; and addressing any other matters regarding audits. The Audit Committee met two times during the Trusts most
recent fiscal year.
The Trust also has a Nominating Committee, consisting of Messrs. Weisser and Shanley, each of whom is a disinterested
member of the Board. The primary responsibilities of the nominating committee are to make recommendations to the Board on issues related to the composition and operation of the Board, and communicate with management on those issues. The Nominating
Committee also evaluates and nominates Board member candidates. The Nominating Committee will consider nominees recommended by shareholders. Such recommendations should be in writing and addressed to the Fund with attention to the Nominating
Committee Chair. The recommendations must include the following Preliminary Information regarding the nominee: (1) name; (2) date of birth; (3) education; (4) business professional or other relevant experience and areas of
expertise; (5) current business and home addresses and contact information; (6) other board positions or prior experience; and (7) any knowledge and experience relating to investment companies and investment company governance. The
Nominating Committee did not meet during the Trusts most recent fiscal year.
The Trust has a Qualified Legal Compliance Committee,
consisting of Messrs. Weisser and Shanley. The members of the Qualified Legal Compliance Committee are not interested persons of the Trust (as defined in the 1940 Act). The primary responsibility of the Trusts Qualified Legal
Compliance Committee is to receive, review and take appropriate action with respect to any report (Report) made or referred to the Committee by an attorney of evidence of a material violation of applicable U.S. federal or state
securities law, material breach of a fiduciary duty under U.S. federal or state law or a similar material violation by the Trust or by any officer, director, employee or agent of the Trust. The Qualified Legal Compliance Committee did not meet
during the Trusts most recent fiscal year.
Principal Officers of the Trust
The officers of the Trust conduct and supervise its daily business. Unless otherwise noted, an individuals business address is 1301 Avenue of the
Americas (6th Avenue), 35th Floor, New York, New York 10019. As of the date of this SAI, the officers of the Trust, their ages, their business address and their principal occupations during the past five years are as follows:
30
|
|
|
|
|
|
|
|
|
|
|
Name, Address and Age
|
|
Position(s) Held with Fund
|
|
Term of
Office and
Length
of
Time
Served
(1)
|
|
Principal Occupation(s)
During Past Five Years
|
|
# of
Portfolios in
Direxion
Family of
Investment
Companies
Overseen by
Trustee
(2)
|
|
Other
Trusteeships/
Directorships Held
by Trustee During
Past Five Years
|
Daniel D. ONeill
Age: 45
|
|
Chief Executive Officer
and Chief Investment
Officer
|
|
One Year;
Since 2008
|
|
Managing Director of
Rafferty, 1999-present.
|
|
125
|
|
N/A
|
|
|
Chairman of the Board
of Trustees
|
|
Lifetime of
Trust until
removal or
resignation;
Since 2008
|
|
|
|
|
|
|
Eric Falkeis:
Age: 40
|
|
President
|
|
One Year;
Since 2013
|
|
President, Rafferty Asset
Management, LLC,
since March 2013;
formerly, Senior Vice
President, U.S. Bancorp
Fund Services, LLC
(USBFS),
September
2007 March 2013;
Chief Financial Officer,
USBFS, April 2006
March 2013; Vice
President, USBFS,
(1997-2007); formerly,
Chief Financial Officer,
Quasar Distributors,
LLC (2000-2003).
|
|
N/A
|
|
Trustee,
Professionally
Managed
Portfolios (35
Funds)
|
Patrick J. Rudnick
Age: 40
|
|
Principal Financial
Officer and Assistant
Secretary
|
|
One Year;
Since 2010
|
|
Senior Vice President
and Principal Financial
Officer, Rafferty Asset
Management, LLC,
since March 2013;
formerly, Vice
President, USBFS,
(2006 2013);
formerly,
Manager,
PricewaterhouseCoopers
LLP (1999-2006).
|
|
N/A
|
|
N/A
|
31
|
|
|
|
|
|
|
|
|
|
|
Name, Address and Age
|
|
Position(s) Held with Fund
|
|
Term of
Office and
Length
of
Time
Served
(1)
|
|
Principal Occupation(s)
During Past Five Years
|
|
# of
Portfolios in
Direxion
Family of
Investment
Companies
Overseen by
Trustee
(2)
|
|
Other
Trusteeships/
Directorships Held
by Trustee During
Past Five Years
|
Angela Brickl
Age: 37
|
|
Chief Compliance Officer
|
|
One Year;
Since 2012
|
|
General Counsel and
Chief Compliance
Officer, Rafferty Asset
|
|
N/A
|
|
N/A
|
|
|
Secretary
|
|
One Year;
Since 2011
|
|
Management, LLC,
since October 2010;
Summer Associate at
Skadden, Arps, Slate,
Meagher & Flom,
LLP, May August
2009; Summer
Associate at Foley
&
Lardner, LLP May
August 2008; Vice
President, USBFS
November 2003
August 2007.
|
|
|
|
|
(1)
|
Each officer of the Trust holds office until his or her successor is elected and qualified or until his or her earlier death, inability to serve,
removal or resignation.
|
(2)
|
The Direxion Family of Investment Companies consists of the Direxion Funds which, as of the date of this SAI, offers for sale to the public 18
portfolios, the Direxion Insurance Trust which, as of the date of this SAI, offers for sale 1 portfolio and the Direxion Shares ETF Trust which, as of the date of this SAI, offers for sale to the public 50 of the 125 funds registered with the SEC.
|
As of the calendar year ended December 31, 2012, no Trustee owns Shares of the Fund. The following table shows the
amount of equity securities owned in the Direxion Family of Investment Companies by the Trustees as of the calendar year ended December 31, 2012:
|
|
|
|
|
|
|
Dollar Range of Equity Securities Owned:
|
|
Interested
Trustee:
|
|
Non-Interested Trustees:
|
|
|
Daniel D.
ONeill
|
|
Gerald E.
Shanley III
|
|
John Weisser
|
Aggregate Dollar Range of Equity Securities in the Direxion Family of Investment Companies
(1)
|
|
$50,001 -
$100,000
|
|
$0
|
|
$50,001 -
$100,000
|
(1)
|
The Direxion Family of Investment Companies consists of: (1) the Direxion Shares ETF Trust, which, as of the date of this SAI, offers
for sale to the public 50 of the 125 funds registered with the SEC; (2) Direxion Funds, which, as of the date of this SAI, offers for sale to the public 18 funds; and (3) the Direxion Insurance Trust, which, as of the date of this SAI,
offers for sale to the public 1 fund.
|
The Trusts Trust Instrument provides that the Trustees will not be liable for
errors of judgment or mistakes of fact or law. However, they are not protected against any liability to which they would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved
in the conduct of their office.
No officer, director or employee of Rafferty receives any compensation from the Fund for acting as a Trustee
or officer of the Trust.
32
The following table shows the compensation earned by each Trustee for the Trusts fiscal year ended
October 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Person, Position
|
|
Aggregate
Compensation
From the
Funds
|
|
|
Pension or
Retirement
Benefits
Accrued
As Part of
the
Trusts
Expenses
|
|
|
Estimated
Annual
Benefits
Upon
Retirement
|
|
|
Aggregate
Compensation
From the
Direxion
Family of
Investment
Companies
Paid to
the
Trustees
|
|
Interested Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daniel D. ONeill
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
Disinterested Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gerald E. Shanley III
|
|
$
|
75,000
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
100,000
|
|
John Weisser
|
|
$
|
75,000
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
100,000
|
|
Principal Shareholders, Control Persons and Management Ownership
A principal shareholder is any person who owns of record or beneficially 5% or more of the outstanding shares of the 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.
Because the Fund had not commenced operations prior to the date of this SAI, the
Fund did not have control persons or principal shareholders and the Trustees and officers did not own shares of the Fund.
Investment Adviser
Rafferty Asset Management, LLC, 1301 Avenue of the Americas (6th Avenue), 35th Floor, New York, New York 10019,
provides investment advice to the Fund. Rafferty was organized as a New York limited liability company in June 1997. Lawrence C. Rafferty controls Rafferty through his ownership in Rafferty Holdings, LLC.
Under an Investment Advisory Agreement (Advisory Agreement) between the Trust, on behalf of the Fund, and Rafferty dated August 13,
2008, Rafferty provides a continuous investment program for the Funds assets in accordance with its investment objectives, policies and limitations, and oversees the day-to-day operations of the Fund, subject to the supervision of the
Trustees. Rafferty bears all costs associated with providing these advisory services and the expenses of the Trustees who are affiliated with or interested persons of Rafferty. The Trust bears all other expenses that are not assumed by Rafferty as
described in the Prospectus. The Trust also is liable for nonrecurring expenses as may arise, including litigation to which the Fund may be a party. The Trust also may have an obligation to indemnify its Trustees and officers with respect to any
such litigation.
The Advisory Agreement was initially approved by the Trustees (including all non-interested Trustees) and Rafferty, as sole
shareholder of the Fund in compliance with the 1940 Act on June 18, 2013. The Advisory Agreement with respect to the Fund will continue in force for an initial period of two years after the date of its approval. Thereafter,
33
the Advisory Agreement will be renewable from year to year with respect to the Fund, so long as its continuance is approved at least annually (1) by the vote, cast in person at a meeting
called for that purpose, of a majority of those Trustees who are not interested persons of Rafferty or the Trust; and (2) by the majority vote of either the full Board or the vote of a majority of the outstanding shares of the Fund.
The Advisory Agreement automatically terminates on assignment and is terminable on a 60-day written notice either by the Trust or Rafferty.
Pursuant to the Advisory Agreement, the Fund pays Rafferty 0.60% at an annual rate based on their average daily net assets.
No advisory fees are provided for the Fund because it had not commenced operations prior to the date of this SAI.
The Fund is responsible for its own operating expenses. Rafferty has entered into an Operating Expense Limitation Agreement with the Fund. Under this
Operating Expense Limitation Agreement, Rafferty has contractually agreed to cap all or a portion of its management fee and/or reimburse the Funds operating expenses (excluding, as applicable, among other expenses, taxes, leverage interest,
dividends or interest on short positions, other interest expenses, brokerage commissions, expenses incurred in connection with any merger or reorganization and extraordinary expenses such as litigation) through September 1, 2015, to the extent that
they exceed 0.65% of the daily net assets of the Fund. Any expense cap is subject to reimbursement by the Fund only within the following three years only if overall expenses fall below these percentage limitations. This agreement may be terminated
at any time at the discretion of the Board upon notice to the Adviser and without the approval of Fund shareholders. The agreement may be terminated by the Adviser only with the consent of the Board.
Rafferty shall not be liable to the Trust or any shareholder for anything done or omitted by it, except acts or omissions involving willful misfeasance,
bad faith, negligence or reckless disregard of the duties imposed upon it by its agreement with the Trust or for any losses that may be sustained in the purchase, holding or sale of any security.
Pursuant to Section 17(j) of the 1940 Act and Rule 17j-1 thereunder, the Trust and Rafferty have adopted Codes of Ethics. These codes permit
portfolio managers and other access persons of the Fund to invest in securities that may be owned by the Fund, subject to certain restrictions.
Portfolio Managers
An investment team of Rafferty employees has the day-to-day responsibility for managing the Fund. The investment team generally decides the target allocation of the Funds investments and on a
day-to-day basis, an individual portfolio manager executes transactions for the Fund consistent with the target allocation. The portfolio managers rotate among the portfolios in the Trust periodically so that no single portfolio manager is
responsible for a specific Fund for extended periods of time. Paul Brigandi, the Funds Portfolio Manager, is primarily responsible for the day-to-day management of the Fund.
In addition to the Fund, each member of the investment team manages the following other accounts as of July 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
|
|
Total Number
of Accounts
|
|
|
Total Assets
|
|
|
Total Number of
Accounts with
Performance
Based Fees
|
|
|
Total Assets of
Accounts with
Performance
Based Fees
|
|
Registered Investment Companies
|
|
|
77
|
|
|
$
|
7.32 billion
|
|
|
|
0
|
|
|
$
|
0
|
|
Other Pooled Investment Vehicles
|
|
|
0
|
|
|
$
|
0
|
|
|
|
0
|
|
|
$
|
0
|
|
Other Accounts
|
|
|
1
|
|
|
$
|
50 million
|
|
|
|
0
|
|
|
$
|
0
|
|
Rafferty manages other accounts with investment objectives similar to that of the Fund. In addition, two or more funds
advised by Rafferty may invest in the same securities but the nature of each investment (long or short) may be opposite and in different proportions. Rafferty ordinarily executes transactions for the Fund market-on-close, in which funds
purchasing or selling the same security receive the same closing price.
34
Rafferty has not identified any additional material conflicts between the Fund and other accounts managed by
the investment team. However, the portfolio managers management of other accounts may give rise to potential conflicts of interest in connection with their management of the Funds investments, on the one hand, and the
investments of other accounts, on the other. The other accounts may have the same investment objective as the Fund. Therefore, a potential conflict of interest may arise as a result of the identical investment objectives, whereby the portfolio
managers could favor one account over and devote unequal time and attention to the Fund and other accounts. Another potential conflict could include the portfolio managers knowledge about size, timing and possible market impact of Fund trades,
whereby a portfolio manager could use this information to the advantage of other accounts and to the disadvantage of the Fund. This could create potential conflicts of interest resulting in the Fund paying higher fees or one investment vehicle out
performing another. The Adviser has established policies ad procedures to ensure that the purchase and sale of securities among all accounts it manages are fairly and equitably allocated.
The investment teams compensation is paid by Rafferty. Their compensation primarily consists of a fixed base salary and a bonus. The investment teams salary is reviewed annually and increases
are determined by factors such as performance and seniority. Bonuses are determined by the individual performance of an employee including factors such as attention to detail, process, and efficiency, and are impacted by the overall performance of
the firm. The investment teams salary and bonus are not based on the Funds performance and as a result, no benchmarks are used. Along with all other employees of Rafferty, the investment team may participate in the firms 401(k)
retirement plan where Rafferty may make matching contributions up to a defined percentage of their salary.
The members of the investment team
do not own any shares of the Fund as of October 31, 2012.
Pr
oxy Voting Policies and Procedures
The Board has adopted proxy voting policies and procedures (Proxy Policies) wherein the Trust has delegated to Rafferty
the responsibility for voting proxies relating to portfolio securities held by the Fund as part of their investment advisory services, subject to the supervision and oversight of the Board. The Proxy Voting Policies of Rafferty are attached as
Appendix B. Notwithstanding this delegation of responsibilities, however, the Fund retains the right to vote proxies relating to its portfolio securities. The fundamental purpose of the Proxy Policies is to ensure that each vote will be in a manner
that reflects the best interest of the Fund and their shareholders, taking into account the value of the Funds investments.
More
Information.
The actual voting records relating to portfolio securities for future 12-month periods ending June 30 will be available without charge, upon request by calling toll-free, 1-866-476-7523 or by accessing the SECs
website at www.sec.gov.
Fund Administrator, Fund Accounting Agent, Transfer Agent and Custodian
U.S. Bancorp Fund Services, LLC, 615 East Michigan Street, Milwaukee, Wisconsin 53202, serves as the Funds administrator and
transfer agent. U.S. Bank, N.A. serves as the Funds custodian. Rafferty also performs certain administrative services for the Fund.
Pursuant to a Fund Administration and Servicing Agreement between the Trust and USBFS, USBFS provides the Trust with administrative and management
services (other than investment advisory services). As compensation for these services, the Trust pays USBFS a fee based on the Trusts total average daily net assets. USBFS also is entitled to certain out-of-pocket expenses.
Pursuant to an Accounting Agreement between the Trust and USBFS, USBFS provides the Trust with accounting services, including portfolio accounting
services, tax accounting services and furnishing financial reports. As compensation for these accounting services, the Trust pays USBFS a fee based on the Trusts total average daily net assets. USBFS also is entitled to certain out-of-pocket
expenses for the services mentioned above, including pricing expenses.
35
Pursuant to a Custodian Agreement, U.S. Bank, N.A. serves as the custodian of the Funds assets. The
custodian holds and administers the assets in the Funds portfolio. Pursuant to the Custodian Agreement, the custodian receives an annual fee based on the Trusts total average daily net assets and certain settlement charges. The custodian
also is entitled to certain out-of-pocket expenses.
No administration and management fees, accounting services fees or custodian fees are
shown for the Fund because it had not commenced operations prior to the date of this SAI.
Distributor
Foreside Fund Services, LLC, located at 3 Canal Plaza, Suite 100, Portland, Maine 04101, serves as the distributor
(Distributor) in connection with the continuous offering of the Funds shares. The Distributor is a broker-dealer registered with the SEC under the Securities Exchange Act of 1934 and a member of the Financial Industry Regulatory
Authority. The Trust offers Shares of the Fund for sale through the Distributor in Creation Units, as described below. The Distributor will not sell or redeem Shares in quantities less than Creation Units. The Distributor will deliver a Prospectus
to persons purchasing Creation Units and will maintain records of Creation Unit orders placed and confirmations furnished by it. Pursuant to a written agreement, the Adviser pays the Distributor for distribution-related services.
Distribution and Service Plan
Rule 12b-1 under the 1940 Act provides that an investment company may bear expenses of distributing its shares only pursuant to a plan adopted in accordance with the rule. The Trustees have adopted a
Rule 12b-1
Distribution and Service Plan (Rule 12b-1 Plan) pursuant to which the Fund may pay certain expenses incurred in the distribution of its shares and the servicing and maintenance of
existing shareholder accounts. The Distributor, as the Funds principal underwriter, and Rafferty may have a direct or indirect financial interest in the Rule 12b-1 Plan or any related agreement. Pursuant to the Rule 12b-1 Plan, the Fund may
pay a fee of up to 0.25% of the Funds average daily net assets. No Rule 12b-1 fee is currently being charged to the Fund.
The Rule
12b-1 Plan was approved by the Board, including a majority of the non-interested Trustees of the Fund. In approving the Rule 12b-1 Plan, the Trustees determined that there is a reasonable likelihood that the plan will benefit the Fund and its
shareholders. The Trustees will review quarterly and annually a written report provided by the Treasurer of the amounts expended under the Rule 12b-1 Plan and the purpose for which such expenditures were made.
The Rule 12b-1 Plan permits payments to be made by the Fund to the Distributor or other third parties for expenditures incurred in connection with the
distribution of Fund shares to investors and the provision of certain shareholder services. The Distributor or other third parties are authorized to engage in advertising, the preparation and distribution of sales literature and other promotional
activities on behalf of the Fund. In addition, the Rule 12b-1 Plan authorizes payments by the Fund to the Distributor or other third parties for the cost related to selling or servicing efforts, preparing, printing and distributing Fund
prospectuses, statements of additional information, and shareholder reports to investors.
Independent
Registered Public Accounting Firm
Ernst & Young LLP (E&Y), 5 Times Square, New York, New York 10036 is the
independent registered public accounting firm for the Trust.
Legal Counsel
The Trust has selected K&L Gates LLP, 1601 K Street, N.W., Washington, DC 20006, as its legal counsel.
36
DETERMINATION OF NET ASSET VALUE
The Funds share price is known as its NAV. The Fund calculates its NAV as of the close of regular trading on the NYSE, usually
4:00 p.m. Eastern Time, each day the NYSE is open for business (Business Day.) The NYSE is open every week, Monday through Friday, except when the following holidays are celebrated: New Years Day, Martin Luther King, Jr. Day (the
third Monday in January), Presidents Day (the third Monday in February), Good Friday, Memorial Day (the last Monday in May), July 4
th
, Labor Day (the first Monday in September), Thanksgiving Day (the fourth Thursday in November) and Christmas Day. The
NYSE may close early on the business day before each of these holidays and on the day after Thanksgiving Day. NYSE holiday schedules are subject to change without notice.
If the exchange or market on which the other Funds investments are primarily traded closes early, the NAV may be calculated prior to its normal calculation time. Creation/redemption transaction
order time cutoffs would also be accelerated. The value of the Funds assets that trade in markets outside the United States or in currencies other than the U.S. dollar may fluctuate when foreign markets are open but the Fund is not open for
business.
A security listed or traded on an exchange, domestic or foreign, is valued at its last sales price on the
principal exchange on which it is traded prior to the time when assets are valued. If no sale is reported at that time, the mean of the last bid and asked prices is used. Securities primarily traded on the NASDAQ Global Market
®
(NASDAQ
®
) for which market quotations are readily available shall be valued using the NASDAQ
®
Official Closing Price (NOCP) provided by NASDAQ
®
each business day. The NOCP is the most recently reported price as of 4:00:02 p.m. Eastern time, unless that price is outside the range of the inside bid
and asked prices in that case, NASDAQ
®
will adjust the price to equal the inside bid or asked price,
whichever is closer. If the NOCP is not available, such securities shall be valued at the last sale price on the day of valuation, or if there has been no sale on such day, at the mean between the bid and asked prices.
When market quotations for options and futures positions held by the Fund are readily available, those positions will be valued based upon such
quotations. Securities and other assets for which market quotations are not readily available, or for which Rafferty has reason to question the validity of quotations received, are valued at fair value by procedures as adopted by the Board.
For purposes of determining NAV per share of the Fund, options and futures contracts are valued at the last sales prices of the exchanges on
which they trade. The value of a futures contract equals the unrealized gain or loss on the contract that is determined by marking the contract to the last sale price for a like contract acquired on the day on which the futures contract is being
valued. The value of options on futures contracts is determined based upon the last sale price for a like option acquired on the day on which the option is being valued. A last sale price may not be used for the foregoing purposes if the market
makes a limited move with respect to a particular instrument.
For valuation purposes, quotations of foreign securities or other assets
denominated in foreign currencies are translated to U.S. dollar equivalents using the net foreign exchange rate in effect at the close of the stock exchange in the country where the security is issued. Short-term debt instruments having a maturity
of 60 days or less are valued at amortized cost, which approximates market value. If the Board determines that the amortized cost method does not represent the fair value of the short-term debt instrument, the investment will be valued at fair value
as determined by procedures as adopted by the Board. U.S. government securities are valued at the mean between the closing bid and asked price provided by an independent third party pricing service (Pricing Service).
OTC securities held by the Fund will be valued at the last sales price or, if no sales price is reported, the mean of the last bid and asked price is
used. The portfolio securities of the Fund that are listed on national exchanges are valued at the last sales price of such securities; if no sales price is reported, the mean of the last bid and asked price is used.
Dividend income and other distributions are recorded on the ex-distribution date.
Swaps are valued based upon prices from third party vendor models or quotations from market makers to the extent available.
37
Illiquid securities, securities for which reliable quotations or pricing services are not readily available,
and all other assets not valued in accordance with the foregoing principles will be valued at their respective fair value as determined in good faith by, or under procedures established by, the Trustees, which procedures may include the delegation
of certain responsibilities regarding valuation to Rafferty or the officers of the Trust. The officers of the Trust report, as necessary, to the Trustees regarding portfolio valuation determinations. The Trustees, from time to time, will review
these methods of valuation and will recommend changes that may be necessary to assure that the investments of the Fund are valued at fair value.
Additional Information Regarding Deferred Tax Liability
Because the Fund is treated
as a regular corporation, or C corporation, for U.S. federal income tax purposes, the Fund will incur tax expenses. In calculating the Funds daily NAV, the Fund will, among other things, account for its deferred tax liability
and/or asset balances. As a result, any deferred tax liability is reflected in the Funds daily NAV.
The Fund will accrue, in accordance
with generally accepted accounting principles, a deferred income tax liability balance at the currently effective statutory U.S. federal income tax rate (currently 35%) plus an assumed state and local income tax rate, for its future tax liability
associated with the capital appreciation of its investments and the distributions received by a Fund on equity securities of MLPs considered to be return of capital and for any net operating gains. The Funds current and deferred tax liability,
if any, will depend upon the Funds net investment gains and losses and realized and unrealized gains and losses on investments and therefore may vary greatly from year to year depending on the nature of the Funds investments, the
performance of those investments and general market conditions. Any deferred tax liability balance will reduce a Funds NAV.
The Fund
also will accrue, in accordance with generally accepted accounting principles, a deferred tax asset balance which reflects an estimate of the Funds future tax benefit associated with net operating losses and unrealized losses. Any deferred tax
asset balance will increase the Funds NAV. To the extent the Fund has a deferred tax asset balance, the Fund will assess, in accordance with generally accepted accounting principles, whether a valuation allowance, which would offset the value
of some or all of the Funds deferred tax asset balance, is required. Pursuant to Financial Accounting Standards Board Accounting Standards Codification 740 (FASB ASC 740), the Fund will assess a valuation allowance to reduce some or all of the
deferred tax asset balance if, based on the weight of all available evidence, both negative and positive, it is more likely than not that some or all of the deferred tax asset will not be realized. The Fund will use judgment in considering the
relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence will be commensurate with the extent to which such evidence can be objectively verified. The Funds assessment
considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability (which are dependent on, among other factors, future MLP cash distributions), the duration of statutory
carryforward periods and the associated risk that operating loss carryforwards may be limited or expire unused. However, this assessment generally may not consider the potential for market value increases with respect to the Funds investments
in equity securities of MLPs or any other securities or assets. Significant weight is given to the Funds forecast of future taxable income, which is based on, among other factors, the expected continuation of MLP cash distributions at or near
current levels. Consideration is also given to the effects of the potential of additional future realized and unrealized gains or losses on investments and the period over which deferred tax assets can be realized, as federal tax net operating loss
carryforwards expire in twenty years and federal capital loss carryforwards expire in five years. Recovery of a deferred tax asset is dependent on continued payment of the MLP cash distributions at or near current levels in the future and the
resultant generation of taxable income. The Fund will assess whether a valuation allowance is required to offset some or all of any deferred tax asset in connection with the calculation of a Funds NAV per share each day; however, to the extent
the final valuation allowance differs from the estimates the Fund used in calculating the Funds daily NAV, the application of such final valuation allowance could have a material impact on the Funds NAV.
The Funds deferred tax asset and/or liability balances is estimated using estimates of effective tax rates expected to apply to taxable income in
the years such balances are realized. The Fund will rely to some extent on information provided by MLPs in determining the extent to which distributions received from MLPs constitute a return of capital, which information may not be provided to the
Fund on a timely basis, in order to estimate deferred tax liability and/or asset balances for purposes of financial statement reporting and determining its NAV. If such
38
information is not received from such MLPs on a timely basis, the Fund will estimate the extent to which distributions received from MLPs constitute a return of capital based on average
historical tax characterization of distributions made by MLPs. The Funds estimates regarding its deferred tax liability and/or asset balances are made in good faith; however, the daily estimate of a Funds deferred tax liability and/or
asset balances used to calculate the Funds NAV could vary dramatically from the Funds actual tax liability. Actual income tax expense, if any, will be incurred over many years, depending on if and when investment gains and losses are
realized, the then-current basis of the Funds assets and other factors. As a result, the determination of the Funds actual tax liability may have a material impact on the Funds NAV. The Funds daily NAV calculation will be
based on then current estimates and assumptions regarding the Funds deferred tax liability and/or asset balances and any applicable valuation allowance, based on all information available to the Fund at such time. From time to time, the Fund
may modify its estimates or assumptions regarding its deferred tax liability and/or asset balances and any applicable valuation allowance as new information becomes available. Modifications of the Funds estimates or assumptions regarding its
deferred tax liability and/or asset balances and any applicable valuation allowance, changes in generally accepted accounting principles or related guidance or interpretations thereof, limitations imposed on net operating losses (if any) and changes
in applicable tax law could result in increases or decreases in the Funds NAV per share, which could be material.
ADDITIONAL INFORMATION CONCERNING SHARES
Organization and Description of Shares of Beneficial
Interest
The Trust is a Delaware statutory trust and registered investment company. The Trust was organized on April 23, 2008,
and has authorized capital of unlimited Shares of beneficial interest of no par value which may be issued in more than one class or series. Currently, the Trust consists of multiple separately managed series. The Board may designate additional
series of beneficial interest and classify Shares of a particular series into one or more classes of that series.
All Shares of the Trust are
freely transferable. The Shares do not have preemptive rights or cumulative voting rights, and none of the Shares have any preference to conversion, exchange, dividends, retirements, liquidation, redemption, or any other feature. Shares have equal
voting rights, except that, in a matter affecting a particular series or class of Shares, only Shares of that series of class may be entitled to vote on the matter. Trust shareholders are entitled to require the Trust to redeem Creation Units of
their Shares. The Trust Instrument confers upon the Broad of Trustees the power, by resolution, to alter the number of Shares constituting a Creation Unit or to specify that Shares of the Trust may be individually redeemable. The Trust reserves the
right to adjust the stock prices of Shares of the Trust to maintain convenient trading ranges for investors. Any such adjustments would be accomplished through stock splits or reverse stock splits which would have no effect on the net assets of the
applicable Fund.
Under Delaware law, the Trust is not required to hold an annual shareholders meeting if the 1940 Act does not require such a
meeting. Generally, there will not be annual meetings of Trust shareholders. Trust shareholders may remove Trustees from office by votes cast at a meeting of Trust shareholders or by written consent. If requested by shareholders of at least 10% of
the outstanding Shares of the Trust, the Trust will call a meeting of Funds shareholders for the purpose of voting upon the question of removal of a Trustee of the Trust and will assist in communications with other Trust shareholders.
The Trust Instrument disclaims liability of the shareholders of the officers of the Trust for acts or obligations of the Trust which are
binding only on the assets and property of the Trust. The Trust Instrument provides for indemnification from the Trusts property for all loss and expense of any Fund shareholder held personally liable for the obligations of the Trust. The risk
of a Trust shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the Fund would not be able to meet the Trusts obligations and this risk, thus, should be considered remote.
If the Fund does not grow to a size to permit it to be economically viable, the Fund may cease operations. In such an event, investors may be required to
liquidate or transfer their investments at an inopportune time.
39
Book Entry Only System
The Depository Trust Company (DTC) acts as securities depositary for the Shares. The Shares of the Fund are represented by global securities
registered in the name of DTC or its nominee and deposited with, or on behalf of, DTC. Except as provided below, certificates will not be issued for Shares.
DTC has advised the Trust as follows: it is a limited-purpose trust company organized under the laws of the State of New York, a member of the Federal Reserve System, a clearing corporation
within the meaning of the New York Uniform Commercial Code, and a clearing agency registered pursuant to the provisions of Section 17A of the Exchange Act. DTC was created to hold securities of its participants (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 New York Stock Exchange, Inc., the AMEX and the Financial Industry Regulatory Authority. 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 (Indirect Participants). DTC agrees with and represents to DTC Participants that it will administer its
book-entry system in accordance with its rules and by-laws and requirements of law. 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 laws of some jurisdictions may require that certain purchasers of securities take physical delivery of such securities in definitive form. Such laws may impair the ability of certain investors
to acquire beneficial interests in Shares.
Beneficial owners of Shares are not entitled to have Shares registered in their names, will not
receive or be entitled to receive physical delivery of certificates in definitive form and are not considered the registered holder thereof. Accordingly, each Beneficial owner must rely on the procedures of DTC, the DTC Participant and any Indirect
Participant through which such Beneficial owner holds its interests, to exercise any rights of a holder of Shares. The Trust understands that under existing industry practice, in the event the Trust requests any action of holders of Shares, or a
Beneficial owner desires to take any action that DTC, as the record owner of all outstanding Shares, is entitled to take, DTC would authorize the DTC Participants to take such action and that the DTC Participants would authorize the Indirect
Participants and Beneficial owners acting through such DTC Participants to take such action and would otherwise act upon the instructions of Beneficial owners owning through them. As described above, the Trust recognizes DTC or its nominee as the
owner of all Shares for all purposes. Conveyance of all notices, statements and other communications to Beneficial owners is effected as follows. Pursuant to the Depositary Agreement between the Trust and DTC, DTC is required to make available to
the Trust upon request and for a fee to be charged to the Trust a listing of Share holdings of each DTC Participant. The Trust shall inquire of each such DTC Participant as to 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.
Distributions of Shares 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 Shares 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
40
responsibility of such DTC Participants. The Trust has no responsibility or liability for any aspects of the records relating to or notices to Beneficial owners, or payments made on account of
beneficial ownership interests in such 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 an the Indirect Participants and Beneficial owners owning through such DTC Participants.
DTC may
determine to discontinue providing its service with respect to Shares at any time by giving reasonable notice to the Trust and discharging its responsibilities with respect thereto under applicable law. Under such circumstances, the Trust shall take
action either to find a replacement for DTC to perform its functions at a comparable cost or, if such a 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. 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 brokers may make a dividend
reinvestment service available to their clients. Brokers offering such services may require investors to adhere to specific procedures and timetables in order to participate. Investors interested in such a service should contact their broker for
availability and other necessary details.
PURCHASES AND REDEMPTIONS
The Trust issues and redeems Shares of the Fund only in aggregations of Creation Units. The number of Shares of the Fund that constitute a Creation Unit
for the Fund and the value of such Creation Unit will be 50,000 and $2,000,000, respectively.
See Purchase and Issuance of Shares in
Creation Units and Redemption of Creation Units below. The Board reserves the right to declare a split or a consolidation in the number of Shares outstanding of any Fund, and may make a corresponding change in the number of Shares
constituting a Creation Unit, in the event that the per Shares price in the secondary market rises (or declines) to an amount that falls outside the range deemed desirable by the Board for any other reason.
Purchase and Issuance of Creation Units
The Trust issues and sells Shares only in Creation Units on a continuous basis through the Distributor, without a sales load, at their net asset value next determined after receipt, on any Business Day
(as defined above), of an order in proper form.
Creation Units of Shares may be purchased only by or through an Authorized Participant. Such
Authorized Participant will agree pursuant to the terms of such Authorized Participant Agreement on behalf of itself or any investor on whose behalf it will act, as the case may be, to certain conditions, including that such Authorized Participant
will make available an amount of cash sufficient to pay the Balancing Amount and the transaction fee described below. The Authorized Participant may require the investor to enter into an agreement with such Authorized Participant with respect to
certain matters, including payment of the Balancing Amount. Investors who are not Authorized Participants must make appropriate arrangements with an Authorized Participant. Investors should be aware that their particular broker may not be a DTC
Participant or may not have executed an Authorized Participant Agreement, and that therefore orders to purchase Creation Units of Shares may have to be placed by the investors broker through an Authorized Participant. As a result, purchase
orders placed through an Authorized Participant may result in additional charges to such investor.
Purchases
through the Clearing Process
An Authorized Participant may place an order to purchase (or redeem) Creation Units (i) through the
Continuous Net Settlement clearing processes of NSCC as such processes have been enhanced to effect purchases (and redemptions) of Creation Units, such processes being referred to herein as the Enhanced Clearing Process, or
(ii) outside the Enhanced Clearing Process, being referred to herein as the Manual Clearing Process. To purchase or redeem through the Enhanced Clearing Process, an Authorized Participant must be a member of National Securities Clearing
Corporation (NSCC) that is eligible to use the Continuous Net Settlement system. For purchase orders placed through the Enhanced Clearing Process, in the Authorized Participant Agreement the Participant authorizes
41
the Transfer Agent to transmit to the NSCC, on behalf of an Authorized Participant, such trade instructions as are necessary to effect the Authorized Participants purchase order. Pursuant
to such trade instructions to the NSCC, the Authorized Participant agrees to deliver the Portfolio Deposit and such additional information as may be required by the Transfer Agent or the Distributor. A purchase order must be received in good order
by the transfer agent by 4:00 p.m. Eastern Time, whether transmitted by mail, through the transfer agents automated system, telephone, facsimile or other means permitted under the Authorized Participant Agreement, in order to receive that
days NAV per Share. All other procedures set forth in the Authorized Participant Agreement must be followed in order for you to receive the NAV determined on that day.
The consideration for purchase of a Creation Unit of Shares of the Fund consists of either cash or the Deposit Securities that is a representative sample of the securities in the Funds underlying
index, the Balancing Amount, and the appropriate Transaction Fee (collectively, the Portfolio Deposit). The Balancing Amount will be the amount equal to the differential, if any, between the total aggregate market value of the Deposit
Securities and the NAV of the Creation Unit(s) being purchased and will be paid to, or received from, the Trust after the NAV has been calculated.
USBFS makes available through the NSCC on each Business Day, either immediately prior to the opening of business on the Exchange or the night before, the list of the names and the required number of
shares of each Deposit Security to be included in the current Portfolio Deposit (based on information at the end of the previous Business Day) for the Fund. Such Portfolio Deposit is applicable, subject to any adjustments as described below, in
order to effect purchases of Creation Units of Shares of a given Fund until such time as the next-announced Portfolio Deposit made available.
The identity and number of shares of the Deposit Securities required for the Fund changes as rebalancing adjustments and corporate action events are
reflected from time to time by Rafferty with a view to the investment objective of the Fund. The composition of the Deposit Securities may also change in response to adjustments to the weighting or composition of the securities constituting the
relevant securities index. In addition, the Trust reserves the right to permit or require the substitution of an amount of cash (
i.e.
, a cash in lieu amount) to be added to the Balancing Amount to replace any Deposit Security
which may not be available in sufficient quantity for delivery or for other similar reasons. The adjustments described above will reflect changes, known to Rafferty on the date of announcement to be in effect by the time of delivery of the Portfolio
Deposit, in the composition of the subject index being tracked by the relevant Fund, or resulting from stock splits and other corporate actions.
In addition to the list of names and numbers of securities constituting the current Deposit Securities of a Portfolio Deposit, on each Business Day, the Balancing Amount effective through and including
the previous Business Day, per outstanding Share of the Fund, will be made available.
Shares may be issued 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 greater value than the NAV of the Shares on the date the order is placed in proper form since, in addition to the
available Deposit Securities, cash must be deposited in an amount equal to the sum of (i) the Balancing Amount, plus (ii) 115% of the market value of the undelivered Deposit Securities (the Additional Cash Deposit). 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 115% of the
daily marked to market value of the missing Deposit Securities. The Participation Agreement will permit the Trust to buy the missing Deposit Securities 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 Bank or purchased by the Trust and deposited into the Trust. In addition, a transaction fee, as listed below, will be charged in all cases. The delivery of Shares so purchased will occur no later than the third Business Day
following the day on which the purchase order is deemed received by the Distributor. Due to the schedule of holidays in certain countries, however, the delivery of Shares may take longer than three Business Days following the day on which the
purchase order is received. In such cases, the local market settlement procedures will not commence until the end of local holiday periods. A list of local holidays in the foreign countries or markets relevant to the international funds is set forth
under Regular Foreign Holidays below.
42
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 Trusts determination shall be final and binding.
Purchases Through the Manual Clearing Process
An
Authorized Participant that wishes to place an order to purchase Creation Units outside the Enhanced Clearing Process must state that it is not using the Enhanced Clearing Process and that the purchase instead will be effected through a transfer of
securities and cash either through the Federal Reserve System (for cash and U.S. government securities) or directly through DTC. Purchases (and redemptions) of Creation Units of the Fund settled outside the Enhanced Clearing Process will be subject
to a higher Transaction Fee than those settled through the Enhanced Clearing Process. Purchase orders effected outside the Enhanced Clearing Process are likely to require transmittal by the Authorized Participant earlier on the Transmittal Date than
orders effected using the Enhanced Clearing Process. Those persons placing orders outside the Enhanced Clearing Process should ascertain the deadlines applicable to DTC and the Federal Reserve System (for cash and U.S. government securities) by
contacting the operations department of the broker or depository institution effectuating such transfer of the Portfolio Deposit.
Rejection of Purchase Orders
The Trust reserves the absolute right to reject a purchase order transmitted to it by the Distributor
in respect of any Fund if (a) the purchaser or group of purchasers, upon obtaining the shares ordered, would own 80% or more of the currently outstanding Shares of any Fund; (b) the Deposit Securities delivered are not as specified by
Rafferty and Rafferty has not consented to acceptance of an in-kind deposit that varies from the designated Deposit Securities; (c) acceptance of the purchase transaction order would have certain adverse tax consequences to the Fund;
(d) the acceptance of the purchase transaction order would, in the opinion of counsel, be unlawful; (e) the acceptance of the purchase transaction order would otherwise, in the discretion of the Trust or Rafferty, have an adverse effect on
the Trust or the rights of beneficial owners; (f) the value of a Cash Purchase Amount, or the value of the Balancing Amount to accompany an in-kind deposit exceed a purchase authorization limit extended to an Authorized Participant by the
custodian and the Authorized Participant has not deposited an amount in excess of such purchase authorization with the custodian by 4:00 p.m. Eastern Time on the Transmittal Date; or (g) in the event that circumstances outside the control of
the Trust, the Distributor and Rafferty make it impractical to process purchase orders. The Trust shall notify a prospective purchaser of its rejection of the order of such person. The Trust and the Distributor are under no duty, however, to give
notification of any defects or irregularities in the delivery of purchase transaction orders nor shall either of them incur any liability for the failure to give any such notification.
Redemption of Creation Units
Shares may be redeemed only
in Creation Units at their NAV next determined after receipt of a redemption request in proper form by the Distributor on any Business Day. The Trust will not redeem Shares in amounts less than Creation Units. Beneficial owners also may sell Shares
in the secondary market, but must accumulate enough Shares 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 of Shares. Investors should expect to incur brokerage and other costs in connection with assembling a sufficient number of Shares to constitute a redeemable Creation Unit.
Placement of Redemption Orders Using Enhanced Clearing Process
Orders to redeem Creation Units of Fund through the Enhanced Clearing Process must be delivered through an Authorized Participant that is a member of NSCC
that is eligible to use the Continuous Net Settlement System. A redemption order must be received in good order by the transfer agent by 4:00 p.m. Eastern Time, whether transmitted by mail, through the transfer agents automated system,
telephone, facsimile or other means permitted under the Authorized Participant Agreement, in order to receive that days NAV per Share. All other procedures set forth in the Authorized Participant Agreement must be followed in order for you to
receive the NAV determined on that day.
43
With respect to the Fund, Rafferty makes available through the NSCC immediately prior to the opening of
business on the Exchange on each day that the Exchange is open for business the 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
(Redemption Securities). These securities may, at times, not be identical to Deposit Securities which are applicable to a purchase of Creation Units.
The redemption proceeds for a Creation Unit consist of either cash or Redemption Securities, as announced by Rafferty through the NSCC on any Business Day, plus the Balancing Amount. The redemption
transaction fee described below is deducted from such redemption proceeds.
Placement of Redemption Orders
Outside Clearing Process
Orders to redeem Creation Units of the Fund outside the Clearing Process must be delivered through a DTC
Participant that has executed the Authorized Participant Agreement. A DTC Participant who wishes to place an order for redemption of Creation Units of the Fund to be effected outside the Clearing Process need not be an Authorized Participant, but
such orders must state that the DTC Participant is not using the Clearing Process and that redemption of Creation Units will instead be effected through transfer of Shares directly through DTC or the Federal Reserve System (for cash and U.S.
government securities). A redemption order must be received in good order by the transfer agent by 4:00 p.m. Eastern Time, whether transmitted by mail, through the transfer agents automated system, telephone, facsimile or other means permitted
under the Authorized Participant Agreement, in order to receive that days NAV per Share. All other procedures set forth in the Authorized Participant Agreement must be followed in order for you to receive the NAV determined on that day. The
order must be accompanied or preceded by the requisite number of Shares specified in such order, which delivery must be made through DTC or the Federal Reserve System to the Custodian by the third Business Day following such Transmittal Date
(DTC Cut-Off Time); and (iii) all other procedures set forth in the Authorized Participant Agreement must be properly followed.
If it is not possible to effect deliveries of the Redemption Securities, the Fund may in its discretion exercise its option to redeem such Shares in cash, and the redeeming shareholder will be required to
receive its redemption proceeds in cash. In addition, an investor may request a redemption in cash which the Fund may, in its sole discretion, permit. The Fund may also, in its sole discretion, upon request of a shareholder, provide such redeemer a
portfolio of securities which differs from the exact composition of the Fund Securities but does not differ in net asset value.
After the
Transfer Agent has deemed an order for redemption of the Funds shares outside the Clearing Process received, the Transfer Agent will initiate procedures to transfer the requisite Redemption Securities, which are expected to be delivered within
three Business Days, and the Balancing Amount minus the Transaction Fee. In addition, with respect to Fund redemptions honored in cash, the redeeming party will receive the Cash Redemption Amount by the third Business Day following the Transmittal
Date on which such redemption order is deemed received by the Transfer Agent. Due to the schedule of holidays in certain countries, however, the receipt of the Cash Redemption Amount may take longer than three Business Days following the Transmittal
Date. In such cases, the local market settlement procedures will not commence until the end of local holiday periods.
In certain instances,
Authorized Participants may create and redeem Creation Unit aggregations of the Fund on the same trade date. In this instance, the Trust reserves the right to settle these transactions on a net basis.
The right of redemption may be suspended or the date of payment postponed with respect to any Fund (1) for any period during which the New York
Stock Exchange is closed (other than customary weekend and holiday closings); (2) for any period during which trading on the New York Stock 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 Funds portfolio securities or determination of its net asset value is not reasonably practicable; or (4) in such other circumstance as is permitted by the SEC.
44
Regular Foreign Holidays
The Fund generally intends to effect deliveries of Creation Units and portfolio securities on a basis of T plus three Business Days (
i.e.
, days on which the national securities exchange
is open). The Fund may effect deliveries of Creation Units and portfolio securities on a basis other than T plus three in order to accommodate local holiday schedules, to account for different treatment among foreign and U.S. markets of dividend
record dates and ex-dividend dates or under certain other circumstances. The ability of the Trust to effect in-kind creations and redemptions within three Business Days of receipt of an order in good form is subject, among other things, to the
condition that, within the time period from the date of the order to the date of delivery of the securities, there are no days that are holidays in the applicable foreign market. For every occurrence of one or more intervening holidays in the
applicable foreign market that are not holidays observed in the U.S. equity market, the redemption settlement cycle will be extended by the number of such intervening holidays. In addition to holidays, other unforeseeable closings in a foreign
market due to emergencies may also prevent the Trust from delivering securities within normal settlement periods. The securities delivery cycles currently practicable for transferring portfolio securities to redeeming Authorized Participants,
coupled with foreign market holiday schedules, will require a delivery process longer than seven calendar days in certain circumstances. The holidays applicable during such periods are listed below, as are instances where more than seven days will
be needed to deliver redemption proceeds. Although certain holidays may occur on different dates in subsequent years, the number of days required to deliver redemption proceeds in any given year is not expected to exceed the maximum number of days
listed below. The proclamation of new holidays, the treatment by market participants of certain days as informal holidays (
e.g.
, days on which no or limited securities transactions occur, as a result of substantially shortened
trading hours), the elimination of existing holidays or changes in local securities delivery practices could affect the information set forth herein at some time in the future.
The dates from January 1, 2013 through December 31, 2013 in which the regular holidays affecting the relevant securities markets of the below listed countries are as follows:
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Australia
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Austria
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Belgium
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Brazil
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Canada
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Chile
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China
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Colombia
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January 1
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January 1
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January 1
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January 1
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January 1
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January 1
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January 1
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January 1
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January 28
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March 29
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March 29
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January 25
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January 2
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March 29
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January 2
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January 7
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March 4
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April 1
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April 1
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February 11
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February 18
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May 1
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January 3
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March 25
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March 28
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May 1
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May 1
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February 12
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March 29
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May 21
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February 11
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March 28
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March 29
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May 9
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May 9
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February 13
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May 20
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July 16
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February 12
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March 29
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April 1
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May 20
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May 20
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March 29
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June 24
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August 15
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February 13
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May 1
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April 25
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May 30
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August 15
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May 1
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July 1
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September 18
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February 14
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May 13
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May 6
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August 15
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November 1
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May 30
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August 5
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September 19
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February 15
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June 3
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June 10
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November 1
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November 11
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July 9
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September 2
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September 20
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April 4
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June 10
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August 5
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December 24
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December 25
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November 15
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October 14
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October 31
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April 5
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July 1
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October 7
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December 25
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December 26
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November 20
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November 11
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November 1
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April 29
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August 7
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November 5
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December 26
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December 24
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December 25
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December 25
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April 30
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August 19
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December 24
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December 31
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December 25
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December 26
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December 31
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May 1
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October 14
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December 25
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December 31
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June 10
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November 4
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December 26
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June 11
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November 11
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December 31
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June 12
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December 25
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April 4
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September 19
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September 20
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October 1
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October 2
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October 3
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October 4
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October 7
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Czech
Republic
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Denmark
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Egypt
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Finland
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France
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Germany
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Greece
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Hong Kong
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January 1
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January 1
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January 1
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January 1
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January 1
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January 1
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January 1
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January 1
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April 1
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March 28
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January 7
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March 28
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March 29
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March 29
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March 18
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February 11
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May 1
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March 29
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January 24
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March 29
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April 1
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April 1
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March 25
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February 12
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May 8
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April 1
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April 25
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April 1
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May 1
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May 1
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March 29
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February 13
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July 5
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April 26
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May 1
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May 1
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May 8
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May 9
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April 1
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March 29
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October 28
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May 9
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May 5
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May 9
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May 9
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May 20
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May 1
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April 1
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December 24
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May 10
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May 6
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June 21
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May 20
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May 30
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May 3
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April 4
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December 25
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May 20
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July 1
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December 6
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August 15
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October 3
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May 6
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May 1
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December 26
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June 5
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July 23
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December 24
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November 1
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December 24
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June 24
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May 17
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December 24
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August 8
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December 25
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November 11
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December 25
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August 15
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June 12
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December 25
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October 6
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December 26
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December 25
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December 26
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October 28
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July 1
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December 26
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October 14
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December 31
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December 26
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December 28
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December 24
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September 20
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December 31
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October 15
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December 31
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December 25
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October 1
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October 16
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December 26
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October 14
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November 5
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December 25
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December 26
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Hungary
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India
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Indonesia
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Ireland
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Israel
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Italy
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Japan
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Malaysia
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January 1
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January 25
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January 1
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January 1
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January 22
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January 1
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January 1
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January 1
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March 15
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February 19
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January 24
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January 21
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February 24
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March 29
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January 2
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January 24
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April 1
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March 27
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March 12
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February 18
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March 25
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April 1
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January 3
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January 28
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May 1
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March 29
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March 29
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March 18
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March 26
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April 25
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January 14
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February 1
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May 20
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April 1
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May 9
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March 29
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March 31
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May 1
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February 11
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February 11
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August 19
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April 11
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June 6
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April 1
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April 1
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August 15
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March 20
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February 12
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August 20
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April 19
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August 5
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May 1
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April 15
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November 1
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April 29
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May 1
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August 24
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April 24
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August 6
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May 6
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April 16
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December 24
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May 3
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May 24
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October 23
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May 1
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August 7
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May 27
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May 14
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December 25
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May 6
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August 8
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November 1
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August 9
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August 8
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July 4
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May 15
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December 26
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July 15
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August 9
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December 7
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August 15
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August 9
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July 12
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July 16
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December 31
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September 16
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September 16
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December 21
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September 9
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October 14
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August 26
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September 4
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September 23
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October 15
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December 24
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September 30
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October 15
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September 2
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September 5
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October 14
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November 5
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December 25
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October 2
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November 5
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October 14
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September 6
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November 4
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December 25
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December 26
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October 16
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December 25
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November 11
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September 13
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December 23
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December 27
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November 4
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December 26
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November 28
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September 18
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December 31
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November 14
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December 31
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December 25
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September 19
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|
|
|
|
|
December 25
|
|
|
|
December 26
|
|
September 25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mexico
|
|
Morocco
|
|
The
Netherlands
|
|
New Zealand
|
|
Norway
|
|
Peru
|
|
The
Philippines
|
|
Poland
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
February 4
|
|
January 11
|
|
March 29
|
|
January 2
|
|
March 27
|
|
March 28
|
|
March 28
|
|
March 29
|
March 18
|
|
May 1
|
|
April 1
|
|
January 21
|
|
March 28
|
|
March 29
|
|
March 29
|
|
April 1
|
March 28
|
|
July 30
|
|
April 30
|
|
January 28
|
|
March 29
|
|
May 1
|
|
April 9
|
|
May 1
|
March 29
|
|
August 14
|
|
May 1
|
|
February 6
|
|
April 1
|
|
July 29
|
|
May 1
|
|
May 3
|
September 16
|
|
August 20
|
|
May 9
|
|
March 29
|
|
May 1
|
|
August 30
|
|
June 12
|
|
May 30
|
|
|
August 21
|
|
May 20
|
|
April 1
|
|
May 9
|
|
October 8
|
|
August 21
|
|
August 15
|
|
|
November 6
|
|
December 25
|
|
April 25
|
|
May 17
|
|
November 1
|
|
August 26
|
|
November 1
|
|
|
November 18
|
|
December 26
|
|
June 3
|
|
May 20
|
|
December 25
|
|
November 1
|
|
November 11
|
|
|
|
|
|
|
October 28
|
|
December 24
|
|
|
|
December 24
|
|
December 24
|
|
|
|
|
|
|
December 25
|
|
December 25
|
|
|
|
December 25
|
|
December 25
|
|
|
|
|
|
|
December 26
|
|
December 26
|
|
|
|
December 30
|
|
December 26
|
|
|
|
|
|
|
|
|
December 31
|
|
|
|
December 31
|
|
December 31
|
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|
|
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|
|
|
Portugal
|
|
Russia
|
|
Singapore
|
|
South Africa
|
|
South Korea
|
|
Spain
|
|
Sweden
|
|
Switzerland
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
February 12
|
|
January 2
|
|
February 11
|
|
March 21
|
|
February 11
|
|
January 7
|
|
March 28
|
|
January 2
|
March 29
|
|
January 3
|
|
February 12
|
|
March 29
|
|
March 1
|
|
March 18
|
|
March 29
|
|
March 29
|
April 1
|
|
January 4
|
|
March 29
|
|
April 1
|
|
May 1
|
|
March 28
|
|
April 1
|
|
April 1
|
April 25
|
|
January 7
|
|
May 1
|
|
May 1
|
|
May 17
|
|
March 29
|
|
May 1
|
|
April 15
|
May 1
|
|
January 8
|
|
May 24
|
|
June 17
|
|
June 6
|
|
April 1
|
|
May 8
|
|
May 1
|
June 10
|
|
February 22
|
|
August 8
|
|
August 9
|
|
August 15
|
|
May 1
|
|
May 9
|
|
May 9
|
June 13
|
|
March 7
|
|
August 9
|
|
September 24
|
|
September 18
|
|
August 15
|
|
June 6
|
|
May 20
|
August 15
|
|
March 8
|
|
October 15
|
|
December 16
|
|
September 19
|
|
November 1
|
|
June 21
|
|
August 1
|
December 24
|
|
April 30
|
|
November 4
|
|
December 25
|
|
September 20
|
|
December 6
|
|
November 1
|
|
September 9
|
December 25
|
|
May 1
|
|
December 25
|
|
December 26
|
|
October 3
|
|
December 25
|
|
December 24
|
|
December 24
|
December 26
|
|
May 2
|
|
|
|
|
|
December 25
|
|
December 26
|
|
December 25
|
|
December 25
|
December 31
|
|
May 3
|
|
|
|
|
|
December 31
|
|
|
|
December 26
|
|
December 26
|
|
|
May 8
|
|
|
|
|
|
|
|
|
|
December 31
|
|
December 31
|
|
|
May 9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May 10
|
|
|
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|
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|
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|
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June 11
|
|
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|
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|
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June 12
|
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November 4
|
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46
|
|
|
|
|
|
|
Taiwan
|
|
Thailand
|
|
Turkey
|
|
United Kingdom
|
January 1
|
|
January 1
|
|
January 1
|
|
January 1
|
February 7
|
|
February 25
|
|
April 23
|
|
January 21
|
February 8
|
|
April 8
|
|
May 1
|
|
February 18
|
February 11
|
|
April 15
|
|
August 7
|
|
March 29
|
February 12
|
|
April 16
|
|
August 8
|
|
April 1
|
February 13
|
|
May 1
|
|
August 9
|
|
May 1
|
February 14
|
|
May 6
|
|
August 30
|
|
May 6
|
February 15
|
|
May 24
|
|
October 14
|
|
May 27
|
February 28
|
|
July 1
|
|
October 15
|
|
July 4
|
April 4
|
|
July 22
|
|
October 16
|
|
August 26
|
April 5
|
|
August 12
|
|
October 17
|
|
September 2
|
May 1
|
|
October 23
|
|
October 18
|
|
October 14
|
June 12
|
|
December 5
|
|
October 28
|
|
November 11
|
September 19
|
|
December 10
|
|
October 29
|
|
November 28
|
September 20
|
|
December 31
|
|
|
|
December 25
|
October 10
|
|
|
|
|
|
December 26
|
Redemption
The longest redemption cycle is a function of the longest redemption cycles among the countries whose stocks are held by the Fund.
Transaction Fees
Transaction fees are imposed as set
forth in the table in the Prospectus. Transaction Fees payable to the Trust are imposed to compensate the Trust for the transfer and other transaction costs of the Fund associated with the issuance and redemption of Creation Units of Shares. There
is a fixed and a variable component to the total Transaction Fee. A fixed Transaction Fee is applicable to each creation or redemption transaction, regardless of the number of Creation Units purchased or redeemed. In addition, a variable Transaction
Fee based upon the value of each Creation Unit also is applicable to each redemption transaction.
Purchasers of Creation Units of the Fund
for cash are required to pay an additional charge to compensate the relevant Fund for brokerage and market impact expenses relating to investing in portfolios securities. Where the Trust permits an in-kind purchaser to substitute cash in lieu of
depositing a portion of the Deposit Securities, the purchaser will be assessed an additional charge for cash purchases.
Purchasers of Shares
in Creation Units are responsible for the costs of transferring the securities constituting the Deposit Securities to the account of the Trust. The purchase transaction fees for in-kind purchases and cash purchases (when available) are listed in the
table below. Investors will also bear the costs of transferring securities from the Fund to their account or on their order. Investors who use the services of a broker or other such intermediary may be charged a fee for such services. In addition,
Rafferty may, from time to time, at its own expense, compensate purchasers of Creation Units who have purchased substantial amounts of Creation Units and other financial institutions for administrative or marketing services.
Continuous Offering
The method by which Creation Units of Shares are created and traded may raise certain issues under applicable securities laws. Because new Creation Units of Shares are issued and sold by the Trust 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 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 Units after placing an order with the Distributor, breaks them down into constituent Shares, and sells some or all of the Shares comprising such Creation Units directly to its 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 a person is an underwriter for the
47
purposes of the Securities Act depends upon all the facts and circumstances pertaining to that persons activities. Thus, 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 effecting transactions in Shares, whether or not participating in the distribution of Shares, are
generally required to deliver a prospectus. This is because the prospectus delivery exemption in Section 4(3) of the Securities Act is not available in respect of such transactions as a result of Section 24(d) of the 1940 Act.
Broker-dealer firms should note that dealers who are not underwriters but are participating in a distribution (as contrasted to ordinary secondary market transaction), and thus dealing with Shares that are part of an unsold
allotment within the meaning of section 4(3)(C) of the Securities Act, would be unable to take advantage of the prospectus delivery exemption provided by section 4(3) of the Securities Act. Firms that incur a prospectus-delivery obligation
with respect to Shares are reminded that under Securities Act Rule 153 a prospectus delivery obligation under Section 5(b)(2) of the Securities Act owed to a national securities exchange member in connection with a sale on the national
securities exchange is satisfied by the fact that the Funds prospectus is available at the national securities exchange on which the Shares of such Fund trade upon request. The prospectus delivery mechanism provided in Rule 153 is only
available with respect to transactions on a national securities exchange and not with respect to upstairs transactions.
DIVIDENDS, OTHER DISTRIBUTIONS AND TAXES
Dividends and other Distributions
As stated in the Prospectus, the Fund declares and distributes dividends to its shareholders
from its net investment income at least annually; for these purposes, net investment income includes dividends, accrued interest, and accretion of OID and market discount, less amortization of market premium and estimated expenses, and is calculated
immediately prior to the determination of the Funds NAV per share. The Fund also distributes the excess of its net short-term capital gain over net long-term capital loss (short-term gain), if any, annually but may make more
frequent distributions thereof if necessary. The Fund may realize net capital gain (
i.e.
, the excess of net long-term capital gain over net short-term capital loss) and thus anticipates annual distributions thereof. The Trustees may revise
this distribution policy, or postpone the payment of distributions, if the Fund has or anticipates any large unexpected expense, loss or fluctuation in net assets that, in the Trustees opinion, might have a significant adverse effect on its
shareholders.
Investors should be aware that if shares are purchased shortly before the record date for any dividend or capital gain
distribution, the shareholder will pay full price for the shares and receive some portion of the purchase price back as a taxable distribution (with the tax consequences described in the Prospectus).
Taxes
The Fund is taxed as a regular corporation under Subchapter C of the Code for federal income tax purposes and as such is obligated to pay federal and
applicable state and foreign corporate taxes on its taxable income. This differs from most investment companies, which elect to be treated as regulated investment companies under the Code in order to avoid paying entity level income
taxes. Under current law, the Fund is not eligible to elect treatment as a regulated investment company due to its investments primarily in MLPs invested in energy assets. As a result, the Fund will be obligated to pay federal and state taxes on its
taxable income as opposed to most other investment companies which are not so obligated.
As discussed below, the Fund expects that a portion
of the distribution it receives from MLPs may be treated as a tax-deferred return of capital, thus reducing the Funds current tax liability. However, the amount of taxes currently paid by the Fund will vary depending on the amount of income
and gains derived from investments and/or sales of MLP interests and such taxes will reduce your return from an investment in the Fund.
The
Fund invests its assets primarily in MLPs, which generally are treated as partnerships for federal income tax purposes. As a partner in the MLPs, the fund must report its allocable share of the MLPs taxable income in computing its taxable
income, regardless of the extent (if any) to which the MLPs make distributions. Based upon the Advisers review of the historic results of the types of MLPs in which the Fund invests, the Adviser expects that the cash flow received by the Fund
with respect to its MLP investments will generally exceed the taxable income allocated to the Fund (and this excess generally will not be currently taxable to the Fund but, rather, will result in a
48
reduction of the Funds adjusted tax basis in each MLP as described in the following paragraph). This is the result of a variety of factors, including significant non-cash deductions, such
as accelerated depreciation. There is no assurance that the Advisers expectation regarding the tax character of MLP distributions will be realized. If this expectation is not realized, there may be greater tax expense borne by the Fund and
less cash available to distribute to you or to pay to expenses.
The Fund will also be subject to U.S. federal income tax at the regular
graduated corporate tax rates on any gain recognized by the Fund on any sale of equity securities of an MLP. Cash distributions from an MLP to the Fund that exceed Funds allocable share of such MLPs net taxable income will reduce the
Funds adjusted tax basis in the equity securities of the MLP. These reductions in Funds adjusted tax basis in the MLP equity securities will increase the amount of any taxable gain (or decrease the amount of any tax loss) recognized by
the Fund on a subsequent sale of the securities.
The Fund will accrue deferred income taxes for any future tax liability associated with
(i) that portion of MLP distributions considered to be a tax-deferred return of capital and (ii) capital appreciation of its investments. Upon the sale of MLP security, the Fund may be liable for previously deferred taxes, and an
adjustment to the deferred income tax liability will be made at such time to reflect the actual taxes paid. The Fund will rely to some extent on information provided by the MLPs which is not necessarily timely, to estimate deferred tax liability for
purposes of financial statement reporting and determining the NAV. From time to time, the Adviser will modify the estimates or assumptions regarding the Funds deferred tax liability as new information becomes available. The Fund will generally
compute deferred income taxes based on the federal income tax rate applicable to corporations currently 35% and an assumed rate attributable to state taxes.
Distributions made to you by the Fund (other than distributions in redemption of shares subject to Section 302(b) of the Code) will generally constitute dividends to the extent of your allocable
share of the Funds current or accumulated earnings and profits, as calculated for federal income tax purposes. Generally, a corporations earnings and profits are computed based upon taxable income, with certain specified adjustments.
Based upon the historic performance of the types of MLPs in which the Fund intends to invest, the Adviser anticipates that the cash distributed from the MLPs generally will exceed the Funds Share of the MLPs taxable income. Consequently,
the Adviser anticipates that only a portion of the Funds distributions will be treated as dividend income to you. To the extent that distributions to you exceed your allocable share of the Funds current and accumulated earnings and
profits, your tax basis in the Funds Shares with respect to which the distribution is made will be reduced, which will increase the amount of any taxable gain (or decrease the amount of any tax loss) realized upon a subsequent sale or
redemption of such shares. To the extent you hold such shares as a capital asset and have no further basis in the shares to offset the distribution, you will report the excess as capital gain.
Distributions treated as dividends under the foregoing rules generally will be taxable as ordinary income to you but may be treated as qualified
dividend income. Under current federal income tax law, qualified dividend income received by individuals and other non corporate shareholders is taxed at long-term capital gain rates, which currently reach a maximum of 15% (20% for taxpayers
with taxable income exceeding $400,000 or $450,000 if married filing jointly). For a dividend to constitute qualified dividend income, the shareholder generally must hold the shares paying the dividend for more than 60 days during the 121-day period
beginning 60 days before the ex-dividend date, although a longer period may apply if the shareholder engages in certain risk reduction transactions with respect to the common stock.
Deferred income taxes reflect (1) taxes on unrealized gains/(losses) which are attributable to the difference between the fair market value and tax basis of the Funds investments and
(2) the tax benefit of accumulated capital or net operating losses. The Fund will accrue a net deferred tax liability if its future tax liability on its unrealized gains exceeds the tax benefit of its accumulated capital or net operating
losses, if any. The Fund does not currently intend to accrue a net deferred tax asset. However, the Fund may in the future determine to accrue a net deferred tax asset if the Funds future tax liability on unrealized gains is less than the tax
benefit of the Funds accumulated capital or net operating losses or if the Fund has net unrealized losses on its investments.
To the
extent we have a net deferred tax asset, consideration is given as to whether or not a valuation allowance is required. The need to establish a valuation allowance for deferred tax assets is assessed periodically based on the criteria established by
the Statement of Financial Standards, Accounting for Income Taxes (ASC 740) that it is more
49
likely than not that some portion or all of the deferred tax asset will not be realized. In our assessment for a valuation allowance, consideration is given to all positive and negative evidence
related to the realization of the deferred tax asset. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability (which are highly dependent on future MLP
cash distributions), the duration of statutory carryforward periods and the associated risk that capital or net operating loss carryforwards may expire unused. If a valuation allowance is required to reduce the deferred tax asset in the future, it
could have a material impact on the Funds NAV and results of operations in the period it is recorded.
A sale or exchange of shares in
the Fund may give rise to a gain or loss. In general, any 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 one year. Otherwise, the gain or loss
on the taxable disposition of shares will be treated as short-term capital gain or loss. All or a portion of any loss realized upon a taxable disposition of shares will be disallowed if other substantially identical shares of the Fund 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.
Income from Foreign Securities
. Dividends and interest the Fund receives, and gains it realizes, on foreign securities may be subject to
income, withholding, or other taxes imposed by foreign countries and U.S. possessions that would reduce the yield and/or total return on its securities. Tax conventions between certain countries and the United States may reduce or eliminate these
taxes, however, and many foreign countries do not impose taxes on capital gains in respect of investments by foreign investors.
Gains or
losses (1) from the disposition of foreign currencies, including forward currency contracts, (2) on the disposition of each foreign-currency-denominated debt security that are attributable to fluctuations in the value of the foreign
currency between the dates of acquisition and disposition of the security, and (3) that are attributable to fluctuations in exchange rates that occur between the time the Fund accrues dividends, interest, or other receivables, or expenses or
other liabilities, denominated in a foreign currency and the time the Fund actually collects the receivables or pays the liabilities, generally will be treated as ordinary income or loss. These gains or losses will increase or decrease the amount of
the Funds investment company taxable income to be distributed to its shareholders.
The Fund may invest in the stock of passive
foreign investment companies (PFICs). A PFIC is any foreign corporation (with certain exceptions) that, in general, meets either of the following tests: (1) at least 75% of its gross income for the taxable year is passive; or
(2) an average of at least 50% of its assets produce, or are held for the production of, passive income. Under certain circumstances, the Fund will be subject to federal income tax on a portion of any excess distribution it receives
on the stock of a PFIC or of any gain on its disposition of the stock (collectively, PFIC income), plus interest thereon, even if the Fund distributes the PFIC income as a dividend to its shareholders.
If the Fund invests in a PFIC and elects to treat the PFIC as a qualified electing fund (QEF), then, in lieu of the foregoing tax
and interest obligation, the Fund would be required to include in income each year its
pro rata
share of the QEFs annual ordinary earnings and net capital gain even if the Fund did not receive those earnings and gain from the QEF. In
most instances it will be very difficult, if not impossible, to make this election because of certain requirements thereof.
The Fund may
elect to mark to market its stock in any PFIC whose shares are traded on an established. Marking-to-market, in this context, means including in gross income each taxable year (and treating as ordinary income) the excess, if
any, of the fair market value of the PFICs stock over the Funds adjusted basis therein as of the end of that year. Pursuant to the election, the Fund also would be allowed to deduct (as an ordinary, not a capital, loss) the excess, if
any, of its adjusted basis in PFIC stock over the fair market value thereof as of the taxable year-end, but only to the extent of any net mark-to-market gains with respect to that stock the Fund included in income for prior taxable years under the
election. The Funds adjusted basis in each PFICs stock with respect to which it makes this election would be adjusted to reflect the amounts of income included and deductions taken thereunder.
50
Derivatives Strategies
. The use of derivatives strategies, such as writing (selling) and
purchasing options and futures contracts and entering into forward contracts, involves complex rules that will determine for income tax purposes the amount, character, and timing of recognition of the gains and losses the Fund realizes in connection
therewith.
Some futures contracts, foreign currency contracts that are traded in the interbank market, and nonequity options
(
i.e.
, certain listed options, such as those on a broad-based securities index) except any securities futures contract that is not a dealer securities futures contract (both as defined in the Code) and any
interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement in which the Fund invests may be subject to Code section 1256
(collectively section 1256 contracts). Section 1256 contracts that the Fund holds at the end of its taxable year must be marked to market (that is, treated as having been sold at that time for their fair market value)
for federal income tax purposes, with the result that unrealized gains or losses will be treated as though they were realized. Sixty percent of any net gain or loss recognized on these deemed sales, and 60% of any net realized gain or loss from any
actual sales of section 1256 contracts, will be treated as long-term capital gain or loss, and the balance will be treated as short-term capital gain or loss. The Fund may elect not to have the foregoing rules apply to any mixed straddle
(that is, a straddle, which the Fund clearly identifies in accordance with applicable regulations, at least one (but not all) of the positions of which are section 1256 contracts), although doing so may have the effect of increasing the relative
proportion of short-term capital gain (taxable as ordinary income) and thus increasing the amount of dividends it must distribute.
Code
section 1092 (dealing with straddles) also may affect the taxation of options, futures, and forward contracts in which the Fund may invest. That section defines a straddle as offsetting positions with respect to actively traded personal
property; for these purposes, options, futures, and forward contracts are positions in personal property. Under that section, any loss from the disposition of a position in a straddle may be deducted only to the extent the loss exceeds the
unrealized gain on the offsetting position(s) of the straddle. In addition, these rules may postpone the recognition of loss that otherwise would be recognized under the mark-to-market rules discussed above. The regulations under section 1092 also
provide certain wash sale rules, which apply to transactions where a position is sold at a loss and a new offsetting position is acquired within a prescribed period, and short sale rules applicable to straddles. If the Fund
makes certain elections, the amount, character, and timing of recognition of gains and losses from the affected straddle positions would be determined under rules that vary according to the elections made. Because only a few of the regulations
implementing the straddle rules have been promulgated, the tax consequences to the Fund of straddle transactions are not entirely clear.
If a
call option written by the Fund lapses (
i.e.
, terminates without being exercised), the amount of the premium it received for the option will be short-term capital gain. If the Fund enters into a closing purchase transaction with respect to a
written call option, it will have a short-term capital gain or loss based on the difference between the premium it received for the option it wrote and the premium it pays for the option it buys. If such an option is exercised and the Fund thus
sells the securities or futures contract subject to the option, the premium the Fund received will be added to the exercise price to determine the gain or loss on the sale. If a call option purchased by the Fund lapses, it will realize short-term or
long-term capital loss, depending on its holding period for the option. If the Fund exercises a purchased call option, the premium it paid for the option will be added to the basis in the subject securities or futures contract.
If the Fund has an appreciated financial position generally, an interest (including an interest through an option, futures, or forward
contract or short sale) with respect to any stock, debt instrument (other than straight debt), or partnership interest the fair market value of which exceeds its adjusted basis and enters into a constructive sale of
the position, the Fund will be treated as having made an actual sale thereof, with the result that it will recognize gain at that time. A constructive sale generally consists of a short sale, an offsetting notional principal contract, or a futures
or forward contract the Fund or a related person enters into with respect to the same or substantially identical property. In addition, if the appreciated financial position is itself a short sale or such a contract, acquisition of the underlying
property or substantially identical property will be deemed a constructive sale. The foregoing will not apply, however, to any Funds transaction during any taxable year that otherwise would be treated as a constructive sale if the transaction
is closed within 30 days after the end of that year and the Fund holds the appreciated financial position unhedged for 60 days after that closing (
i.e
., at no time during that 60-day period is the Funds risk of loss regarding that
position reduced by reason of certain specified transactions with respect to substantially identical or related property, such as having an option to sell, being contractually obligated to sell, making a short sale, or granting an option to buy
substantially identical stock or securities).
51
Income from Zero-Coupon and Payment-in-Kind Securities
. The Fund may acquire zero-coupon or
other securities (such as strips) issued with OID. As a holder of those securities, the Fund must include in its gross income the OID that accrues on the securities during the taxable year, even if it receives no corresponding payment on them during
the year. Similarly, the Fund must include in its gross income securities it receives as interest on payment-in-kind securities. With respect to market discount bonds (
i.e.
, bonds purchased at a price less than their
issue price plus the portion of OID previously accrued thereon), the Fund may elect to accrue and include in income each taxable year a portion of the bonds market discount.
* * * * *
The foregoing is only a general summary of some of the important federal tax considerations generally affecting the Fund. No attempt is made to present a
complete explanation of the federal tax treatment of the Funds activities, and this discussion is not intended as a substitute for careful tax planning. Accordingly, potential investors are urged to consult their own tax advisers for more
detailed information and for information regarding any state, local, or foreign taxes applicable to the Fund and to distributions therefrom.
FINANCIAL STATEMENTS
Because the Fund had not commenced
operations prior to the date of this SAI, no financial statements are available for the Fund.
52
APPENDIX B
Direxion Shares ETF Trust
Proxy Voting Policies and Procedures
Recognizing the increased scrutiny that both
institutions and corporations are under, it is important to have corporate governance that appreciates the importance of consistently applied policy guidelines that are aligned with investors views on key issues. With this in mind we currently
use ISSs proxy voting service to execute ballots on behalf of the Direxion Shares ETF Trust (collectively, the Trust). ISS prepares custom research and votes per their recommendation. If we agree with their recommendation, no
action is required. However, we retain the right and ability to override the vote if you disagree with ISSs vote recommendation.
I. Duty to Vote Proxies
Rafferty Asset Management, LLC
(Rafferty) views seriously its responsibility to exercise voting authority over securities that are owned by the Trust.
To document that proxies are being voted, ISS (on behalf of the Trust) will maintain a record reflecting when and how each proxy is voted consistent with the requirements of Rule 206(4)-6 under the
Investment Advisors Act of 1940 and other applicable regulations. Rafferty will make its proxy voting history and policies and procedures available to shareholders upon request.
II. Guidelines for Voting Proxies
Rafferty generally follows the recommendations of ISSs proxy voting guidelines as outlined below. Proxy proposals are considered on their own merits and a determination is made as to support or
oppose managements recommendation. Rafferty will typically accept ISSs recommendations on social issues as it does not have the means to evaluate the economic impact of such proposals, or determine a consensus among shareholders
social or political viewpoints.
III. Review and Compliance
It is Raffertys responsibility to oversee ISSs proxy voting to ensure compliance and timely reporting to
US Bank. Reports are verified monthly through ISSs Votex website. ISS provides US Bank with the NP-X file covering the period from July 1
st
through June 30
th
of the following year. US Bank files the NP-X with the SEC on the Trusts behalf. These records are maintained
for five years and the previous two years proxy voting records can be accessed by contacting US Bank.
Below is a summary outlining
ISSs US Proxy Voting Guidelines.
1. Auditors
Ratifying Auditors
Vote FOR proposals to ratify auditors, unless:
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An auditor has a financial interest in or association with the company, and is therefore not independent;
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There is reason to believe that the independent auditor has rendered an opinion which is neither accurate nor indicative of the companys
financial position; or
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Fees for non-audit services are excessive.
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2. Board of Directors
Voting on Director Nominees in Uncontested Elections
Vote CASE-BY-CASE on director nominees, examining, but not limited to, the following factors:
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Composition of the board and key board committees;
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Attendance at board and committee meetings;
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Corporate governance provisions and takeover activity;
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Disclosures under Section 404 of the Sarbanes-Oxley Act;
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B-1
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Long-term company performance relative to a market and peer index;
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Extent of the directors investment in the company;
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Existence of related party transactions;
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Whether the chairman is also serving as CEO;
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Whether a retired CEO sits on the board;
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Number of outside boards at which a director serves.
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WITHHOLD from individual directors who:
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Attend less than 75 percent of the board and committee meetings without a valid excuse (such as illness, service to the nation, work on behalf of the
company);
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Sit on more than six public company boards;
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Are CEOs of public companies who sit on the boards of more than two public companies besides their own (withhold only at their outside boards).
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WITHHOLD from the entire board (except for new nominees, who should be considered on a CASE-BY-CASE basis) if:
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The companys poison pill has a dead-hand or modified dead-hand feature. Withhold every year until this feature is removed;
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The board adopts or renews a poison pill without shareholder approval since the beginning of 2005, does not commit to putting it to shareholder vote
within 12 months of adoption or reneges on a commitment to put the pill to a vote and has not yet been withheld from for this issue;
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The board failed to act on a shareholder proposal that received approval by a majority of the shares outstanding the previous year;
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The board failed to act on a shareholder proposal that received approval of the majority of shares cast for the previous two consecutive years;
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The board failed to act on takeover offers where the majority of the shareholders tendered their shares;
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At the previous board election, any director received more than 50 percent withhold votes of the shares cast and the company has failed to address the
issue(s) that caused the high withhold rate;
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A Russell 3000 company underperformed its industry group (GICS group). The test will consist of the bottom performers within each industry group.
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WITHHOLD from inside directors and affiliated outside directors when:
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The inside or affiliated outside director serves on any of the three key committees: audit, compensation, or nominating;
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The company lacks an audit, compensation, or nominating committee so that the full board functions as that committee;
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The full board is less than majority independent.
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WITHHOLD from the members of the Audit Committee if:
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The non-audit fees paid to the auditor are excessive;
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A material weakness identified in the Section 404 disclosures rises to a level of serious concern; there are chronic internal control issues and
an absence of established effective control mechanisms.
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WITHHOLD from the members of the Compensation Committee if:
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There is a negative correlation between chief executive pay and company performance;
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The company fails to submit one-time transfers of stock options to a shareholder vote;
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The company fails to fulfill the terms of a burn rate commitment they made to shareholders;
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The company has poor compensation practices.
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WITHHOLD from directors, individually or the entire board, for egregious actions or failure to replace management as appropriate.
Classification/Declassification of the Board
Vote AGAINST proposals to classify the board.
Vote FOR proposals to repeal classified boards and to elect all directors annually.
B-2
Independent Chair (Separate Chair/CEO)
Generally vote FOR shareholder proposals requiring the position of chair be filled by an independent director unless there are compelling reasons to recommend against the proposal, such as a
counterbalancing governance structure. This should include all of the following:
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Designated lead director, elected by and from the independent board members with clearly delineated and comprehensive duties. (The role may
alternatively reside with a presiding director, vice chairman, or rotating lead director; however the director must serve a minimum of one year in order to qualify as a lead director.);
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Two-thirds independent board;
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All-independent key committees;
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Established governance guidelines;
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The company does not under-perform its peers.
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Majority Vote Shareholder Proposals
Generally vote FOR reasonably crafted shareholders
proposals calling for directors to be elected with an affirmative majority of votes cast and/or the elimination of the plurality standard for electing directors (including binding resolutions requesting that the board amend the companys
bylaws), provided the proposal includes a carve-out for a plurality voting standard when there are more director nominees than board seats (
e.g.
, contested elections). Consider voting AGAINST the shareholder proposal if the company has
adopted a formal corporate governance policy that present a meaningful alternative to the majority voting standard and provide an adequate response to both new nominees as well as incumbent nominees who fail to receive a majority of votes cast.
At a minimum, a companys policy should articulate the following elements to adequately address each director nominee who fails to
receive an affirmative of majority of votes cast in an election:
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Established guidelines disclosed annually in the proxy statement concerning the process to follow for nominees who receive majority withhold votes;
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The policy needs to outline a clear and reasonable timetable for all decision-making regarding the nominees status;
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The policy needs to specify that the process of determining the nominees status will be managed by independent directors and must exclude the
nominee in question;
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An outline of a range of remedies (for example, acceptance of the resignation, maintaining the director but curing the underlying causes of the
withheld votes, etc.);
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The final decision on the nominees status should be promptly disclosed via an SEC filing. The policy needs to include the timeframe for
disclosure and require a full explanation of how the decision was reached.
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In addition, the company should articulate to
shareholders why its policy is the best structure for demonstrating accountability to shareholders.
3. Proxy Contests
Voting for Director Nominees in Contested Elections
Vote CASE-BY-CASE on the election of directors in contested elections, considering the following factors:
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Long-term financial performance of the target company relative to its industry;
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Managements track record;
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Background to the proxy contest;
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Qualifications of director nominees (both slates);
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Strategic plan of dissident slate and quality of critique against management;
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Likelihood that the proposed goals and objectives can be achieved (both slates);
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Stock ownership positions.
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Reimbursing Proxy Solicitation Expenses
Vote CASE-BY-CASE on proposals to reimburse proxy solicitation expenses. When voting in conjunction with support of a dissident slate, vote FOR the
reimbursement of all appropriate proxy solicitation expenses associated with the election.
B-3
4. Takeover Defenses
Poison Pills
Vote FOR shareholder proposals requesting that the company submit its poison
pill to a shareholder vote or redeem it UNLESS the company has: (1) A shareholder approved poison pill in place; or (2) The company has adopted a policy concerning the adoption of a pill in the future specifying that the board will only
adopt a shareholder rights plan if either:
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Shareholders have approved the adoption of the plan; or
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The board, in its exercise of its fiduciary responsibilities, determines that it is in the best interest of shareholders under the circumstances to
adopt a pill without the delay in adoption that would result from seeking stockholder approval (
i.e.
the fiduciary out provision). A poison pill adopted under this fiduciary out will be put to a shareholder ratification vote
within twelve months of adoption or expire. If the pill is not approved by a majority of the votes cast on this issue, the plan will immediately terminate.
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Vote FOR shareholder proposals calling for poison pills to be put to a vote within a time period of less than one year after adoption. If the company has no non-shareholder approved poison pill in place
and has adopted a policy with the provisions outlined above, vote AGAINST the proposal. If these conditions are not met, vote FOR the proposal, but with the caveat that a vote within twelve months would be considered sufficient.
Vote CASE-by-CASE on management proposals on poison pill ratification, focusing on the features of the shareholder rights plan. Rights plans should
contain the following attributes:
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No lower than a 20 percent trigger, flip-in or flip-over;
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A term of no more than three years;
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No dead-hand, slow-hand, no-hand or similar feature that limits the ability of a future board to redeem the pill;
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Shareholder redemption feature (qualifying offer clause); if the board refuses to redeem the pill 90 days after a qualifying offer is announced, ten
percent of the shares may call a special meeting or seek a written consent to vote on rescinding the pill.
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Supermajority
Vote Requirements
Vote AGAINST proposals to require a supermajority shareholder vote. Vote FOR proposals to lower supermajority vote
requirements.
5. Mergers and Corporate Restructurings
For mergers and acquisitions, evaluate the proposed transaction based on these factors:
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ValuationIs the value to be received by the target shareholders (or paid by the acquirer) reasonable?
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Market reactionHow has the market responded to the proposed deal?
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Strategic rationaleDoes the deal make sense strategically? Cost and revenue synergies should not be overly aggressive or optimistic, but
reasonably achievable.
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Negotiations and processWere the terms of the transaction negotiated at arms length? Was the process fair and equitable?
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Conflicts of interestAre insiders benefiting from the transaction disproportionately and inappropriately as compared to non-insider shareholders?
As the result of potential conflicts, the directors and officers of the company may be more likely to vote to approve a merger than if they did not hold these interests.
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GovernanceWill the combined company have a better or worse governance profile than the parties to the transaction?
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6. State of Incorporation
Reincorporation Proposals
Vote
CASE-BY-CASE on proposals to change a companys state of incorporation, taking into consideration both financial and corporate governance concerns, including the reasons for reincorporating, a comparison of the governance provisions,
comparative economic benefits, and a comparison of the jurisdictional laws. Vote FOR reincorporation when the economic factors outweigh any neutral or negative governance changes.
B-4
7. Capital Structure
Common Stock Authorization
Vote CASE-BY-CASE on proposals to increase the number of shares
of common stock authorized for issuance using a model developed by ISS. Vote FOR proposals to approve increases beyond the allowable increase when a companys shares are in danger of being de-listed or if a companys ability to continue to
operate as a going concern is uncertain. In addition, for capital requests less than or equal to 300 percent of the current authorized shares that marginally fail the calculated allowable cap (
i.e.
, exceed the allowable cap by no more than 5
percent), on a CASE-BY-CASE basis, vote FOR the increase based on the companys performance and whether the companys ongoing use of shares has shown prudence.
Issue Stock for Use with Rights Plan
Vote AGAINST proposals that increase authorized
common stock for the explicit purpose of implementing a non-shareholder approved shareholder rights plan (poison pill).
Preferred Stock
Vote AGAINST proposals authorizing the creation of new classes of preferred stock with unspecified voting, conversion, dividend
distribution, and other rights (blank check preferred stock). Vote AGAINST proposals to increase the number of blank check preferred stock authorized for issuance when no shares have been issued or reserved for a specific purpose.
Vote FOR proposals to create de-clawed blank check preferred stock (stock that cannot be used as a takeover defense). Vote FOR
proposals to authorize preferred stock in cases where the company specifies the voting, dividend, conversion, and other rights of such stock and the terms of the preferred stock appear reasonable. Vote CASE-BY-CASE on proposals to increase the
number of blank check preferred shares after analyzing the number of preferred shares available for issue given a companys industry and performance in terms of shareholder returns.
8. Executive and Director Compensation
Equity Compensation Plans
Vote CASE-BY-CASE on equity-based compensation plans. Vote AGAINST the plan if:
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The total cost of the companys equity plans is unreasonable;
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The plan expressly permits the repricing of stock options without prior shareholder approval;
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There is a disconnect between CEO pay and the companys performance;
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The companys three year burn rate exceeds the greater of 2 percent and the mean plus 1 standard deviation of its industry group; or
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The plan is a vehicle for poor pay practices.
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Director Compensation
Vote CASE-BY-CASE on compensation plans for non-employee directors,
based on the cost of the plans against the companys allowable cap. Vote for the plan if ALL of the following qualitative factors in the boards compensation plan are met and disclosed in the proxy statement:
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Stock ownership guidelines with a minimum of three times the annual cash retainer.
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Vesting schedule or mandatory holding/deferral period:
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minimum vesting of three years for stock options or restricted stock; or
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Deferred stock payable at the end of a three-year deferral period.
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A balanced mix between cash and equity. If the mix is heavier on equity, the vesting schedule or deferral period should be more stringent, with the
lesser of five years or the term of directorship.
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No retirement/benefits and perquisites for non-employee directors; and
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A table with a detailed disclosure of the cash and equity compensation for each non-employee director for the most recent fiscal year.
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Disclosure of CEO Compensation-Tally Sheet
Companies should provide better and more transparent disclosure related to CEO pay. Consider withhold votes in the future from the compensation committee and voting against equity plans if compensation
disclosure is not improved and a tally sheet is not provided.
Employee Stock Purchase PlansQualified Plans
Vote CASE-BY-CASE on qualified employee stock purchase plans. Vote FOR plans if:
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Purchase price is at least 85 percent of fair market value;
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B-5
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Offering period is 27 months or less; and
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The number of shares allocated to the plan is ten percent or less of the outstanding shares.
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Employee Stock Purchase PlansNon-Qualified Plans
Vote CASE-by-CASE on nonqualified employee stock purchase plans. Vote FOR plans with:
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Broad-based participation (
i.e.
, all employees with the exclusion of individuals with 5 percent or more of beneficial ownership of the company);
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Limits on employee contribution (a fixed dollar amount or a percentage of base salary);
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Company matching contribution up to 25 percent of employees contribution, which is effectively a discount of 20 percent from market value;
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No discount on the stock price on the date of purchase since there is a company matching contribution.
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Option Exchange Programs/Re-pricing Options
Vote CASE-by-CASE on management proposals seeking approval to exchange/reprice options, taking into consideration historic trading patterns, rationale for the re-pricing, value-for-value exchange
treatment of surrendered options, option vesting, term of the option, exercise price and participation. Vote FOR shareholder proposals to put option re-pricing to a shareholder vote.
Severance Agreements for Executives/Golden Parachutes
Vote FOR shareholder proposals to
require golden parachutes or executive severance agreements to be submitted for shareholder ratification, unless the proposal requires shareholder approval prior to entering into employment contracts. Vote on a CASE-BY-CASE basis on proposals to
ratify or cancel golden parachutes. An acceptable parachute should include:
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A trigger beyond the control of management;
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The amount should not exceed three times base amount (defined as the average annual taxable W-2 compensation during the five years prior to the year in
which the change of control occurs;
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Change-in-control payments should be double-triggered,
i.e.
, (1) after a change in the companys ownership structure has taken place,
and (2) termination of the executive as a result of the change in control.
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9. Corporate Responsibility
Animal Rights
Generally
vote AGAINST proposals to phase out the use of animals in product testing unless:
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The company is conducting animal testing programs that are unnecessary or not required by regulation;
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The company is conducting animal testing when suitable alternatives are accepted and used at peer firms;
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The company has been the subject of recent, significant controversy related to its testing programs.
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Generally vote FOR proposals seeking a report on the companys animal welfare standards.
Drug Pricing and Re-importation
Generally vote AGAINST proposals requesting that companies
implement specific price restraints on pharmaceutical products unless the company fails to adhere to legislative guidelines or industry norms in its product pricing. Vote CASE-BY-CASE on proposals requesting that the company evaluate their product
pricing considering:
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The existing level of disclosure on pricing policies;
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Deviation from established industry pricing norms;
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The companys existing initiatives to provide its products to needy consumers;
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Whether the proposal focuses on specific products or geographic regions.
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Generally vote FOR proposals requesting that companies report on the financial and legal impact of their policies regarding prescription drug re-importation unless such information is already publicly
disclosed. Generally vote AGAINST proposals requesting that companies adopt specific policies to encourage or constrain prescription drug re-importation.
B-6
Genetically Modified Foods
Vote AGAINST proposals asking companies to voluntarily label genetically engineered (GE) ingredients in their products or alternatively to provide interim labeling and eventually eliminate GE ingredients
due to the costs and feasibility of labeling and/or phasing out the use of GE ingredients.
Tobacco
Most tobacco-related proposals (such as on second-hand smoke, advertising to youth and spin-offs of tobacco-related business) should be evaluated on a
CASE-BY-CASE basis.
Toxic Chemicals
Generally vote FOR resolutions requesting that a company discloses its policies related to toxic chemicals. Vote CASE-BY-CASE on resolutions requesting that companies evaluate and disclose the potential
financial and legal risks associated with utilizing certain chemicals.
Generally vote AGAINST resolutions requiring that a company
reformulate its products within a certain timeframe unless such actions are required by law in specific markets.
Arctic National Wildlife
Refuge
Generally vote AGAINST request for reports outlining potential environmental damage from drilling in the Arctic National Wildlife
Refuge (ANWR) unless:
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New legislation is adopted allowing development and drilling in the ANWR region;
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The company intends to pursue operations in the ANWR; and
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The company has not disclosed an environmental risk report for its ANWR operations.
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Concentrated Area Feeding Operations (CAFOs)
Vote FOR resolutions requesting that companies report to shareholders on the risks and liabilities associated with CAFOs unless:
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The company has publicly disclosed guidelines for its corporate and contract farming operations, including compliance monitoring; or
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The company does not directly source from CAFOs.
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Global Warming and Kyoto Protocol Compliance
Generally vote FOR proposals requesting a
report on greenhouse gas emissions from company operations and/or products unless this information is already publicly disclosed or such factors are not integral to the companys line of business. Generally vote AGAINST proposals that call for
reduction in greenhouse gas emissions by specified amounts or within a restrictive time frame unless the company lags industry standards and has been the subject of recent, significant fines or litigation resulting from greenhouse gas emissions.
Generally vote FOR resolutions requesting that companies outline their preparations to comply with standards established by Kyoto Protocol
signatory markets unless:
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The company does not maintain operations in Kyoto signatory markets;
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The company already evaluates and substantially discloses such information; or,
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Greenhouse gas emissions do not significantly impact the companys core businesses.
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Political Contributions
Vote
CASE-BY-CASE on proposals to improve the disclosure of a companys political contributions considering: any recent significant controversy or litigation related to the companys political contributions or governmental affairs; and the
public availability of a policy on political contributions. Vote AGAINST proposals barring the company from making political contributions.
Link Executive Compensation to Social Performance
Vote CASE-BY-CASE on proposals to review ways of linking executive compensation to social factors, such as corporate downsizings, customer or employee satisfaction, community involvement, human rights,
environmental performance, predatory lending, and executive/employee pay disparities.
B-7
Outsourcing/Offshoring
Vote CASE-BY-CASE on proposals calling for companies to report on the risks associated with outsourcing, considering: the risks associated with certain international markets; the utility of such a report;
and the existence of a publicly available code of corporate conduct that applies to international operations.
Human Rights Reports
Vote CASE-BY-CASE on requests for reports detailing the companys operations in a particular country and on proposals to implement
certain human rights standards at company facilities or those of its suppliers and to commit to outside, independent monitoring.
10.
Mutual Fund Proxies
Election of Directors
Vote CASE-BY-CASE on the election of directors and trustees, following the same guidelines for uncontested directors for public company shareholder meetings. However, mutual fund boards do not usually
have compensation committees, so do not withhold for the lack of this committee.
Converting Closed-end Fund to Open-end Fund
Vote CASE-BY-CASE on conversion proposals, considering the following factors:
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Past performance as a closed-end fund;
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Market in which the fund invests;
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Measures taken by the board to address the discount; and
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Past shareholder activism, board activity, and votes on related proposals.
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Establish Director Ownership Requirement
Generally vote AGAINST shareholder proposals that
mandate a specific minimum amount of stock that directors must own in order to qualify as a director or to remain on the board.
Reimburse
Shareholder for Expenses Incurred
Vote CASE-BY-CASE on shareholder proposals to reimburse proxy solicitation expenses. When supporting the
dissidents, vote FOR the reimbursement of the solicitation expenses.
Terminate the Investment Advisor
Vote CASE-BY-CASE on proposals to terminate the investment advisor, considering the following factors:
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Performance of the funds net asset value;
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The funds history of shareholder relations;
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The performance of other funds under the advisors management.
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B-8