STATEMENT OF
ADDITIONAL INFORMATION
Merrill Lynch
Municipal Bond Fund, Inc.
High Yield Portfolio
P.O. Box 9011,
Princeton, New Jersey 08543-9011
•
Phone No. (609) 282-2800
This Statement of Additional
Information of High Yield Portfolio (the “Portfolio”) of Merrill Lynch Municipal Bond
Fund, Inc. is not a prospectus and should be read in conjunction with the Prospectus of
the Portfolio, dated July 12, 2006, which has been filed with the Securities and Exchange
Commission (the “Commission”) and can be obtained, without charge, by calling
1-800-637-3863 or by writing to the Portfolio at the above address. The Portfolio’s
Prospectus is incorporated by reference into this Statement of Additional Information,
and Part I of this Statement of Additional Information and the portions of Part II of
this Statement of Additional Information that relate to the Portfolio have been
incorporated by reference into the Portfolio’s Prospectus. The portions of Part II of
this Statement of Additional Information that do not relate to the Portfolio do not form
a part of the Portfolio’s Statement of Additional Information, have not been incorporated
by reference into the Portfolio’s Prospectus and should not be relied upon by investors
in the Portfolio.
Fund Asset
Management, L.P. — Investment Adviser
FAM Distributors, Inc.
— Distributor
The date of this
Statement of Additional Information is July 12, 2006
TABLE OF CONTENTS
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Part I
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Investment Objectives and Policies
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I-1
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Investment Restrictions
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I-2
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Information on Officers and Directors
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I-4
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Management and Advisory Arrangements
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I-8
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Information on Sales Charges and Distribution Related Expenses
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I-11
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Computation of Offering Price
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I-11
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Portfolio Transactions and Brokerage
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I-11
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Additional Information
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I-12
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Part II
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Investment Risks and Considerations
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II-1
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Management and other Service Arrangements
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II-36
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Purchase of Shares
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II-43
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Redemption of Shares
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II-53
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Shareholder Services
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II-54
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Pricing of Shares
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II-59
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Portfolio Transactions and Brokerage
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II-61
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Dividends and Taxes
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II-64
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Performance Data
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II-68
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Proxy Voting Policies and Procedures
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II-70
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General Information
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II-73
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Appendix A
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A-1
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PART I: INFORMATION
ABOUT HIGH YIELD PORTFOLIO OF
MERRILL LYNCH MUNICIPAL BOND FUND, INC.
Part I of this Statement of
Additional Information sets forth information about High Yield Portfolio (the
“Portfolio”) of Merrill Lynch Municipal Bond Fund, Inc. (the “Fund”). This Part I
includes information about the Fund’s Board of Directors, the advisory services provided
to and the management fees paid by the Portfolio and information about other fees paid by
and services provided to the Portfolio. This Part I should be read in conjunction with
the Portfolio’s Prospectus and those portions of Part II of this Statement of Additional
Information that pertain to the Portfolio.
I. Investment
Objectives and Policies
The investment objective of the
Portfolio is to provide shareholders with as high a level of income exempt from Federal
income taxes as is consistent with the investment policies of the Portfolio. The
Portfolio seeks to achieve its objective by investing in a diversified portfolio of debt
obligations issued by or on behalf of states, territories and possessions of the United
States and their political subdivisions, agencies and instrumentalities, the interest on
which, in the opinion of bond counsel to the issuer, is generally excludable from gross
income for Federal income tax purposes, except that the interest may be includable in
taxable income for purposes of the Federal alternative minimum tax (such obligations are
herein referred to as “Municipal Bonds”). Municipal Bonds include general obligation
bonds, revenue or special obligation bonds, private activity bonds, variable rate demand
notes, and short-term tax-exempt municipal obligations such as tax anticipation notes.
Under normal circumstances, the Portfolio invests at least 80% of its net assets in
Municipal Bonds. For this purpose, net assets include any borrowings for investment
purposes. This is a fundamental policy of the Portfolio and may not be changed without a
vote of the majority of the outstanding shares of the Portfolio as defined in the
Investment Company Act of 1940, as amended (the “Investment Company Act”). The Fund is
classified as diversified under the Investment Company Act. The Portfolio currently
contemplates that it will not invest more than 25% of its total assets (taken at market
value) in Municipal Bonds whose issuers are located in the same state. There can be no
assurance that the investment objective of the Portfolio can be attained.
While the Portfolio does not intend
to realize significant taxable investment income, the Portfolio has the authority to
invest as much as 20% of its assets on a temporary basis in taxable money market
securities with remaining maturities not in excess of one year from the date of purchase
(“Temporary Investments”) for liquidity purposes or as a temporary investment of cash
pending investment of such cash in Municipal Bonds. In addition, the Portfolio reserves
the right to temporarily invest a greater portion of its assets in Temporary Investments
for defensive purposes, when, in the judgment of Fund Asset Management, L.P. (the
“Investment Adviser” or “FAM”), market conditions warrant such action. Temporary
Investments consist of U.S. Government securities, U.S. Government Agency securities,
domestic bank certificates of deposit and bankers’ acceptances, short-term corporate debt
securities such as commercial paper and repurchase agreements. From time to time, the
Portfolio may realize capital gains that will constitute taxable income.
The Portfolio may invest in certain
tax-exempt securities that are classified as “private activity bonds,” which may subject
certain investors to an alternative minimum tax.
Certain instruments in which the
Portfolio may invest may be characterized as derivative instruments. The Portfolio is
authorized to engage in transactions in financial futures contracts and options thereon
only for hedging purposes. The Portfolio is also authorized to invest in indexed and
inverse floating rate obligations and swap agreements, including credit default swap
agreements, both for hedging purposes and to seek to enhance income.
Investment Policies of
the Portfolio
The Portfolio pursues its investment
objective through the investment policies described below. These policies can be expected
to affect the yield on the Portfolio and the degree of market, financial and interest
rate risk to which the Portfolio is subject. Generally, Municipal Bonds with longer
maturities tend to produce higher yields and are subject to greater market fluctuations
as a result of changes in interest rates (“interest rate risk”) than are Municipal Bonds
with shorter maturities. In addition, lower rated Municipal Bonds generally will provide
a higher yield than higher rated Municipal Bonds of similar maturity but are also
generally subject to greater market risk and to a greater degree of risk with respect to
the ability of the issuer to meet its principal and interest obligations (“credit
risk”). The Portfolio’s net asset
value may fall when interest rates rise and rise when interest rates fall. Because of its
emphasis on investments in Municipal Bonds, the Portfolio should be considered as a means
of diversifying an investment portfolio and not in itself a balanced investment plan.
The Portfolio may invest in
Municipal Bonds rated in any rating category or in unrated Municipal Bonds. The Portfolio
will usually invest in Municipal Bonds that have a maturity of five years or longer.
Portfolio management chooses Municipal Bonds that it believes offer a relatively high
potential for total return relative to their total risk. Although the Portfolio may
invest in Municipal Bonds in any rating category, Portfolio management presently intends
to invest at least 65% of the Portfolio’s net assets in medium- to low-quality bonds as
rated by at least one independent rating agency (BBB or lower by Standard & Poor’s (“S&P”)
or Fitch Ratings (“Fitch”) or Baa or lower by Moody’s Investors Service, Inc.
(“Moody’s”)), or if unrated, judged to be of comparable quality by the Portfolio’s
investment adviser. Obligations rated below BBB or Baa are commonly known as “junk
bonds.” It is possible that the Portfolio could invest up to 100% of its assets in junk
bonds. The Portfolio may also invest up to 10% of its total assets in Municipal Bonds
that are the subject of bankruptcy proceedings or otherwise in default as to the
repayment of principal and/or payment of interest at the time of acquisition by the
Portfolio or are rated in the lowest rating categories by at least one rating agency (CC
or lower by S&P or Fitch or Ca or lower by Moody’s), or if unrated, judged to be of
comparable quality by the Portfolio’s investment adviser.
Because investment in medium to
lower rated Municipal Bonds entails relatively greater risks of loss of income or
principal than an investment in higher rated securities, an investment in the Portfolio
may not be appropriate for all investors. Investors should consider these risks before
investing.
II. Investment
Restrictions
The Fund, on behalf of the
Portfolio, has adopted restrictions and policies relating to the investment of the
Portfolio’s assets and its activities. Certain of the restrictions are fundamental
policies of the Portfolio and may not be changed without the approval of the holders of a
majority of the Portfolio’s outstanding voting securities (which for this purpose and
under the Investment Company Act, means the lesser of (i) 67% of the shares represented
at a meeting at which more than 50% of the outstanding shares are represented or (ii)
more than 50% of the outstanding shares). The Fund, on behalf of the Portfolio, has also
adopted certain non-fundamental investment restrictions, which may be changed by the
Board of Directors without shareholder approval.
Set forth below are the Portfolio’s
fundamental and non-fundamental investment restrictions. Unless otherwise provided, all
references below to the assets of the Portfolio are in terms of current market value.
Under the Portfolio’s fundamental
investment restrictions, the Portfolio may not:
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1.
Make any investment inconsistent with the Fund’s classification as a diversified
company under the Investment Company Act.
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2.
Invest more than 25% of its assets, taken at market value, in the securities of
issuers in any particular industry (excluding the U.S. Government and its agencies
and instrumentalities).
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3.
Make investments for the purpose of exercising control or management.
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4.
Purchase or sell real estate, except that, to the extent permitted by applicable
law, the Portfolio may invest in securities directly or indirectly secured by real
estate or interests therein or issued by companies which invest in real estate or
interests therein.
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5.
Make loans to other persons, except (i) that the acquisition of bonds, debentures
or other corporate debt securities and investments in government obligations,
commercial paper, pass-through instruments, certificates of deposit, bankers’
acceptances, repurchase agreements or any similar instruments shall not be deemed
to be the making of a loan, (ii) that the Portfolio may lend its portfolio
securities, provided that the lending of portfolio securities may be made only in
accordance with applicable law and the guidelines set forth in the Portfolio’s
Prospectus and Statement of Additional Information, as they may be amended from
time to time and (iii) as may otherwise be permitted by an exemptive order
issued to the Fund by the SEC.
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6.
Issue senior securities to the extent such issuance would violate applicable law.
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7.
Borrow money, except that (i) the Portfolio may borrow in amounts up to 33
1
/
3
% of
its total assets (including the amount borrowed), (ii) the Portfolio may, to the
extent permitted by applicable law, borrow up to an additional 5% of its total
assets for temporary purposes, (iii) the Portfolio may obtain such short term
credit as may be necessary for the clearance of purchases and sales of portfolio
securities and (iv) the Portfolio may purchase securities on margin to the extent
permitted by applicable law. The Portfolio may not pledge its assets other than to
secure such borrowings or, to the extent permitted by the Portfolio’s
investment policies as set forth in its Prospectus and Statement of
Additional Information, as they may be amended from time to time, in
connection with hedging transactions, short sales, when-issued and forward
commitment transactions and similar investment strategies.
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8.
Underwrite securities of other issuers except insofar as the Portfolio technically
may be deemed an underwriter under the Securities Act of 1933, as amended (the
“Securities Act”), in selling portfolio securities.
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9.
Purchase or sell commodities or contracts on commodities, except to the extent that
the Portfolio may do so in accordance with applicable law and the Portfolio’s
Prospectus and Statement of Additional Information, as they may be amended from
time to time, and without registering as a commodity pool operator under the
Commodity Exchange Act.
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Under the Portfolio’s
non-fundamental investment restrictions, the Portfolio may not:
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a.
Purchase securities of other investment companies, except to the extent such
purchases are permitted by applicable law. As a matter of policy, however, the
Portfolio will not purchase shares of any registered open-end investment company or
registered unit investment trust, in reliance on Section 12(d)(1)(F) or (G) (the
“fund of funds” provisions) of the Investment Company Act, at any time its shares
are owned by another investment company that is part of the same group of
investment companies as the Portfolio.
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b.
Make short sales of securities or maintain a short position, except to the extent
permitted by applicable law. The Portfolio currently does not intend to engage in
short sales, except short sales “against the box.”
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c.
Invest in securities that cannot be readily resold or that cannot otherwise be
marketed, redeemed or put to the issuer or a third party, if at the time of
acquisition more than 15% of its net assets would be invested in such securities.
This restriction shall not apply to securities that mature within seven days or
securities that the Board of Directors of the Fund has otherwise determined to be
liquid pursuant to applicable law. Securities purchased in accordance with Rule
144A under the Securities Act (a “Rule 144A Security”) and determined to be liquid
by the Fund’s Board of Directors are not subject to the limitations set forth
in this investment restriction.
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d.
Notwithstanding fundamental investment restriction (7) above, borrow money or
pledge its assets, except that the Portfolio (a) may borrow as a temporary measure
for extraordinary or emergency purposes or to meet redemptions in amounts not
exceeding 33 1/3% (taken at market value) of its total assets and pledge its assets
to secure such borrowings, (b) may obtain such short-term credit as may be
necessary for the clearance of purchases and sales of portfolio securities and (c)
may purchase securities on margin to the extent permitted by applicable law. The
deposit or payment by the Portfolio of initial or variation margin in
connection with financial futures contracts or options transactions is not
considered to be the purchase of a security on margin. The purchase of
securities while borrowings are outstanding will have the effect of
leveraging the Portfolio. The Portfolio will not purchase securities while
borrowings exceed 5% of its total assets.
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Except with respect to restriction
(7), if a percentage restriction on the investment or use of assets set forth above is
adhered to at the time a transaction is effected, later changes in percentages resulting
from changing values will not be considered a violation.
For purposes of investment
restriction (2) above, the Portfolio uses the classifications and subclassifications of
Morgan Stanley Capital International as a guide to identify industries. Also for purposes
of investment restriction (2), tax-exempt securities issued by states, municipalities and
their political subdivisions are not considered to be part of any industry.
III. Information on
Officers and Directors
The Board of Directors of the Fund
consists of seven individuals, six of whom are not “interested persons” of the Fund as
defined in the Investment Company Act (the “non-interested Directors”). The Directors are
responsible for the oversight of the operations of the Fund and perform the various
duties imposed on the directors of investment companies by the Investment Company Act.
Each non-interested Director is a
member of the Fund’s Audit Committee (the “Audit Committee”). The principal
responsibilities of the Audit Committee are the appointment, compensation and oversight
of the Fund’s independent accountants, including the resolution of disagreements
regarding financial reporting between Fund management and such independent accountants.
The Audit Committee’s responsibilities include, without limitation, to (i) review with
the independent accountants the arrangements for and scope of annual and special audits
and any other services provided by the independent accountants to the Fund; (ii) discuss
with the independent accountants certain matters relating to the Fund’s financial
statements, including any adjustment to such financial statements recommended by such
independent accountants or any other results of any audit; (iii) ensure that the
independent accountants submit on a periodic basis a formal written statement with
respect to their independence, discuss with the independent accountants any relationships
or services disclosed in the statement that may impact the objectivity and independence
of the Fund’s independent accountants and recommend that the Board take appropriate
action in response thereto to satisfy itself of the independent accountants’
independence; and (iv) consider the comments of the independent accountants with respect
to the quality and adequacy of the Fund’s accounting and financial reporting policies and
practices and internal controls and Fund management’s responses thereto. The Board of the
Fund has adopted a written charter for the Audit Committee. The Audit Committee has
retained independent legal counsel to assist it in connection with these duties. The
Audit Committee met four times during the fiscal year ended June 30, 2005.
Cynthia A. Montgomery and Edward D.
Zinbarg are the members of the Fund’s Nominating Committee. The principal
responsibilities of the Nominating Committee are to identify individuals qualified to
serve as non-interested Directors of the Fund and to recommend its nominees for
consideration by the full Board. While the Nominating Committee is solely responsible for
the selection and nomination of the Fund’s non-interested Directors, the Nominating
Committee may consider nominations for the office of Director made by Portfolio
shareholders as it deems appropriate. Portfolio shareholders who wish to recommend a
nominee should send nominations to the Secretary of the Fund that include biographical
information and set forth the qualifications of the proposed nominee. The Nominating
Committee did not meet during the fiscal year ended June 30, 2005.
Biographical
Information
Certain biographical and other
information relating to the non-interested Directors of the Fund is set forth below,
including their ages, their principal occupations for at least the last five years, the
length of time served, the total number of funds and portfolios overseen in the complex
of funds advised by the Investment Adviser, Merrill Lynch Investment Managers, L.P.
(“MLIM”) or their affiliates (“MLIM/FAM-advised funds”), and other public directorships.
Name, Address*
and Age of
Director
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Position(s)
Held with
the Fund
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Term of
Office** and
Length
of
Time Served
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Principal Occupation(s)
During
Past Five Years
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Number of
MLIM/FAM-
Advised
Funds
and Portfolio Overseen
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Public
Directorships
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Ronald W. Forbes (65)***
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Director
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Director since 1977
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Professor Emeritus of
Finance, School of Business, State University of New York at Albany since
2000 and Professor thereof from 1989 to 2000; International Consultant, Urban
Institute, Washington, D.C. from 1995 to 1999.
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49 registered investment
companies consisting of 50 portfolios
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None
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Name, Address*
and Age of
Director
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Position(s)
Held with
the Fund
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Term of
Office** and
Length
of
Time Served
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Principal Occupation(s)
During
Past Five Years
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Number of
MLIM/FAM-
Advised
Funds
and Portfolio Overseen
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Public
Directorships
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Cynthia A. Montgomery
(53)****
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Director
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Director since 1994
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Professor, Harvard Business
School since 1989; Associate Professor, J.L. Kellogg Graduate School of
Management, Northwestern University from 1985 to 1989; Associate Professor,
Graduate School of Business Administration, University of Michigan from 1979
to 1985; Director, Harvard Business School of Publishing since 2005.
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49 registered investment
companies consisting of 50 portfolios
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Newell Rubbermaid Inc.
(manufacturing)
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Jean Margo Reid (60)
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Director
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Director since 2004
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Self-employed consultant
since 2001; Counsel of Alliance Capital Management (investment adviser) in
2000; General Counsel, Director and Secretary of Sanford C. Bernstein &
Co., Inc. (investment adviser/broker-dealer) from 1997 to 2000; Secretary,
Sanford C. Bernstein Fund, Inc. from 1994 to 2000; Director and Secretary of
SCB, Inc. since 1998; Director and Secretary of SCB Partners, Inc. since
2000; and Director of Covenant House from 2001 to 2004.
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49 registered investment
companies consisting of 50 portfolios
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None
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Roscoe S. Suddarth (70)
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Director
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Director since 2000
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President, Middle East
Institute, from 1995 to 2001; Foreign Service Officer, United States Foreign
Service, from 1961 to 1995; Career Minister from 1989 to 1995; Deputy
Inspector General, U.S. Department of State, from 1991 to 1994; U.S.
Ambassador to the Hashemite Kingdom of Jordan from 1987 to 1990.
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49 registered investment
companies consisting of 50 portfolios
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None
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Richard R. West (68)
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Director
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Director since 1981
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Professor of Finance from
1984 to 1995, Dean from 1984 to 1993 and since 1995 Dean Emeritus of New York
University’s Leonard N. Stern School of Business
Administration.
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49 registered investment
companies consisting of 50 portfolios
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Bowne & Co., Inc.
(financial printers); Vornado Realty Trust (real estate company);
Alexander’s, Inc. (real estate company)
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Edward D. Zinbarg (71)
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Director
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Director since 2000
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Self-employed financial
consultant since 1994; Executive Vice President of the Prudential Insurance
Company of America from 1988 to 1994; Former Director of Prudential
Reinsurance Company and former Trustee of the Prudential Foundation.
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49 registered investment
companies consisting of 50 portfolios
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None
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*
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The
address of each non-interested Director is P.O. Box 9095, Princeton, New Jersey
08543-9095.
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**
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Each
Director serves until his or her successor is elected and qualified, or until
December 31 of the year in which he or she turns 72, or until his or her death or
resignation, or removal as provided in the Fund’s by-laws or charter or by statute.
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***
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Chairman of the Board of Directors and the Audit Committee.
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****
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Chairman
of the Nominating Committee.
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Certain biographical and other
information relating to the Director who is an officer and an “interested person” of the
Fund as defined in the Investment Company Act (the “interested Director”) and to the
other officers of the Fund is set forth below, including their ages, their principal
occupations for at least the last five years, the length of time served, the total number
of funds and portfolios overseen in MLIM/FAM-advised funds and public directorships held.
Name, Address*
and Age
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Position(s)
Held with
the Fund
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|
Term of
Office** and
Length
of
Time Served
|
|
Principal Occupation(s)
During
Past Five Years
|
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Number of
MLIM/FAM-
Advised
Funds
and Portfolio Overseen
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Public
Directorships
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Robert C. Doll, Jr.
(51)***
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President and Director
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President and Director****
since 2005
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President of the
MLIM/FAM-advised funds since 2005; President of MLIM and FAM since 2001;
Co-Head (Americas Region) thereof from 2000 to 2001 and Senior Vice President
from 1999 to 2001; President and Director of Princeton Services, Inc.
(“Princeton Services”) since 2001; President of Princeton Administrators,
L.P. (“Princeton Administrators”) since 2001; Chief Investment Officer of
OppenheimerFunds, Inc. in 1999 and Executive Vice President thereof from 1991
to 1999.
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131 registered investment
companies consisting of 177 portfolios
|
|
None
|
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|
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Kenneth A. Jacob (55)
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Senior Vice President
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Senior Vice President since
2002
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Managing Director of MLIM
since 2000; Director (Tax-Exempt Fund Management) of MLIM from 1997 to 2000.
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39 registered investment
companies consisting of 53 portfolios
|
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None
|
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John Loffredo (42)
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Senior Vice President
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Senior Vice President since
2002
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Managing Director of MLIM
since 2000; Director (Tax Exempt Fund Management) of MLIM from 1997 to 2000.
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40 registered investment
companies consisting of 54 portfolios
|
|
None
|
|
|
|
|
|
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Theodore R. Jaeckel, Jr.
(46)
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Vice President and
Portfolio Manager of the Portfolio
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Vice President since 2006
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Managing Director of MLIM
since 2005; Director (Municipal Tax-Exempt Fund Management) of MLIM from 1997
to 2004.
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8 registered investment
companies consisting of 8 portfolios
|
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None
|
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|
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|
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Donald C. Burke (45)
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Vice President and
Treasurer
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Vice President since 1993
and Treasurer since 1999
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First Vice President of
MLIM and FAM since 1997 and Treasurer thereof since 1999; Senior Vice
President and Treasurer of Princeton Services since 1999 and Director since
2004; Vice President of FAM Distributors, Inc. (“FAMD”) since 1999; Vice
President of MLIM and FAM from 1990 to 1997; Director of Taxation of MLIM
from 1990 to 2001; Vice President, Treasurer and Secretary of the IQ Funds
since 2004.
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139 registered investment
companies consisting of 185 portfolios
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None
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Name, Address*
and Age
|
|
Position(s)
Held with
the Fund
|
|
Term of
Office** and
Length
of
Time Served
|
|
Principal Occupation(s)
During
Past Five Years
|
|
Number of
MLIM/FAM-
Advised
Funds
and Portfolio Overseen
|
|
Public
Directorships
|
|
Jeffrey Hiller (54)
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Chief Compliance Officer
|
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Chief Compliance Officer
since 2004
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Chief Compliance Officer of
the MLIM/FAM-advised funds and First Vice President and Chief Compliance
Officer of MLIM (Americas Region) since 2004; Chief Compliance Officer of the
IQ Funds since 2004; Global Director of Compliance at Morgan Stanley Investment
Management from 2002 to 2004; Managing Director and Global Director of
Compliance at Citigroup Asset Management from 2000 to 2002; Chief Compliance
Officer at Soros Fund Management in 2000; Chief Compliance Officer at
Prudential Financial from 1995 to 2000; Senior Counsel in the Commission’s
Division of Enforcement in Washington, D.C. from 1990 to 1995.
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140 registered investment
companies consisting of 186 portfolios
|
|
None
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Alice A. Pellegrino (46)
|
|
Secretary
|
|
Secretary since 2004
|
|
Director (Legal Advisory)
of MLIM since 2002; Vice President of MLIM from 1999 to 2002; Attorney
associated with MLIM since 1997; Secretary of MLIM, FAM, FAMD and Princeton
Services since 2004.
|
|
132 registered investment
companies consisting of 178 portfolios
|
|
None
|
|
*
|
|
The
address of each officer is P.O. Box 9011, Princeton, New Jersey 08543-9011.
|
|
**
|
|
Each
officer is elected by and serves at the pleasure of the Board of Directors of the Fund.
|
|
***
|
|
Mr.
Doll is an “interested person,” as defined in the Investment Company Act, of the
Fund based on his positions with MLIM, FAM, Princeton Services and Princeton
Administrators.
|
|
****
|
|
As
a Director, Mr. Doll serves until his successor is elected and qualified, until
December 31 of the year in which he turns 72 or until his death, resignation, or
removal as provided in the Fund’s by-laws or charter or by statute.
|
Information relating to each
Director’s share ownership in the Fund and in all registered funds in the
MLIM/FAM-advised funds that are overseen by the respective Director (“Supervised Funds”)
as of December 31, 2005 is set forth in the chart below.
Name
|
Aggregate Dollar Range
of Equity Securities in the Fund
|
Aggregate Dollar Range of Equity
Securities in Supervised Funds
|
|
Interested Director:
|
|
|
|
|
|
|
Robert C. Doll, Jr
|
|
$10,001-$50,000
|
|
Over $100,000
|
|
|
Non-Interested Directors:
|
|
|
Ronald W. Forbes
|
|
$1-$10,000
|
|
Over $100,000
|
|
|
Cynthia A. Montgomery
|
|
None
|
|
Over $100,000
|
|
|
Roscoe S. Suddarth
|
|
None
|
|
Over $100,000
|
|
|
Jean Margo Reid
|
|
Over $100,000
|
|
Over $100,000
|
|
|
Richard R. West
|
|
None
|
|
Over $100,000
|
|
|
Edward D. Zinbarg
|
|
Over $100,000
|
|
Over $100,000
|
|
Directors of the Fund may purchase
Class I shares of the Portfolio.
As of June 30, 2006, the Directors and
officers of the Fund as a group owned an aggregate of less than 1% of the outstanding
shares of the Fund. As of June 30, 2006, none of the non-interested Directors of the
Fund or their immediate family members owned beneficially or of record any securities in
Merrill Lynch &Co., Inc. (“ML&Co.”).
|
|
Compensation
of Directors
|
The Fund pays each non-interested
Director a combined fee, for service on the Board and Audit Committee, of $9,000 per year
plus $250 per in-person Board meeting attended and $250 per in-person Audit Committee
meeting attended. The Chairman of the Audit Committee receives an additional fee of
$2,083 per year. The Fund reimburses each non-interested Director for his or her
out-of-pocket expenses relating to attendance at Board, Audit Committee and any
Nominating Committee meetings.
The following table shows the
compensation earned by the non-interested Directors with respect to the Fund for the
fiscal year ended June 30, 2005 and the aggregate compensation paid to them by all
MLIM/FAM-advised funds for the calendar year ended December 31, 2005.
Name
|
Compensation
from Fund
|
Pension or
Retirement Benefits
Accrued as Part of
Fund Expense
|
Aggregate
Compensation from
Fund and Other
MLIM/FAM-
Advised Funds*
|
|
Ronald W. Forbes**
|
|
$10,214
|
|
None
|
|
$304,567
|
|
|
Cynthia A. Montgomery
|
|
$ 9,000
|
|
None
|
|
$254,567
|
|
|
Jean Margo Reid
|
|
$ 7,333
|
|
None
|
|
$254,567
|
|
|
Roscoe S. Suddarth
|
|
$ 9,000
|
|
None
|
|
$254,567
|
|
|
Richard R. West
|
|
$ 9,000
|
|
None
|
|
$254,567
|
|
|
Edward D. Zinbarg
|
|
$ 9,000
|
|
None
|
|
$254,567
|
|
|
*
|
|
For
the number of MLIM/FAM-advised funds from which each Director receives compensation,
see the table beginning on page I-8.
|
|
**
|
|
Chairman
of the Board and Audit Committee
|
IV. Management and
Advisory Arrangements
The Fund, on behalf of the
Portfolio, has entered into an investment advisory agreement with FAM (the “Investment
Advisory Agreement”), pursuant to which FAM acts as the investment adviser for the
Portfolio and provides the Fund and the Portfolio with management services.
As compensation for its services to
the Portfolio, the Investment Adviser receives at the end of each month a fee from the
Portfolio at the annual rate of 0.55% of that portion of the average daily net assets of
the Portfolio not exceeding $250 million; 0.525% of that portion of the average daily net
assets of the Portfolio in excess of $250 million but not exceeding $500 million; and
0.50% of that portion of the average daily net assets of the Portfolio in excess of $500
million.
BlackRock Investment
Advisory Agreement
BlackRock, Inc. (“BlackRock”) and
Merrill Lynch & Co., Inc. (“Merrill Lynch”) have announced the proposed combination
of Merrill Lynch’s investment management business, MLIM and certain affiliates (including
FAM), and BlackRock to create a new independent company (the “BlackRock Transaction”).
The BlackRock Transaction is expected to close in the third quarter of 2006. As a result
of the BlackRock Transaction, the Fund, on behalf of the Portfolio, will enter into an
investment advisory agreement (the “BlackRock Advisory Agreement”) with BlackRock
Advisors, Inc. or its successor (“BlackRock Advisors”), that will become effective as of
the closing date of the BlackRock Transaction. Pursuant to the BlackRock Advisory
Agreement, BlackRock Advisors will provide investment advisory and administrative
services to the Fund.
The BlackRock Advisory Agreement
generally will provide that, subject to the oversight of the Fund’s Directors, BlackRock
Advisors will (a) act as investment adviser for and supervise and manage the investment
and reinvestment of the Portfolio’s assets with complete discretion in purchasing and
selling securities and other assets for the Portfolio and in voting, exercising consents
and exercising all other rights pertaining to such securities and other assets on behalf
of the Portfolio, (b) supervise continuously the investment program of the Portfolio and
the composition of its investment portfolio, (c) arrange, subject to the restrictions of
the Portfolio’s organizational documents, the provisions of the Investment Company Act
and the Investment Advisers Act of 1940, as amended, and the Portfolio’s investment
objectives and policies, and the applicable rules and regulations of the Commission, and
other applicable federal and state law, as well as any specific policies and
determinations of the Directors disclosed to BlackRock Advisors, for the purchase and
sale of securities and other assets held in the investment portfolio of the Portfolio;
and (d) provide investment research to the Portfolio.
Under the BlackRock Advisory
Agreement, BlackRock Advisors also will be obligated to provide, or arrange for its
affiliates to provide, certain administrative services on behalf of the Portfolio. These
administrative services include furnishing office facilities and equipment and clerical,
bookkeeping and administrative services (other than such services provided by the
Portfolio’s custodian, transfer agent and dividend disbursing agent and other service
providers) to the Portfolio. To the extent requested by the Portfolio, BlackRock Advisors
will provide other administrative services, including overseeing the maintenance by the
Portfolio’s custodian and transfer agent and dividend disbursing agent of certain books
and records of the Portfolio and consulting with the Portfolio’s officers, independent
accountants, legal counsel, custodian, accounting agent and transfer and dividend
disbursing agent in establishing the accounting policies of the Portfolio and monitoring
financial and shareholder accounting services.
Pursuant to the BlackRock Advisory
Agreement, the Fund, on behalf of the Portfolio, will pay BlackRock Advisors at the same
advisory fee rate described above.
Transfer Agency
Services
As of the date of this Statement of
Additional Information, the Portfolio has not made any payments to Financial Data
Services, Inc. for transfer agency services.
Accounting Services
As of the date of this Statement of
Additional Information, the Portfolio has not made any payments to State Street Bank and
Trust Company or to the Investment Adviser for accounting services.
Information Regarding
the Portfolio Manager
Theodore R. Jaeckel, Jr., CFA,
is the Portfolio’s portfolio manager and is primarily responsible for the
day-to-day operations of the Portfolio.
Other Funds and
Accounts Managed
The following table sets forth
information about funds and accounts other than the Portfolio for which the Portfolio’s
portfolio manager is primarily responsible for the day-to-day portfolio management as of
March 31, 2006.
|
|
Number of Other Accounts Managed
and Assets by Account Type
|
Number of Accounts and Assets for Which
Advisory Fee is Performance-Based
|
Name of
Portfolio Manager
|
Registered
Investment
Companies
|
Other Pooled
Investment
Vehicles
|
Other
accounts
|
Registered
Investment
Companies
|
Other Pooled
Investment
Vehicles
|
Other
accounts
|
|
Theodore R. Jaeckel, Jr
|
|
8
|
|
1
|
|
0
|
|
0
|
|
1
|
|
0
|
|
|
|
|
$2,695,203,498
|
|
$23,063,965
|
|
$0
|
|
$0
|
|
$23,063,965
|
|
$0
|
|
Portfolio Manager
Compensation Overview
The portfolio manager compensation
program of Merrill Lynch Investment Managers, L.P. and its affiliates (collectively,
herein “MLIM”) is critical to MLIM’s ability to attract and retain the most talented
asset management professionals. This program ensures that compensation is aligned with
maximizing investment returns and it provides a competitive pay opportunity for
competitive performance.
Compensation Program
The elements of total compensation
for MLIM portfolio managers are: fixed base salary, annual performance-based cash and
stock compensation (cash and stock bonus) and other benefits. MLIM has balanced these
components of pay to provide portfolio managers with a powerful incentive to achieve
consistently superior investment performance. By design, portfolio manager compensation
levels fluctuate — both up and down — with the relative investment performance
of the portfolios that they manage.
Base Salary
Under the MLIM approach, like that
of many asset management firms, base salaries represent a relatively small portion of a
portfolio manager’s total compensation. This approach serves to enhance the motivational
value of the performance-based (and therefore variable) compensation elements of the
compensation program.
Performance-Based Compensation
MLIM believes that the best
interests of investors are served by recruiting and retaining exceptional asset
management talent and managing their compensation within a consistent and disciplined
framework that emphasizes pay for performance in the context of an intensely competitive
market for talent. To that end, the portfolio manager incentive compensation is based on
a formulaic compensation program.
MLIM’s formulaic portfolio manager
compensation program includes: pre-tax investment performance relative to the appropriate
competitors or benchmarks (
i.e.
, Lipper High Yield Municipal Debt Funds) over 1-, 3- and 5-year
performance periods and a measure of operational efficiency. If a portfolio manager’s
tenure is less than 5 years, performance periods will reflect time in position. Portfolio
managers are compensated based on products they manage. A smaller discretionary element
of portfolio manager compensation may include consideration of: financial results,
expense control, profit margins, strategic planning and implementation, quality of client
service, market share, corporate reputation, capital allocation, compliance and risk
control, leadership, workforce diversity, supervision, technology and innovation. MLIM
also considers the extent to which individuals exemplify and foster Merrill Lynch’s
principles of
Client Focus, Respect for the Individual, Teamwork, Responsible Citizenship
and Integrity
. All factors are considered collectively by MLIM management.
Cash Bonus
Performance-based compensation is
distributed to portfolio managers in a combination of cash and stock. Typically, the cash
bonus, when combined with base salary, represents more than 60% of total compensation for
portfolio managers.
Stock Bonus
A portion of the dollar value of the
total annual performance-based bonus is paid in restricted shares of stock of Merrill
Lynch & Co., Inc. (the “Company”). Paying a portion of annual bonuses in stock puts
compensation earned by a portfolio manager for a given year “at risk” based on the
Company’s ability to sustain and improve its performance over future periods. The
ultimate value of stock bonuses is dependent on future Company stock price performance.
As such, the stock bonus aligns each portfolio manager’s financial interests with those
of the Company’s shareholders and encourages a balance between short-term goals and
long-term strategic objectives. Management strongly believes that providing a significant
portion of competitive performance-based compensation in stock is in the best interests
of investors and shareholders. This approach ensures that portfolio managers participate
as shareholders in both the “downside risk” and “upside opportunity” of the Company’s
performance. Portfolio managers therefore have a direct incentive to protect the
Company’s reputation for integrity.
Other Compensation Programs
Portfolio managers who meet relative
investment performance and financial management objectives during a performance year are
eligible to participate in a deferred cash program. Awards under this program are in the
form of deferred cash that may be benchmarked to a menu of MLIM mutual funds (including
their own fund) during a five-year vesting period. The deferred cash program aligns the
interests of participating portfolio managers with the investment results of MLIM
products and promotes continuity of successful portfolio management teams.
Other Benefits
Portfolio managers are also eligible
to participate in broad-based plans offered generally to Merrill Lynch employees,
including broad-based retirement, 401(k), health, and other employee benefit plans.
Potential Material
Conflicts of Interest
Real, potential or apparent
conflicts of interest may arise when a portfolio manager has day-to-day portfolio
management responsibilities with respect to more than one fund or account, including the
following:
Certain investments may be
appropriate for the Portfolio and also for other clients advised by MLIM and its
affiliates, including other client accounts managed by the Portfolio’s portfolio manager.
Investment decisions for the Portfolio and other clients are made with a view to
achieving their respective investment objectives and after consideration of such factors
as their current holdings, availability of cash for investment and the size of their
investments generally. Frequently, a
particular security may be bought or sold for only one client or in different amounts and
at different times for more than one but less than all clients. Likewise, because clients
of MLIM and its affiliates may have differing investment strategies, a particular
security may be bought for one or more clients when one or more other clients are selling
the security. The investment results for the Portfolio may differ from the results
achieved by other clients of MLIM and its affiliates and results among clients may
differ. In addition, purchases or sales of the same security may be made for two or more
clients on the same day. In such event, such transactions will be allocated among the
clients in a manner believed by MLIM to be equitable to each. MLIM will not determine
allocations based on whether it receives a performance based fee from the client. In some
cases, the allocation procedure could have an adverse effect on the price or amount of
the securities purchased or sold by the Portfolio. Purchase and sale orders for the
Portfolio may be combined with those of other clients of MLIM and its affiliates in the
interest of achieving the most favorable net results to the Portfolio.
To the extent that the Portfolio’s
portfolio manager has responsibilities for managing accounts in addition to the
Portfolio, the portfolio manager will need to divide his time and attention among
relevant accounts.
In some cases, a real, potential or
apparent conflict may also arise where (i) MLIM may have an incentive, such as a
performance based fee, in managing one account and not with respect to other accounts it
manages or (ii) where the Portfolio’s portfolio manager owns an interest in one fund or
account he manages and not another.
Portfolio Ownership
As of the date of this Statement of
Additional Information the Portfolio has not yet commenced operations, therefore the
portfolio manager does not own shares of the Portfolio at this time.
V. Information on
Sales Charges and Distribution Related Expenses
As of the date of this Statement of
Additional Information, the Portfolio has not made any payments pursuant to the Fund’s
Distribution Plans.
VI. Computation of
Offering Price
An illustration of the computation
of the offering price for Class A, Class C and Class I shares of the Portfolio based on a
hypothetical investment of $10,000 in each class of shares is set forth below.
|
|
Class A
|
Class C
|
Class I
|
|
Net Assets
|
|
$10,000
|
|
$10,000
|
|
$10,000
|
|
|
Number of Shares Outstanding
|
|
1,000
|
|
1,000
|
|
1,000
|
|
|
Net Asset Value Per share (net assets divided
|
|
|
by number of shares outstanding)
|
|
$ 10.00
|
|
$ 10.00
|
|
$ 10.00
|
|
|
Sales charge (for Class A shares:
|
|
|
4.00% of offering price; 4.17% of
|
|
|
net asset value per share)*
|
|
$ 0.42
|
|
**
|
|
***
|
|
|
|
|
|
|
|
|
|
|
Offering Price
|
|
$ 10.42
|
|
$ 10.00
|
|
$ 10.00
|
|
|
|
|
|
|
|
|
|
|
*
|
|
Rounded
to the nearest one-hundredth percent; assumes maximum sales charge is applicable.
|
|
**
|
|
Class
C shares are not subject to an initial sales charge but may be subject to a CDSC on
redemption of shares. See “Your Account — Pricing of Shares — Class C Shares
- Deferred Sales Charge Option” in the Prospectus and “Purchase of Shares — Deferred
Sales Charge Alternatives — Class C Shares” in Part II of this Statement of
Additional Information.
|
|
***
|
|
Class
I shares are not subject to any sales charge.
|
VII. Portfolio
Transactions and Brokerage
See “Portfolio Transactions and
Brokerage” in Part II of this Statement of Additional Information for more information.
As of the date of this Statement of
Additional Information, the Portfolio has not paid any brokerage commissions.
VIII. Additional
Information
The Fund is a diversified, open-end
management investment company organized under the laws of the State of Maryland that
commenced operations on October 21, 1977. Prior to September 21, 1979, the Fund consisted
solely of the Insured Portfolio. Currently, the Fund is comprised of four separate
Portfolios: Insured Portfolio, National Portfolio, Short-Term Portfolio and High Yield
Portfolio.
The authorized capital stock of the
Fund consists of 4,150,000,000 shares of Common Stock, divided into four series, each of
which is divided into four classes, designated Class A, Class B, Class C and Class I
Common Stock, having a par value of $0.10 per share. The authorized shares of each series
are as follows: Insured Portfolio Series Common Stock (500,000,000 Class A shares,
375,000,000 Class B shares, 375,000,000 Class C shares, 500,000,000 Class I shares),
National Portfolio Series Common Stock (375,000,000 Class A shares, 375,000,000 Class B
shares, 375,000,000 Class C shares, 375,000,000 Class I shares), Short-Term Portfolio
Series Common Stock (150,000,000 Class A shares, 150,000,000 Class B shares, 150,000,000
Class C shares, 150,000,000 Class I shares), and High Yield Portfolio Series Common Stock
(100,000,000 Class A shares, 100,000,000 Class C shares, 100,000,000 Class I shares).
Each Class A, Class B, Class C and Class I share of common stock of each of the
Portfolios represents an interest in the same assets of such Portfolio and are identical
in all respects to the shares of the other classes except that the Class A, Class B and
Class C shares bear certain expenses related to the account maintenance associated with
such shares, and Class B and Class C shares bear certain expenses related to the
distribution of such shares. Each Class of shares of the Portfolio has exclusive voting
rights with respect to matters relating to account maintenance services and distribution
expenditures relative to that Portfolio, as applicable (except that Class B shareholders
have certain voting rights with respect to the Class A Distribution Plan). Only shares of
each respective Portfolio are entitled to vote on matters concerning only that Portfolio.
As of the date of this Statement of
Additional Information, the Investment Adviser owned 100% of the outstanding common stock
of the Portfolio. The Investment Adviser may be deemed to control the Portfolio until
such time as it owns less than 25% of the outstanding shares of the Portfolio.
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholder and Board of
Directors of High Yield Portfolio of Merrill Lynch Municipal Bond Fund, Inc.:
We have audited the accompanying
statement of assets and liabilities of High Yield Portfolio of Merrill Lynch Municipal
Bond Fund, Inc. as of July 10, 2006. This financial statement is the responsibility of the
Fund’s management. Our responsibility is to express an opinion on this financial
statement based on our audit.
We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the statement of assets and liabilities is free of material misstatement.
The Fund is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Fund’s internal control over financial reporting. Accordingly, we
express no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the statement of assets and liabilities,
assessing the accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the statement of assets and liabilities.
We believe that our audit of the statement of assets and liabilities provides a
reasonable basis for our opinion.
In our opinion, the statement of
assets and liabilities referred to above presents fairly, in all material respects, the
financial position of High Yield Portfolio of Merrill Lynch Municipal Bond Fund, Inc. as
of July 10, 2006 in conformity with U.S. generally accepted accounting principles.
|
/s/
Deloitte & Touche
LLP
|
|
|
|
|
|
|
|
|
|
|
Princeton,
New Jersey
July 10, 2006
|
|
|
|
|
HIGH YIELD PORTFOLIO
OF
MERRILL LYNCH MUNICIPAL BOND FUND, INC.
STATEMENT OF ASSETS
AND LIABILITIES
JULY 10, 2006
|
|
|
|
ASSETS:
|
|
|
|
|
Cash (Note 1)
|
|
$ 750
|
|
|
Deferred offering costs (Note 3)
|
|
138,200
|
|
|
|
|
|
|
Total assets
|
|
138,950
|
|
|
|
|
|
|
LIABILITIES:
|
|
|
Liabilities and accrued expenses
|
|
138,200
|
|
|
|
|
|
|
NET ASSETS
:
|
|
$ 750
|
|
|
|
|
|
|
NET ASSETS CONSIST OF:
|
|
|
Class A Shares of Common Stock, $.10 par value,
|
|
|
100,000,000 Shares authorized, 25 shares issued and outstanding
|
|
$ 3
|
|
|
Class C Shares of Common Stock, $.10 par value,
|
|
|
100,000,000 Shares authorized, 25 shares issued and outstanding
|
|
3
|
|
|
Class I Shares of Common Stock, $.10 par value,
|
|
|
100,000,000 Shares authorized, 25 shares issued and outstanding
|
|
3
|
|
|
Paid-in Capital in excess of par
|
|
741
|
|
|
|
|
|
|
NET ASSETS:
|
|
$ 750
|
|
|
|
|
|
|
NET ASSET VALUE:
|
|
|
Class A – Based on net assets of $250 and 25 shares outstanding
|
|
$ 10.00
|
|
|
Class C – Based on net assets of $250 and 25 shares outstanding
|
|
$ 10.00
|
|
|
Class I – Based on net assets of $250 and 25 shares outstanding
|
|
$ 10.00
|
|
Notes to Statement of Assets and
Liabilities.
|
(1)
|
|
Merrill
Lynch Municipal Bond Fund, Inc. (the “Fund”) is a diversified, open-end management
investment company organized under the laws of the State of Maryland that commenced
operations on October 21, 1977. Currently, the Fund is comprised of four separate
Portfolios: Insured Portfolio, National Portfolio, Short-Term Portfolio and High
Yield Portfolio. To date, the High Yield Portfolio has not had any transactions other
than those relating to organizational matters and the sale of 75 shares of common
stock to Fund Asset Management, L.P. (the “Investment Adviser”). A statement of
operations and a statement of changes in net assets is not presented since the High
Yield Portfolio has not commenced operations and has only had transactions
relating to organizational matters and the sale of its shares to the Investment
Adviser.
|
|
(2)
|
|
The
Fund, on behalf of the High Yield Portfolio, has entered into an investment advisory
agreement with FAM. Upon the commencement of operations of the High Yield Portfolio,
the Investment Adviser will receive a fee from the High Yield Portfolio at the annual
rate of 0.55% of that portion of the average daily net assets of the High Yield
Portfolio not exceeding $250 million; 0.525% of that portion of the average daily net
assets of the High Yield Portfolio in excess of $250 million but not exceeding $500
million; and 0.50% of that portion of the average daily net assets of the High Yield
Portfolio in excess of $500 million. The Fund, on behalf of the High Yield
Portfolio, has also entered into a distribution agreement with FAM Distributors,
Inc. (the “Distributor”) and a transfer agency agreement with Financial Data
Services, Inc. (the “Transfer Agent”). Upon commencement of operations of the High Yield Portfolio, the Distributor will receive from the High Yield Portfolio an account maintenance fee of 0.25% for Class A Shares, and an account maintenance fee of 0.25% and a distribution fee of 0.75% for Class C Shares under the distribution agreement. Certain officers and/or Directors of the Fund
are officers and/or directors or trustees of the Investment Adviser, the Distributor
and the Transfer Agent.
|
|
(3)
|
|
Deferred
offering costs consist of registration fees, legal fees and printing fees related to
preparing the registration statement, and will be amortized over a 12-month period
beginning with the commencement of operations of the High Yield Portfolio. The
Investment Adviser, on behalf of the High Yield Portfolio, will incur organizational
costs estimated at $5,000.
|
|
(4)
|
|
The
High Yield Portfolio’s statement of assets and liabilities is prepared in conformity
with accounting principles generally accepted in the United States of America, which
may require the use of management accruals and estimates. Actual results may differ
from these estimates.
|
|
(5)
|
|
It
is the High Yield Portfolio’s policy to comply with the requirements of the Internal Revenue Code of
1986, as amended, applicable to regulated investment companies and to distribute
substantially all of its taxable income to its shareholders.
|
P
ART
II
Part II of this Statement
of Additional Information contains information about the following funds: Core
Bond Portfolio, High Income Portfolio and Intermediate Term Portfolio of Merrill
Lynch Bond Fund, Inc. (“Bond Fund”); Merrill Lynch California Insured
Municipal Bond Fund of the Merrill Lynch California Municipal Series Trust (“California
Insured”); Merrill Lynch Inflation Protected Fund (“Inflation Protected”);
Merrill Lynch Low Duration Fund of Merrill Lynch Investment Managers Funds, Inc.
(“Low Duration”); High Yield Portfolio, Insured Portfolio, National Portfolio and Short Term
Portfolio of Merrill Lynch Municipal Bond Fund, Inc. (“Municipal Bond”);
Merrill Lynch Municipal Intermediate Term Fund of Merrill Lynch Municipal Series
Trust (“Municipal Intermediate Term”); Merrill Lynch Florida Municipal
Bond Fund (“Florida Municipal Bond”), Merrill Lynch New Jersey Municipal
Bond Fund (“New Jersey Municipal Bond”), Merrill Lynch New York Municipal
Bond Fund (“New York Municipal Bond”) and Merrill Lynch Pennsylvania
Municipal Bond Fund (“Pennsylvania Municipal Bond”) of Merrill Lynch
Multi-State Municipal Series Trust; Merrill Lynch Short Term U.S. Government Fund,
Inc. (“Short Term U.S. Government”); Merrill Lynch Real Investment Fund
(“Real Investment”); Merrill Lynch U.S. Government Fund (“U.S.
Government”); Merrill Lynch U.S. High Yield Fund, Inc. (“U.S. High Yield”)
and Merrill Lynch World Income Fund, Inc. (“World Income”).
Throughout this Statement
of Additional Information, each of the above listed funds may be referred to as
a “Fund” or collectively as the “Funds.” California Insured,
Municipal Bond, Municipal Intermediate Term, Florida Municipal Bond, New Jersey
Municipal Bond, New York Municipal Bond, Pennsylvania Municipal Bond and Municipal
Investment Accumulation are collectively referred to herein as the “Municipal
Funds.”
Each Fund is organized either
as a Maryland corporation or a Massachusetts business trust. In each jurisdiction,
nomenclature varies. For ease and clarity of presentation, shares of common stock
and shares of beneficial interest are referred to herein as “shares”
or “Common Stock,” holders of shares or Common Stock are referred to
as “shareholders,” the trustees or directors of each Fund are referred
to as “Directors,” Merrill Lynch Investment Managers, L.P. (“MLIM”)
or Fund Asset Management, L.P. (“FAM”) as applicable, is the investment
adviser or manager of each Fund and each is referred to as the “Manager,”
and the investment advisory agreement or management agreement applicable to each
Fund is referred to as the “Management Agreement.” Each Fund’s
Articles of Incorporation or Declaration of Trust is referred to as its “charter.”
The Investment Company Act of 1940, as amended, is referred to herein as the “Investment
Company Act” and the Securities and Exchange Commission is referred to as
the “Commission.”
Certain Funds are “feeder”
funds (each, a “Feeder Fund”) that invest all or a portion of their
assets in a corresponding “master” portfolio (each, a “Master Portfolio”)
of a master trust (each, a “Master Trust”), a mutual fund that has the
same objective and strategies as the Feeder Fund. All investments are generally
made at the level of the Master Portfolio. This structure is sometimes called
a “master/feeder” structure. A Feeder Fund’s investment results
will correspond directly to the investment results of the underlying Master Portfolio
in which it invests. For simplicity, this Statement of Additional Information
uses the term “Fund” to include both a Feeder Fund and its Master Portfolio.
I
NVESTMENT
R
ISKS
AND
C
ONSIDERATION
S
Set forth below are descriptions
of some of the types of investments and investment strategies that one or more
of the Funds may use, and the risks and considerations associated with those investments
and investment strategies. Please see each Fund’s Prospectus and the “Investment
Objectives and Policies” section of this Statement of Additional Information
for further information on each Fund’s investment policies and risks. Information
contained in this section about the risks and considerations associated with a
Fund’s investments and/or investment strategies applies only to those Funds
specifically identified as making each type of investment or using each investment
strategy (each, a “Covered Fund”). Information that does not apply to
a Covered Fund does not form a part of that Covered Fund’s Statement of Additional
Information and should not be relied on by investors in that Covered Fund. Only
information that is clearly identified as applicable to a Covered Fund is considered
to form a part of that Covered Fund’s Statement of Additional Information.
|
|
Bond
Fund
–
Core
Bond
Portfolio
|
Bond
Fund –
High
Income
Portfolio
|
Bond
Fund –
Intermediate
Term
Portfolio
|
California
Insured
|
Inflation
Protected
|
Low
Duration
|
Municipal
Bond –
High
Yield
Portfolio
|
Municipal
Bond –
Insured
Portfolio
|
Municipal
Bond –
Short
Term
Portfolio
|
Municipal
Bond –
National
Portfolio
|
Municipal
Intermediate
Term
|
|
144 A Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Asset Backed
Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Borrowing and Leverage
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Convertible
Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Corporate Loans
|
|
X
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
|
Debt Securities
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Derivatives
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Hedging
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Indexed
and Inverse
Floating Rate
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Swap Agreements
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Interest
Rate Swaps,
Caps and Floors
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Credit Default Swap
Agreements
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Credit Linked Securities
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Total
Return Swap
Agreements
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Hybrid Instruments
|
|
|
|
|
|
|
|
|
|
|
|
Options
on Securities
and Securities Indices
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Types of Options
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Call
Options
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Put Options
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Options on Government
National
Mortgage
Association (“GNMA”)
Certificates
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Futures
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Foreign Exchange
Transactions
|
X
|
X
|
X
|
|
|
X
|
|
|
|
|
|
Forward Foreign
Exchange
Transactions
|
X
|
X
|
X
|
|
|
X
|
|
|
|
|
|
|
Currency
Futures
|
X
|
X
|
X
|
|
|
X
|
|
|
|
|
|
|
Currency
Options
|
X
|
X
|
X
|
|
|
X
|
|
|
|
|
|
Limitations
on
Currency Hedging
|
X
|
X
|
X
|
|
|
X
|
|
|
|
|
|
Risk Factors in
Hedging
Foreign
Currency Risks
|
X
|
X
|
X
|
|
|
X
|
|
|
|
|
|
Risk Factors in
Derivatives
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Credit Risk
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Currency Risk
|
X
|
X
|
X
|
|
|
X
|
|
|
|
|
|
|
Leverage Risk
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Liquidity Risk
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Additional Risk Factors
of
OTC Transactions;
Limitations on the
use
of OTC Derivatives
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Distressed Securities
|
|
X
|
|
|
|
|
|
|
|
|
|
|
Dollar Rolls
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Foreign Investment Risks
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Foreign
Market Risk
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Foreign Economy Risk
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Currency Risk and
Exchange
Risk
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Governmental Supervision
and Regulation /
Accounting
Standards
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Certain Risks of Holding
Fund Assets Outside
the
United States
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Settlement Risk
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
|
Florida
Municipal
Bond
|
New Jersey
Municipal
Bond
|
New York
Municipal
Bond
|
Pennsylvania
Municipal
Bond
|
Real
Investment
|
Short
Term
U.S.
Government
|
U.S.
Government
|
U.S.
High
Yield
|
World
Income
|
|
144 A Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Asset Backed Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Borrowing and Leverage
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Convertible Securities
|
|
|
|
|
X
|
|
|
X
|
X
|
|
Corporate Loans
|
|
|
|
|
|
|
|
X
|
|
|
Debt Securities
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Derivatives
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Hedging
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Indexed and Inverse
Floating
Rate
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Swap Agreements
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Interest Rate Swaps,
Caps
and Floors
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Credit Default Swap
Agreements
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Credit
Linked Securities
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Total Return Swap
Agreements
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Hybrid
Instruments
|
|
|
|
|
X
|
|
|
|
|
Options on Securities
and
Securities Indices
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Types of Options
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Call Options
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Put
Options
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Options on Government
National
Mortgage
Association (“GNMA”)
Certificates
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Futures
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Foreign Exchange
Transactions
|
|
|
|
|
X
|
|
|
X
|
X
|
Forward
Foreign
Exchange Transactions
|
|
|
|
|
X
|
|
|
X
|
X
|
|
Currency
Futures
|
|
|
|
|
X
|
|
|
X
|
X
|
|
Currency Options
|
|
|
|
|
X
|
|
|
X
|
X
|
Limitations
on
Currency Hedging
|
|
|
|
|
X
|
|
|
X
|
X
|
Risk
Factors in
Hedging
Foreign
Currency Risks
|
|
|
|
|
X
|
|
|
X
|
X
|
Risk
Factors in
Derivatives
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Credit
Risk
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Currency Risk
|
|
|
|
|
X
|
|
|
X
|
X
|
|
Leverage
Risk
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Liquidity Risk
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Additional
Risk Factors
of OTC Transactions;
Limitations on the use
of
OTC Derivatives
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Distressed Securities
|
|
|
|
|
|
|
|
X
|
X
|
|
Dollar Rolls
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Foreign Investment Risks
|
|
|
|
|
X
|
|
|
X
|
X
|
|
Foreign Market Risk
|
|
|
|
|
X
|
|
|
X
|
X
|
|
Foreign
Economy Risk
|
|
|
|
|
X
|
|
|
X
|
X
|
Currency Risk and
Exchange
Risk
|
|
|
|
|
X
|
|
|
X
|
X
|
Governmental Supervision
and
Regulation /
Accounting Standards
|
|
|
|
|
X
|
|
|
X
|
X
|
Certain
Risks of Holding
Fund Assets Outside
the United States
|
|
|
|
|
X
|
|
|
X
|
X
|
|
Settlement Risk
|
|
|
|
|
X
|
|
|
X
|
X
|
|
|
Bond
Fund
–
Core
Bond
Portfolio
|
Bond
Fund –
High
Income
Portfolio
|
Bond
Fund –
Intermediate
Term
Portfolio
|
California
Insured
|
Inflation
Protected
|
Low
Duration
|
Municipal
Bond –
High
Yield
Portfolio
|
Municipal
Bond –
Insured
Portfolio
|
Municipal
Bond –
Limited
Maturity
Portfolio
|
Municipal
Bond –
National
Portfolio
|
Municipal
Intermediate
Term
|
Illiquid or Restricted
Securities
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Inflation-indexed
Bonds
|
X
|
X
|
X
|
|
X
|
|
|
|
|
|
|
Investment in
Emerging Markets
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Restriction on
Certain
Investments
|
|
|
|
|
|
|
|
|
|
|
|
Investment in
Other Investment
Companies
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Junk Bonds
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
|
X
|
X
|
Mortgage-Related
Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Mortgage Backed
Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Mortgage Pass-
Through
Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Collateralized Mortgage
Obligations (“CMOs”)
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Adjustable Rate
Mortgage
Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
CMO Residuals
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Stripped Mortgage
Backed
Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Tiered Index Bonds
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Municipal Investments
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Risk
Factors and
Special Considerations
Relating to Municipal
Bonds
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Description of Municipal
Bonds
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
General Obligation
Bonds
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Revenue Bonds
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
PABs
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Moral Obligation
Bonds
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Municipal Notes
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Municipal
Commercial
Paper
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Municipal
Lease
Obligations
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Yields
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Variable Rate Demand
Obligations
(“VRDOs”)
and Participating
VRDOs
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Transactions in Financial
Futures Contracts
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Call
Rights
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Municipal Interest Rate
Swap Transactions
|
|
|
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Real Estate
Investment
Trusts (“REITs”)
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Repurchase
Agreements
and Purchase and
Sale
Contracts
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Reverse Repurchase
Agreements
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Securities Lending
|
X
|
X
|
X
|
|
X
|
X
|
X
|
|
|
|
|
|
Short Sales
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Sovereign Debt
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
Standby Commitment
Agreements
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Stripped
Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Supranational Entities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
Warrants
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
When Issued Securities,
Delayed Delivery
Securities and Forward
Commitments
|
X
|
X
|
X
|
X
|
X
|
X
|
|
X
|
X
|
X
|
X
|
|
Zero Coupon Securities
|
X
|
X
|
X
|
|
X
|
X
|
|
|
|
|
|
|
|
Florida
Municipal
Bond
|
New Jersey
Municipal
Bond
|
New York
Municipal
Bond
|
Pennsylvania
Municipal
Bond
|
Real
Investment
|
Short
Term
U.S.
Government
|
U.S.
Government
Mortgage
|
U.S.
High
Yield
|
World
Income
|
Illiquid or Restricted
Securities
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Inflation-indexed
Bonds
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Investment in
Emerging
Markets
|
|
|
|
|
X
|
|
|
|
X
|
Restriction on
Certain
Investments
|
|
|
|
|
|
|
|
|
X
|
Investment in
Other Investment
Companies
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Junk Bonds
|
X
|
X
|
X
|
X
|
X
|
|
|
X
|
X
|
Mortgage-Related
Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Mortgage Backed
Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Mortgage
Pass-
Through Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Collateralized
Mortgage
Obligations (“CMOs”)
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Adjustable
Rate
Mortgage Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
CMO
Residuals
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Stripped Mortgage
Backed
Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Tiered Index Bonds
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Municipal Investments
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Risk Factors and
Special
Considerations
Relating to Municipal
Bonds
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Description of Municipal
Bonds
|
X
|
X
|
X
|
X
|
|
|
|
|
|
General Obligation
Bonds
|
X
|
X
|
X
|
X
|
|
|
|
|
|
|
Revenue
Bonds
|
X
|
X
|
X
|
X
|
|
|
|
|
|
|
PABs
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Moral Obligation
Bonds
|
X
|
X
|
X
|
X
|
|
|
|
|
|
|
Municipal
Notes
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Municipal Commercial
Paper
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Municipal
Lease
Obligations
|
X
|
X
|
X
|
X
|
|
|
|
|
|
|
Yields
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Variable Rate Demand
Obligations
(“VRDOs”)
and Participating
VRDOs
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Transactions in Financial
Futures
Contracts
|
X
|
X
|
X
|
X
|
|
|
|
|
|
|
Call Rights
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Municipal Interest Rate
Swap Transactions
|
X
|
X
|
X
|
X
|
|
|
|
|
|
Real Estate Investment
Trusts
(“REITs”)
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
Repurchase Agreements
and Purchase and
Sale Contracts
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
Reverse Repurchase
Agreements
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Securities
Lending
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Short Sales
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Sovereign Debt
|
|
|
|
|
X
|
|
|
X
|
X
|
Standby Commitment
Agreements
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Stripped
Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
|
Supranational Entities
|
|
|
|
|
X
|
|
|
X
|
X
|
|
Warrants
|
|
|
|
|
X
|
|
|
X
|
X
|
When Issued Securities,
Delayed
Delivery
Securities and Forward
Commitments
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|
Zero Coupon
Securities
|
|
|
|
|
X
|
X
|
X
|
X
|
X
|
144A Securities.
A Fund may purchase securities that can be offered and sold only to “qualified
institutional buyers” under Rule 144A under the Securities Act. The Directors
have determined to treat as liquid Rule 144A securities that are either freely
tradable in their primary markets offshore or have been determined to be liquid
in accordance with the policies and procedures adopted by the Fund’s Directors.
The Directors have adopted guidelines and delegated to the Manager the daily function
of determining and monitoring liquidity of 144A securities. The Directors, however,
will retain sufficient oversight and be ultimately responsible for the determinations.
Since it is not possible to predict with assurance exactly how the market for
securities sold and offered under Rule 144A will continue to develop, the Directors
will carefully monitor a Fund’s investments in these securities. This investment
practice could have the effect of increasing the level of illiquidity in a Fund
to the extent that qualified institutional buyers become for a time uninterested
in purchasing these securities.
Asset-Backed Securities.
Asset-backed securities are “pass-through” securities, meaning
that principal and interest payments - net of expenses - made by the borrower
on the underlying assets (such as credit card receivables) are passed through
to a Fund. The value of asset-backed securities, like that of traditional fixed-income
securities, typically increases when interest rates fall and decreases when interest
rates rise. However, asset-backed securities differ from traditional fixed-income
securities because of their potential for prepayment. The price paid by a Fund
for its asset-backed securities, the yield the Fund expects to receive from such
securities and the average life of the securities are based on a number of factors,
including the anticipated rate of prepayment of the underlying assets. In a period
of declining interest rates, borrowers may prepay the underlying assets more quickly
than anticipated, thereby reducing the yield to maturity and the average life
of the asset-backed securities. Moreover, when a Fund reinvests the proceeds of
a prepayment in these circumstances, it will likely receive a rate of interest
that is lower than the rate on the security that was prepaid. To the extent that
a Fund purchases asset-backed securities at a premium, prepayments may result
in a loss to the extent of the premium paid. If a Fund buys such securities at
a discount, both scheduled payments and unscheduled prepayments will increase
current and total returns and unscheduled prepayments will also accelerate the
recognition of income which, when distributed to shareholders, will be taxable
as ordinary income. In a period of rising interest rates, prepayments of the underlying
assets may occur at a slower than expected rate, creating maturity extension risk.
This particular risk may effectively change a security that was considered short
or intermediate-term at the time of purchase into a longer term security. Since
the value of longer-term securities generally fluctuates more widely in response
to changes in interest rates than shorter term securities, maturity extension
risk could increase the volatility of the Fund.
Borrowing and Leverage.
Each Fund may borrow as a temporary measure for extraordinary or emergency
purposes, including to meet redemptions or to settle securities transactions.
Most Funds will not purchase securities at any time when borrowings exceed 5%
of their total assets, except (a) to honor prior commitments or (b) to exercise
subscription rights when outstanding borrowings have been obtained exclusively
for settlements of other securities transactions. Certain Funds may also borrow
in order to make investments. The purchase of securities while borrowings are
outstanding will have the effect of leveraging the Fund. Such leveraging increases
the Fund’s exposure to capital risk, and borrowed funds are subject to interest
costs that will reduce net income. The use of leverage by a Fund creates an opportunity
for greater total return, but, at the same time, creates special risks. For example,
leveraging may exaggerate changes in the net asset value of Fund shares and in
the yield on the Fund’s portfolio. Although the principal of such borrowings
will be fixed, the Fund’s assets may change in value during the time the
borrowings are outstanding. Borrowings will create interest expenses for the Fund
that can exceed the income from the assets purchased with the borrowings. To the
extent the income or capital appreciation derived from securities purchased with
borrowed funds exceeds the interest the Fund will have to pay on the borrowings,
the Fund’s return will be greater than if leverage had not been used. Conversely,
if the income or capital appreciation from the securities purchased with such
borrowed funds is not sufficient to cover the cost of borrowing, the return to
the Fund will be less than if leverage had not been used and, therefore, the amount
available for distribution to shareholders as dividends will be reduced. In the
latter case, the Manager in its best judgment nevertheless may determine to maintain
the Fund’s leveraged position if it expects that the benefits to the Fund’s
shareholders of maintaining the leveraged position will outweigh the current reduced
return.
Certain types of borrowings
by a Fund may result in the Fund being subject to covenants in credit agreements
relating to asset coverage, portfolio composition requirements and other matters.
It is not anticipated that observance of such covenants would impede the Manager
from managing a Fund’s portfolio in accordance with the Fund’s investment
objectives and policies. However, a breach of any such covenants not cured within
the specified cure period may result in acceleration of outstanding indebtedness
and require the Fund to dispose of portfolio investments at a time when it may
be disadvantageous to do so.
Each Fund may at times borrow
from affiliates of the Manager, provided that the terms of such borrowings are
no less favorable than those available from comparable sources of funds in the
marketplace.
Convertible Securities.
Convertible securities entitle the holder to receive interest payments
paid on corporate debt securities or the dividend preference on a preferred stock
until such time as the convertible security matures or is redeemed or until the
holder elects to exercise the conversion privilege.
The characteristics of convertible
securities make them potentially attractive investments for an investment company
seeking a high total return from capital appreciation and investment income. These
characteristics include the potential for capital appreciation as the value of
the underlying common stock increases, the relatively high yield received from
dividend or interest payments as compared to common stock dividends and decreased
risks of decline in value relative to the underlying common stock due to their
fixed-income nature. As a result of the conversion feature, however, the interest
rate or dividend preference on a convertible security is generally less than would
be the case if the securities were issued in nonconvertible form.
In analyzing convertible
securities, the Manager will consider both the yield on the convertible security
relative to its credit quality and the potential capital appreciation that is
offered by the underlying common stock, among other things.
Convertible securities are
issued and traded in a number of securities markets. Even in cases where a substantial
portion of the convertible securities held by a Fund are denominated in U.S. dollars,
the underlying equity securities may be quoted in the currency of the country
where the issuer is domiciled. As a result, fluctuations in the exchange rate
between the currency in which the debt security is denominated and the currency
in which the share price is quoted will affect the value of the convertible security.
With respect to convertible securities denominated in a currency different from
that of the underlying equity securities, the conversion price may be based on
a fixed exchange rate established at the time the security is issued, which may
increase the effects of currency risk. As described below, a Fund is authorized
to enter into foreign currency hedging transactions in which it may seek to reduce
the effect of exchange rate fluctuations.
Apart from currency considerations,
the value of convertible securities is influenced by both the yield on nonconvertible
securities of comparable issuers and by the value of the underlying common stock.
The value of a convertible security viewed without regard to its conversion feature
(
i.e.,
strictly on the basis of its yield) is sometimes referred to as
its “investment value.” To the extent interest rates change, the investment
value of the convertible security typically will fluctuate. At the same time,
however, the value of the convertible security will be influenced by its “conversion
value,” which is the market value of the underlying common stock that would
be obtained if the convertible security were converted. Conversion value fluctuates
directly with the price of the underlying common stock. If the conversion value
of a convertible security is substantially below its investment value, the price
of the convertible security is governed principally by its investment value. To
the extent the conversion value of a convertible security increases to a point
that approximates or exceeds its investment value, the price of the convertible
security will be influenced principally by its conversion value. A convertible
security will sell at a premium over the conversion value to the extent investors
place value on the right to acquire the underlying common stock while holding
a fixed-income security. The yield and conversion premium of convertible securities
issued in Japan and the Euromarket are frequently determined at levels that cause
the conversion value to affect their market value more than the securities’
investment value.
Holders of convertible securities
generally have a claim on the assets of the issuer prior to the common stockholders
but may be subordinated to other debt securities of the same issuer. A convertible
security may be subject to redemption at the option of the issuer at a price established
in a charter provision, indenture or other governing instrument pursuant to which
the convertible security was issued. If a convertible security held by a Fund
is called for redemption, the Fund will be required to redeem the security, convert
it into the underlying common stock or sell it to a third party. Certain convertible
debt securities may provide a put option to the holder, which entitles the holder
to cause the security to be redeemed by the issuer at a premium over the stated
principal amount of the debt security under certain circumstances.
A Fund may also invest in
synthetic convertible securities. Synthetic convertible securities may include
either Cash-Settled Convertibles or Manufactured Convertibles. Cash-Settled Convertibles
are instruments that are created by
the issuer and have the economic
characteristics of traditional convertible securities but may not actually permit
conversion into the underlying equity securities in all circumstances. As an example,
a private company may issue a Cash-Settled Convertible that is convertible into
common stock only if the company successfully completes a public offering of its
common stock prior to maturity and otherwise pays a cash amount to reflect any
equity appreciation. Manufactured Convertibles are created by the Manager or another
party by combining separate securities that possess one of the two principal characteristics
of a convertible security,
i.e.,
fixed income (“fixed income component”)
or a right to acquire equity securities (“convertibility component”).
The fixed income component is achieved by investing in nonconvertible fixed income
securities, such as nonconvertible bonds, preferred stocks and money market instruments.
The convertibility component is achieved by investing in call options, warrants,
or other securities with equity conversion features (“equity features”)
granting the holder the right to purchase a specified quantity of the underlying
stocks within a specified period of time at a specified price or, in the case
of a stock index option, the right to receive a cash payment based on the value
of the underlying stock index.
A Manufactured Convertible
differs from traditional convertible securities in several respects. Unlike a
traditional convertible security, which is a single security that has a unitary
market value, a Manufactured Convertible is comprised of two or more separate
securities, each with its own market value. Therefore, the total “market
value” of such a Manufactured Convertible is the sum of the values of its
fixed-income component and its convertibility component.
More flexibility is possible
in the creation of a Manufactured Convertible than in the purchase of a traditional
convertible security. Because many corporations have not issued convertible securities,
the Manager may combine a fixed income instrument and an equity feature with respect
to the stock of the issuer of the fixed income instrument to create a synthetic
convertible security otherwise unavailable in the market. The Manager may also
combine a fixed income instrument of an issuer with an equity feature with respect
to the stock of a different issuer when the Manager believes such a Manufactured
Convertible would better promote a Fund’s objective than alternate investments.
For example, the Manager may combine an equity feature with respect to an issuer’s
stock with a fixed income security of a different issuer in the same industry
to diversify the Fund’s credit exposure, or with a U.S. Treasury instrument
to create a Manufactured Convertible with a higher credit profile than a traditional
convertible security issued by that issuer. A Manufactured Convertible also is
a more flexible investment in that its two components may be purchased separately
and, upon purchasing the separate securities, “combined” to create a
Manufactured Convertible. For example, the Fund may purchase a warrant for eventual
inclusion in a Manufactured Convertible while postponing the purchase of a suitable
bond to pair with the warrant pending development of more favorable market conditions.
The
value of a Manufactured Convertible may respond to certain market fluctuations
differently from a traditional convertible security with similar characteristics.
For example, in the event a Fund created a Manufactured Convertible by combining
a short-term U.S. Treasury instrument and a call option on a stock, the Manufactured
Convertible would be expected to outperform a traditional convertible of similar
maturity that is convertible into that stock during periods when Treasury instruments
outperform corporate fixed income securities and underperform during periods when
corporate fixed-income securities outperform Treasury instruments.
Corporate Loans.
Commercial banks and other financial institutions or institutional investors
make corporate loans to companies that need capital to grow or restructure. Corporate
Loans generally bear interest at rates set at a margin above a generally recognized
base lending rate that may fluctuate on a day-to-day basis, in the case of the
Prime Rate of a U.S. bank, or that may be adjusted on set dates, typically 30
days but generally not more than one year, in the case of the London Interbank
Offered Rate (“LIBOR”). Consequently, the value of Corporate Loans held
by a Fund may be expected to fluctuate significantly less than the value of fixed
rate bond instruments as a result of changes in the interest rate environment.
On the other hand, because the secondary trading market for certain Corporate
Loans may be less developed than the secondary trading market for bonds and notes,
a Fund may have difficulty from time to time in valuing and/or selling its Corporate
Loans. Borrowers frequently provide collateral to secure repayment of these obligations.
Leading financial institutions often act as agent for a broader group of lenders,
generally referred to as a “syndicate.” The syndicate agent arranges
the Corporate Loans, holds collateral and accepts payments of principal and interest.
If the agent develops financial problems, a Fund may not recover its investment,
or there might be a delay in the Fund’s recovery. By investing in a Corporate
Loan, a Fund becomes a member of the syndicate.
The Corporate Loans in which
a Fund may invest are subject to the risk of loss of principal and income. Although
borrowers frequently provide collateral to secure repayment of these obligations
they do not always do so. If they do provide collateral, the value of the collateral
may not completely cover the borrower’s obligations at the time of investment
or at the time of a default. If a borrower files for protection from its creditors
under the U.S. bankruptcy laws, these laws may limit a Fund’s rights to its
collateral. In addition, the value of collateral may erode during a bankruptcy
case. In the event of a bankruptcy, the holder of a Corporate Loan may not recover
its principal, may experience a long delay in recovering its investment and may
not receive interest during the delay. Corporate Loans are frequently secured
by pledges of liens and security interests in the assets of the borrower, and
the holders of Corporate Loans are frequently the beneficiaries of debt service
subordination provisions imposed on the borrower’s bondholders. These arrangements
are designed to give Corporate Loan investors preferential treatment over junk
bond investors in the event of a deterioration in the credit quality of the issuer.
Even when these arrangements exist, however, there can be no assurance that the
principal and interest owed on the Corporate Loans will be repaid in full.
A Fund may acquire interests
in Corporate Loans by means of an assignment or participation. A Fund may purchase
an assignment, in which case the Fund may be required to rely on the assigning
institution to demand payment and enforce its rights against the borrower but
would otherwise typically be entitled to all of such assigning institution’s
rights under the credit agreement. Participation interests in a portion of a debt
obligation typically result in a contractual relationship only with the institution
selling the participation interest and not with the borrower. In purchasing a
loan participation, a Fund generally will have no right to enforce compliance
by the borrower with the terms of the loan agreement, nor any rights of set-off
against the borrower, and the Fund may not directly benefit from the collateral
supporting the debt obligation in which it has purchased the participation. As
a result, a Fund will assume the credit risk of both the borrower and the institution
selling the participation to the Fund.
Debt Securities.
Debt securities, such as bonds, involve credit risk. This is the risk
that the issuer will not make timely payments of principal and interest. The degree
of credit risk depends on the issuer’s financial condition and on the terms
of the debt securities. Changes in an issuer’s credit rating or the market’s
perception of an issuer’s creditworthiness may also affect the value of a
Fund’s investment in that issuer. Credit risk is reduced to the extent a
Fund limits its debt investments to U.S. Government securities. All debt securities,
however, are subject to interest rate risk. This is the risk that the value of
the security may fall when interest rates rise. If interest rates move sharply
in a manner not anticipated by Fund management, a Fund’s investments in debt
securities could be adversely affected and the Fund could lose money. In general,
the market price of debt securities with longer maturities will go up or down
more in response to changes in interest rates than the market price of shorter-term
debt securities.
Derivatives
Each Fund may use instruments
referred to as derivative securities (“Derivatives”). Derivatives are
financial instruments the value of which is derived from another security, a commodity
(such as gold or oil), a currency or an index (a measure of value or rates, such
as the S&P 500 Index or the prime lending rate). Derivatives allow a Fund
to increase or decrease the level of risk to which the Fund is exposed more quickly
and efficiently than transactions in other types of instruments. Each Fund may
use Derivatives for hedging purposes. Certain Funds may also use derivatives for
speculative purposes to seek to enhance returns. The use of a Derivative is speculative
if the Fund is primarily seeking to achieve gains, rather than offset the risk
of other positions. When a Fund invests in a Derivative for speculative purposes,
the Fund will be fully exposed to the risks of loss of that Derivative, which
may sometimes be greater than the Derivative’s cost. No Fund may use any
Derivative to gain exposure to an asset or class of assets that it would be prohibited
by its investment restrictions from purchasing directly.
Hedging.
Hedging
is a strategy in which a Derivative is used to offset the risks associated with
other Fund holdings. Losses on the other investment may be substantially reduced
by gains on a Derivative that reacts in an opposite manner to market movements.
While hedging can reduce losses, it can also reduce or eliminate gains or cause
losses if the market moves in a manner different from that anticipated by the
Fund or if the cost of the Derivative outweighs the benefit of the hedge. Hedging
also involves correlation risk, i.e. the risk that changes in the value of the
Derivative will not match those of the holdings being hedged as expected by a
Fund, in which case any losses on the holdings being hedged may not be reduced
or may be increased. The inability to close options and futures positions also
could have an adverse impact on a Fund’s ability to hedge effectively its
portfolio. There is also a risk of loss by the Fund of margin deposits or collateral
in the event of bankruptcy of a broker with whom the Fund has an open position
in an option, a futures contract or a related option. There can be no assurance
that a Fund’s hedging
strategies will be effective.
No Fund is required to engage in hedging transactions and each Fund may choose
not to do so.
A Fund may use Derivative
instruments and trading strategies, including the following:
Indexed and Inverse Floating
Rate Securities
. A Fund may invest in securities that provide a potential
return based on a particular index of value or interest rates. For example, a
Fund may invest in securities that pay interest based on an index of interest
rates. The principal amount payable upon maturity of certain securities also may
be based on the value of the index. To the extent a Fund invests in these types
of securities, the Fund’s return on such securities will be subject to risk
with respect to the value of the particular index: that is, if the value of the
index falls the the value of the indexed securities owned by the Fund will fall.
Interest and principal payable on certain securities may also be based on relative
changes among particular indices. A Fund may also invest in so-called “inverse
floating obligations” or “residual interest bonds” on which the
interest rates vary inversely with a floating rate (which may be reset periodically
by a dutch auction, a remarketing agent, or by reference to a short-term tax-exempt
interest rate index). A Fund may purchase synthetically-created inverse floating
rate bonds evidenced by custodial or trust receipts. Generally, income on inverse
floating rate bonds will decrease when interest rates increase, and will increase
when interest rates decrease. Such securities have the effect of providing a degree
of investment leverage, since they may increase or decrease in value in response
to changes, as an illustration, in market interest rates at a rate that is a multiple
(typically two) of the rate at which fixed-rate securities increase or decrease
in response to such changes. As a result, the market values of such securities
will generally be more volatile than the market values of fixed-rate securities.
To seek to limit the volatility of these securities, a Fund may purchase inverse
floating obligations that have shorter-term maturities or that contain limitations
on the extent to which the interest rate may vary. Certain investments in such
obligations may be illiquid. The Manager believes that indexed and inverse floating
obligations represent flexible portfolio management instruments for a Fund that
allow the Fund to seek potential investment rewards, hedge other portfolio positions
or vary the degree of investment leverage relatively efficiently under different
market conditions. A Fund may invest in indexed and inverse securities for hedging
purposes or to seek to increase returns. When used for hedging purposes, indexed
and inverse securities involve correlation risk. Furthermore, where such a security
includes a contingent liability, in the event of an adverse movement in the underlying
index or interest rate, a Fund may be required to pay substantial additional margin
to maintain the position.
Swap Agreements
. A
Fund may enter into swap agreements, including interest rate and index swap agreements,
for hedging purposes or to seek to obtain a particular desired return at a lower
cost to the Fund than if the Fund had invested directly in an instrument that
yielded the desired return. Swap agreements are two party contracts entered into
primarily by institutional investors for periods ranging from a few weeks 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 dollar amount invested at a
particular interest rate, in a particular foreign currency, or in a “basket”
of securities representing a particular index. The “notional amount”
of the swap agreement is only a fictive basis on which to calculate the obligations
that the parties to a swap agreement have agreed to exchange. A Fund’s obligations
(or rights) under a swap agreement will generally be equal only 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”). A
Fund’s obligations under a swap agreement will be accrued daily (offset against
any amounts owing to the Fund) and any accrued but unpaid net amounts owed to
a swap counterparty will be covered by marking as segregated liquid, unencumbered
assets, marked to market daily, to avoid any potential leveraging of the Fund’s
portfolio.
Whether a Fund’s use
of swap agreements will be successful in furthering its investment objective will
depend on the Manager’s ability to correctly predict whether certain types
of investments are likely to produce greater returns than other investments. Because
they are two party contracts and because they may have terms of greater than seven
days, some swap agreements may be considered to be illiquid. Moreover, a 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. A
Fund will seek to lessen this risk to some extent by entering into a transaction
only if the counterparty meets the current credit requirement for OTC option counterparties.
Swap agreements also bear the risk that a Fund will not be able to meet its payment
obligations to the counterparty. As noted, however, a Fund will deposit in a segregated
account liquid assets permitted to be so segregated by the Commission in an amount
equal to or greater than the market value of the Fund’s liabilities under
the swap agreement or the amount it would cost the
Fund initially to make an
equivalent direct investment plus or minus any amount the Fund is obligated to
pay or is to receive under the swap agreement. Restrictions imposed by the tax
rules applicable to regulated investment companies, may limit the Fund’s
ability to use swap agreements. The swap market is largely unregulated. It is
possible that developments in the swap market, including potential government
regulation, could adversely affect each Fund’s ability to terminate existing
swap agreements or to realize amounts to be received under such agreements.
See “Credit Default
Swap Agreements,” “Interest Rate Swaps, Caps and Floors” and “Municipal
Interest Rate Swap Agreements” below for further information on particular
types of swap agreements that may be used by certain Funds.
Interest Rate Swaps,
Caps and Floors.
In order to hedge the value of a Fund’s portfolio against
interest rate fluctuations or to enhance a Fund’s income, a Fund may enter
into various transactions, such as interest rate swaps and the purchase or sale
of interest rate caps and floors. Interest rate swaps are OTC contracts in which
each party agrees to make a periodic interest payment based on an index or the
value of an asset in return for a periodic payment from the other party based
on a different index or asset. The purchase of an interest rate floor entitles
the purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest on a notional principal amount
from the party selling such interest rate floor. The purchase of an interest rate
cap entitles the purchaser, to the extent that a specified index rises above a
predetermined interest rate, to receive payments of interest on a notional principal
amount from the party selling such interest rate cap.
A Fund expects to enter into
these transactions primarily to preserve a return or spread on a particular investment
or portion of its portfolio or to protect against any increase in the price of
securities the Fund anticipates purchasing at a later date. A Fund generally will
use these transactions primarily as a hedge and not as a speculative investment.
However, a Fund may also invest in interest rate swaps to enhance income or to
increase the Fund’s yield during periods of steep interest rate yield curves
(
i.e.,
wide differences between short term and long term interest rates).
In an interest rate swap, a Fund may exchange with another party their respective
commitments to pay or receive interest,
e.g.,
an exchange of fixed rate
payments for floating rate payments. For example, if a Fund holds a mortgage-
backed security with an interest rate that is reset only once each year, it may
swap the right to receive interest at this fixed rate for the right to receive
interest at a rate that is reset every week. This would enable a Fund to offset
a decline in the value of the mortgage backed security due to rising interest
rates but would also limit its ability to benefit from falling interest rates.
Conversely, if a Fund holds a mortgage-backed security with an interest rate that
is reset every week and it would like to lock in what it believes to be a high
interest rate for one year, it may swap the right to receive interest at this
variable weekly rate for the right to receive interest at a rate that is fixed
for one year. Such a swap would protect the Fund from a reduction in yield due
to falling interest rates and may permit the Fund to enhance its income through
the positive differential between one week and one year interest rates, but would
preclude it from taking full advantage of rising interest rates.
A Fund usually will enter
into interest rate swap transactions on a net basis (
i.e.,
the two payment
streams are netted against one another with the Fund receiving or paying, as the
case may be, only the net amount of the two payment streams). Inasmuch as these
transactions are entered into for good faith hedging purposes, the Manager believes
that such obligations do not constitute senior securities and, accordingly, will
not treat them as being subject to its borrowing restrictions. The net amount
of the excess, if any, of a Fund’s obligations over its entitlements with
respect to each interest rate swap will be accrued on a daily basis, and an amount
of liquid assets that have an aggregate net asset value at least equal to the
accrued excess will be maintained in a segregated account by the Fund. If the
interest rate swap transaction is entered into on other than a net basis, the
full amount of a Fund’s obligations will be accrued on a daily basis, and
the full amount of the Fund’s obligations will be maintained in a segregated
account.
Typically the parties with
which a Fund will enter into interest rate transactions will be broker-dealers
and other financial institutions. A Fund will enter into interest rate swap, cap
or floor transactions only with counterparties that are rated investment grade
quality by at least one nationally recognized statistical rating organization
at the time of entering into such transaction or whose creditworthiness is believed
by the Manager to be equivalent to such rating. If there is a default by the counterparty
to such a transaction, a Fund will have contractual remedies pursuant to the agreements
related to the transaction. 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 using standardized swap documentation. As a result, the
swap market has become relatively liquid in comparison with other similar
instruments traded in the
interbank market. Caps and floors, however, are less liquid than swaps. Certain
Federal income tax requirements may limit a Fund’s ability to engage in certain
interest rate transactions. Gains from transactions in interest rate swaps distributed
to shareholders will be taxable as ordinary income or, in certain circumstances,
as long term capital gains to shareholders.
Credit Default Swap
Agreements and Similar Instruments.
Certain Funds may enter into credit default
swap agreements and similar agreements, and may also buy credit-linked securities.
The credit default swap agreement or similar instrument may have as reference
obligations one or more securities that are not currently held by a Fund. The
protection “buyer” in a credit default contract may be obligated to
pay the protection “seller” an up front payment or a periodic stream
of payments over the term of the contract provided generally that no credit event
on a reference obligation has occurred. If a credit event occurs, the seller generally
must pay the buyer the “par value” (full notional value) of the swap
in exchange for an equal face amount of deliverable obligations of the reference
entity described in the swap, or the seller may be required to deliver the related
net cash amount, if the swap is cash settled. A Fund may be either the buyer or
seller in the transaction. If a Fund is a buyer and no credit event occurs, the
Fund recovers nothing if the swap is held through its termination date. However,
if a credit event occurs, the Fund may elect to receive the full notional value
of the swap in exchange for an equal face amount of deliverable obligations of
the reference entity that may have little or no value. As a seller, a Fund generally
receives an up front payment or a fixed rate of income throughout the term of
the swap, which typically is between six months and three years, provided that
there is no credit event. If a credit event occurs, generally the seller must
pay the buyer the full notional value of the swap in exchange for an equal face
amount of deliverable obligations of the reference entity that may have little
or no value.
Credit default swaps and
similar instruments involve greater risks than if a Fund had invested in the reference
obligation directly, since, in addition to general market risks, they are subject
to illiquidity risk, counterparty risk and credit risks. A Fund will enter into
credit default swap agreements and similar instruments only with counterparties
who are rated investment grade quality by at least one nationally recognized statistical
rating organization at the time of entering into such transaction or whose creditworthiness
is believed by the Manager to be equivalent to such rating. A buyer also will
lose its investment and recover nothing should no credit event occur and the swap
is held to its termination date. If a credit event were to occur, the value of
any deliverable obligation received by the seller, coupled with the up front or
periodic payments previously received, may be less than the full notional value
it pays to the buyer, resulting in a loss of value to the Fund. When a Fund acts
as a seller of a credit default swap or a similar instrument, it is exposed to
many of the same risks of leverage since, if a credit event occurs, the seller
may be required to pay the buyer the full notional value of the contract net of
any amounts owed by the buyer related to its delivery of deliverable obligations.
Credit
Linked Securities.
Among the income producing securities in which a Fund may
invest are credit linked securities, which are issued by a limited purpose trust
or other vehicle that, in turn, invests in a derivative instrument or basket of
derivative instruments, such a credit default swaps, interest rate swaps and other
securities, in order to provide exposure to certain fixed income markets. For
instance, a Fund may invest in credit linked securities as a cash management tool
in order to gain exposure to a certain market and/or to remain fully invested
when more traditional income producing securities are not available.
Like an investment in a bond,
investments in these credit linked securities represent the right to receive periodic
income payments (in the form of distributions) and payment of principal at the
end of the term of the security. However, these payments are conditioned on the
issuer’s receipt of payments from, and the issuer’s potential obligations
to, the counterparties to the derivative instruments and other securities in which
the issuer invests. For instance, the issuer may sell one or more credit default
swaps, under which the issuer would receive a stream of payments over the term
of the swap agreements provided that no event of default has occurred with respect
to the referenced debt obligation upon which the swap is based. If a default occurs,
the stream of payments may stop and the issuer would be obligated to pay the counterparty
the par (or other agreed upon value) of the referenced debt obligation. This,
in turn, would reduce the amount of income and principal that a Fund would receive.
A Fund’s investments in these instruments are indirectly subject to the risks
associated with derivative instruments, including, among others, credit risk,
default or similar event risk, counterparty risk, interest rate risk, leverage
risk and management risk. It is also expected that the securities will be exempt
from registration under the Securities Act of 1933. Accordingly, there may be
no established trading market for the securities and they may constitute illiquid
investments.
Total Return Swap Agreements.
Total return swap agreements are contracts in which one party agrees to make
periodic payments to another party based on the change in market value of the
assets underlying the contract, which may include a specified security, basket
of securities or securities indices during the specified period, in return for
periodic payments based on a fixed or variable interest rate or the total return
from other underlying assets. Total return swap agreements may be used to obtain
exposure to a security or market without owning or taking physical custody of
such security or investing directly in such market. Total return swap agreements
may effectively add leverage to the Fund’s portfolio because, in addition
to its total net assets, the Fund would be subject to investment exposure on the
notional amount of the swap.
Total return swap agreements
are subject to the risk that a counterparty will default on its payment obligations
to the Fund thereunder. Swap agreements also bear the risk that the Fund will
not be able to meet its obligation to the counterparty. Generally, the Fund will
enter into total return swaps on a net basis (
i.e.,
the two payment streams
are netted against one another with the Fund receiving or paying, as the case
may be, only the net amount of the two payments). The net amount of the excess,
if any, of the Fund’s obligations over its entitlements with respect to each
total return swap will be accrued on a daily basis, and an amount of liquid assets
having an aggregate net asset value at least equal to the accrued excess will
be segregated by the Fund. If the total return swap transaction is entered into
on other than a net basis, the full amount of the Fund’s obligations will
be accrued on a daily basis, and the full amount of the Fund’s obligations
will be segregated by the Fund in an amount equal to or greater than the market
value of the liabilities under the total return swap agreement or the amount it
would have cost the Fund initially to make an equivalent direct investment, plus
or minus any amount the Fund is obligated to pay or is to receive under the total
return swap agreement.
Hybrid Instruments.
Certain Funds seek to gain exposure to the commodities markets primarily through
investments in hybrid instruments. Hybrid instruments are either equity or debt
derivative securities with one or more commodity-dependent components that have
payment features similar to a commodity futures contract, a commodity option contract,
or a combination of both. Therefore, these instruments are “commodity-linked.”
They are considered “hybrid” instruments because they have both commodity-like
and security-like characteristics. Hybrid instruments are derivative instruments
because at least part of their value is derived from the value of an underlying
commodity, futures contract, index or other readily measurable economic variable.
Qualifying
Hybrid Instruments.
Certain Funds may invest in hybrid instruments that qualify
for exclusion from regulation under the Commodity Exchange Act and the regulations
adopted thereunder. A hybrid instrument that qualifies for this exclusion from
regulation must be “predominantly a security.” A hybrid instrument is
considered to be predominantly a security if (a) the issuer of the hybrid instrument
receives payment in full of the purchase price of the hybrid instrument, substantially
contemporaneously with delivery of the hybrid instrument; (b) the purchaser or
holder of the hybrid instrument is not required to make any payment to the issuer
in addition to the purchase price paid under subparagraph (a), whether as margin,
settlement payment, or otherwise, during the life of the hybrid instrument or
at maturity; (c) the issuer of the hybrid instrument is not subject by the terms
of the instrument to mark-to-market margining requirements; and (d) the hybrid
instrument is not marketed as a contract of sale of a commodity for future delivery
(or option on such a contract) subject to applicable provisions of the Commodity
Exchange Act. Hybrid instruments may be principal protected, partially protected,
or offer no principal protection. A principal protected hybrid instrument means
that the issuer will pay, at a minimum, the par value of the note at maturity.
Therefore, if the commodity value to which the hybrid instrument is linked declines
over the life of the note, the Fund will receive at maturity the face or stated
value of the note. With a principal protected hybrid instrument, the Fund will
receive at maturity the greater of the par value of the note or the increase in
its value based on the underlying commodity or index. This protection is, in effect,
an option whose value is subject to the volatility and price level of the underlying
commodity. The Manager’s decision whether to use principal protection depends
in part on the cost of the protection. In addition, the protection feature depends
upon the ability of the issuer to meet its obligation to buy back the security,
and, therefore, depends on the creditworthiness of the issuer. With full principal
protection, the Fund will receive at maturity of the hybrid instrument either
the stated par value of the hybrid instrument, or potentially, an amount greater
than the stated par value if the underlying commodity, index, futures contract
or economic variable to which the hybrid instrument is linked has increased in
value. Partially protected hybrid instruments may suffer some loss of principal
if the underlying commodity, index, futures contract or economic variable to which
the hybrid instrument is linked declines in value during the term of the hybrid
instrument. However, partially protected hybrid instruments have a specified limit
as to the amount of principal that they may lose.
Hybrid Instruments Without
Principal Protection.
Certain Funds may invest in hybrid instruments that
offer no principal protection. At maturity, there is a risk that the underlying
commodity price, futures contract, index or other economic variable may have declined
sufficiently in value such that some or all of the face value of the hybrid instrument
might not be returned. The Manager, at its discretion, may invest in a partially
protected principal structured note or a note without principal protection. In
deciding to purchase a note without principal protection, the Manager may consider,
among other things, the expected performance of the underlying commodity futures
contract, index or other economic variable over the term of the note, the cost
of the note, and any other economic factors that the Manager believes are relevant.
Limitations
on Leverage.
Some of the hybrid instruments in which a Fund may invest may
involve leverage. To avoid being subject to undue leverage risk, a Fund will seek
to limit the amount of economic leverage it has under any one hybrid instrument
that it buys and the leverage of the Fund’s overall portfolio. A Fund will
not invest in a hybrid instrument if, at the time of purchase: (i) that instrument’s
“leverage ratio” exceeds 300% of the price increase in the underlying
commodity, futures contract, index or other economic variable or (ii) the Fund’s
“portfolio leverage ratio” exceeds 150%, measured at the time of purchase.
“Leverage ratio” is the expected increase in the value of a hybrid instrument,
assuming a one percent price increase in the underlying commodity, futures contract,
index or other economic factor. In other words, for a hybrid instrument with a
leverage factor of 150%, a 1% gain in the underlying economic variable would be
expected to result in a 1.5% gain in value for the hybrid instrument. Conversely,
a hybrid instrument with a leverage factor of 150% would suffer a 1.5% loss if
the underlying economic variable lost 1% of its value. “Portfolio leverage
ratio” is defined as the average (mean) leverage ratio of all instruments
in a Fund’s portfolio, weighted by the market values of such instruments
or, in the case of futures contracts, their notional values. To the extent that
the policy on a Fund’s use of leverage stated above conflicts with the Investment
Company Act or the rules and regulations thereunder, the Fund will comply with
the applicable provisions of the Investment Company Act. A Fund may at times or
from time to time decide not to use leverage in its investments or use less leverage
than may otherwise be allowable.
Counterparty Risk.
A
significant risk of hybrid instruments is counterparty risk. Unlike exchange-traded
futures and options, which are standard contracts, hybrid instruments are customized
securities, tailor-made by a specific issuer. With a listed futures or options
contract, an investor’s counterparty is the exchange clearinghouse. Exchange
clearinghouses are capitalized by the exchange members and typically have high
investment grade ratings (
e.g.,
ratings of AAA or AA by Standard &
Poor’s). Therefore, the risk is small that an exchange clearinghouse might
be unable to meet its obligations at maturity. However, with a hybrid instrument,
a Fund will take on the counterparty credit risk of the issuer. That is, at maturity
of the hybrid instrument, there is a risk that the issuer may be unable to perform
its obligations under the structured note.
Options
on Securities and Securities Indices
Types of Options.
A
Fund may engage in transactions in options on individual securities, baskets of
securities or securities indices, or particular measurements of value or rates
(an “index”), such as an index of the price of treasury securities or
an index representative of short-term interest rates. Such investments may be
made on exchanges and in the over-the-counter markets. In general, exchange-traded
options have standardized exercise prices and expiration dates and require the
parties to post margin against their obligations, and the performance of the parties’
obligations in connection with such options is guaranteed by the exchange or a
related clearing corporation. OTC options have more flexible terms negotiated
between the buyer and the seller, but generally do not require the parties to
post margin and are subject to greater credit risk. OTC options also involve greater
liquidity risk. See “Additional Risk Factors of OTC Transactions; Limitations
on the Use of OTC Derivatives” below.
Call Options.
Each
Fund may purchase call options on any of the types of securities or instruments
in which it may invest. A purchased call option gives a Fund the right to buy,
and obligates the seller to sell, the underlying security at the exercise price
at any time during the option period. A Fund also may purchase and sell call options
on indices. Index options are similar to options on securities except that, rather
than taking or making delivery of securities underlying the option at a specified
price upon exercise, an index option gives the holder the right to receive cash
upon exercise of the option if the level of the index upon which the option is
based is greater than the exercise price of the option.
Each Fund also is authorized
to write (
i.e.,
sell) covered call options on the securities or instruments
in which it may invest and to enter into closing purchase transactions with respect
to certain of such options. A covered call option is an option in which a Fund,
in return for a premium, gives another party a right to buy specified securities
owned by the Fund at a specified future date and price set at the time of the
contract. The principal reason for writing call options is the attempt to realize,
through the receipt of premiums, a greater return than would be realized on the
securities alone. By writing covered call options, a Fund gives up the opportunity,
while the option is in effect, to profit from any price increase in the underlying
security above the option exercise price. In addition, a Fund’s ability to
sell the underlying security will be limited while the option is in effect unless
the Fund enters into a closing purchase transaction. A closing purchase transaction
cancels out a Fund’s position as the writer of an option by means of an offsetting
purchase of an identical option prior to the expiration of the option it has written.
Covered call options also serve as a partial hedge to the extent of the premium
received against the price of the underlying security declining.
Each Fund also is authorized
to write (
i.e.,
sell) uncovered call options on securities or instruments
in which it may invest but that are not currently held by the Fund. The principal
reason for writing uncovered call options is to realize income without committing
capital to the ownership of the underlying securities or instruments. When writing
uncovered call options, a Fund must deposit and maintain sufficient margin with
the broker dealer through which it made the uncovered call option as collateral
to ensure that the securities can be purchased for delivery if and when the option
is exercised. In addition, in connection with each such transaction a Fund will
segregate unencumbered liquid securities or cash with a value at least equal to
the Fund’s exposure (the difference between the unpaid amounts owed by the
Fund on such transaction minus any collateral deposited with the broker dealer),
on a marked-to-market basis (as calculated pursuant to requirements of the Commission).
Such segregation will ensure that the Fund has assets available to satisfy its
obligations with respect to the transaction and will avoid any potential leveraging
of the Fund’s portfolio. Such segregation will not limit the Fund’s
exposure to loss. During periods of declining securities prices or when prices
are stable, writing uncovered calls can be a profitable strategy to increase a
Fund’s income with minimal capital risk. Uncovered calls are riskier than
covered calls because there is no underlying security held by a Fund that can
act as a partial hedge. Uncovered calls have speculative characteristics and the
potential for loss is unlimited. When an uncovered call is exercised, a Fund must
purchase the underlying security to meet its call obligation. There is also a
risk, especially with less liquid preferred and debt securities, that the securities
may not be available for purchase. If the purchase price exceeds the exercise
price, a Fund will lose the difference.
Put Options.
Each
Fund is authorized to purchase put options to seek to hedge against a decline
in the value of its securities or to enhance its return. By buying a put option,
a Fund acquires a right to sell the underlying securities or instruments at the
exercise price, thus limiting the Fund’s risk of loss through a decline in
the market value of the securities or instruments until the put option expires.
The amount of any appreciation in the value of the underlying securities or instruments
will be partially offset by the amount of the premium paid for the put option
and any related transaction costs. Prior to its expiration, a put option may be
sold in a closing sale transaction and profit or loss from the sale will depend
on whether the amount received is more or less than the premium paid for the put
option plus the related transaction costs. A closing sale transaction cancels
out a Fund’s position as the purchaser of an option by means of an offsetting
sale of an identical option prior to the expiration of the option it has purchased.
A Fund also may purchase uncovered put options.
Each Fund also has authority
to write (
i.e.,
sell) put options on the types of securities or instruments
that may be held by the Fund, provided that such put options are covered, meaning
that such options are secured by segregated, liquid assets. A Fund will receive
a premium for writing a put option, which increases the Fund’s return. A
Fund will not sell puts if, as a result, more than 50% of the Fund’s assets
would be required to cover its potential obligations under its hedging and other
investment transactions.
Each Fund is also authorized
to write (
i.e.,
sell) uncovered put options on securities or instruments
in which it may invest but with respect to which the Fund does not currently have
a corresponding short position or has not deposited as collateral cash equal to
the exercise value of the put option with the broker dealer through which it made
the uncovered put option. The principal reason for writing uncovered put options
is to receive premium income and to acquire such securities or instruments at
a net cost below the current market value. A Fund has the obligation to buy the
securities or instruments at an agreed upon price if the price of the securities
or instruments decreases below the exercise price. If the price of the securities
or instruments increases during the option period, the option will expire worthless
and a Fund will retain the premium and will not have to purchase the securities
or instruments at the
exercise price. In connection
with such a transaction, a Fund will segregate unencumbered liquid assets with
a value at least equal to the Fund’s exposure, on a marked-to-market basis
(as calculated pursuant to requirements of the Commission). Such segregation will
ensure that a Fund has assets available to satisfy its obligations with respect
to the transaction and will avoid any potential leveraging of the Fund’s
portfolio. Such segregation will not limit the Fund’s exposure to loss.
Options on Government
National Mortgage Association (“GNMA”) Certificates.
The following
information relates to the unique characteristics of options on GNMA Certificates.
Since the remaining principal balance of GNMA Certificates declines each month
as a result of mortgage payments, a Fund, as a writer of a GNMA call holding GNMA
Certificates as “cover” to satisfy its delivery obligation in the event
of exercise, may find that the GNMA Certificates it holds no longer have a sufficient
remaining principal balance for this purpose. Should this occur, a Fund will purchase
additional GNMA Certificates from the same pool (if obtainable) or other GNMA
Certificates in the cash market in order to maintain its “cover.”
A
GNMA Certificate held by a Fund to cover an option position in any but the nearest
expiration month may cease to represent cover for the option in the event of a
decline in the GNMA coupon rate at which new pools are originated under the FHA/VA
loan ceiling in effect at any given time. If this should occur, a Fund will no
longer be covered, and the Fund will either enter into a closing purchase transaction
or replace such Certificate with a certificate that represents cover. When a Fund
closes its position or replaces such Certificate, it may realize an unanticipated
loss and incur transaction costs.
Futures
A
Fund may engage in transactions in futures and options on futures. Futures are
standardized, exchange-traded contracts that obligate a purchaser to take delivery,
and a seller to make delivery, of a specific amount of an asset at a specified
future date at a specified price. No price is paid upon entering into a futures
contract. Rather, upon purchasing or selling a futures contract a Fund is required
to deposit collateral (“margin”) equal to a percentage (generally less
than 10%) of the contract value. Each day thereafter until the futures position
is closed, the Fund will pay additional margin representing any loss experienced
as a result of the futures position the prior day or be entitled to a payment
representing any profit experienced as a result of the futures position the prior
day. Futures involve substantial leverage risk.
The sale of a futures contract
limits a Fund’s risk of loss from a decline in the market value of portfolio
holdings correlated with the futures contract prior to the futures contract’s
expiration date. In the event the market value of the portfolio holdings correlated
with the futures contract increases rather than decreases, however, a Fund will
realize a loss on the futures position and a lower return on the portfolio holdings
than would have been realized without the purchase of the futures contract.
The purchase of a futures
contract may protect a Fund from having to pay more for securities as a consequence
of increases in the market value for such securities during a period when the
Fund was attempting to identify specific securities in which to invest in a market
the Fund believes to be attractive. In the event that such securities decline
in value or a Fund determines not to complete an anticipatory hedge transaction
relating to a futures contract, however, the Fund may realize a loss relating
to the futures position.
A Fund is also authorized
to purchase or sell call and put options on futures contracts including financial
futures and stock indices. Generally, these strategies would be used under the
same market and market sector conditions (
i.e.,
conditions relating to
specific types of investments) in which the Fund entered into futures transactions.
A Fund may purchase put options or write call options on futures contracts and
stock indices in lieu of selling the underlying futures contract in anticipation
of a decrease in the market value of its securities. Similarly, a Fund can purchase
call options, or write put options on futures contracts and stock indices, as
a substitute for the purchase of such futures to hedge against the increased cost
resulting from an increase in the market value of securities which the Fund intends
to purchase.
Each Fund’s Manager
has claimed an exclusion from the definition of the term “commodity pool
operator” under the Commodity Exchange Act (“CEA”) pursuant to
Rule 4.5 under the CEA. The Manager is not, therefore, subject
to registration or regulation
as a “commodity pool operator” under the CEA and each Fund is operated
so as not to be deemed a “commodity pool” under the regulations of the
Commodity Futures Trading Commission.
Foreign Exchange Transactions.
A Fund may engage in spot and forward foreign exchange transactions and currency
swaps, purchase and sell options on currencies and purchase and sell currency
futures and related options thereon (collectively, “Currency Instruments”)
for purposes of hedging against the decline in the value of currencies in which
its portfolio holdings are denominated against the U.S. dollar or, with respect
to certain Funds, to seek to enhance returns. Such transactions could be effected
with respect to hedges on non-U.S. dollar denominated securities owned by a Fund,
sold by a Fund but not yet delivered, or committed or anticipated to be purchased
by a Fund. As an illustration, a Fund may use such techniques to hedge the stated
value in U.S. dollars of an investment in a yen-denominated security. In such
circumstances, for example, the Fund may purchase a foreign currency put option
enabling it to sell a specified amount of yen for dollars at a specified price
by a future date. To the extent the hedge is successful, a loss in the value of
the yen relative to the dollar will tend to be offset by an increase in the value
of the put option. To offset, in whole or in part, the cost of acquiring such
a put option, the Fund may also sell a call option which, if exercised, requires
it to sell a specified amount of yen for dollars at a specified price by a future
date (a technique called a “straddle”). By selling such a call option
in this illustration, the Fund gives up the opportunity to profit without limit
from increases in the relative value of the yen to the dollar. “Straddles”
of the type that may be used by a Fund are considered to constitute hedging transactions.
No Fund will attempt to hedge all of its foreign portfolio positions.
Forward
Foreign Exchange Transactions.
Forward foreign exchange transactions are OTC
contracts to purchase or sell a specified amount of a specified currency or multinational
currency unit at a price and future date set at the time of the contract. Spot
foreign exchange transactions are similar but require current, rather than future,
settlement. A Fund will enter into foreign exchange transactions for purposes
of hedging either a specific transaction or a portfolio position, or, with respect
to certain Funds, to seek to enhance returns. A Fund may enter into a foreign
exchange transaction for purposes of hedging a specific transaction by, for example,
purchasing a currency needed to settle a security transaction or selling a currency
in which the Fund has received or anticipates receiving a dividend or distribution.
A Fund may enter into a foreign exchange transaction for purposes of hedging a
portfolio position by selling forward a currency in which a portfolio position
of the Fund is denominated or by purchasing a currency in which the Fund anticipates
acquiring a portfolio position in the near future. A Fund may also hedge portfolio
positions through currency swaps, which are transactions in which one currency
is simultaneously bought for a second currency on a spot basis and sold for the
second currency on a forward basis. Forward foreign exchange transactions involve
substantial currency risk, and also involve credit and liquidity risk.
Currency
Futures.
A Fund may also seek to enhance returns or hedge against the decline
in the value of a currency against the U.S. dollar through use of currency futures
or options thereon. Currency futures are similar to forward foreign exchange transactions
except that futures are standardized, exchange-traded contracts while forward
foreign exchange transactions are traded in the OTC market. Currency futures involve
substantial currency risk, and also involve leverage risk.
Currency Options.
A
Fund may also seek to enhance returns or hedge against the decline in the value
of a currency against the U.S. dollar through the use of currency options. Currency
options are similar to options on securities, but in consideration for an option
premium the writer of a currency option is obligated to sell (in the case of a
call option) or purchase (in the case of a put option) a specified amount of a
specified currency on or before the expiration date for a specified amount of
another currency. A Fund may engage in transactions in options on currencies either
on exchanges or OTC markets. See “Types of Options” above and “Additional
Risk Factors of OTC Transactions; Limitations on the Use of OTC Derivatives”
below. Currency options involve substantial currency risk, and may also involve
credit, leverage or liquidity risk.
Limitations on Currency
Hedging.
Most Funds will not speculate in Currency Instruments although certain
Funds may use such instruments to seek to enhance returns. Accordingly, a Fund
will not hedge a currency in excess of the aggregate market value of the securities
that it owns (including receivables for unsettled securities sales), or has committed
to or anticipates purchasing, which are denominated in such currency. A Fund may,
however, hedge a currency by entering into a transaction in a Currency Instrument
denominated in a currency other than the currency being hedged (a “cross-hedge”).
A Fund will only enter into a cross-hedge if the Manager believes that (i) there
is a demonstrable high correlation between the currency in which the cross-hedge
is denominated and the currency being hedged, and (ii) executing a cross-hedge
through the currency in which the cross-hedge is denominated will be
significantly more cost-effective
or provide substantially greater liquidity than executing a similar hedging transaction
by means of the currency being hedged.
Risk Factors in Hedging
Foreign Currency Risks.
Hedging transactions involving Currency Instruments
involve substantial risks, including correlation risk. While a Fund’s use
of Currency Instruments to effect hedging strategies is intended to reduce the
volatility of the net asset value of the Fund’s shares, the net asset value
of the Fund’s shares will fluctuate. Moreover, although Currency Instruments
will be used with the intention of hedging against adverse currency movements,
transactions in Currency Instruments involve the risk that anticipated currency
movements will not be accurately predicted and that the Fund’s hedging strategies
will be ineffective. To the extent that a Fund hedges against anticipated currency
movements that do not occur, the Fund may realize losses and decrease its total
return as the result of its hedging transactions. Furthermore, a Fund will only
engage in hedging activities from time to time and may not be engaging in hedging
activities when movements in currency exchange rates occur.
In connection with its trading
in forward foreign currency contracts, a Fund will contract with a foreign or
domestic bank, or foreign or domestic securities dealer, to make or take future
delivery of a specified amount of a particular currency. There are no limitations
on daily price moves in such forward contracts, and banks and dealers are not
required to continue to make markets in such contracts. There have been periods
during which certain banks or dealers have refused to quote prices for such forward
contracts or have quoted prices with an unusually wide spread between the price
at which the bank or dealer is prepared to buy and that at which it is prepared
to sell. Governmental imposition of credit controls might limit any such forward
contract trading. With respect to its trading of forward contracts, if any, a
Fund will be subject to the risk of bank or dealer failure and the inability of,
or refusal by, a bank or dealer to perform with respect to such contracts. Any
such default would deprive the Fund of any profit potential or force the Fund
to cover its commitments for resale, if any, at the then market price and could
result in a loss to the Fund.
It may not be possible for
a Fund to hedge against currency exchange rate movements, even if correctly anticipated,
in the event that (i) the currency exchange rate movement is so generally anticipated
that the Fund is not able to enter into a hedging transaction at an effective
price, or (ii) the currency exchange rate movement relates to a market with respect
to which Currency Instruments are not available and it is not possible to engage
in effective foreign currency hedging. The cost to a Fund of engaging in foreign
currency transactions varies with such factors as the currencies involved, the
length of the contract period and the market conditions then prevailing. Since
transactions in foreign currency exchange usually are conducted on a principal
basis, no fees or commissions are involved.
Risk Factors in Derivatives
Derivatives
are volatile and involve significant risks, including:
Credit Risk
—
the risk that the counterparty in a Derivative transaction will be unable to honor
its financial obligation to a Fund, or the risk that the reference entity in a
credit default swap or similar derivative will not be able to honor its financial
obligations.
Currency Risk
—
the risk that changes in the exchange rate between two currencies will adversely
affect the value (in U.S. dollar terms) of an investment.
Leverage Risk
—
the risk associated with certain types of investments or trading strategies (such
as, for example, borrowing money to increase the amount of investments) that relatively
small market movements may result in large changes in the value of an investment.
Certain investments or trading strategies that involve leverage can result in
losses that greatly exceed the amount originally invested.
Liquidity Risk
—
the risk that certain securities may be difficult or impossible to sell at the
time that the seller would like or at the price that the seller believes the security
is currently worth.
Correlation Risk
—
the risk that changes in the value of a Derivative will not match the changes
in the value of the portfolio holdings that are being hedged or of the particular
market or security to which the Fund seeks exposure.
A Fund intends to enter into
transactions involving Derivatives only if there appears to be a liquid secondary
market for such instruments or, in the case of illiquid instruments traded in
OTC transactions, such instruments satisfy the criteria set forth below under
“Additional Risk Factors of OTC Transactions; Limitations on the Use of OTC
Derivatives.” However, there can be no assurance that, at any specific time,
either a liquid secondary market will exist for a Derivative or the Fund will
otherwise be able to sell such instrument at an acceptable price. It may, therefore,
not be possible to close a position in a Derivative without incurring substantial
losses, if at all.
Certain transactions in Derivatives
(such as futures transactions or sales of put options) involve substantial leverage
risk and may expose a Fund to potential losses that exceed the amount originally
invested by the Fund. When a Fund engages in such a transaction, the Fund will
deposit in a segregated account liquid assets with a value at least equal to the
Fund’s exposure, on a mark-to-market basis, to the transaction (as calculated
pursuant to requirements of the Commission). Such segregation will ensure that
a Fund has assets available to satisfy its obligations with respect to the transaction,
but will not limit the Fund’s exposure to loss.
Additional
Risk Factors of OTC Transactions; Limitations on the Use of OTC Derivatives
Certain Derivatives traded
in OTC markets, including indexed securities, swaps and OTC options, involve substantial
liquidity risk. The absence of liquidity may make it difficult or impossible for
a Fund to sell such instruments promptly at an acceptable price. The absence of
liquidity may also make it more difficult for a Fund to ascertain a market value
for such instruments. A Fund will, therefore, acquire illiquid OTC instruments
(i) if the agreement pursuant to which the instrument is purchased contains a
formula price at which the instrument may be terminated or sold, or (ii) for which
the Manager anticipates the Fund can receive on each business day at least two
independent bids or offers, unless a quotation from only one dealer is available,
in which case that dealer’s quotation may be used.
Because Derivatives traded
in OTC markets are not guaranteed by an exchange or clearing corporation and generally
do not require payment of margin, to the extent that a Fund has unrealized gains
in such instruments or has deposited collateral with its counterparty the Fund
is at risk that its counterparty will become bankrupt or otherwise fail to honor
its obligations. A Fund will attempt to minimize these risks by engaging in transactions
in Derivatives traded in OTC markets only with financial institutions that have
substantial capital or that have provided the Fund with a third-party guaranty
or other credit enhancement.
Distressed Securities.
A Fund may invest in securities, including loans purchased in the secondary market,
that are the subject of bankruptcy proceedings or otherwise in default or in risk
of being in default as to the repayment of principal and/or interest at the time
of acquisition by the Fund or that are rated in the lower rating categories by
one or more nationally recognized statistical rating organizations (for example,
Ca or lower by Moody’s Investors Service, Inc. (“Moody’s”)
and CC or lower by Standard & Poor’s (“S&P”) or Fitch Ratings
(“Fitch”)) or, if unrated, are in the judgment of the Manager of equivalent
quality (“Distressed Securities”). Investment in Distressed Securities
is speculative and involves significant risks.
A Fund will generally make
such investments only when the Manager believes it is reasonably likely that the
issuer of the Distressed Securities will make an exchange offer or will be the
subject of a plan of reorganization pursuant to which the Fund will receive new
securities in return for the Distressed Securities. However, there can be no assurance
that such an exchange offer will be made or that such a plan of reorganization
will be adopted. In addition, a significant period of time may pass between the
time at which a Fund makes its investment in Distressed Securities and the time
that any such exchange offer or plan of reorganization is completed. During this
period, it is unlikely that a Fund will receive any interest payments on the Distressed
Securities, the Fund will be subject to significant uncertainty as to whether
or not the exchange offer or plan of reorganization will be completed and the
Fund may be required to bear certain extraordinary expenses to protect and recover
its investment. Even if an exchange offer is made or plan of reorganization is
adopted with respect to Distressed Securities held by a Fund, there can be no
assurance that the securities or other assets received by a Fund in connection
with such exchange offer or plan of reorganization will not have a lower value
or income potential than may have been anticipated when the investment was made.
Moreover, any securities received by a Fund upon completion of an exchange offer
or plan of reorganization may be restricted as to resale. Similarly, if a Fund
participates in negotiations with respect to any exchange offer or plan of reorganization
with respect to an issuer of Distressed Securities, the Fund may be restricted
from disposing of such securities.
Dollar Rolls.
A Fund may enter into dollar rolls, in which the Fund will sell or buy securities
for delivery in the current month and simultaneously contract to repurchase or
resell substantially similar (the same type and coupon) securities on a specified
future date from the same party. During the roll period, a Fund forgoes principal
and interest paid on the securities sold. In a sale of securities, a Fund is compensated
by the difference between the current sales price and the forward price for the
future purchase (often referred to as the “drop”) as well as by the
interest earned on the cash proceeds of the initial sale. In a purchase, the Fund
will benefit from the difference between the current purchase price and the forward
price for the future sale.
Dollar rolls involve the
risk that the market value of the securities subject to a Fund’s forward
purchase commitment may decline below, or the market value of the securities subject
to a Fund’s forward sale commitment may increase above, the exercise price
of the forward commitment. In the event the buyer of the securities files for
bankruptcy or becomes insolvent, a Fund’s use of the proceeds of the current
sale portion of the transaction may be restricted pending a determination by the
other party, or its trustee or receiver, whether to enforce the Fund’s obligation
to purchase the similar securities in the forward transaction. Dollar rolls are
speculative techniques that can be deemed to involve leverage. At the time a Fund
sells securities and agrees to repurchase securities at a future date, the Fund
will segregate liquid assets with a value equal to the repurchase price. A Fund
may engage in dollar roll transactions to enhance return. Each dollar roll transaction
is accounted for as a sale or purchase of a portfolio security and a subsequent
purchase or sale of a substantially similar security in the forward market.
Foreign
Investment Risks
Foreign Market Risk.
Funds that may invest in foreign securities offer the potential for more diversification
than a Fund that invests only in the United States because securities traded on
foreign markets have often (though not always) performed differently from securities
traded in the United States. However, such investments often involve risks not
present in U.S. investments that can increase the chances that a Fund will lose
money. In particular, a Fund is subject to the risk that, because there are generally
fewer investors on foreign exchanges and a smaller number of shares traded each
day, it may be difficult for the Fund to buy and sell securities on those exchanges.
In addition, prices of foreign securities may fluctuate more than prices of securities
traded in the United States. Investments in foreign markets may also be adversely
affected by governmental actions such as the imposition of punitive taxes. In
addition, the governments of certain countries may prohibit or impose substantial
restrictions on foreign investing in their capital markets or in certain industries.
Any of these actions could severely affect security prices, impair a Fund’s
ability to purchase or sell foreign securities or transfer the Fund’s assets
or income back into the United States, or otherwise adversely affect a Fund’s
operations. Other potential foreign market risks include exchange controls, difficulties
in pricing securities, defaults on foreign government securities, difficulties
in enforcing favorable legal judgments in foreign courts, and political and social
instability. Legal remedies available to investors in certain foreign countries
may be less extensive than those available to investors in the United States or
other foreign countries.
Foreign Economy Risk.
The economies of certain foreign markets often do not compare favorably with
that of the United States with respect to such issues as growth of gross national
product, reinvestment of capital, resources, and balance of payments position.
Certain such economies may rely heavily on particular industries or foreign capital
and are more vulnerable to diplomatic developments, the imposition of economic
sanctions against a particular country or countries, changes in international
trading patterns, trade barriers, and other protectionist or retaliatory measures.
Currency
Risk and Exchange Risk.
Securities in which a Fund invests may be denominated
or quoted in currencies other than the U.S. dollar. In this case, changes in foreign
currency exchange rates will affect the value of a Fund’s portfolio. Generally,
when the U.S. dollar rises in value against a foreign currency, a security denominated
in that currency loses value because the currency is worth fewer U.S. dollars.
Conversely, when the U.S. dollar decreases in value against a foreign currency,
a security denominated in that currency gains value because the currency is worth
more U.S. dollars. This risk, generally known as “currency risk,” means
that a stronger U.S. dollar will reduce returns for U.S. investors while a weak
U.S. dollar will increase those returns.
Governmental Supervision
and Regulation/Accounting Standards.
Many foreign governments supervise and
regulate stock exchanges, brokers and the sale of securities less than does the
United States. Some countries may not have laws to protect investors comparable
to the U.S. securities laws. For example, some foreign countries may have no
laws or rules against insider
trading. Insider trading occurs when a person buys or sells a company’s securities
based on nonpublic information about that company. Accounting standards in other
countries are not necessarily the same as in the United States. If the accounting
standards in another country do not require as much detail as U.S. accounting
standards, it may be harder for Fund management to completely and accurately determine
a company’s financial condition. In addition, the U.S. Government has from
time to time in the past imposed restrictions, through penalties and otherwise,
on foreign investments by U.S. investors such as the Fund. If such restrictions
should be reinstituted, it might become necessary for the Fund to invest all or
substantially all of its assets in U.S. securities.
Certain Risks of Holding
Fund Assets Outside the United States.
A Fund generally holds its foreign
securities and cash in foreign banks and securities depositories. Some foreign
banks and securities depositories may be recently organized or new to the foreign
custody business. In addition, there may be limited or no regulatory oversight
over their operations. Also, the laws of certain countries may put limits on a
Fund’s ability to recover its assets if a foreign bank or depository or issuer
of a security or any of their agents goes bankrupt. In addition, it is often more
expensive for a Fund to buy, sell and hold securities in certain foreign markets
than in the United States. The increased expense of investing in foreign markets
reduces the amount a Fund can earn on its investments and typically results in
a higher operating expense ratio for the Fund as compared to investment companies
that invest only in the United States.
Settlement Risk.
Settlement
and clearance procedures in certain foreign markets differ significantly from
those in the United States. Foreign settlement procedures and trade regulations
also may involve certain risks (such as delays in payment for or delivery of securities)
not typically generated by the settlement of U.S. investments. Communications
between the United States and emerging market countries may be unreliable, increasing
the risk of delayed settlements or losses of security certificates in markets
that still rely on physical settlement. Settlements in certain foreign countries
at times have not kept pace with the number of securities transactions; these
problems may make it difficult for a Fund to carry out transactions. If a Fund
cannot settle or is delayed in settling a purchase of securities, it may miss
attractive investment opportunities and certain of its assets may be uninvested
with no return earned thereon for some period. If a Fund cannot settle or is delayed
in settling a sale of securities, it may lose money if the value of the security
then declines or, if it has contracted to sell the security to another party,
the Fund could be liable to that party for any losses incurred.
Dividends or interest on,
or proceeds from the sale of, foreign securities may be subject to foreign withholding
taxes.
Illiquid or Restricted
Securities.
Each Fund may invest up to 15% of its net assets in securities
that lack an established secondary trading market or otherwise are considered
illiquid. Liquidity of a security relates to the ability to dispose easily of
the security and the price to be obtained upon disposition of the security, which
may be less than would be obtained for a comparable more liquid security. Illiquid
securities may trade at a discount from comparable, more liquid investments. Investment
of a Fund’s assets in illiquid securities may restrict the ability of the
Fund to dispose of its investments in a timely fashion and for a fair price as
well as its ability to take advantage of market opportunities. The risks associated
with illiquidity will be particularly acute where a Fund’s operations require
cash, such as when the Fund redeems shares or pays dividends, and could result
in the Fund borrowing to meet short term cash requirements or incurring capital
losses on the sale of illiquid investments.
A Fund may invest in securities
that are not registered under the Securities Act of 1933, as amended (“restricted
securities”). Restricted securities may be sold in private placement transactions
between issuers and their purchasers and may be neither listed on an exchange
nor traded in other established markets. In many cases, privately placed securities
may not be freely transferable under the laws of the applicable jurisdiction or
due to contractual restrictions on resale. As a result of the absence of a public
trading market, privately placed securities may be less liquid and more difficult
to value than publicly traded securities. To the extent that privately placed
securities may be resold in privately negotiated transactions, the prices realized
from the sales, due to illiquidity, could be less than those originally paid by
the Fund or less than their fair market value. In addition, issuers whose securities
are not publicly traded may not be subject to the disclosure and other investor
protection requirements that may be applicable if their securities were publicly
traded. If any privately placed securities held by a Fund are required to be registered
under the securities laws of one or more jurisdictions before being resold, the
Fund may be required to bear the expenses of registration. Certain of the Fund’s
investments in private placements may consist of direct investments and may include
investments in smaller, less seasoned issuers, which may involve greater risks.
These issuers may have limited product lines, markets or financial resources,
or they may be dependent on a limited
management group. In making
investments in such securities, a Fund may obtain access to material nonpublic
information, which may restrict the Fund’s ability to conduct portfolio transactions
in such securities.
Inflation-Indexed
Bonds.
Inflation-indexed bonds are fixed income securities or other instruments
whose principal value is periodically adjusted according to the rate of inflation.
Two structures are common. The U.S. Treasury and some other issuers use a structure
that accrues inflation into the principal value of the bond. Most other issuers
pay out the Consumer Price Index (“CPI”) accruals as part of a semi-annual
coupon.
Inflation-indexed securities
issued by the U.S. Treasury have maturities of five, ten or thirty years, although
it is possible that securities with other maturities will be issued in the future.
The U.S. Treasury securities pay interest on a semi-annual basis, equal to a fixed
percentage of the inflation-adjusted principal amount. For example, if the Fund
purchased an inflation-indexed bond with a par value of $1,000 and a 3% real rate
of return coupon (payable 1.5% semi-annually), and inflation over the first six
months was 1%, the mid-year value of the bond would be $1,010 and the first semi-annual
interest payment would be $15.15 ($1,010 times 1.5%). If inflation during the
second half of the year resulted in the whole year’s inflation equaling 3%,
the end of year value of the bond would be $1,030 and the second semi-annual interest
payment would be $15.45 ($1,030 times 1.5%).
If the periodic adjustment
rate measuring inflation falls, the principal value of inflation-indexed bonds
will be adjusted downward, and, consequently, the interest payable on these securities
(calculated with respect to a smaller principal amount) will be reduced. Repayment
of the original bond principal on maturity (as adjusted for inflation) is guaranteed
in the case of U.S. Treasury inflation-indexed bonds, even during a period of
deflation. However, the current market value of the bonds is not guaranteed and
will fluctuate. The Fund may also invest in other inflation related bonds that
may or may not provide a similar guarantee. If a guarantee of principal is not
provided, the adjusted principal value of the bond repaid at maturity may be less
than the original principal. In addition, if the Fund purchases inflation-indexed
bonds offered by foreign issuers, the rate of inflation measured by the foreign
inflation index may not be correlated to the rate of inflation in the United States.
The
value of inflation-indexed bonds is expected to change in response to changes
in real interest rates. Real interest rates, in turn, are tied to the relationship
between nominal interest rates and the rate of inflation. Therefore, if inflation
were to rise at a faster rate than nominal interest rates, real interest rates
might decline, leading to an increase in value of inflation-indexed bonds. In
contrast, if nominal interest rates increased at a faster rate than inflation,
real interest rates might rise, leading to a decrease in value of inflation-indexed
bonds. There can be no assurance, however, that the value of inflation-indexed
bonds will be directly correlated to changes in interest rates.
While these securities are
expected to be protected from long-term inflationary trends, short-term increases
in inflation may lead to a decline in value. If interest rates rise due to reasons
other than inflation (for example, due to changes in currency exchange rates),
investors in these securities may not be protected to the extent that the increase
is not reflected in the bond’s inflation measure.
In general, the measure used
to determine the periodic adjustment of U.S. inflation-indexed bonds is the CPI
for Urban Consumers (“CPI-U”), which is calculated monthly by the U.S.
Bureau of Labor Statistics. The CPI-U is a measurement of changes in the cost
of living, made up of components such as housing, food, transportation and energy.
Inflation-indexed bonds issued by a foreign government are generally adjusted
to reflect a comparable inflation index calculate by the applicable government.
There can be no assurance that the CPI-U or any foreign inflation index will accurately
measure the real rate of inflation in the prices of goods and services. Moreover,
there can be no assurance that the rate of inflation in a foreign country will
be correlated to the rate of inflation in the United States.
An increase in the principal
amount of an inflation-indexed bond will be considered taxable ordinary income,
even though investors do not receive their principal until maturity.
Investment in Emerging
Markets.
Certain Funds may invest in the securities of issuers domiciled
in various countries with emerging capital markets. Specifically, a country with
an emerging capital market is any country that the World Bank, the International
Finance Corporation, the United Nations or its authorities has determined to have
a low or middle income economy. Countries with emerging markets can be found in
regions such as Asia, Latin America, Eastern Europe and Africa.
Investments in the securities
of issuers domiciled in countries with emerging capital markets involve certain
additional risks that do not generally apply to investments in securities of issuers
in more developed capital markets, such as (i) low or non-existent trading volume,
resulting in a lack of liquidity and increased volatility in prices for such securities,
as compared to securities of comparable issuers in more developed capital markets;
(ii) uncertain national policies and social, political and economic instability,
increasing the potential for expropriation of assets, confiscatory taxation, high
rates of inflation or unfavorable diplomatic developments; (iii) possible fluctuations
in exchange rates, differing legal systems and the existence or possible imposition
of exchange controls, custodial restrictions or other foreign or U.S. governmental
laws or restrictions applicable to such investments; (iv) national policies that
may limit a Fund’s investment opportunities such as restrictions on investment
in issuers or industries deemed sensitive to national interests; and (v) the lack
or relatively early development of legal structures governing private and foreign
investments and private property. In addition to withholding taxes on investment
income, some countries with emerging markets may impose differential capital gains
taxes on foreign investors.
Emerging capital markets
are developing in a dynamic political and economic environment brought about by
events over recent years that have reshaped political boundaries and traditional
ideologies. In such a dynamic environment, there can be no assurance that any
or all of these capital markets will continue to present viable investment opportunities
for a Fund. In the past, governments of such nations have expropriated substantial
amounts of private property, and most claims of the property owners have never
been fully settled. There is no assurance that such expropriations will not reoccur.
In such an event, it is possible that a Fund could lose the entire value of its
investments in the affected market.
Also, there may be less publicly
available information about issuers in emerging markets than would be available
about issuers in more developed capital markets, and such issuers may not be subject
to accounting, auditing and financial reporting standards and requirements comparable
to those to which U.S. companies are subject. In certain countries with emerging
capital markets, reporting standards vary widely. As a result, traditional investment
measurements used in the United States, such as price/earnings ratios, may not
be applicable. Emerging market securities may be substantially less liquid and
more volatile than those of mature markets, and company shares may be held by
a limited number of persons. This may adversely affect the timing and pricing
of the Fund’s acquisition or disposal of securities.
Practices in relation to
settlement of securities transactions in emerging markets involve higher risks
than those in developed markets, in part because a Fund will need to use brokers
and counterparties that are less well capitalized, and custody and registration
of assets in some countries may be unreliable. The possibility of fraud, negligence,
undue influence being exerted by the issuer or refusal to recognize ownership
exists in some emerging markets, and, along with other factors, could result in
ownership registration being completely lost. A Fund would absorb any loss resulting
from such registration problems and may have no successful claim for compensation.
Restrictions
on Certain Investments.
A number of publicly traded closed-end investment
companies have been organized to facilitate indirect foreign investment in developing
countries, and certain of such countries, such as Thailand, South Korea, Chile
and Brazil, have specifically authorized such funds. There also are investment
opportunities in certain of such countries in pooled vehicles that resemble open-end
investment companies. In accordance with the Investment Company Act, a Fund may
invest up to 10% of its total assets in securities of other investment companies,
not more than 5% of which may be invested in any one such company. In addition,
under the Investment Company Act, a Fund may not own more than 3% of the total
outstanding voting stock of any investment company. These restrictions on investments
in securities of investment companies may limit opportunities for a Fund to invest
indirectly in certain developing countries. Shares of certain investment companies
may at times be acquired only at market prices representing premiums to their
net asset values. If a Fund acquires shares of other investment companies, shareholders
would bear both their proportionate share of expenses of the Fund (including management
and advisory fees) and, indirectly, the expenses of such other investment companies.
Brady
Bonds
. Brady Bonds are debt obligations that are created through the exchange
of existing commercial bank loans to sovereign entities for new obligations in
connection with debt restructuring under a plan introduced in 1989 by former U.S.
Secretary of the Treasury, Nicholas F. Brady (the “Brady Plan”). Brady
Plan debt restructurings have been implemented to date in Mexico, Venezuela, Argentina,
Uruguay, Costa Rica, Nigeria, the Philippines, Brazil, Peru, Ecuador, Panama,
Poland and Bulgaria. To date, Brady Bonds aggregating approximately $100 billion
are outstanding, based on current estimates, with the largest proportion of Brady
Bonds having been issued by Mexico,
Argentina and Venezuela.
The Fund anticipates that it will invest in bank loans (through participations
or assignments) that may be restructured as Brady Bond obligations.
Brady Bonds may be collateralized
and issued in various currencies (although most are U.S. dollar-denominated) and
they are actively traded in the over-the-counter secondary market. U.S. dollar-denominated,
collateralized Brady Bonds, which may be fixed rate par bonds or floating rate
discount bonds, are generally collateralized in full as to principal by U.S. Treasury
zero coupon bonds that have the same maturity as the Brady Bonds. Interest payments
on these Brady Bonds generally are collateralized on a one-year or longer rolling-forward
basis by cash or securities in an amount that, in the case of fixed rate bonds,
is equal to at least one year of interest payments or, in the case of floating
rate bonds, initially is equal to at least one year’s interest payments based
on the applicable interest rate at that time and is adjusted at regular intervals
thereafter. Certain Brady Bonds are entitled to “value recovery payments”
in certain circumstances, which in effect constitute supplemental interest payments
but generally are not collateralized. For example, some Mexican and Venezuelan
Brady Bonds include attached value recovery options, which increase interest payments
if oil revenues rise. Brady Bonds are often viewed as having three or four valuation
components: (i) the collateralized repayment of principal at final maturity; (ii)
the collateralized interest payments; (iii) the uncollateralized interest payments;
and (iv) any uncollateralized repayment of principal at maturity (these uncollateralized
amounts constitute the “residual risk”). In light of the residual risk
of Brady Bonds and, among other factors, the history of defaults with respect
to commercial bank loans by public and private entities of countries issuing Brady
Bonds, investments in Brady Bonds are considered speculative.
Most Mexican Brady Bonds
issued to date have principal repayments at final maturity fully collateralized
by U.S. Treasury zero coupon bonds (or comparable collateral denominated in other
currencies) and interest coupon payments collateralized on an 18-month rolling-forward
basis by funds held in escrow by an agent for the bondholders. A significant portion
of the Brady Bonds issued to date by Costa Rica, Nigeria, the Philippines, Brazil,
Peru, Ecuador, Panama, Poland, Bulgaria, Venezuela and Argentina have principal
repayments at final maturity collateralized by U.S. Treasury zero coupon bonds
(or comparable collateral denominated in other currencies) and/or interest coupon
payments collateralized on a 14-month (for Venezuela) or 12-month (for Argentina)
rolling-forward basis by securities held by the Federal Reserve Bank of New York
as collateral agent.]
Investment in Other
Investment Companies.
Each Fund may invest in other investment companies,
including exchange traded funds. In accordance with the Investment Company Act,
a Fund may invest up to 10% of its total assets in securities of other investment
companies. In addition, under the Investment Company Act a Fund may not own more
than 3% of the total outstanding voting stock of any investment company and not
more than 5% of the value of the Fund’s total assets may be invested in securities
of any investment company. (These limits do not restrict a Feeder Fund from investing
all of its assets in shares of its Master Portfolio.) Each Fund has received an
exemptive order from the Commission permitting it to invest in affiliated registered
money market funds and in an affiliated private investment company without regard
to such limitations, provided however, that in all cases the Fund’s aggregate
investment of cash in shares of such investment companies shall not exceed 25%
of the Fund’s total assets at any time. As with other investments, investments
in other investment companies are subject to market and selection risk. In addition,
if a Fund acquires shares in investment companies, shareholders would bear both
their proportionate share of expenses in the Fund (including management and advisory
fees) and, indirectly, the expenses of such investment companies (including management
and advisory fees). Investments by a Fund in wholly owned investment entities
created under the laws of certain countries will not be deemed an investment in
other investment companies.
Junk Bonds.
Junk
bonds are debt securities that are rated below investment grade by the major rating
agencies or are unrated securities that Fund management believes are of comparable
quality. Although junk bonds generally pay higher rates of interest than investment
grade bonds, they are high risk investments that may cause income and principal
losses for a Fund. The major risks in junk bond investments include the following:
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Junk
bonds may be issued by less creditworthy companies. These securities are vulnerable
to adverse changes in the issuer’s industry and to general economic conditions.
Issuers of junk bonds may be unable to meet their interest or principal payment
obligations because of an economic downturn, specific issuer developments or the
unavailability of additional financing.
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The
issuers of junk bonds may have a larger amount of outstanding debt relative to
their assets than issuers of investment grade bonds. If the issuer experiences
financial stress, it may be unable to meet its debt obligations. The issuer’s
ability to pay its debt obligations also may be lessened by specific issuer developments,
or the unavailability of additional financing.
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Junk
bonds are frequently ranked junior to claims by other creditors. If the issuer
cannot meet its obligations, the senior obligations are generally paid off before
the junior obligations.
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Junk
bonds frequently have redemption features that permit an issuer to repurchase
the security from a Fund before it matures. If an issuer redeems the junk bonds,
a Fund may have to invest the proceeds in bonds with lower yields and may lose
income.
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Prices
of junk bonds are subject to extreme price fluctuations. Negative economic developments
may have a greater impact on the prices of junk bonds than on those of other higher
rated fixed income securities.
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Junk
bonds may be less liquid than higher rated fixed income securities even under
normal economic conditions. There are fewer dealers in the junk bond market, and
there may be significant differences in the prices quoted for junk bonds by the
dealers. Because they are less liquid, judgment may play a greater role in valuing
certain of a Fund’s portfolio securities than in the case of securities trading
in a more liquid market.
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A
Fund may incur expenses to the extent necessary to seek recovery upon default
or to negotiate new terms with a defaulting issuer.
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Mortgage-Related
Securities
Mortgage-Backed Securities.
Mortgage-backed securities represent interests in pools of mortgages in
which payments of both principal and interest on the securities are generally
made monthly, in effect “passing through” monthly payments made by borrowers
on the residential or commercial mortgage loans that underlie the securities (net
of any fees paid to the issuer or guarantor of the securities). Mortgage-backed
securities differ from other forms of debt securities, which normally provide
for periodic payment of interest in fixed amounts with principal payments at maturity
or specified call dates.
Mortgage-backed securities
are subject to the general risks associated with investing in real estate securities;
that is, they may lose value if the value of the underlying real estate to which
a pool of mortgages relates declines. In addition, investments in mortgage-backed
securities involve certain specific risks. These risks include the failure of
a party to meet its commitments under the related operative documents, adverse
interest rate changes and the effects of prepayments on mortgage cash flows. Mortgage-backed
securities are “pass-through” securities, meaning that principal and
interest payments made by the borrower on the underlying mortgages are passed
through to a Fund. The value of mortgage-backed securities, like that of traditional
fixed-income securities, typically increases when interest rates fall and decreases
when interest rates rise. However, mortgage-backed securities differ from traditional
fixed-income securities because of their potential for prepayment without penalty.
The price paid by a Fund for its mortgage-backed securities, the yield the Fund
expects to receive from such securities and the weighted average life of the securities
are based on a number of factors, including the anticipated rate of prepayment
of the underlying mortgages. In a period of declining interest rates, borrowers
may prepay the underlying mortgages more quickly than anticipated, thereby reducing
the yield to maturity and the average life of the mortgage-backed securities.
Moreover, when a Fund reinvests the proceeds of a prepayment in these circumstances,
it will likely receive a rate of interest that is lower than the rate on the security
that was prepaid.
To the extent that a Fund
purchases mortgage-backed securities at a premium, mortgage foreclosures and principal
prepayments may result in a loss to the extent of the premium paid. If a Fund
buys such securities at a discount, both scheduled payments of principal and unscheduled
prepayments will increase current and total returns and will accelerate the recognition
of income, which, when distributed to shareholders, will be taxable as ordinary
income. In a period of rising interest rates, prepayments of the underlying mortgages
may occur at a slower than expected rate, creating maturity extension risk. This
particular risk may effectively change a security that was considered short or
intermediate-term at the
time of purchase into a long-term security. Since the value of long-term securities
generally fluctuates more widely in response to changes in interest rates than
that of shorter-term securities, maturity extension risk could increase the inherent
volatility of the Fund. Under certain interest rate and prepayment scenarios,
a Fund may fail to recoup fully its investment in mortgage-backed securities notwithstanding
any direct or indirect governmental or agency guarantee.
There are currently three
types of mortgage pass-through securities: (1) those issued by the U.S. government
or one of its agencies or instrumentalities, such as the Government National Mortgage
Association (“Ginnie Mae”), the Federal National Mortgage Association
(“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie
Mac”); (2) those issued by private issuers that represent an interest in
or are collateralized by pass-through securities issued or guaranteed by the U.S.
government or one of its agencies or instrumentalities; and (3) those issued by
private issuers that represent an interest in or are collateralized by whole mortgage
loans or pass-through securities without a government guarantee but that usually
have some form of private credit enhancement.
Ginnie Mae is a wholly owned
U.S. government corporation within the Department of Housing and Urban Development.
Ginnie Mae is authorized to guarantee, with the full faith and credit of the U.S.
government, the timely payment of principal and interest on securities issued
by the institutions approved by Ginnie Mae (such as savings and loan institutions,
commercial banks and mortgage banks), and backed by pools of Federal Housing Administration
(“FHA”)-insured or Veterans’ Administration (“VA”)-guaranteed
mortgages.
Obligations of Fannie Mae
and Freddie Mac are not backed by the full faith and credit of the U. S. government.
In the case of obligations not backed by the full faith and credit of the U.S.
government, the Fund must look principally to the agency issuing or guaranteeing
the obligation for ultimate repayment. Fannie Mae and Freddie Mac each may borrow
from the U.S. Treasury to meet its obligations, but the U.S. Treasury is under
no obligation to lend to Fannie Mae or Freddie Mac.
Private mortgage pass-through
securities are structured similarly to Ginnie Mae, Fannie Mae, and Freddie Mac
mortgage pass-through securities and are issued by originators of and investors
in mortgage loans, including depository institutions, mortgage banks, investment
banks and special purpose subsidiaries of the foregoing.
Pools created by private
mortgage pass-through issuers generally offer a higher rate of interest than government
and government-related pools because there are no direct or indirect government
or agency guarantees of payments in the private pools. However, timely payment
of interest and principal of these pools may be supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard insurance
and letters of credit. The insurance and guarantees are issued by governmental
entities, private insurers and the mortgage poolers. The insurance and guarantees
and the creditworthiness of the issuers thereof will be considered in determining
whether a mortgage-related security meets a Fund’s investment quality standards.
There can be no assurance that the private insurers or guarantors can meet their
obligations under the insurance policies or guarantee arrangements. Private mortgage
pass-through securities may be bought without insurance or guarantees if, through
an examination of the loan experience and practices of the originator/servicers
and poolers, the Manager determines that the securities meet a Fund’s quality
standards.
Collateralized Mortgage
Obligations (“CMOs”)
. CMOs are debt obligations collateralized by
residential or commercial mortgage loans or residential or commercial mortgage
pass-through securities. Interest and prepaid principal are generally paid monthly.
CMOs may be collateralized by whole mortgage loans or private mortgage pass-through
securities but are more typically collateralized by portfolios of mortgage pass-through
securities guaranteed by Ginnie Mae, Freddie Mac, or Fannie Mae. The issuer of
a series of CMOs may elect to be treated as a Real Estate Mortgage Investment
Conduit (“REMIC”). All future references to CMOs also include REMICs.
CMOs
are structured into multiple classes, each bearing a different stated maturity.
Actual maturity and average life will depend upon the prepayment experience of
the collateral, which is ordinarily unrelated to the stated maturity date. CMOs
often provide for a modified form of call protection through a de facto breakdown
of the underlying pool of mortgages according to how quickly the loans are repaid.
Monthly payment of principal received from the pool of underlying mortgages, including
prepayments, is first returned to investors holding the shortest maturity class.
Investors holding the longer maturity classes usually receive principal only after
the first class has been
retired. An investor may
be partially protected against a sooner than desired return of principal because
of the sequential payments.
Certain issuers of CMOs are
not considered investment companies pursuant to a rule adopted by the Commission,
and a Fund may invest in the securities of such issuers without the limitations
imposed by the Investment Company Act on investments by a Fund in other investment
companies. In addition, in reliance on an earlier Commission interpretation, a
Fund’s investments in certain other qualifying CMOs, which cannot or do not
rely on the rule, are also not subject to the limitation of the Investment Company
Act on acquiring interests in other investment companies. In order to be able
to rely on the Commission’s interpretation, these CMOs must be unmanaged,
fixed asset issuers, that: (1) invest primarily in mortgage-backed securities;
(2) do not issue redeemable securities; (3) operate under general exemptive orders
exempting them from all provisions of the Investment Company Act; and (4) are
not registered or regulated under the Investment Company Act as investment companies.
To the extent that a Fund selects CMOs that cannot rely on the rule or do not
meet the above requirements, the Fund may not invest more than 10% of its assets
in all such entities and may not acquire more than 3% of the voting securities
of any single such entity.
A Fund may also invest in,
among other things, parallel pay CMOs, Planned Amortization Class CMOs (“PAC
bonds”), sequential pay CMOs, and floating rate CMOs. Parallel pay CMOs are
structured to provide payments of principal on each payment date to more than
one class. PAC bonds generally require payments of a specified amount of principal
on each payment date. Sequential pay CMOs generally pay principal to only one
class at a time while paying interest to several classes. Floating rate CMOs are
securities whose coupon rate fluctuates according to some formula related to an
existing market index or rate. Typical indices would include the eleventh district
cost-of-funds index (“COFI”), LIBOR, one-year Treasury yields, and ten-year
Treasury yields.
Adjustable Rate Mortgage
Securities
. Adjustable rate mortgage securities (“ARMs”) are pass-through
securities collateralized by mortgages with adjustable rather than fixed rates.
ARMs eligible for inclusion in a mortgage pool generally provide for a fixed initial
mortgage interest rate for a set number of scheduled monthly payments. After that
schedule of payments has been completed, the interest rates are subject to periodic
adjustment based on changes to a designated benchmark index.
ARMs contain maximum and
minimum rates beyond which the mortgage interest rate may not vary over the lifetime
of the security. In addition, certain ARMs provide for additional limitations
on the maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. In the event that market rates of interest rise more rapidly
to levels above that of the ARM’s maximum rate, the ARM’s coupon may
represent a below market rate of interest. In these circumstances, the market
value of the ARM security will likely have fallen.
Certain ARMs contain limitations
on changes in the required monthly payment. In the event that a monthly payment
is not sufficient to pay the interest accruing on an ARM, any such excess interest
is added to the principal balance of the mortgage loan, which is repaid through
future monthly payments. If the monthly payment for such an instrument exceeds
the sum of the interest accrued at the applicable mortgage interest rate and the
principal payment required at such point to amortize the outstanding principal
balance over the remaining term of the loan, the excess is then used to reduce
the outstanding principal balance of the ARM.
CMO Residuals
. CMO
residuals are derivative mortgage securities issued by agencies or instrumentalities
of the U.S. government or by private originators of, or investors in, mortgage
loans, including savings and loan associations, homebuilders, mortgage banks,
commercial banks, investment banks, and special purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs is
applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The residual
in a CMO structure generally represents the interest in any excess cash flow remaining
after making the foregoing payments. Each payment of such excess cash flow to
a holder of the related CMO residual represents income and/or a return of capital.
The amount of residual cash flow resulting from a CMO will depend on, among other
things, the characteristics of the mortgage assets, the coupon rate of each class
of CMO, prevailing interest rates, the amount of administrative expenses and the
prepayment experience on the mortgage assets. In part, the yield to maturity on
the CMO residuals is extremely sensitive to prepayments on the related underlying
mortgage assets, in the same manner as an interest-only (“IO”) class
of stripped mortgage-related securities. In addition, if a series of a CMO includes
a class that bears interest at an adjustable rate, the yield to maturity on the
related CMO
residual will also be extremely
sensitive to changes in the level of the index upon which interest rate adjustments
are based. In certain circumstances, a Fund may fail to recoup fully its initial
investment in a CMO residual.
CMO residuals are generally
purchased and sold by institutional investors through one or more investment banking
firms acting as brokers or dealers. The CMO residual market has developed relatively
recently and CMO residuals may not have the liquidity of other more established
securities trading in other markets. Transactions in CMO residuals are generally
completed only after careful review of the characteristics of the securities in
question. In addition, CMO residuals may or, pursuant to an exemption therefrom,
may not have been registered under the Securities Act.
Stripped Mortgage-Backed
Securities
. A Fund may invest in stripped mortgage-backed securities (“SMBSs”)
issued by agencies or instrumentalities of the United States. SMBSs are derivative
multi-class mortgage-backed securities. SMBS arrangements commonly involve two
classes of securities that receive different proportions of the interest and principal
distributions on a pool of mortgage assets. A common variety of SMBS is where
one class (the principal only or PO class) receives some of the interest and most
of the principal from the underlying assets, while the other class (the interest
only or IO class) receives most of the interest and the remainder of the principal.
In the most extreme case, the IO class receives all of the interest, while the
PO class receives all of the principal. While a Fund may purchase securities of
a PO class, a Fund is more likely to purchase the securities of an IO class. The
yield to maturity of an IO class is extremely sensitive to the rate of principal
payments (including prepayments) on the related underlying assets, and a rapid
rate of principal payments in excess of that considered in pricing the securities
will have a material adverse effect on an IO security’s yield to maturity.
If the underlying mortgage assets experience greater than anticipated payments
of principal, a Fund may fail to recoup fully its initial investment in IOs. In
addition, there are certain types of IOs that represent the interest portion of
a particular class as opposed to the interest portion of the entire pool. The
sensitivity of this type of IO to interest rate fluctuations may be increased
because of the characteristics of the principal portion to which they relate.
As a result of the above factors, a Fund generally will purchase IOs only as a
component of so called “synthetic” securities. This means that purchases
of IOs will be matched with certain purchases of other securities, such as POs,
inverse floating rate CMOs or fixed rate securities; as interest rates fall, presenting
a greater risk of unanticipated prepayments of principal, the negative effect
on a Fund because of its holdings of IOs should be diminished somewhat because
of the increased yield on the inverse floating rate CMOs or the increased appreciation
on the POs or fixed rate securities.
Tiered Index Bonds
.
Tiered index bonds are relatively new forms of mortgage-related securities. The
interest rate on a tiered index bond is tied to a specified index or market rate.
So long as this index or market rate is below a predetermined “strike”
rate, the interest rate on the tiered index bond remains fixed. If, however, the
specified index or market rate rises above the “strike” rate, the interest
rate of the tiered index bond will decrease. Thus, under these circumstances,
the interest rate on a tiered index bond, like an inverse floater, will move in
the opposite direction of prevailing interest rates, with the result that the
price of the tiered index bond may be considerably more volatile than that of
a fixed-rate bond.
Municipal
Investments
The Municipal Funds may invest
in obligations issued by or on behalf of states, territories and possessions of
the United States and the District of Columbia and their political subdivisions,
agencies and instrumentalities, the payments from which, in the opinion of bond
counsel to the issuer, are excludable from gross income for Federal income tax
purposes (“Municipal Bonds”). California Insured, Florida Municipal
Bond, New Jersey Municipal Bond, New York Municipal Bond and Pennsylvania Municipal
Bond also invest in Municipal Bonds that pay interest excludable from gross income
for applicable state and local income tax purposes and/or allow the value of a
Fund’s shares to be exempt from applicable state and local taxes (“State
Municipal Bonds”). The Municipal Funds may also invest in securities not
issued by or on behalf of a state or territory or by an agency or instrumentality
thereof, if the Manager believes such securities to pay interest excludable from
gross income for Federal and applicable state and local income tax purposes and/or
applicable state and local personal property taxes (“Non-Municipal Tax-Exempt
Securities”). Non-Municipal Tax-Exempt Securities could include trust certificates
or other instruments evidencing interest in one or more long term municipal securities.
Non-Municipal Tax-Exempt Securities also may include securities issued by other
investment companies that invest in municipal bonds, to the extent such investments
are permitted by applicable law. Non-Municipal Tax-Exempt Securities that pay
interest excludable from gross income for Federal income tax purposes will be
considered “Municipal Bonds” for purposes of a Municipal Fund’s
investment objective and policies. Non-Municipal Tax-Exempt Securities that pay
interest
excludable from gross income
for Federal and applicable state and local income tax purposes and/or allow the
value of a Fund’s shares to be exempt from applicable state and local personal
property taxes will be considered “State Municipal Bonds” for purposes
of the investment objective and policies of each of California Insured, Florida
Municipal Bond, New Jersey Municipal Bond, New York Municipal Bond and Pennsylvania
Municipal Bond.
Risk Factors and Special
Considerations Relating to Municipal Bonds
. The risks and special considerations
involved in investment in Municipal Bonds vary with the types of instruments being
acquired. Investments in Non-Municipal Tax-Exempt Securities may present similar
risks, depending on the particular product. Certain instruments in which a Fund
may invest may be characterized as derivative instruments.
The value of Municipal Bonds
generally may be affected by uncertainties in the municipal markets as a result
of legislation or litigation, including legislation or litigation that changes
the taxation of Municipal Bonds or the rights of Municipal Bond holders in the
event of a bankruptcy. Municipal bankruptcies are rare and certain provisions
of the U.S. Bankruptcy Code governing such bankruptcies are unclear. Further,
the application of state law to Municipal Bond issuers could produce varying results
among the states or among Municipal Bond issuers within a state. These uncertainties
could have a significant impact on the prices of the Municipal Bonds in which
a Fund invests.
Description
of Municipal Bonds
Municipal Bonds include debt
obligations issued to obtain funds for various public purposes, including the
construction of a wide range of public facilities, refunding of outstanding obligations
and obtaining funds for general operating expenses and loans to other public institutions
and facilities. In addition, certain types of bonds are issued by or on behalf
of public authorities to finance various privately owned or operated facilities,
including certain facilities for the local furnishing of electric energy or gas,
sewage facilities, solid waste disposal facilities and other specialized facilities.
Such obligations are included within the term Municipal Bonds if the interest
paid thereon is excluded from gross income for Federal income tax purposes and
any applicable state and local taxes. Other types of private activity bonds, the
proceeds of which are used for the construction, equipment or improvement of privately
operated industrial or commercial facilities, may constitute Municipal Bonds,
although the current Federal tax laws place substantial limitations on the size
of such issues. The interest on Municipal Bonds may bear a fixed rate or be payable
at a variable or floating rate. The two principal classifications of Municipal
Bonds are “general obligation” and “revenue” or “special
obligation” bonds, which latter category includes private activity bonds
(“PABs”) (or “industrial development bonds” under pre-1986
law).
General Obligation Bonds
.
General obligation bonds are secured by the issuer’s pledge of its faith,
credit and taxing power for the payment of principal and interest. The taxing
power of any governmental entity may be limited, however, by provisions of its
state constitution or laws, and an entity’s creditworthiness will depend
on many factors, including potential erosion of its tax base due to population
declines, natural disasters, declines in the state’s industrial base or inability
to attract new industries, economic limits on the ability to tax without eroding
the tax base, state legislative proposals or voter initiatives to limit ad valorem
real property taxes and the extent to which the entity relies on Federal or state
aid, access to capital markets or other factors beyond the state’s or entity’s
control. Accordingly, the capacity of the issuer of a general obligation bond
as to the timely payment of interest and the repayment of principal when due is
affected by the issuer’s maintenance of its tax base.
Revenue Bonds
. Revenue
bonds are payable only from the revenues derived from a particular facility or
class of facilities or, in some cases, from the proceeds of a special excise tax
or other specific revenue source such as payments from the user of the facility
being financed; accordingly, the timely payment of interest and the repayment
of principal in accordance with the terms of the revenue or special obligation
bond is a function of the economic viability of such facility or such revenue
source.
PABs
. PABs are,
in most cases, tax-exempt securities issued by states, municipalities or public
authorities to provide funds, usually through a loan or lease arrangement, to
a private entity for the purpose of financing construction or improvement of a
facility to be used by the entity. Such bonds are secured primarily by revenues
derived from loan repayments or lease payments due from the entity, which may
or may not be guaranteed by a parent company or otherwise secured. PABs generally
are not secured by a pledge of the taxing power of the issuer of such bonds. Therefore,
an investor should understand that repayment of such bonds generally depends on
the revenues of a
private entity and be aware
of the risks that such an investment may entail. The continued ability of an entity
to generate sufficient revenues for the payment of principal and interest on such
bonds will be affected by many factors including the size of the entity, its capital
structure, demand for its products or services, competition, general economic
conditions, government regulation and the entity’s dependence on revenues
for the operation of the particular facility being financed.
Moral Obligation Bonds
.
“Moral obligation” bonds are normally issued by special purpose public
authorities. If an issuer of moral obligation bonds is unable to meet its obligations,
the repayment of such bonds becomes a moral commitment but not a legal obligation
of the state or municipality that created the special purpose public authority
that issued the bonds.
Municipal Notes
.
Municipal notes are shorter term municipal debt obligations. They may provide
interim financing in anticipation of tax collection, bond sales or revenue receipts.
If there is a shortfall in the anticipated proceeds, repayment on the note may
be delayed or the note may not be fully repaid, and a Fund may lose money.
Municipal
Commercial Paper
. Municipal commercial paper is generally unsecured and issued
to meet short-term financing needs. The lack of security presents some risk of
loss to a Fund since, in the event of an issuer’s bankruptcy, unsecured creditors
are repaid only after the secured creditors out of the assets, if any, that remain.
Municipal
Lease Obligations
. Also included within the general category of Municipal
Bonds are certificates of participation (“COPs”) issued by government
authorities or entities to finance the acquisition or construction of equipment,
land and/or facilities. The COPs represent participations in a lease, an installment
purchase contract or a conditional sales contract (hereinafter collectively called
“lease obligations”) relating to such equipment, land or facilities.
Although lease obligations do not constitute general obligations of the issuer
for which the issuer’s unlimited taxing power is pledged, a lease obligation
is frequently backed by the issuer’s covenant to budget for, appropriate
and make the payments due under the lease obligation. However, certain lease obligations
contain “non-appropriation” clauses, which provide that the issuer has
no obligation to make lease or installment purchase payments in future years unless
money is appropriated for such purpose on a yearly basis. Although “non-appropriation”
lease obligations are secured by the leased property, disposition of the property
in the event of foreclosure might prove difficult. These securities represent
a type of financing that has not yet developed the depth of marketability associated
with more conventional securities. Certain investments in lease obligations may
be illiquid. A Fund may not invest in illiquid lease obligations if such investments,
together with all other illiquid investments, would exceed 15% of the Fund’s
net assets. A Fund may, however, invest without regard to such limitation in lease
obligations that the Manager, pursuant to guidelines that have been adopted by
the Directors and subject to the supervision of the Directors, determines to be
liquid. The Manager will deem lease obligations to be liquid if they are publicly
offered and have received an investment grade rating of Baa or better by Moody’s,
or BBB or better by S&P or Fitch Ratings (“Fitch”). Unrated lease
obligations, or those rated below investment grade, will be considered liquid
if the obligations come to the market through an underwritten public offering
and at least two dealers are willing to give competitive bids. In reference to
the latter, the Manager must, among other things, also review the creditworthiness
of the entity obligated to make payment under the lease obligation and make certain
specified determinations based on such factors as the existence of a rating or
credit enhancement - such as insurance - the frequency of trades or quotes for
the obligation and the willingness of dealers to make a market in the obligation.
Yields
.
Yields on Municipal Bonds are dependent on a variety of factors, including the
general condition of the money market and of the municipal bond market, the size
of a particular offering, the financial condition of the issuer, the maturity
of the obligation and the rating of the issue. The ability of a Fund to achieve
its investment objective is also dependent on the continuing ability of the issuers
of the securities in which the Fund invests to meet their obligations for the
payment of interest and principal when due. There are variations in the risks
involved in holding Municipal Bonds, both within a particular classification and
between classifications, depending on numerous factors. Furthermore, the rights
of owners of Municipal Bonds and the obligations of the issuer of such Municipal
Bonds may be subject to applicable bankruptcy, insolvency and similar laws and
court decisions affecting the rights of creditors generally and to general equitable
principles, which may limit the enforcement of certain remedies.
Variable Rate Demand
Obligations (“VRDOs”) and Participating VRDOs
. VRDOs are tax-exempt
obligations that contain a floating or variable interest rate adjustment formula
and a right of demand on the part of the holder thereof to receive payment of
the unpaid principal balance plus accrued interest upon a short notice period
not to exceed seven days. Participating VRDOs provide a Fund with a specified
undivided interest (up to 100%) of the underlying obligation and the right to
demand payment of the unpaid principal balance plus accrued interest on the Participating
VRDOs from the financial institution that issued the participation interest upon
a specified number of days notice, not to exceed seven days. In addition, the
Participating VRDO is backed by an irrevocable letter of credit or guaranty of
the financial institution. A Fund would have an undivided interest in the underlying
obligation and thus participate on the same basis as the financial institution
in such obligation except that the financial institution typically retains fees
out of the interest paid on the obligation for servicing the obligation, providing
the letter of credit and issuing the repurchase commitment.
There is the possibility
that because of default or insolvency the demand feature of VRDOs and Participating
VRDOs may not be honored. The interest rates are adjustable at intervals (ranging
from daily to up to one year) to some prevailing market rate for similar investments,
such adjustment formula being calculated to maintain the market rate of the VRDOs
at approximately the par value of the VRDOs on the adjustment date. The adjustments
typically are based upon the Public Securities Association Index or some other
appropriate interest rate adjustment index. The Funds have been advised by counsel
that they should be entitled to treat the income received on Participating VRDOs
as interest from tax-exempt obligations. It is not contemplated that any Fund
will invest more than a limited amount of its total assets in Participating VRDOs.
Because
of the interest rate adjustment formula on VRDOs (including Participating VRDOs),
VRDOs are not comparable to fixed rate securities. During periods of declining
interest rates, a Fund’s yield on a VRDO will decrease and its shareholders
will forego the opportunity for capital appreciation. During periods of rising
interest rates, however, a Fund’s yield on a VRDO will increase and the Fund’s
shareholders will have a reduced risk of capital depreciation.
VRDOs that contain a right
of demand to receive payment of the unpaid principal balance plus accrued interest
on a notice period exceeding seven days may be deemed to be illiquid securities.
A VRDO with a demand notice period exceeding seven days will therefore be subject
to a Fund’s restriction on illiquid investments unless, in the judgment of
the Directors such VRDO is liquid. The Directors may adopt guidelines and delegate
to the Manager the daily function of determining and monitoring liquidity of such
VRDOs. The Directors, however, will retain sufficient oversight and will be ultimately
responsible for such determinations.
The VRDOs and Participating
VRDOs in which a Fund may invest will be in the following rating categories at
the time of purchase: MIG-1/ VMIG-1 through MIG-3/VMIG-3 for notes and VRDOs and
Prime-1 through Prime-3 for commercial paper (as determined by Moody’s),
SP-1 through SP-2 for notes and A-1 through A-3 for VRDOs and commercial paper
(as determined by S&P), or F-1 through F-3 for notes, VRDOs and commercial
paper (as determined by Fitch).
Transactions
in Financial Futures Contracts.
The Municipal Funds and certain
other funds deal in financial futures contracts based on a long-term municipal
bond index developed by the Chicago Board of Trade (“CBT”) and The Bond
Buyer (the “Municipal Bond Index”). The Municipal Bond Index is comprised
of 40 tax-exempt municipal revenue and general obligation bonds. Each bond included
in the Municipal Bond Index must be rated A or higher by Moody’s or S&P
and must have a remaining maturity of 19 years or more. Twice a month new issues
satisfying the eligibility requirements are added to, and an equal number of old
issues are deleted from, the Municipal Bond Index. The value of the Municipal
Bond Index is computed daily according to a formula based on the price of each
bond in the Municipal Bond Index, as evaluated by six dealer-to-dealer brokers.
The
Municipal Bond Index futures contract is traded only on the CBT. Like other contract
markets, the CBT assures performance under futures contracts through a clearing
corporation, a nonprofit organization managed by the exchange membership that
is also responsible for handling daily accounting of deposits or withdrawals of
margin.
The particular municipal
bonds comprising the index underlying the Municipal Bond Index financial futures
contract may vary from the bonds held by a Municipal Fund. As a result, a Municipal
Fund’s ability to hedge effectively all or a portion of the value of its
Municipal Bonds through the use of such financial futures contracts will depend
in part on the degree to which price movements in the index underlying the financial
futures contract correlate with the price movements of the Municipal Bonds held
by the Fund. The correlation may be affected by disparities in the average maturity,
ratings, geographical mix or structure of a Municipal Fund’s investments
as compared to those comprising the Municipal Bond Index and general economic
or political factors. In addition, the correlation between movements in the value
of the Municipal Bond Index may be subject to change over time as additions to
and deletions from the Municipal Bond Index alter its structure. The correlation
between futures contracts on U.S. Government securities and the Municipal Bonds
held by a Municipal Fund may be adversely affected by similar factors and the
risk of imperfect correlation between movements in the prices of such futures
contracts and the prices of Municipal Bonds held by a Municipal Fund may be greater.
Municipal Bond Index futures contracts were approved for trading in 1986. Trading
in such futures contracts may tend to be less liquid than trading in other futures
contracts. The trading of futures contracts also is subject to certain market
risks, such as inadequate trading activity, which could at times make it difficult
or impossible to liquidate existing positions.
Call Rights.
A Fund may purchase a Municipal
Bond issuer’s right to call all or a portion of such Municipal Bond for mandatory
tender for purchase (a “Call Right”). A holder of a Call Right may exercise
such right to require a mandatory tender for the purchase of related Municipal
Bonds, subject to certain conditions. A Call Right that is not exercised prior
to maturity of the related Municipal Bond will expire without value. The economic
effect of holding both the Call Right and the related Municipal Bond is identical
to holding a Municipal Bond as a non-callable security. Certain investments in
such obligations may be illiquid. A Fund may not invest in such illiquid obligations
if such investments, together with other illiquid investments, would exceed 15%
of a Fund’s net assets.
Municipal Interest
Rate Swap Transactions.
In order to hedge the value
of a Fund against interest rate fluctuations or to enhance a Fund’s income,
a Fund may enter into interest rate swap transactions such as Municipal Market
Data AAA Cash Curve swaps (“MMD Swaps”) or Bond Market Association Municipal
Swap Index swaps (“BMA Swaps”). To the extent that a Fund enters into
these transactions, the Fund expects to do so primarily to preserve a return or
spread on a particular investment or portion of its portfolio or to protect against
any increase in the price of securities the Fund anticipates purchasing at a later
date. A Fund intends to use these transactions primarily as a hedge rather than
as a speculative investment. However, a Fund also may invest in MMD Swaps and
BMA Swaps to enhance income or gain or to increase the Fund’s yield, for
example, during periods of steep interest rate yield curves (
i.e.,
wide
differences between short term and long term interest rates).
A Fund may purchase and sell
BMA Swaps in the BMA swap market. In a BMA Swap, a Fund exchanges with another
party their respective commitments to pay or receive interest (
e.g.,
an
exchange of fixed rate payments for floating rate payments linked to the Bond
Market Association Municipal Swap Index). Because the underlying index is a tax-exempt
index, BMA Swaps may reduce cross-market risks incurred by a Fund and increase
a Fund’s ability to hedge effectively. BMA Swaps are typically quoted for
the entire yield curve, beginning with a seven day floating rate index out to
30 years. The duration of a BMA Swap is approximately equal to the duration of
a fixed-rate Municipal Bond with the same attributes as the swap (
e.g.,
coupon,
maturity, call feature).
A Fund may also purchase
and sell MMD Swaps, also known as MMD rate locks. An MMD Swap permits a Fund to
lock in a specified municipal interest rate for a portion of its portfolio to
preserve a return on a particular investment or a portion of its portfolio as
a duration management technique or to protect against any increase in the price
of securities to be purchased at a later date. By using an MMD Swap, a Fund can
create a synthetic long or short position, allowing the Fund to select the most
attractive part of the yield curve. An MMD Swap is a contract between a Fund and
an MMD Swap provider pursuant to which the parties agree to make payments to each
other on a notional amount, contingent upon whether the Municipal Market Data
AAA General Obligation Scale is above or below a specified level on the expiration
date of the contract. For example, if a Fund buys an MMD Swap and the Municipal
Market Data AAA General Obligation Scale is below the specified level on the expiration
date, the counterparty to the contract will make a payment to the Fund equal to
the specified level minus the actual level,
multiplied by the notional
amount of the contract. If the Municipal Market Data AAA General Obligation Scale
is above the specified level on the expiration date, a Fund will make a payment
to the counterparty equal to the actual level minus the specified level, multiplied
by the notional amount of the contract.
In connection with investments
in BMA and MMD Swaps, there is a risk that municipal yields will move in the opposite
direction than anticipated by a Fund, which would cause the Fund to make payments
to its counterparty in the transaction that could adversely affect the Fund’s
performance. A Fund has no obligation to enter into BMA or MMD Swaps and may not
do so. The net amount of the excess, if any, of a Fund’s obligations over
its entitlements with respect to each interest rate swap will be accrued on a
daily basis and an amount of liquid assets that have an aggregate net asset value
at least equal to the accrued excess will be maintained in a segregated account
by the Fund.
Real Estate Investment
Trusts (“REITs”)
. Investing in REITs involves certain unique
risks in addition to those risks associated with investing in the real estate
industry in general. Equity REITs may be affected by changes in the value of the
underlying property owned by the REITs, while mortgage REITs may be affected by
the quality of any credit extended. REITs are dependent upon management skills,
may not be diversified geographically or by property type, and are subject to
heavy cash flow dependency, default by borrowers and self-liquidation. REITs must
also meet certain requirements under the Code to avoid entity level tax and be
eligible to pass-through certain tax attributes of their income to shareholders.
REITs are consequently subject to the risk of failing to meet these requirements
for favorable tax treatment, which could result in reduced distributions to shareholders,
and failing to maintain their exemptions from registration under the Investment
Company Act. REITs are also subject to the risks of changes in the Code, including
changes involving their tax status.
REITs (especially mortgage
REITs) are also subject to interest rate risk. Rising interest rates may cause
REIT investors to demand a higher annual yield, which may, in turn, cause a decline
in the market price of the equity securities issued by a REIT. Rising interest
rates also generally increase the costs of obtaining financing, which could cause
the value of a Fund’s REIT investments to decline. During periods when interest
rates are declining, mortgages are often refinanced. Refinancing may reduce the
yield on investments in mortgage REITs. In addition, since REITs depend on payment
under their mortgage loans and leases to generate cash to make distributions to
their sharholders, investments in REITs may be adversely affected by defaults
on such mortgage loans or leases.
Investing in certain REITs,
which often have small market capitalizations, may also involve the same risks
as investing in other small capitalization companies. REITs may have limited financial
resources and their securities may trade less frequently and in limited volume
and may be subject to more abrupt or erratic price movements than larger company
securities. Historically, small capitalization stocks, such as REITs, have been
more volatile in price than the larger capitalization stocks included in the S&P
500 Index. The management of a REIT may be subject to conflicts of interest with
respect to the operation of the business of the REIT and may be involved in real
estate activities competitive with the REIT. REITs may own properties through
joint ventures or in other circumstances in which the REIT may not have control
over its investments. REITs may incur significant amounts of leverage.
Repurchase Agreements and
Purchase and Sale Contracts. Under repurchase agreements and purchase and sale
contracts , the other party agrees, upon entering into the contract with a Fund,
to repurchase a security sold to the Fund at a mutually agreed-upon time and price
in a specified currency, thereby determining the yield during the term of the
agreement. This results in a fixed rate of return insulated from market fluctuations
during the term of the agreement, although such return may be affected by currency
fluctuations. In the case of repurchase agreements, the prices at which the trades
are conducted do not reflect accrued interest on the underlying obligation; whereas,
in the case of purchase and sale contracts, the prices take into account accrued
interest. Both types of agreement usually cover short periods, such as under one
week, although they may have longer terms, and may be construed to be collateralized
loans by the purchaser to the seller secured by the securities transferred to
the purchaser. In the case of a repurchase agreement, as a purchaser, a Fund will
require the seller to provide additional collateral if the market value of the
securities falls below the repurchase price at any time during the term of the
repurchase agreement. The Fund does not have this right to seek additional collateral
as a purchaser in the case of purchase and sale contracts. In the event of default
by the seller under a repurchase agreement construed to be a collateralized loan,
the underlying securities are not owned by the Fund but only constitute collateral
for the seller’s obligation to pay the repurchase price. Therefore, the Fund
may suffer time delays and incur costs or possible losses in connection with disposition
of the collateral. A purchase and sale contract differs from a repurchase agreement
in that the contract arrangements stipulate that securities are owned by the Fund
and the purchaser receives any interest on the security paid during the period.
In the event of a default under a repurchase agreement or under a purchase and
sale contract,
instead of the contractual
fixed rate, the rate of return to the Fund would be dependent upon intervening
fluctuations of the market values of the securities underlying the contract and
the accrued interest on those securities. In such event, the Fund would have rights
against the seller for breach of contract with respect to any losses arising from
market fluctuations following the default. A Fund may not invest in repurchase
agreements or purchase and sale contracts maturing in more than seven days if
such investments, together with the Fund’s other illiquid investments, would
exceed 15% of the Fund’s net assets. Repurchase agreements and purchase and
sale contracts may be entered into only with financial institutions that have
capital of at least $50 million or whose obligations are guaranteed by an entity
that has capital of at least $50 million.
Reverse Repurchase
Agreements.
A Fund may enter into reverse repurchase agreements with the
same parties with whom it may enter into repurchase agreements. Under a reverse
repurchase agreement, a Fund sells securities to another party and agrees to repurchase
them at a mutually agreed-upon date and price. At the time a Fund enters into
a reverse repurchase agreement, it will segregate liquid assets with a value not
less than the repurchase price (including accrued interest). Reverse repurchase
agreements involve the risk that (i) the market value of the securities retained
in lieu of sale by a Fund may decline below the price of the securities the Fund
has sold but is obligated to repurchase and (ii) the price of the securities sold
will decline below the price at which the Fund is required to repurchase them.
In addition, 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 a Fund’s obligations
to repurchase the securities and the Fund’s use of the proceeds of the reverse
repurchase agreement may effectively be restricted pending such decision.
Securities
Lending.
Each Fund may lend portfolio securities with a value not exceeding
33
1
/3
% of its total assets or the limit prescribed
by applicable law to banks, brokers and other financial institutions. In return,
the Fund receives collateral in cash or securities issued or guaranteed by the
U.S. Government, which will be maintained at all times in an amount equal to at
least 100% of the current market value of the loaned securities. Each Fund maintains
the ability to obtain the right to vote or consent on proxy proposals involving
material events affecting securities loaned. A Fund receives the income on the
loaned securities. Where a Fund receives securities as collateral, the Fund receives
a fee for its loans from the borrower and does not receive the income on the collateral.
Where a Fund receives cash collateral, it may invest such collateral and retain
the amount earned, net of any amount rebated to the borrower. As a result, the
Fund’s yield may increase. Loans of securities are terminable at any time
and the borrower, after notice, is required to return borrowed securities within
the standard time period for settlement of securities transactions. The Fund is
obligated to return the collateral to the borrower at the termination of the loan.
A Fund could suffer a loss in the event the Fund must return the cash collateral
and there are losses on investments made with the cash collateral. In the event
the borrower defaults on any of its obligations with respect to a securities loan,
a Fund could suffer a loss where there are losses on investments made with the
cash collateral or, where the value of the securities collateral falls below the
market value of the borrowed securities. A Fund could also experience delays and
costs in gaining access to the collateral. Each Fund may pay reasonable finder’s,
lending agent, administrative and custodial fees in connection with its loans.
Each Fund has received an exemptive order from the Commission permitting it to
lend portfolio securities to affiliates of the Fund and to retain an affiliate
of the Fund as lending agent.
Short Sales.
Certain
Funds may make short sales of securities, either as a hedge against potential
declines in value of a portfolio security or to realize appreciation when a security
that the Fund does not own declines in value. When a Fund makes a short sale,
it borrows the security sold short and delivers it to the broker-dealer through
which it made the short sale. A Fund may have to pay a fee to borrow particular
securities and is often obligated to turn over any payments received on such borrowed
securities to the lender of the securities.
A Fund secures its obligation
to replace the borrowed security by depositing collateral with the broker-dealer,
usually in cash, U.S. Government securities or other liquid securities similar
to those borrowed. With respect to uncovered short positions, a Fund is required
to deposit similar collateral with its custodian, if necessary, to the extent
that the value of both collateral deposits in the aggregate is at all times equal
to at least 100% of the current market value of the security sold short. Depending
on arrangements made with the broker-dealer from which the Fund borrowed the security,
regarding payment received by the Fund on such security, a Fund may not receive
any payments (including interest) on its collateral deposited with such broker-dealer.
Because
making short sales in securities that it does not own exposes a Fund to the risks
associated with those securities, such short sales involve speculative exposure
risk. A Fund will incur a loss as a result of a short sale if the
price of the security increases
between the date of the short sale and the date on which the Fund replaces the
borrowed security. As a result, if a Fund makes short sales in securities that
increase in value, it will likely underperform similar mutual funds that do not
make short sales in securities. A Fund will realize a gain on a short sale if
the security declines in price between those dates. There can be no assurance
that a Fund will be able to close out a short sale position at any particular
time or at an acceptable price. Although a Fund’s gain is limited to the
price at which it sold the security short, its potential loss is limited only
by the maximum attainable price of the security, less the price at which the security
was sold and may, theoretically, be unlimited.
A Fund may also make short
sales “against the box” without being subject to such limitations. In
this type of short sale, at the time of the sale, the Fund owns or has the immediate
and unconditional right to acquire the identical security at no additional cost.
Sovereign
Debt.
Investment in sovereign debt can involve a high degree of risk.
The governmental entity that controls the repayment of sovereign debt may not
be able or willing to repay the principal and/or interest when due in accordance
with the terms of such debt. A governmental entity’s willingness or ability
to repay principal and interest due in a timely manner may be affected by, among
other factors, its cash flow situation, the extent of its foreign reserves, the
availability of sufficient foreign exchange on the date a payment is due, the
relative size of the debt service burden to the economy as a whole, the governmental
entity’s policy towards the International Monetary Fund and the political
constraints to which a governmental entity may be subject. Governmental entities
may also be dependent on expected disbursements from foreign governments, multilateral
agencies and others abroad to reduce principal and interest arrearages on their
debt. The commitment on the part of these governments, agencies and others to
make such disbursements may be conditioned on the implementation of economic reforms
and/or economic performance and the timely service of such debtor’s obligations.
Failure to implement such reforms, achieve such levels of economic performance
or repay principal or interest when due may result in the cancellation of such
third parties’ commitments to lend funds to the governmental entity, which
may further impair such debtor’s ability or willingness to timely service
its debts. Consequently, governmental entities may default on their sovereign
debt.
Holders of sovereign debt
may be requested to participate in the rescheduling of such debt and to extend
further loans to governmental entities. In the event of a default by a governmental
entity, there may be few or no effective legal remedies for collecting on such
debt.
Standby Commitment
Agreements.
Standby Commitment Agreements commit a Fund, for a stated
period of time, to purchase a stated amount of securities that may be issued and
sold to that Fund at the option of the issuer. The price of the security is fixed
at the time of the commitment. At the time of entering into the agreement, the
Fund is paid a commitment fee, regardless of whether or not the security is ultimately
issued. A Fund will enter into such agreements for the purpose of investing in
the security underlying the commitment at a price that is considered advantageous
to the Fund. A Fund will limit its investment in such commitments so that the
aggregate purchase price of securities subject to such commitments, together with
the value of the Fund’s other illiquid investments, will not exceed 15% of
its net assets taken at the time of the commitment. A Fund segregates liquid assets
in an aggregate amount equal to the purchase price of the securities underlying
the commitment.
There can be no assurance
that the securities subject to a standby commitment will be issued, and the value
of the security, if issued, on the delivery date may be more or less than its
purchase price. Since the issuance of the security underlying the commitment is
at the option of the issuer, the Fund may bear the risk of a decline in the value
of such security and may not benefit from an appreciation in the value of the
security during the commitment period.
The purchase of a security
subject to a standby commitment agreement and the related commitment fee will
be recorded on the date on which the security can reasonably be expected to be
issued, and the value of the security thereafter will be reflected in the calculation
of a Fund’s net asset value. The cost basis of the security will be adjusted
by the amount of the commitment fee. In the event the security is not issued,
the commitment fee will be recorded as income on the expiration date of the standby
commitment.
Stripped Securities.
Stripped securities are created when the issuer separates the interest
and principal components of an instrument and sells them as separate securities.
In general, one security is entitled to receive the interest payments on the underlying
assets (the interest only or “IO” security) and the other to receive
the principal payments
(the principal only or “PO”
security). Some stripped securities may receive a combination of interest and
principal payments. The yields to maturity on IOs and POs are sensitive to the
expected or anticipated rate of principal payments (including prepayments) on
the related underlying assets, and principal payments may have a material effect
on yield to maturity. If the underlying assets experience greater than anticipated
prepayments of principal, a Fund may not fully recoup its initial investment in
IOs. Conversely, if the underlying assets experience less than anticipated prepayments
of principal, the yield on POs could be adversely affected. Stripped securities
may be highly sensitive to changes in interest rates and rates of prepayment.
Supranational
Entities.
A Fund may invest in debt securities of supranational entities.
Examples of such entities include the International Bank for Reconstruction and
Development (the World Bank), the European Steel and Coal Community, the Asian
Development Bank and the Inter-American Development Bank. The government members,
or “stockholders,” usually make initial capital contributions to the
supranational entity and in many cases are committed to make additional capital
contributions if the supranational entity is unable to repay its borrowings. There
is no guarantee that one or more stockholders of a supranational entity will continue
to make any necessary additional capital contributions. If such contributions
are not made, the entity may be unable to pay interest or repay principal on its
debt securities, and a Fund may lose money on such investments.
Warrants.
Warrants are securities that permit, but do not obligate, the warrant holder
to subscribe for other securities. Buying a warrant does not make the Fund a
shareholder of the underlying stock. The warrant holder has no voting or dividend
rights with respect to the underlying stock. A warrant does not carry any right
to assets of the issuer, and for this reason investment in warrants may be more
speculative than other equity-based investments.
When Issued Securities,
Delayed Delivery Securities and Forward Commitments.
A Fund may purchase
or sell securities that it is entitled to receive on a when issued basis. A Fund
may also purchase or sell securities on a delayed delivery basis or through a
forward commitment. These transactions involve the purchase or sale of securities
by a Fund at an established price with payment and delivery taking place in the
future. The Fund enters into these transactions to obtain what is considered an
advantageous price to the Fund at the time of entering into the transaction. When
a Fund purchases securities in these transactions, the Fund segregates liquid
securities in an amount equal to the amount of its purchase commitments.
There
can be no assurance that a security purchased on a when issued basis will be issued
or that a security purchased or sold on a delayed delivery basis or through a
forward commitment will be delivered. Also, the value of securities in these transactions
on the delivery date may be more or less than the price paid by the Fund to purchase
the securities. The Fund will lose money if the value of the security in such
a transaction declines below the purchase price and will not benefit if the value
of the security appreciates above the sale price during the commitment period.
Zero
Coupon Securities.
Zero coupon securities are securities that are sold
at a discount to par value and do not pay interest during the life of the security.
The discount approximates the total amount of interest the security will accrue
and compound over the period until maturity at a rate of interest reflecting the
market rate of the security at the time of issuance. Upon maturity, the holder
of a zero coupon security is entitled to receive the par value of the security.
While interest payments are not made on such securities, holders of such securities
are deemed to have received income (“phantom income”) annually, notwithstanding
that cash may not be received currently. The effect of owning instruments that
do not make current interest payments is that a fixed yield is earned not only
on the original investment but also, in effect, on all discount accretion during
the life of the obligations. This implicit reinvestment of earnings at a fixed
rate eliminates the risk of being unable to invest distributions at a rate as
high as the implicit yield on the zero coupon bond, but at the same time eliminates
the holder’s ability to reinvest at higher rates in the future. For this
reason, some of these securities may be subject to substantially greater price
fluctuations during periods of changing market interest rates than are comparable
securities that pay interest currently. Longer term zero coupon bonds are more
exposed to interest rate risk than shorter term zero coupon bonds. These investments
benefit the issuer by mitigating its need for cash to meet debt service, but also
require a higher rate of return to attract investors who are willing to defer
receipt of cash. A Fund accrues income with respect to these securities for Federal
income tax and accounting purposes prior to the receipt of cash payments. Zero
coupon securities may be subject to greater fluctuation in value and less liquidity
in the event of adverse market conditions than comparably rated securities that
pay cash interest at regular intervals.
In addition to the above-described
risks, there are certain other risks related to investing in zero coupon securities.
During a period of severe market conditions, the market for such securities may
become even less liquid. In addition, as these securities do not pay cash interest,
a Fund’s investment exposure to these securities and their risks, including
credit risk, will increase during the time these securities are held in the Fund’s
portfolio. Further, to maintain its qualification for pass-through treatment under
the Federal tax laws, a Fund is required to distribute income to its shareholders
and, consequently, may have to dispose of other, more liquid portfolio securities
under disadvantageous circumstances or may have to leverage itself by borrowing
to generate the cash to satisfy these distributions. The required distributions
may result in an increase in a Fund’s exposure to zero coupon securities.
Suitability
(All Funds)
The economic benefit of an
investment in any Fund depends upon many factors beyond the control of the Fund,
the Manager and its affiliates. Each Fund should be considered a vehicle for diversification
and not as a balanced investment program. The suitability for any particular investor
of a purchase of shares in a Fund will depend upon, among other things, such investor’s
investment objectives and such investor’s ability to accept the risks associated
with investing in securities, including the risk of loss of principal.
Investment
Restrictions (All Funds)
See Part I, Section II
“Investment Restrictions” of each Fund’s Statement of Additional
Information for the specific fundamental and non-fundamental investment restrictions
adopted by each Fund. In addition to those investment restrictions, each Fund
is also subject to the restrictions discussed below.
The staff of the Commission
has taken the position that purchased OTC options and the assets used as cover
for written OTC options are illiquid securities. Therefore, each Fund has adopted
an investment policy pursuant to which it will not purchase or sell OTC options
(including OTC options on futures contracts) if, as a result of any such transaction,
the sum of the market value of OTC options currently outstanding that are held
by the Fund, the market value of the underlying securities covered by OTC call
options currently outstanding that were sold by the Fund and margin deposits on
the Fund’s existing OTC options on financial futures contracts would exceed
15% of the net assets of the Fund, taken at market value, together with all other
assets of the Fund that are determined to be illiquid. However, if an OTC option
is sold by a Fund to a primary U.S. Government securities dealer recognized by
the Federal Reserve Bank of New York and if the Fund has the unconditional contractual
right to repurchase such OTC option from the dealer at a predetermined price,
then the Fund will treat as illiquid only such amount of the underlying securities
as is equal to the repurchase price less the amount by which the option is “in-the-money”
(
i.e.,
current market value of the underlying securities minus the option’s
strike price). The repurchase price with the primary dealers is typically a formula
price that is generally based on a multiple of the premium received for the option,
plus the amount by which the option is “in-the-money.” This policy as
to OTC options is not a fundamental policy of any Fund and may be amended by the
Board of Directors of the Fund without the approval of the Fund’s shareholders.
Each
Fund’s investments will be limited in order to allow the Fund to qualify
as a “regulated investment company” for purposes of the Code. See “Dividends
and Taxes — Taxes.” To qualify, among other requirements, each Fund
will limit its investments so that, at the close of each quarter of the taxable
year, (i) not more than 25% of the market value of the Fund’s total assets
will be invested in the securities of a single issuer, and (ii) with respect to
50% of the market value of its total assets, not more than 5% of the market value
of its total assets will be invested in the securities of a single issuer and
the Fund will not own more than 10% of the outstanding voting securities of a
single issuer. For purposes of this restriction, the Municipal Funds generally
will regard each state and each of its political subdivisions, agencies or instrumentalities
and each multi-state agency of which the state is a member as a separate issuer.
Each public authority that issues securities on behalf of a private entity generally
will also be regarded as a separate issuer, except that if the security is backed
only by the assets and revenues of a non-government entity, then the entity with
the ultimate responsibility for the payment of interest and principal may be regarded
as the sole issuer. Foreign government securities (unlike U.S. government securities)
are not exempt from the diversification requirements of the Code and the securities
of each foreign government issuer are considered to be obligations of a single
issuer. These tax-related limitations may be changed by the Directors of a Fund
to the extent necessary to comply with changes to the Federal tax requirements.
A Fund that is “diversified” under the Investment Company Act must satisfy
the foregoing 5% and 10% requirements with respect to 75% of its total assets.
M
ANAGEMENT
AND
O
THER
S
ERVICE
A
RRANGEMENTS
Directors and Officers
See
Part I, Section III “Information on Directors and Officers,” —
Biographical Information,” — Share Ownership” and “—
Compensation of Directors” of each Fund’s Statement of Additional Information
for biographical and certain other information relating to the Directors and officers
of your Fund, including Directors’ compensation.
Management
Arrangements
Management Services
.
The Manager provides each Fund with investment advisory and management services.
Subject to the supervision of the Board of Directors, the Manager is responsible
for the actual management of a Fund’s portfolio and reviews the Fund’s
holdings in light of its own research analysis and that from other relevant sources.
The responsibility for making decisions to buy, sell or hold a particular security
rests with the Manager. The Manager performs certain of the other administrative
services and provides all the office space, facilities, equipment and necessary
personnel for management of each Fund.
Each Feeder Fund invests
all or a portion of its assets in shares of a Master Portfolio. To the extent
a Feeder Fund invests all of its assets in a Master Portfolio, it does not invest
directly in portfolio securities and does not require management services. For
such Feeder Funds, portfolio management occurs at the Master Portfolio level.
Management
Fee
. Each Fund has entered into a management agreement with the Manager pursuant
to which the Manager receives for its services to the Fund monthly compensation
at an annual rate based on the average daily net assets of the Fund. For information
regarding specific fee rates for your Fund and the fees paid by your Fund to the
Manager for the Fund’s last three fiscal years or other applicable periods,
see Part I, Section IV “Management and Advisory Arrangements” of each
Fund’s Statement of Additional Information.
For Funds that do not have
an Administrator, each Management Agreement obligates the Manager to provide management
services and to pay all compensation of and furnish office space for officers
and employees of a Fund connected with investment and economic research, trading
and investment management of the Fund, as well as the fees of all Directors of
the Fund who are interested persons of the Fund. Each Fund pays all other expenses
incurred in the operation of that Fund, including among other things: taxes; expenses
for legal and auditing services; costs of preparing, printing and mailing proxies,
shareholder reports, prospectuses and statements of additional information, except
to the extent paid by FAM Distributors, Inc. (the “Distributor”); charges
of the custodian and sub-custodian, and the transfer agent; expenses of redemption
of shares; Commission fees; expenses of registering the shares under Federal,
state or foreign laws; fees and expenses of Directors who are not interested persons
of a Fund as defined in the Investment Company Act; accounting and pricing costs
(including the daily calculations of net asset value); insurance; interest; brokerage
costs; litigation and other extraordinary or non-recurring expenses; and other
expenses properly payable by the Fund. Certain accounting services are provided
to each Fund by State Street Bank and Trust Company (“State Street”)
pursuant to an agreement between State Street and each Fund. Each Fund pays a
fee for these services. In addition, the Manager provides certain accounting services
to each Fund and the Fund pays the Manager a fee for such services. The Distributor
pays certain promotional expenses of the Funds incurred in connection with the
offering of shares of the Funds. Certain expenses are financed by each Fund pursuant
to distribution plans in compliance with Rule 12b-1 under the Investment Company
Act. See “Purchase of Shares — Distribution Plans.”
Organization of the
Manager
. Fund Asset Management, L.P. and Merrill Lynch Investment Managers,
L.P. each is a limited partnership. The partners of FAM and MLIM are Merrill Lynch
& Co., Inc. (“ML & Co.”), a financial services holding company
and the parent of Merrill Lynch, Pierce, Fenner & Smith Incorporated (“Merrill
Lynch”), and Princeton Services, Inc. (“Princeton Services”). ML
& Co. and Princeton Services are “controlling persons” of FAM and
MLIM (as defined under the Investment Company Act) because of their ownership
of FAM’s and MLIM’s voting securities or their power to exercise a controlling
influence over FAM’s and MLIM’s management or policies. Merrill Lynch
Investment Managers International Limited (“MLIMIL”) is an affiliate
of FAM and MLIM. The ultimate parent of MLIMIL is ML & Co. ML & Co. is
a controlling person of MLIMIL (as defined under the Investment Company Act) because
of its ownership of MLIMIL’s voting securities or its power to exercise a
controlling influence over MLIMIL’s management or policies.
The following entities may
be considered “controlling persons” of Merrill Lynch Asset Management
U.K. Limited (“MLAM U.K.”): Merrill Lynch Europe PLC (MLAM U.K.’s
parent), a subsidiary of Merrill Lynch International Holdings, Inc., a subsidiary
of Merrill Lynch International, Inc., a subsidiary of ML & Co.
Other Service
Arrangements
Administrative Services
and Administrative Fee
. Certain Funds have entered into an administration
agreement (the “Administration Agreement”) with an administrator identified
in the Fund’s Prospectus and Part I of the Fund’s Statement of Additional
Information (each, an “Administrator”). For its services to a Fund,
the Administrator receives monthly compensation at the annual rate set forth in
each applicable Fund’s prospectus. For information regarding any administrative
fees paid by your Fund to the Administrator for the periods indicated, see Part
I, Section IV “Management and Advisory Arrangements” of that Fund’s
Statement of Additional Information.
For Funds that have an Administrator,
the Administration Agreement obligates the Administrator to provide certain administrative
services to the Fund and to pay, or cause its affiliates to pay, for maintaining
its staff and personnel and to provide office space, facilities and necessary
personnel for the Fund. Each Administrator is also obligated to pay, or cause
its affiliates to pay, the fees of those officers and Directors of the Fund who
are affiliated persons of the Administrator or any of its affiliates.
Duration and Termination
of Administration Agreement
. Unless earlier terminated as described below,
each Administration Agreement will continue from year to year if approved annually
(a) by the Board of Trustees of each applicable Fund or by a vote of a majority
of the outstanding voting securities of such Fund and (b) by a majority of the
Trustees of the Fund who are not parties to such contract or interested persons
(as defined in the Investment Company Act) of any such party. Such contract is
not assignable and may be terminated without penalty on 60 days’ written
notice at the option of either party thereto or by the vote of the shareholders
of the Fund.
Duration and Termination
.
Unless earlier terminated as described below, each Management Agreement and, if
applicable, each Sub-Advisory Agreement will remain in effect from year to year
if approved annually (a) by the Directors or by a vote of a majority of the outstanding
voting securities of the Fund and (b) by a majority of the Directors who are not
parties to such agreement or interested persons (as defined in the Investment
Company Act) of any such party. Each Agreement is not assignable and may be terminated
without penalty on 60 days’ written notice at the option of either party
thereto or by the vote of the shareholders of the Fund.
Transfer Agency Services
.
Financial Data Services, Inc. (the “Transfer Agent”), a subsidiary of
ML & Co., acts as each Fund’s Transfer Agent pursuant to a Transfer Agency,
Dividend Disbursing Agency and Shareholder Servicing Agency Agreement (each, a
“Transfer Agency Agreement”). Pursuant to each Transfer Agency Agreement,
the Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening and maintenance of shareholder accounts. Each Fund currently
pays between $16.00 and $20.00 for each Class A or Class I shareholder account,
between $19.00 and $23.00 for each Class B or Class C shareholder account, depending
on the level of service required, and, where applicable, $16.00 for each Class
R shareholder account. Each Fund reimburses the Transfer Agent’s reasonable
out-of-pocket expenses and pays a fee of 0.10% of account assets for certain accounts
that participate in the Merrill Lynch Mutual Funds Advisor (Merrill Lynch MFA
SM
)
Program (the “MFA Program”). For purposes of each Transfer Agency Agreement,
the term “account” includes a shareholder account maintained directly
by the Transfer Agent and any other account representing the beneficial interest
of a person in the relevant share class on a recordkeeping system, provided the
recordkeeping system is maintained by a subsidiary of ML & Co. See Part I,
Section IV “Management and Advisory Arrangements — Transfer Agency Fees”
of each Fund’s Statement of Additional Information for information on the
transfer agency fees paid by your Fund for the periods indicated.
Independent Registered
Public Accounting Firm
. The Audit Committee of each Fund, which is comprised
of all of the Fund’s non-interested Directors, has selected an independent
registered public accounting firm for that Fund that audits the Fund’s financial
statements. Please see the inside back cover page of your Fund’s Prospectus
for information on your Fund’s independent registered public accounting firm.
Custodian
Services
. The name and address of the custodian (the “Custodian”)
of each Fund are identified on the inside back cover page of the Fund’s Prospectus.
The Custodian is responsible for safeguarding and controlling the
Fund’s cash and securities,
handling the receipt and delivery of securities and collecting interest and dividends
on the Fund’s investments. The Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by the Fund
to be held in its offices outside the United States and with certain foreign banks
and securities depositories.
For certain Feeder Funds,
the Custodian also acts as the custodian of the Master Portfolio’s assets.
Accounting
Services
. Each Fund has entered into an agreement with State Street, pursuant
to which State Street provides certain accounting services to the Fund. Each Fund
pays a fee for these services. State Street provides similar accounting services
to the Master Trusts. The Manager or the Administrator also provides certain accounting
services to each Fund and each Fund reimburses the Manager or the Administrator
for these services.
See Part I, Section IV “Management
and Advisory Arrangements — Accounting Services” of each Fund’s
Statement of Additional Information for information on the amounts paid by your
Fund and, if applicable, Master Trust to State Street and the Manager or, if applicable,
the Administrator for the periods indicated.
Distribution Expenses
.
Each Fund has entered into a distribution agreement with the Distributor in connection
with the continuous offering of each class of shares of the Fund (the “Distribution
Agreement”). The Distribution Agreement obligates the Distributor to pay
certain expenses in connection with the offering of each class of shares of the
Select Pricing Funds. After the prospectuses, statements of additional information
and periodic reports have been prepared, set in type and mailed to shareholders,
the Distributor pays for the printing and distribution of these documents used
in connection with the offering to dealers and investors. The Distributor also
pays for other supplementary sales literature and advertising costs. The Distribution
Agreement is subject to the same renewal requirements and termination provisions
as the Management Agreement described above.
Code of Ethics
The Board of each Fund has
approved a Code of Ethics pursuant to Rule 17j-1 under the Investment Company
Act, which covers the Fund, the Manager, the Sub-Adviser, if any, and the Distributor.
The Code of Ethics establishes procedures for personal investing and restricts
certain transactions. Employees subject to the Code of Ethics may invest in securities
for their personal investment accounts, including securities that may be purchased
or held by the Fund.
Selective Disclosure
of Portfolio Holdings
Pursuant to policies and
procedures adopted by the Fund and the Manager, the Fund and the Manager may,
under certain circumstances as set forth below, make selective disclosure with
respect to the Fund’s portfolio holdings. The Fund’s Board of Directors
has approved the adoption by the Fund of the policies and procedures set forth
below, and has delegated to the Manager the responsibility for ongoing monitoring
and supervision to ensure compliance with these policies and procedures. The Board
provides ongoing oversight of the Fund’s and Manager’s compliance with
the policies and procedures. As part of this oversight function, the Directors
receive from the Fund’s Chief Compliance Officer at least quarterly and more
often, as necessary, reports on compliance with these policies and procedures,
including reports on any violations of these policies and procedures that may
occur. In addition, the Directors receive an annual assessment of the adequacy
and effect of the policies and procedures with respect to the Fund, and any changes
thereto, and an annual review of the operation of the policies and procedures.
Examples
of the information that may be disclosed pursuant to the Fund’s policies
and procedures would include (but is not limited to) specific portfolio holdings
- including the number of shares held, weightings of particular holdings, specific
sector and industry weightings, trading details, and the Fund manager’s discussion
of Fund performance and reasoning for significant changes in portfolio composition.
This information may be both material non-public information (“Confidential
Information”) and proprietary information of the firm. The Fund may disclose
such information to individual investors, institutional investors, financial advisers
and other financial intermediaries that sell the Fund’s shares, affiliates
of the Fund, third party service providers to the Fund, lenders to the Fund, and
independent rating agencies and ranking organizations. The Fund, the Manager and
it affiliates receive no compensation or other consideration with respect to such
disclosures.
Subject to the exceptions
set forth below, Confidential Information relating to the Fund may not be disclosed
to persons not employed by the Manager or its affiliates unless such information
has been publicly disclosed via a filing with the Commission (
e.g.,
fund
annual report), through a press release or placement on a publicly-available internet
web site, including our web site at www.mutualfunds.ml.com. If the Confidential
Information has not been publicly disclosed, an employee of the Manager who wishes
to distribute Confidential Information relating to the Fund must first do the
following: (i) require the person or company receiving the Confidential Information
to sign, before the Manager will provide disclosure of any such information, a
confidentiality agreement approved by an attorney in the Manager’s Legal
department in which he/she (a) agrees to use the Confidential Information solely
in connection with a legitimate business use (
i.e.,
due diligence, etc.)
and (b) agrees not to trade on the basis of the information so provided; (ii)
obtain the authorization of the an attorney in the Manager’s Legal department
prior to disclosure; and (iii) only distribute Confidential Information that is
at least thirty (30) calendar days old
unless a shorter period has specifically
been approved by an attorney in the Manager’s Legal department. Prior to
providing any authorization for such disclosure of Confidential Information, an
attorney in the Manager’s Legal Department must review the proposed arrangement
and make a determination that it is in the best interests of the Fund’s shareholders.
In connection with day-to-day portfolio management, the Fund may disclose Confidential
Information to executing brokers-dealers that is less than thirty days old in
order to facilitate the purchase and sale of portfolio holdings. The Fund has
adopted policies and procedures, including a Code of Ethics, Code of Conduct,
and various policies regarding securities trading and trade allocations, to address
potential conflicts of interest that may arise in connection with disclosure of
Confidential Information. These procedures are designed, among other things, to
prohibit personal trading based on Confidential Information, to ensure that portfolio
transactions are conducted in the best interests of each Fund and its shareholders
and to prevent portfolio management from using Confidential Information for the
benefit of one fund or account at the expense of another. In addition, as noted,
an attorney in the Manager’s Legal Department must determine that disclosure
of Confidential Information is for a legitimate business purpose and is in the
best interests of the Fund’s shareholders, and that any conflicts of interest
created by release of the Confidential Information have been addressed by the
Manager’s existing policies and procedures. For more information with respect
to potential conflicts of interest, see the section entitled “Management
and Other Services Arrangements - Potential Conflicts of Interest” in this
Statement of Additional Information.
Confidential Information
- whether or not publicly disclosed - may be disclosed to Fund Directors, the
independent Directors’ counsel, outside Fund counsel, the Fund’s accounting
services provider and the Fund’s independent registered public accounting
firm without meeting the conditions outlined above. Confidential Information may,
with the prior approval of the Fund’s Chief Compliance Officer or the Manager’s
General Counsel, also be disclosed to any auditor of the parties to a service
agreement involving the Fund, or as required by judicial or administrative process
or otherwise by applicable law or regulation. If Confidential Information is disclosed
to such persons, each such person will be subject to restrictions on trading in
the subject securities under either the Fund’s and Manager’s Code of
Ethics or an applicable confidentiality agreement, or under applicable laws or
regulations or court order.
The Manager has entered into
ongoing arrangements to provide selective disclosure of Fund portfolio holdings
to the following persons or entities:
Fund’s Board of Directors
Fund’s Transfer Agent
Fund’s Independent Registered Public Accounting
Firm
Fund’s accounting services provider — State Street Bank and
Trust Company
Fund Custodian
Independent Rating Agencies — Morningstar,
Inc. and Lipper Inc.
Information aggregators — Wall Street on Demand
and Thomson Financial
Sponsors of 401(k) plans that include MLIM/FAM-advised
funds — E.I. Dupont de Nemours and Company, Inc.
Consultants for pension
plans that invest in MLIM/FAM-advised funds — Rocaton Investment Advisors,
LLC;
Mercer Investment Consulting; Watson Wyatt Investment Consulting; Towers
Perrin HR Services
Other than with respect to
the Board of Directors, each of the persons or entities set forth above is subject
to an agreement to keep the information disclosed confidential and to use it only
for legitimate business purposes. The Board of Directors has a fiduciary duty
as directors to act in the best interests of the Fund and its shareholders. Selective
disclosure is made to the Fund’s Board of Directors and independent registered
public accounting firm at least quarterly and otherwise as frequently as necessary
to enable such persons or entities to provide services to the Fund. Selective
disclosure is made to the Fund’s Transfer Agent, accounting services provider,
and Custodian as
frequently as necessary to
enable such persons or entities to provide services to the Fund, typically on
a daily basis. Disclosure is made to Lipper Inc. and Wall Street on Demand on
a monthly basis and to Morningstar and Thomson Financial on a quarterly basis,
and to each such firm upon specific request with the approval of the Manager’s
Legal department. Disclosure is made to 401(k) plan sponsors on a yearly basis
and pension plan consultants on a quarterly basis.
The Fund and the Manager
monitor, to the extent possible, the use of Confidential Information by the individuals
or firms to which it has been disclosed. To do so, in addition to the requirements
of any applicable confidentiality agreement and/or the terms and conditions of
the Fund’s and Manager’s Code of Ethics and Code of Conduct - all of
which require persons or entities in possession of Confidential Information to
keep such information confidential and not to trade on such information for their
own benefit - the Manager’s compliance personnel under the supervision of
the Fund’s Chief Compliance Officer, monitor the Manager’s securities
trading desks to determine whether individuals or firms who have received Confidential
Information have made any trades on the basis of that information. In addition,
the Manager maintains an internal restricted list to prevent trading by the personnel
of the Manager or its affiliates in securities - including securities held by
the Fund - about which the Manager has Confidential Information. There can be
no assurance, however, that the Fund’s policies and procedures with respect
to the selective disclosure of Fund portfolio holdings will prevent the misuse
of such information by individuals or firms that receive such information.
Potential Conflicts
of Interest
Activities of the Manager,
Merrill Lynch & Co., Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated
and their Affiliates (collectively, “Merrill Lynch”) and Other Accounts
Managed by Merrill Lynch
. Merrill Lynch is a worldwide, full service investment
banking, broker-dealer, asset management and financial services organization.
As a result, Merrill Lynch (including, for these purposes, its directors, partners,
trustees, managing members, officers and employees), including the entities and
personnel who may be involved in the investment activities and business operations
of a Fund, is engaged in businesses and has interests other than that of managing
the Fund. These are considerations of which investors in a Fund should be aware,
and which may cause conflicts of interest that could disadvantage the Fund. These
activities and interests include potential multiple advisory, transactional, financial
and other interests in securities and other instruments, and companies that may
be purchased or sold by a Fund.
Merrill Lynch and its affiliates,
including, without limitation, the Manager and its advisory affiliates, have proprietary
interests in, and may manage or advise with respect to, accounts or funds (including
separate accounts and other funds and collective investment vehicles) that have
investment objectives similar to those of a Fund and/or that engage in transactions
in the same types of securities, currencies and instruments as the Fund. Merrill
Lynch and its affiliates are also major participants in the global currency, equities,
swap and fixed-income markets, in each case both on a proprietary basis and for
the accounts of customers. As such, Merrill Lynch and its affiliates are actively
engaged in transactions in the same securities, currencies, and instruments in
which a Fund invests. Such activities could affect the prices and availability
of the securities, currencies, and instruments in which a Fund invests, which
could have an adverse impact on the Fund’s performance. Such transactions,
particularly in respect of most proprietary accounts or customer accounts, will
be executed independently of a Fund’s transactions and thus at prices or
rates that may be more or less favorable than those obtained by the Fund. When
the Manager and its advisory affiliates seek to purchase or sell the same assets
for their managed accounts, including a Fund, the assets actually purchased or
sold may be allocated among the accounts on a basis determined in their good faith
discretion to be equitable. In some cases, this system may adversely affect the
size or the price of the assets purchased or sold for a Fund.
The results of a Fund’s
investment activities may differ significantly from the results achieved by the
Manager and its affiliates for their proprietary accounts or other accounts (including
investment companies or collective investment vehicles) managed or advised by
them. It is possible that Merrill Lynch and its affiliates and such other accounts
will achieve investment results that are substantially more or less favorable
than the results achieved by a Fund. Moreover, it is possible that a Fund will
sustain losses during periods in which Merrill Lynch and its affiliates achieve
significant profits on their trading for proprietary or other accounts. The opposite
result is also possible.
The investment activities
of Merrill Lynch and its affiliates for their proprietary accounts and accounts
under their management may also limit the investment opportunities for a Fund
in certain emerging and other markets in which limitations are imposed upon the
amount of investment, in the aggregate or in individual issuers, by affiliated
foreign investors.
From time to time, a Fund’s
activities may also be restricted because of regulatory restrictions applicable
to Merrill Lynch and its affiliates, and/or their internal policies designed to
comply with such restrictions. As a result, there may be periods, for example,
when the Manager, and/or its affiliates, will not initiate or recommend certain
types of transactions in certain securities or instruments with respect to which
the Manager and/or its affiliates are performing services or when position limits
have been reached.
In connection with its management
of a Fund, the Manager may have access to certain fundamental analysis and proprietary
technical models developed by Merrill Lynch. The Manager will not be under any
obligation, however, to effect transactions on behalf of a Fund in accordance
with such analysis and models. In addition, neither Merrill Lynch nor any of its
affiliates will have any obligation to make available any information regarding
their proprietary activities or strategies, or the activities or strategies used
for other accounts managed by them, for the benefit of the management of a Fund
and it is not anticipated that the Manager will have access to such information
for the purpose of managing the Fund. The proprietary activities or portfolio
strategies of Merrill Lynch and its affiliates or the activities or strategies
used for accounts managed by them or other customer accounts could conflict with
the transactions and strategies employed by the Manager in managing a Fund.
In addition, certain principals
and certain employees of the Manager are also principals or employees of Merrill
Lynch or its affiliated entities. As a result, the performance by these principals
and employees of their obligations to such other entities may be a consideration
of which investors in a Fund should be aware.
The Manager may enter into
transactions and invest in securities, instruments and currencies on behalf of
a Fund in which customers of Merrill Lynch (or, to the extent permitted by the
Commission, Merrill Lynch) serve as the counterparty, principal or issuer. In
such cases, such party’s interests in the transaction will be adverse to
the interests of the Fund, and such party may have no incentive to assure that
the Fund obtains the best possible prices or terms in connection with the transactions.
In addition, the purchase, holding and sale of such investments by a Fund may
enhance the profitability of Merrill Lynch. Merrill Lynch and its affiliates may
also create, write or issue derivative instruments for customers of Merrill Lynch
or its affiliates, the underlying securities, currencies or instruments of which
may be those in which a Fund invests or which may be based on the performance
of the Fund. A Fund may, subject to applicable law, purchase investments that
are the subject of an underwriting or other distribution by Merrill Lynch or its
affiliates and may also enter into transactions with other clients of Merrill
Lynch or its affiliates where such other clients have interests adverse to those
of the Fund. At times, these activities may cause departments of Merrill Lynch
or its affiliates to give advice to clients that may cause these clients to take
actions adverse to the interests of the Fund. To the extent affiliated transactions
are permitted, a Fund will deal with Merrill Lynch and its affiliates on an arms-length
basis. Merrill Lynch may also have an ownership interest in certain trading or
information systems used by a Fund. A Fund’s use of such trading or information
systems may enhance the profitability of Merrill Lynch.
A Fund will be required to
establish business relationships with its counterparties based on the Fund’s
own credit standing. Neither Merrill Lynch nor its affiliates will have any obligation
to allow their credit to be used in connection with a Fund’s establishment
of its business relationships, nor is it expected that the Fund’s counterparties
will rely on the credit of Merrill Lynch or any of its affiliates in evaluating
the Fund’s creditworthiness.
It is also possible that,
from time to time, Merrill Lynch or any of its affiliates may, although they are
not required to, purchase and hold shares of a Fund in order to increase the assets
of the Fund. Increasing a Fund’s assets may enhance investment flexibility
and diversification and may contribute to economies of scale that tend to reduce
the Fund’s expense ratio. Merrill Lynch reserves the right to redeem at any
time some or all of the shares of a Fund acquired for its own account. A large
redemption of shares of a Fund by Merrill Lynch could significantly reduce the
asset size of the Fund, which might have an adverse effect on the Fund’s
investment flexibility, portfolio diversification and expense ratio. Merrill Lynch
will consider the effect of redemptions on a Fund and other shareholders in deciding
whether to redeem its shares.
It is possible that a Fund
may invest in securities of companies with which Merrill Lynch has or is trying
to develop investment banking relationships as well as securities of entities
in which Merrill Lynch has significant debt or equity investments or in which
Merrill Lynch makes a market. A Fund also may invest in securities of companies
that Merrill Lynch provides or may someday provide research coverage. Such investments
could cause conflicts between the interests of a Fund and the interests of other
Merrill Lynch clients. In making investment decisions for a Fund, the Manager
is not permitted to obtain or use material non-public information acquired by
any division, department or affiliate of Merrill Lynch in the course of these
activities. In addition, from time to time, Merrill Lynch’s activities may
limit a Fund’s flexibility in purchases and sales of securities. When Merrill
Lynch is engaged in an underwriting or other distribution of securities of an
entity, the Manager may be prohibited from purchasing or recommending the purchase
of certain securities of that entity for a Fund.
The Manager, its affiliates
and their Directors, officers and employees, may buy and sell securities or other
investments for their own accounts, and may have conflicts of interest with respect
to investments made on behalf of a Fund. As a result of differing trading and
investment strategies or constraints, positions may be taken by Directors, officers
and employees and affiliates of the Manager that are the same, different from
or made at different times than positions taken for the Fund. To lessen the possibility
that a Fund will be adversely affected by this personal trading, the Fund and
the Manager each has adopted a Code of Ethics in compliance with Section 17(j)
of the Investment Company Act that restricts securities trading in the personal
accounts of investment professionals and others who normally come into possession
of information regarding the Fund’s portfolio transactions. The Code of Ethics
can be reviewed and copied at the SEC’s Public Reference Room in Washington,
D.C. Information on the operation of the Public Reference Room may be obtained
by calling the SEC at 1-202-551-8090. The Code of Ethics is also available on
the EDGAR Database on the SEC’s Internet site at http://www.sec.gov, and
copies may be obtained, after paying a duplicating fee, by e-mail at publicinfo@sec.gov
or by writing the SEC’s Public Reference Section, Washington, DC 20549-0102.
The
Manager and its affiliates will not purchase securities or other property from,
or sell securities or other property to, a Fund, except that the Fund may in accordance
with rules adopted under the Investment Company Act engage in transactions with
accounts that are affiliated with the Fund as a result of common officers, Directors,
or investment advisers. These transactions would be effected in circumstances
in which the Manager determined that it would be appropriate for the Fund to purchase
and another client to sell, or the Fund to sell and another client to purchase,
the same security or instrument on the same day.
Present and future activities
of Merrill Lynch, including the Manager, in addition to those described in this
section, may give rise to additional conflicts of interest.
P
URCHASE
OF
S
HARES
Each Fund offers multiple classes of shares under a Select Pricing
SM
System adopted under Rule 18f-3 of the Investment Company Act (the “Select Pricing System”): Class A shares are sold to investors choosing the initial sales charge alternatives and Class B and Class C shares are sold to investors choosing the deferred sales charge alternatives. Class I shares are sold to certain investors without a sales charge. In addition, certain Funds offer Class R shares, which are available only to certain retirement plans and are sold without a sales charge. Please see your Fund’s Prospectus to determine whether it offers Class R shares. Each class has different exchange privileges. See “Shareholder Services — Exchange Privileges.”
The Select Pricing System is used by more than 50 registered investment companies advised by the Manager and its affiliates. Funds that use the Select Pricing System are referred to herein as “Select Pricing Funds.”
The applicable offering price
for purchase orders is based on the net asset value of a Fund next determined
after receipt of the purchase order by a dealer or other financial intermediary
(“Selling Dealer”) that has been authorized by the Distributor by contract
to accept such orders. As to purchase orders received by Selling Dealers prior
to the close of business on the New York Stock Exchange (“NYSE”) (generally,
the NYSE closes at 4:00 p.m. Eastern time), on the day the order is placed, which
includes orders received after the close of business on the previous day, the
applicable offering price is based on the net asset value determined as of the
close of business on the NYSE on that day. If the purchase orders are not received
by the Selling Dealer before the close of business on the NYSE, such orders are
deemed received on the next business day.
Each Fund or the Distributor
may suspend the continuous offering of the Fund’s shares of any class at
any time in response to conditions in the securities markets or otherwise and
may resume offering of shares from time to time. Any order may be rejected by
a Fund or the Distributor. Neither the Distributor, the securities dealers nor
other financial intermediaries are permitted to withhold placing orders to benefit
themselves by a price change.
The term “purchase,”
as used in the Prospectus and this Statement of Additional Information refers
to (i) a single purchase by an individual, (ii) concurrent purchases by an individual,
his or her spouse and their children under the age of 21 years purchasing shares
for his, her or their own account, and (iii) single purchases by a trustee or
other fiduciary purchasing shares for a single trust estate or single fiduciary
account although more than one beneficiary may be involved. The term “purchase”
also includes purchases by any “company,” as that term is defined in
the
Investment Company Act, but
does not include (i) purchases by any company that has not been in existence for
at least six months, (ii) a company that has no purpose other than the purchase
of shares of a Fund or shares of other registered investment companies at a discount,
or (iii) any group of individuals whose sole organizational nexus is that its
participants are credit cardholders of a company, policyholders of an insurance
company, customers of either a bank or broker-dealer or clients of an investment
adviser.
Class I Shares
Class I shares may be purchased
at net asset value without a sales charge. Only certain investors are eligible
to purchase Class I shares. Investors who are eligible to purchase Class I shares
should purchase Class I shares because they are not subject to any sales charge
and have lower ongoing expenses than Class A, Class B, Class C or Class R shares.
Eligible
Class I Investors
. Class I shares are offered to a limited group of investors.
Investors who currently own Class I shares in a shareholder account are entitled
to purchase additional Class I shares of a Fund in that account. Certain employer-sponsored
retirement or savings plans, including eligible 401(k) plans, may purchase Class
I shares provided such plans meet the required minimum number of eligible employees
or required amount of assets advised by the Manager or any of its affiliates.
Class I shares are available to corporate warranty insurance reserve fund programs
and U.S. branches of foreign banking institutions provided that the program or
bank has $3 million or more initially invested in Select Pricing Funds. Also eligible
to purchase Class I shares are participants in certain investment programs, including
TMA
SM
Managed Trusts, to which Merrill Lynch
Trust Company provides discretionary trustee services, collective investment trusts
for which Merrill Lynch Trust Company serves as trustee, certain other trusts
managed by banks, thrifts or trust companies, and certain purchases made in connection
with certain fee-based programs. In addition, Class I shares are offered to ML
& Co. and its subsidiaries and their directors and employees and to members
of the Boards of investment companies advised by MLIM, FAM or their affiliates
and to employees or customers of selected securities dealers that meet certain
qualifications. Class I shares of Bond Fund are also available to institutional
investors that purchase more than $50 million of that Fund’s shares. In addition,
Class I shares of each Select Pricing Fund are offered to shareholders of certain
continuously offered closed-end funds advised by MLIM or FAM who wish to reinvest
the net proceeds from the sale of certain of their shares of common stock pursuant
to a tender offer conducted by such funds. See “Purchase of Shares - Closed-End
Fund Reinvestment Options.”
Purchase Privileges
of Certain Persons
. Directors of each Fund, members of the Boards of other
funds advised by the Manager or an affiliate, ML & Co. and its subsidiaries
and their directors and employees and any trust, pension, profit-sharing or other
benefit plan for such persons, may purchase Class I shares. A Fund realizes economies
of scale and reduction of sales-related expenses by virtue of the familiarity
of these persons with the Fund. Employees, Directors, and Board members of other
funds wishing to purchase shares of a Fund must satisfy the Fund’s suitability
standards.
Initial Sales
Charge Alternatives — Class A Shares
Investors who prefer an initial
sales charge alternative may elect to purchase Class A shares. Investors qualifying
for significantly reduced initial sales charges may find the initial sales charge
alternative particularly attractive because similar sales charge reductions are
not available with respect to the deferred sales charges imposed in connection
with purchases of Class B or Class C shares. Investors who do not qualify for
reduced initial sales charges and who expect to maintain their investment for
an extended period of time also may elect to purchase Class A shares,
because
over time the accumulated ongoing account maintenance and distribution fees on
Class B, Class C and Class R shares may exceed the Class A initial sales charge
and, account maintenance fee. Although some investors who previously purchased
Class I shares may no longer be eligible to purchase Class I shares of other Select
Pricing Funds, those previously purchased Class I shares, together with Class
A, Class B and Class C share holdings, will count toward a right of accumulation
that may qualify the investor for a reduced initial sales charge on new initial
sales charge purchases. In addition, the ongoing Class B, Class C and Class R
shares account maintenance and distribution fees will cause Class B, Class C and
Class R shares to have higher expense ratios, pay lower dividends and have lower
total returns than the initial sales charge shares. The ongoing Class A account
maintenance fees will cause Class A shares to have a higher expense ratio, pay
lower dividends and have a lower total return than Class I shares.
See Part I, Section V “Information
on Sales Charges and Distribution Related Expenses — Class A Sales Charge
Information” of each Fund’s Statement of Additional Information for
information about amounts paid to the Distributor in connection with Class A shares
for the periods indicated.
The Distributor may reallow
discounts to selected securities dealers and other financial intermediaries and
retain the balance over such discounts. At times the Distributor may reallow the
entire sales charge to such dealers. Since securities dealers and other financial
intermediaries selling Class A shares of a Fund will receive a concession equal
to most of the sales charge, they may be deemed to be underwriters under the Securities
Act.
Reduced Initial
Sales Charges
Certain investors may be
eligible for a reduction in or waiver of a sales load due to the nature of the
investors and/or the reduced sales efforts necessary to obtain their investments.
Reinvested
Dividends
. No sales charges are imposed upon shares issued as a result of
the automatic reinvestment of dividends.
Rights of Accumulation
.
Eligible investors may purchase shares of a Fund subject to an initial sales charge
at the offering price applicable to the total of (a) the public offering price
of the shares then being purchased plus (b) an amount equal to the then current
net asset value or cost, whichever is higher, of the purchaser’s combined
holdings of Class A, Class B, Class C and Class I shares of a Fund and of any
other Select Pricing Funds. The purchaser or the purchaser’s securities dealer
or other financial intermediary must provide the Distributor at the time of purchase
with sufficient information to confirm qualification. Acceptance of the purchase
order is subject to such confirmation. The right of accumulation may be amended
or terminated at any time. Shares held in the name of a nominee or custodian under
pension, profit sharing or other employee benefit plans may not be combined with
other shares to qualify for the right of accumulation.
Letter of Intent
.
Reduced sales charges are applicable to purchases aggregating $25,000 or more
($100,000 or more for Bond Fund - Intermediate Term Portfolio and Municipal Bond
- Short Term Portfolio) of Class A shares of a Fund or any Select Pricing Funds
made within a 13 month period pursuant to a Letter of Intent. The Letter of Intent
is not available to employee benefit plans for which affiliates of the Manager
provide plan participant record-keeping services. The Letter of Intent is not
a binding obligation to purchase any amount of Class A shares. If you bought Class
A or shares prior to signing a Letter of Intent, those shares may be included
under a subsequent Letter of Intent executed within 90 days of the purchase if
you inform the Distributor in writing of your intent within the 90-day period.
The value (at cost or maximum offering price, whichever is higher) of Class A
shares of a Select Pricing Fund presently held on the date of the first purchase
under the Letter of Intent may be included as a credit toward the completion of
such Letter, but the reduced sales charge will be applied only to new purchases.
If the total amount of shares does not equal the amount stated in the Letter of
Intent, you will be notified and must pay, within 20 days of the expiration of
such Letter, the difference between the reduced sales charge and the applicable
sales charge. Class A shares equal to at least 5.00% of the intended amount will
be held in escrow during the 13-month period (while remaining registered in the
name of the purchaser) for this purpose. The first purchase under the Letter of
Intent must be at least 5.00% of the dollar amount of such Letter. You may be
entitled to further reduced sales charges under a right of accumulation for purchases
made during the term of a Letter. You will not, however, be entitled to further
reduced sales charges on any purchases made before the execution of the Letter.
The
value of any shares you redeem prior to termination or completion of the Letter
of Intent will be deducted from the total purchases made under such Letter. An
exchange from the Summit Cash Reserves Fund (“Summit”), a series of
Financial Institutions Series Trust, into a Fund that imposes a sales charge will
count toward completing a Letter of Intent for the Fund.
Merrill Lynch Blueprint
SM
Program
. Class
A shares of certain Funds are offered to participants in the Merrill Lynch Blueprint
SM
Program (“Blueprint”).
In addition, participants in Blueprint who own Class I shares of a Fund may purchase
additional Class I shares of the Fund through Blueprint. Blueprint is directed
to small investors, group IRAs and participants in certain affinity groups such
as credit unions, trade associations and benefit plans. Investors purchasing Class
A shares of a Fund through Blueprint will acquire the shares at net asset value
plus a sales charge
calculated in accordance
with the Blueprint sales charge schedule. Under this schedule, purchases of up
to $300 are subject to a sales charge of 4.25%; purchases of $300.01 up to $5,000
are subject to a sales charge of 3.25% plus $3; and purchases of $5,000.01 or
more are subject to the standard sales charge rates disclosed in the Prospectus.
In addition, Class A shares of each Fund are offered at net asset value plus a
sales charge of .50% of 1% for corporate or group IRA programs purchasing shares
through Blueprint.
Class A shares are offered
at net asset value to participants in Blueprint through the Merrill Lynch Directed
IRA Rollover Program (“IRA Rollover Program”) available from Merrill
Lynch Business Financial Services, a business unit of Merrill Lynch. The IRA Rollover
Program is available to custodian rollover assets from employer-sponsored retirement
and savings plans whose trustee and/or plan sponsor has entered into a Merrill
Lynch Directed IRA Rollover Program Service Agreement.
Shareholder services, including
the exchange privilege, available to Class A, Class B and Class I investors through
Blueprint may differ from those available to other Class A, Class B or Class I
investors. Orders for purchases and redemptions of Class A, Class B or Class I
shares of a Fund may be grouped for execution purposes which, in some circumstances,
may involve the execution of such orders two business days following the day such
orders are placed. The minimum initial purchase price is $100, with a $50 minimum
for subsequent purchases through Blueprint. There are no minimum initial or subsequent
purchase requirements for participants who are part of an automatic investment
plan. Additional information concerning purchases through Blueprint, including
any annual fees and transaction charges, is available from Merrill Lynch, Pierce,
Fenner & Smith Incorporated, The Blueprint
SM
Program, P.O. Box
30441, New Brunswick, New Jersey 08989-0441.
Purchase Privileges
of Certain Persons
. Class A shares are also available at net asset value to
investors that, for regulatory reasons, are required to transfer investment positions
from a non-U.S. registered investment company advised by MLIM, FAM or their affiliates
to a U.S. registered MLIM/FAM-advised fund.
Acquisition of Certain
Investment Companies
. Class A shares may be offered at net asset value in
connection with the acquisition of the assets of or merger or consolidation with
a personal holding company or a public or private investment company.
Purchases
Through Certain Financial Intermediaries
. Reduced sales charges may be applicable
for purchases of Class A shares of a Fund through certain financial advisors,
selected securities dealers and other financial intermediaries that meet and adhere
to standards established by the Manager from time to time.
Deferred Sales
Charge Alternatives — Class B and Class C Shares
Investors choosing the deferred
sales charge alternatives should consider Class B shares if they intend to hold
their shares for an extended period of time and Class C shares if they are uncertain
as to the length of time they intend to hold their assets in a Fund.
The deferred sales charge
alternatives may be particularly appealing to investors who do not qualify for
the reduction in initial sales charges. Both Class B and Class C shares are subject
to ongoing account maintenance fees and distribution fees; however, these fees
potentially may be offset to the extent any return is realized on the additional
funds initially invested in Class B or Class C shares. In addition, Class B shares
will be converted into
Class A shares of the Fund after a conversion period of
approximately ten years, and, thereafter, investors will be subject to lower ongoing
fees.
Merrill Lynch compensates
financial advisers and other financial intermediaries for selling Class B and
Class C shares at the time of purchase from its own funds. Proceeds from the CDSC
(as defined below) and the distribution fee are paid to the Distributor and are
used by the Distributor to defray the expenses of securities dealers or other
financial intermediaries (including Merrill Lynch) related to providing distribution-related
services to each Fund in connection with the sale of the Class B and Class C shares.
The combination of the CDSC and the ongoing distribution fee facilitates the ability
of each Fund to sell the Class B and Class C shares without a sales charge being
deducted at the time of purchase. See “Distribution Plans” below. Imposition
of the CDSC and the distribution fee on Class B and Class C shares
is limited by the NASD asset-based sales charge rule. See “Limitations on
the Payment of Deferred Sales Charges” below.
Contingent Deferred
Sales Charges — Class B Shares
. If you redeem Class B shares within six
years of purchase (three years for Bond Fund - Intermediate Term Portfolio, Municipal
Bond - Short Term Portfolio and Municipal Intermediate Term, and Class B1 shares
of Short Term U.S. Government), you may be charged a contingent deferred sales
charge (“CDSC”) at the rates indicated in the Prospectus and below.
The CDSC will be calculated in a manner that results in the lowest applicable
rate being charged. The charge will be assessed on an amount equal to the lesser
of the proceeds of redemption or the cost of the shares being redeemed. Accordingly,
no CDSC will be imposed on increases in net asset value above the initial purchase
price. In addition, no CDSC will be assessed on shares acquired through reinvestment
of dividends. The order of redemption will be first of shares held for over six
years or three years, as applicable, in the case of Class B shares, next of shares
acquired pursuant to reinvestment of dividends, and finally of shares in the order
of those held longest. The same order of redemption will apply if you transfer
shares from your account to another account.
The following table sets forth
the schedule that applies to the Class B CDSC for all Funds except Bond Fund -
Intermediate Term Portfolio, Municipal Bond - Short Term Portfolio, and Municipal
Intermediate Term:
Years
Since Purchase
Payment Made
|
CDSC
as a Percentage
of Dollar Amount
Subject to Charge*
|
|
0 — 1
|
4.0%
|
|
1 — 2
|
4.0%
|
|
2 — 3
|
3.0%
|
|
3 — 4
|
3.0%
|
|
4 — 5
|
2.0%
|
|
5 — 6
|
1.0%
|
|
6
and thereafter
|
None
|
|
*
|
|
For
Class B shares purchased before December 1, 2002, the four-year CDSC schedule
in effect at that time will apply.
|
To provide an example, assume
an investor purchased 100 shares at $10 per share (at a cost of $1,000) and in
the third year after purchase, the net asset value per share is $12 and, during
such time, the investor has acquired 10 additional shares upon dividend reinvestment.
If at such time the investor makes his or her first redemption of 50 shares (proceeds
of $600), 10 shares will not be subject to a CDSC because they were issued through
dividend reinvestment. With respect to the remaining 40 shares, the charge is
applied only to the original cost of $10 per share and not to the increase in
net asset value of $2 per share. Therefore, $400 of the $600 redemption proceeds
will be charged at a rate of 3.00% (the applicable rate in the third year after
purchase).
The following table sets
forth the schedule that applies to the Class B1 CDSC for Short Term U.S. Government
and the Class B CDSC for Bond Fund - Intermediate Term Portfolio, Municipal Bond
- Short Term Portfolio, and Municipal Intermediate Term:
Years
Since Purchase
Payment Made
|
CDSC
as a Percentage
of Dollar Amount
Subject to Charge*
|
|
0 -- 1
|
1.00%
|
|
1 -- 2
|
0.50%
|
|
2 -- 3
|
0.25%
|
|
3
and thereafter
|
None
|
|
*
|
|
For
Class B shares purchased before December 1, 2002, the one-year CDSC schedule in
effect at that time will apply.
|
The Class B CDSC may be
waived on redemptions of shares in connection with certain post-retirement withdrawals
from an Individual Retirement Account (“IRA”) or other retirement plan
or following the death or disability (as defined in the Code) of a shareholder
(including one who owns the Class B shares as joint tenant with his or her spouse),
provided the redemption is requested within one year of the death or initial determination
of disability or, if later, reasonably promptly following completion of probate.
The Class B CDSC also may be waived on redemptions of shares by certain eligible
401(a) and 401(k) plans. The CDSC may also be waived for any Class B shares that
are purchased by eligible 401(k) or eligible 401(a) plans that are rolled over
into a Merrill Lynch or Merrill Lynch Trust Company custodied IRA and held in
such account at the time of redemption. The Class B CDSC may be waived for any
Class B shares that were acquired and held at the time of the redemption in an
Employee Access
SM
Account available
through employers providing eligible 401(k) plans. The Class B CDSC may also be
waived for any Class B shares that are purchased by a Merrill Lynch rollover IRA
that was funded by a rollover from a terminated 401(k) plan managed by MLIM Private
Investors and held in such account at the time of redemption. The Class B CDSC
may also be waived or its terms may be modified in connection with certain fee-based
programs. The Class B CDSC may also be waived in connection with involuntary termination
of an account in which Fund shares are held or for withdrawals through a systematic
withdrawal plan offered by an affiliate of the Manager of up to 10% per year of
your Class B account value at the time the plan is established, or on redemptions
made in connection with the payment of account custodial fees. See “Shareholder
Services — Fee-Based Programs” and “— Systematic Withdrawal
Plans.”
Class B shareholders of a
Fund who exercise the exchange privilege described under “Shareholder Services
-- Exchange Privilege” will be subject to the CDSC schedule of the Class
B shares involved in the exchange that have the longer such schedule.
The CDSC on Class B shares
purchased through Blueprint will be waived upon redemption of those Class B shares.
Employer-Sponsored
Retirement or Savings Plans and Certain Other Arrangements
. Certain employer-sponsored
retirement or savings plans and certain other arrangements may purchase Class
B shares with a waiver of the CDSC upon redemption, based on the number of employees
or number of employees eligible to participate in the plan, the aggregate amount
invested by the plan in specified investments and/or the services provided by
Merrill Lynch to the Plan. Such Class B shares will convert into Class A shares
approximately ten years after the plan purchases the first share of any Select
Pricing Fund. Minimum purchase requirements may be waived or varied for such plans.
Additional information regarding purchases by employer-sponsored retirement or
savings plans and certain other arrangements is available toll-free from Merrill
Lynch Business Financial Services at 1-800-237-7777.
Conversion of Class
B Shares to Class A Shares
. Approximately ten years after purchase (the “Conversion
Period”), Class B shares of each Fund will convert automatically into Class
A shares of that Fund. The conversion will occur at least once each month (on
the “Conversion Date”) on the basis of the relative net asset value
of the shares of the two classes on the Conversion Date, without the imposition
of any sales load, fee or other charge. Conversion of Class B shares to Class
A shares will not be deemed a purchase or sale of the shares for Federal income
tax purposes.
Shares acquired through reinvestment
of dividends on Class B shares will also convert automatically to Class A shares.
The Conversion Date for dividend reinvestment shares will be calculated taking
into account the length of time the shares underlying the dividend reinvestment
shares were outstanding. If at the Conversion Date the
conversion will result
in less than $50 worth of Class B shares being left in an account, all of the
Class B shares of the Fund held in the account will be converted into Class A
shares of the Fund.
In general, Class B shares
of equity Select Pricing Funds will convert approximately eight years after initial
purchase and Class B shares of taxable and tax-exempt fixed income Select Pricing
Funds will convert approximately ten years after initial purchase. If you exchange
Class B shares with an eight-year Conversion Period for Class B shares with a
ten-year Conversion Period, or vice versa, the longer Conversion Period will apply
to the Class B shares acquired in the exchange and the holding period for the
shares exchanged will be tacked on to the holding period for the shares acquired.
The Conversion Period also may be modified for investors that participate in certain
fee-based programs. See “Shareholder Services — Fee-Based Programs.”
If you own shares of a Fund
that, in the past, issued stock certificates and you continue to hold such stock
certificates, you must deliver any certificates for Class B shares of the Fund
to be converted to the Transfer Agent at least one week prior to the Conversion
Date applicable to those shares. If the Transfer Agent does not receive the certificates
at least one week prior to the Conversion Date, your Class B shares will convert
to Class A shares on the next scheduled Conversion Date after the certificates
are delivered.
Contingent
Deferred Sales Charges - Class C Shares
Class C shares that are redeemed
within one year of purchase may be subject to a 1.00% CDSC charged as a percentage
of the dollar amount subject thereto. In determining whether a Class C CDSC is
applicable to a redemption, the calculation will be determined in the manner that
results in the lowest possible rate being charged. The charge will be assessed
on an amount equal to the lesser of the proceeds of redemption or the cost of
the shares being redeemed. Accordingly, no Class C CDSC will be imposed on increases
in net asset value above the initial purchase price. In addition, no Class C CDSC
will be assessed on shares acquired through reinvestment of dividends. It will
be assumed that the redemption is first of shares held for over one year or shares
acquired pursuant to reinvestment of dividends and then of shares held longest
during the one-year period. A transfer of shares from a shareholder’s account
to another account will be assumed to be made in the same order as a redemption.
The Class C CDSC may be waived in connection with involuntary termination of an
account in which Fund shares are held, for withdrawals through a systematic withdrawal
plan offered by an affiliate of the Manager, and in connection with the redemption
of Class C shares by certain retirement plans or on redemptions made in connection
with the payment of account custodial fees. See “Shareholder Services --
Systematic Withdrawal Plan.”
See Part I, Section V “Information
on Sales Charges and Distribution Related Expenses -- Class B and Class C Sales
Charge Information” of each Fund’s Statement of Additional Information
for information about amounts paid to the Distributor in connection with Class
B and C shares for the periods indicated.
Class R Shares
Certain of the Funds offer
Class R shares as described in each such Fund’s Prospectus. Class R shares
are available only to certain retirement plans. Class R shares are not subject
to an initial sales charge or a contingent deferred sales charge but are subject
to an ongoing distribution fee of 0.25% per year and an ongoing account maintenance
fee of 0.25% per year. Distribution fees are used to support the Fund’s marketing
and distribution efforts, such as compensating financial advisers and other financial
intermediaries, advertising and promotion. Account maintenance fees are used to
compensate securities dealers and other financial intermediaries for account maintenance
activities. If Class R shares are held over time, these fees may exceed the maximum
sales charge that an investor would have paid as a shareholder of one of the other
share classes.
Redemption
Fee
Certain Funds charge a 2.00%
redemption fee on the proceeds (calculated at market value) of a redemption (either
by sale or exchange) of Fund shares made within 30 days of purchase. The redemption
fee is paid to the Fund and is intended to offset the trading costs, market impact
and other costs associated with short-term trading into and out of the Fund. The
redemption fee is imposed to the extent that the number of Fund shares redeemed
within 30 days exceeds the number of Fund shares that have been held for more
than 30 days. For redemptions of Fund shares acquired by exchange, your holding
period for the shares exchanged will not be tacked on to the holding period for
the Fund shares acquired in determining whether to apply the redemption fee. The
redemption fee will not apply in the following circumstances:
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Redemptions
resulting from death or disability
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Redemptions
through a Systematic Withdrawal Plan
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Redemptions
of shares purchased through an Automatic Investment Plan
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Redemptions
of shares acquired through dividend reinvestment
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Redemptions
of shares held in certain omnibus accounts, including retirement plans qualified
under Sections 401(a) or 401(k) of the Internal Revenue Code of 1986, as amended,
or plans administered as college savings plans under Section 529 of the Internal
Revenue Code
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Redemptions
of shares held through advisory fee-based programs that the Distributor determines
are not designed to facilitate short-term trading
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Distribution
Plans
The distribution plan for
each of the Class A, Class B, Class C and Class R shares of the Select Pricing
Funds (each, a “Plan”) provides that a Fund pays the Distributor an
account maintenance fee, accrued daily and paid monthly, at an annual rate based
on the average daily net assets of the Fund attributable to shares of the relevant
class. This fee compensates the Distributor, a selected securities dealer or other
financial intermediary (pursuant to a sub-agreement) for account maintenance activities
with respect to Class A, Class B, Class C and Class R shares of the Select Pricing
Funds.
The Plan for each of the
Class B, Class C and Class R shares also provides that the Fund pays the Distributor
a distribution fee, accrued daily and paid monthly, at an annual rate based on
the average daily net assets of the Fund attributable to the shares of the relevant
class. This fee compensates the Distributor, a selected securities dealer or other
financial intermediary (pursuant to a sub-agreement) for providing shareholder
and distribution services and bearing certain distribution-related expenses of
the Fund, including payments to financial advisers or other financial intermediaries
for selling Class B, Class C and Class R shares of the Fund.
Each Fund’s Plans are
subject to the provisions of Rule 12b-1 under the Investment Company Act. In their
consideration of a Plan, the Directors must consider all factors they deem relevant,
including information as to the benefits of the Plan to the Fund and the related
class of shareholders. In approving a Plan in accordance with Rule 12b-1, the
non-Interested Directors concluded that there is reasonable likelihood that the
Plan will benefit the Fund and its related class of shareholders.
Each Plan provides that,
so long as the Plan remains in effect, the non-interested Directors then in office
will select and nominate other non-interested Directors. Each Plan can be terminated
at any time, without penalty, by the vote of a majority of the non-interested
Directors or by the vote of the holders of a majority of the outstanding related
class of voting securities of a Fund. A Plan cannot be amended to increase materially
the amount to be spent by the Fund without the approval of the related class of
shareholders. All material amendments are required to be approved by the vote
of Directors, including a majority of the non-interested Directors who have no
direct or indirect financial interest in the Plan, cast in person at a meeting
called for that purpose. Rule 12b-1 further requires that each Fund preserve copies
of each Plan and any report made pursuant to such plan for a period of not less
than six years from the date of the Plan or such report, the first two years in
an easily accessible place.
Among other things, each
Plan provides that the Directors will review quarterly reports of the account
maintenance and/or distribution fees paid to the Distributor. Payments under the
Plans are based on a percentage of average daily net assets attributable to the
shares regardless of the amount of expenses incurred. As a result, distribution-related
revenues from the Plans may be more or less than distribution-related expenses
of the related class. Information with respect to the distribution-related revenues
and expenses is presented to the Directors for their consideration quarterly.
Distribution-related revenues consist of the account maintenance fees, the distribution
fees and the CDSCs. Distribution-related expenses consist of financial adviser
compensation, branch office and regional operation center selling and transaction
processing expenses, advertising, sales promotion and marketing expenses and interest
expense. Distribution-related revenues paid with respect to one class will not
be used to finance the distribution expenditures of another class. Sales personnel
may receive different compensation for selling different classes of shares.
See Part I, Section V “Distribution
Related Expenses” of each Fund’s Statement of Additional Information
for information relating to the fees paid by your Fund to the Distributor under
each Distribution Plan during the Fund’s most recent fiscal year.
Limitations
on the Payment of Deferred Sales Charges
The maximum sales charge
rule in the Conduct Rules of the NASD imposes a limitation on certain asset-based
sales charges such as the distribution fee borne by Class R shares, and the distribution
fee and the CDSC borne by the Class B and Class C shares. This limitation does
not apply to the account maintenance fee. The maximum sales charge rule is applied separately
to each class and limits the aggregate of distribution fee payments and CDSCs
payable by a Fund to (1) 6.25% of eligible gross sales of Class B, Class C and
Class R shares, computed separately (excluding shares issued pursuant to dividend
reinvestments and exchanges), plus (2) interest on the unpaid balance for the
respective class, computed separately, at the prime rate plus 1% (the unpaid balance
being the maximum amount payable minus amounts received from the payment of the
distribution fee and the CDSC). In connection with the Class B shares, the Distributor
has for certain Funds voluntarily agreed to waive interest charges on the unpaid
balance in excess of 0.50% of eligible gross sales. Consequently, the maximum
amount payable to the Distributor (referred to as the “voluntary maximum”)
in connection with the Class B shares is 6.75% of eligible gross sales. The Distributor
retains the right to stop waiving the interest charges at any time. To the extent
payments would exceed the voluntary maximum, a Fund will not make further payments
of the distribution fee with respect to Class B shares and any CDSCs will be paid
to the Fund rather than to the Distributor; however, each Fund will continue to
make payments of the account maintenance fee. In certain circumstances, the amount
payable pursuant to the voluntary maximum may exceed the amount payable under
the NASD formula. In such circumstances, payment in excess of the amount payable
under the NASD formula will not be made.
See Part I, Section V “Information
on Sales Charges and Distribution Related Expenses - Limitation on the Payment
of Deferred Sales Charge” of each Select Pricing Fund’s Statement of
Additional Information for comparative information as of your Fund’s most
recent fiscal year end with respect to the Class B, Class C and, if applicable,
Class R shares of your Fund.
Closed-End
Fund Reinvestment Options
Subject to the conditions
set forth below, shares of each Fund are offered at net asset value to shareholders
of certain continuously offered closed-end funds advised by a Manager (an “Eligible
Fund”) who wish to reinvest the net proceeds from a sale of eligible shares.
Upon exercise of this reinvestment option, shareholders of Merrill Lynch Senior
Floating Rate Fund, Inc. will receive Class I shares of a Fund and shareholders
of Merrill Lynch Senior Floating Rate Fund II, Inc. will receive Class C shares
of a Fund.
In order to exercise this
reinvestment option, a shareholder of an Eligible Fund must sell his or her shares
back to the Eligible Fund in connection with a tender offer conducted by the Eligible
Fund and reinvest the proceeds immediately in the designated class of shares of
a Fund. This option is available only with respect to shares as to which no Early
Withdrawal Charge (as defined in the Eligible Fund’s prospectus) is applicable.
Purchase orders from Eligible Fund shareholders who wish to exercise this reinvestment
option will be accepted only on the day that the related tender offer terminates
and will be effected at the net asset value of the designated class of shares
of a Fund on such day. The Class C CDSC may be waived upon redemption of Class
C shares purchased by an investor pursuant to this closed-end fund reinvestment
option. This waiver is subject to the requirement that the investor has held the
tendered shares for a minimum of one year and to such other conditions as are
set forth in the prospectus for the related closed-end fund.
Other Compensation
to Selling Dealers.
The Manager, the Distributor and their affiliates,
at their expense, currently provide additional compensation to certain financial
intermediaries that make Fund shares available to their customers. With respect
to affiliates of the Manager or the Distributor, including Merrill Lynch, Pierce,
Fenner & Smith Incorporated, such compensation may be in the form of payments
or intercompany transfers.
The amount of payments made
to a financial intermediary in any given year will vary based on the amount of
the previous year’s fund sales by a financial intermediary and/or the amount
of assets attributable to a financial intermediary. These payments help defray
the costs incurred by financial intermediaries for, among other things,
providing
marketing and other services intended to assist in the offer and sale of Fund
shares, for shareholder servicing activities, and/or for sub-transfer agency services
provided to individual shareholders where a financial intermediary maintains omnibus
accounts with the Fund’s Transfer Agent.
As of the date of this Statement
of Additional Information, the financial intermediaries that the Distributor anticipates
will receive additional payments include:
ADP Broker Dealer Inc.
AIG
Valic Retirement Services
American Express / Ameriprise
Financial
American Skandia Advisory Services
Amvescap Services, Inc. Retirement
Services
AST
AXA Advisors
Bear Stearns
Bisys
BMO Nesbitt
Burns Co.
Boston Financial Data Services, Inc. (BFDS)
Brown Brothers Harriman
Co.
Ceridian Retirement Plan Services
Charles Schwab & Co., Inc.
Chicago
Mercantile Exchange
Citigroup Global Markets
Citistreet, LLC
CNS Distributors,
Inc.
Columbia Funds Distributor, Inc.
Edgewood Services / Federated Trust
Fascorp / GWFS Equities, Inc.
Federated Edgewood Services, Inc.
Fidelity
Brokerage Services, LLC / National Financial
Fidelity Investment Retirement
Services
Fidelity Investments Institutional Operations Company, Inc.
First
Trust - Trustlynx
First Trust - Datalynx
Fiserv Securities, Inc.
Great
West / Benefits Corp.
Hand Benefits & Trust Company
Hartford Life
Insurance Company
Hewitt Services, LLC
HSBC Bank USA (Fedders) Services
ICMA-RC Services LLC
Invesmart
Janney Montgomery Scott
JP Morgan
Retirement Services
LPL
M&I Trust
Manulife Financial Group
Manulife
/ John Hancock
Matrix
Mercer (Putnam)
Merrill Lynch, Pierce, Fenner
& Smith Incorporated
Metlife Securities
MFS Investment Services
MidAtlantic
Capital Corporation
MSCS Financial Services, LLC
National Investor Services
Corp.
Nationwide Financial Services, Inc.
Pershing, LLC
PFPC / WySTAR
PNC
Prudential Investment Management Services
Prudential Securities,
Inc.
Putnam Fiduciary Trust Company
RBC Dain Rauscher, Inc.
Salomon
Smith Barney, Inc.
SEI
Sungard
T. Rowe Price Retirement
Plans Services Inc.
TC Advisors
Trust Company of America
UBS
US
Asset Management, LLC
US Bancorp / US Bank National Association
US Bank
US Clearing
USAA
Vining Sparks
Wachovia Bank NA
Wachovia Securities
Wells Fargo NA Institutional Investments
R
EDEMPTION
OF
S
HARES
Each Fund is required to
redeem for cash all shares of the Fund upon receipt of a written request in proper
form. The redemption price is the net asset value per share next determined after
the initial receipt of proper notice of redemption. The value of shares of each
Fund at the time of redemption may be more or less than your cost at the time
of purchase, depending in part on the market value of the securities held by the
Fund at such time. Except for any CDSC or redemption fee that may be applicable,
there will be no redemption charge if your redemption request is sent directly
to the Transfer Agent. If you are liquidating your holdings you will receive all
dividends reinvested through the date of redemption.
The right to redeem shares
may be suspended for more than seven days only (i) for any period during which
trading on the NYSE is restricted as determined by the Securities and Exchange
Commission (the “Commission”) or during which the NYSE is closed (other
than customary weekend and holiday closings), (ii) for any period during which
an emergency exists, as defined by the Commission, as a result of which disposal
of portfolio securities or determination of the net asset value of the Fund is
not reasonably practicable, or (iii) for such other periods as the Commission
may by order permit for the protection of shareholders of the Fund.
Each Fund has entered into
a joint committed line of credit with other investment companies advised by the
Manager and a syndicate of banks that is intended to provide the Fund with a temporary
source of cash to be used to meet redemption requests from shareholders in extraordinary
or emergency circumstances.
Redemption
If you hold shares with the
Transfer Agent you may redeem such shares without charge by writing to the Fund’s
Transfer Agent, Financial Data Services, Inc., P.O. Box 45289, Jacksonville, Florida
32232-5289. Redemption requests delivered other than by mail should be sent to
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville, Florida
32246-6484. If you hold share certificates issued by your Fund, the letter must
be accompanied by certificates for the shares. Redemption requests should not
be sent to the Fund. A redemption request requires the signature(s) of all persons
in whose name(s) the shares are registered, signed exactly as such name(s) appear(s)
on the Transfer Agent’s register. The signature(s) on the redemption request
may require a guarantee by an “eligible guarantor institution” as defined
in Rule 17Ad-15 under the Securities Exchange Act of 1934 (the “Exchange
Act”), whose existence and validity may be verified by the Transfer Agent
through the use of industry publications. In the
event a signature guarantee is
required, notarized signatures are not sufficient. In general, signature guarantees
are waived on redemptions of less than $50,000 as long as the following requirements
are met: (i) the request contains the signature(s) of all persons in whose name(s)
shares are recorded on the Transfer Agent’s register; (ii) the check is mailed
to the stencil address of record on the Transfer Agent’s register and (iii)
the stencil address has not changed within 30 days. Certain rules may apply regarding
certain types of accounts, including but not limited to UGMA/UTMA accounts, Joint
Tenancies With Rights of Survivorship, contra broker transactions and institutional
accounts. In certain instances, the Transfer Agent may require additional documents
such as, but not limited to, trust instruments, death certificates, appointments
as executor or administrator, or certificates of corporate authority.
You may also redeem shares
held with the Transfer Agent by calling 1-800-637-3863. You must be the shareholder
of record and the request must be for an amount less than $50,000. Before telephone
requests will be honored, signature approval from all shareholders of record on
the account must be obtained. The shares being redeemed must have been held for
at least 15 days. Telephone redemption requests will not be honored if: (i) the
accountholder is deceased, (ii) the proceeds are to be sent to someone other than
the shareholder of record, (iii) funds are to be wired to the client’s bank
account, (iv) a systematic withdrawal plan is in effect, (v) the request is by
an individual other than the accountholder of record, (vi) the account is held
by joint tenants who are divorced, (vii) the address on the account has changed
within the last 30 days or share certificates have been issued on the account,
or (viii) to protect against fraud, if the caller is unable to provide the account
number, the name and address registered on the account and the social security
number registered on the account. The Funds or the Transfer Agent may temporarily
suspend telephone transactions at any time.
If you redeem shares directly
with the Transfer Agent, payments will generally be mailed within seven days of
receipt of the proper notice of redemption. A Fund may delay the mailing of a
redemption check until good payment (that is, cash, Federal funds or certified
check drawn on a U.S. bank) has been collected for the purchase of Fund shares,
which delay will usually not exceed 10 days. If your account is held directly
with the Transfer Agent and contains a fractional share balance following a redemption,
the fractional share balance will be automatically redeemed by the Fund.
Repurchase
A Fund normally will accept
orders to repurchase shares from Selling Dealers for their customers. Shares will
be priced at the net asset value of the Fund next determined after receipt of
the repurchase order by a Selling Dealer that has been authorized by the Distributor
by contract to accept such orders. As to repurchase orders received by Selling
Dealers prior to the close of business on the NYSE (generally, the NYSE closes
at 4:00 p.m. Eastern time), on the day the order is placed, which includes orders
received after the close of business on the previous day, the repurchase price
is the net asset value determined as of the close of business on the NYSE on that
day. If the orders for repurchase are not received by the Selling Dealer before
the close of business on the NYSE, such orders are deemed received on the next
business day.
These repurchase arrangements
are for your convenience and do not involve a charge by the Fund (other than any
applicable CDSC or redemption fee). However, Selling Dealers may charge a processing
fee in connection with such transactions. In addition, securities firms that do
not have selected dealer agreements with the Distributor may impose a transaction
charge for transmitting the notice of repurchase to the Fund. Each Fund reserves
the right to reject any order for repurchase. A shareholder whose order for repurchase
is rejected by a Fund, however, may redeem shares as set out above.
Reinstatement
Privilege - Class A Shares
If you redeemed Class A or
Class I shares of a Fund, you may reinstate your account by buying Class A shares,
of the Fund at net asset value without a sales charge up to the dollar amount
you redeemed, provided that you do so within 30 days after the redemption request
was accepted by the Transfer Agent or the Distributor. You may exercise the reinstatement
privilege by sending a notice of exercise along with a check for the amount to
be reinstated to the Transfer Agent or by contacting your financial adviser or
other financial intermediary within the required 30 day period. The reinstatement
will be made at the net asset value per share next determined after the notice
of reinstatement is received and cannot exceed the amount of the redemption proceeds.
S
HAREHOLDER
S
ERVICES
Each Fund offers one
or more of the shareholder services described below that are designed to facilitate
investment in its shares. You can obtain more information about these services
from each Fund, by calling the telephone number on the cover page, or from the
Distributor, your financial adviser, your selected securities dealer or other
financial intermediary. Certain of these services are available only to U.S. investors.
Investment
Account
If your account is maintained
at the Transfer Agent (an “Investment Account”) you will receive statements,
at least quarterly, from the Transfer Agent. These statements will serve as confirmations
for automatic investment purchases and the reinvestment of dividends. The statements
also will show any other activity in your Investment Account since the last statement.
You also will receive separate confirmations for each purchase or sale transaction
other than automatic investment purchases and the reinvestment of dividends. If
your Investment Account is held at the Transfer Agent you may make additions to
it at any time by mailing a check directly to the Transfer Agent. You may also
maintain an account through a selected securities dealer or other financial intermediary.
If you transfer shares out of an account maintained with a selected securities
dealer or other financial intermediary, an Investment Account in your name may
be opened automatically at the Transfer Agent.
You may transfer Fund shares
from a selected securities dealer or other financial intermediary to another securities
dealer or other financial intermediary that has entered into an agreement with
the Distributor. Certain shareholder services may not be available for the transferred
shares. After the transfer, you may purchase additional shares of Funds owned
before the transfer. All future trading of these assets must be coordinated by
the new firm. If you wish to transfer your shares to a securities dealer or other
financial intermediary that has not entered into an agreement with the Distributor,
you must either (i) redeem your shares, paying any applicable CDSC or (ii) continue
to maintain an Investment Account at the Transfer Agent for those shares. You
also may request that the new securities dealer or other financial intermediary
maintain the shares in an account at the Transfer Agent registered in the name
of the securities dealer or other financial intermediary for your benefit whether
the securities dealer or other financial intermediary has entered into a selected
dealer agreement or not. In the interest of economy and convenience and because
of the operating procedures of each Fund, share certificates will not be issued
physically. Shares are maintained by each Fund on its register maintained by the
Transfer Agent and the holders thereof will have the same rights and ownership
with respect to such shares as if certificates had been issued.
If you are considering transferring
a tax-deferred retirement account, such as an individual retirement account, from
one selected securities dealer to another securities dealer or other financial
intermediary, you should be aware that if the new firm will not take delivery
of shares of the Fund, you must either redeem the shares (paying any applicable
CDSC) so that the cash proceeds can be transferred to the account at the new firm,
or you must continue to maintain a retirement account at the original selected
securities dealer for those shares.
Exchange Privilege
U.S. shareholders of Class
A, Class B, Class C and Class I shares of each Fund have an exchange privilege
with certain other Select Pricing Funds and Summit, which is a money market fund
advised by FAM specifically designated for exchange by shareholders of Select
Pricing Funds. In order to qualify for the exchange privilege, the shares you
wish to exchange are required to have a net asset value of at least $100 and must
have been held by you for at least 15 days. In addition, if you held the shares
used in the exchange for 30 days or less, you may be charged a redemption fee
at the time of the exchange. Before effecting an exchange, you should obtain a
currently effective prospectus of the fund into which you wish to make the exchange.
Exercise of the exchange privilege is treated as a sale of the exchanged shares
and a purchase of the acquired shares for Federal income tax purposes.
Exchanges of Class A and
Class I Shares
. You may exchange Class A or Class I shares of a Fund for Class
I shares of a second Select Pricing Fund if you hold any Class I shares of the
second fund in your account at the time of the exchange or are eligible to purchase
Class I shares of the second fund; otherwise, you will receive Class A shares
of the second fund. Class A shares are exchangeable with shares of the same class
of other Select Pricing Funds.
Exchanges of Class I shares
outstanding (“outstanding Class I shares”) for Class I shares of a second
Select Pricing Fund, or for Class A shares of Summit (“new Class I shares”)
are effected on the basis of relative net asset value per Class I share. Exchanges
of Class A shares outstanding (“outstanding Class A shares”) for Class
A shares of a second Select Pricing Fund, or for Class A shares of Summit (“new
Class A shares”) are effected on the basis of relative net asset value per
Class A share, plus an amount equal to the difference, if any, between the sales
charge previously paid on the outstanding Class A or Class I shares and the sales
charge payable at the time of the exchange on the new Class A shares. With respect
to outstanding Class A shares received in a previous exchange, the “sales
charge previously paid” will include the aggregate of the sales charges paid
with respect to such Class A shares in
the initial purchase and
any subsequent exchange. Class A shares issued pursuant to dividend reinvestment
are not subject to a sales charge. For purposes of the exchange privilege, however,
these shares will be deemed to have been sold with a sales charge equal to the
sales charge previously paid on the Class A shares on which the dividend was paid.
Based on this formula, Class A shares of a Fund generally may be exchanged into
the Class A shares, of a second Fund with a reduced sales charge or without a
sales charge.
Exchanges of Class B
and Class C Shares
. Shareholders of certain Select Pricing Funds with Class
B and Class C shares outstanding (“outstanding Class B or Class C shares”)
may exchange their Class B or Class C shares for Class B or Class C shares, respectively,
of a second Select Pricing Fund or for Class B shares of Summit (“new Class
B or Class C shares”) on the basis of relative net asset value per Class
B or Class C share, without the payment of any CDSC. Certain Select Pricing Funds
impose different CDSC schedules. If you exchange your Class B shares for shares
of a fund with a different CDSC schedule the longer schedule will apply. For purposes
of computing the CDSC upon redemption of new Class B or Class C shares, the time
you held both the exchanged Class B or Class C shares and the new Class B shares
or Class C shares will count towards the holding period of the new Class B or
Class C shares. For example, if you exchange Class B shares of a Fund for those
of a second Fund after having held the first Fund’s Class B shares for two-and-a-half
years, the 3.00% CDSC that generally would apply to a redemption would not apply
to the exchange. Four years later if you decide to redeem the Class B shares of
the second Fund and receive cash, there will be no CDSC due on this redemption
since by adding the two-and-a-half year holding period of the first Fund’s
Class B shares to the four year holding period for the second Fund’s Class
B shares, you will be deemed to have held the second Fund’s Class B shares
for more than six years. The length of the CDSC period was extended from four
years to six years on June 1, 2001 for certain equity Select Pricing Funds and
from four to six years (or from one to three years for certain funds) on December
1, 2002 for certain fixed income Select Pricing Funds. Class B shares of the applicable
Select Pricing Funds purchased prior to these dates are subject to the shorter
CDSC schedule in effect at the time of purchase. This shorter CDSC schedule will
also generally apply to Class B shares received in exchange for such shares. However,
if you exchange Class B shares of a fixed income Select Pricing Fund purchased
on or after June 1, 2001 for those of an equity Select Pricing Fund, the equity
fund’s six year CDSC schedule will apply to the shares acquired in the exchange.
Exchanges
for Shares of a Money Market Fund
. You may exchange Class A and Class I shares
of a Fund for Class A shares of Summit and Class B and Class C shares of a Fund
for Class B shares of Summit. You may exchange Class A shares of Summit back into
Class A or Class I shares of a Fund. You may exchange Class B shares of Summit
back into Class B or Class C shares of a Fund and, in the event of such an exchange,
the period of time that you held Class B shares of Summit will count toward satisfaction
of the holding period requirement for purposes of reducing any CDSC and toward
satisfaction of any Conversion Period with respect to Class B shares. Class B
shares of Summit are subject to a distribution fee at an annual rate of 0.75%
of average daily net assets of such Class B shares. Please see your financial
adviser or other financial intermediary for further information.
Prior to October 12, 1998,
exchanges from certain Select Pricing Funds into a money market fund were directed
to certain money market funds advised by the Manager other than Summit (“Other
Money Funds”). If you exchanged Select Pricing Fund shares for shares of
Other Money Funds and subsequently wish to exchange Other Money Fund shares for
shares of a Select Pricing Fund (“Acquired Fund”), you will be subject
to the CDSC schedule applicable to the Acquired Fund shares, if any. The holding
period for Other Money Fund shares will not count toward satisfaction of the holding
period requirement for reduction of the CDSC imposed on Acquired Fund shares,
if any, and, with respect to Class B shares, toward satisfaction of the Conversion
Period. However, the time you held the fund shares originally exchanged for Other
Money Fund shares will count towards the holding period of the Class B or C shares
of the Acquired Fund for purposes of reducing the CDSC or satisfying the Conversion
Period.
Exchanges by Participants
in Certain Programs
. The exchange privilege is modified with respect to certain
participants in mutual fund advisory programs and other fee-based programs sponsored
by the Manager, an affiliate
of the Manager, or selected securities dealers or
other financial intermediaries that have an agreement with the Distributor. See
“Fee -- Based Programs” below.
Exercise of the Exchange
Privilege
. To exercise the exchange privilege, you should contact your financial
adviser, who will advise each Fund of the exchange. If you do not hold share certificates,
you may exercise the exchange privilege by wire through your securities dealer
or other financial intermediary. Each Fund reserves the right to require a properly
completed exchange application.
You may also request exchanges
by calling the Transfer Agent at 1-800-637-3863 if your account is held with the
Transfer Agent for amounts up to $50,000. The request must be from the shareholder
of record. Before telephone requests will be honored, signature approval from
all shareholders of record must be obtained. The shares being exchanged must have
been held for at least 15 days. Telephone requests for an exchange will not be
honored if: (i) the accountholder is deceased, (ii) the request is by an individual
other than the accountholder of record, (iii) the account is held by joint tenants
who are divorced or the address on the account has changed within the last 30
days, or (iv) if the caller is unable to provide the account number, the name
and address registered on the account and the social security number registered
on the account. Each Fund or the Transfer Agent may temporarily suspend telephone
transactions at any time.
This exchange privilege may
be modified or terminated in accordance with the rules of the Commission. Each
Fund reserves the right to limit the number of times an investor may exercise
the exchange privilege. Certain Funds may suspend the continuous offering of their
shares to the general public at any time and may resume such offering from time
to time. The exchange privilege is available only to U.S. shareholders in states
where the exchange legally may be made. The exchange privilege may be applicable
to other new mutual funds whose shares may be distributed by the Distributor.
Fee-Based
Programs
Certain fee-based programs
offered by the Manager or its affiliates, or by a selected securities dealer or
other financial intermediary that has an agreement with the Distributor, including
pricing alternatives for securities transactions (each referred to in this paragraph
as a “Program”), may permit the purchase of Class I shares at net asset
value. Under specified circumstances, participants in certain Programs may exchange
their shares in the Program for Class I shares. Initial or deferred sales charges
otherwise due in connection with such exchanges may be waived or modified, as
may the Conversion Period applicable to the deposited shares. Termination of participation
in a Program may result in the redemption of shares or the automatic exchange
of shares to another class at net asset value. Shareholders that participate in
a fee based Program generally have two options at termination. A Program can be
terminated and the shares liquidated or a Program can be terminated and the shares
held in an account. In general, when a shareholder chooses to continue to hold
the shares, whatever share class was held in the Program can be held after termination.
Shares that have been held for less than specified periods within a Program may
be subject to a fee upon redemption. Shareholders that held Class A or Class I
shares in a Program are eligible to purchase additional shares of the respective
share class of the fund, but purchase of Class A shares may be subject to upfront
sales charges. A shareholder may only make additional purchases of Class I shares
if the shareholder has an existing position at the time of purchase or is otherwise
eligible to purchase Class I shares.
Retirement
and Education Savings Plans
Individual retirement accounts
and other retirement and education savings plans are available from your financial
intermediary. Under these plans, investments may be made in a Fund (other than
a Municipal Fund) and certain of the other mutual funds sponsored by MLIM or its
affiliates as well as in other securities. There may be fees associated with investing
through these plans. Information with respect to these plans is available on request
from your financial intermediary.
Dividends received in each
of the plans referred to above are exempt from Federal taxation until distributed
from the plans and, in the case of Roth IRAs and education savings plans, may
be exempt from taxation when distributed as well. Investors considering participation
in any retirement or education savings plan should review specific tax laws relating
to the plan and should consult their attorneys or tax advisers with respect to
the establishment and maintenance of any such plan.
Automatic Investment
Plans
You may make additions to
an Investment Account through a service known as the Automatic Investment Plan.
Under the Automatic Investment Plan, a Fund is authorized, on a regular basis,
to provide systematic additions to your Investment Account through charges of
$50 or more to your regular bank account by either pre-authorized checks or automated
clearing house debits. If you buy shares of a Fund through Blueprint, no minimum
charge to your bank account is required.
Alternatively, if you maintain a cash management account you may arrange to have
periodic investments made in a Fund. Contact your financial intermediary for more
information.
Automatic Dividend
Reinvestment Plan
Unless you provide specific
instructions as to the method of payment, dividends will be automatically reinvested,
without sales charge, in additional full and fractional shares of the same Fund.
You may, at any time, elect to have dividends paid in cash, rather than reinvested
in shares of a Fund (provided that, if a payment on an account maintained at the
Transfer Agent would amount to $10.00 or less, the payment will automatically
be reinvested in additional shares). If your account is maintained with the Transfer
Agent, you may contact the Transfer Agent in writing or by telephone (1-800-637-3863).
For other accounts, you should contact your financial adviser, selected securities
dealer or other financial intermediary. Your instructions will be effected ten
days after the receipt by the Transfer Agent of such notice. A Fund is not responsible
for any failure of delivery to the shareholder’s address of record and no
interest will accrue on amounts represented by uncashed dividend checks. Cash
payments can also be deposited directly in the shareholder’s bank account.
Systematic
Withdrawal Plans
You may elect to receive
systematic withdrawals from your Investment Account by check or through automatic
payment by direct deposit to your bank account on either a monthly or quarterly
basis as provided below. Quarterly withdrawals are available if you have acquired
shares of a Fund that have a value, based on cost or the current offering price,
of $5,000 or more, and monthly withdrawals are available if your shares have a
value of $10,000 or more.
At the time of each withdrawal
payment, sufficient shares are redeemed from your account to provide the withdrawal
payment specified by you. You may specify the dollar amount and class of shares
to be redeemed. Redemptions will be made at net asset value as determined as of
the close of business on the NYSE on the 24th day of each month or the 24th day
of the last month of each quarter, whichever is applicable. If the NYSE is not
open for business on such date, the shares will be redeemed at the net asset value
determined as of the close of business on the NYSE on the following business day.
The check for the withdrawal payment will be mailed or the direct deposit will
be made, on the next business day following redemption. When you make systematic
withdrawals, dividends and distributions on all shares in the Investment Account
are reinvested automatically in Fund shares. Your systematic withdrawal plan may
be terminated at any time, without charge or penalty, by you, a Fund, the Transfer
Agent or the Distributor.
The maximum number of Class
B or Class C shares that can be redeemed from an Investment Account annually will
not exceed 10% of the value of shares of such class in that account at the time
the election to join the systematic withdrawal plan was made. Any CDSC that might
be due on such redemption of Class B or Class C shares will be waived. Shares
redeemed pursuant to a systematic withdrawal plan will be redeemed in the same
order as Class B or Class C shares are normally redeemed. See “Purchase of
Shares -- Deferred Sales Charge Alternatives -- Class B and Class C Shares.”
Where the systematic withdrawal plan is applied to Class B shares, upon conversion
of the last Class B shares in an account to Class A shares, you must make a new
election to join the systematic withdrawal program with respect to the Class A
shares. If you wish to change the amount being withdrawn in a systematic withdrawal
plan, you should contact your financial adviser or other financial intermediary.
Withdrawal
payments should not be considered as dividends. Withdrawals generally are treated
as sales of shares and may result in taxable gain or loss. If periodic withdrawals
continuously exceed reinvested dividends, the original investment will be reduced
correspondingly. Purchases of additional shares concurrent with withdrawals are
ordinarily disadvantageous to the shareholder because of sales charges and tax
liabilities. A Fund will not knowingly accept purchase orders for shares of a
Fund from investors who maintain a systematic withdrawal plan with respect
to
that Fund unless such purchase is equal to at least one year’s scheduled
withdrawals or $1,200, whichever is greater. Periodic investments may not be made
into an Investment Account in which a shareholder has elected to make systematic
withdrawals.
Alternatively, if your shares
are held within a cash management account or retirement account you may elect
to have shares redeemed on a periodic basis as determined by the program. The
proceeds of systematic redemptions will be
posted to your account three
business days after the date the shares are redeemed. All redemptions are made
at net asset value. A systematic redemption program may not be available if Fund
shares are being purchased within the account pursuant to the automatic investment
program. For more information shareholders should contact their financial adviser
or other financial intermediary.
P
RICING
OF
S
HARES
Determination
of Net Asset Value
The net asset value of each
class of shares of each Fund is determined once daily Monday through Friday as
of the close of business on the NYSE on each day the NYSE is open for trading
based on prices at the time of closing. The NYSE generally closes at 4:00 p.m.
Eastern time. Any assets or liabilities initially expressed in terms of foreign
currencies are translated into U.S. dollars at the prevailing market rates as
quoted by one or more banks or dealers on the day of valuation. The NYSE is not
open for trading on New Year’s Day, Martin Luther King, Jr. Day, Presidents’
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day.
Net asset value per share
is computed by dividing the value of the securities held by a Fund plus any cash
or other assets (including interest and dividends accrued but not yet received)
minus all liabilities (including accrued expenses) by the total number of shares
outstanding at such time (on a class by class basis), rounded to the nearest cent.
Expenses, including the fees payable to the Manager and Distributor, are accrued
daily.
The principal asset of each
Feeder Fund will normally be its interest in an underlying Master Portfolio. The
value of that interest is based on the net assets of the Master Portfolio, which
are comprised of the value of the securities held by the Master Portfolio plus
any cash or other assets (including interest and dividends accrued but not yet
received) minus all liabilities (including accrued expenses of the Master Portfolio).
Expenses of a Master Portfolio, including the investment advisory fees, are accrued
daily. The net asset value of a Feeder Fund is equal to the value of the Feeder
Fund’s proportionate interest in the net assets of the Master Portfolio plus
any cash or other assets, minus all liabilities (including accrued expenses) of
the Feeder Fund. To determine a Feeder Fund’s net asset value per share,
the Feeder Fund’s net asset value is divided by the total number of shares
outstanding of the Feeder Fund at such time (on a class by class basis), rounded
to the nearest cent. Expenses, including fees payable to the Administrator and
Distributor, are accrued daily.
The per share net asset value
of Class A, Class B, Class C and Class R shares generally will be lower than the
per share net asset value of Class I shares, reflecting the daily expense accruals
of the account maintenance, distribution and higher transfer agency fees applicable
with respect to Class B and Class C shares, the daily expense accruals of the
account maintenance fees applicable with respect to Class A shares and the daily
expense accruals of the account maintenance and distribution fees applicable to
Class R shares. Moreover, the per share net asset value of the Class B, Class
C and Class R shares generally will be lower than the per share net asset value
of Class A shares reflecting the daily expense accruals of the distribution fees
and higher transfer agency fees applicable with respect to Class B and Class C
shares and the daily expense accruals of the distribution fees applicable to Class
R shares of a Fund. In addition, the per share net asset value of Class B and
Class C shares generally will be lower than the per share net asset value of Class
R shares due to the daily expense accruals of the higher distribution fees and
higher transfer agency fees applicable to Class B and Class C shares. It is expected,
however, that the per share net asset value of all classes of a Fund will tend
to converge (although not necessarily meet) immediately after the payment of dividends,
which will differ by approximately the amount of the expense accrual differentials
between the classes.
Securities that are held
by a Fund that are traded on stock exchanges or NASDAQ National Market are valued
at the last sale price or official close price on the exchange, as of the close
of business on the day the securities are being valued or, lacking any sales,
at the last available bid price for long positions, and at the last available
ask price for
short positions. In cases where equity securities are traded on
more than one exchange, the securities are valued on the exchange designated as
the primary market by or under the authority of the Board of Directors of the
Fund. Long positions traded in the OTC market, NASDAQ Small Cap or Bulletin Board
are valued at the last available bid price or yield equivalent obtained from one
or more dealers or pricing services approved by the Board of Directors of the
Fund. Short positions traded in the OTC market are valued at the last available
ask price. Portfolio securities that are
traded both in the OTC market
and on a stock exchange are valued according to the broadest and most representative
market.
Options written are valued
at the last sale price in the case of exchange-traded options or, in the case
of options traded in the OTC market, the last ask price. Options purchased are
valued at their last sale price in the case of exchange-traded options or, in
the case of options traded in the OTC market, the last bid price. Swap agreements
are valued daily based upon quotations from market makers or by a pricing service
approved by each Fund’s Board of Directors. Financial futures contracts and
options thereon, which are traded on exchanges, are valued at their last sale
price as of the close of such exchanges. Obligations with remaining maturities
of 60 days or less are valued at amortized cost unless the Manager believes that
this method no longer produces fair valuations. Repurchase agreements are valued
at cost plus accrued interest.
Each Fund employs pricing
services to provide certain securities prices for the Fund. Securities and assets
for which market quotations are not readily available are valued at fair value
as determined in good faith by or under the direction of the Board of Directors
of a Fund, including valuations furnished by the pricing services retained by
the Fund, which may use a matrix system for valuations. The procedures of a pricing
service and its valuations are reviewed by the officers of a Fund under the general
supervision of the Fund’s Board of Directors. Such valuations and procedures
will be reviewed periodically by the Board of Directors of the Fund.
Generally, trading in foreign
securities, as well as U.S. Government securities and money market instruments
and certain fixed income securities, is substantially completed each day at various
times prior to the close of business on the NYSE. The values of such securities
used in computing the net asset value of a Fund’s shares are determined as
of such times. Foreign currency exchange rates also are generally determined prior
to the close of business on the NYSE. Occasionally, events affecting the values
of such securities and such exchange rates may occur between the times at which
they are determined and the close of business on the NYSE that may not be reflected
in the computation of a Fund’s net asset value. If events (for example, a
company announcement, market volatility or a natural disaster) occur during such
periods that are expected to materially affect the value of such securities, those
securities will be valued at their fair value as determined in good faith by a
Fund’s Board of Directors or by the Manager using a pricing service and/or
procedures approved by a Fund’s Board of Directors.
For funds organized in a
master-feeder structure, each investor in a Master Portfolio may add to or reduce
its investment in the Master Portfolio on each day the NYSE is open for trading.
The value of each investor’s (including a Feeder Fund’s) interest in
a Master Portfolio will be determined after the close of business on the NYSE
by multiplying the net asset value of the Master Portfolio by the percentage,
effective for that day, that represents that investor’s share of the aggregate
interests in the Master Portfolio. Any additions or withdrawals to be effected
on that day will then be effected. The investor’s percentage of the aggregate
beneficial interests in a Master Portfolio will then be recomputed as the percentage
equal to the fraction (i) the numerator of which is the value of such investor’s
investment in the Master Portfolio as of the time of determination on such day
plus or minus, as the case may be, the amount of any additions to or withdrawals
from the investor’s investment in the Master Portfolio effected on such day,
and (ii) the denominator of which is the aggregate net asset value of the Master
Portfolio as of such time on such day plus or minus, as the case may be, the amount
of the net additions to or withdrawals from the aggregate investments in the Master
Portfolio by all investors in the Master Portfolio. The percentage so determined
will then be applied to determine the value of the investor’s interest in
a Master Portfolio after the close of business of the NYSE or the next determination
of net asset value of the Master Portfolio.
Computation
of Offering Price Per Share
See Part I, Section VI “Computation
of Offering Price” of each Fund’s Statement of Additional Information
for an illustration of the computation of the offering price for Class A, Class
B, Class C, Class I, and, if applicable, Class R shares of your Fund.
P
ORTFOLIO
T
RANSACTIONS
AND
B
ROKERAGE
Transactions
in Portfolio Securities
Subject to policies established
by the Board of each Fund, the Manager is primarily responsible for the execution
of a Fund’s portfolio transactions and the allocation of brokerage. The Manager
does not execute transactions through any particular broker or dealer, but seeks
to obtain the best net results for the Fund, taking into account such factors
as price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution, operational facilities of the firm and the
firm’s risk and skill in positioning blocks of securities. While the Manager
generally seeks reasonable trade execution costs, a Fund does not necessarily
pay the lowest spread or commission available. Subject to applicable legal requirements,
the Manager may select a broker based partly upon brokerage or research services
provided to the Manager and its clients, including a Fund. In return for such
services the Manager may cause a Fund to pay a higher commission than other brokers
would charge if the Manager determines in good faith that the commission is reasonable
in relation to the services provided.
In the case of Feeder Funds,
because each Feeder Fund generally invests exclusively in beneficial interests
of a Master Portfolio, it is expected that all transactions in portfolio securities
will be entered into by the Master Portfolio.
Section 28(e) of the Exchange
Act (“Section 28(e)”) permits an investment adviser, under certain circumstances,
to cause an account to pay a broker or dealer a commission for effecting a transaction
that exceeds the amount another broker or dealer would have charged for effecting
the same transaction in recognition of the value of brokerage and research services
provided by that broker or dealer. This includes commissions paid on riskless
principal transactions under certain conditions. Brokerage and research services
include (1) furnishing advice as to the value of securities, the advisability
of investing in, purchasing or selling securities, and the availability of securities
or purchasers or sellers of securities; (2) furnishing analyses and reports concerning
issuers, industries, securities, economic factors and trends, portfolio strategy,
and the performance of accounts; and (3) effecting securities transactions and
performing functions incidental to securities transactions (such as clearance,
settlement, and custody). The Manager believes that access to independent investment
research is beneficial to its investment decision-making processes and, therefore,
to a Fund.
To the extent research services
may be a factor in selecting brokers, such services may be in written form or
through direct contact with individuals and may include information as to particular
companies and securities as well as market, economic, or institutional areas and
information that assists in the valuation of investments. Examples of research-oriented
services for which the Manager might pay with Fund commissions include research
reports and other information on the economy, industries, groups of securities,
individual companies, statistical information, political developments, technical
market action, pricing and appraisal services, credit analysis, risk measurement
analysis, performance and other analysis. Except as noted immediately below, research
services furnished by brokers may be used in servicing some or all client accounts
and not all services may be used in connection with the account that paid commissions
to the broker providing such services. In some cases, research information received
from brokers by mutual fund management personnel, or personnel principally responsible
for the Manager’s individually managed portfolios, is not necessarily shared
by and between such personnel. Any investment advisory or other fees paid by a
Fund to the Manager are not reduced as a result of the Manager’s receipt
of research services. In some cases the Manager may receive a service from a broker
that has both a “research” and a “non-research” use. When
this occurs the Manager makes a good faith allocation, under all the circumstances,
between the research and non-research uses of the service. The percentage of the
service that is used for research purposes may be paid for with client commissions,
while the Manager will use its own funds to pay for the percentage of the service
that is used for non-research purposes. In making this good faith allocation,
the Manager faces a potential conflict of interest, but the Manager believes that
its allocation procedures are reasonably designed to ensure that it appropriately
allocates the anticipated use of such services to their research and non-research
uses.
From time to time, a Fund
may purchase new issues of securities in a fixed price offering. In these situations,
the broker may be a member of the selling group that will, in addition to selling
securities, provide the Manager with research services. The NASD has adopted rules
expressly permitting these types of arrangements under certain circumstances.
Generally, the broker will provide research “credits” in these situations
at a rate that is higher than
that available for typical
secondary market transactions. These arrangements may not fall within the safe
harbor of Section 28(e).
The Manager does not consider
sales of shares of the mutual funds it advises as a factor in the selection of
brokers or dealers to execute portfolio transactions for a Fund; however, whether
or not a particular broker or dealer sells shares of the mutual funds advised
by the Manager neither qualifies nor disqualifies such broker or dealer to execute
transactions for those mutual funds.
Each Fund anticipates that
its brokerage transactions involving foreign securities generally will be conducted
primarily on the principal stock exchanges of the applicable country. Foreign
equity securities may be held by a Fund in the form of Depositary Receipts, or
other securities convertible into foreign equity securities. Depositary Receipts
may be listed on stock exchanges, or traded in over-the-counter markets in the
United States or Europe, as the case may be. American Depositary Receipts, like
other securities traded in the United States, will be subject to negotiated commission
rates. Because the shares of each Fund are redeemable on a daily basis in U.S.
dollars, each Fund intends to manage its portfolio so as to give reasonable assurance
that it will be able to obtain U.S. dollars to the extent necessary to meet anticipated
redemptions. Under present conditions, it is not believed that these considerations
will have significant effect on a Fund’s portfolio strategies.
See Part I, Section VII “Portfolio
Transactions and Brokerage” of each Fund’s Statement of Additional Information
for information about the brokerage commissions paid by your Fund, including commissions
paid to Merrill Lynch, if any, for the periods indicated.
Each Fund may invest in certain
securities traded in the OTC market and intends to deal directly with the dealers
who make a market in the particular securities, except in those circumstances
in which better prices and execution are available elsewhere. Under the Investment
Company Act, persons affiliated with a Fund and persons who are affiliated with
such affiliated persons are prohibited from dealing with the Fund as principal
in the purchase and sale of securities unless a permissive order allowing such
transactions is obtained from the Commission. Since transactions in the OTC market
usually involve transactions with the dealers acting as principal for their own
accounts, the Funds will not deal with affiliated persons, including Merrill Lynch
and its affiliates, in connection with such transactions. However, an affiliated
person of a Fund may serve as its broker in OTC transactions conducted on an agency
basis provided that, among other things, the fee or commission received by such
affiliated broker is reasonable and fair compared to the fee or commission received
by non-affiliated brokers in connection with comparable transactions. In addition,
a Fund may not purchase securities during the existence of any underwriting syndicate
for such securities of which Merrill Lynch is a member or in a private placement
in which Merrill Lynch serves as placement agent except pursuant to procedures
approved by the Board of the Fund that either comply with rules adopted by the
Commission or with interpretations of the Commission staff.
The Municipal Funds have
received an exemptive order under which they may purchase investment grade Municipal
Bonds through group orders from an underwriting syndicate of which Merrill Lynch
is a member subject to conditions set forth in such order (the “Group Order
Exemptive Order”). A group order is an order for securities held in an underwriting
syndicate for the account of all members of the syndicate, and in proportion to
their respective participation in the syndicate. Under another exemptive order,
the Municipal Funds may effect principal transactions with Merrill Lynch in high
quality, short-term, tax-exempt securities subject to conditions set forth in
such order. Please see Part I, Section VII “Portfolio Transactions and Brokerage”
of each Fund’s Statement of Additional Information for information regarding
transactions executed by your Fund pursuant to these exemptive orders.
The Funds may not purchase
securities, including Municipal Bonds, during the existence of any underwriting
syndicate of which Merrill Lynch is a member or in a private placement in which
Merrill Lynch serves as placement agent except pursuant to procedures approved
by the Directors that either comply with rules adopted by the Commission or with
interpretations of the Commission staff or pursuant to the Group Order Exemptive
Order. Rule 10f-3 under the Investment Company Act and the Group Order Exemptive
Order set forth conditions under which a Fund may purchase Municipal Bonds from
an underwriting syndicate of which Merrill Lynch is a member. The rule and the
Group Order Exemptive Order set forth requirements relating to, among other things,
the terms of an issue of Municipal Bonds purchased by a Fund, the amount of Municipal
Bonds that may be purchased in any one issue and the assets of the Fund that may
be invested in a particular issue.
Each Fund has received an
exemptive order from the Commission permitting it to lend portfolio securities
to Merrill Lynch or its affiliates. Pursuant to that order, each Fund also has
retained an affiliated entity of the Manager as the securities lending agent (the
“lending agent”) for a fee, including a fee based on a share of the
returns on investment of cash collateral. Please see Part I, Section VII “Portfolio
Transactions and Brokerage” of each Fund’s Statement of Additional Information
for information on the securities lending fees paid the lending agent by your
Fund. In connection with securities lending activities, the lending agent may,
on behalf of a Fund, invest cash collateral received by the Fund for such loans,
among other things, in a private investment company managed by the lending agent
or in registered money market funds advised by the Manager or its affiliates,
or in a private investment company managed by the lending agent. If a Fund acquires
shares in either the private investment company or an affiliated money market
fund, shareholders would bear both their proportionate share of the Fund’s
expenses, and indirectly, the expense of such other entities. However, in accordance
with the exemptive order, the manager to the private investment company will not
charge any advisory fees with respect to shares purchased by a Fund. Such shares
also will not be subject to a sales load, redemption fee, distribution fee or
service fee, or in the case of the shares of an affiliated money market fund,
the payment of any such sales load, redemption fee, distribution fee or service
fee will be offset by the Manager’s waiver of a portion of its advisory fee.
Section
11(a) of the Exchange Act generally prohibits members of the U.S. national securities
exchanges from executing exchange transactions for their affiliates and institutional
accounts that they manage unless the member (i) has obtained prior express authorization
from the account to effect such transactions, (ii) at least annually furnishes
the account with a statement setting forth the aggregate compensation received
by the member in effecting such transactions, and (iii) complies with any rules
the Commission has prescribed with respect to the requirements of clauses (i)
and (ii). To the extent Section 11(a) would apply to Merrill Lynch acting as a
broker for a Fund in any of its portfolio transactions executed on any securities
exchange of which it is a member, appropriate consents have been obtained from
each Fund and annual statements as to aggregate compensation will be provided
to each Fund.
The Directors of each Fund
have considered the possibility of seeking to recapture for the benefit of the
Fund brokerage commissions and other expenses of possible portfolio transactions
by conducting portfolio transactions through affiliated entities. For example,
brokerage commissions received by affiliated brokers could be offset against the
advisory fee paid by each Fund to a Manager. After considering all factors deemed
relevant, the Directors of each Fund made a determination not to seek such recapture.
The Directors of each Fund will reconsider this matter from time to time.
Because of different objectives
or other factors, a particular security may be bought for one or more funds or
clients advised by the Manager or its affiliates (collectively, “clients”)
when one or more clients of the Manager or its affiliates are selling the same
security. If purchases or sales of securities arise for consideration at or about
the same time that would involve a Fund or other clients or funds for which the
Manager or an affiliate act as investment manager, transactions in such securities
will be made, insofar as feasible, for the respective funds and clients in a manner
deemed equitable to all. To the extent that transactions on behalf of more than
one client of the Manager or its affiliates during the same period may increase
the demand for securities being purchased or the supply of securities being sold,
there may be an adverse effect on price.
Portfolio Turnover
While a Fund generally does
not expect to engage in trading for short term gains, it will effect portfolio
transactions without regard to holding period if, in Fund management’s judgment,
such transactions are advisable in light of a change in circumstances of a particular
company or within a particular industry or in general market, economic or financial
conditions. The portfolio turnover rate is calculated by dividing the lesser of
a Fund’s annual sales or purchases of portfolio securities (exclusive of
purchases or sales of U.S. government securities and all other securities whose
maturities at the time of acquisition were one year or less) by the monthly average
value of the securities in the portfolio during the year. A high rate of portfolio
turnover results in certain tax consequences, such as increased capital gain dividends
and/or ordinary income dividends, and in correspondingly greater transaction costs
in the form of dealer spreads and brokerage commissions, which are borne directly
by a Fund.
D
IVIDENDS
AND
T
AXES
Dividends
Each Fund intends to distribute
substantially all of its net investment income, if any. Dividends from such net
investment income are paid as set forth in each Fund’s prospectus. Each Fund
will also distribute all net realized capital gains, if any, as set forth in such
Fund’s prospectus. From time to time, a Fund may declare a special distribution
at or about the end of the calendar year in order to comply with Federal tax requirements
that certain percentages of its ordinary income and capital gains be distributed
during the year. If in any fiscal year, a Fund has net income from certain foreign
currency transactions, such income will be distributed at least annually.
For information concerning
the manner in which dividends may be reinvested automatically in shares of each
Fund, see “Shareholder Services -- Automatic Dividend Reinvestment Plan.”
Shareholders may also elect in writing to receive any such dividends in cash.
Dividends are taxable to shareholders, as discussed below, whether they are reinvested
in shares of the Fund or received in cash. The per share dividends on Class A,
Class B, Class C and Class R shares will be lower than the per share dividends
on Class I shares as a result of the account maintenance, distribution and higher
transfer agency fees applicable to Class B and Class C shares, the account maintenance
fees applicable to Class A shares, and the account maintenance and distribution
fees applicable to Class R shares. Similarly, the per share dividends on Class
B, Class C and Class R shares will be lower than the per share dividends on Class
A shares as a result of the distribution fees and higher transfer agency fees
applicable to Class B and Class C shares and the distribution fees applicable
to Class R shares, and the per share dividends on Class B and Class C shares will
be lower than the per share dividends on Class R shares as a result of the distribution
fees and higher transfer agency fees applicable to Class B and Class C shares.
Taxes
Each Fund intends to continue
to qualify for the special tax treatment afforded to regulated investment companies
(“RICS”) under the Code. As long as a Fund so qualifies, the Fund (but
not its shareholders) will not be subject to Federal income tax on the part of
its net ordinary income and net realized capital gains that it distributes to
its shareholders.
Each Fund intends to distribute
substantially all of such income and gains. If, in any taxable year, a Fund fails
to qualify as a RIC under the Code, such Fund would be taxed in the same manner
as an ordinary corporation and all distributions from earnings and profits (as
determined under U.S. Federal income tax principals) to its shareholders would
be taxable as ordinary dividend income eligible for the maximum 15% tax rate for
non-corporate shareholders and the dividends-received deduction for corporate
shareholders. However, a Municipal Fund’s distributions derived from income
on tax-exempt obligations, as defined herein, would no longer qualify for treatment
as exempt interest.
The Code requires a RIC to
pay a nondeductible 4% excise tax to the extent the RIC does not distribute, during
each calendar year, 98% of its ordinary income, determined on a calendar year
basis, and 98% of its capital gains, determined, in general as if the RIC’s
taxable year ended on October 31, plus certain undistributed amounts from the
previous years. While each Fund intends to distribute its income and capital gains
in the manner necessary to avoid imposition of the 4% excise tax, there can be
no assurance that sufficient amount of the Fund’s taxable income and capital
gains will be distributed to avoid entirely the imposition of the tax. In such
event, a Fund will be liable for the tax only on the amount by which it does not
meet the foregoing distribution requirements.
Dividends paid by a Fund
from its ordinary income or from an excess of net short-term capital gains over
net long term capital losses (together referred to as “ordinary income dividends”)
are taxable to shareholders as ordinary income. Distributions made from an excess
of net long term capital gains over net short term capital losses (including gains
or losses from certain transactions in futures and options) (“capital gain
dividends”) are taxable to shareholders as long term capital gains, regardless
of the length of time the shareholder has owned Fund shares. Certain dividend
income and long-term capital gain are eligible for taxation at a reduced rate
that applies to non-corporate shareholders for taxable years ending in or prior
to 2008. Under these new rules, a certain portion of ordinary income dividends
constituting “qualified dividend income” when paid by a RIC to non-corporate
shareholders may be taxable to such shareholders at long term capital gain rates.
However, to the extent a Fund’s
distributions are derived
from income on debt securities, certain types of preferred stock treated as debt
for federal income tax purposes and short-term capital gain, such distributions
will not constitute “qualified dividend income.” Thus, ordinary income
dividends paid by the Funds generally will not be eligible for taxation at the
reduced rate.
Ordinary income and capital
gain dividends are taxable to shareholders even if they are reinvested in additional
shares of a Fund. If a Fund pays a dividend in January that was declared in the
previous October, November or December to shareholders of record on a specified
date in one of such months, then such dividend will be treated for tax purposes
as being paid by the Fund and received by its shareholders on December 31 of the
year in which the dividend was declared.
For the Select Pricing Funds
no gain or loss will be recognized by Class B shareholders on the conversion of
their Class B shares into Class A shares. A shareholder’s tax basis in the
Class A shares acquired upon conversion will be the same as the shareholder’s
tax basis in the converted Class B shares, and the holding period of the acquired
Class A shares will include the holding period for the converted Class B shares.
If
a shareholder of a Select Pricing Fund exercises an exchange privilege within
90 days of acquiring the shares of a Fund, then the loss that the shareholder
recognizes on the exchange will be reduced (or the gain increased) to the extent
any sales charge paid on the exchanged shares reduces any sales charge the shareholder
would have owed upon the purchase of the new shares in the absence of the exchange
privilege. Instead, such sales charge will be treated as an amount paid for the
new shares.
A loss realized on a sale
or exchange of shares of a Fund will be disallowed if such shares are acquired
(whether through the automatic reinvestment of dividends or otherwise) within
a 61-day period beginning 30 days before and ending 30 days after the date on
which the shares are sold or exchanged. In such case, the basis of the shares
acquired will be adjusted to reflect the disallowed loss.
Certain Funds may invest
in zero coupon U.S. Treasury bonds and other debt securities that are issued at
a discount or provide for deferred interest. Even though a Fund receives no actual
interest payments on these securities, it will be deemed to receive income equal,
generally, to a portion of the excess of the face value of the securities over
their issue price (“original issue discount”) each year that the securities
are held. Since the original issue discount income earned by a Fund in a taxable
year may not be represented by cash income, it may have to dispose of securities,
which it might otherwise have continued to hold, or borrow to generate cash in
order to satisfy its distribution requirements. In addition, a Fund’s investment
in foreign currencies or foreign currency denominated or referenced debt securities,
certain asset-backed securities and contingent payment and inflation-indexed debt
instruments also may increase or accelerate the Fund’s recognition of income,
including the recognition of taxable income in excess of cash generated by such
investments.
Ordinary income dividends
paid to stockholders who are nonresident aliens or foreign entities generally
will be subject to a 30% U.S. withholding tax under existing provisions of the
Code applicable to foreign individuals and entities unless a reduced rate of
withholding or a withholding exemption is provided under applicable treaty law.
Under the provisions of the American Jobs Creation Act of 2004 (the “2004
Tax Act”), dividends derived by a RIC from short-term capital gains and
qualifying net interest income (including income from original issue discount
and market discount) and paid to stockholders who are nonresident aliens and
foreign entities if and to the extent properly designated as “interest-related
dividends” or “short-term capital gain dividends,” generally
will not be subject to U.S. withholding tax. Where possible, the Fund intends
to make such designations. Under recent guidance issued by the IRS, a RIC will
generally be allowed to designate the maximum amount of its qualified dividend
income, interest related dividends and short term capital gain dividends even
where the aggregate of the amounts designated exceed the amounts of the RIC
distributions. However, in any given tax year, there may be circumstances which
would cause the Fund not to designate the maximum amount of interest-related
income or short term capital gain income eligible for exemption. It is not possible
to predict what portion, if any, of the Fund’s distributions will be designated
as short-term capital gains or interest income exempt from withholding in the
hands of nonresident and foreign stockholders.
The 2004 Tax Act also provides
that distributions of the Fund attributable to gains from sales or exchanges
of “U.S. real property interests,” as defined in the Code and Treasury
regulations (including gains on the sale or exchange of shares in certain “U.S.
real property holding corporations,” which may include certain REITs and
certain REIT
capital gain dividends among
other entities) generally will cause a foreign stockholder to treat such gain
as income effectively connected to a trade or business within the United States,
generally subject to tax at the graduated rates applicable to U.S. stockholders.
Such distributions may be subject to U.S. withholding tax and may require the
foreign stockholder to file a U.S. federal income tax return.
These provisions generally would apply to distributions with respect
to taxable years of the Fund beginning after December 31, 2004 and before January
1, 2008. Nonresident stockholders are urged to consult their own tax advisers
concerning the applicability of the U.S. withholding tax.
Under certain provisions
of the Code, some shareholders may be subject to a withholding tax on ordinary
income dividends, capital gain dividends and redemption payments (“backup
withholding”). Generally, shareholders subject to backup withholding will
be those for whom no certified taxpayer identification number is on file with
the Fund or who, to the Fund’s knowledge, have furnished an incorrect number.
When establishing an account, an investor must certify under penalty of perjury
that such number is correct and that such investor is not otherwise subject
to backup withholding. Backup withholding is not an additional tax. Any amount
withheld generally may be allowed as a refund or a credit against a shareholder’s
Federal income tax liability, provided that the required information is timely
forwarded to the IRS.
Dividends and interest received
by a Fund may give rise to withholding and other taxes imposed by foreign countries.
Tax conventions between certain foreign countries and the U.S. may reduce or
eliminate such taxes. Shareholders of certain Funds that invest more than 50%
of the value of their assets at the close of a taxable year in foreign securities
may be able to claim U.S. foreign tax credits with respect to such foreign taxes
paid by the Fund,
subject
to certain requirements and limitations contained in the Code. For example,
certain retirement accounts and certain tax-exempt organizations cannot claim
foreign tax credits on investments in foreign securities held in a Fund. In
addition, a foreign tax credit may be claimed with respect to withholding tax
on a dividend only if the shareholder meets certain holding period requirements.
A Fund also must meet these holding period requirements, and if a Fund fails
to do so, it will not be able to “pass through” to shareholders the
ability to claim a credit or a deduction for the related foreign taxes paid
by the Fund. Further, to the extent that a Fund engages in securities lending
with respect to security paying income subject to foreign taxes, it may not
be able to pass through to its shareholders the ability to take a foreign tax
credit. If a Fund satisfies the applicable requirements, such Fund will be eligible
to file an election with the Internal Revenue Service pursuant to which shareholders
of the Fund will be required to include their proportionate shares of such foreign
taxes in their U.S. income tax returns as gross income, treat such proportionate
shares as taxes paid by them, and deduct such proportionate shares in computing
their taxable incomes or, alternatively, use them as foreign tax credits against
their U.S. income taxes. No deductions for foreign taxes, however, may be claimed
by noncorporate shareholders who do not itemize deductions. A shareholder that
is a nonresident alien individual or a foreign corporation may be subject to
U.S. withholding tax on the income resulting from a Fund’s election described
in this paragraph but may not be able to claim a credit or deduction against
such U.S. tax for the foreign taxes treated as having been paid by such shareholder.
A Fund will report annually to its shareholders the amount per share of such
foreign taxes and other information needed to claim the foreign tax credit.
For this purpose, a Fund will allocate foreign source income among each class
of shareholders according to a method similar to that described above for the
allocation of dividends eligible for the dividends-received deduction and dividends
taxable at the maximum 15% tax rate.
Certain transactions entered
into by the Funds are subject to special tax rules of the Code that may, among
other things, (a) affect the character of gains and losses realized, (b) disallow,
suspend or otherwise limit the allowance of certain losses or deductions, and
(c) accelerate the recognition of income without a corresponding receipt of cash
(with which to make the necessary distributions to satisfy distribution requirements
applicable to RICs). Operation of these rules could, therefore, affect the character,
amount and timing of distributions to shareholders. Special tax rules also may
require a Fund to mark to market certain types of positions in its portfolio (
i.e.,
treat them as sold on the last day of the taxable year), and may result in
the recognition of income without a corresponding receipt of cash. Funds engaging
in transactions affected by these provisions intend to monitor their transactions,
make appropriate tax elections and make appropriate entries in their books and
records to lessen the effect of these tax rules and avoid any possible disqualification
for the special treatment afforded RICs under the Code.
Passive Foreign Investment
Companies
If a Fund purchases shares
of an investment company (or similar investment entity) organized under foreign
law, the Fund will generally be treated as owning shares in a passive foreign
investment company (“PFIC”) for U.S. Federal income tax purposes. A
Fund may be subject to U.S. Federal income tax, and an interest charge (at the
rate applicable to tax underpayments) on tax liability treated as having been
deferred with respect to certain distributions from such a company and on gain
from the disposition of the shares of such a company (collectively referred to
as “excess distributions”), even if such excess distributions are paid
by the Fund as a dividend to its shareholders. However, a Fund could elect to
“mark to market” at the end of each taxable year all shares that it
holds in PFICs. If it makes this election, a Fund would recognize as ordinary
income any increase in the value of such shares as of the close of the taxable
year over their adjusted tax basis and as ordinary loss any decrease in such value
but only to the extent of previously recognized “mark-to-market” gains.
By making the mark-to-market election, a Fund could avoid imposition of the interest
charge with respect to excess distributions from PFICs, but in any particular
year might be required to recognize income in excess of the distributions it received
from PFICs.
Municipal Funds
Each Municipal Fund intends
to qualify to pay “exempt-interest dividends” as defined in Section
852(b)(5) of the Code. Under such section if, at the close of each quarter of
a Fund’s taxable year, at least 50% of the value of the Fund’s total
assets consists of obligations exempt from Federal income tax (“tax-exempt
obligations”) under Section 103(a) of the Code (relating generally to obligations
of a state or local governmental unit), the Fund shall be qualified to pay exempt-interest
dividends to its Class A, Class B, Class C and Class I shareholders (together
the “shareholders”). Exempt-interest dividends are dividends or any
part thereof paid by a Fund that are attributable to interest on tax-exempt
obligations and designated by the Fund as exempt-interest dividends in a written
notice mailed to the Fund’s shareholders within 60 days after the close
of the Fund’s taxable year. A Fund will allocate
interest
from tax-exempt obligations (as well as ordinary income, capital gains and tax
preference items discussed below) among the Class A, Class B, Class C and Class
I shareholders according to a method (which it believes is consistent with the
Commission rule permitting the issuance and sale of multiple classes of shares)
that is based upon the gross income that is allocable to the Class A, Class
B, Class C and Class I shareholders during the taxable year, or such other method
as the Internal Revenue Service may prescribe.
Exempt-interest dividends
will be excludable from a shareholder’s gross income for Federal income tax
purposes. Exempt-interest dividends are included, however, in determining the
portion, if any, of a person’s social security and railroad retirement benefits
subject to Federal income taxes. Interest on indebtedness incurred or continued
to purchase or carry shares of a RIC paying exempt-interest dividends, such as
the Fund, will not be deductible by the investor for Federal income tax purposes
to the extent attributable to exempt-interest dividends. Shareholders are advised
to consult their tax advisers with respect to whether exempt-interest dividends
retain the exclusion under Code Section 103(a) if a shareholder would be treated
as a “substantial user” or “related person” under Code Section
147(a) with respect to property financed with the proceeds of an issue of PABs,
if any, held by a Fund.
All or a portion of a Fund’s
gains from the sale or redemption of tax-exempt obligations purchased at a market
discount will be treated as ordinary income rather than capital gain. This rule
may increase the amount of ordinary income dividends received by shareholders.
Distributions in excess of a Fund’s earnings and profits will first reduce
the adjusted tax basis of a holder’s shares and, after such adjusted tax
basis is reduced to zero, will constitute capital gains to such holder (assuming
the shares are held as a capital asset). Any loss upon the sale or exchange of
Fund shares held for six months or less will be disallowed to the extent of any
exempt-interest dividends received by the shareholder. In addition, any such loss
that is not disallowed under the rule stated above will be treated as long-term
capital loss to the extent of any capital gain dividends received by the shareholder.
The Code subjects interest
received on certain otherwise tax-exempt securities to a Federal alternative
minimum tax. The alternative minimum tax applies to interest received on certain
“PABs” issued after August 7, 1986. PABs are bonds that, although
tax-exempt, are used for purposes other than those generally performed by governmental
units and that benefit non-governmental entities (
e.g.,
bonds used for
industrial development or housing purposes). Income received on such bonds is
classified as an item of “tax preference,” which could subject certain
investors in such bonds, including shareholders of a Fund, to a Federal alternative
minimum tax. A Fund will purchase such “PABs” and will report to shareholders
after the close of the calendar year-end the portion of the Fund’s dividends
declared during the year
that constitute an item of tax preference for alternative minimum tax purposes.
The Code further provides that corporations are subject to a Federal alternative
minimum tax based, in part, on certain differences between taxable income as
adjusted for other tax preferences and the corporation’s “adjusted
current earnings,” which more closely reflect a corporation’s economic
income. Because an exempt-interest dividend paid by a Fund will be included
in adjusted current earnings, a corporate shareholder may be required to pay
alternative minimum tax on exempt-interest dividends paid by the Fund.
Each Municipal Fund may engage
in interest rate swap transactions. The Federal income tax rules governing the
taxation of interest rate swaps are not entirely clear and may require a Fund
to treat payments received under such arrangements as ordinary income and to amortize
payments made under certain circumstances. Because payments received by a Fund
in connection with swap transactions will be taxable rather than tax-exempt, they
may result in increased taxable distributions to shareholders.
Please see Part I of your
Fund’s Statement of Additional Information for certain state tax information
relevant to an investment in California Insured, Florida Municipal Bond, New Jersey
Municipal Bond, New York Municipal Bond and Pennsylvania Municipal Bond, as well
as information on economic conditions within each applicable state.
The foregoing is a general
and abbreviated summary of the applicable provisions of the Code and Treasury
regulations presently in effect. For the complete provisions, reference should
be made to the pertinent Code sections and the Treasury regulations promulgated
thereunder. The Code and the Treasury regulations are subject to change by legislative,
judicial or administrative action either prospectively or retroactively.
Ordinary income and capital
gain dividends may also be subject to state and local taxes. Certain states
exempt from state income taxation dividends paid by RICs that are derived from
interest on U.S. Government obligations. State
law
varies as to whether dividend income attributable to U.S. Government obligations
is exempt from state income tax.
Shareholders of each Fund
are urged to consult their tax advisers regarding specific questions as to Federal,
foreign, state or local taxes with respect to their Fund. Foreign investors should
consider applicable foreign taxes in their evaluation of an investment in a Fund.
In
the case of a Feeder Fund, such Fund is entitled to look to the underlying assets
of the Master Portfolio in which it has invested for purposes of satisfying various
qualification requirements of the Code applicable to RICs. Each Master Portfolio
is classified as a partnership for U.S. Federal income tax purposes. If applicable
tax provisions were to change, then the Board of a Feeder Fund will determine,
in its discretion, the appropriate course of action for the Feeder Fund. One possible
course of action would be to withdraw the Feeder Fund’s investments from
the Master Portfolio and to retain an investment manager to manage the Feeder
Fund’s assets in accordance with the investment policies applicable to the
Feeder Fund.
P
ERFORMANCE
D
ATA
From time to time a Fund
may include its average annual total return and other total return data, and,
if applicable, yield and tax-equivalent yield in advertisements or information
furnished to present or prospective shareholders. Total return, yield and tax-equivalent
yield each is based on a Fund’s historical performance and is not intended
to indicate future performance. Average annual total return is determined separately
for Class A, Class B, Class C, Class I and Class R shares in accordance with a
formula specified by the Commission.
Quotations of average annual
total return, before tax, for the specified periods are computed by finding the
average annual compounded rates of return (based on net investment income and
any realized and unrealized capital gains or losses on portfolio investments over
such periods) that would equate the initial amount invested to the redeemable
value of such investment at the end of each period. Average annual total return
before taxes is computed assuming all dividends are reinvested and taking into
account all applicable recurring and nonrecurring expenses, including the maximum
sales charge, in the case of Class A shares and the CDSC that would be applicable
to a complete redemption of the investment at the end of the specified period
in the case of Class B and Class C shares but does not take into account taxes
payable on dividends or on redemption.
Quotations of average annual
total return, after taxes, on dividends for the specified periods are computed
by finding the average annual compounded rates of return that would equate the
initial amount invested to the ending value of such investment at the end of
each period assuming payment of taxes on dividends received during such period.
Average annual total return after taxes on dividends is computed assuming all
dividends, less the taxes due on such dividends, are reinvested and taking into
account all applicable recurring and nonrecurring expenses, including the maximum
sales charge, in the case of Class A shares and the CDSC that would be applicable
to a complete redemption of the investment at the end of the specified period
in the case of Class B and Class C shares. The taxes due on dividends are calculated
by applying to each dividend the highest applicable marginal Federal individual
income tax rates in effect on the reinvestment date for that dividend. The rates
used correspond to the tax character (including eligibility for the maximum
15% tax rate applicable to qualified dividend income) of each dividend. The
taxable amount and tax character of each dividend are specified by each Fund
on the dividend declaration date, but may be adjusted to reflect subsequent
recharacterizations of distributions. The applicable tax rates may vary over
the measurement period. The effects of state and local taxes are not reflected.
Applicable tax credits, such as foreign credits, are taken into account according
to Federal law. The ending value is determined assuming complete redemption
at the end of the applicable periods with no tax consequences associated with
such redemption.
Quotations of average annual
total return, after taxes, on both dividends and redemption for the specified
periods are computed by finding the average annual compounded rates of return
that would equate the initial amount invested to the ending value of such investment
at the end of each period assuming payment of taxes on dividends received during
such period as well as on complete redemption. Average annual total return after
taxes on distributions and redemption is computed assuming all dividends, less
the taxes due on such dividends, are reinvested and taking into account all
applicable recurring and nonrecurring expenses, including the maximum sales
charge in the case of Class A shares and the CDSC that would be applicable to
a complete redemption of the investment at the end of the specified period in
the case of Class B and Class C shares and assuming, for all classes of shares,
complete
redemption
and payment of taxes due on such redemption. The ending value is determined
assuming complete redemption at the end of the applicable periods, subtracting
capital gains taxes resulting from the redemption and adding the presumed tax
benefit from capital losses resulting from redemption. The taxes due on dividends
and on the deemed redemption are calculated by applying the highest applicable
marginal Federal individual income tax rates in effect on the reinvestment and/or
the redemption date. The rates used correspond to the tax character (including
eligibility for the maximum 15% tax rate applicable to qualified dividend income)
of each component of each dividend and/or the redemption payment. The applicable
tax rates may vary over the measurement period. The effects of state and local
taxes are not reflected.
A
Fund also may quote annual, average annual and annualized total return and aggregate
total return performance data, both as a percentage and as a dollar amount based
on a hypothetical investment of $1,000 or some other amount, for various periods
other than those noted below. Such data will be computed as described above, except
that (1) as required by the periods of the quotations, actual annual, annualized
or aggregate data, rather than average annual data, may be quoted and (2) the
maximum applicable sales charges will not be included with respect to annual or
annualized rates of return calculations. Aside from the impact on the performance
data calculations of including or excluding the maximum applicable sales charges,
actual annual or annualized total return data generally will be lower than average
annual total return data since the average rates of return reflect compounding
of return; aggregate total return data generally will be higher than average annual
total return data since the aggregate rates of return reflect compounding over
a longer period of time.
Yield quotations will be
computed based on a 30-day period by dividing (a) the net income based on the
yield of each security earned during the period by (b) the average daily number
of shares outstanding during the period that were entitled to receive dividends
multiplied by the maximum offering price per share on the last day of the period.
Tax equivalent yield quotations will be computed by dividing (a) the part of a
Fund’s yield that is tax-exempt by (b) one minus a stated tax rate and adding
the result to that part, if any, of the Fund’s yield that is not tax-exempt.
See
Part I, Section VIII “Fund Performance” of each Fund’s Statement
of Additional Information for performance information for the Class A, Class B,
Class C, Class I and, if applicable, Class R shares of your Fund for the periods
indicated.
A Fund’s total return
will vary depending on market conditions, the securities comprising a Fund’s
portfolio, a Fund’s operating expenses and the amount of realized and unrealized
net capital gains or losses during the period.
The value of an investment
in a Fund will fluctuate and an investor’s shares, when redeemed, may be
worth more or less than their original cost.
In order to reflect the reduced
sales charges in the case of Class A shares or the waiver of the CDSC in the case
of Class B or Class C shares applicable to certain investors, as described under
“Purchase of Shares” and “Redemption of Shares,” respectively,
the total return data quoted by a Fund in advertisements directed to such investors
may take into account the reduced, and not the maximum, sales charge or may take
into account the CDSC waiver and, therefore, may reflect greater total return
since, due to the reduced sales charges or the waiver of sales charges, a lower
amount of expenses is deducted.
On occasion, a Fund may
compare its performance to, among other things, the Fund’s benchmark index
indicated in the Prospectus, the Value Line Composite Index, the Dow Jones Industrial
Average, or to other published indices, or to performance data published by Lipper
Inc., Morningstar, Inc. (“MorningStar”),
Money Magazine, U.S. News
& World Report, BusinessWeek, Forbes Magazine, Fortune Magazine
or other
industry publications. When comparing its performance to a market index, a Fund
may refer to various statistical measures derived from the historical performance
of a Fund and the index, such as standard deviation and beta. As with other performance
data, performance comparisons should not be considered indicative of a Fund’s
relative performance for any future period. In addition, from time to time a Fund
may include the Fund’s Morningstar risk-adjusted performance ratings assigned
by Morningstar in advertising or supplemental sales literature. From time to time
a Fund may quote in advertisements or other materials other applicable measures
of Fund performance and may also make reference to awards that may be given to
the Manager. Certain Funds may also compare their performance to composite indices
developed by Fund Management.
A Fund may provide information
designed to help investors understand how the Fund is seeking to achieve its
investment objectives. This may include information about past, current or possible
economic, market, political or other conditions, descriptive information or
general principles of investing such as asset allocation, diversification and
risk tolerance, discussion of a Fund’s portfolio composition, investment
philosophy, strategy or investment techniques, comparisons of the Fund’s
performance or portfolio composition to that of other funds or types of investments,
indices relevant to the comparison being made, or to a hypothetical or model
portfolio. A Fund may also quote various measures of volatility and benchmark
correlation in advertising and other materials, and may compare these measures
to those of other funds or types of investments.
P
ROXY
V
OTING
P
OLICIES
AND
P
ROCEDURES
Each Fund’s Board of
Trustees has delegated to the Manager authority to vote all proxies relating to
the Fund’s portfolio securities. The Manager has adopted policies and procedures
(the “Proxy Voting Procedures”) with respect to the voting of proxies
related to the portfolio securities held in the account of one or more of its
clients, including a Fund. Pursuant to these Proxy Voting Procedures, the Manager’s
primary objective when voting proxies is to make proxy voting decisions solely
in the best interests of each Fund and its shareholders, and to act in a manner
that the Manager believes is most likely to enhance the economic value of the
securities held by the Fund. The Proxy Voting Procedures are designed to ensure
that the Manager considers the interests of its clients, including each Fund,
and not the interests of the Manager, when voting proxies and that real (or perceived)
material conflicts that may arise between the Manager’s interest and those
of the Manager’s clients are properly addressed and resolved.
In order to implement the
Proxy Voting Procedures, the Manager has formed a Proxy Voting Committee (the
“Committee”). The Committee is comprised of the Manager’s Chief
Investment Officer (the “CIO”), one or more other senior investment
professionals appointed by the CIO, portfolio managers and investment analysts
appointed by the CIO and any other personnel the CIO deems appropriate. The
Committee will also include two non-voting representatives from the Manager’s
legal department appointed by the Manager’s General Counsel. The Committee’s
membership shall be limited to full-time employees of the Manager. No person
with any investment banking, trading, retail brokerage or research responsibilities
for the Manager’s affiliates may serve as a member of the Committee or
participate in its decision making (except to the extent such person is asked
by the Committee to present information to the Committee on the same basis as
other interested knowledgeable parties not affiliated with the Manager might
be asked to do so). The Committee determines how to vote the proxies of all
clients, including a Fund, that have delegated proxy voting authority to the
Manager and seeks to ensure that all votes are consistent with the best interests
of those clients and are free from unwarranted and inappropriate influences.
The Committee
establishes general proxy
voting policies for the Manager and is responsible for determining how those
policies are applied to specific proxy votes, in light of each issuer’s
unique structure, management, strategic options and, in certain circumstances,
probable economic and other anticipated consequences of alternate actions. In
so doing, the Committee may determine to vote a particular proxy in a manner
contrary to its generally stated policies. In addition, the Committee will be
responsible for ensuring that all reporting and recordkeeping requirements related
to proxy voting are fulfilled.
The Committee may determine
that the subject matter of a recurring proxy issue is not suitable for general
voting policies and requires a case-by-case determination. In such cases, the
Committee may elect not to adopt a specific voting policy applicable to that issue.
The Manager believes that certain proxy voting issues require investment analysis
- such as approval of mergers and other significant corporate transactions - akin
to investment decisions, and are, therefore, not suitable for general guidelines.
The Committee may elect to adopt a common position for the Manager on certain
proxy votes that are akin to investment decisions, or determine to permit the
portfolio manager to make individual decisions on how best to maximize economic
value for a Fund (similar to normal buy/sell investment decisions made by such
portfolio managers). While it is expected that the Manager will generally seek
to vote proxies over which the Manager exercises voting authority in a uniform
manner for all the Manager’s clients, the Committee, in conjunction with
a Fund’s portfolio manager, may determine that the Fund’s specific circumstances
require that its proxies be voted differently.
To assist the Manager in
voting proxies, the Committee has retained Institutional Shareholder Services
(“ISS”). ISS is an independent adviser that specializes in providing
a variety of fiduciary-level proxy-related services to institutional investment
managers, plan sponsors, custodians, consultants, and other institutional investors.
The services provided to the Manager by ISS include in-depth research, voting
recommendations (although the Manager
is
not obligated to follow such recommendations), vote execution, and recordkeeping.
ISS will also assist the Fund in fulfilling its reporting and recordkeeping
obligations under the Investment Company Act.
The Manager’s Proxy
Voting Procedures also address special circumstances that can arise in connection
with proxy voting. For instance, under the Proxy Voting Procedures, the Manager
generally will not seek to vote proxies related to portfolio securities that are
on loan, although it may do so under certain circumstances. In addition, the Manager
will vote proxies related to securities of foreign issuers only on a best efforts
basis and may elect not to vote at all in certain countries where the Committee
determines that the costs associated with voting generally outweigh the benefits.
The Committee may at any time override these general policies if it determines
that such action is in the best interests of a Fund.
From time to time, the Manager
may be required to vote proxies in respect of an issuer where an affiliate of
the Manager (each, an “Affiliate”), or a money management or other client
of the Manager, including investment companies for which the Manager provides
investment advisory, administrative and/or other services (each, a “Client”)
is involved. The Proxy Voting Procedures and the Manager’s adherence to those
procedures are designed to address such conflicts of interest. The Committee intends
to strictly adhere to the Proxy Voting Procedures in all proxy matters, including
matters involving Affiliates and Clients. If, however, an issue representing a
non-routine matter that is material to an Affiliate or a widely known Client is
involved such that the Committee does not reasonably believe it is able to follow
its guidelines (or if the particular proxy matter is not addressed by the guidelines)
and vote impartially, the Committee may, in its discretion for the purposes of
ensuring that an independent determination is reached, retain an independent fiduciary
to advise the Committee on how to vote or to cast votes on behalf of the Manager’s
clients.
In the event that the Committee
determines not to retain an independent fiduciary, or it does not follow the
advice of such an independent fiduciary, the Committee may pass the voting power
to a subcommittee, appointed by the CIO (with advice from the Secretary of the
Committee), consisting solely of Committee members selected by the CIO. The
CIO shall appoint to the subcommittee, where appropriate, only persons whose
job responsibilities do not include contact with the Client and whose job evaluations
would not be affected by the Manager’s relationship with the Client (or
failure to retain such relationship). The subcommittee shall determine whether
and how to vote all proxies on behalf of the Manager’s clients or, if the
proxy matter is, in their judgment, akin to an investment decision, to defer
to the applicable portfolio managers, provided that, if the subcommittee determines
to alter the Manager’s normal voting guidelines or, on matters where the
Manager’s policy is case-by-case, does not follow the voting recommendation
of any proxy voting service or other independent fiduciary that may be retained
to provide research or advice to the Manager on that matter, no proxies relating
to the Client may be voted unless the Secretary,
or in the Secretary’s
absence, the Assistant Secretary of the Committee concurs that the subcommittee’s
determination is consistent with the Manager’s fiduciary duties.
In addition to the general
principles outlined above, the Manager has adopted voting guidelines with respect
to certain recurring proxy issues that are not expected to involve unusual circumstances.
These policies are guidelines only, and the Manager may elect to vote differently
from the recommendation set forth in a voting guideline if the Committee determines
that it is in a Fund’s best interest to do so. In addition, the guidelines
may be reviewed at any time upon the request of a Committee member and may be
amended or deleted upon the vote of a majority of Committee members present at
a Committee meeting at which there is a quorum.
The Manager has adopted specific
voting guidelines with respect to the following proxy issues:
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Proposals
related to the composition of the Board of Directors of issuers other than investment
companies. As a general matter, the Committee believes that a company’s Board
of Directors (rather than shareholders) is most likely to have access to important,
nonpublic information regarding a company’s business and prospects, and is,
therefore, best-positioned to set corporate policy and oversee management. The
Committee, therefore, believes that the foundation of good corporate governance
is the election of qualified, independent corporate directors who are likely to
diligently represent the interests of shareholders and oversee management of the
corporation in a manner that will seek to maximize shareholder value over time.
In individual cases, the Committee may look at a nominee’s number of other
directorships, history of representing shareholder interests as a director of
other companies or other factors, to the extent the Committee deems relevant.
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Proposals
related to the selection of an issuer’s independent auditors. As a general
matter, the Committee believes that corporate auditors have a responsibility to
represent the interests of shareholders and provide an independent view on the
propriety of financial reporting decisions of corporate management. While the
Committee will generally defer to a corporation’s choice of auditor, in individual
cases, the Committee may look at an auditors’ history of representing shareholder
interests as auditor of other companies, to the extent the Committee deems relevant.
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Proposals
related to management compensation and employee benefits. As a general matter,
the Committee favors disclosure of an issuer’s compensation and benefit policies
and opposes excessive compensation, but believes that compensation matters are
normally best determined by an issuer’s board of directors, rather than shareholders.
Proposals to “micro-manage” an issuer’s compensation practices
or to set arbitrary restrictions on compensation or benefits will, therefore,
generally not be supported.
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Proposals
related to requests, principally from management, for approval of amendments that
would alter an issuer’s capital structure. As a general matter, the Committee
will support requests that enhance the rights of common shareholders and oppose
requests that appear to be unreasonably dilutive.
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Proposals
related to requests for approval of amendments to an issuer’s charter or
by-laws. As a general matter, the Committee opposes poison pill provisions.
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Routine
proposals related to requests regarding the formalities of corporate meetings.
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Proposals
related to proxy issues associated solely with holdings of investment company
shares. As with other types of companies, the Committee believes that a fund’s
Board of Directors (rather than its shareholders) is best positioned to set fund
policy and oversee management. However, the Committee opposes granting Boards
of Directors authority over certain matters, such as changes to a fund’s
investment objective, which the Investment Company Act envisions will be approved
directly by shareholders.
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Proposals
related to limiting corporate conduct in some manner that relates to the shareholder’s
environmental or social concerns. The Committee generally believes that annual
shareholder meetings are inappropriate forums for discussion of larger social
issues, and opposes shareholder resolutions “micromanaging” corporate
conduct or requesting release of information that would not help a shareholder
evaluate an investment in the corporation as an economic matter. While the Committee
is generally supportive of proposals to require corporate disclosure of matters
that seem relevant and material to the economic interests of shareholders, the
Committee is generally not supportive of proposals to require disclosure of corporate
matters for other purposes.
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Information about how a Fund
voted proxies relating to securities held in the Fund’s portfolio during
the most recent 12 month period ended June 30 is available without charge (1)
at www.mutualfunds.ml.com and (2) on the Commission’s web site at http://www.sec.gov.
G
ENERAL
I
NFORMATION
Description
of Shares
Shareholders of a Fund are
entitled to one vote for each full share held and fractional votes for fractional
shares held in the election of Directors and generally on other matters submitted
to the vote of shareholders of the Fund. Shareholders of a class that bears distribution
and/or account maintenance expenses have exclusive voting rights with respect
to matters relating to such distribution and account maintenance expenditures
(except that Class B shareholders may vote upon any material changes to such expenses
charged under the Class A Distribution Plan). Voting rights are not cumulative,
so that the holders of more than 50% of the shares voting in the election of Directors
can, if they choose to do so, elect all the Directors of a Fund, in which event
the holders of the remaining shares would be unable to elect any person as a Director.
Each
Fund does not intend to hold annual meetings of shareholders in any year in which
the Investment Company Act does not require shareholders to act upon any of the
following matters: (i) election of Directors; (ii) approval of a management agreement;
(iii) approval of a distribution agreement; and (iv) ratification of selection
of independent accountants. Shares issued are fully paid and non-assessable and
have no preemptive rights. Redemption and conversion rights are discussed elsewhere
herein and in each Fund’s Prospectus. Each share of Class A, Class B, Class
C, Class I and Class R Common Stock is entitled to participate equally in dividends
and distributions declared by a Fund and in the net assets of the Fund upon liquidation
or dissolution after satisfaction of outstanding liabilities.
For Funds organized as Maryland
corporations, the by-laws of the Fund require that a special meeting of shareholders
be held upon the written request of a minimum percentage of the outstanding
shares of the Fund entitled to vote at such meeting, if they comply with applicable
Maryland law.
Certain Funds are organized
as Delaware statutory trusts.
See Part I, Section IX “Additional
Information — Description of Shares” of each Fund’s Statement of
Additional Information for additional capital stock information for your Fund.
Additional
Information
Under a separate agreement,
ML & Co. has granted each Fund the right to use the “Merrill Lynch”
name and has reserved the right to withdraw its consent to the use of such name
by a Fund at any time or to grant the use of such name to any other company, and
each Fund has granted ML & Co. under certain conditions, the use of any other
name it might assume in the future, with respect to any corporation organized
by ML & Co.
See Part I, Section IX “Additional
Information — Principal Shareholders” section of each Fund’s Statement
of Additional Information for information on the holders of 5% or more of any
class of shares of your Fund.
