STATEMENT OF ADDITIONAL INFORMATION
1301 Avenue of
the Americas (6
th
Avenue), 35
th
Floor
New York, New York 10019
(800) 851-0511
Dynamic HY Bond Fund
(PDHYX)
The Direxion Funds (the Trust) is a management investment company, or mutual fund, that offers shares of a variety of investment
portfolios to the public.
This Statement of Additional Information (SAI) relates to one of those portfolios, the Dynamic HY Bond Fund (the Fund).
This SAI, dated [ ], 2013, is not a prospectus. It should be read in conjunction with the Funds Prospectus dated
[ ], 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.
Dated:
[ ], 2013
TABLE OF CONTENTS
ii
iii
THE DIREXION FUNDS
The Trust is a Massachusetts business trust organized on June 6, 1997 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 (the 1940 Act). The Trust currently consists of numerous separate series, one of which is included in this SAI. On
April 28, 2006, the Trust changed its name to Direxion Funds. Prior to that date, the Trust was known as Potomac Funds.
This SAI relates
only to the Fund.
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. The Fund, however, intends to continue to meet certain tax-related diversification standards for each quarter
of its taxable year.
INVESTMENT P
OLICIES AND TECHNIQUES
The Fund is an actively managed Fund that seeks to maximize total return (income plus capital appreciation) by investing primarily in debt instruments,
including convertible securities, and derivatives of such instruments, with an emphasis on lower-quality debt instruments.
The Fund, under
normal circumstances, will invest at least 80% of its net assets (plus any borrowings for investment purposes) in high-yield debt instruments, commonly referred to as junk bonds, or derivatives of such instruments. The Fund may engage in
the types of transactions discussed below and in the Funds Prospectus. There is no assurance that any method of investment available to the Fund will result in the achievement of its objectives.
This section provides a detailed 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 a mutual fund 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.
1
Asset-Backe
d Securities
The Fund may invest in asset-backed securities of any rating or maturity. Asset-backed securities are securities issued by trusts and special purpose
entities that are backed by pools of assets, such as automobile and credit-card receivables and home equity loans, which pass through the payments on the underlying obligations to the security holders (less servicing fees paid to the originator or
fees for any credit enhancement). Typically, the originator of the loan or accounts receivable paper transfers it to a specially created trust, which repackages it as securities with a minimum denomination and a specific term. The securities are
then privately placed or publicly offered. Examples include certificates for automobile receivables and so-called plastic bonds, backed by credit card receivables.
The value of an asset-backed security is affected by, among other things, changes in the markets perception of the asset backing the security, the creditworthiness of the servicing agent for the
loan pool, the originator of the loans and the financial institution providing any credit enhancement. Payments of principal and interest passed through to holders of asset-backed securities are frequently supported by some form of credit
enhancement, such as a letter of credit, surety bond, limited guarantee by another entity or by having a priority to certain of the borrowers other assets. The degree of credit enhancement varies, and generally applies to only a portion of the
asset-backed securitys par value. Value is also affected if any credit enhancement has been exhausted.
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.
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 $250,000 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 $250,000 or more without regard to the interest rate ceilings on other deposits. To remain fully insured, these investments must be limited to $250,000 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 Group (S&P
®
) or
Prime-1
or
Prime-2
by
Moodys Investors Service, Inc. (Moodys), and in other lower quality commercial paper.
2
Caps, Floors an
d 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 a buyer and seller 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.
Corporat
e 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.
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.
3
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 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.
Fo
reign 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 over-the-counter (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.
4
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 Trusts Board of Trustees (Board or Trustees) or Rafferty Asset Management, LLC, the Funds investment
adviser, (Rafferty or Adviser) 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 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.
Index
ed 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.
5
Interest Rate Swaps
The Fund may enter into interest rate 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 interest rate 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 interest rate 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 interest rate 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.
Junk Bonds
The Fund may invest in lower-rated debt securities, including securities in the lowest credit rating category, of any maturity,
often called junk bonds.
Junk bonds generally offer a higher current yield than that available for higher-grade issues.
However, lower-rated securities involve higher risks, in that they are especially subject to adverse changes in general economic conditions and in the industries in which the issuers are engaged, to changes in the financial condition of the issuers
and to price fluctuations in response to changes in interest rates. During periods of economic downturn or rising interest rates, highly leveraged issuers may experience financial stress that could adversely affect their ability to make payments of
interest and principal and increase the possibility of default. In addition, the market for lower-rated debt securities has expanded rapidly in recent years, and its growth paralleled a long economic expansion. At times in recent years, the prices
of many lower-rated debt securities declined substantially, reflecting an expectation that many issuers of such securities might experience financial difficulties. As a result, the yields on lower-rated debt securities rose dramatically, but such
higher yields did not reflect the value of the income stream that holders of such securities expected, but rather, the risk that holders of such securities could lose a substantial portion of their value as a result of the issuers financial
restructuring or default. There can be no assurance that such declines will not recur.
The market for lower-rated debt issues generally
is thinner and less active than that for higher quality securities, which may limit the Funds ability to sell such securities at fair value in response to changes in the economy or financial markets. Adverse publicity and investor perceptions,
whether based on fundamental analysis or not, may also decrease the values and liquidity of lower-rated securities, especially in a thinly traded market. Changes by recognized rating services in their ratings of a fixed-income security may affect
the value of these investments. The Fund will not necessarily dispose of a security when its rating is reduced below its rating at the time of purchase. However, Rafferty will monitor the investment to determine whether continued investment in the
security will assist in meeting the Funds investment objective.
Options, Futures and Other Derivative
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.
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, the Fund is not deemed to be a
6
commodity pool operator or a commodity pool under the CEA. However, the registration exclusion was amended in February 2012, and such amendments took effect on April 24, 2012.
Under these amendments, 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).
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 operations 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 operation 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 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.
7
(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, U.S. Bank, N.A. (Custodian), 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
®
), NYSE MKT LLC
®
(the AMEX
®
) 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.
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.
8
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.
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.
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
9
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.
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 I
nvestment Companies
The Fund may invest in the securities of other investment companies, including open- and closed-end funds, and in exchange-traded funds. Investments in the securities of other investment companies may
involve duplication of advisory fees and certain other expenses. By investing in another investment company, the Fund becomes a shareholder of that investment company. As a result, Fund shareholders indirectly will bear the Funds proportionate
share of the fees and expenses paid by shareholders of the other investment company, in addition to the fees and expenses Fund shareholders bear in connection with the Funds own operations. The Fund intends to limit investments in securities
issued by other investment companies in accordance with the 1940 Act.
The Fund intends to limit its investments in securities issued by other
investment companies in accordance with the 1940 Act. Section 12(d)(1) of the 1940 Act precludes the Fund from acquiring (i) more than 3% of the total outstanding shares of another investment company; (ii) shares of another investment
company having an aggregate value in excess of 5% of the value of the total assets of the Fund; or (iii) shares of another registered investment company and all other investment companies having an aggregate value in excess of 10% of the value
of the total assets of the Fund. However, Section 12(d)(1)(F) of the 1940 Act provides that the provisions of paragraph 12(d) shall not apply to securities purchased or otherwise acquired by the Fund if (i) immediately after such purchase
or acquisition not more than 3% of the total outstanding shares of such investment company is owned by the Fund and all affiliated persons of the Fund; and (ii) the Fund has not offered or sold, and is not proposing to offer or sell its shares
through a principal underwriter or otherwise at a public or offering price that includes a sales load of more than 1 1/2%.
10
If the Fund invests in investment companies pursuant to Section 12(d)(1)(F), it must comply with
the following voting restrictions: when the Fund exercises voting rights, by proxy or otherwise, with respect to investment companies owned by the Fund, the Fund will either seek instruction from the Fund shareholders with regard to the voting
of all proxies and vote in accordance with such instructions, or vote the shares held by the Fund in the same proportion as the vote of all other holders of such security. In addition, an investment company purchased by the Fund pursuant to
Section 12(d)(1)(F) shall not be required to redeem its shares in an amount exceeding 1% of such investment companys total outstanding shares in any period of less than thirty days. Also, to the extent that an ETF has exemptive relief
under Section 12(d)(1)(j), the Fund may rely on that exemptive relief to exceed the limits imposed by Section 12(d)(1)(a).
Repurc
hase 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. The Fund may not 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 Re
purchase 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.
Sho
rt 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
11
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.
An interest rate swap is an agreement between two parties to exchange interest payments on a designated amount of two different securities for a
designated period of time. For example, two parties may agree to exchange interest payments on variable and fixed rate instruments. The Fund may enter into interest rate swap transactions to preserve a return or spread on a particular investment or
a portion of its bond portfolio.
A total return swap is a contract whereby one party agrees to make a series of payments to another party
based on the change in the market value of the assets underlying such contract (which can include a security, commodity, index or baskets thereof) during the specified period. In exchange, the other party to the contract agrees to make a series of
payments calculated by reference to an interest rate and/or some other agreed-upon amount (including the change in market value of other underlying assets). The Fund may use total return swaps to gain exposure to an asset without owning it or taking
physical custody of it. For example, if the Fund invested in total return commodity swaps, it would receive the price appreciation of a commodity, commodity index or portion thereof in exchange for payment of an agreed-upon fee.
In a credit default swap, the credit default protection buyer makes periodic payments, known as premiums, to the credit default protection seller. In
return the credit default protection seller will make a payment to the credit default protection buyer upon the occurrence of a specified credit event. A credit default swap can refer to a single issuer or asset, a basket of issuers or assets or
index of assets, each known as the reference entity or underlying asset. The Fund may act as either the buyer or the seller of a credit default swap. The Fund may buy or sell credit default protection on a basket of issuers or assets, even if a
number of the underlying assets referenced in the basket are lower-quality debt securities. In an unhedged credit default swap, the Fund buys credit default protection on a single issuer or asset, a basket of issuers or assets or index of assets
without owning the underlying asset or debt issued by the reference entity. Credit default swaps involve greater and different risks than investing directly in the referenced asset, because, in addition to market risk, credit default swaps include
liquidity, counterparty and operational risk.
Credit default swaps allow a fund to acquire or reduce credit exposure to a particular issuer,
asset or basket of assets. If a swap agreement calls for payments by a fund, the Fund must be prepared to make such payments when due. If the Fund is the credit default protection seller, the Fund will experience a loss if a credit event occurs and
the credit of the reference entity or underlying asset has deteriorated. If the Fund is the credit default protection buyer, the Fund will be required to pay premiums to the credit default protection seller.
12
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 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.
The Fund may enter into a swap agreement with respect to an index in circumstances where
Rafferty believes that it may be more cost effective or practical than buying the underlying 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.
Unrated Debt Securities
The Fund may also invest in unrated debt securities. Unrated debt, while not necessarily lower in quality than rated
securities, may not have as broad a market. Because of the size and perceived demand for the issue, among other factors, certain issuers may decide not to pay the cost of getting a rating for their bonds. The creditworthiness of the issuer, as well
as any financial institution or other party responsible for payments on the security, will be analyzed to determine whether to purchase unrated bonds.
13
U.S. Gove
rnment 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 they employ, as part of a cash reserve and 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.
U.S. government securities
include Treasury Bills (which mature within one year of the date they are issued), Treasury Notes (which have maturities of one to ten years) and Treasury Bonds (which generally have maturities of more than 10 years). All such Treasury securities
are backed by the full faith and credit of the United States.
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, a 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. A fund will invest in securities of such instrumentalities only when the Adviser is satisfied that the credit risk with respect to any such instrumentality is
comparatively minimal.
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-
14
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.
Zero-Co
upon Securities
The Fund may invest in zero-coupon bonds of any rating or maturity. Zero-coupon securities make no periodic interest payments, but are
sold at a deep discount from their face value (original issue discount or OID). The buyer recognizes a rate of return determined by the gradual appreciation of the security, which is redeemed at face value on a specified
maturity date. The OID varies depending on the time remaining until maturity, as well as market interest rates, liquidity of the security, and the issuers perceived credit quality. If the issuer defaults, the holder may not receive any return
on its investment. Because zero-coupon securities bear no interest and compound semi-annually at the rate fixed at the time of issuance, their value generally is more volatile than the value of other fixed-income securities. Since zero-coupon
bondholders do not receive interest payments, when interest rates rise, zero-coupon securities fall more dramatically in value than bonds paying interest on a current basis. When interest rates fall, zero-coupon securities rise more rapidly in value
because the bonds reflect a fixed rate of return. Zero-coupon securities allow an issuer to avoid the need to generate cash to meet current interest payments.
An investment in zero-coupon and delayed interest securities may cause the Fund to recognize income and make distributions to shareholders before it receives any cash payments on its investment.
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, the 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 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
15
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.
In addition to the foregoing, the Fund may borrow money from a bank as a temporary measure for extraordinary or emergency purposes in amounts not in excess of 5% of the value of its total assets. This
borrowing is not subject to the foregoing 300% asset coverage requirement. The Fund may pledge portfolio securities as Rafferty deems appropriate in connection with any borrowings.
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 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. 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 currently has no intention of lending its portfolio securities.
Portfolio Turnover
. The Trust anticipates that the Funds will have very high portfolio turnover due to the active management of its
portfolio..
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 from the
Funds distributions to them of any net capital gains recognized as a result of the sales. The trading costs and tax effects associated with portfolio turnover may adversely affect the Funds after-tax performance.
In 2011, the Fund experienced a high number of purchases and sales of Fund shares, necessitating multiple adjustments to Fund holdings. Because these
adjustments occurred in a period of lower overall assets for the Fund the resulting portfolio turnover was significantly higher than the Fund experienced in 2012, when trends in purchases and sales of Fund shares were not as dramatic and overall
Fund assets were steadily increasing.
INVEST
MENT RESTRICTIONS
In addition to the investment policies and limitations described above and described in the Prospectus, the Trust, on behalf of the Fund has adopted the
following investment limitations, which are fundamental policies and may not be changed without the vote of a majority of the outstanding voting securities of that Fund. Under the 1940 Act, a vote of the 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 of the Fund present at a shareholders meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by proxy.
16
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.
The Fund has adopted the following fundamental investment policy
that enables it to invest in another investment company or series thereof that
has substantially similar investment objectives and policies:
Notwithstanding any other limitation, the Fund may invest all of
its investable assets in an open-end management investment company with substantially the same investment objectives, policies and limitations as the Fund. For this purpose, all of the Funds investable assets means that the only
investment securities that will be held by the Fund will be the Funds interest in the investment company.
The Fund shall not:
1.
|
Lend any security or make any other loan if, as a result, more than 33 1/3% of the value of the Funds total assets would be lent to other parties, except
(1) through the purchase of a portion of an issue of debt securities in accordance with the Funds investment objective, policies and limitations; or (2) by engaging in repurchase agreements with respect to portfolio securities.
|
2.
|
Underwrite securities of any other issuer.
|
3.
|
Purchase, hold, or deal in real estate or oil and gas interests.
|
4.
|
Pledge, mortgage, or hypothecate the Funds assets, except (1) to the extent necessary to secure permitted borrowings; (2) in connection with the
purchase of securities on a forward-commitment or delayed-delivery basis or the sale of securities on a delayed-delivery basis; and (3) in connection with options, futures contracts, options on futures contracts, forward contracts, swaps, caps,
floors, collars and other financial instruments.
|
5.
|
Invest in physical commodities, except that the Fund may purchase and sell foreign currency, options, futures contracts, options on futures contracts, forward
contracts, swaps, caps, floors, collars, securities on a forward-commitment or delayed-delivery basis, and other financial instruments.
|
6.
|
Issue any senior security (as such term is defined in Section 18(f) of the 1940 Act) (including the amount of senior securities issued by excluding
liabilities and indebtedness not constituting senior securities), except (1) that the Fund may issue senior securities in connection with transactions in options, futures, options on futures and forward contracts, swaps, caps, floors, collars
and other similar investments; (2) as otherwise permitted herein and in Limitation 4 above and 7 below; and (3) the Fund may make short sales of securities.
|
7.
|
Borrow money, except (1) to the extent permitted under the 1940 Act (which currently limits borrowing to no more than 33 1/3% of the value of the Funds total
assets; (2) as a temporary measure and then only in amounts not to exceed 5% of the value of the Funds total assets; (3) to enter into reverse repurchase agreements; or (4) to lend portfolio securities. For purposes of this
investment limitation, the purchase or sale of options, futures contracts, options on futures contracts, forward contracts, swaps, caps, floors, collars and other financial instruments shall not constitute borrowing.
|
8.
|
Invest more than 25% of the value of its net assets in the securities of issuers in any single industry, provided that there shall be no limitation on the purchase of
obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities.
|
17
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 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 the Fund; 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.
Aggregate brokerage commissions paid by the Fund for the fiscal years shown are set forth in the table below. As discussed in the Prospectus, Rafferty expects a significant portion of the assets of the
Fund to come from professional money managers and investors who use the Fund as part of asset allocation and market timing investment strategies. If a large number of investors purchase or sell the Fund, the Fund will need to
reposition its portfolio and incur related brokerage fees. Depending on frequency and magnitude of these portfolio transactions, over the course of a year the total impact on brokerage fees paid can vary greatly from year to year. Additionally, the
Fund will invest significantly in over-the-counter financial instruments with negotiated terms. These financial instruments often include a provision that requires the Fund to close out its position during periods of higher market volatility. In
such instances, the Fund would then reinvest in similar financial instruments in order to continue to seek its investment objective. As a result, depending on the market volatility that the Fund has experienced in the course of a year, the resulting
brokerage commissions could vary significantly.
18
|
|
|
|
|
Fiscal Year
|
|
Brokerage Fees Paid
|
|
Year Ended August 31, 2012
|
|
$
|
310,225
|
|
Year Ended August 31, 2011*
|
|
$
|
327,483
|
|
Year Ended August 31, 2010
|
|
$
|
14,938
|
|
*
|
In 2011, the Dynamic HY Bond Fund shifted its investment style from investments that primarily do not incur brokerage charges to those which incur customary brokerage
charges. This shift was consistent with the Funds investment strategy.
|
PORTFOLIO HOLDINGS INFORMATION
The Trust maintains portfolio holdings disclosure policies that govern the timing and circumstances of disclosure to shareholders and third parties of information regarding the Funds portfolio
investments to ensure that such disclosure is in the best interests of the Funds shareholders. In adopting the policies, the Board considered actual and potential material conflicts that could arise between the interest of Fund shareholders,
the Adviser, distributor, or any other affiliated person of the Fund. 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.
From time to time, rating and ranking organizations such as S&P
®
and Morningstar, Inc. may request complete portfolio holdings information in connection with rating the Fund. Similarly, pension plan sponsors, consultants and/or
other financial institutions may request a complete list of portfolio holdings in order to assess the risks of the Funds portfolio along with related performance attribution statistics. The Trust believes that these third parties have
legitimate objectives in requesting such portfolio holdings information. To prevent such parties from potentially misusing the complete portfolio holdings information, the Fund will generally only disclose such information as of the end of the most
recent calendar quarter, with a lag of approximately 60 days. In addition, the Funds President or Chief Compliance Officer 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 recipient is subject to a confidentiality agreement; (2) the recipient will utilize the information to reach certain conclusions about
the investment management characteristics of the Fund and will not use the information to facilitate or assist in any investment program; and (3) the recipient will not provide access to third parties to this information. The Chief Compliance
Officer shall report any disclosures made pursuant to this exception to the Board.
In addition, the Funds service providers, such as
custodian, administrator, transfer agent, distributor, legal counsel and independent registered public accounting firm may receive portfolio holdings information in connection with their services to the Fund. In no event shall the Advisers, their
affiliates or employees, or the Fund receive any direct or indirect compensation in connection with the disclosure of information about the Funds portfolio holdings.
In the event a portfolio holdings disclosure made pursuant to the policies presents a conflict of interest between the Funds shareholders and Rafferty, the distributor and their affiliates or
employees and any affiliated person of the Fund, the disclosure will not be made unless a majority of the Independent Trustees approves such disclosure.
19
MANAGEMENT OF THE TRUST
The Board of Trustees
The Trust is governed by its Board of Trustees. 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 Commonwealth of Massachusetts, 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, U.S. Bancorp Fund Services, LLC (USBFS) and 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, USBFS and Alaric 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 also reports regularly to the Board on Fund valuation matters. In addition,
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.
20
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 funds 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 funds in the complex.
The Trust is part of the Direxion Family of Investment Companies, which is comprised
of the 1 portfolio within the Direxion Insurance Trust, [ ] portfolios within the Direxion Funds and [ ] portfolios within Direxion Shares ETF Trust. The same persons who
constitute the Board also constitute the board of trustees of the Direxion Insurance Trust. In addition, the Independent Trustees constitute two-thirds of the board of trustees of the Direxion Shares ETF 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 Independent Trustees of the Trust also serve on the Board of the Direxion Insurance Trust and Direxion Shares ETF Trust, the other registered investment companies in the Direxion mutual fund
complex. In addition, Mr. Rafferty serves on the Board of the Direxion Insurance Trust. Unless otherwise noted, an individuals business address is 1301 Avenue of the Americas (6
th
Avenue), 35
th
Floor, New York, New York 10019.
21
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
Fund
Complex
Overseen by
Trustee
(2)
|
|
Other Trusteeships/
Directorships Held by
Trustee During Past
Five Years
|
Lawrence C. Rafferty
(1)
Age:
70
|
|
Chairman of the Board of Trustees
|
|
Lifetime of Trust until removal or resignation; Since 1997
|
|
Chairman and Chief
Executive Officer of
Rafferty,
1997-present;
Chief Executive Officer of
Rafferty Companies, LLC,
1996-present; Chief
Executive Officer of
Rafferty Capital
Markets,
Inc., 1995-present.
|
|
[ ]
|
|
Board of Trustees,
Fairfield University;
Board of Directors, St.
Vincents Services;
Executive Committee,
Metropolitan Golf
Association
|
|
|
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
Fund
Complex
Overseen by
Trustee
(2)
|
|
Other Trusteeships/
Directorships Held by
Trustee
During Past Five
Years
|
Gerald E. Shanley III
Age:
69
|
|
Trustee
|
|
Lifetime of Trust until removal or resignation; Since 1997
|
|
Retired, Since 2002; Business Consultant, 1985-present; Trustee of Trust Under Will of Charles S. Payson, 1987-present; C.P.A., 1979-present.
|
|
[ ]
|
|
None
|
|
|
|
|
|
|
John Weisser
Age:
71
|
|
Trustee
|
|
Lifetime of Trust until removal or resignation; Since 2007
|
|
Retired, Since 1995; Salomon Brothers, Inc, 1971-1995, most recently as Managing Director.
|
|
[ ]
|
|
Director, Eclipse Funds (2 Funds), Eclipse Funds, Inc. (1 Fund); 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. Rafferty is affiliated with Rafferty. Mr. Rafferty is the Chairman and Chief Executive Officer 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 [ ]
portfolios, the Direxion Insurance Trust, which, as of the date of this SAI, offers for sale one portfolio, and the Direxion Shares ETF Trust, which, as of the date of this SAI, offers for sale to the public
[ ] of the [ ] funds currently registered with the SEC.
|
22
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.
Lawrence C. Rafferty: Mr. Rafferty has extensive experience in financial services businesses, including as chairman and chief executive officer of Rafferty. He has served on the boards of both a
private university and a childcare agency. He also has multiple years of service as a Trustee.
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.
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 auditors); 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 four 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 (as defined
in the 1940 Act) of the Trust. 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.
23
Principa
l Office
rs 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:
|
|
|
|
|
|
|
|
|
|
|
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 the
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
|
|
Chief Executive Officer and Chief Investment Officer
|
|
One Year;
Since 2006
|
|
Managing Director of
Rafferty, 1999-present.
|
|
[ ]
|
|
N/A
|
|
|
|
|
|
|
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:
39
|
|
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
|
24
|
|
|
|
|
|
|
|
|
|
|
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 the
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
Secretary
|
|
One Year;
Since 2012
One Year; Since 2011
|
|
General Counsel and Chief Compliance Officer, Rafferty Asset Management, LLC, since October 2010; Summer Associate at Skadden, Arps, Slate, Meagher & Flom, LLP, May Aug
2009; Summer Associate at Foley & Lardner, LLP May - August 2008; Vice President USBFS November 2003 August 2007.
|
|
N/A
|
|
N/A
|
(1)
|
Mr. ONeill serves as Chairman of the Board of Trustees of the Direxion Shares ETF Trust.
|
(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
[ ] 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 [ ] of the [ ] funds currently registered with the SEC.
|
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:
|
|
|
|
Lawrence C.
Rafferty
|
|
|
Gerald E.
Shanley III
|
|
|
John Weisser
|
|
Aggregate Dollar Range of Equity Securities in the Direxion Family of Investment Companies
(1)
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
$
|
50,001-
100,000
|
|
(1)
|
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 [
] 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
[ ] of the [ ] funds currently registered with the SEC.
|
The
Trusts Declaration of Trust 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 Trust for acting as a Trustee or officer of the Trust.
The following tables show the
compensation earned by each Trustee for the Trusts fiscal year ended August 31, 2012.
25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Person, Position
|
|
Aggregate
Compensation
From the Dynamic
HY Bond Fund
|
|
|
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
(1)
|
|
Interested Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lawrence C. Rafferty
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
0
|
|
Disinterested Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daniel J. Byrne
(
2
)
|
|
$
|
946
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
100,000
|
|
Gerald E. Shanley III
|
|
$
|
946
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
100,000
|
|
John Weisser
|
|
$
|
946
|
|
|
$
|
0
|
|
|
$
|
0
|
|
|
$
|
100,000
|
|
(1)
|
For the fiscal year ended August 31, 2013 trustees fees and expenses in the amount of
$[ ] were incurred by the Trust.
|
(2)
|
Effective June 24, 2013, Mr. Byrne resigned as a Trustee of the Trust.
|
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. As of [ ], 2013, the following shareholders were considered to be either a control person or principal shareholder of
the Fund:
Dynamic HY Bond Fund
|
|
|
|
|
|
|
|
|
|
|
|
|
Name and Address
|
|
Parent Company
|
|
|
Jurisdiction
|
|
|
% Ownership
|
|
National Financial Services Corp.
One World Financial Center
200 Liberty Street, Floor 5
New York, NY 10281-1003
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
[
|
]%
|
Trust Company of America
P.O. Box 6503
Englewood, CO 80155-6503
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
[
|
]%
|
Millennium Trust Company LLC
2001 Spring Road, Suite 700
Oak Brook, IL 60523-1890
|
|
|
N/A
|
|
|
|
N/A
|
|
|
|
[
|
]%
|
In addition, as of [ ], 2013,
the Trustees and officers as a group owned less than 1% of the outstanding shares of the Fund.
26
Investment Adviser
Rafferty Asset Management, LLC, 1301 Avenue of the Americas (6
th
Avenue), 35
th
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, 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 Independent Trustees) and Rafferty, as sole shareholder of the Fund, in compliance with the 1940 Act. The Advisory Agreement with respect to the Fund continued in force for an initial
period of two years after the date of its approval. The Advisory Agreement is renewable thereafter 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 0.75% at an annual rate based on its average daily net assets. Rafferty has contractually
agreed to waive 0.15% of this fee for the Fund, so that it does not exceed 0.60%, through September 1, 2015.
The table below shows the amount
of advisory fees incurred by the Fund and the amount of fees waived and/or reimbursed by Rafferty for the fiscal years ended August 31.
|
|
|
|
|
|
|
|
|
|
|
|
|
Dynamic HY Bond Fund
|
|
Advisory Fees Incurred
|
|
|
Waived fees and/or
expenses
reimbursed by Adviser
|
|
|
Net Fees Paid to Advisor
|
|
Year Ended August 31, 2012
|
|
$
|
1,477,298
|
|
|
$
|
295,459
|
|
|
$
|
1,181,839
|
|
Year Ended August 31, 2011
|
|
$
|
1,410,592
|
|
|
$
|
41,024
|
|
|
$
|
1,369,568
|
|
Year Ended August 31, 2010
|
|
$
|
438,195
|
|
|
$
|
0
|
|
|
$
|
438,195
|
|
Additionally, Rafferty has entered into an Operating Services Agreement with the Fund. Under this Operating
Service Agreement, Rafferty, in exchange for an Operating Services Fee paid to Rafferty by the Fund, has contractually obligated to pay all Fund expenses through September 1, 2015 other than the following: excluding, management fees, distribution
and/or service fees, shareholder service fees, Acquired Fund Fees and 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 or other expenses outside the typical day-to-day operations of the Fund. This agreement may be terminated at any time by the Board of Trustees.
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, Rafferty and the Funds distributor 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.
27
Portfolio Manager
An investment team of Rafferty employees has the day-to-day responsibility for managing the Fund. The members of the investment team that are jointly and
primarily responsible for the day-to-day management of the Fund are Paul Brigandi and Tony Ng. In addition to the Fund, the team manages the following other accounts as of [ ],
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
|
|
|
[
|
]
|
|
$
|
[
|
]
|
|
|
0
|
|
|
$
|
0
|
|
Other Pooled Investment Vehicles
|
|
|
[
|
]
|
|
$
|
[
|
]
|
|
|
0
|
|
|
$
|
0
|
|
Other Accounts
|
|
|
[
|
]
|
|
$
|
[
|
]
|
|
|
0
|
|
|
$
|
0
|
|
Rafferty manages no other accounts with an investment objective similar to that of the Fund. However, the Fund
may invest in the same securities but the nature of each investment may be opposite and in different proportions. Rafferty ordinarily executes transactions for a Fund market-on-close, in which Funds purchasing or selling the same
security receive the same closing price.
Rafferty has not identified any additional material conflicts between the Fund and other accounts
managed by the investment committee. However, other actual or apparent conflicts of interest may arise in connection with the day-to-day management of the Fund and other accounts. The management of the Fund and other accounts may result in unequal
time and attention being devoted to the Fund and other accounts. Raffertys management fees for the services it provides to other accounts varies and may be higher or lower than the advisory fees it receives from the Fund. This could create
potential conflicts of interest in which the portfolio manager may appear to favor one investment vehicle over another resulting in an account paying higher fees or one investment vehicle out performing another.
The investment committees compensation is paid by Rafferty. Their compensation primarily consists of a fixed base salary and a bonus. The
investment committees 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 committees 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 committee 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 August 31, 2012.
Proxy 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 its 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 its shareholders, taking into account the value of the Funds investments.
28
More Information.
The actual voting records relating to portfolio securities during the most
recent 12-month period ended June 30 is available without charge, upon request by calling toll-free, 1-800-851-0511 or by accessing the SECs website at www.sec.gov.
Fund Admi
nistrator, Fund Accountant, Transfer Agent and Custodian
U.S. Bancorp Fund Services, LLC (Administrator), 615 East Michigan Street, Milwaukee, Wisconsin 53202, provides administrative, fund accounting and transfer agent services to the Fund. U.S.
Bank, N.A., Custody Operations, 1555 N. River Center Drive, Suite 302, Milwaukee, Wisconsin, 53202, an affiliate of the Administrator, provides custodian services to the Fund.
Pursuant to an Administration Servicing Agreement (Service Agreement) between the Trust and the Administrator, the Administrator provides the Trust with administrative and management services
(other than investment advisory services). As compensation for these services, the Trust pays the Administrator a fee based on the Trusts total average daily net assets of 0.045% on net assets. The Administrator also is entitled to certain
out-of-pocket expenses.
The tables below show the amount of administrative and management services fees incurred by the Fund to the
Administrator for the fiscal year ended August 31.
|
|
|
|
|
Fiscal Year
|
|
Fees Paid to the Administrator
|
|
Year Ended August 31, 2012
|
|
$
|
109,594
|
|
Year ended August 31, 2011
|
|
$
|
89,274
|
|
Year ended August 31, 2010
|
|
$
|
29,620
|
|
Pursuant to a Fund Accounting Servicing Agreement between the Trust and U.S. Bancorp Fund Services, LLC
(Fund Accountant), the Fund Accountant provides the Trust with accounting services, including portfolio accounting services, tax accounting services and furnishing financial reports. For these services, the Trust pays the Fund Accountant
a fee based on the Trusts total average daily net assets. The Fund Accountant also is entitled to certain out-of-pocket expenses, including pricing expenses.
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 portfolios. Pursuant to the Custodian
Agreement, the Custodian receives an annual fee based on the Trusts total average daily net assets. The Custodian also is entitled to certain out-of-pocket expenses. U.S. Bank N.A. and/or its affiliates receive revenue from certain
broker-dealers that may receive Rule 12b-1 fees or other payments from mutual funds in which the Fund may invest. In recognition of this revenue, the Fund may receive a credit from U.S. Bank N.A. and/or its affiliates for fees otherwise payable by
the Fund.
Distri
butor
Rafferty Capital Markets, LLC, 1010 Franklin Avenue, 3
rd
Floor, Garden City, New York 11530, serves as the distributor (Distributor) in connection with the
continuous offering of the Funds shares. The Distributor and participating dealers with whom it has entered into dealer agreements offer shares of the Fund as agents on a best efforts basis and are not obligated to sell any specific amount of
shares. For the fiscal year ended October 31, 2012, the Distributor received $90,000 as compensation from Rafferty for distribution services for the Trust with respect to each other series of the Trust. Mr. Rafferty is an affiliated person of
the Distributor.
Distribution Plan and Service Fees
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 Plan of Distribution (the Plan) for shares of the Fund 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 Plan or any related agreement.
29
Pursuant to the Plan, the Fund may pay up to 1.00% of the shares average daily net assets. The
Board has authorized the Fund to pay 0.25% of the Funds average daily net assets.
In addition, the Board approved a separate annualized
shareholder services fee of 0.25% of its average daily net assets. The fee compensates service providers and/or financial intermediaries for shareholder services provided to the Fund, including but not limited to: (a) answering shareholder
inquiries regarding the manner in which purchases, exchanges and redemptions of shares of the Fund may be effected and other matters pertaining to the Fund; (b) providing necessary personnel and facilities to establish and maintain shareholder
accounts and records; (c) assisting shareholders in arranging for processing of purchase, exchange and redemption transactions; (d) assisting in the enhancement of relations and communication between shareholders and the Fund;
(e) assisting in the maintenance of Fund records containing shareholder information; and (g) providing such other related personal services as the shareholder may request.
Under an agreement with the Fund, your Financial Advisor may provide services, as described in the Prospectus, and as described above, and receive Rule 12b-1 fees and or shareholder servicing fees from
the Fund.
The Plan was approved by the Trustees and the Independent Trustees of the Fund. In approving the 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 Plan and the purpose for which
such expenditures were made.
The 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 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.
The table below show the amount
of Rule 12b-1 fees incurred and the allocation of such fees by the Fund for the fiscal year ended August 31, 2012.
12b-1 Fees Paid
$492,432
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fund
|
|
Advertising
and
Marketing
|
|
|
Printing
and
Postage
|
|
|
Payment
to
Distributor
|
|
|
Payment to
Dealers
|
|
|
Compensation
to Sales
Personnel
|
|
|
Other
Marketing
Expenses
|
|
Dynamic HY Bond Fund
|
|
$
|
403,794
|
|
|
$
|
0
|
|
|
$
|
9,849
|
|
|
$
|
4,924
|
|
|
$
|
59,092
|
|
|
$
|
14,773
|
|
Independent Registered Public Accounting Fi
rm
[ ], is the independent registered public accounting firm for the Trust. The
Financial Statements of the Fund for the fiscal years ended August 31, 2012 have been audited by [ ] and are incorporated by reference herein, which is given upon their
authority as experts in accounting and auditing.
DETE
RMINATION OF NET ASSET VALUE
The NAV per share of the Fund is determined daily, Monday through Friday, as of the close of regular trading on the New York Stock
Exchange (NYSE) (normally at 4:00 p.m. Eastern time), each day the NYSE is open for business (Business Day). However, on days that the Securities Industry and Financial Markets Association (SIFMA) recommends that
the bond markets close all day (a Bond Market Holiday), the Fund does not calculate its NAV, even if the NYSE is open for business. On such days, orders for purchase or redemption will receive the NAV next calculated on the following
Business Day that is not a Bond Market Holiday. Similarly, on days that the bond markets close early, the Fund treats the portion of the day that the bond markets are closed as a
30
Bond Market Holiday and calculates its NAV as of the SIFMA recommended closing time for the bond markets, which may be before 4:00 p.m. Eastern time, subject to the discretion of the Adviser. In
such instances, orders for purchase or redemption that are received prior to the close of bond markets will receive the NAV calculated at the time of the bond markets closure, whereas orders for purchase or redemption that are received thereafter
will receive the NAV next calculated on the following Business Day that is not a Bond Market Holiday. The NYSE is not open on New Years Day, Presidents Day, Martin Luther Kings Birthday, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day, and Christmas Day. In addition to these holidays, the Bond Market is not open on Columbus Day and Veterans Day.
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, on a particular day, an exchange-traded security does not trade, then the mean between the closing bid and asked prices will be used. All equity securities that are not traded on a listed exchange
held by the Fund will be valued at the last sales price in the OTC market, or, if no sales price is reported, the mean of the last bid and asked price is used. 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, exchange-traded options and options on futures are valued at the composite price using the
National Best Bid and Offer quotes (NBBO). NBBO consists of the highest bid price and lowest asked price across any of the exchanges on which an option is quoted, thus providing a view across the entire U.S. options marketplace.
Specifically, composite pricing looks at the last trades on exchanges where the options are traded. If there are no trades for the option on a given business day, the composite option pricing calculates the mean of the highest bid price and lowest
ask price across the exchanges where the option is traded. Non-exchange traded options are valued at the mean between the last bid and asked quotations.
The prices of futures contracts are valued either at the settlement prices established each day on the exchange on which they are traded if the settlement price reflects trading prior to the close of
regular trading or at the last sales price prior to the close of regular trading if the settlement prices established by the exchange reflects trading after the close of regular trading.
Swap contracts are valued using the closing prices of the underlying reference entity or the closing value of the underlying reference index.
Foreign securities, currencies and other assets denominated in foreign currencies are translated into U.S. Dollars at the exchange rate of such currencies against the U.S. Dollar, as provided by an
independent pricing service or reporting agency.
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. Other debt securities (including credit default swaps) are valued by using either the closing bid and ask prices provided by the Funds pricing service or the mean between the closing bid and ask prices provided by brokers that make
markets in such instruments, or if such prices are unavailable, by a pricing matrix method. U.S. government securities are valued at the mean between the closing bid and asked price provided by an independent third party pricing service.
Dividend income and other distributions are recorded on the ex-distribution date.
31
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.
For purposes of calculating its daily NAV, the Fund typically reflects changes in its holdings of portfolio securities on the first business day following a portfolio trade (commonly known as T+1
accounting). However, the Fund is permitted to include same day trades when calculating its NAV (commonly referred to as trade date accounting) on days when the Fund receives substantial redemptions. Such redemptions can result in
an adverse impact on the Funds NAV when there is a disparity between the trade price and the closing price of the security. Thus, the Funds use of trade date accounting is likely to lessen the impact of substantial redemptions on the
Funds NAV.
REDEMPTIONS
Redemption In-Kind
The Trust has filed a notice of election under Rule 18f-1 of the 1940 Act, which obligates the Fund to redeem shares for any shareholder for cash during any 90-day period up to $250,000 or 1% of the
Funds NAV, whichever is less. Any redemption beyond this amount also will be in cash unless the Trustees determine that further cash payments will have a material adverse effect on remaining shareholders. In such a case, the Fund will pay all
or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines NAV. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. To the extent that the
Fund redeems its shares in this manner, the shareholder assumes the risk of a subsequent change in the market value of those securities, the cost of liquidating the securities and the possibility of a lack of a liquid market for those securities.
Shareholders who receive futures contracts or options on futures contracts in connection with a redemption in-kind may be responsible for making any margin payments due on those contracts.
Redemptions by Te
lephone
Shareholders may redeem shares of the Fund by telephone. When acting on verbal instructions believed to be genuine, the Trust, Rafferty, transfer agent and their trustees, directors, officers and
employees are not liable for any loss resulting from a fraudulent telephone transaction request and the investor will bear the risk of loss. In acting upon telephone instructions, these parties use procedures that are reasonably designed to ensure
that such instructions are genuine, such as (1) obtaining some or all of the following information: account number, name(s) and social security number(s) registered to the account, and personal identification; (2) recording all telephone
transactions; and (3) sending written confirmation of each transaction to the registered owner. To the extent that the Trust, Rafferty, transfer agent and their trustees, directors, officers and employees do not employ such procedures, some or
all of them may be liable for losses due to unauthorized or fraudulent transactions.
Receiving
Payment
Payment of redemption proceeds will be made within seven days following the Funds receipt of your request (if received in
good order as described below) for redemption. For investments that have been made by check, payment on redemption requests may be delayed until the transfer agent is reasonably satisfied that the purchase payment has been collected by the Trust
(which may require up to 10 calendar days). To avoid redemption delays, purchases should be made by direct wire transfer.
A redemption
request will be considered to be received in good order if:
|
|
|
The number or amount of shares and the class of shares to be redeemed and shareholder account number have been indicated;
|
|
|
|
Any written request is signed by a shareholder and by all co-owners of the account with exactly the same name or names used in establishing the
account;
|
32
|
|
|
Any written request is accompanied by certificates representing the shares that have been issued, if any, and the certificates have been endorsed for
transfer exactly as the name or names appear on the certificates or an accompanying stock power has been attached; and
|
|
|
|
The signatures on any written redemption request in excess of $100,000 or more and on any certificates for shares (or an accompanying stock power) have
been guaranteed by a national bank, a state bank that is insured by the Federal Deposit Insurance Corporation, a trust company or by any member firm of the New York, American, Boston, Chicago, Pacific or Philadelphia Stock Exchanges. Signature
guarantees also will be accepted from savings banks and certain other financial institutions that are deemed acceptable by U.S. Bancorp Funds Services, LLC, as transfer agent, under its current signature guarantee program.
|
The right of redemption may be suspended or the date of payment postponed for any period during which (1) the NYSE
is closed (other than customary weekend or holiday closings); (2) trading on the NYSE is restricted; (3) situations where an emergency exists as a result of which it is not reasonably practicable for the Fund to fairly determine the value
of its net assets or disposal of the Funds securities is not reasonably practicable; or (4) the SEC has issued an order for the protection of the Funds shareholders.
Anti-Money
Laundering
The Fund is required to comply
with various federal anti-money laundering laws and regulations. Consequently, the Fund may be required to freeze the account of a shareholder if the shareholder appears to be involved in suspicious activity or if certain account
information matches information on government lists of known terrorists or other suspicious persons, or the Fund may be required to transfer the account or proceeds of the account to a government agency. In addition, pursuant to the Funds
Customer Identification Program, the Funds transfer agent will complete a thorough review of all new opening account applications and will not transact business with any person or entity whose identity cannot be adequately verified.
EXCHANGE P
RIVILEGE
An exchange is effected through the redemption of the shares tendered for exchange and the purchase of shares being acquired at their respective NAVs as next determined following receipt by the Fund whose
shares are being exchanged of (1) proper instructions and all necessary supporting documents; or (2) a telephone request for such exchange in accordance with the procedures set forth in the Prospectus and below. Telephone requests for an
exchange received by the Fund before 4:00 p.m. Eastern time will be effected at the close of regular trading on that day. Requests for an exchange received after the close of regular trading will be effected on the NYSEs next trading day. Due
to the volume of calls or other unusual circumstances, telephone exchanges may be difficult to implement during certain time periods.
The Trust reserves the right to reject any order to acquire its shares through exchange or otherwise to restrict or terminate the exchange privilege at
any time. In addition, the Trust may terminate this exchange privilege upon a 60-day notice.
SHAREH
OLDER AND OTHER INFORMATION
Each share of the Fund gives the shareholder one vote in matters submitted to shareholders for a vote. Each class of the Fund has equal voting rights, except that, in matters affecting only a particular
class, only shares of that class are entitled to vote. Share voting rights are not cumulative, and shares have no preemptive or conversion rights. Shares are not transferable. As a Massachusetts business trust, the Trust is not required to hold
annual shareholder meetings. Shareholder approval will be sought only for certain changes in a Trusts or the Funds operation and for the election of Trustees under certain circumstances. Trustees may be removed by the Trustees or by
shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of a Trusts outstanding shares.
33
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 discounts, 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 its net
short-term capital gain
, if any, annually but may make more frequent distributions thereof if necessary to avoid income or excise taxes. 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 making 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.
Ta
xes
Taxation of Shareholders
. Dividends (including distributions of the excess of net short-term capital gain
over net long-term capital loss (short-term gain)) the Fund distributes, if any, are taxable to its shareholders as ordinary income (at rates up to 35% for individuals), except to the extent they constitute QDI, regardless of whether the
dividends are reinvested in Fund shares or received in cash. Distributions of the Funds net capital gain, if any, are taxable to its shareholders as long-term capital gains, regardless of how long they have held their Fund shares and whether
the distributions are reinvested in Fund shares or received in cash.
A shareholders redemption of Fund shares may result in a taxable
gain, depending on whether the redemption proceeds are more or less than the shareholders adjusted basis in the shares. An exchange of Fund shares for shares of another fund advised by Rafferty generally will have similar consequences. If Fund
shares are redeemed at a loss after being held for six months or less, the loss will be treated as long-term, instead of short-term, capital loss to the extent of any capital gain distributions received on those shares. Investors also 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.
Regulated Investment Company Status
. The Fund is treated as a separate
corporation for federal tax purposes and intends to continue to qualify for treatment as a RIC. If the Fund so qualifies and satisfies the Distribution Requirement (defined below) for a taxable year, it will not be subject to federal income tax on
the part of its investment company taxable income (generally consisting of net investment income, short-term gain, and net gains and losses from certain foreign currency transactions, all determined without regard to any deduction for dividends
paid) and net capital gain it distributes to its shareholders for that year.
To qualify for treatment as a RIC, the Fund must distribute to
its shareholders for each taxable year at least 90% of its investment company taxable income (Distribution Requirement) and must meet several additional requirements. For the Fund, these requirements include the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from the following sources (collectively, Qualifying income) (a) dividends, interest, payments with respect to securities loans, and gains from the sale or other
disposition of securities or foreign currencies, or other income (including gains from options, futures, or forward contracts) derived with respect to its business of investing in securities or those currencies, and (b) net income from an
interest in a qualified publicly traded partnership (QPTP) (Income Requirement); and (2) at the close of each quarter of the Funds taxable year, (a) at least 50% of the value of its total assets
must be represented by cash and cash items, government securities, securities of other RICs, and other securities, with those other securities limited, in respect of any one issuer, to an amount that does not exceed 5% of the value of the
Funds total assets and that does not represent more than 10% of the issuers outstanding voting securities (equity securities of QPTPs being considered voting securities for these purposes), and (b) not more than 25% of the value of
its total assets may be invested in (i) securities (other than government securities or the securities of other RICs) of any one issuer, (ii) securities (other than securities of other RICs) of two or more issuers the Fund controls that
are determined to be engaged in the same, similar, or
34
related trades or businesses, or (iii) securities of one or more QPTPs (collectively, Diversification Requirements). The Internal Revenue Service (IRS) has ruled that
income from a derivative contract on a commodity index generally is not Qualifying Income.
Although the Fund intends to continue to satisfy
all the foregoing requirements, there is no assurance that the Fund will be able to do so. The investment by the Fund primarily in options and futures positions entails some risk that it might fail to satisfy one or both of the Diversification
Requirements. There is some uncertainty regarding the valuation of such positions for purposes of those requirements; accordingly, it is possible that the method of valuation the Fund uses, pursuant to which it would expect to be treated as
satisfying the Diversification Requirements, would not be accepted in an audit by the IRS, which might apply a different method resulting in disqualification of the Fund.
If the Fund failed to qualify for treatment as a RIC for any taxable year, (1) its taxable income, including net capital gain, would be taxed at corporate income tax rates (up to 35%), (2) it
would not receive a deduction for the distributions it makes to its shareholders, and (3) the shareholders would treat all those distributions, including distributions of net capital gain, as dividends that is, ordinary income, except
for the part of those dividends that is qualified dividend income (described in the Prospectus) (QDI), which is subject to a maximum federal income tax rates for individuals and certain other non-corporate shareholders
described in the Prospectus to the extent of the Funds earnings and profits; those dividends would be eligible for the dividends-received deduction available to corporations under certain circumstances. In addition, the Fund would be
required to recognize unrealized gains, pay substantial taxes and interest, and make substantial distributions before requalifying for RIC treatment. However, the Regulated Investment Company Modernization Act of 2010 provides certain savings
provisions that enable a RIC to cure a failure to satisfy any of the Income and Diversification Requirements as long as the failure is due to reasonable cause and not due to willful neglect and the RIC pays a deductible tax calculated in
accordance with those provisions and meets certain other requirements.
Excise Tax
.
The Fund will be subject to a nondeductible
4% excise tax (Excise Tax) to the extent it fails to distribute by the end of any calendar year substantially all of its ordinary income for that year and capital gain net income for the one-year period ending on October 31 of that
year, plus certain other amounts.
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 foreign 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. The balance of the PFIC income will be included in the Funds investment company taxable income and, accordingly, will not be taxable to it to the extent it distributes that income
to its shareholders. Fund distributions thereof will not be eligible for the 15% maximum federal income tax rate on individuals QDI.
35
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 taxable year its
pro rata
share of the QEFs annual ordinary earnings and net capital gain which
the Fund probably would have to distribute to satisfy the Distribution Requirement and avoid imposition of the Excise Tax 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. 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.
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. Gains from the disposition of foreign currencies (except certain gains therefrom that may be excluded by future regulations), and gains from
options, futures, and forward contracts the Fund derives with respect to its business of investing in securities or foreign currencies, will be treated as Qualifying Income. The Fund will monitor its transactions, make appropriate tax elections, and
make appropriate entries in its books and records when it acquires any foreign currency, option, futures contract, forward contract, or hedged investment to mitigate the effect of these rules, seek to prevent its disqualification as a RIC, and
minimize the imposition of federal income and excise taxes.
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 may invest 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. These rules may operate to
increase the amount that the Fund must distribute to satisfy the Distribution Requirement (
i.e.
, with respect to the portion treated as short-term capital gain), which will be taxable to its shareholders as ordinary income when distributed to
them, and to increase the net capital gain the Fund recognizes, without in either case increasing the cash available to it. 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. Section 1256 contracts also may be marked-to-market for purposes of the Excise Tax.
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
36
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 security or futures contract subject thereto. 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.
* * * * *
The foregoing is only a general summary of some of the important federal income 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.
Capital Loss Carryovers.
As of August 31, 2012, the Fund had capital loss carryovers on a tax basis of:
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|
|
|
|
|
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|
|
|
|
|
|
|
|
Short-Term
|
|
|
Long-Term
|
|
|
Total
|
|
Dynamic HY Bond Fund
|
|
$
|
9,436,010
|
|
|
$
|
|
|
|
$
|
9,436,010
|
|
Pursuant to the Regulated Investment Company Modernization Act of 2010, capital losses sustained in
future taxable years will not expire and may be carried over without limitation.
FIN
ANCIAL
STATEMENTS
The financial statements for the Fund are incorporated by reference from the Funds Annual
Report to shareholders dated August 31, 2012.
To receive a copy of the Prospectus or Annual or Semi-Annual Report to shareholders,
without charge, write to or call the Trust at the address or telephone number listed above.
37
A
ppendix
A
Description of Corporate Bond Ratings
Moodys Investors Service and Standard and Poors are two prominent independent rating agencies that rate the quality of bonds. Following are expanded explanations of the ratings shown in the
Prospectus and this SAI.
Moodys Investors Service Long-Term Corporate Obligation Ratings
Moodys long-term obligation ratings are opinions of the relative credit risk of fixed-income obligations with an original maturity of one year or
more. They address the possibility that a financial obligation will not be honored as promised. Such ratings have been published by Moodys Investors Service, Inc. and Moodys Analytics Inc. and reflect both the likelihood of default and
any financial loss suffered in the event of default.
Aaa
: Obligations rated Aaa are judged to be of the highest quality, with minimal
credit risk.
Aa
: Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.
A
: Obligations rated A are considered upper-medium grade and are subject to low credit risk.
Baa
: Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and as such may possess certain speculative
characteristics.
Ba
: Obligations rated Ba are judged to have speculative elements and are subject to substantial credit risk.
B
: Obligations rated B are considered speculative and are subject to high credit risk.
Caa
: Obligations rated Caa are judged to be of poor standing and are subject to very high credit risk.
Ca
: Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and
interest.
C
: Obligations rated C are the lowest rated class of bonds and are typically in default, with little prospect for recovery
of principal or interest.
Note
: Moodys appends numerical modifiers 1, 2, and 3 to each generic rating classification from Aa
through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.
Moodys Investors Service Municipal Bond Ratings
The following descriptions of Moodys long-term municipal bond ratings have been published by Moodys Investors Service, Inc. and Moodys Analytics Inc.
Aaa:
Issuers or issues rated Aaa demonstrate the strongest creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Aa:
Issuers or issues rated Aa demonstrate very strong creditworthiness relative to other US municipal or tax-exempt issuers or
issues.
A:
Issuers or issues rated A present above-average creditworthiness relative to other US municipal or tax-exempt issuers or
issues.
Baa:
Issuers or issues rated Baa represent average creditworthiness relative to other US municipal or tax- exempt issuers or
issues.
A-1
Ba:
Issuers or issues rated Ba demonstrate below-average creditworthiness relative to other US
municipal or tax-exempt issuers or issues.
B:
Issuers or issues rated B demonstrate weak creditworthiness relative to other US
municipal or tax- exempt issuers or issues.
Caa:
Issuers or issues rated Caa demonstrate very weak creditworthiness relative to other
US municipal or tax-exempt issuers or issues.
Ca:
Issuers or issues rated Ca demonstrate extremely weak creditworthiness relative to
other US municipal or tax-exempt issuers or issues.
C:
Issuers or issues rated C demonstrate the weakest creditworthiness relative to
other US municipal or tax-exempt issuers or issues.
Note
: Moodys appends numerical modifiers 1, 2, and 3 to each generic rating
category from Aa through Caa. The modifier 1 indicates that the issuer or obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of
that generic rating category.
Standard and Poors Long-Term Corporate and Municipal Bond Ratings
Issue credit ratings are based, in varying degrees, on the following considerations:
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Likelihood of paymentcapacity and willingness of the obligor to meet its financial commitment on an obligation in accordance with the terms of
the obligation;
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Nature of and provisions of the obligation;
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Protection afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of
bankruptcy and other laws affecting creditors rights.
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Issue ratings are an assessment of default risk, but may
incorporate an assessment of relative seniority or ultimate recovery in the event of default. Junior obligations are typically rated lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such differentiation
may apply when an entity has both senior and subordinated obligations, secured and unsecured obligations, or operating company and holding company obligations.)
AAA
: An obligation rated AAA has the highest rating assigned by S&P. The obligors capacity to meet its financial commitment on the obligation is extremely strong.
AA
: An obligation rated AA differs from the highest-rated obligations only to a small degree. The obligors capacity to meet its
financial commitment on the obligation is very strong.
A
: An obligation rated A is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligors capacity to meet its financial commitment on the obligation is still strong.
BBB
: An obligation rated BBB exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.
BB, B, CCC, CC, and C:
Obligations rated BB, B, CCC, CC, and C are regarded as having significant speculative characteristics. BB indicates the least degree of speculation and C the
highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions.
A-2
BB:
An obligation rated BB is less vulnerable to nonpayment than other speculative
issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to the obligors inadequate capacity to meet its financial commitment on the obligation.
B:
An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the obligor currently has the
capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligors capacity or willingness to meet its financial commitment on the obligation.
CCC:
An obligation rated CCC is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.
CC:
An obligation rated CC is currently highly vulnerable to nonpayment.
C:
A C rating is assigned to obligations that are currently highly vulnerable to nonpayment, obligations that have payment arrearages
allowed by the terms of the documents, or obligations of an issuer that is the subject of a bankruptcy petition or similar action which have not experienced a payment default. Among others, the C rating may be assigned to subordinated
debt, preferred stock or other obligations on which cash payments have been suspended in accordance with the instruments terms or when preferred stock is the subject of a distressed exchange offer, whereby some or all of the issue is either
repurchased for an amount of cash or replaced by other instruments having a total value that is less than par.
D:
An obligation rated
D is in payment default. The D rating category is used when payments on an obligation, including a regulatory capital instrument, are not made on the date due even if the applicable grace period has not expired, unless
Standard & Poors believes that such payments will be made during such grace period. The D rating also will be used upon the filing of a bankruptcy petition or the taking of similar action if payments on an obligation are
jeopardized. An obligations rating is lowered to D upon completion of a distressed exchange offer, whereby some or all of the issue is either repurchased for an amount of cash or replaced by other instruments having a total value
that is less than par.
Plus (+) or Minus (-):
The ratings from AA to CCC may be modified by the addition
of a plus (+) or minus (-) sign to show relative standing within the major rating categories.
NR:
This indicates that no rating
has been requested, that there is insufficient information on which to base a rating, or that Standard & Poors does not rate a particular obligation as a matter of policy.
Moodys Investors Service Short-Term Ratings
MIG 1:
This
designation denotes superior credit quality. Excellent protection is afforded by established cash flows, highly reliable liquidity support, or demonstrated broad-based access to the market for refinancing.
MIG 2:
This designation denotes strong credit quality. Margins of protection are ample, although not as large as in the preceding group.
MIG 3:
This designation denotes acceptable credit quality. Liquidity and cash-flow protection may be narrow, and market access for
refinancing is likely to be less well-established.
SG:
This designation denotes speculative-grade credit quality. Debt instruments in
this category may lack sufficient margins of protection.
A-3
Standard and Poors Short-Term Municipal Ratings
SP-1:
Strong capacity to pay principal and interest. An issue determined to possess a very strong capacity to pay debt service is given a plus
(+) designation.
SP-2:
Satisfactory capacity to pay principal and interest, with some vulnerability to adverse financial and
economic changes over the term of the notes.
SP-3:
Speculative capacity to pay principal and interest.
Moodys Investors Service Commercial Paper Ratings
P-1:
Issuers (or supporting institutions) rated Prime-1 have a superior ability to repay short-term debt obligations.
P-2:
Issuers (or supporting institutions) rated Prime-2 have a strong ability to repay short-term debt obligations.
P-3:
Issuers (or supporting institutions) rated Prime-3 have an acceptable ability to repay short-term obligations.
NP:
Issuers (or supporting institutions) rated Not Prime do not fall within any of the Prime rating categories.
Note:
Canadian issuers rated P-1 or P-2 have their short-term ratings enhanced by the senior-most long-term rating of the issuer, its guarantor or support-provider.
Standard and Poors Commercial Paper Ratings
A-1:
A short-term obligation rated A-1 is rated in the highest category by Standard & Poors. The obligors capacity to meet its financial commitment on the
obligation is strong. Within this category, certain obligations are designated with a plus sign (+). This indicates that the obligors capacity to meet its financial commitment on these obligations is extremely strong.
A-2:
A short-term obligation rated A-2 is somewhat more susceptible to the adverse effects of changes in circumstances and economic
conditions than obligations in higher rating categories. However, the obligors capacity to meet its financial commitment on the obligation is satisfactory.
A-3:
A short-term obligation rated A-3 exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened
capacity of the obligor to meet its financial commitment on the obligation.
B:
A short-term obligation rated B is regarded
as having significant speculative characteristics. Ratings of B-1, B-2, and B-3 may be assigned to indicate finer distinctions within the B category. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing uncertainties which could lead to the obligors inadequate capacity to meet its financial commitment on the obligation.
B-1:
A short-term obligation rated B-1 is regarded as having significant speculative characteristics, but the obligor has a relatively
stronger capacity to meet its financial commitments over the short-term compared to other speculative-grade obligors.
B-2:
A
short-term obligation rated B-2 is regarded as having significant speculative characteristics, and the obligor has an average speculative-grade capacity to meet its financial commitments over the short-term compared to other
speculative-grade obligors.
B-3:
A short-term obligation rated B-3 is regarded as having significant speculative
characteristics, and the obligor has a relatively weaker capacity to meet its financial commitments over the short-term compared to other speculative-grade obligors.
C:
A short-term obligation rated C is currently vulnerable to nonpayment and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its
financial commitment on the obligation.
A-4
D:
A short-term obligation rated D is in payment default. The D rating
category is used when payments on an obligation , including a regulatory capital instrument, are not made on the date due even if the applicable grace period has not expired, unless Standard & Poors believes that such payments will be
made during such grace period. The D rating also will be used upon the filing of a bankruptcy petition or the taking of a similar action if payments on an obligation are jeopardized.
Dual Ratings:
S&P assigns dual ratings to all debt issues that have a put option or demand feature as part of their structure. The
first rating addresses the likelihood of repayment of principal and interest as due, and the second rating addresses only the demand feature. The long-term rating symbols are used for bonds to denote the long-term maturity and the short-term rating
symbols for the put option (for example, AAA/A-1+). With U.S. municipal short-term demand debt, note rating symbols are used with the short-term issue credit rating symbols (for example, SP-1+/A-1+).
A-5
APP
ENDIX B
D
IREXION
F
UNDS
D
IREXION
I
NSURANCE
T
RUST
P
ROXY
V
OTING
P
OLICIES
AND
P
ROCEDURES
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 Funds and the Direxion
Insurance 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.
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.
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II.
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Guidelines for Voting Proxies
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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.
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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:
Composition of the board and key board committees;
Attendance at board and committee meetings;
Corporate governance provisions and takeover activity;
Disclosures under Section 404 of the Sarbanes-Oxley Act;
Long-term company performance relative to a market and peer index;
Extent of the directors investment in the company;
Existence of related party transactions;
Whether the chairman is also serving as CEO;
Whether a retired CEO sits on the board;
Number of outside boards at which a director serves.
B-1
WITHHOLD from individual directors who:
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);
Sit on more than six public company boards;
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).
WITHHOLD from the entire board (except for new nominees, who should be considered on a CASE-BY-CASE basis) if:
The companys poison pill has a dead-hand or modified dead-hand feature. Withhold every year until this feature is removed;
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;
The board failed to act on a shareholder proposal that received approval by a majority of the shares outstanding the previous
year;
The board failed to act on a shareholder proposal that received approval of the majority of shares cast for the previous two consecutive years;
The board failed to act on takeover offers where the majority of the shareholders tendered their shares;
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;
A Russell 3000 company underperformed its industry group (GICS group).
The test will consist of the bottom performers within each industry group.
WITHHOLD from inside directors and affiliated outside directors
when:
The inside or affiliated outside director serves on any of the three key committees: audit, compensation, or nominating;
The company lacks an audit, compensation, or nominating committee so that the full board functions as that committee;
The full board is less than majority independent.
WITHHOLD from the members of the Audit
Committee if:
The non-audit fees paid to the auditor are excessive;
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.
WITHHOLD from the members of the Compensation Committee
if:
There is a negative correlation between chief executive pay and company performance;
The company fails to submit one-time transfers of stock options to a
shareholder vote;
The company fails to fulfill the terms of a burn rate commitment they made to shareholders;
The company has poor compensation practices.
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.
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:
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.);
Two-thirds independent board;
All-independent key committees;
Established governance guidelines;
The company does not under-perform its peers.
B-2
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:
Established guidelines disclosed annually in the proxy statement
concerning the process to follow for nominees who receive majority withhold votes;
The policy needs to outline a clear and reasonable timetable for all decision-making regarding the nominees status;
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;
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.);
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.
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:
Long-term financial performance of the target company relative to its industry;
Managements track record;
Background to the proxy contest;
Qualifications of director nominees (both slates);
Strategic plan of dissident slate and quality of critique against management;
Likelihood that the proposed goals and objectives can be achieved (both
slates);
Stock ownership positions.
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.
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:
Shareholders have approved the adoption of the plan; or
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.
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:
No lower than a 20 percent trigger, flip-in or flip-over;
A term of no more than three years;
No dead-hand, slow-hand, no-hand or similar feature that limits the ability of a future board to redeem the pill;
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.
B-3
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:
ValuationIs the value to be received by the target shareholders (or paid by the acquirer) reasonable?
Market reactionHow has the market responded to the proposed deal?
Strategic rationaleDoes the deal make sense strategically? Cost
and revenue synergies should not be overly aggressive or optimistic, but reasonably achievable.
Negotiations and processWere the terms of the transaction negotiated at arms length? Was the process fair and
equitable?
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.
GovernanceWill the combined company have a better or worse
governance profile than the parties to the transaction?
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.
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:
The total cost of the companys equity plans is unreasonable;
The plan expressly permits the repricing of stock options without prior shareholder approval;
There is a disconnect between CEO pay and the companys
performance;
The companys three year burn rate exceeds the greater of 2 percent and the mean plus 1 standard deviation of its industry group; or
The plan is a vehicle for poor pay practices.
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:
Stock ownership guidelines with a minimum of three times the annual
cash retainer.
Vesting schedule or mandatory holding/deferral period:
B-4
A minimum vesting of three years for stock options or restricted stock; or
Deferred stock payable at the end of a three-year deferral period.
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.
No retirement/benefits and perquisites for non-employee directors; and
A table with a detailed disclosure of the cash and equity compensation
for each non-employee director for the most recent fiscal year.
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:
Purchase price is at least 85 percent of fair market value;
Offering period is 27 months or less; and
The number of shares allocated to the plan is ten percent or less of the outstanding shares.
Employee Stock Purchase PlansNon-Qualified Plans
Vote CASE-by-CASE on nonqualified employee stock purchase plans. Vote FOR plans with:
Broad-based participation (i.e., all employees with the exclusion of
individuals with 5 percent or more of beneficial ownership of the company);
Limits on employee contribution (a fixed dollar amount or a percentage of base salary);
Company matching contribution up to 25 percent of employees contribution, which is effectively a discount of 20 percent from market value;
No discount on the stock price on the date of purchase since there is a company matching contribution.
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:
A trigger beyond the control of management;
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;
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.
9. Corporate Responsibility
Animal Rights
Generally
vote AGAINST proposals to phase out the use of animals in product testing unless:
The company is conducting animal testing programs that are unnecessary or not required by regulation;
The company is conducting animal testing when suitable alternatives are accepted and used at peer firms;
The company has been the subject of recent, significant controversy
related to its testing programs.
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:
The existing level of disclosure on pricing policies;
Deviation from established industry pricing norms;
The companys existing initiatives to provide its products to needy consumers;
Whether the proposal focuses on specific products or geographic
regions.
B-5
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.
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:
New legislation is adopted allowing development and drilling in the ANWR region;
The company intends to pursue operations in the ANWR; and
The company has not disclosed an environmental risk report for its ANWR operations.
Concentrated Area Feeding Operations (CAFOs)
Vote FOR resolutions requesting that companies report to shareholders on the risks and liabilities associated with CAFOs unless:
The company has publicly disclosed guidelines for its corporate and contract farming operations, including compliance monitoring; or
The company does not directly source from CAFOs.
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:
The company does not maintain operations in Kyoto signatory markets;
The company already evaluates and substantially discloses such
information; or,
Greenhouse gas emissions do not significantly impact the companys core businesses.
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.
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.
B-6
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:
Past performance as a closed-end fund;
Market in which the fund invests;
Measures taken by the board to address the discount; and
Past shareholder activism, board activity, and votes on related proposals.
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:
Performance of the funds net asset value;
The funds history of shareholder relations;
The performance of other funds under the advisors management.
B-7
DIREXION FUNDS