As filed with the Securities and Exchange
Commission on November 22, 2019
Securities Act
File No. 333-191837
Investment Company Act File No.
811-22903
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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Pre-Effective
Amendment No.
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Post-Effective
Amendment No. 241
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and/or
REGISTRATION STATEMENT
UNDER
THE INVESTMENT COMPANY ACT OF 1940
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Amendment
No. 243
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(Check appropriate box or
boxes)
J.P. Morgan Exchange-Traded Fund Trust
(Exact Name of Registrant Specified in Charter)
277 Park Avenue
New York, New York, 10172
(Address of Principal Executive Offices)
Registrant’s Telephone Number, Including Area
Code: (800) 480-4111
Gregory S. Samuels,
Esq.
J.P. Morgan Investment Management Inc.
4 New York
Plaza
New York, New York 10004
(Name and Address of Agent for Service)
With copies to:
Anthony
Geron, Esq.
JPMorgan Chase & Co.
4 New York Plaza
New York, NY 10004
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Jon
S. Rand, Esq.
Dechert LLP
1095 Avenue of the Americas
New York, NY 10036
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It is proposed that this filing will become
effective (check appropriate box):
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immediately upon
filing pursuant to paragraph (b)
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on
December 2, 2019 pursuant to paragraph (b)
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60
days after filing pursuant to paragraph (a)(1)
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on
(date) pursuant to paragraph (a)(1)
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75
days after filing pursuant to paragraph (a)(2)
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on
(date) pursuant to paragraph (a)(2)
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If
appropriate, check the following box:
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The
post-effective amendment designates a new effective date for a previously filed post-effective amendment.
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Prospectus
J.P. Morgan Exchange-Traded Funds
December 2, 2019
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JPMorgan BetaBuilders International Equity ETF
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Ticker: BBIN
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Listing Exchange: Cboe BZX Exchange, Inc.
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Beginning on January 1, 2021, as permitted by regulations adopted by the Securities and Exchange
Commission, paper copies of the Funds annual and semi-annual shareholder reports will no longer be sent by mail, unless you specifically request paper copies of the reports. Instead, the reports will be made available on the Funds
website www.jpmorganfunds.com and you will be notified by mail each time a report is posted and provided with a website to access the report. If you already elected to receive shareholder reports electronically, you will not be affected by this
change and you need not take any action.
You may elect to receive shareholder reports and other communications from the Fund
electronically anytime by contacting your financial intermediary (such as a broker dealer, bank, or retirement plan).
Alternatively, you may elect to receive paper copies of all future reports free of charge by contacting your financial intermediary. Your
election to receive paper reports will apply to all funds held within your account(s).
The Securities and Exchange Commission has not approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
CONTENTS
JPMorgan BetaBuilders International Equity ETF
Ticker: BBIN
What is the goal of the Fund?
The Fund seeks investment results that closely correspond, before
fees and expenses, to the performance of the Morningstar® Developed Markets ex-North America Target Market Exposure
IndexSM.
Fees and Expenses of the Fund
The following
table describes the fees and expenses that you may pay if you buy and hold Shares of the Fund. Investors purchasing Shares in the secondary market may be subject to costs (including customary brokerage commissions) charged by their broker.
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ANNUAL FUND OPERATING EXPENSES
(Expenses that you pay each year as a percentage of the value
of your investment)
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Management Fees
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0.07
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%
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Other Expenses
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NONE
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Total Annual Fund Operating Expenses1
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0.07
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1
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The Funds management agreement provides that the adviser will pay substantially all expenses of the Trust relating to the Fund and the
Fund, except for the management fees, payments under the Funds 12b-1 plan (if any), interest expenses, dividend and interest expenses related to short sales, taxes, acquired fund fees and
expenses (other than fees for funds advised by the adviser and/or its affiliates), costs of holding shareholder meetings, and litigation and potential litigation and other extraordinary expenses not incurred in the ordinary course of the Funds
business. Additionally, the Fund shall be responsible for its non-operating expenses, including brokerage commissions and fees and expenses associated with the Funds securities lending program, if
applicable.
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Example
This Example is intended to help you compare the cost of investing in the Fund with the cost of investing in other funds. The Example does not take into account brokerage commissions that you pay when
purchasing or selling Shares of the Fund. The Example assumes that you invest $10,000 in the Fund for the time periods indicated. The Example also assumes that your investment has a 5% return each year and that the Funds operating expenses
remain the same. Your actual costs may be higher or lower.
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WHETHER OR NOT YOU SELL YOUR SHARES, YOUR
COST WOULD BE
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1 Year
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3 Years
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SHARES ($)
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7
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23
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Portfolio Turnover
The Fund pays transaction costs, such as commissions, when it buys and sells securities (or turns over its portfolio). A higher portfolio turnover rate may indicate higher transaction costs and
may result in higher taxes when Shares are held in a taxable account. These costs, which are not reflected in annual fund operating expenses or in the Example, affect the Funds performance. The Fund has not yet commenced operations as of the
date of this prospectus. Therefore, there is no portfolio turnover rate for the Fund to report at this time.
What are the Funds main
investment strategies?
The Fund seeks investment results that closely correspond, before fees and expenses, to the performance of the
Morningstar® Developed Markets ex-North America Target Market Exposure IndexSM (the Underlying Index). The Fund will invest at least 80% of its Assets in securities included in the Underlying Index. Assets means net assets, plus the amount of borrowing for
investment purposes. Morningstar, Inc. is the index provider for the Underlying Index (the Index Provider). The Underlying Index is a free float adjusted market capitalization weighted index which consists of equity securities from
developed countries or regions, including: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the
United Kingdom. The Underlying Index targets 85% of the stocks traded on the primary exchanges in each country by market capitalization, and primarily includes large- and mid-capitalization companies. Components of the Underlying Index are allocated
across various sectors, including the financials and industrials sectors. The components of the Underlying Index and the countries and sectors represented are likely to change over time. The Funds equity securities include common stock,
stapled securities and depositary receipts. As of October 31, 2019, the market capitalizations of the companies in the Underlying Index ranged from $197.15 million to $317.64 billion and the Underlying Index included 1,087 securities.
Beta is a measure of the volatility of a security or a portfolio relative to a market benchmark. The term
BetaBuilders in the Funds name conveys the intended outcome of providing investors with passive exposure and return that generally correspond to a market cap weighted benchmark. The Fund, along with other JPMorgan BetaBuilders
Funds, can be used to help an investor build a portfolio of passive exposure to various markets.
The Fund, using a passive or
indexing investment approach, attempts to closely correspond to the performance of the Underlying Index. The adviser expects that, over time, the correlation between the Funds performance before fees and
JPMorgan BetaBuilders International Equity ETF (continued)
expenses and that of the Underlying Index will be 95% or better. A figure of 100% would indicate perfect
correlation. Unlike actively-managed funds, the Fund does not seek to outperform the Underlying Index and does not seek temporary defensive positions when markets decline or appear overvalued.
The Funds intention is to replicate the constituent securities of the Underlying Index as closely as possible. Replication is a passive indexing strategy in which a fund invests in
substantially all of the securities in its underlying index in approximately the same proportions as the underlying index. However, under various circumstances, it may not be possible or practicable to purchase or hold all of, or only, the
constituent securities in their respective weightings in the Underlying Index. In these circumstances, the Fund may utilize a representative sampling strategy whereby securities are chosen in order to attempt to approximate the
investment characteristics of the constituent securities. To the extent the Fund uses a representative sampling strategy, it would hold a significant number of the constituent securities of the Underlying Index, but may not track the Underlying
Index with the same degree of accuracy as would an investment vehicle replicating the entire Underlying Index. Even when the Fund is utilizing representative sampling, it must invest at least 80% of its Assets in securities included in the
Underlying Index. The Funds portfolio will be rebalanced quarterly in accordance with the quarterly rebalancing of the Underlying Index.
The Fund may invest up to 20% of its assets in exchange-traded futures and forward foreign currency contracts to seek performance that corresponds to the
Underlying Index.
The Fund is classified as diversified under the Investment Company Act of 1940 (1940 Act). However, the Fund
may operate as a non-diversified fund, as defined by the 1940 Act, to the approximate extent the Underlying Index is non-diversified. The Fund may, therefore, operate as non-diversified solely as a result of a change in the relative
market capitalization or index weighting of one or more constituents of the Underlying Index. A non-diversified fund may invest a greater percentage of its assets in a particular issuer or group of issuers than a diversified fund would.
To the extent that the securities in the Underlying Index are concentrated in one or more industries or groups of industries, the Fund may concentrate
in such industries or groups of industries.
The Funds Main Investment Risks
An investment in this Fund or any other fund may not provide a complete investment program. The suitability
of an investment in the Fund should be considered based on the investment objective, strategies and risks described in this prospectus, considered in light of all of the other investments in your portfolio, as well as your risk tolerance, financial
goals and time horizons. You may want to consult with a financial advisor to determine if this Fund is suitable for you.
The Fund is subject to the main risks noted below, any of which may adversely affect the Funds net asset
value (NAV), market price, performance and ability to meet its investment objective.
Equity Market Risk. The price of equity securities
may rise or fall because of changes in the broad market or changes in a companys financial condition, sometimes rapidly or unpredictably. These price movements may result from factors affecting individual companies, sectors or industries
included in the Underlying Index or the securities market as a whole, such as changes in economic or political conditions. When the value of the Funds securities goes down, your investment in the Fund decreases in value.
General Market Risk. Economies and financial markets throughout the world are becoming increasingly interconnected, which increases the likelihood
that events or conditions in one country or region will adversely impact markets or issuers in other countries or regions. Securities in the Underlying Index or in the Funds portfolio may underperform in comparison to securities in the general
financial markets, a particular financial market or other asset classes, due to a number of factors, including inflation (or expectations for inflation), interest rates, global demand for particular products or resources, natural disasters or
events, terrorism, regulatory events and government controls.
Foreign Securities Risk. Investments in foreign issuers and foreign
securities (including depositary receipts) are subject to additional risks, including political and economic risks, civil conflicts and war, greater volatility, expropriation and nationalization risks, sanctions or other measures by the United
States or other governments, currency fluctuations, higher transaction costs, delayed settlement, possible foreign controls on investment, liquidity risks and less stringent investor protection and disclosure standards of foreign markets. In certain
markets where securities and other instruments are not traded delivery versus payment, the Fund may not receive timely payment for securities or other instruments it has delivered or receive delivery of securities paid for and may be
subject to increased risk that the counterparty will fail to make payments or delivery when due or default completely. Events and evolving conditions in certain economies or markets may alter the risks associated with investments tied to countries
or regions that historically were perceived as comparatively stable becoming riskier and more volatile.
Currency Risk. Changes in foreign
currency exchange rates will affect the value of the Funds securities and the price of the Funds Shares. Generally, when the value of the U.S. dollar rises in value relative to a foreign currency, an investment impacted by that currency
loses value because that currency is worth less in U.S. dollars. Currency exchange rates may fluctuate significantly over short periods of time for a number of reasons, including changes in interest rates. Devaluation of a currency
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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by a countrys government or banking authority also will have a significant impact on the value of any investments denominated in that currency. Currency markets generally are not as
regulated as securities markets, may be riskier than other types of investments and may increase the volatility of the Fund.
Index Related
Risk. The Funds return may not track the return of the Underlying Index for a number of reasons and therefore may not achieve its investment objective. For example, the Fund incurs a number of operating expenses not applicable to the
Underlying Index, and incurs costs in buying and selling securities, especially when rebalancing the Funds securities holdings to reflect changes in the composition of the Underlying Index. These transaction costs may be higher for a fund
investing in foreign securities. In addition, the Funds return may differ from the return of the Underlying Index as a result of, among other things, pricing differences between the valuation of securities in the Underlying Index and in the
Funds NAV and the inability to purchase certain securities included in the Underlying Index due to regulatory or other restrictions.
In
addition, when the Fund uses a representative sampling approach, the Fund may not be as well correlated with the return of the Underlying Index as when the Fund purchases all of the securities in the Underlying Index in the proportions in which they
are represented in the Underlying Index. To the extent the Fund calculates its NAV based on fair value prices and the value of the Underlying Index is based on securities closing prices on local foreign markets (i.e., the value of the
Underlying Index is not based on fair value prices), the Funds ability to track the performance of the Underlying Index may be adversely affected.
Errors in the construction or calculation of the Underlying Index may occur from time to time. Any such errors may not be identified and corrected by the Index Provider for some period of time, which may
have an adverse impact on the Fund and its shareholders.
The risk that the Fund may not track the performance of the Underlying Index may be
heightened during times of increased market volatility or other unusual market conditions.
Passive Management Risk. Unlike many investment
companies, the Fund is not actively managed. Therefore, it would not generally sell a security because the securitys issuer was in financial trouble unless that security is removed from the Underlying Index. As a result, the
Funds performance could be lower than funds that may actively shift their portfolio assets to take advantage of market opportunities or lessen the impact of a market decline or a decline in the value of one or more issuers. The Fund will not
take defensive positions under any market conditions, including in declining markets.
Sampling Risk. To the extent the Fund uses a
representative sampling approach, it will hold a smaller number of securities
than are in the Underlying Index. As a result, an adverse development respecting an issuer of securities held by the Fund could result in a greater decline in the Funds NAV than would be
the case if the Fund held all of the securities in the Underlying Index. Conversely, a positive development relating to an issuer of securities in the Underlying Index that is not held by the Fund could cause the Fund to underperform the Underlying
Index. To the extent the assets in the Fund are smaller, these risks may be greater.
Derivatives Risk. Derivatives, including futures and
forward foreign currency contracts, may be riskier than other types of investments and may increase the volatility of the Fund. Derivatives may be sensitive to changes in economic and market conditions and may create leverage, which could result in
losses that significantly exceed the Funds original investment. Certain derivatives expose the Fund to counterparty risk, which is the risk that the derivative counterparty will not fulfill its contractual obligations (and includes credit risk
associated with the counterparty). Certain derivatives are synthetic instruments that attempt to replicate the performance of certain reference assets. With regard to such derivatives, the Fund does not have a claim on the reference assets
and is subject to enhanced counterparty risk. Derivatives may not perform as expected, so the Fund may not realize the intended benefits. In addition, given their complexity, derivatives expose the Fund to risks of mispricing or
improper valuation.
Mid-Cap Company Risk. The Funds risks increase as it invests more heavily in mid-cap companies. Investments
in mid-cap companies may be riskier, less liquid, more volatile and more vulnerable to economic, market and industry changes than investments in larger, more established companies. The securities of smaller companies may trade less frequently and in
smaller volumes than securities of larger companies. As a result, share price changes may be more sudden or erratic than the prices of other equity securities, especially over the short term.
ETF Shares Trading Risk. Shares are listed for trading on the Cboe BZX Exchange, Inc. (the Exchange) and are bought and sold in the
secondary market at market prices. The market prices of Shares are expected to fluctuate, in some cases materially, in response to changes in the Funds NAV, the intraday value of the Funds holdings, and supply and demand for Shares. The
adviser cannot predict whether Shares will trade above, below or at their NAV. Disruptions to creations and redemptions, the existence of significant market volatility or potential lack of an active trading market for the Shares (including through a
trading halt), as well as other factors, may result in the Shares trading significantly above (at a premium) or below (at a discount) to NAV or to the intraday value of the Funds holdings. During such periods, you may incur significant losses
if you sell your Shares.
JPMorgan BetaBuilders International Equity ETF (continued)
The securities held by the Fund may be traded in markets that close at a different time than the Exchange.
Liquidity in those securities may be reduced after the applicable closing times. Accordingly, during the time when the Exchange is open but after the applicable market closing, fixing or settlement times, bid-ask spreads on the Exchange and the
corresponding premium or discount to the Shares NAV may widen.
Authorized Participant Concentration Risk. Only an authorized
participant may engage in creation or redemption transactions directly with the Fund. The Fund has a limited number of intermediaries that act as authorized participants and none of these authorized participants is or will be obligated to engage in
creation or redemption transactions. To the extent that these intermediaries exit the business or are unable to or choose not to proceed with creation and/or redemption orders with respect to the Fund and no other authorized participant creates or
redeems, Shares may trade at a discount to NAV and possibly face trading halts and/or delisting.
Industry and Sector Focus Risk.
At times the Underlying Index and the Fund may increase the relative emphasis of its investments in a particular industry or sector. The prices of securities of issuers in a particular industry or sector may be more susceptible to fluctuations due
to changes in economic or business conditions, government regulations, availability of basic resources or supplies, or other events that affect that industry or sector more than securities of issuers in other industries and sectors. To the extent
that the Underlying Index and the Fund increase the relative emphasis of their investments in a particular industry or sector, the Funds Share values may fluctuate in response to events affecting that industry or sector.
Financials Sector Risk. Financial services companies are subject to extensive governmental regulation which may limit both the amounts and types of
loans and other financial commitments they can make, the interest rates and fees they can charge, the scope of their activities, the prices they can charge and the amount of capital they must maintain. Profitability is largely dependent on the
availability and cost of capital funds and can fluctuate significantly when interest rates change or due to increased competition. In addition, deterioration of the credit markets generally may cause an adverse impact in a broad range of markets,
including U.S. and international credit and interbank money markets generally, thereby affecting a wide range of financial institutions and markets. Certain events in the financials sector may cause an unusually high degree of volatility in the
financial markets, both domestic and foreign, and cause certain financial services companies to incur large losses. Securities of financial services companies may experience a dramatic decline in value when such companies experience substantial
declines in the valuations of their assets, take action to raise capital (such as the issuance of debt or equity securities), or cease operations. Credit losses resulting from
financial difficulties of borrowers and financial losses associated with investment activities can negatively impact the sector. Insurance companies may be subject to severe price competition.
Adverse economic, business or political developments could adversely affect financial institutions engaged in mortgage finance or other lending or investing activities directly or indirectly connected to the value of real estate.
Industrials Sector Risk. The industrials sector may be adversely affected by changes in the supply of and demand for products and services, product
obsolescence, claims for environmental damage or product liability and general economic conditions, among other factors.
Geographic Focus
Risk. The Fund may focus its investments in one or more regions or small groups of countries. As a result, the Funds performance may be subject to greater volatility than a more geographically diversified fund.
Concentration Risk. To the extent that the securities in the Underlying Index are concentrated in one or more industries or groups of industries,
the Fund may concentrate in such industries or groups of industries. This concentration increases the risk of loss to the Fund by increasing its exposure to economic, business, political or regulatory developments that may be adverse to a particular
industry or group of industries.
Diversification Risk. The Fund is classified as diversified under the 1940 Act. However, the
Fund may operate as a non-diversified fund, as defined by the 1940 Act, to the approximate extent the Underlying Index is non-diversified. The Fund may, therefore, operate as non-diversified solely as a result of a change in the relative
market capitalization or index weighting of one or more constituents of the Underlying Index. A non-diversified fund may invest a greater percentage of its assets in a particular issuer or group of issuers than a diversified fund would. This
increased investment in fewer issuers may result in the Funds Shares being more sensitive to economics results of those issuing the securities.
Investments in the Fund are not deposits or obligations of, or guaranteed or endorsed by, any bank and are
not insured or guaranteed by the FDIC, the Federal Reserve Board or any other government agency.
You could lose money investing in the Fund.
The Funds Past Performance
The Fund has
not commenced operations as of the date of this prospectus and therefore, has no reportable performance history. Once the Fund has operated for at least one calendar year, a bar chart and performance table will be included in the prospectus to show
the performance of the Fund. When such information is included, this section will provide some indication of the risks of investing in the Fund by showing
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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changes in the Funds performance history from year to year and showing how the Funds average annual total returns compare with those of a broad measure of market performance. Although
past performance of the Fund is no guarantee of how it will perform in the future, historical performance may give you some indication of the risks of investing in the Fund.
Management
J.P. Morgan Investment Management Inc. (the adviser)
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Portfolio Manager
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Managed the
Fund Since
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Primary Title with
Investment Adviser
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Nicholas DEramo
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2019
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Executive Director
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Michael Loeffler
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2019
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Executive Director
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Oliver Furby
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2019
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Executive Director
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Alex Hamilton
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2019
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Executive Director
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Purchase and Sale of Shares
The Fund will issue and redeem Shares at NAV only in a large specified number of Shares called a Creation Unit or multiples thereof. A Creation Unit consists of 200,000 Shares. The Fund generally
issues and redeems Creation Units in return for a designated portfolio of securities (and an amount of cash) that the Fund specifies each day. Except when aggregated in Creation Units, Shares are not redeemable securities of the Fund.
Individual Shares of the Fund may only be purchased and sold
in secondary market transactions through brokers or financial intermediaries. Shares of the Fund are listed for trading on the Exchange, and because Shares trade at market prices rather than NAV,
Shares of the Fund may trade at a price greater than or less than NAV. Certain affiliates of the Fund and the adviser may purchase and resell Shares pursuant to this prospectus.
Tax Information
To the extent the Fund makes distributions, those distributions will be taxed as
ordinary income or capital gains, except when your investment is in an IRA, 401(k) plan or other tax-advantaged investment plan, in which case you may be subject to federal income tax upon withdrawal from
the tax-advantaged investment plan.
Payments to Broker-Dealers and Other Financial Intermediaries
If you purchase Shares of the Fund through a broker-dealer or other financial intermediary (such as a bank), the adviser and its related
companies may pay the financial intermediary for the sale of Shares and related services. These payments may create a conflict of interest by influencing the broker-dealer or financial intermediary and your salesperson to recommend the Fund over
another investment. Ask your salesperson or visit your financial intermediarys website for more information.
More About the Fund
ADDITIONAL INFORMATION ABOUT THE FUNDS
INVESTMENT STRATEGIES
Main Investment Strategies
The Fund seeks investment results that closely correspond, before fees and expenses, to the performance of the Underlying Index. The Fund will invest at least 80% of its Assets in securities included in the
Underlying Index. Assets means net assets, plus the amount of borrowing for investment purposes. The Underlying Index is a free float adjusted market capitalization weighted index which consists of equity securities from developed
countries or regions, including: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.
The Underlying Index targets 85% of the stocks traded on the primary exchanges in each country by market capitalization, and primarily includes large- and mid-capitalization companies, although small capitalization companies may be included.
Components of the Underlying Index are allocated across various sectors, including the financials and industrials sectors. The components of the Underlying Index and the countries and sectors represented are likely to change over time. For purposes
of investing at least 80% of its Assets in securities included in the Underlying Index, the Fund may invest in depositary receipts representing securities included in the Underlying Index. The Funds equity securities include common stock,
stapled securities and depositary receipts. A stapled security is a type of financial instrument that consists of two or more securities that are contractually bound to form a single salable unit; they cannot be bought or sold separately. As of
October 31, 2019, the market capitalizations of the companies in the Underlying Index ranged from $197.15 million to $317.64 billion and the Underlying Index included 1,087 securities. All listed securities are generally eligible for
inclusion in the Underlying Index. The securities must trade on one of the major exchanges in the included countries or regions.
Beta is a measure of the volatility of a security or a portfolio relative to a market benchmark. The term
BetaBuilders in the Funds name conveys the intended outcome of providing investors with passive exposure and return that generally correspond to a market cap weighted benchmark. The Fund, along with other JPMorgan BetaBuilders
Funds, can be used to help an investor build a portfolio of passive exposure to various markets.
The Fund, using a passive or
indexing investment approach, attempts to closely correspond to the investment performance of the Underlying Index. The Underlying Index is a financial calculation based on a group of financial instruments that is not an investment product and
cannot be purchased directly like the Fund. The adviser expects that, over time, the correlation between the Funds performance before fees and expenses and that of the Underlying Index will be 95% or better. A figure of 100% would indicate
perfect correlation. Unlike actively-managed funds, the Fund does not seek to outperform the Underlying Index and does not seek temporary defensive positions when markets decline or appear overvalued.
The Funds intention is to replicate the constituent securities of the Underlying Index as closely as possible. Replication is a passive
indexing strategy in which a fund invests in substantially all of the securities in its underlying index in approximately the same proportions as the underlying index. However, under various circumstances, it may not be possible or practicable to
purchase or hold all of, or only, the constituent securities in their respective weightings in the Underlying Index. In these circumstances, the Fund may utilize a representative sampling strategy whereby securities are chosen in order
to attempt to approximate the investment characteristics of the constituent securities. To the extent the Fund uses a representative sampling strategy, it would hold a significant number of the constituent securities of the Underlying Index, but may
not track the Underlying Index with the same degree of accuracy as would an investment vehicle replicating the entire Underlying Index. Even when the Fund is utilizing representative sampling, it must invest at least 80% of its Assets in securities
included in the Underlying Index. The Funds portfolio will be rebalanced quarterly in accordance with the quarterly rebalancing of the Underlying Index.
The Fund may invest up to 20% of its assets in exchange-traded futures and forward foreign currency contracts to seek performance that corresponds to the Underlying Index.
The Fund is classified as diversified under the 1940 Act. However, the Fund may operate as a non-diversified fund, as defined by the
1940 Act, to the approximate extent the Underlying Index is non-diversified. The Fund may therefore, operate as non-diversified solely as a result of a change in the relative market capitalization or index weighting of one or more constituents of
the Underlying Index. A non-diversified fund may invest a greater percentage of its assets in a particular issuer or group of issuers than a diversified fund would.
To the extent that the securities in the Underlying Index are concentrated in one or more industries or groups of industries, the Fund may concentrate in such industries or groups of industries.
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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Additional Investment Strategies
In addition to purchasing the securities that are included in its Underlying Index or described above, the Fund may also utilize the following:
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Other equity securities that are not included in the Underlying Index.
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Derivatives, including exchange-traded futures contracts, for the efficient management of cash flows.
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The Fund will not invest in money market instruments as a part of a temporary defensive position to protect against potential stock market decline, but may
purchase money market funds (including affiliated money market funds) for the efficient management of cash flows.
The Fund may invest in shares
of ETFs, affiliated ETFs and affiliated money market funds. In allocating the Funds assets between affiliated and unaffiliated ETFs, in most circumstances the adviser will use an affiliated ETF if one within the desired asset class is
available. ETFs, which are pooled investment vehicles whose ownership interests are purchased and sold on a securities exchange, may be passively or actively managed. Passively managed ETFs generally seek to track the performance of a particular
market index, including broad-based market indexes, as well as indexes relating to particular sectors, markets, regions or industries. Actively managed ETFs do not seek to track the performance of a particular market index. Ordinarily, the Fund must
limit its investments in a single non-affiliated ETF to 5% of its total assets and in all non-affiliated ETFs to 10% of its total assets.
The
frequency with which the Fund buys and sells securities will vary from year to year, depending on the composition of the Underlying Index.
The
Fund has adopted a policy that requires the Fund to provide shareholders with at least 60 days notice prior to any change in its policy to invest at least 80% of its Assets in securities included in its Underlying Index. The Board of Trustees of the
Trust may change the Funds investment strategies and other policies without shareholder approval, except as otherwise indicated.
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NON-FUNDAMENTAL INVESTMENT
OBJECTIVE
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An investment objective is fundamental if it
cannot be changed without the consent of a majority of the outstanding Shares of the Fund. The Funds investment objective is not fundamental and may be changed without the consent of a majority of the outstanding Shares of the
Fund.
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Securities Lending. The Fund may engage in securities lending to increase its income. Securities
lending involves the lending of securities owned by the Fund to financial institutions such as certain broker-dealers in exchange for cash collateral. The Fund may invest cash collateral in one or more money market funds advised by the adviser or
its affiliates. The adviser or its affiliates will receive additional compensation from the affiliated money market funds on the Funds investment in such money market funds. During the term of the loan, the Fund is entitled to receive amounts
equivalent to distributions paid on the loaned securities as well as the return on the cash collateral investments. Upon termination of the loan, the Fund is required to return the cash collateral to the borrower plus any agreed upon rebate. Cash
collateral investments will be subject to market depreciation or appreciation, and the Fund will be responsible for any loss that might result from its investment of cash collateral. If the adviser determines to make securities loans, the value of
the securities loaned may not exceed
331/3% of the value of total assets of the Fund. Loan collateral (including any investment of that collateral) is not subject to the percentage limitations regarding the Funds investments described
elsewhere in this prospectus.
INVESTMENT RISKS
There can be no assurance that the Fund will achieve its investment objective.
The main risks
associated with investing in the Fund are summarized in the Risk/Return Summary at the front of this prospectus. In addition to the Funds main risks, the Fund may be subject to additional risks in connection with investments and
strategies used by the Fund from time to time. The table below identifies main risks and some of the additional risks for the Fund.
The Fund
also may use other non-principal strategies that are not described herein, but which are described in the Statement of Additional Information.
More About the Fund
(continued)
An investment in the Fund or any other fund may not provide a complete investment program. The suitability of
an investment in the Fund should be considered based on the investment objective, strategies and risks described in this prospectus, considered in light of all of the other investments in your portfolio, as well as your risk tolerance, financial
goals and time horizons. You may want to consult with a financial advisor to determine if the Fund is suitable for you.
The Fund is
subject to the risks noted below, any of which may adversely affect the Funds NAV, market price, performance and ability to meet its investment objective.
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BetaBuilders
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Equity ETF
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Authorized Participant Concentration Risk
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Concentration Risk
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Currency Rick
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Derivatives Risk
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Diversification Risk
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Equity Market Risk
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Financials Sector Risk
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Foreign Securities Risk
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General Market Risk
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Geographic Focus Risk
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Index Related Risk
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Industrials Sector Risk
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Industry and Sector Focus Risk
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Investment Company Risk
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Market Trading Risk
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Passive Management Risk
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Sampling Risk
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Securities Lending Risk
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Smaller Company Risk
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Transactions and Liquidity Risk
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Volcker Rule Risk
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Equity
Market Risk. The price of equity securities may rise or fall because of changes in the broad market or changes in a companys financial condition, sometimes rapidly or unpredictably. These price movements may result from factors affecting
individual companies, sectors or industries selected for the Funds portfolio or the securities market as a whole, such as changes in economic or political conditions. Equity securities are subject to stock market risk meaning that
stock prices in general (or in particular, the prices of the types of securities in which the Fund invests) may decline over short or extended periods of time. When the value of the Funds securities goes down, your investment in the Fund
decreases in value.
General Market Risk. Economies and financial markets throughout the world are becoming increasingly interconnected,
which increases the likelihood that events or conditions in one country or region will adversely impact markets or issuers in other countries or regions. Securities in the Underlying Index or in the Funds portfolio may underperform in
comparison to securities in the general financial markets, a particular financial market or other asset classes, due to a number of factors, including inflation (or expectations for inflation), interest rates, global demand for particular products
or resources, natural disasters or events, terrorism, regulatory events and government controls.
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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Foreign Securities Risk. Because the Fund invests in foreign securities, it is subject to special risks
in addition to those applicable to U.S. investments. These risks include political and economic risks, civil conflicts and war, greater volatility, expropriation and nationalization risks, sanctions or other measures by the United States or other
governments, currency fluctuations, higher transaction costs, delayed settlement, possible foreign controls on investment, liquidity risks and less stringent investor protection and disclosure standards of foreign markets. The securities markets of
many foreign countries are relatively small, with a limited number of companies representing a small number of industries. If foreign securities are denominated and traded in a foreign currency, the value of the Funds foreign holdings can be
affected by currency exchange rates and exchange control regulations. In certain markets where securities and other instruments are not traded delivery versus payment, the Fund may not receive timely payment for securities or other
instruments it has delivered or receive delivery of securities paid for and may be subject to increased risk that the counterparty will fail to make payments or delivery when due or default completely. Events and evolving conditions in certain
economies or markets may alter the risks associated with investments tied to countries or regions that historically were perceived as comparatively stable becoming riskier and more volatile.
In addition to the more general foreign risks above, at various times the Fund may focus its investments in one or more foreign regions or small groups of countries. As a result, such Funds performance
may be subject to greater volatility than a more geographically diversified fund and may be subject to the risks in the following regional areas:
Asia Pacific Market Risk. The economies in the Asia Pacific region are in all stages of economic development and may be intertwined. The small size of
securities markets and the low trading volume in some countries in the Asia Pacific region may lead to a lack of liquidity. The share prices of companies in the region tend to be volatile and there is a significant possibility of loss. Many of the
countries in the region are developing, both politically and economically, and as a result companies in the region may be subject to risks like nationalization or other forms of government interference, and/or may be heavily reliant on only a few
industries or commodities. Investments in the region may also be subject to currency risks, such as restrictions on the flow of money in and out of the country, extreme volatility relative to the U.S. dollar, and devaluation, all of which could
decrease the value of the Fund.
China Region Risk. Investments in certain Hong-Kong listed securities may also subject the Fund to
exposure to Chinese companies. Investments in China and Hong Kong are subject to legal, regulatory, monetary and economic risks. Investments involve political and legal uncertainties, currency fluctuations and currency controls, the risk of
confiscatory taxation, and nationalization or expropriation of assets. The Chinese securities markets are emerging markets characterized by greater price volatility. China is dominated by the one-party rule of
the Communist Party, and the Chinese government exercises significant control over Chinas economic growth. The imposition of tariffs or other trade barriers or a downturn in the economy of a significant trading partner could adversely impact
Chinese companies.
European Market Risk. The Funds performance will be affected by political, social and economic conditions in
Europe, such as growth of the economic output (the gross national product), the rate of inflation, the rate at which capital is reinvested into European economies, the success of governmental actions to reduce budget deficits, the resource
self-sufficiency of European countries and interest and monetary exchange rates between European countries. European financial markets may experience volatility due to concerns about high government debt levels, credit rating downgrades, rising
unemployment, the future of the euro as a common currency, possible restructuring of government debt and other government measures responding to those concerns, and fiscal and monetary controls imposed on member countries of the European Union. The
risk of investing in Europe may be heightened due to steps being taken by the United Kingdom to exit the European Union. There is considerable uncertainty relating to the potential consequences of such a withdrawal. The impact on the United Kingdom
and European economies and the broader global economy could be significant, resulting in increased volatility and illiquidity, currency fluctuations, impacts on arrangements for trading and on other existing cross-border cooperation arrangements
(whether economic, tax, fiscal, legal, regulatory or otherwise), and in potentially lower growth for companies in the United Kingdom, Europe and globally, which could have an adverse effect on the value of the Funds investments. In addition,
if one or more other countries were to exit the European Union or abandon the use of the euro as a currency, the value of investments tied to those countries or the euro could decline significantly and unpredictably.
Risk of Investing in Japan. Japan may be subject to political, economic, nuclear, and labor risks, among others. Any of these risks, individually or
in the aggregate, can impact an investment made in Japan.
Economic Risk. The growth of Japans economy has recently
lagged that of its Asian neighbors and other major developed economies. Since the year 2000, Japans economic growth rate has remained relatively low, and it may remain low in the future. The Japanese economy is heavily dependent on
international trade and has been adversely affected in the past by trade tariffs, other protectionist measures, competition from emerging economies and the economic conditions of its trading partners. Japan is also heavily dependent on oil imports,
and higher commodity prices could therefore have a negative impact on
More About the Fund
(continued)
the Japanese economy. In addition, Japans economy has in the past and could in the future be significantly impacted by natural
disasters.
Political Risk. Historically, Japan has had unpredictable national politics and may experience frequent
political turnover. Future political developments may lead to changes in policy that might adversely affect the Funds investments. In addition, China has become an important trading partner with Japan. Japans political relationship with
China, however, is strained and delicate. Should political tension increase, it could adversely affect the Japanese economy and destabilize the region as a whole.
Large Government Debt Risk. The Japanese economy faces several concerns, including a financial system with large levels of nonperforming loans, over-leveraged corporate balance sheets, extensive
cross-ownership by major corporations, a changing corporate governance structure, and large government deficits. These issues may cause a slowdown of the Japanese economy.
Currency Risk. The Japanese yen has fluctuated widely at times and any increase in its value may cause a decline in exports that could weaken the Japanese economy. The Japanese government has, in the
past, intervened in the currency markets to attempt to maintain or reduce the value of the yen. Japanese intervention in the currency markets could cause the value of the yen to fluctuate sharply and unpredictably and could cause losses to
investors.
Labor Risk. Japan has an aging workforce and has experienced a significant population decline in recent years.
Japans labor market appears to be undergoing fundamental structural changes, as a labor market traditionally accustomed to lifetime employment adjusts to meet the need for increased labor mobility, which may adversely affect Japans
economic competitiveness.
Security Risk. Japans relations with its neighbors, particularly China, North Korea, South
Korea and Russia, have at times been strained due to territorial disputes, historical animosities and defense concerns. Most recently, the Japanese government has shown concern over the increased nuclear and military activity by North Korea and
China. Strained relations may cause uncertainty in the Japanese markets and adversely affect the overall Japanese economy in times of crisis.
Currency Risk. Changes in foreign currency exchange rates will affect the value of the Funds securities and the price of the Funds Shares.
Generally, when the value of the U.S. dollar rises in value relative to a foreign currency, an investment impacted by that currency loses value because that currency is worth less in U.S. dollars. Currency exchange rates may fluctuate significantly
over short periods of time for a number of reasons, including changes in interest rates. Devaluation of a currency by a countrys government or banking authority also may have a significant impact on the value of any investments denominated in
that currency. Currency markets generally are not as regulated as securities markets, may be riskier than other types of investments and may increase the volatility of the Fund.
Index Related Risk. The Funds return may not track the return of the Underlying Index for a number of reasons and, therefore, may not achieve its investment objective. For example, the Fund
incurs a number of operating expenses not applicable to the Underlying Index, and incurs costs in buying and selling securities, especially when rebalancing the Funds securities holdings to reflect changes in the composition of the Underlying
Index. These transaction costs may be higher for a fund investing in foreign securities. The Funds return may differ from the return of its Underlying Index as a result of, among other things, pricing differences (including differences between
a securitys price at the local market close and the Funds valuation of a security at the time of calculation of securities in the Underlying Index and the Funds NAV) and the inability to purchase certain securities included in the
Underlying Index due to regulatory or other restrictions.
In addition, when the Fund uses a representative sampling approach, the Fund may not be
as well correlated with the return of the Underlying Index as when the Fund purchases all of the securities in the Underlying Index in the proportions in which they are represented in the Underlying Index. To the extent the Fund calculates its NAV
based on fair value prices and the value of the Underlying Index is based on securities closing prices on local foreign markets (i.e., the value of the Underlying Index is not based on fair value prices), the Funds ability to track the
performance of the Underlying Index may be adversely affected.
Corporate actions affecting securities held by the Fund (such as mergers and
spin-offs) or the Funds ability to purchase round lots of the securities may also cause a deviation between the performance of the Fund and its Underlying Index.
Errors in the construction or calculation of the Underlying Index may occur from time to time. Any such errors may not be identified and corrected by the Index Provider for some period of time, which may
have an adverse impact on the Fund and its shareholders.
It is also possible that the composition of the Fund may not exactly replicate the
composition of the Underlying Index if the Fund has to adjust its portfolio holdings in order to continue to qualify as a regulated investment company under the U.S. Internal Revenue Code of 1986, as amended (the Internal Revenue Code).
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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The risk that the Fund may not track the performance of the Underlying Index may be heightened during times of
increased market volatility or other unusual market conditions.
Passive Management Risk. Unlike many investment companies, the Fund is not
actively managed. Therefore, it would not generally sell a security because the securitys issuer was in financial trouble unless that security is removed from the Underlying Index. As a result, the Funds performance could be
lower than funds that may actively shift their portfolio assets to take advantage of market opportunities or lessen the impact of a market decline or a decline in the value of one or more issuers. The Fund will not take defensive positions under any
market conditions, including in declining markets.
Sampling Risk. To the extent the Fund uses a representative sampling approach, it will
hold a smaller number of securities than are in the Underlying Index. As a result, an adverse development respecting an issuer of securities held by the Fund could result in a greater decline in the Funds NAV than would be the case if the Fund
held all of the securities in the Underlying Index. Conversely, a positive development relating to an issuer of securities in the Underlying Index that is not held by the Fund could cause the Fund to underperform the Underlying Index. To the extent
the assets in the Fund are smaller, these risks may be greater.
Derivatives Risk. The Fund may use derivatives in connection with its
investment strategies. Derivatives may be riskier than other types of investments because they may be more sensitive to changes in economic or market conditions than other types of investments and could result in losses that significantly exceed the
Funds original investment. Derivatives are subject to the risk that changes in the value of a derivative may not correlate perfectly with the underlying asset, rate or index. The use of derivatives may not be successful, resulting in losses to
the Fund, and the cost of such strategies may reduce the Funds returns. Certain derivatives also expose the Fund to counterparty risk (the risk that the derivative counterparty will not fulfill its contractual obligations), including credit
risk of the derivative counterparty. Certain derivatives are synthetic instruments that attempt to replicate the performance of certain reference assets. With regard to such derivatives, the Fund does not have a claim on the reference assets
and is subject to enhanced counterparty risk.
Investing in derivatives will result in a form of leverage. Leverage involves special risks. The
Fund may be more volatile than if the Fund had not been leveraged because leverage tends to exaggerate any effect on the value of the Funds portfolio securities. Registered investment companies are limited in their ability to engage in
derivative transactions and are required to identify and earmark assets to provide asset coverage for derivative transactions.
The possible lack
of a liquid secondary market for derivatives and the resulting inability of the Fund to sell or otherwise close a derivatives position could expose the Fund to losses and could make derivatives more difficult for the Fund to value accurately.
The Funds transactions in futures contracts could also affect the amount, timing and character of distributions to shareholders which may
result in the Fund realizing more short-term capital gain and ordinary income subject to tax at ordinary income tax rates than it would if it did not engage in such transactions, which may adversely impact the Funds after-tax return.
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WHAT IS A DERIVATIVE?
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Derivatives are securities or contracts (for
example, futures) that derive their value from the performance of underlying assets or securities.
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Smaller Company Risk (Mid-Cap Company Risk is a Main Risk and Small-Cap Company Risk is an Additional Risk).
Investments in smaller, newer companies may be riskier and less liquid than investments in larger, more established companies. The securities of smaller companies may trade less frequently and in smaller volumes than securities of larger companies.
In addition, smaller companies may be more vulnerable to economic, market and industry changes. As a result, share price changes may be more sudden or erratic than the prices of large capitalization companies, especially over the short term. Because
mid-cap companies may have limited product lines, markets or financial resources or may depend on a few key employees, they may be more susceptible to particular economic events or competitive factors than large capitalization companies. This may
cause unexpected and frequent decreases in the value of the Funds investments and may affect your investment in the Fund.
Market
Trading Risk
Risk that Shares of the Fund May Trade at Prices Other Than NAV. Shares of the Fund may trade on the Exchange at prices
above, below or at their most recent NAV. The NAV of the Funds Shares, which is calculated at the end of each business day, will generally fluctuate with changes in the market value of the Funds holdings. The market prices of the Shares
will also fluctuate, in some cases materially, in accordance with changes in NAV and the intraday value of the Funds holdings, as well as the relative supply of and
More About the Fund
(continued)
demand for the Shares on the Exchange. Differences between secondary market prices of Shares and the intraday value of the Funds holdings may be due
largely to supply and demand forces in the secondary market, which may not be the same forces as those influencing prices for securities held by the Fund at a particular time.
Given the fact that Shares can be created and redeemed by authorized participants in Creation Units, the adviser believes that large discounts or premiums to the NAV of Shares should not be sustained in the
long-term. While the creation/redemption feature is designed to make it likely that Shares normally will trade close to the value of the Funds holdings, market prices are not expected to correlate exactly to the Funds NAV due to timing
reasons, supply and demand imbalances and other factors. In addition, disruptions to creations and redemptions, adverse developments impacting market makers, authorized participants or other market participants, or high market volatility may result
in market prices for Shares of the Fund that differ significantly from its NAV or to the intraday value of the Funds holdings. As a result of these factors, among others, the Funds Shares may trade at a premium or discount to
NAV, especially during periods of significant market volatility.
Given the nature of the relevant markets for certain of the securities
for the Fund, Shares may trade at a larger premium or discount to NAV than shares of other kinds of ETFs. In addition, the securities held by such Funds may be traded in markets that close at a different time than the Exchange. Liquidity in those
securities may be reduced after the applicable closing times. Accordingly, during the time when the Exchange is open but after the applicable market closing, fixing or settlement times, bid/ask spreads and the resulting premium or discount to the
Shares NAV may widen.
Cost of Buying or Selling Shares. When you buy or sell Shares of the Fund through a broker, you will
likely incur a brokerage commission or other charges imposed by brokers. In addition, the market price of Shares, like the price of any exchange-traded security, includes a bid-ask spread charged by the market makers or other
participants that trade the particular security. The spread of the Funds Shares varies over time based on the Funds trading volume and market liquidity and may increase if the Funds trading volume, the spread of the Funds
underlying securities, or market liquidity decrease. In times of severe market disruption, including when trading of the Funds holdings may be halted, the bid-ask spread may increase significantly. This means that Shares may trade at a
discount to the Funds NAV, and the discount is likely to be greatest during significant market volatility.
Short Selling Risk.
Shares of the Fund, similar to shares of other issuers listed on a stock exchange, may be sold short and are therefore subject to the risk of increased volatility and price decreases associated with being sold short.
No Guarantee of Active Trading Market Risk. While Shares are listed on the Exchange, there can be no assurance that active trading markets for the
Shares will be maintained by market makers or by authorized participants. JPMorgan Distribution Services, Inc., the distributor of the Funds Shares (the Distributor), does not maintain a secondary market in the Shares.
Trading Issues Risk. Trading in Shares on the Exchange may be halted due to market conditions or for reasons that, in the view of the Exchange, make
trading in Shares inadvisable. In addition, trading in Shares on the Exchange is subject to trading halts caused by extraordinary market volatility pursuant to the Exchange circuit breaker rules. If a trading halt or unanticipated early
closing of the Exchange occurs, a Shareholder may be unable to purchase or sell Shares of the Fund. There can be no assurance that the requirements of the Exchange necessary to maintain the listing of the Fund will continue to be met or will remain
unchanged.
Authorized Participant Concentration Risk. Only an authorized participant may engage in creation or redemption transactions
directly with the Fund. The Fund has a limited number of intermediaries that act as authorized participants and none of these authorized participants is or will be obligated to engage in creation or redemption transactions. To the extent that these
intermediaries exit the business or are unable to or choose not to proceed with creation and/or redemption orders with respect to the Fund and no other authorized participant creates or redeems, Shares may trade at a discount to NAV and possibly
face trading halts and/or delisting.
Industry and Sector Focus Risk. At times the Underlying Index and the Fund may increase the
relative emphasis of their investments in a particular industry or sector. The prices of securities of issuers in a particular industry or sector may be more susceptible to fluctuations due to changes in economic or business conditions, government
regulations, availability of basic resources or supplies, or other events that affect that industry or sector more than securities of issuers in other industries and sectors. To the extent that the Underlying Index and the Fund increase the relative
emphasis of their investments in a particular industry or sector, the Funds Share values may fluctuate in response to events affecting that industry or sector.
Financials Sector Risk. Financial services companies are subject to extensive governmental regulation which may limit both the amounts and types of loans and other financial commitments they can make,
the interest rates and fees they can charge, the scope of their activities, the prices they can charge and the amount of capital they must maintain. Profitability is largely dependent on the availability and cost of capital funds and can fluctuate
significantly when interest rates change or due to increased competition. In
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addition, deterioration of the credit markets generally may cause an adverse impact in a broad range of markets, including U.S. and international credit and interbank money markets generally,
thereby affecting a wide range of financial institutions and markets.
Certain events in the financial sector may cause an unusually high degree
of volatility in the financial markets, both domestic and foreign, and cause certain financial services companies to incur large losses. Securities of financial services companies may experience a dramatic decline in value when such companies
experience substantial declines in the valuations of their assets, take action to raise capital (such as the issuance of debt or equity securities), or cease operations. Credit losses resulting from financial difficulties of borrowers and financial
losses associated with investment activities can negatively impact the sector. Insurance companies may be subject to severe price competition. Adverse economic, business or political developments could adversely affect financial institutions engaged
in mortgage finance or other lending or investing activities directly or indirectly connected to the value of real estate.
Industrials Sector
Risk. The value of securities issued by companies in the industrials sector may be adversely affected by supply and demand related to their specific products or services and industrials sector products in general. The products of manufacturing
companies may face obsolescence due to rapid technological developments and frequent new product introduction. Government regulations, world events, economic conditions and exchange rates may adversely affect the performance of companies in the
industrials sector. Companies in the industrials sector may be adversely affected by liability for environmental damage and product liability claims. The industrials sector may also be adversely affected by changes or trends in commodity prices,
which may be influenced by unpredictable factors. Companies in the industrials sector, particularly aerospace and defense companies, may also be adversely affected by government spending policies because companies in this sector tend to rely to a
significant extent on government demand for their products and services.
Geographic Focus Risk. The Fund may focus its investments in one
or more regions or small groups of countries. As a result, the Funds performance may be subject to greater volatility than a more geographically diversified fund.
Concentration Risk. To the extent that the securities in the Underlying Index are concentrated in one or more industries or groups of industries, the Fund may concentrate in such
industries or groups of industries. This concentration increases the risk of loss to the Fund by increasing its exposure to economic, business, political or regulatory developments that may be adverse to a particular industry or group of industries.
Diversification Risk. The Fund is classified as diversified under the 1940 Act. However, the Fund may operate as a
non-diversified fund, as defined by the 1940 Act, to the approximate extent the Underlying Index is non-diversified. The Fund may, therefore, operate as non-diversified solely as a result of a change in the relative market capitalization
or index weighting of one or more constituents of the Underlying Index. A non-diversified fund may invest a greater percentage of its assets in a particular issuer or group of issuers than a diversified fund would. This increased investment in fewer
issuers may result in the Funds Shares being more sensitive to economics results of those issuing the securities.
Transactions and
Liquidity Risk. The Fund could experience a loss when selling securities to meet redemption requests by shareholders and its liquidity may be negatively impacted. The risk of loss increases if the redemption requests are large or frequent, occur
in times of overall market turmoil or declining prices for the securities sold, or when the securities the Fund wishes to or is required to sell are illiquid. To the extent a large proportion of Shares are held by a small number of shareholders (or
a single shareholder) including funds or accounts over which the adviser or its affiliates have investment discretion, the Fund is subject to the risk that these shareholders will purchase or redeem Shares in large amounts rapidly or unexpectedly,
including as a result of an asset allocation decision made by the adviser or its affiliates. To the extent these larger shareholders transact in the secondary market, such transactions may account for a large percentage of the Funds trading
volume on the Exchange, which may have a material effect (upward or downward) on the market price of Shares. In addition to the other risks described in this section, these transactions could adversely affect the ability of the Fund to conduct its
investment program. The Fund may be unable to sell illiquid securities at its desired time or price or the price at which the securities have been valued for purposes of the Funds NAV. Illiquidity can be caused by a drop in overall market
trading volume, an inability to find a ready buyer, or legal restrictions on the securities resale. Certain securities that were liquid when purchased may later become illiquid, particularly in times of overall economic distress.
Large purchases of Shares may adversely affect the Funds performance to the extent that the Fund is delayed in investing new cash and is required to
maintain a larger cash position than it ordinarily would. Large redemptions also could accelerate the realization of capital gains, increase the Funds transaction costs and impact the Funds performance. To the extent redemptions are
effected in cash, an investment in the Fund may be less tax-efficient than an investment in an ETF that distributes portfolio securities entirely in-kind.
Investment Company Risk. The Fund may invest in shares of other investment companies. Shareholders bear both their proportionate share of the Funds expenses and similar expenses of the
underlying investment company when the Fund invests in shares of another investment company.
More About the Fund
(continued)
Securities Lending Risk. The Fund may engage in securities lending. Securities lending involves counterparty risk, including the risk that the loaned
securities may not be returned or returned in a timely manner and/or a loss of rights in the collateral if the borrower or the lending agent defaults. This risk is increased when the Funds loans are concentrated with a single or limited number
of borrowers. In addition, the Fund bears the risk of loss in connection with its investments of the cash collateral it receives from the borrower. To the extent that the value or return of the Funds investments of the cash collateral declines
below the amount owed to a borrower, the Fund may incur losses that exceed the amount it earned on lending the security. In situations where the adviser does not believe that it is prudent to sell the cash collateral investments in the market, the
Fund may borrow money to repay the borrower the amount of cash collateral owed to the borrower upon return of the loaned securities. This will result in financial leverage, which may cause the Fund to be more volatile because financial leverage
tends to exaggerate the effect of any increase or decrease in the value of the Funds portfolio securities.
Volcker Rule Risk.
Pursuant to Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act and certain rules promulgated thereunder known as the Volcker Rule, if the adviser and/or its affiliates own 25% or more of the outstanding ownership interests
of the Fund after the permitted seeding period from the implementation of the Funds investment strategy, the Fund could be subject to restrictions on trading that would adversely impact the Funds ability to execute its investment
strategy. Generally, the permitted seeding period is three years from the implementation of the Funds investment strategy. As a result, the adviser and/or its affiliates may be required to reduce their ownership interests in the Fund at a time
that is sooner than would otherwise be desirable, which may result in the Funds liquidation or, if the Fund is able to continue operating, may result in losses, increased transaction costs and adverse tax consequences as a result of the sale
of portfolio securities.
For more information about risks associated with the types of investments that the Fund purchases, please read the
Risk/Return Summary in the prospectus and the Statement of Additional Information.
CONFLICTS OF
INTEREST
An investment in a Fund is subject to a number of actual or potential conflicts of interest. For example, the Adviser and/or its
affiliates provide a variety of different services to a Fund, for which the Fund compensates them. As a result, the Adviser and/or its affiliates have an incentive to enter into arrangements with a Fund, and face conflicts of interest when balancing
that incentive against the best interests of a Fund. The Adviser and/or its affiliates also face conflicts of interest in their service as investment adviser to other clients, and, from time to time, make investment decisions that differ from and/or
negatively impact those made by the Adviser on behalf of a Fund. In addition, affiliates of the Adviser provide a broad range of services and products to their clients and are major participants in the global currency, equity, commodity,
fixed-income and other markets in which a Fund invests or will invest. In certain circumstances by providing services and products to their clients, these affiliates activities will disadvantage or restrict the Funds and/or benefit these
affiliates. The Adviser may also acquire material non-public information which would negatively affect the Advisers ability to transact in securities for a Fund. JPMorgan and the Funds have adopted policies and procedures reasonably designed
to appropriately prevent, limit or mitigate conflicts of interest. In addition, many of the activities that create these conflicts of interest are limited and/or prohibited by law, unless an exception is available. For more information about
conflicts of interest, see the Potential Conflicts of Interest section in the Statement of Additional Information.
INDEX CONSTRUCTION
The Fund seeks investment results that closely correspond, before fees and expenses, to the performance of
the Underlying Index, which measures the performance of equity securities from developed countries or regions, including: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New
Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom. The Underlying Index targets approximately 85% of the stocks traded on the primary exchanges in each country by free float market capitalization, and primarily
includes large- and mid-capitalization companies, although small capitalization companies may be included.
The stocks in the Underlying Index are
weighted according to the total number of shares that are publicly owned and available for trading, which is also known as free float. The components of the Underlying Index, and the degree to which these components represent certain sectors, are
likely to change over time. This includes recalculation of economic segment and large- and mid-capitalization cutoff breakpoints, free float and total outstanding shares changes. The Underlying Index is rebalanced quarterly in March, June,
September and December to reflect any changes in free float and total outstanding shares.
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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MORNINGSTAR® DESCRIPTION AND DISCLAIMER
Morningstar, Inc. is a leading
provider of independent investment research in North America, Europe, Australia, and Asia. The company offers an extensive line of products and services for individual investors, financial advisors, asset managers, retirement plan providers and
sponsors, and institutional investors in the private capital markets.
Morningstar provides data and research insights on a wide range of
investment offerings, including managed investment products, publicly listed companies, private capital markets, and real-time global market data. Morningstar also offers investment management services through its investment advisory subsidiaries,
with more than $217 billion in assets under advisement and management as of September 30, 2019. The company has operations in 27 countries.
The Adviser has entered into licensing agreements with Morningstar to use the Underlying Index. The Fund is entitled to use the Underlying Index pursuant to a sub-licensing arrangement with the Adviser.
The Fund is not sponsored, endorsed, sold or promoted by Morningstar, Inc., or any of its affiliated companies (collectively,
Morningstar). Morningstar makes no representation or warranty, express or implied, to the owners of the Fund or any member of the public regarding the advisability of investing in securities generally or in the Fund in particular or the
ability of the Underlying Index to track relevant market performance. Morningstars only relationship to J.P. Morgan Investment Management Inc. or any of its affiliates (collectively, the Adviser) is the licensing of:
(i) certain service marks and service names of Morningstar; and (ii) the Underlying Index, which is determined, composed and calculated by Morningstar without regard to the Adviser or the Fund. Morningstar has no obligation to take the needs of the
Adviser, the Fund or its owners into consideration in determining, composing or calculating the Underlying Index. Morningstar is not responsible for and has not participated in the determination of the prices and amount of the Fund or the timing of
the issuance or sale of the Fund or in the determination or calculation of the equation by which the Fund is converted into cash. Morningstar has no obligation or liability in connection with the administration, marketing or trading of the Fund.
MORNINGSTAR DOES NOT GUARANTEE THE ACCURACY, COMPLETENESS OR TIMELINESS OF THE UNDERLYING INDEX OR ANY ASSOCIATED DATA AND MORNINGSTAR SHALL HAVE
NO LIABILITY FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. MORNINGSTAR MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY THE ADVISER, OWNERS OR USERS OF THE FUND, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE
UNDERLYING INDEX OR ANY DATA INCLUDED THEREIN. MORNINGSTAR MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH RESPECT TO THE UNDERLYING INDEX OR ANY DATA
INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL MORNINGSTAR HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
DISCLOSURE OF PORTFOLIO HOLDINGS
A description of the policies and procedures with respect to the disclosure of the Funds portfolio securities is available in the Funds Statement of Additional Information.
ADDITIONAL FEE WAIVER AND/OR EXPENSE REIMBURSEMENT
Service providers to the Fund may, from time to time, voluntarily waive all or a portion of any fees to which they are entitled and/or reimburse certain expenses as they may determine from time to time. The
Funds service providers may discontinue or modify these voluntary actions at any time without notice. Performance for the Fund, when available, will reflect the voluntary waiver of fees and/or the reimbursement of expenses, if any. Without
these voluntary waivers and/or expense reimbursements, performance would be less favorable.
The Funds Management and Administration
The Funds Management and Administration
The Fund is a series of J.P. Morgan Exchange-Traded Fund Trust, a Delaware statutory trust (the Trust). The Trust is governed by the Board of Trustees, which
is responsible for overseeing all business activities of the Fund.
The Funds Investment Adviser and Administrator
J.P. Morgan Investment Management Inc. (JPMIM or the adviser) is the investment adviser and administrator to the Fund. JPMIM is located at
383 Madison Avenue, New York, NY 10179. In addition to managing the Funds portfolio, JPMIM also provides administrative services for and oversees the other service providers of the Fund.
JPMIM is a wholly-owned subsidiary of JPMorgan Asset Management Holdings Inc., which is a wholly-owned subsidiary of JPMorgan Chase & Co. (JPMorgan
Chase), a bank holding company.
In rendering investment advisory services to certain Funds, JPMIM uses the portfolio management, research and
other resources of a foreign (non-U.S.) affiliate of JPMIM and may provide services to the Fund through a participating affiliate arrangement, as that term is used in relief granted by the staff of
the SEC. Under this relief, U.S. registered investment advisers are allowed to use portfolio management or research resources of advisory affiliates subject to the regulatory supervision of the registered investment adviser.
A discussion of the basis the Board of Trustees of the Trust used in approving the management agreement for the Fund will be available in the first
shareholder report for the Fund.
Management Fee and Other Expenses
Pursuant to the Funds management agreement, JPMIM is entitled to a management fee, incurred daily and paid monthly of the Funds average daily net assets at following rate: 0.07%. Under the
management agreement, JPMIM is responsible for substantially all the expenses of the Trust relating to the Fund and the Fund, except for the management fees, payments under the Funds 12b-1 plan (if
any), interest expenses, dividend and interest expenses related to short sales, taxes, acquired fund fees and expenses (other than fees for funds advised by the adviser and/or its affiliates), costs of holding shareholder meetings, and
litigation and potential litigation and other extraordinary expenses not incurred in the ordinary course of the Funds business. Additionally, the Fund shall be responsible for its non-operating expenses,
including brokerage commissions and fees and expenses associated with the Funds securities lending program, if applicable.
The
Portfolio Managers
The portfolio management team utilizes a team-based approach, and the portfolio management team for the Fund is
comprised of Nicholas DEramo, Executive Director, Michael Loeffler, Executive Director, Oliver Furby, Executive Director, and Alex Hamilton, Executive Director. The team is responsible for managing the Fund on a day to day basis with a goal of
seeking investment results that closely correspond, before fees and expenses, to the performance of the Underlying Index. Each portfolio manager is responsible for various functions related to portfolio management, including, but not limited to,
investing cash inflows, coordinating with members of the portfolio management team to focus on certain portfolios, implementing investment strategy, researching and reviewing investment strategy. Mr. DEramo has been a portfolio manager
for JPMIM since 2005 and an employee of the firm or one of its predecessors since 1999. Mr. Loeffler has been a portfolio manager for JPMIM since 2004 and has been an employee of the firm or one of its predecessors since 1999. Mr. Loeffler
is a CFA charterholder. Mr. Furby has been a portfolio manager for JPMIM since 2014. Prior to joining JPMIM, he was a data analysis manager for JPMorgan Chase Bank, N.A. from 2012 to 2014. Before 2012, he worked at State Teachers Retirement
System of Ohio as a portfolio manager. Mr. Hamilton has been a portfolio manager for JPMIM since April 2017. Prior to joining JPMIM, he was an assistant portfolio manager at the Ohio Public Employees Retirement System from 2013 until 2017.
Before that time, he worked at Huntington National Bank in the corporate treasury and mortgage capital markets departments. Mr. Hamilton is a CFA charterholder.
The Statement of Additional Information provides additional information about the portfolio managers compensation, other accounts managed by the portfolio managers and the portfolio managers
ownership of securities.
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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The Funds Distributor
JPMorgan Distribution Services, Inc. (the Distributor) is the distributor of the Funds Shares. The Distributor or its agent distributes Creation Units for the Fund on an agency basis. The Distributor
does not maintain a secondary market in Shares of the Fund. The Distributor has no role in determining the investment policies of the Fund or the securities that are purchased or sold by the Fund. The Distributors principal address is 1111
Polaris Parkway, Columbus, OH 43240.
Payments to Financial Intermediaries
JPMIM and, from time to time, other affiliates of JPMorgan Chase may, at their own expense and out of their own legitimate profits, provide cash payments to Financial Intermediaries whose customers invest in
Shares of the Fund. For this purpose, Financial Intermediaries include financial advisors, investment advisers, brokers, financial planners, banks, insurance companies, retirement or 401(k) plan administrators and others, including various
affiliates of JPMorgan Chase, that may enter into agreements with JPMIM and/or its affiliates. These cash payments may relate to marketing activities and presentations, educational training programs, the support of technology platforms and/or
reporting systems, or the Financial Intermediaries making Shares of the Fund available to their customers. Such compensation may provide such Financial Intermediaries with an incentive to favor sales of Shares of the Fund over other investment
options they make available to their customers. See the Statement of Additional Information for more information.
Purchase and Redemption of Shares
BUYING AND SELLING SHARES
In the Secondary Market. Most investors will buy and sell Shares of the Fund in secondary market transactions through brokers. Shares of the Fund are
listed and traded on the secondary market on the Exchange. Shares can be bought and sold throughout the trading day like other publicly traded shares. There is no minimum investment. Although Shares are generally purchased and sold in round
lots of 100 Shares, brokerage firms typically permit investors to purchase or sell Shares in smaller odd lots, at no per-Share price differential. When buying or selling Shares through a broker, you will incur customary brokerage
commissions and charges, and you may pay some or all of the spread between the bid and the offered price in the secondary market on each leg of a round trip (purchase and sale) transaction. The spread varies over time for Shares of the Fund based on
the Funds trading volume and market liquidity, and is generally lower if the Fund has a lot of trading volume and market liquidity.
Shares
of the Fund trade on the Exchange at prices that may differ to varying degrees from the daily NAV of the Shares.
Directly with the Fund.
The Funds Shares are issued or redeemed by the Fund at NAV per Share only in Creation Units. Investors such as market makers, large investors and institutions who wish to deal in Creation Units directly with the Fund must have entered into an
authorized participant agreement with the Distributor, or purchase through a dealer that has entered into such an agreement. Set forth below is a brief description of the procedures applicable to purchases and redemptions of Creation Units. For more
detailed information, see Creation and Redemption of Creation Unit Aggregations in the Funds Statement of Additional Information.
Beneficial Ownership. The Depository Trust Company (DTC) serves as securities depository for the Shares. (The Shares may be held only in book-entry
form; stock certificates will not be issued.) DTC, or its nominee, is the record or registered owner of all outstanding Shares. Beneficial ownership of Shares will be shown on the records of DTC or its participants (described below). Beneficial
owners of Shares are not entitled to have Shares registered in their names, will not receive or be entitled to receive physical delivery of certificates in definitive form and are not considered the registered holder thereof. Accordingly, to
exercise any rights of a holder of Shares, each beneficial owner must rely on the procedures of: (i) DTC; (ii) DTC Participants, i.e., securities brokers and dealers, banks, trust companies, clearing corporations and
certain other organizations, some of whom (and/or their representatives) own DTC; and (iii) Indirect Participants, i.e., brokers, dealers, banks and trust companies that clear through or maintain a custodial relationship with
a DTC Participant, either directly or indirectly, through which such beneficial owner holds its interests. The Trust understands that under existing industry practice, in the event the Trust requests any action of holders of Shares, or a beneficial
owner desires to take any action that DTC, as the record owner of all outstanding Shares, is entitled to take, DTC would authorize the DTC Participants to take such action and that the DTC Participants would authorize the Indirect Participants and
beneficial owners acting through such DTC Participants to take such action and would otherwise act upon the instructions of beneficial owners owning through them. As described above, the Trust recognizes DTC or its nominee as the owner of all Shares
for all purposes. For more detailed information, see Book Entry Only System in the Funds Statement of Additional Information.
PREMIUM/DISCOUNT INFORMATION
The Fund has not commenced operations as of the date of this prospectus and, therefore, does not have information about the differences between the Funds daily market price on the Exchange and its NAV.
When available, information regarding how often the Shares of the Fund traded on the Exchange at a price above (i.e., at a premium) or below (i.e., at a discount) the NAV of the Fund during the past four calendar quarters, as
applicable, can be found at www.jpmorganfunds.com.
PRICING SHARES
The trading price of the Funds Shares on the Exchange may differ from the Funds daily NAV and can be affected by market forces of supply and
demand, economic conditions and other factors.
The Exchange disseminates the approximate value of Shares of the Fund every fifteen seconds. This
approximate value should not be viewed as a real-time update of the NAV per Share of the Fund because the approximate value may not be calculated in the same manner as the NAV, which is computed only once a day. The approximate value is
generally determined by using both current market quotations and/or price quotations obtained from broker-dealers and other market intermediaries that may trade in the portfolio securities held by the Fund. As the respective international local
markets close, the approximate value will continue to be updated for foreign exchange rates for the remainder of the U.S. trading day at the prescribed 15 second interval, but certain holdings may not be updated otherwise if such holdings do not
trade in the United States. The Fund is not involved in, or responsible for, the calculation or dissemination of the approximate value and the Fund does not make any representation or warranty as to its accuracy.
NAV is calculated each business day as of the close of the Cboe BZX Exchange, Inc. (Exchange), which is typically 4:00 p.m. E.T. On occasion, the Exchange
will close before 4:00 p.m. E.T. When that happens, NAV will be calculated as of the time the Exchange closes. The
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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Fund will not treat an intraday unscheduled disruption or closure in the Exchange trading as a closure of the Exchange and will calculate NAV as of 4:00 p.m. E.T. if the particular
disruption or closure directly affects only the Exchange. The price at which a purchase of a Creation Unit is effected is based on the next calculation of NAV after the order is received in proper form in accordance with this prospectus. To the
extent the Fund invests in securities that are primarily listed on foreign exchanges or other markets that trade on weekends or other days when the Fund does not price its Shares, the value of the Funds Shares may change on days when you will
not be able to purchase or redeem your Shares. The NAV per share of the Fund is equal to the value of all its assets minus its liabilities, divided by the number of outstanding Shares.
Securities for which market quotations are readily available are generally valued at their current market value. Other securities and assets, including securities for which market quotations are not readily
available, market quotations are determined not to be reliable, or, their value has been materially affected by events occurring after the close of trading on the exchange or market on which the security is principally traded but before the
Funds NAV is calculated, may be valued at fair value in accordance with policies and procedures adopted by the Trusts Board of Trustees. Fair value represents a good faith determination of the value of a security or other asset based
upon specifically applied procedures. Fair valuation may require subjective determinations. There can be no assurance that the fair value of an asset is the price at which the asset could have been sold during the period in which the particular fair
value was used in determining the Funds NAV. Use of fair value prices and certain current market valuations could result in a difference between the prices used to calculate the Funds NAV and the prices used by the Underlying Index,
which, in turn, could result in a difference between the Funds performance the performance of the Underlying Index.
Equity securities
listed on a North American, Central American, South American or Caribbean securities exchange are generally valued at the last sale price on the exchange on which the security is principally traded. Other foreign equity securities are fair valued
using quotations from independent pricing services, as applicable. The value of securities listed on the NASDAQ Stock Market, Inc. is generally the NASDAQ official closing price.
Fixed income securities are valued using prices supplied by an approved independent third party or affiliated pricing services or broker/dealers. Those prices are determined using a variety of inputs and
factors as more fully described in the Statement of Additional Information.
Assets and liabilities initially expressed in foreign currencies are
converted into U.S. dollars at the prevailing market rates from an approved independent pricing service as of 4:00 p.m. E.T.
Shares of ETFs are
generally valued at the last sale price on the exchange on which the ETF is principally traded. Shares of other open-end investment companies are valued at their respective NAVs.
Options traded on U.S. securities exchanges are valued at the composite mean price, using the National Best Bid and Offer quotes.
Options traded on foreign exchanges are valued at the settled price, or if no settled price is available, at the last sale price available prior to the calculation of the Funds NAV and will be fair
valued by applying fair value factors provided by independent pricing services, as applicable, for any options involving equity reference obligations listed on exchanges other than North American, Central American, South American or Caribbean
securities exchanges.
Exchange traded futures are valued at the last sale price available prior to the calculation of the Funds NAV. Any
futures involving equity reference obligations listed on exchanges other than North American, Central American, South American or Caribbean securities exchanges will be fair valued by applying fair value factors provided by independent pricing
services, as applicable.
Non-listed over-the-counter futures are valued utilizing market quotations provided by approved pricing services.
Swaps and structured notes are priced generally by an approved independent third party or affiliated pricing service or at an evaluated price
provided by a counterparty or broker/dealer.
Any derivatives involving equity reference obligations listed on exchanges other than North
American, Central American, South American or Caribbean securities exchanges will be fair valued by applying fair value factors provided by independent pricing services, as applicable.
FREQUENT PURCHASES AND REDEMPTIONS
The Fund imposes no restrictions on
the frequency of purchases and redemptions. The Board of Trustees evaluated the risks of market timing activities by the Funds shareholders when they considered that no restriction or policy was necessary. The Board considered that, unlike
mutual funds, the Fund issues and redeems its Shares at NAV only in Creation Units, and the Funds Shares may be purchased and sold on the Exchange at prevailing market prices.
Shareholder Information
TAXES ON DISTRIBUTIONS
The Fund intends to elect to be treated and to qualify each taxable year as a regulated investment company. A regulated investment company is not subject to
tax at the corporate level on income and gains from investments that are distributed to shareholders. The Funds failure to qualify as a regulated investment company would result in corporate-level taxation and, consequently, a reduction in
income available for distribution to shareholders.
The Fund can earn income and realize capital gain. The Fund deducts any expenses and then pays
out the earnings, if any, to shareholders as distributions.
The Fund generally declares and distributes net investment income, if any, at least
quarterly. The Fund will distribute net realized capital gain, if any, at least annually. For each taxable year, the Fund will distribute substantially all of its net investment income and net realized capital gain.
Distributions of net investment income generally are taxable as ordinary income. Dividends of net investment income paid to a non-corporate U.S. shareholder
that are properly reported as qualified dividend income generally will be taxable to such shareholder at a maximum individual federal income tax rate applicable to qualified dividend income of either 15% or 20%, depending on whether the
individuals income exceeds certain threshold amounts. The amount of dividend income that may be so reported by the Fund generally will be limited to the aggregate of the eligible dividends received by the Fund. In addition, the Fund must meet
certain holding period and other requirements with respect to the shares on which the Fund received the eligible dividends, and the non-corporate U.S. shareholder must meet certain holding period and other requirements with respect to the Fund. The
amount of the Funds distributions that would otherwise qualify for this favorable tax treatment will be reduced as a result of the Funds securities lending activities or high portfolio turnover-rate. Dividends of net investment income
that are not reported as qualified dividend income and dividends of net short-term capital gain will be taxable to a U.S. shareholder as ordinary income.
Distributions of net capital gain (that is, the excess of the net gains from the sale of investments that the Fund owned for more than one year over the net losses from investments that the Fund owned for
one year or less) that are properly reported by the Fund as capital gain dividends will be taxable as long-term capital gain, regardless of how long you have held your Shares in the Fund. The maximum individual federal income tax rate applicable to
long-term capital gains is generally either 15% or 20%, depending on whether the individuals income exceeds certain threshold amounts. Distributions of net short-term capital gain (that is, the excess of any net short-term capital gain over
net long-term capital loss), if any, will be taxable to U.S. shareholders as ordinary income. Capital gain of a corporate shareholder is taxed at the same rate as ordinary income.
An additional 3.8% Medicare tax is imposed on certain net investment income (including ordinary dividends and capital gain distributions received from the Fund and net gains from redemptions or other taxable
dispositions of Shares) of U.S. individuals, estates and trusts to the extent that such persons modified adjusted gross income (in the case of an individual) or adjusted gross income (in the case of an estate or trust)
exceeds certain threshold amounts.
If you buy Shares of the Fund just before a distribution, you will be subject to tax on the entire amount of
the taxable distribution you receive. Distributions are taxable to you even if they are paid from income or gain earned by the Fund before your investment (and thus were included in the price you paid for your Shares). Any gain resulting from the
sale or exchange of Shares generally will be taxable as long-term or short-term gain, depending upon how long you have held the Shares.
The Fund is generally subject to foreign withholding or other foreign taxes, which in some cases can be significant, on any income or gain from investments
in foreign stocks or securities. In that case, the Funds total return on those securities would be decreased. The Fund may generally deduct these taxes in computing its taxable income. Rather than deducting these foreign taxes, if the Fund
invests more than 50% of its assets in the stock or securities of foreign corporations or foreign governments at the end of its taxable year it may make an election to treat a proportionate amount of eligible foreign taxes as constituting a taxable
distribution to each shareholder, including the Fund. If the Fund invests more than 50% of its assets in the stock or securities of foreign corporations or foreign governments at the end of its taxable year, or if at least 50% of the value of the
Funds total assets at the close of each quarter of its taxable year is represented by interests in other regulated investment companies, it may make an election to treat a proportionate amount of eligible foreign taxes as constituting a
taxable distribution to each shareholder, which would, subject to certain limitations, generally allow the shareholders to either (i) credit that proportionate amount of taxes against U.S. Federal income tax liability as a foreign tax credit or (ii)
take that amount as an itemized deduction. Any foreign tax withheld on payments made in lieu of dividends or interest with respect to loaned securities will not qualify for the pass-through of foreign tax credits to shareholders.
Although in some cases the Fund may be able to apply for a refund or a portion of such taxes, the ability to successfully obtain such a refund may be uncertain.
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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The Funds investment in REIT securities, derivative instruments and so called passive foreign
investment companies may require the Fund to accrue and distribute income not yet received. In order to generate sufficient cash to make the requisite distributions, the Fund may be required to liquidate other investments in its portfolio that
it otherwise would have continued to hold, including at times when it is not advantageous to do so. The Funds investment in REIT securities may also result in the Funds receipt of cash in excess of the REITs earnings; if the Fund
distributes such amounts, such distribution could constitute a return of capital to Fund shareholders for federal income tax purposes.
The
Funds transactions in derivatives will be subject to special tax rules, the effect of which may be to accelerate income to the Fund, defer losses to the Fund, cause adjustments in the holding periods of the Funds securities, and convert
short-term capital losses into long-term capital losses. These rules could therefore affect the amount, timing and character of distributions to shareholders. The Funds use of these types of transactions may result in the Fund realizing more
short-term capital gain and ordinary income subject to tax at ordinary income tax rates than it would if it did not engage in such transactions.
Please see the Statement of Additional Information for additional discussion of the tax consequences of the above-described and other investments to the Fund
and its shareholders.
The dates on which dividends and capital gain, if any, will be distributed are available online at www.jpmorganfunds.com.
Early in each calendar year, you will receive a notice showing the amount of distributions you received during the preceding calendar year and
the tax status of those distributions.
Any foreign shareholder would generally be subject to U.S.
tax-withholding on distributions by the Fund, as discussed in the Statement of Additional Information.
Any investor for whom the Fund does not have a valid Taxpayer Identification Number may be subject to backup withholding.
The tax considerations described in this section do not apply to tax-deferred accounts or other non-taxable entities.
TAXES ON EXCHANGE-LISTED SHARES SALES
Currently, any capital gain or loss realized upon a sale of Shares is generally treated as long-term capital gain or loss if the Shares have been held for more than one year and as short-term capital gain or
loss if the Shares have been held for one year or less. Capital loss realized on the sale or exchange of Shares held for six months or less will be treated as long-term capital loss to the extent of any capital gain dividends received by the
shareholder. The ability to deduct capital losses may be limited.
TAXES ON PURCHASE AND REDEMPTION OF
CREATION UNITS
At the time of purchase, an Authorized Participant who exchanges equity securities for Creation Units generally will
recognize a gain or loss. The gain or loss will be equal to the difference between the market value of the Creation Units at the time and the exchangers aggregate basis in the securities surrendered and the cash paid. At redemption, a person
who exchanges Creation Units for equity securities will generally recognize a gain or loss equal to the difference between the exchangers basis in the Creation Units and the aggregate market value of the securities received and the cash
received in connection with the redemption. The Internal Revenue Service, however, may assert that a loss realized upon an exchange of securities for Creation Units cannot be deducted currently under the rules governing wash sales on the
basis that there has been no significant change in economic position. Persons exchanging securities should consult their own tax advisor with respect to whether the wash sale rules apply and when a loss might be deductible.
Under current federal tax laws, any capital gain or loss realized upon redemption of Creation Units is generally treated as long-term capital gain or loss if
the Shares have been held for more than one year and as a short-term capital gain or loss if the Shares have been held for one year or less.
If
you purchase or redeem Creation Units, you will be sent a confirmation statement showing how many and at what price you purchased or sold Shares.
The above is a general summary of tax implications of investing in the Fund. Because each investors tax consequences are unique, please consult your
tax advisor to see how investing in the Fund and, for individuals and S corporations, selection of a particular cost method of accounting will affect your own tax situation.
Shareholder Information
(continued)
AVAILABILITY OF PROXY VOTING RECORD
The Trustees have delegated the authority to vote proxies for securities owned by the Fund to JPMIM. When available, a copy of the Funds voting record for the most recent 12-month period ended
June 30 will be available on the SECs website at www.sec.gov or on the Funds website at www.jpmorganfunds.com no later than August 31 of each year. The Funds proxy voting record will include, among other things, a brief
description of the matter voted on for each portfolio security, and will state how each vote was cast, for example, for or against the proposal.
OTHER INFORMATION
For purposes of the 1940 Act, the Fund is treated as a registered investment company. Section 12(d)(1) of the 1940 Act restricts investments by
investment companies in the securities of other investment companies, including Shares of the Fund. Registered investment companies are permitted to invest in the Fund beyond the limits set forth in Section 12(d)(1) subject to certain terms and
conditions set forth in an SEC exemptive order issued to the Trust, including that such investment companies enter into an agreement with the Fund.
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J.P. MORGAN EXCHANGE-TRADED FUNDS
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Financial Highlights
This section would ordinarily include Financial Highlights. The Financial
Highlights table is intended to help you understand the Funds performance for the Funds periods of operations. Because the Fund has not yet commenced operations as of the date of this prospectus, no Financial Highlights are shown.
HOW TO REACH US
MORE INFORMATION
For investors who want more information on the Fund the following documents are available free upon request:
ANNUAL AND SEMI-ANNUAL REPORTS
The Funds annual and semi-annual reports, when available,
will contain more information about the Funds investments and performance. The annual report will also include details about the market conditions and investment strategies that have a significant effect on the Funds performance.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
The SAI contains more detailed information about the Fund and its policies. It is incorporated by reference into this prospectus. This means, by law, it is considered to be part of this prospectus.
You can get a free copy of these documents and other information, or ask us any questions, by calling us at 1-844-457-6383 (844-4JPM ETF)
or writing to:
J.P. Morgan Exchange-Traded Funds
277 Park Avenue
New York, NY 10172
If you buy your shares through a Financial Intermediary, you should contact that Financial Intermediary
directly for more information. You can also find information online at www.jpmorganfunds.com.
You can write or e-mail the SECs Public
Reference Section and ask them to mail you information about the Fund, including the SAI. They will charge you a copying fee for this service.
Public Reference Section
Washington, DC
20549-1520
Email: publicinfo@sec.gov
Reports, a copy of the SAI and other information about the Fund are also available on the EDGAR Database on the SECs website at http://www.sec.gov.
Investment Company Act File No. for the Fund is 811-22903.
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©JPMorgan Chase & Co., 2019. All rights reserved.
December 2019.
PR-BBINETF-1219
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STATEMENT OF ADDITIONAL INFORMATION
PART I
December 2, 2019
J.P. MORGAN EXCHANGE-TRADED FUND TRUST (the Trust)
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Fund Name
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Ticker
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Listing Exchange
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JPMorgan BetaBuilders International Equity ETF (the BetaBuilders International Equity ETF or
the Fund)
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BBIN
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Cboe BZX Exchange, Inc.
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This Statement of Additional Information (SAI) is not a prospectus, but contains
additional information which should be read in conjunction with the prospectus for the Fund, dated December 2, 2019, as supplemented from time to time (the Prospectus). The Prospectus is available without charge upon request by
contacting JPMorgan Distribution Services, Inc. (JPMDS or the Distributor), the Funds distributor, at 1111 Polaris Parkway, Columbus, OH 43240.
This SAI is divided into two Parts Part I and Part II. Part I of this SAI contains information that is particular to the Fund.
Part II of this SAI contains additional information that more generally applies to the Trusts funds.
For more
information about the Fund, simply write or call:
J.P. Morgan Exchange-Traded Funds
277 Park Ave
New
York, NY 10172
1-844-457-6383 (844-4JPM ETF)
SAI-BBINETF-1219
TABLE OF CONTENTS
PART I
PLEASE SEE PART II OF THIS SAI FOR ITS TABLE OF CONTENTS
Part I - i
GENERAL
The Trust and the Fund
The Fund is a series of J.P. Morgan Exchange-Traded Fund Trust (the Trust), an open-end, management investment company formed as a statutory trust under
the laws of the State of Delaware on February 25, 2010 and governed by a Declaration of Trust as amended and restated on February 19, 2014.
The Fund will offer and issue shares at net asset value (NAV) only in aggregations of a specified number of shares (each a Creation Unit or a Creation Unit
Aggregation). The shares of the Fund are collectively referred to as the Shares in this SAI. The Funds Shares will be listed and traded on the Cboe BZX Exchange, Inc. (the Exchange). Fund Shares will trade on the
Exchange at market prices that may be below, at or above NAV. Shares are redeemable only in Creation Unit Aggregations and generally in exchange for portfolio securities held by the Fund and/or a specified cash payment. The amount of Shares in a
Creation Unit for the Fund is 200,000 Shares.
In the event of the liquidation of the Fund, the Trust may lower the number
of Shares in a Creation Unit. The Trust reserves the right to permit or require a full or partial cash option for creations and/or redemptions of Fund Shares. Fund Shares may be issued in advance of receipt of a basket of securities and
other investments (Deposit Instruments) included in the Funds index (Underlying Index) subject to various conditions. See the Creation and Redemption of Creation Units section in Appendix A. In each instance
of such cash creations or redemptions, transaction fees may be imposed that will be higher than the transaction fees associated with in-kind creations or redemptions. In all cases, such fees will be limited in
accordance with the requirements of the Securities and Exchange Commission (the SEC) applicable to management investment companies offering redeemable securities.
Miscellaneous
This SAI describes the financial
history, investment strategies and policies, management and operation of the Fund in order to enable investors to determine whether the Fund best suits their needs.
This SAI provides additional information with respect to the Fund and should be read in conjunction with the Funds current Prospectus. Capitalized terms not otherwise defined herein have the
meanings accorded to them in the Prospectus. The Funds executive offices are located at 277 Park Avenue, New York, NY 10172.
The Trusts Board of Trustees is referred to herein as the Board of Trustees or Board, and each trustee is referred to as a Trustee. J.P. Morgan Investment
Management Inc. (JPMIM or the Adviser) is the investment adviser to the Fund. Investments in the Fund are not deposits or obligations of, nor guaranteed or endorsed by, JPMorgan Chase Bank, N.A. (JPMorgan Chase
Bank), an affiliate of the Adviser, or any other bank. Shares of the Fund are not federally insured or guaranteed by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other governmental agency. An investment in the
Fund is subject to risks that may cause the value of the investment to fluctuate, and when the investment is redeemed, the value may be higher or lower than the amount originally invested by the investor.
The Fund is not subject to registration or regulation as a commodity pool operator as defined in the Commodity Exchange Act
because the Fund has claimed an exclusion from that definition.
INVESTMENT POLICIES
The following investment policies have been adopted by the Trust with respect to the Fund. The investment policies listed
below under the heading Fundamental Investment Policies are fundamental policies which, under the Investment Company Act of 1940, as amended (the 1940 Act), may not be changed without the vote of a majority of the
outstanding voting securities of the Fund, as such term is defined in the Additional Information section in Part II of this SAI. All other investment policies of the Fund (including its investment objective) are non-fundamental, unless otherwise designated in the Prospectus or herein, and may be changed by the Trustees of the Fund without shareholder approval.
Except for each of the restrictions on borrowings set forth in the fundamental investment policies below, the percentage limitations
contained in the policies below apply at the time of purchase of the securities. If a percentage or rating restriction on investment or use of assets set forth in a fundamental investment policy or a
non-fundamental investment policy or in the Prospectus is adhered to at the time of investment, later changes in percentage resulting from any cause other than actions by the Fund will not be considered a
violation. If the value of the Funds holdings of illiquid securities at any time exceeds the percentage limitation applicable at the time of
Part I - 1
acquisition due to subsequent fluctuations in value or other reasons, the Funds Adviser, or persons designated by the Board to make such determination, will consider what actions, if any,
are appropriate to maintain adequate liquidity. With respect to the fundamental investment policy on borrowing, the 1940 Act generally limits the Funds ability to borrow money on a non-temporary basis if
such borrowings constitute senior securities. As noted in Investment Strategies and Policies Miscellaneous Investment Strategies and Risks Borrowings in SAI Part II, in addition to temporary borrowing, the Fund
may borrow from any bank, provided that immediately after any such borrowing there is an asset coverage of at least 300% for all borrowings by the Fund and provided further, that in the event that such asset coverage shall at any time fall below
300%, the Fund shall, within three days (not including Sundays or holidays) thereafter or such longer period as the SEC may prescribe by rules and regulations, reduce the amount of its borrowings to such an extent that the asset coverage of such
borrowing shall be at least 300%. The Fund may also borrow money or engage in economically similar transactions if those transactions do not constitute senior securities under the 1940 Act as interpreted based upon no-action letters and other pronouncements of the staff of the SEC. Under no-action letters and other pronouncements of the staff of the SEC, certain Fund positions (e.g.,
reverse repurchase agreements) are excluded from the definition of senior security so long as the Fund follows applicable law, including, but not limited to, maintaining adequate cover and segregation of assets. Similarly, a short sale
will not be considered a senior security if the Fund takes certain steps contemplated by SEC staff pronouncements, such as ensuring the short sale transaction is adequately covered.
For purposes of the Funds fundamental investment policy regarding industry concentration, to concentrate generally means
to invest more than 25% of the Funds total assets, taken at market value at the time of investment.
With respect to
the Funds fundamental policy with respect to diversification, the Fund intends to be diversified in approximately the same proportion as the Underlying Index.
In addition, the Fund has an 80% investment policy which is described in the Funds Prospectus. In calculating Assets for the purposes of the Funds 80% investment policy, Assets are
net assets plus the amount of any borrowings for investment purposes. This policy may be changed by the Board of Trustees without shareholder approval. However, the Fund will provide shareholders with written notice at least 60 days prior to a
change in its policy to invest at least 80% of its Assets in securities included in its Underlying Index.
Finally, the Fund is
subject to the fundamental and non-fundamental investment policies and investment restrictions applicable to the Fund that are described herein and by any restrictions imposed by applicable law.
Fundamental Investment Policies.
The
Fund:
(1) May purchase any security which would cause the Fund to concentrate more than 25% of its
investments in the securities of issuers primarily engaged in any particular industry or group of industries to the extent the index which the Fund replicates and which may be changed is concentrated in the securities of issuers primarily engaged in
any particular industry or group of industries, but will not concentrate in the securities of issuers primarily engaged in any particular industry or group of industries at any time when the Funds index is not concentrated. This policy does
not apply to investments in securities issued or guaranteed by the U.S. government or any of its agencies or instrumentalities, or repurchase agreements secured thereby, and futures and options transactions issued or guaranteed by the U.S.
government or any of its agencies or instrumentalities;
(2) May issue senior securities, to the extent
permitted by the 1940 Act or any applicable law, rule, order or interpretation;
(3) May borrow money to the
extent permitted by the 1940 Act or any applicable law, rule, order or interpretation;
(4) May not underwrite
the securities of other issuers, except to the extent that the Fund may be deemed an underwriter under certain securities laws in disposing of portfolio securities or in connection with investments in other investment companies;
(5) May purchase or sell real estate or any interest therein (such as securities or instruments backed by or related to
real estate) to the extent permitted by the 1940 Act or any applicable law, rule, order or interpretation;
(6) May not purchase or sell commodities or commodity contracts except as may be permitted by the 1940 Act or unless
acquired as a result of ownership of securities or other instruments issued by persons that purchase or sell commodities or commodities contracts; but this shall not prevent the Fund from purchasing, selling and entering into financial futures
contracts (including futures contracts on indices of securities, interest rates and currencies),
Part I - 2
options on financial futures contracts (including futures contracts on indices of securities, interest rates and currencies), warrants, swaps, forward contracts, foreign currency spot and forward
contracts or other derivative instruments including derivatives related to physical commodities;
(7) May make
loans to the extent permitted by the 1940 Act or any applicable law, rule, order or interpretation; and
(8) May not make any investment inconsistent with its classification as a diversified investment company as that term is
defined in the 1940 Act or as interpreted, modified or applied by the SEC or its staff.
INVESTMENT PRACTICES
The Fund invests in a variety of securities and employs a number of investment techniques. What follows is a list of some of the securities and techniques which may be utilized by the Fund. For a more
complete discussion, see the Investment Strategies and Policies section in Part II of this SAI.
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Instrument
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Part
II
Section Reference
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Bank Obligations: Bankers acceptances, certificates of deposit and time
deposits. Bankers acceptances are bills of exchange or time drafts drawn on and accepted by a commercial bank. Maturities are generally six months or less. Certificates of deposit are negotiable certificates issued by a bank for a specified
period of time and earning a specified return. Time deposits are non-negotiable receipts issued by a bank in exchange for the deposit of funds.
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Bank Obligations
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Borrowings: The Fund may borrow for temporary purposes and/or for investment
purposes. Such a practice will result in leveraging of the Funds assets and may cause the Fund to liquidate portfolio positions when it would not be advantageous to do so. The Fund must maintain continuous asset coverage of 300% of the amount
borrowed, with the exception for borrowings not in excess of 5% of the Funds total assets made for temporary administrative purposes.
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Miscellaneous Investment Strategies and Risks
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Commercial Paper: Secured and unsecured short-term promissory notes issued by
corporations and other entities. Maturities generally vary from a few days to nine months.
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Commercial Paper
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Common Stock: Shares of ownership of a company.
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Equity Securities, Warrants and Rights
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Common Stock Warrants and Rights: Securities, typically issued with preferred stock
or bonds, that give the holder the right to buy a proportionate amount of common stock at a specified price.
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Equity Securities, Warrants and Rights
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Convertible Securities: Bonds or preferred stock that can convert to common
stock.
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Convertible Securities
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Exchange-Traded Funds (ETFs): Ownership interest in unit investment
trusts, depositary receipts, and other pooled investment vehicles that hold a portfolio of securities or stocks designed to track the price performance and dividend yield of a particular broad-based, sector or international index. ETFs include a
wide range of investments.
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Investment Company Securities and Exchange-Traded Funds
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Foreign Currency Transactions: Strategies used to hedge against currency risks, for
other risk management purposes or to increase income or gain to a Fund. These strategies may consist of use of any of the following: options on currencies, currency futures, options on such futures, forward foreign currency transactions (including non-deliverable forwards (NDFs)), forward rate agreements and currency swaps, caps and floors.
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Foreign Investments (including Foreign Currencies)
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Foreign Investments: Equity securities of foreign entities and obligations of foreign
branches of U.S. banks and foreign banks. Foreign securities may also include American Depositary Receipts (ADRs), Global Depositary Receipts (GDRs), European Depositary Receipts (EDRs) and American Depositary
Securities (ADSs).
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Foreign Investments (including Foreign
Currencies)
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Part I - 3
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Instrument
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Part
II
Section Reference
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Investment Company Securities: Shares of other investment companies, including money
market funds for which the Adviser and/or its affiliates serve as investment adviser or administrator. The Adviser will waive certain fees when investing in funds for which it serves as investment adviser, to the extent required by law or by
contract.
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Investment Company Securities and Exchange-Traded Funds
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New Financial Products: New options and futures contracts and other financial
products continue to be developed and a Fund may invest in such options, contracts and products.
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Miscellaneous Investment Strategies and Risks
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Options and Futures Transactions: The Fund may purchase and sell (a) exchange
traded and over-the-counter put and call options on securities, indexes of securities and futures contracts on securities and indexes of securities and (b) futures
contracts on securities and indexes of securities.
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Options and Futures Transactions
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Preferred Stock: A class of stock that generally pays a dividend at a specified rate
and has preference over common stock in the payment of dividends and in liquidation.
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Equity Securities, Warrants and Rights
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Real Estate Investment Trusts (REITs): Pooled investment vehicles which
invest primarily in income producing real estate or real estate related loans or interest.
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Real Estate Investment Trusts
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Securities Issued in Connection with Reorganizations and Corporate Restructurings: In
connection with reorganizing or restructuring of an issuer, an issuer may issue common stock or other securities to holders of its debt securities.
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Miscellaneous Investment Strategies and Risks
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Securities Lending: The lending of up to 33 1/3%
of a Funds total assets. In return a Fund will receive cash as collateral.
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Securities Lending
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U.S. Government Obligations: May include direct obligations of the U.S. Treasury,
including Treasury bills, notes and bonds, all of which are backed as to principal and interest payments by the full faith and credit of the United States, and separately traded principal and interest component parts of such obligations that are
transferable through the Federal book-entry system known as Separate Trading of Registered Interest and Principal of Securities (STRIPS) and Coupons Under Book Entry Safekeeping (CUBES).
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U.S. Government Obligations
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When-Issued Securities, Delayed Delivery Securities and Forward Commitments: Purchase
or contract to purchase securities at a fixed price for delivery at a future date.
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When-Issued Securities, Delayed Delivery Securities and Forward
Commitments
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Exemptive Application Requirements
The Fund must comply with the requirements of the exemptive application which allows it to operate as an exchange-traded fund. Because the Fund is passively managed, it must invest at least 80% of its
assets, exclusive of collateral held from securities lending (if any) in component securities of the Underlying Index and in depositary receipts representing such component securities. Any depositary receipts held by the Fund will be negotiable
securities that represent ownership of a non-U.S. companys publicly traded stock. The Adviser believes that, in certain cases, holding one or more depositary receipts rather than the component securities of the relevant Underlying Index, will
improve the liquidity, tradability, and settlement of that Funds then current portfolio deposit (thereby improving the efficiency of the creation and redemption process and facilitating efficient arbitrage activity), while at the same time
permitting the Fund to maintain direct exposure to component securities of its Underlying Index.
DIVERSIFICATION
The Trust is a registered management investment company. The Fund is a diversified series of the
Trust. However, the Fund may operate as non-diversified solely as a result of a change in the relative market capitalization or index weighting of one or more constituents of the Underlying Index. For a more complete discussion of the
diversification requirements of the 1940 Act, see the Diversification section in Part II of this SAI.
Part I - 4
PORTFOLIO TURNOVER
A portfolio turnover rate is, in summary, the percentage computed by dividing the lesser of the Funds purchases or sales of
securities (excluding short-term securities) by the average market value of the Fund. The Adviser intends to manage the Funds assets by buying and selling securities to help attain its investment objective. A rate of 100% indicates that the
equivalent of all of the Funds assets have been sold and reinvested in a year. Higher portfolio turnover may affect the amount, timing and character of distributions, and, as a result, may increase the amount of taxes payable by shareholders.
High portfolio turnover also results in higher transaction costs. To the extent that net short-term capital gains are realized by the Fund, any distributions resulting from such gains are considered ordinary income for federal income tax purposes.
For a more complete discussion, see the Distributions and Tax Matters section in Part II of this SAI. The Fund has not commenced operations as of the date of this SAI. Therefore, there is no portfolio turnover rate for the Fund to report
at this time.
TRUSTEES
Standing Committees
There are two standing
committees of the Board of Trustees: the Audit and Valuation Committee and the Governance and Nominating Committee. During the fiscal year ended October 31, 2019, the Audit and Valuation Committee met 4 times and the Governance and Nominating
Committee met 2 times. For a more complete discussion, see the Trustees section in Part II of this SAI.
Ownership of Securities
The following table shows the dollar range of each Trustees beneficial ownership of
equity securities in the Fund and each Trustees aggregate dollar range of ownership in the funds that the Trustee oversees in the Family of Investment Companies as of December 31, 2018:
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Name of Trustee
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Dollar Range of
Equity Securities in
BetaBuilders
International Equity ETF
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Aggregate Dollar Range
of Equity Securities
in
All Registered
Investment Companies
Overseen by the
Trustee in Family of
Investment Companies1
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Independent Trustees
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Gary L. French
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None
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$50,001-$100,000
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Robert J. Grassi
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None
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Over $100,000
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Thomas P. Lemke
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None
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Over $100,000
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Lawrence R. Maffia
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None
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Over $100,000
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Emily A. Youssouf
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None
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$10,001-$50,000
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Interested Trustee
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Robert Deutsch
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None
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Over $100,000
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1
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A Family of Investment Companies means any two or more registered investment companies that share the same investment adviser or principal underwriter
and hold themselves out to investors as related companies for purposes of investment and investor services. The Family of Investment Companies for which the Board of Trustees currently serves includes, 35 Funds and one Trust.
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Trustee Compensation
Trustee aggregate compensation paid by the Trust for the calendar year ended December 31, 2018, is set forth below:
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Name of Trustee
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Total Compensation Paid
by the Fund Complex1
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Independent Trustees
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Gary L. French
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$
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87,500
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Robert J. Grassi
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80,000
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Thomas P. Lemke
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88,000
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Lawrence R. Maffia
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80,000
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Emily A. Youssouf
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86,000
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Interested Trustee
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Robert Deutsch2
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0
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1
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A Fund Complex means two or more registered investment companies that (i) hold themselves out to investors as related companies for purposes of
investment and investor services or (ii) have a common investment adviser or have an investment adviser that is an affiliated
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Part I - 5
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person of the investment adviser of any of the other registered investment companies. The J.P. Morgan Funds Complex for which the Board of Trustees currently serves includes, 35 Funds and one
Trust.
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2
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Mr. Deutsch received no compensation directly from the Trust.
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For a more complete discussion, see Trustee Compensation in Part II of this SAI for more information.
INVESTMENT ADVISER AND ADMINISTRATOR
Management Fees
Since the Fund has not
commenced operations as of the date of this SAI, the Fund has not paid any management fees. For more information about the Adviser and the Administrator, see the Investment Adviser and Administrator sections in Part II of
this SAI.
PORTFOLIO MANAGERS
Portfolio Managers Other Accounts Managed*
The following table shows information regarding all of the other accounts for which advisory fees are not based on the performance of the accounts that are managed by the Funds portfolio managers as
of October 31, 2019:
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Non-Performance Based Fee Advisory Accounts
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Registered Investment
Companies
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Other Pooled Investment
Vehicles
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Other Accounts
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Number
of
Accounts
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Total
Assets
($ thousands)
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Number
of
Accounts
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Total Assets
($ thousands)
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Number
of
Accounts
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Total Assets
($ thousands)
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BetaBuilders International Equity ETF
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Nicholas DEramo
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14
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$
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33,438,427
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8
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$
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16,824,549
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4
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$
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118,047
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Michael Loeffler
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14
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33,438,427
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8
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16,824,549
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4
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118,047
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Oliver Furby
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10
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19,503,306
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8
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16,824,549
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4
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118,047
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Alex Hamilton
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10
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19,503,306
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8
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16,824,549
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4
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118,047
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The following table shows information on the other accounts managed by the Funds portfolio
managers that have advisory fees wholly or partly based on performance as of October 31, 2019:
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Performance Based Fee Advisory Accounts
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Registered Investment
Companies
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Other Pooled Investment
Vehicles
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Other Accounts
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Number
of
Accounts
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Total
Assets
($ thousands)
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Number
of
Accounts
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Total
Assets
($ thousands)
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Number
of
Accounts
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Total Assets
($ thousands)
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BetaBuilders International Equity ETF
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Nicholas DEramo
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0
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$
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0
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0
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$
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0
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0
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$
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0
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Michael Loeffler
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0
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0
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0
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0
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0
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0
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Oliver Furby
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0
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0
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0
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0
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0
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0
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Alex Hamilton
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0
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0
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0
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0
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0
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0
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*
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The total value and number of accounts managed by a portfolio manager may include sub-accounts of
asset allocation, multi-managed and other accounts.
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Portfolio Managers Ownership of
Securities
Since the Fund has not commenced operations as of the date of this SAI, the portfolio managers do not own any
Shares of the Fund.
Portfolio Managers Compensation
In evaluating each portfolio managers performance with respect to the funds he or she manages, the Adviser uses the following index
as benchmarks to evaluate the performance of the portfolio manager with respect to the Fund:
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Name of Fund
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Benchmark
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BetaBuilders International Equity ETF
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Morningstar® Developed Markets ex-North America Target Market Exposure Index
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Please see Portfolio Manager Compensation section in Part II of this SAI for a description of
the structure and method of determining the compensation of the portfolio managers identified above.
Part I - 6
SECURITIES LENDING ACTIVITIES
Since the Fund has not commenced operations as of the date of this SAI, the Fund has not engage in securities lending. For more
information, see the Securities Lending Agent section in Part II of this SAI.
BROKERAGE
Brokerage Commissions
Since the Fund has not
commenced operations as of the date of this SAI, the Fund has not paid any brokerage commissions.
Broker
Research
Since the Fund has not commenced operations as of the date of this SAI, there has been no allocation of brokerage
commissions to brokers who provided broker research including third party broker research for the Fund.
Securities of Regular Broker-Dealers
Since the Fund has not commenced operations as of the date of this SAI, the Fund did not own securities of its regular broker-dealers (or parents thereof).
For a more complete discussion, see the Portfolio Transactions section in Part II of this SAI.
PURCHASE AND REDEMPTION OF CREATION UNITS
The Trust will issue and sell its Shares only in Creation Units on a continuous basis through the Distributor, without a sales load, at
the NAV next determined after receipt of an order in proper form as described in Placement of Creation Orders Outside NSCC Clearing Process-Foreign Funds in Appendix A to Part II of this SAI.
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Fund
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Creation*
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Redemption*
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BetaBuilders International Equity ETF
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200,000
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200,000
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*
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May be revised at any time without notice.
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CREATION AND REDEMPTION TRANSACTION FEES. A transaction fee, as set forth in the table below, is imposed for the transfer and other transaction costs associated with the purchase or redemption of Creation
Units, as applicable. Investors who are authorized to deal in Creation Units (Authorized Participants) will be required to pay a fixed creation transaction fee and/or a fixed redemption transaction fee, as applicable, on a given day
regardless of the number of Creation Units created or redeemed on that day. The Fund may adjust the transaction fee from time to time. An additional charge or a variable charge (discussed below) will be applied to certain creation and redemption
transactions, including non-standard orders and whole or partial cash purchases or redemptions. With respect to creation orders, Authorized Participants are responsible for the costs of transferring the
securities constituting the Deposit Instruments to the account of the Trust and with respect to redemption orders, Authorized Participants are responsible for the costs of transferring the securities received on redemption from the Trust to their
account or on their order. Investors who use the services of a broker or other such intermediary may also be charged a fee for such services.
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Fund
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Transaction Fee*, **
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BetaBuilders International Equity ETF
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$
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17,400
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*
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From time to time, the Fund may waive all or a portion of its applicable transaction fee(s).
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**
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In addition to the transaction fees listed above, the Fund may charge an additional variable fee for creations and redemptions in cash of up
to 3% of the amount of a creation transaction and of up to 2% of the amount of a redemption transaction to offset brokerage and impact expenses associated with the cash transaction.
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PURCHASE BY OTHER INVESTMENT COMPANIES
For purposes of the 1940 Act, the Fund is treated as a registered investment company. Section 12(d)(1) of the 1940 Act restricts
investments by investment companies in the securities of other investment companies, including Shares of the Fund.
Part I - 7
FINANCIAL INTERMEDIARIES
Compensation Payments
Since the Fund has not commenced operations as of the date of this SAI, neither JPMIM nor any other affiliate of JPMorgan Chase & Co. (JPMorgan Chase) has made any compensation payments to
intermediaries with respect to the Fund. For a more complete discussion, see the Compensation to Intermediaries section in Part II of this SAI.
TAX MATTERS
Capital Loss
Carryforwards
Since the Fund has not commenced operations as of the date of this SAI, the Fund has not had any capital
loss carryforwards. For more information on tax matters, see the Distributions and Tax Matters section in Part II of this SAI.
SHARE OWNERSHIP
Trustees and
Officers
Since the Fund has not commenced operations as of the date of this SAI, the officers and Trustees do not own any
Shares of the Fund.
Principal Holders
No Shares of the Fund have been issued as of the date of this SAI.
FINANCIAL STATEMENTS
Since the Fund has not commenced operations as of the date of this SAI, there are no financial statements for the Fund. When they become available, financial statements will be available without charge
upon request by calling 1-844-457-6383 (844-4JPM ETF).
Part I - 8
J.P. Morgan Exchange-Traded Fund Trust
STATEMENT OF ADDITIONAL INFORMATION
PART II
Part II of this SAI describes
policies and practices that apply to each of the J.P. Morgan Exchange-Traded Fund Trust’s funds (“ETF Funds”), for which Part I precedes this Part II. Part II is not a standalone document and must be read in conjunction with Part
I. References in this Part II to a “Fund” mean each of the ETF Funds, unless noted otherwise. Capitalized terms used and not otherwise defined in this Part II have the meanings given to them in Part I of this SAI.
Part II
Table of Contents
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A-1
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INVESTMENT STRATEGIES AND POLICIES
As noted in the applicable
Prospectuses for each of the Funds, in addition to the main investment strategy and the main investment risks described in the Prospectuses, each Fund may employ other investment strategies and may be subject to other risks, which are described
below. The Funds may engage in the practices described below to the extent consistent with their investment objectives, strategies, policies and restrictions. Because the following is a combined description of investment strategies of all of the
Funds, certain matters described herein may not apply to particular Funds.
For a list of investment strategies
and policies employed by each Fund, see “INVESTMENT PRACTICES” in Part I of this SAI.
Asset-Backed Securities
Asset-backed securities
consist of securities secured by company receivables, home equity loans, truck and auto loans, leases, or credit card receivables. Asset-backed securities also include other securities backed by other types of receivables or other assets, including
collateralized debt obligations (“CDOs”), asset-backed commercial paper (“ABCP”) and other similarly structured securities. CDOs include collateralized loan obligations (“CLOs”) and collateral bond obligations
(“CBOs”). Such assets are generally securitized through the use of trusts or special purpose corporations. Asset-backed securities are backed by a pool of assets representing the obligations often of a number of different parties.
Certain of these securities may be illiquid.
Asset-backed securities are
generally subject to the risks of the underlying assets. In addition, asset-backed securities, in general, are subject to certain additional risks including depreciation, damage or loss of the collateral backing the security, failure of the
collateral to generate the anticipated cash flow or in certain cases more rapid prepayment because of events affecting the collateral, such as accelerated prepayment of loans backing these securities or destruction of equipment subject to equipment
trust certificates. In addition, the underlying assets (for example, the underlying home equity loans) may be refinanced or paid off prior to maturity during periods of increasing or declining interest rates. Changes in prepayment rates can result
in greater price and yield volatility. If asset-backed securities are pre-paid, a Fund may have to reinvest the proceeds from the securities at a lower rate. Potential market gains on a security subject to prepayment risk may be more limited than
potential market gains on a comparable security that is not subject to prepayment risk. Under certain prepayment rate scenarios, a Fund may fail to recover additional amounts paid (i.e., premiums) for securities with higher interest rates, resulting
in an unexpected loss.
A
CBO is a trust or other special purpose entity (“SPE”) which is typically backed by a diversified pool of fixed income securities (which may include high risk, below investment grade securities). A CLO is a trust or other SPE that is
typically collateralized by a pool of loans, which may include, among others, domestic and non-U.S. senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be rated below investment grade or equivalent
unrated loans. While many CDOs may receive credit enhancement in the form of a senior-subordinate structure, over-collateralization or bond insurance, such enhancement may not always be present and may fail to protect a Fund against the risk of loss
on default of the collateral. Certain CDOs may use derivatives contracts to create “synthetic” exposure to assets rather than holding such assets directly, which entails the risks of derivative instruments described elsewhere in this
SAI. CDOs may charge management fees and administrative expenses, which are in addition to those of a Fund.
The cash flows for CDOs from
the SPE usually are split into two or more portions, called tranches, varying in risk and yield. The riskiest portion is the “equity” tranche, which bears the first loss from defaults from the bonds or loans in the SPE and serves to
protect the other, more senior tranches from default (though such protection is not complete). Since it is partially protected from defaults, a senior tranche from a CDO typically has higher ratings and lower yields than its underlying securities,
and may be rated investment grade. Despite the protection from the equity tranche, CDO tranches can experience substantial losses due to actual defaults, downgrades of the underlying collateral by rating agencies, forced liquidation of the
collateral pool due to a failure of coverage tests, increased sensitivity to defaults due to collateral default and disappearance of protecting tranches, market anticipation of defaults, as well as investor aversion to CDO securities as a class.
Interest on certain tranches of a CDO may be paid in kind or deferred and capitalized (paid in the form of obligations of the same type rather than cash), which involves continued exposure to default risk with respect to such payments.
The risks of an investment in a
CDO depend largely on the type of the collateral or securities and the class of the CDO in which a Fund invests. CDO tranches often have credit ratings and are typically issued in classes with various priorities. Normally, CDOs are privately offered
and sold (that is, they are not registered under the securities laws), and may be subject to additional liquidity risks; however, an active dealer market may exist for CDOs, allowing a CDO to qualify for Rule 144A transactions. In addition to the
normal risks associated with fixed income securities and asset-backed securities generally discussed elsewhere in this SAI, CDOs carry additional risks including, but not limited to: (i) the possibility that distributions from collateral securities
will not be adequate to make interest or other payments; (ii) the risk that the collateral may default or decline in value or be downgraded, if rated by a nationally recognized statistical rating organization (“NRSRO”); (iii) a Fund may
invest in tranches of CDOs that are subordinate to other tranches; (iv) the structure and complexity of the transaction and the legal documents could lead to disputes among investors regarding the characterization of proceeds; (v) the investment
return achieved by the Fund could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary market for CDOs; (vii) risk of forced “fire sale” liquidation due to technical defaults
such as coverage test failures; (viii) values may be volatile; (ix) disputes with the issuer may produce unexpected results; and (x) the CDO’s manager may perform poorly.
Certain Funds may purchase
ABCP that is issued by conduits sponsored by banks, mortgage companies, investment banking firms, finance companies, hedge funds, private equity firms and special purpose finance entities. ABCP typically refers to a debt security with an original
term to maturity of up to 270 days, the payment of which is supported from underlying assets, or one or more liquidity or credit support providers, or both. Assets backing ABCP, which may be included in revolving pools of assets with large numbers
of obligors, include credit card, car loan and other consumer receivables and home or commercial mortgages, including subprime mortgages. To protect investors from the risk of non-payment, ABCP programs are generally structured with various
protections, such as credit enhancement, liquidity support, and commercial paper stop issuance and wind-down triggers. There can be no guarantee that these protections will be sufficient to prevent losses to investors in ABCP. The repayment of ABCP
issued by a conduit depends primarily on the conduit’s ability to issue new ABCP, access to the liquidity or credit support and, to a lesser extent, cash collections received from the conduit’s underlying asset portfolio. There could be
losses to a Fund’s investing in ABCP in the event that: (i) the Fund is unable to access the liquidity or credit support for the ABCP; (ii) the conduit is unable to issue new ABCP; (iii) credit or market deterioration in the conduit’s
underlying portfolio; and (iv) mismatches in the timing of the cash flows of the underlying asset interests the repayment obligations of maturing ABCP.
Some ABCP programs historically
have provided for an extension of the maturity date of the ABCP if, on the related maturity date, the conduit is unable to access sufficient liquidity by issuing additional ABCP. This may delay the sale of the underlying collateral and a Fund may
incur a loss if the value of the collateral deteriorates during the extension period. Alternatively, if collateral for ABCP deteriorates in value, the collateral may be required to be sold at inopportune times or at prices insufficient to repay the
principal and interest on the ABCP. ABCP programs may provide for the issuance of subordinated notes as an additional form of credit enhancement. The subordinated notes are typically of a lower credit quality and have a higher risk of default. A
Fund purchasing these subordinated notes will therefore have a higher likelihood of loss than investors in the senior notes.
Total Annual Fund Operating
Expenses set forth in the fee table and Financial Highlights section of each Fund’s Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the
definition of “investment company” provided by Section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, as amended (the “1940 Act”).
Auction Rate Securities
Auction rate securities
consist of auction rate municipal securities and auction rate preferred securities sold through an auction process issued by closed-end investment companies, municipalities and governmental agencies. For more information on risks associated with
municipal securities, see “Municipal Securities” below.
Provided that the auction
mechanism is successful, auction rate securities usually permit the holder to sell the securities in an auction at par value at specified intervals. The dividend is reset by “Dutch” auction in which bids are made by broker-dealers and
other institutions for a certain amount of securities at a specified minimum yield. The dividend rate set by the auction is the lowest interest or dividend rate that covers all securities offered for sale. While this process is designed to permit
auction rate securities to be traded at par value, there is the risk that an auction will fail due to insufficient demand for the securities. Since February 2008, numerous auctions have failed due to insufficient demand for securities and have
continued to fail for an extended period of time. Failed
auctions may adversely impact the liquidity of auction rate securities investments. Although some issuers of auction rate securities are redeeming or are considering redeeming such securities, such issuers are not obligated to do so and, therefore,
there is no guarantee that a liquid market will exist for a Fund’s investments in auction rate securities at a time when the Fund wishes to dispose of such securities.
Dividends on auction rate
preferred securities issued by a closed-end fund may be designated as exempt from federal income tax to the extent they are attributable to tax-exempt interest income earned by the closed-end fund on the securities in its portfolio and distributed
to holders of the preferred securities. However, such designation may be made only if the closed-end fund treats preferred securities as equity securities for federal income tax purposes and the closed-end fund complies with certain requirements
under the Internal Revenue Code of 1986, as amended (the “Code”).
A Fund’s investment in
auction rate preferred securities of closed-end funds is subject to limitations on investments in other U.S. registered investment companies, which limitations are prescribed under the 1940 Act. Except as permitted by rule or exemptive order (see
“Investment Company Securities and Exchange-Traded Funds” below for more information), a Fund is generally prohibited from acquiring more than 3% of the voting securities of any other such investment company, and investing more than 5%
of a Fund’s total assets in securities of any one such investment company or more than 10% of its total assets in securities of all such investment companies. A Fund will indirectly bear its proportionate share of any management fees paid by
such closed-end funds in addition to the advisory fee payable directly by the Fund.
Bank Obligations
Bank obligations consist of
bankers’ acceptances, certificates of deposit, bank notes and time deposits.
Bankers’ acceptances are
negotiable drafts or bills of exchange typically drawn by an importer or exporter to pay for specific merchandise, which are “accepted” by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the
instrument on maturity.
Certificates of deposit are
negotiable certificates issued against funds deposited in a commercial bank or a savings and loan association for a definite period of time and earning a specified return. Certificates of deposit may also include those issued by foreign banks
outside the United States (“U.S.”). Such certificates of deposit include Eurodollar and Yankee certificates of deposit. Eurodollar certificates of deposit are U.S. dollar-denominated certificates of deposit issued by branches of foreign
and domestic banks located outside the U.S. Yankee certificates of deposit are certificates of deposit issued by a U.S. branch of a foreign bank denominated in U.S. dollars and held in the U.S. Certain Funds may also invest in obligations (including
bankers’ acceptances and certificates of deposit) denominated in foreign currencies (see “Foreign Investments (including Foreign Currencies)”) herein. With regard to certificates of deposit issued by U.S. banks and savings and loan
associations, to be eligible for purchase by a Fund, a certificate of deposit must be issued by (i) a domestic or foreign branch of a U.S. commercial bank which is a member of the Federal Reserve System or the deposits of which are insured by the
Federal Deposit Insurance Corporation, or (ii) a domestic savings and loan association, the deposits of which are insured by the Federal Deposit Insurance Corporation.
Time deposits are
interest-bearing non-negotiable deposits at a bank or a savings and loan association that have a specific maturity date. A time deposit earns a specific rate of interest over a definite period of time. Time deposits cannot be traded on the secondary
market.
The Funds will
not invest in obligations for which a Fund’s Adviser, or any of its affiliated persons, is the ultimate obligor or accepting bank, provided, however, that the Funds maintain demand deposits at their affiliated custodian, JPMorgan Chase Bank,
N.A. (“JPMorgan Chase Bank”).
Subject to a Fund’s
limitations on concentration in a particular industry, there is no limitation on the amount of a Fund’s assets which may be invested in obligations of banks which meet the conditions set forth herein.
Commercial Paper
Commercial paper is defined as
short-term obligations, generally with maturities from 1 to 270 days issued by banks or bank holding companies, corporations and finance companies. Although commercial paper is generally unsecured, the Funds may also purchase secured commercial
paper. In the event of a
default of an issuer of secured commercial paper, a Fund may
hold the securities and other investments that were pledged as collateral even if it does not invest in such securities or investments. In such a case, the Fund would take steps to dispose of such securities or investments in a commercially
reasonable manner. Commercial paper includes master demand obligations. See “Variable and Floating Rate Instruments” below.
Certain Funds may also invest
in Canadian commercial paper, which is commercial paper issued by a Canadian corporation or a Canadian counterpart of a U.S. corporation, and in Europaper, which is U.S. dollar denominated commercial paper of a foreign issuer. See “Risk
Factors of Foreign Investments” below. Certain Funds may purchase commercial paper that is issued by conduits, including ABCP. Additional information about ABCP is included under “Asset-Backed Securities.”
Convertible Securities
Certain Funds may invest in
convertible securities. Convertible securities include any debt securities or preferred stock which may be converted into common stock or which carry the right to purchase common stock. Generally, convertible securities entitle the holder to
exchange the securities for a specified number of shares of common stock, usually of the same company, at specified prices within a certain period of time.
The terms of any convertible
security determine its ranking in a company’s capital structure. In the case of subordinated convertible debentures, the holders’ claims on assets and earnings are subordinated to the claims of other creditors, and are senior to the
claims of preferred and common shareholders. In the case of convertible preferred stock, the holders’ claims on assets and earnings are subordinated to the claims of all creditors and are senior to the claims of common shareholders.
Convertible securities have
characteristics similar to both debt and equity securities. Due to the conversion feature, the market value of convertible securities tends to move together with the market value of the underlying common stock. As a result, selection of convertible
securities, to a great extent, is based on the potential for capital appreciation that may exist in the underlying stock. The value of convertible securities is also affected by prevailing interest rates, the credit quality of the issuer, and any
call provisions. In some cases, the issuer may cause a convertible security to convert to common stock. In other situations, it may be advantageous for a Fund to cause the conversion of convertible securities to common stock. If a convertible
security converts to common stock, a Fund may hold such common stock in its portfolio even if it does not ordinarily invest in common stock.
Certain Funds invest in
contingent securities structured as contingent convertible securities also known as CoCos. Contingent convertible securities are typically issued by non-U.S. banks and are designed to behave like bonds in times of economic health yet absorb losses
when a pre-determined trigger event occurs. A contingent convertible security is a hybrid debt security either convertible into equity at a predetermined share price or written down in value based on the specific terms of the individual security if
a pre-specified trigger event occurs (the “Trigger Event”). Unlike traditional convertible securities, the conversion of a contingent convertible security from debt to equity is “contingent” and will occur only in the case of
a Trigger Event. Trigger Events vary by instrument and are defined by the documents governing the contingent convertible security. Such Trigger Events may include a decline in the issuer’s capital below a specified threshold level, increase in
the issuer’s risk weighted assets, the share price of the issuer falling to a particular level for a certain period of time and certain regulatory events.
Contingent convertible
securities are subject to the credit, interest rate, high yield security, foreign security and markets risks associated with bonds and equities, and to the risks specific to convertible securities in general. Contingent convertible securities are
also subject to additional risks specific to their structure including conversion risk. Because Trigger Events are not consistently defined among contingent convertible securities, this risk is greater for contingent convertible securities that are
issued by banks with capital ratios close to the level specified in the Trigger Event.
In addition, coupon payments on
contingent convertible securities are discretionary and may be cancelled by the issuer at any point, for any reason, and for any length of time. The discretionary cancellation of payments is not an event of default and there are no remedies to
require re-instatement of coupon payments or payment of any past missed payments. Coupon payments may also be subject to approval by the issuer’s regulator and may be suspended in the event there are insufficient distributable reserves. Due to
uncertainty surrounding coupon payments, contingent convertible securities may be volatile and their price may decline rapidly in the event that coupon payments are suspended.
Contingent convertible
securities typically are structurally subordinated to traditional convertible bonds in the issuer’s capital structure. In certain scenarios, investors in contingent convertible securities may suffer a loss of capital ahead of equity holders or
when equity holders do not. Contingent convertible securities are also subject to extension risk. Contingent convertible securities are perpetual instruments and may only be callable at pre-determined dates upon approval of the applicable regulatory
authority. There is no guarantee that a Fund will receive return of principal on contingent convertible securities.
Convertible contingent
securities are a newer form of instrument and the regulatory environment for these instruments continues to evolve. Because the market for contingent convertible securities is evolving, it is uncertain how the larger market for contingent
convertible securities would react to a Trigger Event or coupon suspension applicable to a single issuer.
The value of contingent
convertible securities is unpredictable and will be influenced by many factors such as: (i) the creditworthiness of the issuer and/or fluctuations in such issuer’s applicable capital ratios; (ii) supply and demand for contingent convertible
securities; (iii) general market conditions and available liquidity; and (iv) economic, financial and political events that affect the issuer, its particular market or the financial markets in general.
Custodial Receipts
Certain Funds may acquire
securities in the form of custodial receipts that evidence ownership of future interest payments, principal payments or both on certain U.S. Treasury notes or bonds in connection with programs sponsored by banks and brokerage firms. These are not
considered U.S. government securities and are not backed by the full faith and credit of the U.S. government. These notes and bonds are held in custody by a bank on behalf of the owners of the receipts.
Debt Instruments
Below Investment Grade
Securities. Securities that were rated investment grade at the time of purchase may subsequently be rated below investment grade (BB+ or lower by Standard & Poor’s Corporation (“S&P”) and
Bal or lower by Moody’s Investors Service, Inc. (“Moody’s”)). Certain Funds that do not invest in below investment grade securities as a main investment strategy may nonetheless continue to hold such securities if the Adviser
believes it is advantageous for the Fund to do so. The high degree of risk involved in these investments can result in substantial or total losses. These securities are subject to greater risk of loss, greater sensitivity to interest rate and
economic changes, valuation difficulties, and a potential lack of a secondary or public market for securities. The market price of these securities also can change suddenly and unexpectedly.
Corporate Debt Securities. Corporate debt securities may include bonds and other debt securities of U.S. and non-U.S. issuers, including obligations of industrial, utility, banking and other corporate issuers. All debt securities are subject to
the risk of an issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to such factors as market interest rates, market perception of the creditworthiness of the issuer and
general market liquidity.
High Yield/High Risk
Securities/Junk Bonds. Certain Funds may invest in high yield securities, to varying degrees. High yield, high risk bonds are securities that are generally rated below investment grade by the primary rating agencies
(BB+ or lower by S&P and Bal or lower by Moody’s) or unrated but determined by the Fund’s Adviser to be of comparable quality. Other terms used to describe such securities include “lower rated bonds,”
“non-investment grade bonds,” “below investment grade bonds,” and “junk bonds.” These securities are considered to be high-risk investments.
High yield securities are
regarded as predominately speculative. There is a greater risk that issuers of lower rated securities will default than issuers of higher rated securities. Issuers of lower rated securities generally are less creditworthy and may be highly indebted,
financially distressed, or bankrupt. These issuers are more vulnerable to real or perceived economic changes, political changes or adverse industry developments. In addition, high yield securities are frequently subordinated to the prior payment of
senior indebtedness. If an issuer fails to pay principal or interest, a Fund would experience a decrease in income and a decline in the market value of its investments. A Fund may also incur additional expenses in seeking recovery from the
issuer.
The income and market value of
lower rated securities may fluctuate more than higher rated securities. Non-investment grade securities are more sensitive to short-term corporate, economic and market developments. During periods of economic uncertainty and change, the market price
of the investments in lower rated securities may be volatile. The default rate for high yield bonds tends to be cyclical, with defaults rising in periods of economic downturn.
It is often more difficult to
value lower rated securities than higher rated securities. If an issuer’s financial condition deteriorates, accurate financial and business information may be limited or unavailable. The lower rated investments may be thinly traded and there
may be no established secondary market. Because of the lack of market pricing and current information for investments in lower rated securities, valuation of such investments is much more dependent on the judgment of the Adviser than is the case
with higher rated securities. In addition, relatively few institutional purchasers may hold a major portion of an issue of lower-rated securities at times. As a result, a Fund that invests in lower rated securities may be required to sell
investments at substantial losses or retain them indefinitely even where an issuer’s financial condition is deteriorating.
Credit quality of non-investment
grade securities can change suddenly and unexpectedly, and even recently issued credit ratings may not fully reflect the actual risks posed by a particular high-yield security.
Future legislation may have a
possible negative impact on the market for high yield, high risk bonds. As an example, in the late 1980’s, legislation required federally-insured savings and loan associations to divest their investments in high yield, high risk bonds. New
legislation, if enacted, could have a material negative effect on a Fund’s investments in lower rated securities.
Inflation-Linked Debt
Securities. Inflation-linked securities include fixed and floating rate debt securities of varying maturities issued by the U.S. government, its agencies and instrumentalities, such as Treasury Inflation Protected
Securities (“TIPS”), as well as securities issued by other entities such as corporations, municipalities, foreign governments and foreign issuers, including foreign issuers from emerging markets. See also “Foreign Investments
(including Foreign Currencies).” Typically, such securities are structured as fixed income investments whose principal value is periodically adjusted according to the rate of inflation. The following two structures are common: (i) the U.S.
Treasury and some other issuers issue inflation-linked securities that accrue inflation into the principal value of the security and (ii) other issuers may pay out the Consumer Price Index (“CPI”) accruals as part of a semi-annual
coupon. Other types of inflation-linked securities exist which use an inflation index other than the CPI.
Inflation-linked securities
issued by the U.S. Treasury, such as TIPS, have maturities of approximately five, ten or thirty years, although it is possible that securities with other maturities will be issued in the future. Typically, TIPS pay interest on a semi-annual basis
equal to a fixed percentage of the inflation-adjusted principal amount. For example, if a 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 the rate of inflation
over the first six months was 1%, the mid-year par 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 of 3%, the end-of-year par 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 upon maturity (as adjusted for inflation) is guaranteed in the case of TIPS, even during a period of deflation, although the inflation-adjusted principal received could be less than the inflation-adjusted principal that had
accrued to the bond at the time of purchase. However, the current market value of the bonds is not guaranteed and will fluctuate. Other inflation-related bonds exist which 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.
The value of inflation-linked
securities 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 the rate of inflation rises at a faster
rate than nominal interest rates, real interest rates might decline, leading to an increase in value of inflation-linked securities.
While inflation-linked
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.
The periodic adjustment of U.S.
inflation-linked securities is tied to the Consumer Price Index for All Urban Consumers (“CPI-U”), which is not seasonally adjusted and 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-linked securities issued by a foreign government are generally adjusted to reflect a comparable inflation index calculated by that
government. There can be no assurance that the CPI-U or a 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 U.S.
Any increase in the principal
amount of an inflation-linked security will be considered taxable ordinary income, even though investors do not receive their principal until maturity.
Variable and Floating Rate
Instruments. Certain obligations purchased by the Funds may carry variable or floating rates of interest, may involve a conditional or unconditional demand feature and may include variable amount master demand
notes. Variable and floating rate instruments are issued by a wide variety of issuers and may be issued for a wide variety of purposes, including as a method of reconstructing cash flows.
Subject to their investment
objective policies and restrictions, certain Funds may acquire variable and floating rate instruments. A variable rate instrument is one whose terms provide for the adjustment of its interest rate on set dates and which, upon such adjustment, can
reasonably be expected to have a market value that approximates its par value. Certain Funds may purchase extendable commercial notes. Extendable commercial notes are variable rate notes which normally mature within a short period of time (e.g., 1
month) but which may be extended by the issuer for a maximum maturity of thirteen months.
A floating rate instrument is
one whose terms provide for the adjustment of its interest rate whenever a specified interest rate changes and which, at any time, can reasonably be expected to have a market value that approximates its par value. Floating rate instruments are
frequently not rated by credit rating agencies; however, unrated variable and floating rate instruments purchased by a Fund will be determined by the Fund’s Adviser to be of comparable quality at the time of purchase to rated instruments
eligible for purchase under the Fund’s investment policies. In making such determinations, a Fund’s Adviser will consider the earning power, cash flow and other liquidity ratios of the issuers of such instruments (such issuers include
financial, merchandising, bank holding and other companies) and will continuously monitor their financial condition. There may be no active secondary market with respect to a particular variable or floating rate instrument purchased by a Fund. The
absence of such an active secondary market could make it difficult for the Fund to dispose of the variable or floating rate instrument involved in the event the issuer of the instrument defaulted on its payment obligations, and the Fund could, for
this or other reasons, suffer a loss to the extent of the default. Variable or floating rate instruments may be secured by bank letters of credit or other assets. A Fund may purchase a variable or floating rate instrument to facilitate portfolio
liquidity or to permit investment of the Fund’s assets at a favorable rate of return.
As a result of the floating and
variable rate nature of these investments, the Funds’ yields may decline, and they may forego the opportunity for capital appreciation during periods when interest rates decline; however, during periods when interest rates increase, the
Funds’ yields may increase, and they may have reduced risk of capital depreciation.
Past periods of high inflation,
together with the fiscal measures adopted to attempt to deal with it, have seen wide fluctuations in interest rates, particularly “prime rates” charged by banks. While the value of the underlying floating or variable rate securities may
change with changes in interest rates generally, the nature of the underlying floating or variable rate should minimize changes in value of the instruments. Accordingly, as interest rates decrease or increase, the potential for capital appreciation
and the risk of potential capital depreciation is less than would be the case with a portfolio of fixed rate securities. A Fund’s portfolio may contain floating or variable rate securities on which stated minimum or maximum rates, or maximum
rates set by state law limit the degree to which interest on such floating or variable rate securities may fluctuate; to the extent it does, increases or decreases in value may be somewhat greater than would be the case without such limits. Because
the adjustment of interest rates on the floating or variable rate securities is made in relation to movements of the applicable banks’ “prime rates” or other short-term rate securities adjustment indices, the floating or variable
rate securities are not comparable to long-term fixed rate securities. Accordingly, interest rates on the floating or variable rate securities may be higher or lower than current market rates for fixed rate obligations of comparable quality with
similar maturities.
Variable Amount Master Notes. Variable amount master notes are notes, which may possess a demand feature, that permit the indebtedness to vary and provide for periodic adjustments in the interest rate according to the terms of the instrument.
Variable amount master notes may not be secured by collateral. To the extent that variable amount master notes are secured by collateral, they are subject to the risks described under the section “Loans— Collateral and Subordination
Risk.”
Because master notes are
direct lending arrangements between a Fund and the issuer of the notes, they are not normally traded. Although there is no secondary market in the notes, a Fund may demand payment of principal and accrued interest. If the Fund is not repaid such
principal and accrued interest, the Fund may not be able to dispose of the notes due to the lack of a secondary market.
While master notes are not
typically rated by credit rating agencies, issuers of variable amount master notes (which are normally manufacturing, retail, financial, brokerage, investment banking and other business concerns) must satisfy the same criteria as those set forth
with respect to commercial paper, if any, in Part I of this SAI under the heading “Diversification”. A Fund’s Adviser will consider the credit risk of the issuers of such notes, including its earning power, cash flow, and other
liquidity ratios of such issuers and will continuously monitor their financial status and ability to meet payment on demand. In determining average weighted portfolio maturity, a variable amount master note will be deemed to have a maturity equal to
the period of time remaining until the principal amount can be recovered from the issuer.
Limitations on the Use of
Variable and Floating Rate Notes. Variable and floating rate instruments for which no readily available market exists will be purchased in an amount which, together with securities with legal or contractual
restrictions on resale or for which no readily available market exists (including repurchase agreements providing for settlement more than seven days after notice), exceeds 15% of a Fund’s net assets only if such instruments are subject to a
demand feature that will permit the Fund to demand payment of the principal within seven days after demand by the Fund. Please see the “Liquidity Risk Management Program” section for more details. There is no limit on the extent to which
a Fund may purchase demand instruments that are not illiquid or deemed to be liquid in accordance with the Adviser’s liquidity determination procedures. If not rated, such instruments must be found by the Fund’s Adviser to be of
comparable quality to instruments in which a Fund may invest. A rating may be relied upon only if it is provided by an NRSRO that is not affiliated with the issuer or guarantor of the instruments.
Zero-Coupon, Pay-in-Kind and
Deferred Payment Securities. Zero-coupon securities are securities that are sold at a discount to par value and on which interest payments are not made during the life of the security. Upon maturity, the holder is
entitled to receive the par value of the security. Pay-in-kind securities are securities that have interest payable by delivery of additional securities. Upon maturity, the holder is entitled to receive the aggregate par value of the securities. A
Fund accrues income with respect to zero-coupon and pay-in-kind securities prior to the receipt of cash payments. Deferred payment securities are securities that remain zero-coupon securities until a predetermined date, at which time the stated
coupon rate becomes effective and interest becomes payable at regular intervals. While interest payments are not made on such securities, holders of such securities are deemed to have received “phantom income.” Because a Fund will
distribute “phantom income” to shareholders, to the extent that shareholders elect to receive dividends in cash rather than reinvesting such dividends in additional shares, the applicable Fund will have fewer assets with which to
purchase income-producing securities. Zero-coupon, pay-in-kind and deferred payment securities may be subject to greater fluctuation in value and lesser liquidity in the event of adverse market conditions than comparably rated securities paying cash
interest at regular interest payment periods.
Impact of Market Conditions on the Risks associated
with Debt Securities
Investments in certain debt
securities will be especially subject to the risk that, during certain periods, the liquidity of particular issuers or industries, or all securities within a particular investment category, may shrink or disappear suddenly and without warning as a
result of adverse economic, market or political events, or adverse investor perceptions, whether or not accurate.
Current market conditions pose
heightened risks for Funds that invest in debt securities given the current interest rate environment. Any future interest rate increases or other adverse conditions (e.g., inflation/deflation, increased selling of certain fixed-income investments
across other pooled investment vehicles or accounts, changes in investor perception, or changes in government intervention in the markets) could cause the value of any Fund that invests in debt securities to decrease. As such, debt securities
markets may experience heightened levels of interest rate and liquidity risk, as well as increased volatility. If rising interest rates cause a Fund to lose value, the Fund could also face increased shareholder redemptions, which would further
impair the Fund’s ability to achieve its investment objectives.
The capacity for traditional
dealers to engage in fixed-income trading for certain fixed income instruments has not kept pace with the growth of the fixed income market, and in some cases has decreased. As a result, because dealers acting as market makers provide stability to a
market, the significant reduction in certain dealer inventories could potentially lead to decreased liquidity and increased volatility in the fixed income markets. Such issues may be exacerbated during periods of economic uncertainty or market
volatility.
Demand Features
Certain Funds may acquire
securities that are subject to puts and standby commitments (“Demand Features”) to purchase the securities at their principal amount (usually with accrued interest) within a fixed period (usually seven days) following a demand by the
Fund. The Demand Feature may be issued by the issuer of the underlying securities, a dealer in the securities or by another third party and may not be transferred separately from the underlying security. The underlying securities subject to a put
may be sold at any time at market rates. Applicable Funds expect that they will acquire puts only where the puts are available without the payment of any direct or indirect consideration. However, if advisable or necessary, a premium may be paid for
put features. A premium paid will have the effect of reducing the yield otherwise payable on the underlying security. Demand Features provided by foreign banks involve certain risks associated with foreign investments. See “Foreign Investments
(including Foreign Currencies)” for more information on these risks.
Under a “stand-by
commitment,” a dealer would agree to purchase, at a Fund’s option, specified securities at a specified price. A Fund will acquire these commitments solely to facilitate portfolio liquidity and does not intend to exercise its rights
thereunder for trading purposes. Stand-by commitments may also be referred to as put options.
The purpose of engaging in
transactions involving puts is to maintain flexibility and liquidity to permit a Fund to meet redemption requests and remain as fully invested as possible.
Equity Securities, Warrants and Rights
Common Stock. Common stock represents a share of ownership in a company and usually carries voting rights and may earn dividends. Unlike preferred stock, common stock dividends are not fixed but are declared at the discretion of the
issuer’s board of directors. Common stock occupies the most junior position in a company’s capital structure. As with all equity securities, the price of common stock fluctuates based on changes in a company’s financial condition,
including those that result from management’s performance or changes to the business of the company, and overall market and economic conditions.
Common Stock Warrants and Rights. Common stock warrants entitle the holder to buy common stock from the issuer of the warrant at a specific price (the “strike price”) for a specific period of time. The market price of warrants may be
substantially lower than the current market price of the underlying common stock, yet warrants are subject to similar price fluctuations. As a result, warrants may be more volatile investments than the underlying common stock. If a warrant is
exercised, a Fund may hold common stock in its portfolio even if it does not ordinarily invest in common stock.
Rights are similar to warrants
but normally have a shorter duration and are typically distributed directly by the issuers to existing shareholders, while warrants are typically attached to new debt or preferred stock issuances.
Warrants and rights generally
do not entitle the holder to dividends or voting rights with respect to the underlying common stock and do not represent any rights in the assets of the issuer company. Warrants and rights will expire if not exercised on or prior to the expiration
date.
Preferred Stock. Preferred stock is a class of stock that generally pays dividends at a specified rate and has preference over common stock in the payment of dividends and liquidation. Preferred stock generally does not carry voting
rights. As with all equity securities, the price of preferred stock fluctuates based on changes in a company’s financial condition and on overall market and economic conditions. Because preferred stocks generally pay dividends only after the
issuing company makes required payments to holders of its bonds and other debt, the value of preferred stocks is more sensitive than bonds and other debt to actual or perceived changes in the company’s financial condition or prospects. Similar
to common stock rights described above, rights may also be issued to holders of preferred stock.
Initial Public Offerings
(“IPOs”). The Funds may purchase securities in IPOs. These securities are subject to many of the same risks as investing in companies with smaller market capitalizations. Securities issued in IPOs have
no trading history, and information about the companies may be available for very limited periods. The prices of securities sold in IPOs may be highly volatile. At any particular time or from time to time, a Fund may not be able to invest in
securities issued in IPOs, or invest to the extent desired, because, for example, only a small portion (if any) of the securities being offered in an IPO may be made available to the Fund. In addition, under certain market conditions, a relatively
small number of companies may issue securities in IPOs. Similarly, as the number of Funds to which IPO securities are allocated increases, the number of securities issued to any one Fund may decrease. The investment performance of a Fund during
periods when it is unable to invest significantly or at all in IPOs may be lower than during periods when the Fund is able to do so. In addition, as a Fund increases in size, the impact of IPOs on the Fund’s performance will generally
decrease.
Foreign Investments (including
Foreign Currencies)
Some
of the Funds may invest in certain obligations or securities of foreign issuers. For purposes of a Fund’s investment policies and unless described otherwise in a Fund’s prospectus, an issuer of a security will be deemed to be located in
a particular country if: (i) the principal trading market for the security is in such country, (ii) the issuer is organized under the laws of such country or (iii) the issuer derives at least 50% of its revenues or profits from such country or has
at least 50% of its total assets situated in such country. Possible investments include equity securities and debt securities (e.g., bonds and commercial paper) of foreign entities, obligations of foreign branches of U.S. banks and of foreign banks,
including, without limitation, eurodollar certificates of deposit, eurodollar time deposits, eurodollar bankers’ acceptances, Canadian time deposits and yankee certificates of deposit, and investments in Canadian commercial paper, and
europaper. Securities of foreign issuers may include sponsored and unsponsored American Depositary Receipts (“ADRs”), European Depositary Receipts (“EDRs”), and Global Depositary Receipts (“GDRs”). Sponsored ADRs
are listed on the New York Stock Exchange; unsponsored ADRs are not. Therefore, there may be less information available about the issuers of unsponsored ADRs than the issuers of sponsored ADRs. Unsponsored ADRs are restricted securities. EDRs and
GDRs are not listed on the New York Stock Exchange. As a result, it may be difficult to obtain information about EDRs and GDRs.
Risk Factors of Foreign Investments. The following is a summary of certain risks associated with foreign investments:
Political and Exchange Risks. Foreign investments may subject a Fund to investment risks that differ in some respects from those related to investments in obligations of U.S. domestic issuers. Such risks include potential future adverse political and
economic developments, sanctions or other measures by the United States or other governments, possible imposition of withholding taxes on interest or other income, possible seizure, nationalization or expropriation of foreign deposits, possible
establishment of exchange controls or taxation at the source, greater fluctuations in value due to changes in exchange rates, or the adoption of other foreign governmental restrictions which might adversely affect the payment of principal and
interest on such obligations.
Higher Transaction Costs. Foreign investments may entail higher custodial fees and sales commissions than domestic investments.
Accounting and Regulatory
Differences. Foreign issuers of securities or obligations are often subject to accounting treatment and engage in business practices different from those of domestic issuers of similar securities or obligations. In
addition, foreign issuers are usually not subject to the same degree of regulation as domestic issuers, and their securities may trade on relatively small markets, causing their securities to experience potentially higher volatility and more limited
liquidity than securities of domestic issuers. Foreign branches of U.S. banks and foreign banks are not regulated by U.S. banking authorities and may be subject to less stringent reserve requirements than those applicable to domestic branches of
U.S. banks. In addition, foreign banks generally are not bound by accounting, auditing, and financial reporting standards comparable to those applicable to U.S. banks. Dividends and interest paid by foreign issuers may be subject to withholding and
other foreign taxes which may decrease the net return on foreign investments as compared to dividends and interest paid to a Fund by domestic companies.
Currency Risk. Foreign securities may be denominated in foreign currencies, although foreign issuers may also issue securities denominated in U.S. dollars. The value of a Fund’s investments denominated in foreign currencies and
any funds held in foreign currencies will be affected by changes in currency exchange rates, the relative strength of those currencies and the U.S. dollar, and exchange-control
regulations. Changes in the foreign currency exchange rates also
may affect the value of dividends and interest earned, gains and losses realized on the sale of securities and net investment income and gains, if any, to be distributed to shareholders by a Fund. The exchange rates between the U.S. dollar and other
currencies are determined by the forces of supply and demand in foreign exchange markets and the relative merits of investments in different countries, actual or anticipated changes in interest rates and other complex factors, as seen from an
international perspective. Currency exchange rates may fluctuate significantly over short periods of time. Currency exchange rates also can be affected by intervention (or lack of intervention) by the United States or foreign governments or central
banks or by currency controls or political developments in the United States or elsewhere. Accordingly, the ability of a Fund that invests in foreign securities as part of its principal investment strategy to achieve its investment objective may
depend, to a certain extent, on exchange rate movements. In addition, while the volume of transactions effected on foreign stock exchanges has increased in recent years, in most cases it remains appreciably below that of domestic securities
exchanges. Accordingly, a Fund’s foreign investments may be less liquid and their prices may be more volatile than comparable investments in securities of U.S. companies. In buying and selling securities on foreign exchanges, purchasers
normally pay fixed commissions that are generally higher than the negotiated commissions charged in the U.S. In addition, there is generally less government supervision and regulation of securities exchanges, brokers and issuers located in foreign
countries than in the U.S.
Settlement Risk. The settlement periods for foreign securities and instruments are often longer than those for securities or obligations of U.S. issuers or instruments denominated in U.S. dollars. Delayed settlement may affect the
liquidity of a Fund’s holdings. Certain types of securities and other instruments are not traded “delivery versus payment” in certain markets (e.g., government bonds in Russia) meaning that a Fund may deliver securities or
instruments before payment is received from the counterparty. In such markets, the Fund may not receive timely payment for securities or other instruments it has delivered and may be subject to increased risk that the counterparty will fail to make
payments when due or default completely.
Brady Bonds. Brady bonds are securities created through the exchange of existing commercial bank loans to public and private entities in certain emerging markets for new bonds in connection with debt restructurings. Brady bonds have
been issued since 1989. In light of the history of defaults of countries issuing Brady bonds on their commercial bank loans, investments in Brady bonds may be viewed as speculative and subject to the same risks as emerging market securities. Brady
bonds may be fully or partially collateralized or uncollateralized, are issued in various currencies (but primarily the U.S. dollar) and are actively traded in over-the-counter (“OTC”) secondary markets. Incomplete collateralization of
interest or principal payment obligations results in increased credit risk. Dollar-denominated collateralized Brady bonds, which may be either fixed-rate or floating rate bonds, are generally collateralized by U.S. Treasury securities.
Global Depositary Notes. Foreign securities and emerging markets securities include Global Depositary Notes (“GDNs”). A GDN is a debt instrument created by a bank that evidences ownership of local currency-denominated debt
securities. GDNs reflect the terms of particular local currency-denominated bonds. GDNs trade, settle, and pay interest and principal in U.S. dollars but typically are restricted securities that do not trade on an exchange. Any distributions paid to
the holders of GDNs are usually subject to a fee charged by the depositary bank. In addition to the risks associated with foreign investments, a Fund’s investments in GDNs is subject to the risks associated with the underlying local
currency-denominated bond and derivative instruments including credit risk, default or similar event risk, counterparty risk, interest rate risk, leverage risk, liquidity risk, and management risk. Holders of GDNs may have limited rights, and
investment restrictions in certain countries may adversely impact the value of GDNs because such restrictions may limit the ability to convert the bonds into GDNs and vice versa. Such restrictions may cause bonds of the underlying issuer to trade at
a discount or premium to the market price of the GDN.
Obligations of Supranational
Entities. Obligations of supranational entities include securities designated or supported by governmental entities to promote economic reconstruction or development of international banking institutions and related
government agencies. Examples include the International Bank for Reconstruction and Development (the “World Bank”), the European Coal and Steel Community, the Asian Development Bank and the Inter-American Development Bank. Each
supranational entity’s lending activities are limited to a percentage of its total capital (including “callable capital” contributed by its governmental members at the entity’s call), reserves and net income. There is no
assurance that participating governments will be able or willing to honor their commitments to make capital contributions to a supranational entity.
Sukuk. Foreign securities and emerging market securities include sukuk. Sukuk are certificates, similar to bonds, issued by the issuer to obtain an upfront payment in exchange for an income stream. Sukuks are also known as
Islamic financial certificates that are designed to comply with Islamic religious law commonly known as Sharia. Such income stream may or may not be linked to a tangible asset. For sukuk that are not linked to a tangible asset, the sukuk represents
a contractual payment obligation of the issuer or issuing vehicle to pay income or periodic payments to the investor, and such contractual payment obligation is linked to the issuer or issuing vehicle and not from interest on the investor’s
money for the sukuk. For sukuk linked to a tangible asset, the Fund will not have a direct interest in the underlying asset or pool of assets. The issuer also makes a contractual promise to buy back the certificate at a future date at par value.
Even when the certificate is linked to the returns generated by certain assets of the issuer, the underlying assets are not pledged as security for the certificates, and the Fund (as the investor) is relying on the creditworthiness of the issuer for
all payments required by the sukuk. The issuer may be a special purpose vehicle (“SPV”) with no other assets. Investors do not have direct legal ownership of any underlying assets. In the event of default, the process may take longer to
resolve than conventional bonds. Changing interpretations of Islamic law by courts or prominent scholars may affect the free transferability of sukuk in ways that cannot now be foreseen. In such an event, the Fund may be required to hold its sukuk
for longer than intended, even if their condition is deteriorating.
Issuers of sukuk may include
international financial institutions, foreign governments and agencies of foreign governments. Underlying assets may include, without limitation, real estate (developed and undeveloped), lease contracts and machinery and equipment. Although the
sukuk market has grown significantly in recent years, there may be times when the market is illiquid and where it is difficult for a Fund to make an investment in or dispose of sukuk at the Fund’s desired time. Furthermore, the global sukuk
market is significantly smaller than conventional bond markets, and restrictions imposed by the Shariah board of the issuing entity may limit the number of investors who are interested in investing in particular sukuk. The unique characteristics of
sukuk may lead to uncertainties regarding their tax treatment within a Fund.
Investors’ ability to
pursue and enforce actions with respect to these payment obligations or to otherwise enforce the terms of the sukuk, restructure the sukuk, obtain a judgment in a court of competent jurisdiction, and/or attach assets of the obligor may be limited.
Sukuk are also subject to the risks associated with developing and emerging market economies, which include, among others, the risk of sanctions and inconsistent accounting and legal principles.
Emerging Market Securities. Investing in companies domiciled in emerging market countries may be subject to potentially higher risks than investments in developed countries. These risks include: (i) less social, political, and economic stability;
(ii) greater illiquidity and price volatility due to smaller or limited local capital markets for such securities, or low non-existent trading volumes; (iii) less scrutiny and regulation by local authorities of the foreign exchanges and
broker-dealers; (iv) the seizure or confiscation by local governments of securities held by foreign investors, and the possible suspension or limiting by local governments of an issuer’s ability to make dividend or interest payments; (v)
limiting or entirely restricting repatriation of invested capital, profits, and dividends by local governments; (vi) possible local taxation of capital gains, including on a retroactive basis; (vii) the attempt by issuers facing restrictions on
dollar or euro payments imposed by local governments to make dividend or interest payments to foreign investors in the local currency; (viii) difficulty in enforcing legal claims related to the securities and/or local judges favoring the interests
of the issuer over those of foreign investors; (ix) bankruptcy judgments being paid in the local currency; (x) greater difficulty in determining market valuations of the securities due to limited public information regarding the issuer, and (xi)
difficulty of ascertaining the financial health of an issuer due to lax financial reporting on a regular basis, substandard disclosure and differences in accounting standards.
Emerging country securities
markets are typically marked by a high concentration of market capitalization and trading volume in a small number of issuers representing a limited number of industries, as well as a high concentration of ownership of such securities by a limited
number of investors. Although some emerging markets have become more established and tend to issue securities of higher credit quality, the markets for securities in other emerging countries are in the earliest stages of their development, and these
countries issue securities across the credit spectrum. Even the markets for relatively widely traded securities in emerging countries may not be able to absorb, without price disruptions, a significant increase in trading volume or trades of a size
customarily undertaken by institutional investors in the securities markets of developed countries. The limited size of many of these securities markets can cause prices to be erratic for reasons apart from factors that affect the soundness and
competitiveness of the securities issuers. For example, prices may be unduly influenced by traders who control large positions in these
markets. Additionally, market making and arbitrage activities
are generally less extensive in such markets, which may contribute to increased volatility and reduced liquidity of such markets. The limited liquidity of emerging country securities may also affect a Fund’s ability to accurately value its
portfolio securities or to acquire or dispose of securities at the price and time it wishes to do so or in order to meet redemption requests.
Many emerging market countries
suffer from uncertainty and corruption in their legal frameworks. Legislation may be difficult to interpret and laws may be too new to provide any precedential value. Laws regarding foreign investment and private property may be weak or
non-existent. Sudden changes in governments may result in policies which are less favorable to investors, such as policies designed to expropriate or nationalize “sovereign” assets. Certain emerging market countries in the past have
expropriated large amounts of private property, in many cases with little or no compensation, and there can be no assurance that such expropriation will not occur in the future.
Foreign investment in the
securities markets of certain emerging countries is restricted or controlled to varying degrees. These restrictions may limit a Fund’s investment in certain emerging countries and may increase the expenses of the Fund. Certain emerging
countries require governmental approval prior to investments by foreign persons or limit investment by foreign persons to only a specified percentage of an issuer’s outstanding securities or to a specific class of securities, which may have
less advantageous terms (including price) than securities of the company available for purchase by nationals.
Many developing countries lack
the social, political, and economic stability characteristics of the U.S. Political instability among emerging market countries can be common and may be caused by an uneven distribution of wealth, social unrest, labor strikes, civil wars, and
religious oppression. Economic instability in emerging market countries may take the form of: (i) high interest rates; (ii) high levels of inflation, including hyperinflation; (iii) high levels of unemployment or underemployment; (iv) changes in
government economic and tax policies, including confiscatory taxation; and (v) imposition of trade barriers.
Currencies of emerging market
countries are subject to significantly greater risks than currencies of developed countries. Many emerging market countries have experienced steady declines or even sudden devaluations of their currencies relative to the U.S. dollar. Some emerging
market currencies may not be internationally traded or may be subject to strict controls by local governments, resulting in undervalued or overvalued currencies.
Some emerging market countries
have experienced balance of payment deficits and shortages in foreign exchange reserves. Governments have responded by restricting currency conversions. Future restrictive exchange controls could prevent or restrict a company’s ability to make
dividend or interest payments in the original currency of the obligation (usually U.S. dollars). In addition, even though the currencies of some emerging market countries may be convertible into U.S. dollars, the conversion rates may be artificial
to their actual market values.
A Fund’s income and, in
some cases, capital gains from foreign stocks and securities, will be subject to applicable taxation in certain of the countries in which it invests and treaties between the U.S. and such countries may not be available in some cases to reduce the
otherwise applicable tax rates. Foreign markets also have different clearance and settlement procedures, and in certain markets there have been times when settlements have been unable to keep pace with the volume of securities transactions, making
it difficult to conduct such transactions. Such delays in settlement could result in temporary periods when a portion of the assets of a Fund remains uninvested and no return is earned on such assets. The inability of the Fund to make intended
security purchases or sales due to settlement problems could result either in losses to the Fund due to subsequent declines in value of the portfolio securities, in the Fund deeming those securities to be illiquid, or, if the Fund has entered into a
contract to sell the securities, in possible liability to the purchaser.
In the past, governments within
the emerging markets have become overly reliant on the international capital markets and other forms of foreign credit to finance large public spending programs which cause huge budget deficits. Often, interest payments have become too overwhelming
for a government to meet, representing a large percentage of total gross domestic product (“GDP”). These foreign obligations have become the subject of political debate and have served as fuel for political parties of the opposition,
which pressure the government not to make payments to foreign creditors, but instead to use these funds for social programs. Either due to an inability to pay or submission to political pressure, foreign governments have been forced to seek a
restructuring of their loan and/or bond obligations, have declared a temporary
suspension of interest payments or have defaulted. These events
have adversely affected the values of securities issued by foreign governments and corporations domiciled in emerging market countries and have negatively affected not only their cost of borrowing, but their ability to borrow in the future as
well.
Sovereign
Obligations. Sovereign debt includes investments in securities issued or guaranteed by a foreign sovereign government or its agencies, authorities or political subdivisions. An investment in sovereign debt
obligations involves special risks not present in corporate debt obligations. The issuer of the sovereign debt or the governmental authorities that control the repayment of the debt may be unable or unwilling to repay principal or interest when due,
and a Fund may have limited recourse in the event of a default. During periods of economic uncertainty, the market prices of sovereign debt may be more volatile than prices of U.S. debt obligations. In the past, certain emerging markets have
encountered difficulties in servicing their debt obligations, withheld payments of principal and interest and declared moratoria on the payment of principal and interest on their sovereign debts.
A sovereign debtor’s
willingness or ability to repay principal and pay interest in a timely manner may be affected by, among other factors, its cash flow situation, the extent of its foreign currency reserves, the availability of sufficient foreign exchange, the
relative size of the debt service burden, the sovereign debtor’s policy toward principal international lenders and local political constraints. Sovereign debtors may also be dependent on expected disbursements from foreign governments,
multilateral agencies and other entities to reduce principal and interest arrearages on their debt. The failure of a sovereign debtor to implement economic reforms, achieve specified levels of economic performance or repay principal or interest when
due may result in the cancellation of third-party commitments to lend funds to the sovereign debtor, which may further impair such debtor’s ability or willingness to service its debts.
Foreign Currency Transactions. Certain Funds may engage in foreign currency transactions which include the following, some of which also have been described elsewhere in this SAI: options on currencies, currency futures, options on such futures,
forward foreign currency transactions, forward rate agreements and currency swaps, caps and floors. Certain Funds may engage in such transactions in both U.S. and non-U.S. markets. To the extent a Fund enters into such transactions in markets other
than in the U.S., the Fund may be subject to certain currency, settlement, liquidity, trading and other risks similar to those described above with respect to the Fund’s investments in foreign securities including emerging markets securities.
Certain Funds may engage in such transactions to hedge against currency risks, as a substitute for securities in which the Fund invests, to increase or decrease exposure to a foreign currency, to shift exposure from one foreign currency to another,
for risk management purposes or to increase income or gain to the Fund. To the extent that a Fund uses foreign currency transactions for hedging purposes, the Fund may hedge either specific transactions or portfolio positions.
While a Fund’s use of
hedging strategies is intended to reduce the volatility of the net asset value (“NAV”) of Fund shares, the NAV of the Fund will fluctuate. There can be no assurance that a Fund’s hedging transactions will be effective. Furthermore,
a Fund may only engage in hedging activities from time to time and may not necessarily be engaging in hedging activities when movements in currency exchange rates occur.
Certain Funds are authorized
to deal in forward foreign exchange between currencies of the different countries in which the Fund will invest and multi-national currency units as a hedge against possible variations in the foreign exchange rate between these currencies. This is
accomplished through contractual agreements entered into in the interbank market to purchase or sell one specified currency for another currency at a specified future date (up to one year) and price at the time of the contract.
Transaction Hedging. Generally, when a Fund engages in transaction hedging, it enters into foreign currency transactions with respect to specific receivables or payables of the Fund generally arising in connection with the purchase or sale
of its portfolio securities. A Fund may engage in transaction hedging when it desires to “lock in” the U.S. dollar price (or a non-U.S. dollar currency (“reference currency”)) of a security it has agreed to purchase or sell,
or the U.S. dollar equivalent of a dividend or interest payment in a foreign currency. By transaction hedging, a Fund attempts to protect itself against a possible loss resulting from an adverse change in the relationship between the U.S. dollar or
other reference currency and the applicable foreign currency during the period between the date on which the security is purchased or sold, or on which the dividend or interest payment is declared, and the date on which such payments are made or
received.
A Fund
may purchase or sell a foreign currency on a spot (or cash) basis at the prevailing spot rate in connection with the settlement of transactions in portfolio securities denominated in that foreign currency. Certain Funds reserve the right to purchase
and sell foreign currency futures contracts traded in the U.S. and subject to regulation by the Commodity Futures Trading Commission (“CFTC”).
For transaction hedging
purposes, a Fund may also purchase U.S. exchange-listed call and put options on foreign currency futures contracts and on foreign currencies. A put option on a futures contract gives a Fund the right to assume a short position in the foreign
currency futures contract until expiration of the option. A put option on currency gives a Fund the right to sell a currency at an exercise price until the expiration of the option. A call option on a futures contract gives a Fund the right to
assume a long position in the futures contract until the expiration of the option. A call option on currency gives a Fund the right to purchase a currency at the exercise price until the expiration of the option.
Position Hedging. When engaging in position hedging, a Fund will enter into foreign currency exchange transactions to protect against a decline in the values of the foreign currencies in which their portfolio securities are denominated or
an increase in the value of currency for securities which a Fund’s Adviser expects to purchase. In connection with the position hedging, the Fund may purchase or sell foreign currency forward contracts or foreign currency on a spot basis. A
Fund may purchase U.S. exchange-listed put or call options on foreign currency and foreign currency futures contracts and buy or sell foreign currency futures contracts traded in the U.S. and subject to regulation by the CFTC.
The precise matching of the
amounts of foreign currency exchange transactions and the value of the portfolio securities involved will not generally be possible because the future value of such securities in foreign currencies will change as a consequence of market movements in
the value of those securities between the dates the currency exchange transactions are entered into and the dates they mature.
Forward Foreign Currency
Exchange Contracts. Certain Funds may purchase forward foreign currency exchange contracts, sometimes referred to as “currency forwards” (“Forward Contracts”), which involve an obligation to
purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract as agreed by the parties in an amount and at a price set at the time of the contract. In the case of a cancelable Forward
Contract, the holder has the unilateral right to cancel the contract at maturity by paying a specified fee. The contracts are traded in the interbank market conducted directly between currency traders (usually large commercial banks) and their
customers, so no intermediary is required. A Forward Contract generally has no deposit requirement, and no commissions are charged at any stage for trades.
At the maturity of a Forward
Contract, a Fund may either accept or make delivery of the currency specified in the contract or, at or prior to maturity, enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect
to forward contracts are usually effected with the currency trader who is a party to the original forward contract. For forward foreign currency contracts (other than Non-Deliverable Forwards) that require physical settlement, the Funds will
segregate or earmark liquid assets equal to the current notional value of each contract. In calculating the notional value, the Funds may net long and short contracts with the same currency and the same settlement date. With respect to trades that
do not settle through CLS Bank International, the Funds may only net long and short contracts if the contracts are with the same counterparty. Certain Funds may also engage in non-deliverable forwards which are cash settled and which do not involve
delivery of the currency specified in the contract. For more information on Non-Deliverable Forwards, see “Non-Deliverable Forwards” below.
Foreign Currency Futures
Contracts. Certain Funds may purchase foreign currency futures contracts. Foreign currency futures contracts traded in the U.S. are designed by and traded on exchanges regulated by the CFTC, such as the New York
Mercantile Exchange. A Fund may enter into foreign currency futures contracts for hedging purposes and other risk management purposes as defined in CFTC regulations. Certain Funds may also enter into foreign currency futures transactions to increase
exposure to a foreign currency, to shift exposure from one foreign currency to another or to increase income or gain to the Fund.
At the maturity of a futures
contract, the Fund may either accept or make delivery of the currency specified in the contract, or at or prior to maturity enter into a closing transaction involving the purchase or sale of an offsetting contract. Closing transactions with respect
to futures contracts are effected on a commodities exchange; a clearing corporation associated with the exchange assumes responsibility for closing out such contracts.
Positions in the foreign
currency futures contracts may be closed out only on an exchange or board of trade which provides a secondary market in such contracts. There is no assurance that a secondary market on an exchange or board of trade will exist for any particular
contract or at any particular time. In such event, it may not be possible to close a futures position; in the event of adverse price movements, the Fund would continue to be required to make daily cash payments of variation margin.
For more information on futures
contracts, see “Futures Contracts” under the heading “Options and Futures Transactions” below.
Foreign Currency Options. Certain Funds may purchase and sell U.S. exchange-listed and over the counter call and put options on foreign currencies. Such options on foreign currencies operate similarly to options on securities. When a Fund
purchases a put option, the Fund has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. When a Fund sells or writes a call option, the Fund has the
obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate if the buyer exercises option. Some of the Funds may also purchase and sell non-deliverable currency options (“Non-Deliverable
Options”). Non-Deliverable Options are cash-settled, options on foreign currencies (each a “Option Reference Currency”) that are non-convertible and that may be thinly traded or illiquid. Non-Deliverable Options involve an
obligation to pay an amount in a deliverable currency (such as U.S. Dollars, Euros, Japanese Yen, or British Pounds Sterling) equal to the difference between the prevailing market exchange rate for the Option Reference Currency and the agreed upon
exchange rate (the “Non-Deliverable Option Rate”), with respect to an agreed notional amount. Options on foreign currencies are affected by all of those factors which influence foreign exchange rates and investments
generally.
A Fund
is authorized to purchase or sell listed foreign currency options and currency swap contracts as a short or long hedge against possible variations in foreign exchange rates, as a substitute for securities in which a Fund may invest, and for risk
management purposes. Such transactions may be effected with respect to hedges on non-U.S. dollar denominated securities (including securities denominated in the Euro) owned by the Fund, sold by the Fund but not yet delivered, committed or
anticipated to be purchased by the Fund, or in transaction or cross-hedging strategies. As an illustration, a Fund may use such techniques to hedge the stated value in U.S. dollars of an investment in a Japanese yen-dominated security. In such
circumstances, 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 dollar relative to
the yen 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 also may 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 “collar”). By selling the 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. Certain Funds may also enter into foreign currency futures transactions for non-hedging purposes including to increase or decrease exposure to a foreign currency, to shift exposure from one foreign currency to another or to
increase income or gain to the Fund.
Certain differences exist
among these foreign currency instruments. Foreign currency options provide the holder thereof the right to buy or to sell a currency at a fixed price on a future date. Listed options are third-party contracts (i.e., performance of the parties’
obligations is guaranteed by an exchange or clearing corporation) which are issued by a clearing corporation, traded on an exchange and have standardized strike prices and expiration dates. OTC options are two-party contracts and have negotiated
strike prices and expiration dates. Options on futures contracts are traded on boards of trade or futures exchanges. Currency swap contracts are negotiated two-party agreements entered into in the interbank market whereby the parties exchange two
foreign currencies at the inception of the contract and agree to reverse the exchange at a specified future time and at a specified exchange rate.
The value of a foreign currency
option is dependent upon the value of the foreign currency and the U.S. dollar and may have no relationship to the investment merits of a foreign security. Because foreign currency transactions occurring in the interbank market involve substantially
larger amounts than those that may be involved in the use of foreign currency options, investors may be disadvantaged by having to deal in an odd lot market (generally consisting of transactions of less than $1 million) for the underlying foreign
currencies at prices that are less favorable than those for round lots.
There is no systematic
reporting of last sale information for foreign currencies and there is no regulatory requirement that quotations available through dealer or other market sources be firm or revised on a timely basis. Available quotation information is generally
representative of very large transactions in the interbank market and thus may not reflect relatively smaller transactions (less than $1 million) where rates may be less favorable. The interbank market in foreign currencies is a global,
around-the-clock market. To the extent that the U.S. options markets are closed while the markets for the underlying currencies remain open, significant price and rate movements may take place in the underlying markets that cannot be reflected in
the options market.
The
Funds may write call options on currencies as long as the Fund segregates cash or liquid assets that, when added to the amounts deposited with a futures commission merchant or a broker as margin, equal the obligation under the call option (but not
less than the strike price of the call option). The Funds may also cover a written call option by owning a separate call option permitting the Fund to purchase the
reference currency at a price no higher than the strike price of
the call option sold by the Fund. In addition, a Fund may write a non-deliverable call option if the Fund segregates an amount equal to the current amount obligated to pay. Netting is generally permitted of long and short positions of a specific
country (assuming long and short contracts are similar). If there are securities or currency held in that specific country at least equal to the current notional value of the net currency positions, no segregation is required.
Non-Deliverable Forwards. Some of the Funds may also invest in non-deliverable forwards (“NDFs”). NDFs are cash-settled, short-term forward contracts on foreign currencies (each a “Reference Currency”) that are
non-convertible and that may be thinly traded or illiquid. NDFs involve an obligation to pay an amount (the “Settlement Amount”) equal to the difference between the prevailing market exchange rate for the Reference Currency and the
agreed upon exchange rate (the “NDF Rate”), with respect to an agreed notional amount. NDFs have a fixing date and a settlement (delivery) date. The fixing date is the date and time at which the difference between the prevailing market
exchange rate and the agreed upon exchange rate is calculated. The settlement (delivery) date is the date by which the payment of the Settlement Amount is due to the party receiving payment.
Although NDFs are similar to
forward foreign currency exchange contracts, NDFs do not require physical delivery of the Reference Currency on the settlement date. Rather, on the settlement date, the only transfer between the counterparties is the monetary settlement amount
representing the difference between the NDF Rate and the prevailing market exchange rate. NDFs typically may have terms from one month up to two years and are settled in U.S. dollars.
NDFs are subject to many of the
risks associated with derivatives in general and forward currency transactions including risks associated with fluctuations in foreign currency and the risk that the counterparty will fail to fulfill its obligations. The Funds will segregate or
earmark liquid assets in an amount equal to the marked to market value of each NDF contract on a daily basis of the NDF. In calculating the mark-to-market value, the Funds may net opposing NDF contracts with the same currency and the same settlement
date. With respect to trades that do not settle through CLS Bank International, the Funds may only net opposing NDF contracts if the contracts are with the same counterparty.
The Funds will typically use
NDFs for hedging purposes, but may also, use such instruments to increase income or gain. The use of NDFs for hedging or to increase income or gain may not be successful, resulting in losses to the Fund, and the cost of such strategies may reduce
the Funds’ respective returns.
Under the Dodd-Frank Wall
Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), NDFs are regulated as swaps and are subject to rules requiring central clearing and mandatory trading on an exchange or facility that is regulated by the CFTC for certain
swaps. NDFs traded in the over-the-counter market are subject to initial and variation margin requirements. Implementation of and on-going compliance with the regulations regarding clearing, mandatory trading and margining of NDFs may increase the
cost to the Fund of hedging currency risk and, as a result, may affect returns to investors in the Fund.
Foreign Currency Conversion. Although foreign exchange dealers do not charge a fee for currency conversion, they do realize a profit based on the difference (the “spread”) between prices at which they are buying and selling various
currencies. Thus, a dealer may offer to sell a foreign currency to a Fund at one rate while offering a lesser rate of exchange should the Fund desire to resell that currency to the dealer.
Other Foreign Currency Hedging
Strategies. New options and futures contracts and other financial products, and various combinations thereof, continue to be developed, and certain Funds may invest in any such options, contracts and products as may
be developed to the extent consistent with the Fund’s investment objective and the regulatory requirements applicable to investment companies, and subject to the supervision of the Trust’s Board of Trustees.
Risk Factors in Foreign Currency
Transactions. The following is a summary of certain risks associated with foreign currency transactions:
Imperfect Correlation. Foreign currency transactions present certain risks. In particular, the variable degree of correlation between price movements of the instruments used in hedging strategies and price movements in a security being hedged
creates the possibility that losses on the hedging transaction may be greater than gains in the value of a Fund’s securities.
Liquidity. Hedging instruments may not be liquid in all circumstances. As a result, in volatile markets, the Funds may not be able to dispose of or offset a transaction without incurring losses. Although foreign currency
transactions used for hedging purposes may reduce the risk of loss due to a decline in the value of the hedged security, at the same time the use of these instruments could tend to limit any potential gain which might result from an increase in the
value of such security.
Leverage and Volatility Risk. Derivative instruments, including foreign currency derivatives, may sometimes increase or leverage a Fund’s exposure to a particular market risk. Leverage enhances the price volatility of derivative instruments
held by a Fund.
Strategy Risk. Certain Funds may use foreign currency derivatives for hedging as well as non-hedging purposes including to gain or adjust exposure to currencies and securities markets or to increase income or gain to a Fund. There is
no guarantee that these strategies will succeed and their use may subject a Fund to greater volatility and loss. Foreign currency transactions involve complex securities transactions that involve risks in addition to direct investments in securities
including leverage risk and the risks associated with derivatives in general, currencies, and investments in foreign and emerging markets.
Judgment of the Adviser. Successful use of foreign currency transactions by a Fund depends upon the ability of the Adviser to predict correctly movements in the direction of interest and currency rates and other factors affecting markets for
securities. If the expectations of the Adviser are not met, a Fund would be in a worse position than if a foreign currency transaction had not been pursued. For example, if a Fund has hedged against the possibility of an increase in interest rates
which would adversely affect the price of securities in its portfolio and the price of such securities increases instead, the Fund will lose part or all of the benefit of the increased value of its securities because it will have offsetting losses
in its hedging positions. In addition, when utilizing instruments that require variation margin payments, if the Fund has insufficient cash to meet daily variation margin requirements, it may have to sell securities to meet such
requirements.
Other
Risks. Such sales of securities may, but will not necessarily, be at increased prices which reflect the rising market. Thus, a Fund may have to sell securities at a time when it is disadvantageous to do
so.
It is
impossible to forecast with precision the market value of portfolio securities at the expiration or maturity of a forward contract or futures contract. Accordingly, a Fund may have to purchase additional foreign currency on the spot market (and bear
the expense of such purchase) if the market value of the security or securities being hedged is less than the amount of foreign currency a Fund is obligated to deliver and if a decision is made to sell the security or securities and make delivery of
the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security or securities if the market value of such security or securities exceeds the amount of
foreign currency the Fund is obligated to deliver.
Transaction and position
hedging do not eliminate fluctuations in the underlying prices of the securities which a Fund owns or expects to purchase or sell. Rather, the Adviser may employ these techniques in an effort to maintain an investment portfolio that is relatively
neutral to fluctuations in the value of the U.S. dollar relative to major foreign currencies and establish a rate of exchange which one can achieve at some future point in time. Additionally, although these techniques tend to minimize the risk of
loss due to a decline in the value of the hedged currency, they also tend to limit any potential gain which might result from the increase in the value of such currency. Moreover, it may not be possible for a Fund to hedge against a devaluation that
is so generally anticipated that the Fund is not able to contract to sell the currency at a price above the anticipated devaluation level.
Inverse Floaters and Interest Rate Caps
Inverse floaters are
instruments whose interest rates bear an inverse relationship to the interest rate on another security or the value of an index. The market value of an inverse floater will vary inversely with changes in market interest rates and will be more
volatile in response to interest rate changes than that of a fixed rate obligation. Interest rate caps are financial instruments under which payments occur if an interest rate index exceeds a certain predetermined interest rate level, known as the
cap rate, which is tied to a specific index. These financial products will be more volatile in price than securities which do not include such a structure.
Investment Company Securities and Exchange-Traded
Funds
Investment Company
Securities. A Fund may acquire the securities of other investment companies (“acquired funds”) to the extent permitted under the 1940 Act and consistent with its investment objective and strategies. As a
shareholder of another investment company, a Fund would bear, along with other shareholders, its pro rata portion of the other investment company’s expenses, including advisory fees. These expenses would be in addition to the advisory and
other expenses that a Fund bears directly in connection with its own operations. Except as described below, the 1940 Act currently requires that, as determined immediately after a purchase is made, (i) not more than 5% of the value of a Fund’s
total assets will be invested in the securities of any one investment company, (ii) not more than 10% of the value of its total assets will be invested in the aggregate in securities of investment companies as a group and (iii) not more than 3% of
the outstanding voting stock of any one investment company will be owned by a Fund.
The limitations described above
do not apply to investments in money market funds subject to certain conditions. The Funds may invest in affiliated and unaffiliated money market funds without limit under Rule 12d1-1 under the 1940 Act subject to the acquiring fund’s
investment policies and restrictions and the conditions of the Rule.
Exchange-Traded Funds
(“ETFs”). ETFs are pooled investment vehicles whose ownership interests are purchased and sold on a securities exchange. ETFs may be structured investment companies, depositary receipts or other pooled
investment vehicles. As shareholders of an ETF, the Funds will bear their pro rata portion of any fees and expenses of the ETFs. Although shares of ETFs are traded on an exchange, shares of certain ETFs may not be redeemable by the ETF. In addition,
ETFs may trade at a price below their NAV (also known as a discount).
Certain Funds may use ETFs to
gain exposure to various asset classes and markets or types of strategies and investments. By way of example, ETFs may be structured as broad based ETFs that invest in a broad group of stocks from different industries and market sectors; select
sector; or market ETFs that invest in debt securities from a select sector of the economy, a single industry or related industries; or ETFs that invest in foreign and emerging markets securities. Other types of ETFs continue to be developed and the
Fund may invest in them to the extent consistent with such Funds’ investment objectives, policies and restrictions. The ETFs in which the Funds invest are subject to the risks applicable to the types of securities and investments used by the
ETFs (e.g., debt securities are subject to risks like credit and interest rate risks; emerging markets securities are subject risks like currency risks and foreign and emerging markets risk; derivatives are subject to leverage and counterparty
risk).
ETFs may be
actively managed or index-based. Actively managed ETFs are subject to management risk and may not achieve their objective if the ETF’s manager’s expectations regarding particular securities or markets are not met. An index based
ETF’s objective is to track the performance of a specified index. Index based ETFs may invest in a securities portfolio that includes substantially all of the securities in substantially the same amount as the securities included in the
designated index or a representative sample. Because passively managed ETFs are designed to track an index, securities may be purchased, retained and sold at times when an actively managed ETF would not do so. As a result, shareholders of a Fund
that invest in such an ETF can expect greater risk of loss (and a correspondingly greater prospect of gain) from changes in the value of securities that are heavily weighted in the index than would be the case if ETF were not fully invested in such
securities. This risk is increased if a few component securities represent a highly concentrated weighting in the designated index.
Unless permitted by the 1940
Act or an order or rule issued by the Securities and Exchange Commission (“SEC”) (see “Investment Company Securities” above for more information), the Fund’s investments in unaffiliated ETFs that are structured as
investment companies as defined in the 1940 Act are subject to certain percentage limitations of the 1940 Act regarding investments in other investment companies. As a general matter, these percentage limitations currently require a Fund to limit
its investments in any one issue of ETFs to 5% of the Fund’s total assets and 3% of the outstanding voting securities of the ETF issue. Moreover, a Fund’s investments in all ETFs may not currently exceed 10% of the Fund’s total
assets under the 1940 Act, when aggregated with all other investments in investment companies. ETFs that are not structured as investment companies as defined in the 1940 Act are not subject to these percentage limitations.
SEC exemptive orders granted to
various ETFs and their investment advisers permit the Funds to invest beyond the 1940 Act limits, subject to certain terms and conditions, including a finding of the Board of Trustees that the advisory fees charged by the Adviser to the Fund are for
services that are in addition to, and not duplicative of, the advisory services provided to those ETFs.
Loans
Some of the Funds may invest in
fixed and floating rate loans (“Loans”). Loans may include senior fixed and floating rate loans (“Senior Loans”) and secured and unsecured loans, second lien or more junior loans (“Junior Loans”) and bridge loans
or bridge facilities (“Bridge Loans”). Loans are typically arranged through private negotiations between borrowers in the U.S. or in foreign or emerging markets which may be corporate issuers or issuers of sovereign debt obligations
(“Obligors”) and one or more financial institutions and other lenders (“Lenders”). Generally, the Funds invest in Loans by purchasing assignments of all or a portion of Loans (“Assignments”) or Loan participations
(“Participations”) from third parties although certain Funds may originate Loans.
A Fund has direct rights
against the Obligor on the Loan when it purchases an Assignment. Because Assignments are arranged through private negotiations between potential assignees and potential assignors, however, the rights and obligations acquired by a Fund as the
purchaser of an Assignment may differ from, and be more limited than, those held by the assigning Lender. With respect to Participations, typically, a Fund will have a contractual relationship only with the Lender and not with the Obligor. The
agreement governing Participations may limit the rights of a Fund to vote on certain changes which may be made to the Loan agreement, such as waiving a breach of a covenant. However, the holder of a Participation will generally have the right to
vote on certain fundamental issues such as changes in principal amount, payment dates and interest rate. Participations may entail certain risks relating to the creditworthiness of the parties from which the participations are obtained.
Assignments and Participations
are typically originated, negotiated and structured by a U.S. or foreign commercial bank, insurance company, finance company or other financial institution (the “Agent”) for a group of Loan investors. The Agent typically administers and
enforces the Loan on behalf of the other Loan investors in the syndicate. The Agent’s duties may include responsibility for the collection of principal and interest payments from the Obligor and the apportionment of these payments to the
credit of all Loan investors. The Agent is also typically responsible for monitoring compliance with the covenants contained in the Loan agreement based upon reports prepared by the Obligor. In addition, an institution, typically but not always the
Agent, holds any collateral on behalf of the Loan investors. In the event of a default by the Obligor, it is possible, though unlikely, that the Fund could receive a portion of the borrower’s collateral. If the Fund receives collateral other
than cash, any proceeds received from liquidation of such collateral will be available for investment as part of the Fund’s portfolio.
In the process of buying,
selling and holding Loans, a Fund may receive and/or pay certain fees. These fees are in addition to interest payments received and may include facility fees, commitment fees, commissions and prepayment penalty fees. When a Fund buys or sells a Loan
it may pay a fee. In certain circumstances, a Fund may receive a prepayment penalty fee upon prepayment of a Loan.
Additional Information
concerning Senior Loans. Senior Loans typically hold the most senior position in the capital structure of the Obligor, are typically secured with specific collateral and have a claim on the assets and/or stock of the
Obligor that is senior to that held by subordinated debtholders and shareholders of the Obligor. Collateral for Senior Loans may include (i) working capital assets, such as accounts receivable and inventory; (ii) tangible fixed assets, such as real
property, buildings and equipment; (iii) intangible assets, such as trademarks and patent rights; and/or (iv) security interests in shares of stock of subsidiaries or affiliates.
Additional Information
concerning Junior Loans. Junior Loans include secured and unsecured loans including subordinated loans, second lien and more junior loans, and bridge loans. Second lien and more junior loans (“Junior Lien
Loans”) are generally second or further in line in terms of repayment priority. In addition, Junior Lien Loans may have a claim on the same collateral pool as the first lien or other more senior liens or may be secured by a separate set of
assets. Junior Loans generally give investors priority over general unsecured creditors in the event of an asset sale.
Additional Information
concerning Bridge Loans. Bridge Loans are short-term loan arrangements (e.g., 12 to 36 months) typically made by an Obligor in anticipation of intermediate-term or long-term permanent financing. Most Bridge Loans are
structured as floating-rate debt with step-up provisions under which the interest rate on the Bridge Loan rises the longer the Loan remains outstanding. In addition, Bridge Loans commonly contain a conversion feature that allows the Bridge Loan
investor to convert its Loan interest to senior exchange notes if the Loan has not been prepaid in full on or prior to its maturity date. Bridge Loans typically are structured as Senior Loans but may be structured as Junior Loans.
Additional Information
concerning Unfunded Commitments. Unfunded commitments are contractual obligations pursuant to which the Fund agrees to invest in a Loan at a future date. Typically, the Fund receives a commitment fee for entering
into the Unfunded Commitment.
Additional Information
concerning Synthetic Letters of Credit. Loans include synthetic letters of credit. In a synthetic letter of credit transaction, the Lender typically creates a special purpose entity or a credit-linked deposit account
for the purpose of funding a letter of credit to the borrower. When a Fund invests in a synthetic letter of credit, the Fund is typically paid a rate based on the Lender’s borrowing costs and the terms of the synthetic letter of credit.
Synthetic letters of credit are typically structured as Assignments with the Fund acquiring direct rights against the Obligor.
Additional Information
concerning Loan Originations. In addition to investing in loan assignments and participations, the Global Bond Opportunities ETF may originate Loans in which the Fund would lend money directly to a borrower by
investing in limited liability companies or corporations that make loans directly to borrowers. The terms of the Loans are negotiated with borrowers in private transactions. Such Loans would be collateralized, typically with tangible fixed assets
such as real property or interests in real property. Such Loans may also include mezzanine loans. Unlike Loans secured by a mortgage on real property, mezzanine loans are collateralized by an equity interest in a SPV that owns the real
property.
Limitations on Investments in
Loan Assignments and Participations. If a government entity is a borrower on a Loan, the Fund will consider the government to be the issuer of an Assignment or Participation for purposes of a Fund’s fundamental
investment policy that it will not invest 25% or more of its total assets in securities of issuers conducting their principal business activities in the same industry (i.e., foreign government).
Limited Federal Securities Law
Protections. Certain Loans may not be considered securities under the federal securities laws. In such circumstances, fewer legal protections may be available with respect to a Fund’s investment in those Loans.
In particular, if a Loan is not considered a security under the federal securities laws, certain legal protections normally available to investors under the federal securities laws, such as those against fraud and misrepresentation, may not be
available.
Multiple Lender Risk. There may be additional risks associated with Loans, including loan originations, when there are Lenders or other participants in addition to the Fund. For example, a Fund could lose the ability to consent to certain
actions taken by the Borrower if certain conditions are not met. In addition, for example, certain governing agreements that provide the Fund with the right to consent to certain actions taken by a Borrower may provide that the Fund will no longer
have the right to provide such consent if another Lender makes a subsequent advance to the Borrower.
Risk Factors of Loans. Loans are subject to the risks associated with debt obligations in general including interest rate risk, credit risk and market risk. When a Loan is acquired from a Lender, the risk includes the credit risk associated
with the Obligor of the underlying Loan. The Fund may incur additional credit risk when the Fund acquires a participation in a Loan from another lender because the Fund must assume the risk of insolvency or bankruptcy of the other lender from which
the Loan was acquired. To the extent that Loans involve Obligors in foreign or emerging markets, such Loans are subject to the risks associated with foreign investments or investments in emerging markets in general. The following outlines some of
the additional risks associated with Loans.
High Yield
Securities Risk. The Loans that a Fund invests in may not be rated by an NRSRO, will not be registered with the SEC or any state securities commission and will not be listed on any national securities exchange. To
the extent that such high yield Loans are rated, they typically will be rated below investment grade and are subject to an increased risk of default in the payment of principal and interest as well as the other risks described under
“High Yield/High Risk Securities/Junk Bonds.” Loans are vulnerable to market sentiment such that economic conditions or other events may reduce the demand for Loans and cause their value to decline
rapidly and unpredictably.
Liquidity
Risk. Loans that are deemed to be liquid at the time of purchase may become illiquid or less liquid. No active trading market may exist for certain Loans and certain Loans may be subject to restrictions on resale or
have a limited secondary market. Certain Loans may be subject to irregular trading activity, wide bid/ask spreads and extended trade settlement periods. The inability to dispose of certain Loans in a timely fashion or at a favorable price could
result in losses to a Fund.
Collateral
and Subordination Risk. With respect to Loans that are secured, a Fund is subject to the risk that collateral securing the Loan will decline in value or have no value or that the Fund’s lien is or will become
junior in payment to other liens. A decline in value of the collateral, whether as a result of
market value declines, bankruptcy proceedings
or otherwise, could cause the Loan to be under collateralized or unsecured. In such event, the Fund may have the ability to require that the Obligor pledge additional collateral. The Fund, however, is subject to the risk that the Obligor may not
pledge such additional collateral or a sufficient amount of collateral. In some cases (for example, in the case of non-recourse Loans), there may be no formal requirement for the Obligor to pledge additional collateral. In addition, collateral may
consist of assets that may not be readily liquidated, and there is no assurance that the liquidation of such assets would satisfy an Obligor’s obligation on a Loan. If the Fund were unable to obtain sufficient proceeds upon a liquidation of
such assets, this could negatively affect Fund performance.
If an
Obligor becomes involved in bankruptcy proceedings, a court may restrict the ability of the Fund to demand immediate repayment of the Loan by Obligor or otherwise liquidate the collateral. A court may also invalidate the Loan or the Fund’s
security interest in collateral or subordinate the Fund’s rights under a Senior Loan or Junior Loan to the interest of the Obligor’s other creditors, including unsecured creditors, or cause interest or principal previously paid to be
refunded to the Obligor. If a court required interest or principal to be refunded, it could negatively affect Fund performance. Such action by a court could be based, for example, on a “fraudulent conveyance” claim to the effect that the
Obligor did not receive fair consideration for granting the security interest in the Loan collateral to a Fund. For Senior Loans made in connection with a highly leveraged transaction, consideration for granting a security interest may be deemed
inadequate if the proceeds of the Loan were not received or retained by the Obligor, but were instead paid to other persons (such as shareholders of the Obligor) in an amount which left the Obligor insolvent or without sufficient working capital.
There are also other events, such as the failure to perfect a security interest due to faulty documentation or faulty official filings, which could lead to the invalidation of a Fund’s security interest in Loan collateral. If the Fund’s
security interest in Loan collateral is invalidated or a Senior Loan were subordinated to other debt of an Obligor in bankruptcy or other proceedings, the Fund would have substantially lower recovery, and perhaps no recovery on the full amount of
the principal and interest due on the Loan, or the Fund could have to refund interest. Lenders and investors in Loans can be sued by other creditors and shareholders of the Obligors. Losses can be greater than the original Loan amount and occur
years after the principal and interest on the Loan have been repaid.
Agent Risk. Selling Lenders, Agents and other entities who may be positioned between a Fund and the Obligor will likely conduct their principal business activities in the banking, finance and financial services industries.
Investments in Loans may be more impacted by a single economic, political or regulatory occurrence affecting such industries than other types of investments. Entities engaged in such industries may be more susceptible to, among other things,
fluctuations in interest rates, changes in the Federal Open Market Committee’s monetary policy, government regulations concerning such industries and concerning capital raising activities generally and fluctuations in the financial markets
generally. An Agent, Lender or other entity positioned between a Fund and the Obligor may become insolvent or enter Federal Deposit Insurance Corporation (“FDIC”) receivership or bankruptcy. The Fund might incur certain costs and delays
in realizing payment on a Loan or suffer a loss of principal and/ or interest if assets or interests held by the Agent, Lender or other party positioned between the Fund and the Obligor are determined to be subject to the claims of the
Agent’s, Lender’s or such other party’s creditors.
Regulatory
Changes. To the extent that legislation or state or federal regulators that regulate certain financial institutions impose additional requirements or restrictions with respect to the ability of such institutions to
make Loans, particularly in connection with highly leveraged transactions, the availability of Loans for investment may be adversely affected. Furthermore, such legislation or regulation could depress the market value of Loans held by the
Fund.
Inventory
Risk. Affiliates of the Adviser may participate in the primary and secondary market for Loans. Because of limitations imposed by applicable law, the presence of the Adviser’s affiliates in the Loan market may
restrict a Fund’s ability to acquire some Loans, affect the timing of such acquisition or affect the price at which the Loan is acquired.
Information
Risk. There is typically less publicly available information concerning Loans than other types of fixed income investments. As a result, a Fund generally will be dependent on reports and other information provided by
the Obligor, either directly or through an Agent, to evaluate the Obligor’s creditworthiness or to determine the Obligor’s compliance with the covenants and other terms of the Loan Agreement. Such reliance may make investments in Loans
more susceptible to
fraud than other types of investments. In
addition, because the Adviser may wish to invest in the publicly traded securities of an Obligor, it may not have access to material non-public information regarding the Obligor to which other Loan investors have access.
Junior Loan
Risk. Junior Loans are subject to the same general risks inherent to any Loan investment. Due to their lower place in the Obligor’s capital structure and possible unsecured status, Junior Loans involve a higher
degree of overall risk than Senior Loans of the same Obligor. Junior Loans that are Bridge Loans generally carry the expectation that the Obligor will be able to obtain permanent financing in the near future. Any delay in obtaining permanent
financing subjects the Bridge Loan investor to increased risk. An Obligor’s use of Bridge Loans also involves the risk that the Obligor may be unable to locate permanent financing to replace the Bridge Loan, which may impair the
Obligor’s perceived creditworthiness.
Mezzanine
Loan Risk. In addition to the risk factors described above, mezzanine loans are subject to additional risks. Unlike conventional mortgage loans, mezzanine loans are not secured by a mortgage on the underlying real
property but rather by a pledge of equity interests (such as a partnership or limited liability company membership) in the property owner or another company in the ownership structures that has control over the property. Such companies are typically
structured as special purpose entities. Generally, mezzanine loans may be more highly leveraged than other types of Loans and subordinate in the capital structure of the Obligor. While foreclosure of a mezzanine loan generally takes substantially
less time than foreclosure of a traditional mortgage, the holders of a mezzanine loan have different remedies available versus the holder of a first lien mortgage loan. In addition, a sale of the underlying real property would not be unencumbered,
and thus would be subject to encumbrances by more senior mortgages and liens of other creditors. Upon foreclosure of a mezzanine loan, the holder of the mezzanine loan acquires an equity interest in the Obligor. However, because of the subordinate
nature of a mezzanine loan, the real property continues to be subject to the lien of the mortgage and other liens encumbering the real estate. In the event the holder of a mezzanine loan forecloses on its equity collateral, the holder may need to
cure the Obligor’s existing mortgage defaults or, to the extent permissible under the governing agreements, sell the property to pay off other creditors. To the extent that the amount of mortgages and senior indebtedness and liens exceed the
value of the real estate, the collateral underlying the mezzanine loan may have little or no value.
Foreclosure
Risk. There may be additional costs associated with enforcing a Fund’s remedies under a Loan including additional legal costs and payment of real property transfer taxes upon foreclosure in certain
jurisdictions or legal costs and expenses associated with operating real property. As a result of these additional costs, the Fund may determine that pursuing foreclosure on the Loan collateral is not worth the associated costs. In addition, if the
Fund incurs costs and the collateral loses value or is not recovered by the Fund in foreclosure, the Fund could lose more than its original investment in the Loan. Foreclosure risk is heightened for Junior Loans, including certain mezzanine
loans.
Miscellaneous Investment
Strategies and Risks
Borrowings. A Fund may borrow for temporary purposes and/or for investment purposes. Such a practice will result in leveraging of a Fund’s assets and may cause a Fund to liquidate portfolio positions when it would not be
advantageous to do so. This borrowing may be secured or unsecured. If a Fund utilizes borrowings, for investment purposes or otherwise, it may pledge up to
33 1⁄3% of its total assets to
secure such borrowings. Provisions of the 1940 Act require a Fund to maintain continuous asset coverage (that is, total assets including borrowings, less liabilities exclusive of borrowings) of 300% of the amount borrowed, with an exception for
borrowings not in excess of 5% of the Fund’s total assets made for temporary administrative or emergency purposes. Any borrowings for temporary administrative purposes in excess of 5% of the Fund’s total assets must maintain continuous
asset coverage. If the 300% asset coverage should decline as a result of market fluctuations or other reasons, a Fund may be required to sell some of its portfolio holdings within three days to reduce the debt and restore the 300% asset coverage,
even though it may be disadvantageous from an investment standpoint to sell securities at that time. Borrowing will tend to exaggerate the effect on NAV of any increase or decrease in the market value of a Fund’s portfolio. Money borrowed will
be subject to interest costs which may or may not be recovered by appreciation of the securities purchased. A Fund also may be required to maintain minimum average balances in connection with such borrowing or to pay a commitment or other fee to
maintain a line of credit; either of these requirements would increase the cost of borrowing over the stated interest rate.
Certain types of investments are
considered to be borrowings under precedents issued by the SEC. Such investments are subject to the limitations as well as asset segregation requirements.
LIBOR Discontinuance or
Unavailability Risk. The London InterBank Offered Rate (“LIBOR”) is intended to represent the rate at which contributing banks may obtain short-term borrowings from each other in the London interbank
market. The regulatory authority that oversees financial services firms and financial markets in the U.K. has announced that, after the end of 2021, it would no longer persuade or compel contributing banks to make rate submissions for purposes of
determining the LIBOR rate. As a result, it is possible that commencing in 2022, LIBOR may no longer be available or no longer deemed an appropriate reference rate upon which to determine the interest rate on or impacting certain loans, notes,
derivatives and other instruments or investments comprising some or all of a Fund’s portfolio. In light of this eventuality, public and private sector industry initiatives are currently underway to identify new or alternative reference rates
to be used in place of LIBOR. There is no assurance that the composition or characteristics of any such alternative reference rate will be similar to or produce the same value or economic equivalence as LIBOR or that it will have the same volume or
liquidity as did LIBOR prior to its discontinuance or unavailability, which may affect the value or liquidity or return on certain of a Fund’s investments and result in costs incurred in connection with closing out positions and entering into
new trades. These risks may also apply with respect to changes in connection with other interbank offering rates (e.g., Euribor) and a wide range of other index levels, rates and values that are treated as “benchmarks” and are the
subject of recent regulatory reform.
Commodity-Linked Derivatives. Commodity-linked derivatives are derivative instruments the value of which is linked to the value of a commodity, commodity index or commodity futures contract. A Fund’s investment in commodity-linked derivative
instruments may subject the Fund to greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market
movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory
developments. Use of leveraged commodity-linked derivatives creates the possibility for greater loss (including the likelihood of greater volatility of the Fund’s NAV), and there can be no assurance that a Fund’s use of leverage will be
successful. Tax considerations may limit a Fund’s ability to pursue investments in commodity-linked derivatives.
Commodity-Related Pooled
Investment Vehicles. Commodity-related pooled investment vehicles include ownership interests in grantor trusts and other pooled investment vehicles that hold tangible assets such as gold, silver or other
commodities or invest in commodity futures. Grantor trusts are typically traded on an exchange.
Investors do not have the
rights normally associated with ownership of other types of shares when they invest in pooled investment vehicles holding commodities or commodity futures, including those structured as limited partnerships or grantor trusts holding commodities. For
example, the owners of these commodity-related grantor trusts or limited partnerships do not have the right to elect directors, receive dividends or take other actions normally associated with the ownership of shares of a corporation. Holders of a
certain percentage of shares in a grantor trust may have the right to terminate the trust or exercise other rights which would not be available to small investors. If investors other than a Fund exercise their right to terminate, a Fund that wishes
to invest in the underlying commodity through the pooled investment vehicle will have to find another investment and may not be able to find another vehicle that offers the same investment features. In the event that one or more participants holding
a substantial interest in these pooled investment vehicles withdraw from participation, the liquidity of the pooled investment vehicle will likely decrease which could adversely affect the market price of the pooled investment vehicle and result in
a Fund incurring a loss on its investments.
These pooled investment
vehicles are not registered investment companies, and many are not commodity pools, and therefore, do not have the protections available to those types of investments under federal securities or commodities laws. For example, unlike registered
investment companies, these vehicles are not subject to federal securities laws that limit transactions with affiliates, require redemption of shares, or limit sales load. Although shares of these vehicles may be traded on an exchange, there may be
no active market for such shares and such shares may be highly illiquid.
These vehicles are subject to
the risks associated with direct investments in commodities. The market price of shares of these vehicles will be as unpredictable as the price of the underlying commodity. Many factors can cause a decline in the prices of commodities including a
change in economic conditions, such as a recession. This risk is magnified when the commodity is used in manufacturing. In addition, the prices
of commodities may be adversely impacted by a change in the
attitude of speculators and investors toward the applicable commodity, or a significant increase in commodity price hedging activity. In addition, the value of the shares will be adversely affected if the assets owned by the trust are lost, damaged
or of inferior quality.
The commodities represented by
shares of a grantor trust will decrease over the life of the trust due to sales of the underlying commodities necessary to pay trust fees and expenses, including expenses associated with indemnification of certain service providers to the pooled
investment vehicle. Without increases in the price of the underlying commodity sufficient to compensate for that decrease, the price of the investment will decline and a Fund will incur a loss on its investment.
Commodity-related grantor
trusts are passive investment vehicles. This means that the value of the investment in a grantor trust may be adversely affected by trust losses that, if the trust had been actively managed, it might have been possible to avoid. A Fund’s
intention to qualify as a regulated investment company under Subchapter M of the Code may limit its ability to make investments in grantor trusts or limited partnerships that invest in commodities or commodity futures.
Cyber Security Risk. As the use of technology has become more prevalent in the course of business, the Funds have become more susceptible to operational and financial risks associated with cyber security, including: theft, loss, misuse,
improper release, corruption and destruction of, or unauthorized access to, confidential or highly restricted data relating to a Fund and its shareholders; and compromises or failures to systems, networks, devices and applications relating to the
operations of a Fund and its service providers. Cyber security risks may result in financial losses to a Fund and its shareholders; the inability of a Fund to transact business with its shareholders; delays or mistakes in the calculation of a
Fund’s NAV or other materials provided to shareholders; the inability to process transactions with shareholders or other parties; violations of privacy and other laws; regulatory fines, penalties and reputational damage; and compliance and
remediation costs, legal fees and other expenses. A Fund’s service providers (including, but not limited to, its investment adviser, any sub-advisers, administrator, transfer agent, and custodian or their agents), financial intermediaries,
companies in which a Fund invests and parties with which a Fund engages in portfolio or other transactions also may be adversely impacted by cyber security risks in their own businesses, which could result in losses to a Fund or its shareholders.
While measures have been developed which are designed to reduce the risks associated with cyber security, there is no guarantee that those measures will be effective, particularly since the Funds do not directly control the cyber security defenses
or plans of their service providers, financial intermediaries and companies in which they invest or with which they do business.
Volcker Rule Risk. Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act and certain rules promulgated thereunder (known as the Volcker Rule) places restrictions on the activities of banking entities, including the
adviser and its affiliates, and may impact the long-term viability of a Fund. Under the Volcker Rule, if the adviser or its affiliates own 25% or more of the ownership interests of a Fund outside of the permitted seeding time period, a Fund could be
subject to restrictions on trading that would adversely impact a Fund’s ability to execute its investment strategy. Generally, the permitted seeding period is three years from the implementation of a Fund’s investment strategy. As a
result, the adviser and/or its affiliates may be required to reduce their ownership interests in a Fund at a time that is sooner than would otherwise be desirable. This may require the sale of Fund securities, which may result in losses, increased
transaction costs and adverse tax consequences. In addition, the ongoing viability of a Fund may be adversely impacted by the anticipated or actual redemption of Fund shares owned by the adviser and its affiliates and could result in a Fund’s
liquidation.
Impact
of Large Redemptions and Purchases of Fund Shares. Under applicable regulations, the Adviser or an affiliate of the Adviser may be required to reduce its seed investment or other ownership interest in a Fund at a
time that is sooner than the Adviser or its affiliate otherwise would. In addition to such redemptions of seed investment, from time to time, shareholders of a Fund (which may include the Adviser or affiliates of the Adviser or accounts for which
the Adviser or its affiliates serve as investment adviser or trustee or, for certain Funds, affiliated and/or non-affiliated registered investment companies that invest in a Fund) may make relatively large redemptions or purchases of Fund shares.
These transactions may cause a Fund to have to sell securities, or invest additional cash, as the case may be. While it is impossible to predict the overall impact of these transactions over time, there could be adverse effects on a Fund’s
performance to the extent that the Fund is required to sell securities or invest cash at times when it would not otherwise do so, which may result in a loss to the Fund. These transactions may result in higher portfolio turnover, accelerate the
realization of taxable income if sales of securities resulted in capital gains or other income and increase transaction costs, which may impact the Fund’s expense ratio. Additionally, a significant reduction in Fund assets would result in Fund
expenses being spread over a
small asset base, potentially causing an increase in the
Fund’s expense ratio. To the extent that such transactions result in short-term capital gains, such gains will generally be taxed at the ordinary income tax rate. In addition to the above information, the Funds’ SAIs include disclosure
of accounts holding more than 5% of a Fund’s voting securities.
Government Intervention in
Financial Markets. Events in the financial sector over the past several years have resulted in reduced liquidity in credit and fixed income markets and in an unusually high degree of volatility in the financial
markets, both domestically and internationally. While entire markets have been impacted, issuers that have exposure to the real estate, mortgage and credit markets have been particularly affected. These events and the potential for continuing market
turbulence may have an adverse effect on the Funds’ investments. It is uncertain how long these conditions will continue.
Recent instability in the
financial markets has led governments and regulators around the world to take a number of unprecedented actions designed to support certain financial institutions and segments of the financial markets that have experienced extreme volatility, and in
some cases a lack of liquidity. Governments, their regulatory agencies, or self-regulatory organizations may take actions that affect the regulation of the instruments in which the Funds invest, or the issuers of such instruments, in ways that are
unforeseeable. Legislation or regulation may also change the way in which the Funds themselves are regulated. For instance, in 2016, the SEC adopted rules that regulate the Funds’ management of liquidity risk. Such legislation or regulation
could limit or preclude a Fund’s ability to achieve its investment objective.
Governments or their agencies
may also acquire distressed assets from financial institutions and acquire ownership interests in those institutions. The implications of government ownership and disposition of these assets are unclear, and such a program may have positive or
negative effects on the liquidity, valuation and performance of a Fund’s portfolio holdings. Furthermore, volatile financial markets can expose the Funds to greater market and liquidity risk and potential difficulty in valuing portfolio
instruments held by the Funds.
Master Limited Partnerships. Certain companies are organized as master limited partnerships (“MLPs”) in which ownership interests are publicly traded. MLPs often own several properties or businesses (or directly own interests) that are
related to real estate development and oil and gas industries, but they also may finance motion pictures, research and development and other projects or provide financial services. Generally, an MLP is operated under the supervision of one or more
managing general partners. Limited partners (like a Fund that invests in an MLP) are not involved in the day-to-day management of the partnership. They are allocated income and capital gains associated with the partnership project in accordance with
the terms established in the partnership agreement.
The risks of investing in an
MLP are generally those inherent in investing in a partnership as opposed to a corporation. For example, state law governing partnerships is often less restrictive than state law governing corporations. Accordingly, there may be fewer protections
afforded investors in an MLP than investors in a corporation. Additional risks involved with investing in an MLP are risks associated with the specific industry or industries in which the partnership invests, such as the risks of investing in real
estate, or oil and gas industries.
New Financial Products. New options and futures contracts and other financial products, and various combinations thereof, including over-the-counter products, continue to be developed. These various products may be used to adjust the risk and
return characteristics of certain Funds’ investments. These various products may increase or decrease exposure to security prices, interest rates, commodity prices, or other factors that affect security values, regardless of the issuer’s
credit risk. If market conditions do not perform as expected, the performance of a Fund would be less favorable than it would have been if these products were not used. In addition, losses may occur if counterparties involved in transactions do not
perform as promised. These products may expose the Fund to potentially greater return as well as potentially greater risk of loss than more traditional fixed income investments.
Private Placements, Restricted
Securities and Other Unregistered Securities. Subject to its investment policies, a Fund may acquire investments such as obligations issued in reliance on the so-called “private placement” exemption from
registration afforded by Section 4(a)(2) under the Securities Act of 1933, as amended (the “1933 Act”), which cannot be offered for public sale in the U.S. without first being registered under the 1933 Act. These securities may be
subject to liquidity risks and certain private placements may be determined to be Illiquid Investments under the Liquidity Risk Management Program applicable to the Funds.
A Fund is subject to a risk
that should the Fund decide to sell such securities when a ready buyer is not available at a price the Fund deems representative of their value, the value of the Fund’s net assets could be adversely affected. Where a security must be
registered under the 1933 Act before it may be sold, a Fund may be obligated to pay all or part of the registration expenses, and a considerable period may elapse between the time of the decision to sell and the time the Fund may be permitted to
sell a security under an effective registration statement. If, during such a period, adverse market conditions were to develop, a Fund might obtain a less favorable price than prevailed when it decided to sell.
The Funds may invest in
commercial paper issued in reliance on the exemption from registration afforded by Section 4(a)(2) of the 1933 Act and other restricted securities (i.e., other securities subject to restrictions on resale). Section 4(a)(2) commercial paper
(“4(a)(2) paper”) is restricted as to disposition under federal securities law and is generally sold to institutional investors, such as the Funds, that agree that they are purchasing the paper for investment purposes and not with a view
to public distribution. Any resale by the purchaser must be in an exempt transaction. 4(a)(2) paper is normally resold to other institutional investors through or with the assistance of the issuer or investment dealers who make a market in 4(a)(2)
paper, thus providing liquidity.
Securities Issued in Connection
with Reorganizations and Corporate Restructuring. Debt securities may be downgraded and issuers of debt securities including investment grade securities may default in the payment of principal or interest or be
subject to bankruptcy proceedings. In connection with reorganizing or restructuring of an issuer, an issuer may issue common stock or other securities to holders of its debt securities. A Fund may hold such common stock and other securities even
though it does not ordinarily invest in such securities and such common stock or other securities may be denominated in currencies that a Fund may not ordinarily hold.
Stapled Securities. From time to time, the Funds may invest in stapled securities to gain exposure to companies. A stapled security is a security that is comprised of two or more parts that cannot be separated from one another. The
resulting security is influenced by both parts, and must be treated as one unit at all times, such as when buying or selling a security. The value of stapled securities and the income derived from them may fall as well as rise. Stapled securities
are not obligations of, deposits in, or guaranteed by, the Fund. The listing of stapled securities on a domestic or foreign exchange does not guarantee a liquid market for stapled securities.
Temporary Defensive Positions. To respond to unusual market conditions, the actively managed Funds may invest their assets in cash or cash equivalents. Cash equivalents are highly liquid, high quality instruments with maturities of three months or
less on the date they are purchased (“Cash Equivalents”) for temporary defensive purposes. These investments may result in a lower yield than lower-quality or longer term investments and may prevent the Funds from meeting their
investment objectives. The percentage of Fund’s total assets that a Fund may invest in cash or cash equivalents is described in the applicable Fund’s Prospectuses. They include securities issued by the U.S. government, its agencies,
Government-Sponsored Enterprises (“GSEs”) and instrumentalities, repurchase agreements with maturities of 7 days or less, certificates of deposit, bankers’ acceptances, commercial paper, money market mutual funds, and bank deposit
accounts. In order to invest in repurchase agreements with the Federal Reserve Bank of New York for temporary defensive purposes, certain Funds may engage in periodic “test” trading in order to assess operational abilities at times when
the Fund would otherwise not enter into such a position. These exercises may vary in size and frequency.
Mortgage-Related Securities
Mortgages (Directly Held). Mortgages are debt instruments secured by real property. Unlike mortgage-backed securities, which generally represent an interest in a pool of mortgages, direct investments in mortgages involve prepayment and credit
risks of an individual issuer and real property. Consequently, these investments require different investment and credit analysis by a Fund’s Adviser.
Directly placed mortgages may
include residential mortgages, multifamily mortgages, mortgages on cooperative apartment buildings, commercial mortgages, and sale-leasebacks. These investments are backed by assets such as office buildings, shopping centers, retail stores,
warehouses, apartment buildings and single-family dwellings. In the event that a Fund forecloses on any non-performing mortgage, and acquires a direct interest in the real property, such Fund will be subject to the risks generally associated with
the ownership of real property. There may be fluctuations in the market value of the foreclosed property and its occupancy rates, rent schedules and operating expenses. There may also be adverse changes in local, regional or general economic
conditions, deterioration of the real estate market and the financial circumstances of tenants and sellers, unfavorable changes in zoning, building, environmental and
other laws, increased real property taxes, rising interest
rates, reduced availability and increased cost of mortgage borrowings, the need for unanticipated renovations, unexpected increases in the cost of energy, environmental factors, acts of God and other factors which are beyond the control of a Fund or
the Fund’s Adviser. Hazardous or toxic substances may be present on, at or under the mortgaged property and adversely affect the value of the property. In addition, the owners of property containing such substances may be held responsible,
under various laws, for containing, monitoring, removing or cleaning up such substances. The presence of such substances may also provide a basis for other claims by third parties. Costs of clean up or of liabilities to third parties may exceed the
value of the property. In addition, these risks may be uninsurable. In light of these and similar risks, it may be impossible to dispose profitably of properties in foreclosure.
Mortgage-Backed Securities
(“CMOs” and “REMICs”). Mortgage-backed securities include collateralized mortgage obligations (“CMOs”) and Real Estate Mortgage Investment Conduits (“REMICs”). A REMIC
is a CMO that qualifies for special tax treatment under the Code and invests in certain mortgages principally secured by interests in real property and other permitted investments.
Mortgage-backed securities
represent pools of mortgage loans assembled for sale to investors by:
•
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various
governmental agencies such as the Government National Mortgage Association (“Ginnie Mae”);
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•
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organizations such
as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”); and
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•
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non-governmental
issuers such as commercial banks, savings and loan institutions, mortgage bankers, and private mortgage insurance companies (non-governmental mortgage securities cannot be treated as U.S. government securities for purposes of investment policies).
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There
are a number of important differences among the agencies, GSEs and instrumentalities of the U.S. government that issue mortgage-related securities and among the securities that they issue.
Ginnie Mae
Securities. Mortgage-related securities issued by Ginnie Mae include Ginnie Mae Mortgage Pass-Through Certificates which are guaranteed as to the timely payment of principal and interest by Ginnie Mae. Ginnie
Mae’s guarantee is backed by the full faith and credit of the U.S. Ginnie Mae is a wholly-owned U.S. government corporation within the Department of Housing and Urban Development. Ginnie Mae certificates also are supported by the authority of
Ginnie Mae to borrow funds from the U.S. Treasury to make payments under its guarantee.
Fannie Mae
Securities. Mortgage-related securities issued by Fannie Mae include Fannie Mae Guaranteed Mortgage Pass-Through Certificates which are solely the obligations of Fannie Mae and are not backed by or entitled to the
full faith and credit of the U.S. Fannie Mae is a government-sponsored organization owned entirely by private stockholders. Fannie Mae Certificates are guaranteed as to timely payment of the principal and interest by Fannie Mae.
Freddie Mac
Securities. Mortgage-related securities issued by Freddie Mac include Freddie Mac Mortgage Participation Certificates. Freddie Mac is a corporate instrumentality of the U.S., created pursuant to an Act of Congress,
which is owned by private stockholders. Freddie Mac Certificates are not guaranteed by the U.S. or by any Federal Home Loan Bank and do not constitute a debt or obligation of the U.S. or of any Federal Home Loan Bank. Freddie Mac Certificates
entitle the holder to timely payment of interest, which is guaranteed by Freddie Mac. Freddie Mac guarantees either ultimate collection or timely payment of all principal payments on the underlying mortgage loans. When Freddie Mac does not guarantee
timely payment of principal, Freddie Mac may remit the amount due on account of its guarantee of ultimate payment of principal at any time after default on an underlying mortgage, but in no event later than one year after it becomes
payable.
For more
information on recent events impacting Fannie Mae and Freddie Mac securities, see “Recent Events Regarding Fannie Mae and Freddie Mac Securities” under the heading “Risk Factors of
Mortgage-Related Securities” below.
CMOs and guaranteed REMIC
pass-through certificates (“REMIC Certificates”) issued by Fannie Mae, Freddie Mac, Ginnie Mae and private issuers are types of multiple class pass-through securities. Investors may purchase beneficial interests in REMICs, which are
known as “regular” interests or “residual” interests. The Funds do not currently intend to purchase residual interests in REMICs. The REMIC Certificates represent beneficial ownership interests in a REMIC Trust, generally
consisting of mortgage loans or Fannie Mae, Freddie Mac or Ginnie Mae guaranteed mortgage pass-through certificates
(the “Mortgage Assets”). The obligations of Fannie
Mae, Freddie Mac or Ginnie Mae under their respective guaranty of the REMIC Certificates are obligations solely of Fannie Mae, Freddie Mac or Ginnie Mae, respectively.
Fannie Mae
REMIC Certificates. Fannie Mae REMIC Certificates are issued and guaranteed as to timely distribution of principal and interest by Fannie Mae. In addition, Fannie Mae will be obligated to distribute the principal
balance of each class of REMIC Certificates in full, whether or not sufficient funds are otherwise available.
Freddie Mac
REMIC Certificates. Freddie Mac guarantees the timely payment of interest, and also guarantees the payment of principal as payments are required to be made on the underlying mortgage participation certificates
(“PCs”). PCs represent undivided interests in specified residential mortgages or participation therein purchased by Freddie Mac and placed in a PC pool. With respect to principal payments on PCs, Freddie Mac generally guarantees ultimate
collection of all principal of the related mortgage loans without offset or deduction. Freddie Mac also guarantees timely payment of principal on certain PCs referred to as “Gold PCs.”
Ginnie Mae
REMIC Certificates. Ginnie Mae guarantees the full and timely payment of interest and principal on each class of securities (in accordance with the terms of those classes as specified in the related offering circular
supplement). The Ginnie Mae guarantee is backed by the full faith and credit of the U.S. REMIC Certificates issued by Fannie Mae, Freddie Mac and Ginnie Mae are treated as U.S. Government securities for purposes of investment policies.
CMOs and REMIC Certificates
provide for the redistribution of cash flow to multiple classes. Each class of CMOs or REMIC Certificates, often referred to as a “tranche,” is issued at a specific adjustable or fixed interest rate and must be fully retired no later
than its final distribution date. This reallocation of interest and principal results in the redistribution of prepayment risk across different classes. This allows for the creation of bonds with more or less risk than the underlying collateral
exhibits. Principal prepayments on the mortgage loans or the Mortgage Assets underlying the CMOs or REMIC Certificates may cause some or all of the classes of CMOs or REMIC Certificates to be retired substantially earlier than their final
distribution dates. Generally, interest is paid or accrues on all classes of CMOs or REMIC Certificates on a monthly basis.
The principal of and interest
on the Mortgage Assets may be allocated among the several classes of CMOs or REMIC Certificates in various ways. In certain structures (known as “sequential pay” CMOs or REMIC Certificates), payments of principal, including any principal
prepayments, on the Mortgage Assets generally are applied to the classes of CMOs or REMIC Certificates in the order of their respective final distribution dates. Thus, no payment of principal will be made on any class of sequential pay CMOs or REMIC
Certificates until all other classes having an earlier final distribution date have been paid in full.
Additional structures of CMOs
and REMIC Certificates include, among others, principal only structures, interest only structures, inverse floaters and “parallel pay” CMOs and REMIC Certificates. Certain of these structures may be more volatile than other types of CMO
and REMIC structures. Parallel pay CMOs or REMIC Certificates are those which are structured to apply principal payments and prepayments of the Mortgage Assets to two or more classes concurrently on a proportionate or disproportionate basis. These
simultaneous payments are taken into account in calculating the final distribution date of each class.
A wide variety of REMIC
Certificates may be issued in the parallel pay or sequential pay structures. These securities include accrual certificates (also known as “Z-Bonds”), which only accrue interest at a specified rate until all other certificates having an
earlier final distribution date have been retired and are converted thereafter to an interest-paying security, and planned amortization class (“PAC”) certificates, which are parallel pay REMIC Certificates which generally require that
specified amounts of principal be applied on each payment date to one or more classes of REMIC Certificates (the “PAC Certificates”), even though all other principal payments and prepayments of the Mortgage Assets are then required to be
applied to one or more other classes of the certificates. The scheduled principal payments for the PAC Certificates generally have the highest priority on each payment date after interest due has been paid to all classes entitled to receive interest
currently. Shortfalls, if any, are added to the amount of principal payable on the next payment date. The PAC Certificate payment schedule is taken into account in calculating the final distribution date of each class of PAC. In order to create PAC
tranches, one or more tranches generally must be created that absorb most of the volatility in the underlying Mortgage Assets. These tranches tend to have market prices and yields that are much more volatile than the PAC classes. The Z-Bonds in
which the Funds may invest may bear the same non-credit-related risks as do other types of Z-Bonds. Z-Bonds in which the Fund may invest will not include residual interest.
Total Annual Fund Operating
Expenses set forth in the fee table and Financial Highlights section of each Fund’s Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the
definition of “investment company” provided by section 3(c)(1) or 3(c)(7) of the 1940 Act.
GSE Credit Risk Transfer
Securities and GSE Credit-Linked Notes. GSE Credit risk transfer securities are notes issued directly by a GSE, such as Fannie Mae and Freddie Mac, and GSE credit-linked notes are notes issued by a SPV sponsored by
a GSE. Investors in these notes provide credit protection for the applicable GSE’s mortgage-related securities guarantee obligations. In this regard, a noteholder receives compensation for providing credit protection to the GSE and, when a
specified level of losses on the relevant mortgage loans occurs, the principal balance and certain payments owed to the noteholder may be reduced. In addition, noteholders may receive a return of principal prior to the stated maturity date
reflecting prepayment on the underlying mortgage loans and in any other circumstances that may be set forth in the applicable loan agreement. The notes may be issued in different tranches representing the issuance of different levels of credit risk
protection to the GSE on the underlying mortgage loans and the notes are not secured by the reference mortgage loans. There are important differences between the structure of GSE credit risk transfer securities and GSE credit-linked
notes.
GSE Credit
Risk Transfer Securities Structure. In this structure, the GSE receives the note sale proceeds. The GSE pays noteholders monthly interest payments and a return of principal on the stated maturity date based on the
initial investment amount, as reduced by any covered losses on the reference mortgage loans.
GSE
Credit-Linked Notes Structure. In this structure, the SPV receives the note sale proceeds and the SPV’s obligations to the noteholder are collateralized by the note sale proceeds. The SPV invests the proceeds
in cash or other short-term assets. The SPV also enters into a credit protection agreement with the GSE pursuant to which the GSE pays the SPV monthly premium payments and the SPV compensates the GSE for covered losses on the reference mortgage
loans. The SPV pays noteholders monthly interest payments based on the premium payments paid by the GSE and the performance on the invested note sale proceeds. The noteholders also receive a return of principal on a stated maturity date based on the
initial investment amount, as reduced by any covered losses on the reference mortgage loans paid by the SPV or the GSE.
Mortgage TBAs. A Fund may invest in mortgage pass-through securities eligible to be sold in the “to-be-announced” or TBA market (“Mortgage TBAs”). Mortgage TBAs provide for the forward or delayed delivery of
the underlying instrument with settlement up to 180 days. The term TBA comes from the fact that the actual mortgage-backed security that will be delivered to fulfill a TBA trade is not designated at the time the trade is made, but rather is
generally announced 48 hours before the settlement date. Mortgage TBAs are subject to the risks described in the “When-Issued Securities, Delayed Delivery Securities and Forward Commitments” section. Additionally, amendments to
applicable rolls include certain mandatory margin requirements for the TBA market, which may require the Funds to pay collateral in connection with their TBA transactions. The required margin could increase the cost of the Funds and add additional
complexity for Funds engaging in these transactions.
Mortgage Dollar Rolls. In a mortgage dollar roll transaction, one party sells mortgage-backed securities, principally Mortgage TBAs, for delivery in the current month and simultaneously contracts with the same counterparty to repurchase
similar (same type, coupon and maturity) but not identical securities on a specified future date. When a Fund enters into TBAs/mortgage dollar rolls, the Fund will segregate or earmark until the settlement date liquid assets, in an amount equal to
the agreed-upon purchase price of each long and short position. Economically offsetting TBA positions with the same agency, coupon, and maturity date, are generally permitted to be netted if the short position settles on the same date or before the
long position. During the period between the sale and repurchase in a mortgage dollar roll transaction, the Fund will not be entitled to receive interest and principal payments on securities sold. Losses may arise due to changes in the value of the
securities or if the counterparty does not perform under the terms of the agreement. If the counterparty files for bankruptcy or becomes insolvent, the Fund’s right to repurchase or sell securities may be limited. Mortgage dollar rolls may be
subject to leverage risks. In addition, mortgage dollar rolls may increase interest rate risk and result in an increased portfolio turnover rate which increases costs and may increase taxable gains. The benefits of mortgage dollar rolls may depend
upon a Fund’s Adviser’s ability to predict mortgage prepayments and interest rates. There is no assurance that mortgage dollar rolls can be successfully employed. For purposes of diversification and investment limitations, mortgage
dollar rolls are considered to be mortgage-backed securities.
Stripped Mortgage-Backed
Securities. Stripped Mortgage-Backed Securities (“SMBS”) are derivative multi-class mortgage securities issued outside the REMIC or CMO structure. SMBS may be 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, mortgage banks, commercial banks, investment banks and special purpose entities. SMBS are usually structured with two
classes that receive different proportions of the interest and principal distributions from a pool of mortgage assets. A common type of SMBS will have one class receiving all of the interest from the mortgage assets (“IOs”), while the
other class will receive all of the principal (“POs”). Mortgage IOs receive monthly interest payments based upon a notional amount that declines over time as a result of the normal monthly amortization and unscheduled prepayments of
principal on the associated mortgage POs.
In addition to the risks
applicable to Mortgage-Related Securities in general, SMBS are subject to the following additional risks:
Prepayment/Interest
Rate Sensitivity. SMBS are extremely sensitive to changes in prepayments and interest rates. Even though these securities have been guaranteed by an agency or instrumentality of the U.S. government, under certain
interest rate or prepayment rate scenarios, the Funds may lose money on investments in SMBS.
Interest Only
SMBS. Changes in prepayment rates can cause the return on investment in IOs to be highly volatile. Under extremely high prepayment conditions, IOs can incur significant losses.
Principal
Only SMBS. POs are bought at a discount to the ultimate principal repayment value. The rate of return on a PO will vary with prepayments, rising as prepayments increase and falling as prepayments decrease. Generally,
the market value of these securities is unusually volatile in response to changes in interest rates.
Yield
Characteristics. Although SMBS may yield more than other mortgage-backed securities, their cash flow patterns are more volatile and there is a greater risk that any premium paid will not be fully recouped. A
Fund’s Adviser will seek to manage these risks (and potential benefits) by investing in a variety of such securities and by using certain analytical and hedging techniques.
Privately Issued
Mortgage-Related Securities. Non-government issuers, including commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers and other secondary market issuers, also create
pass-through pools of conventional residential mortgage loans. Such issuers may be the originators and/or servicers of the underlying mortgage loans as well as the guarantors of the mortgage-related securities. Mortgage pools created by
non-governmental 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 former pools. However, timely payment of
interest and principal of these pools may be supported by various forms of insurance of guarantees, including individual loan, title, pool and hazard insurance and letters of credit, which may be issued by governmental entities or private insurers.
Such insurance and guarantees and the creditworthiness of the issuers thereof may be considered in determining whether a mortgage-related security meets a Fund’s investment quality standards. There can be no assurance that insurers or
guarantors can meet their obligations under the insurance policies or guarantee arrangements.
Privately issued
mortgage-related securities may not be subject to the same underwriting requirements for the underlying mortgages that are applicable to those mortgage-related securities that have a government or government-sponsored entity guarantee. As a result,
the mortgage loans underlying privately issued mortgage-related securities may have less favorable collateral, credit risk or other underwriting characteristics than government or government-sponsored mortgage-related securities and have wider
variances in a number of terms including interest rate, term, size, purpose and borrower characteristics. Mortgage pools underlying privately issued mortgage-related securities may include second mortgages, high loan-to-value ratio mortgages where a
government or government-sponsored entity guarantee is not available. The coupon rates and maturities of the underlying mortgage loans in a privately-issued mortgage-related securities pool may vary to a greater extent than those included in a
government guaranteed pool, and the pool may include subprime mortgage loans. Subprime loans are loans made to borrowers with low credit ratings or other factors that increase the risk of default. For these reasons, the loans underlying these
securities historically have had higher default rates than those loans that meet government underwriting requirements.
The risk of non-payment is
greater for mortgage-related securities that are backed by loans that were originated under weak underwriting standards, including loans made to borrowers with limited means to make repayment. A level of risk exists for all loans, although,
historically, the poorest performing loans
have been those classified as subprime. Other types of privately
issued mortgage-related securities, such as those classified as pay-option adjustable rate or Alt-A, at times, have also performed poorly. Even loans classified as prime may experience higher levels of delinquencies and defaults. A decline in real
property values across the U.S. may exacerbate the level of losses that investors in privately issued mortgage-related securities have experienced. Market factors that may adversely affect mortgage loan repayment include adverse economic conditions,
unemployment, a decline in the value of real property, or an increase in interest rates.
Privately issued
mortgage-related securities are not traded on an exchange and there may be a limited market for these securities, especially when there is a perceived weakness in the mortgage and real estate market sectors. Without an active trading market,
mortgage-related securities held in a Fund’s portfolio may be particularly difficult to value because of the complexities involved in assessing the value of the underlying mortgage loans.
The Funds may purchase
privately issued mortgage-related securities that are originated, packaged and serviced by third party entities. Such third parties may have obligations to investors of mortgage-related securities under trust or other documents. For example, loan
servicers may be liable to the holder of the mortgage-related securities for negligence or willful misconduct in carrying out their servicing duties. Similarly, loan originators/servicers may make certain representations and warranties regarding the
quality of the mortgages and properties underlying a mortgage-related security, which if untrue, may trigger an obligation of the originator/service or its affiliates, as applicable, to repurchase the mortgages from the issuing trust. Although trust
and other documents may include protective provisions, investors in certain mortgage-related securities have had limited success in enforcing terms or such agreements against such third parties. In addition, such third parties may have had interests
that are in conflict with those holders of the mortgage-related.
For example, to the extent
third party entities are involved in litigation relating to the securities, actions may be taken by such third parties that are adverse to the interest of the holders of the mortgage-related securities, including the Funds, such as withholding
proceeds due to holders of the mortgage-related securities, to cover legal or related costs. Any such action could result in losses to the Funds.
In addition, certain
mortgage-related securities, which may include loans that originally qualified under standards established by government-sponsored entities (for example, certain REMICs that include Fannie Mae mortgages), are not considered as government securities
for purposes of a Fund’s investment strategies or policies and may be subject to the same risks as privately-issued mortgage-related securities. There is no government or government-sponsored guarantee for such privately issued
investments.
Adjustable
Rate Mortgage Loans. Certain Funds may invest in adjustable rate mortgage loans (“ARMs”). ARMs eligible for inclusion in a mortgage pool will generally provide for a fixed initial mortgage interest rate
for a specified period of time. Thereafter, the interest rates (the “Mortgage Interest Rates”) may be subject to periodic adjustment based on changes in the applicable index rate (the “Index Rate”). The adjusted rate would be
equal to the Index Rate plus a gross margin, which is a fixed percentage spread over the Index Rate established for each ARM at the time of its origination.
Adjustable interest rates can
cause payment increases that some borrowers may find difficult to make. However, certain ARMs may provide that the Mortgage Interest Rate may not be adjusted to a rate above an applicable lifetime maximum rate or below an applicable lifetime minimum
rate for such ARM. Certain ARMs may also be subject to limitations on the maximum amount by which the Mortgage Interest Rate may adjust for any single adjustment period (the “Maximum Adjustment”). Other ARMs (“Negatively Amortizing
ARMs”) may provide instead or as well for limitations on changes in the monthly payment on such ARMs. Limitations on monthly payments can result in monthly payments which are greater or less than the amount necessary to amortize a Negatively
Amortizing ARM by its maturity at the Mortgage Interest Rate in effect in any particular month. In the event that a monthly payment is not sufficient to pay the interest accruing on a Negatively Amortizing ARM, any such excess interest is added to
the principal balance of the loan, causing negative amortization and will be repaid through future monthly payments. It may take borrowers under Negatively Amortizing ARMs longer periods of time to achieve equity and may increase the likelihood of
default by such borrowers. In the event that a monthly payment exceeds the sum of the interest accrued at the applicable Mortgage Interest Rate and the principal payment which would have been necessary to amortize the outstanding principal balance
over the remaining term of the loan, the excess (or “accelerated amortization”) further reduces the principal balance of the ARM. Negatively Amortizing ARMs do not provide for the extension of their original maturity to accommodate
changes in their Mortgage Interest Rate. As a result, unless there is a periodic recalculation of the payment amount
(which there generally is), the final payment may be
substantially larger than the other payments. These limitations on periodic increases in interest rates and on changes in monthly payments protect borrowers from unlimited interest rate and payment increases.
Certain ARMs may provide for
periodic adjustments of scheduled payments in order to amortize fully the mortgage loan by its stated maturity. Other ARMs may permit their stated maturity to be extended or shortened in accordance with the portion of each payment that is applied to
interest as affected by the periodic interest rate adjustments.
There are two main categories
of indices which provide the basis for rate adjustments on ARMs: those based on U.S. Treasury securities and those derived from a calculated measure such as a cost of funds index or a moving average of mortgage rates. Commonly utilized indices
include the one-year, three-year and five-year constant maturity Treasury bill rates, the three-month Treasury bill rate, the 180-day Treasury bill rate, rates on longer-term Treasury securities, the 11th District Federal Home Loan Bank Cost of
Funds, the National Median Cost of Funds, the one-month, three-month, six-month or one-year LIBOR, the prime rate of a specific bank, or commercial paper rates. Some indices, such as the one-year constant maturity Treasury rate, closely mirror
changes in market interest rate levels. Others, such as the 11th District Federal Home Loan Bank Cost of Funds index, tend to lag behind changes in market rate levels and tend to be somewhat less volatile. The degree of volatility in the market
value of the Fund’s portfolio and therefore in the NAV of the Fund’s shares will be a function of the length of the interest rate reset periods and the degree of volatility in the applicable indices.
In general, changes in both
prepayment rates and interest rates will change the yield on Mortgage-Backed Securities. The rate of principal prepayments with respect to ARMs has fluctuated in recent years. As is the case with fixed mortgage loans, ARMs may be subject to a
greater rate of principal prepayments in a declining interest rate environment. For example, if prevailing interest rates fall significantly, ARMs could be subject to higher prepayment rates than if prevailing interest rates remain constant because
the availability of fixed rate mortgage loans at competitive interest rates may encourage mortgagors to refinance their ARMs to “lock-in” a lower fixed interest rate. Conversely, if prevailing interest rates rise significantly, ARMs may
prepay at lower rates than if prevailing rates remain at or below those in effect at the time such ARMs were originated. As with fixed rate mortgages, there can be no certainty as to the rate of prepayments on the ARMs in either stable or changing
interest rate environments. In addition, there can be no certainty as to whether increases in the principal balances of the ARMs due to the addition of deferred interest may result in a default rate higher than that on ARMs that do not provide for
negative amortization.
Other
factors affecting prepayment of ARMs include changes in mortgagors’ housing needs, job transfers, unemployment, mortgagors’ net equity in the mortgage properties and servicing decisions.
Risk Factors of Mortgage-Related
Securities. The following is a summary of certain risks associated with Mortgage-Related Securities:
Guarantor Risk. There can be no assurance that the U.S. government would provide financial support to Fannie Mae or Freddie Mac if necessary in the future. Although certain mortgage-related securities are guaranteed by a third party or
otherwise similarly secured, the market value of the security, which may fluctuate, is not so secured.
Interest Rate Sensitivity. If a Fund purchases a mortgage-related security at a premium, that portion may be lost if there is a decline in the market value of the security whether resulting from changes in interest rates or prepayments in the
underlying mortgage collateral. As with other interest-bearing securities, the prices of such securities are inversely affected by changes in interest rates. Although the value of a mortgage-related security may decline when interest rates rise, the
converse is not necessarily true since in periods of declining interest rates the mortgages underlying the securities are prone to prepayment. For this and other reasons, a mortgage-related security’s stated maturity may be shortened by
unscheduled prepayments on the underlying mortgages and, therefore, it is not possible to predict accurately the security’s return to the Fund. In addition, regular payments received in respect of mortgage-related securities include both
interest and principal. No assurance can be given as to the return the Fund will receive when these amounts are reinvested.
Liquidity. The liquidity of certain mortgage-backed securities varies by type of security; at certain times the Fund may encounter difficulty in disposing of such investments. In the past, in stressed markets, certain types of
mortgage-backed securities suffered periods of illiquidity when disfavored by the market. It is possible that the Fund may be unable to sell a mortgage-backed security at a desirable time or at the value the Fund has placed on the
investment.
Market Value. The market value of the Fund’s adjustable rate Mortgage-Backed Securities may be adversely affected if interest rates increase faster than the rates of interest payable on such securities or by the adjustable rate
mortgage loans underlying such securities. Furthermore, adjustable rate Mortgage-Backed Securities or the mortgage loans underlying such securities may contain provisions limiting the amount by which rates may be adjusted upward and downward and may
limit the amount by which monthly payments may be increased or decreased to accommodate upward and downward adjustments in interest rates. When the market value of the properties underlying the Mortgage-Backed Securities suffer broad declines on a
regional or national level, the values of the corresponding Mortgage-Backed Securities or Mortgage-Backed Securities as a whole, may be adversely affected as well.
Prepayments. Adjustable rate Mortgage-Backed Securities have less potential for capital appreciation than fixed rate Mortgage-Backed Securities because their coupon rates will decline in response to market interest rate declines. The
market value of fixed rate Mortgage-Backed Securities may be adversely affected as a result of increases in interest rates and, because of the risk of unscheduled principal prepayments, may benefit less than other fixed rate securities of similar
maturity from declining interest rates. Finally, to the extent Mortgage-Backed Securities are purchased at a premium, mortgage foreclosures and unscheduled principal prepayments may result in some loss of the Fund’s principal investment to the
extent of the premium paid. On the other hand, if such securities are purchased at a discount, both a scheduled payment of principal and an unscheduled prepayment of principal will increase current and total returns and will accelerate the
recognition of income.
Yield Characteristics. The yield characteristics of Mortgage-Backed Securities differ from those of traditional fixed income securities. The major differences typically include more frequent interest and principal payments, usually monthly,
and the possibility that prepayments of principal may be made at any time. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic, social and other factors and cannot be predicted with certainty.
As with fixed rate mortgage loans, adjustable rate mortgage loans may be subject to a greater prepayment rate in a declining interest rate environment. The yields to maturity of the Mortgage-Backed Securities in which the Funds invest will be
affected by the actual rate of payment (including prepayments) of principal of the underlying mortgage loans. The mortgage loans underlying such securities generally may be prepaid at any time without penalty. In a fluctuating interest rate
environment, a predominant factor affecting the prepayment rate on a pool of mortgage loans is the difference between the interest rates on the mortgage loans and prevailing mortgage loan interest rates taking into account the cost of any
refinancing. In general, if mortgage loan interest rates fall sufficiently below the interest rates on fixed rate mortgage loans underlying mortgage pass-through securities, the rate of prepayment would be expected to increase. Conversely, if
mortgage loan interest rates rise above the interest rates on the fixed rate mortgage loans underlying the mortgage pass-through securities, the rate of prepayment may be expected to decrease.
Recent Events Regarding Fannie
Mae and Freddie Mac Securities. On September 6, 2008, the Federal Housing Finance Agency (“FHFA”) placed Fannie Mae and Freddie Mac into conservatorship. As the conservator, FHFA succeeded to all rights,
titles, powers and privileges of Fannie Mae and Freddie Mac and of any stockholder, officer or director of Fannie Mae and Freddie Mac with respect to Fannie Mae and Freddie Mac and the assets of Fannie Mae and Freddie Mac. FHFA selected a new chief
executive officer and chairman of the board of directors for each of Fannie Mae and Freddie Mac. In connection with the conservatorship, the U.S. Treasury entered into a Senior Preferred Stock Purchase Agreement with each of Fannie Mae and Freddie
Mac pursuant to which the U.S. Treasury will purchase up to an aggregate of $100 billion of each of Fannie Mae and Freddie Mac to maintain a positive net worth in each enterprise. This agreement contains various covenants, discussed below, that
severely limit each enterprise’s operations. In exchange for entering into these agreements, the U.S. Treasury received $1 billion of each enterprise’s senior preferred stock and warrants to purchase 79.9% of each enterprise’s
common stock. In 2009, the U.S. Treasury announced that it was doubling the size of its commitment to each enterprise under the Senior Preferred Stock Program to $200 billion. The U.S. Treasury’s obligations under the Senior Preferred Stock
Program are for an indefinite period of time for a maximum amount of $200 billion per enterprise. In 2009, the U.S. Treasury further amended the Senior Preferred Stock Purchase Agreement to allow the cap on the U.S. Treasury’s funding
commitment to increase as necessary to accommodate any cumulative reduction in Fannie Mae’s and Freddie Mac’s net worth through the end of 2012. In August 2012, the Senior Preferred Stock Purchase Agreement was further amended to, among
other things, accelerate the wind down of the retained portfolio, terminate the requirement that Fannie Mae and Freddie Mac each pay a 10% dividend annually on all amounts received under the funding commitment, and require the submission of an
annual risk management plan to the U.S. Treasury.
Fannie Mae and Freddie Mac are
continuing to operate as going concerns while in conservatorship and each remain liable for all of its obligations, including its guaranty obligations, associated with its mortgage-backed securities. The Senior Preferred Stock Purchase Agreement is
intended to enhance each of Fannie Mae’s and Freddie Mac’s ability to meet its obligations. The FHFA has indicated that the conservatorship of each enterprise will end when the director of FHFA determines that FHFA’s plan to
restore the enterprise to a safe and solvent condition has been completed.
Under the Federal Housing
Finance Regulatory Reform Act of 2008 (the “Reform Act”), which was included as part of the Housing and Economic Recovery Act of 2008, FHFA, as conservator or receiver, has the power to repudiate any contract entered into by Fannie Mae
or Freddie Mac prior to FHFA’s appointment as conservator or receiver, as applicable, if FHFA determines, in its sole discretion, that performance of the contract is burdensome and that repudiation of the contract promotes the orderly
administration of Fannie Mae’s or Freddie Mac’s affairs. The Reform Act requires FHFA to exercise its right to repudiate any contract within a reasonable period of time after its appointment as conservator or receiver. FHFA, in its
capacity as conservator, has indicated that it has no intention to repudiate the guaranty obligations of Fannie Mae or Freddie Mac because FHFA views repudiation as incompatible with the goals of the conservatorship. However, in the event that FHFA,
as conservator or if it is later appointed as receiver for Fannie Mae or Freddie Mac, were to repudiate any such guaranty obligation, the conservatorship or receivership estate, as applicable, would be liable for actual direct compensatory damages
in accordance with the provisions of the Reform Act. Any such liability could be satisfied only to the extent of Fannie Mae’s or Freddie Mac’s assets available therefor. In the event of repudiation, the payments of interest to holders of
Fannie Mae or Freddie Mac mortgage-backed securities would be reduced if payments on the mortgage loans represented in the mortgage loan groups related to such mortgage-backed securities are not made by the borrowers or advanced by the servicer. Any
actual direct compensatory damages for repudiating these guaranty obligations may not be sufficient to offset any shortfalls experienced by such mortgage-backed security holders. Further, in its capacity as conservator or receiver, FHFA has the
right to transfer or sell any asset or liability of Fannie Mae or Freddie Mac without any approval, assignment or consent. Although FHFA has stated that it has no present intention to do so, if FHFA, as conservator or receiver, were to transfer any
such guaranty obligation to another party, holders of Fannie Mae or Freddie Mac mortgage-backed securities would have to rely on that party for satisfaction of the guaranty obligation and would be exposed to the credit risk of that party.
In addition, certain rights
provided to holders of mortgage-backed securities issued by Fannie Mae and Freddie Mac under the operative documents related to such securities may not be enforced against FHFA, or enforcement of such rights may be delayed, during the
conservatorship or any future receivership. The operative documents for Fannie Mae and Freddie Mac mortgage-backed securities may provide (or with respect to securities issued prior to the date of the appointment of the conservator may have
provided) that upon the occurrence of an event of default on the part of Fannie Mae or Freddie Mac, in its capacity as guarantor, which includes the appointment of a conservator or receiver, holders of such mortgage-backed securities have the right
to replace Fannie Mae or Freddie Mac as trustee if the requisite percentage of mortgage-backed securities holders consent. The Reform Act prevents mortgage-backed security holders from enforcing such rights if the event of default arises solely
because a conservator or receiver has been appointed. The Reform Act also provides that no person may exercise any right or power to terminate, accelerate or declare an event of default under certain contracts to which Fannie Mae or Freddie Mac is a
party, or obtain possession of or exercise control over any property of Fannie Mae or Freddie Mac, or affect any contractual rights of Fannie Mae or Freddie Mac, without the approval of FHFA, as conservator or receiver, for a period of 45 or 90 days
following the appointment of FHFA as conservator or receiver, respectively.
In addition, in a February 2011
report to Congress from the Treasury Department and the Department of Housing and Urban Development, the Obama administration provided a plan to reform America’s housing finance market. The plan would reduce the role of and eventually
eliminate Fannie Mae and Freddie Mac. Notably, the plan does not propose similar significant changes to Ginnie Mae, which guarantees payments on mortgage-related securities backed by federally insured or guaranteed loans such as those issued by the
Federal Housing Association or guaranteed by the Department of Veterans Affairs. The report also identified three proposals for Congress and the administration to consider for the long-term structure of the housing finance markets after the
elimination of Fannie Mae and Freddie Mac, including implementing: (i) a privatized system of housing finance that limits government insurance to very limited groups of creditworthy low- and moderate-income borrowers; (ii) a privatized system with a
government backstop mechanism that would allow the government to insure a larger share of the housing
finance market during a future housing crisis; and (iii) a
privatized system where the government would offer reinsurance to holders of certain highly-rated mortgage-related securities insured by private insurers and would pay out under the reinsurance arrangements only if the private mortgage insurers were
insolvent.
The conditions
attached to the financial contribution made by the Treasury to Freddie Mac and Fannie Mae and the issuance of senior preferred stock place significant restrictions on the activities of Freddie Mac and Fannie Mae. Freddie Mac and Fannie Mae must
obtain the consent of the Treasury to, among other things, (i) make any payment to purchase or redeem its capital stock or pay any dividend other than in respect of the senior preferred stock, (ii) issue capital stock of any kind, (iii) terminate
the conservatorship of the FHFA except in connection with a receivership, or (iv) increase its debt beyond certain specified levels. In addition, significant restrictions are placed on the maximum size of each of Freddie Mac’s and Fannie
Mae’s respective portfolios of mortgages and mortgage-backed securities, and the purchase agreements entered into by Freddie Mac and Fannie Mae provide that the maximum size of their portfolios of these assets must decrease by a specified
percentage each year. The future status and role of Freddie Mac and Fannie Mae could be impacted by (among other things) the actions taken and restrictions placed on Freddie Mac and Fannie Mae by the FHFA in its role as conservator, the restrictions
placed on Freddie Mac’s and Fannie Mae’s operations and activities as a result of the senior preferred stock investment made by the U.S. Treasury, market responses to developments at Freddie Mac and Fannie Mac, and future legislative and
regulatory action that alters the operations, ownership, structure and/or mission of these institutions, each of which may, in turn, impact the value of, and cash flows on, any mortgage-backed securities guaranteed by Freddie Mac and Fannie Mae,
including any such mortgage-backed securities held by a Fund.
Risks Related to GSE Credit Risk
Transfer Securities and GSE Credit-Linked Notes. GSE Credit risk transfer securities are general obligations issued by a GSE and are unguaranteed and unsecured. GSE Credit-linked notes are similar, except that the
notes are issued by an SPV, rather than by a GSE, and the obligations of the SPV are collateralized by the note proceeds as invested by the SPV, which are invested in cash or short-term securities. Although both GSE credit risk transfer securities
and GSE credit-linked notes are unguaranteed, obligations of an SPV are also not backstopped by the Department of Treasury or an obligation of a GSE.
The risks associated with these
investments are different than the risks associated with an investment in mortgage-backed securities issued by GSEs or a private issuer. For example, in the event of a default on the obligations to noteholders, noteholders such as the Funds have no
recourse to the underlying mortgage loans. In addition, some or all of the mortgage default risk associated with the underlying mortgage loans is transferred to noteholders. As a result, there can be no assurance that losses will not occur on an
investment in GSE credit risk transfer securities or GSE credit-linked notes and Funds investing in these instruments may be exposed to the risk of loss on their investment. In addition, these investments are subject to prepayment risk.
In the case of GSE
credit-linked notes, if a GSE fails to make a premium or other required payment to the SPV, the SPV may be unable to pay a noteholder the entire amount of interest or principal payable to the noteholder. In the event of a default on the obligations
to noteholders, the SPV’s principal and interest payment obligations to noteholders will be subordinated to the SPV’s credit protection payment obligations to the GSE. Payment of such amounts to noteholders depends on the cash available
in the trust from the loan proceeds and the GSE’s premium payments.
Any income earned by the SPV on
investments of loan proceeds is expected to be less than the interest payments amounts to be paid to noteholders of the GSE credit-linked notes and interest payments to noteholders will be reduced if the GSE fails to make premium payments to the
SPV. An SPV’s investment of loan proceeds may also be concentrated in the securities of a few number of issuers. A noteholder bears any investment losses on the allocable portion of the loan proceeds.
An SPV that issues GSE
credit-linked notes may fall within the definition of a “commodity pool” under the Commodity Exchange Act. Certain GSEs are not registered as commodity pool operators in reliance on CFTC no-action relief, subject to certain conditions
similar to those under CFTC Rule 4.13(a)(3), which respect to the operation of the SPV. If the GSE or SPV fails to comply with such conditions, noteholders that are investment vehicles, such as the Funds, may need to register as a CPO, which could
cause such a Fund to incur increased costs.
Municipal Securities
Municipal Securities are issued
to obtain funds for a wide variety of reasons. For example, municipal securities may be issued to obtain funding for the construction of a wide range of public facilities such as:
1.
|
bridges;
|
2.
|
highways;
|
3.
|
roads;
|
4.
|
schools;
|
5.
|
waterworks and
sewer systems; and
|
6.
|
other
utilities.
|
Other public purposes for which
Municipal Securities may be issued include:
1.
|
refunding
outstanding obligations;
|
2.
|
obtaining funds
for general operating expenses; and
|
3.
|
obtaining
funds to lend to other public institutions and facilities.
|
In addition, certain debt
obligations known as “Private Activity Bonds” may be issued by or on behalf of municipalities and public authorities to obtain funds to provide:
1.
|
water, sewage and
solid waste facilities;
|
2.
|
qualified
residential rental projects;
|
3.
|
certain local
electric, gas and other heating or cooling facilities;
|
4.
|
qualified
hazardous waste facilities;
|
5.
|
high-speed
intercity rail facilities;
|
6.
|
governmentally-owned
airports, docks and wharves and mass transportation facilities;
|
7.
|
qualified
mortgages;
|
8.
|
student loan and
redevelopment bonds; and
|
9.
|
bonds
used for certain organizations exempt from Federal income taxation.
|
Certain debt obligations known as
“Industrial Development Bonds” under prior Federal tax law may have been issued by or on behalf of public authorities to obtain funds to provide:
1.
|
privately operated
housing facilities;
|
2.
|
sports facilities;
|
3.
|
industrial parks;
|
4.
|
convention or
trade show facilities;
|
5.
|
airport, mass
transit, port or parking facilities;
|
6.
|
air or water
pollution control facilities;
|
7.
|
sewage or solid
waste disposal facilities; and
|
8.
|
facilities
for water supply.
|
Other private activity bonds
and industrial development bonds issued to fund the construction, improvement, equipment or repair of privately-operated industrial, distribution, research, or commercial facilities may also be Municipal Securities, however the size of such issues
is limited under current and prior Federal tax law. The aggregate amount of most private activity bonds and industrial development bonds is limited (except in the case of certain types of facilities) under Federal tax law by an annual “volume
cap.” The volume cap limits the annual aggregate principal amount of such obligations issued by or on behalf of all governmental instrumentalities in the state.
The two principal
classifications of Municipal Securities consist of “general obligation” and “limited” (or revenue) issues. General obligation bonds are obligations involving the credit of an issuer possessing taxing power and are payable
from the issuer’s general unrestricted revenues and not from any particular fund or source. The characteristics and method of enforcement of general obligation bonds vary according to the law applicable to the particular issuer, and payment
may be dependent upon appropriation by the issuer’s legislative body. Limited obligation 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 or other specific revenue source. Private activity bonds and industrial development bonds generally are revenue bonds and thus not payable from the unrestricted revenues of the issuer. The credit and quality of such bonds is generally related
to the credit of the bank selected to provide the letter of credit underlying the bond. Payment of principal of and interest on industrial development revenue bonds is the responsibility of the corporate user (and any guarantor).
The Funds may also acquire
“moral obligation” issues, which are normally issued by special purpose authorities, and in other tax-exempt investments including pollution control bonds and tax-exempt commercial paper. Each Fund that may purchase municipal bonds may
purchase:
1.
|
Short-term
tax-exempt General Obligations Notes;
|
2.
|
Tax Anticipation
Notes;
|
3.
|
Bond Anticipation
Notes;
|
4.
|
Revenue
Anticipation Notes;
|
5.
|
Project Notes; and
|
6.
|
Other
forms of short-term tax-exempt loans.
|
Such notes are issued with a
short-term maturity in anticipation of the receipt of tax funds, the proceeds of bond placements, or other revenues. Project Notes are issued by a state or local housing agency and are sold by the Department of Housing and Urban Development. While
the issuing agency has the primary obligation with respect to its Project Notes, they are also secured by the full faith and credit of the U.S. through agreements with the issuing authority which provide that, if required, the Federal government
will lend the issuer an amount equal to the principal of and interest on the Project Notes.
There are, of course,
variations in the quality of Municipal Securities, both within a particular classification and between classifications. Also, the yields on Municipal Securities depend upon a variety of factors, including:
1.
|
general money
market conditions;
|
2.
|
coupon rate;
|
3.
|
the financial
condition of the issuer;
|
4.
|
general conditions
of the municipal bond market;
|
5.
|
the size of a
particular offering;
|
6.
|
the maturity of
the obligations; and
|
7.
|
the
rating of the issue.
|
The ratings of Moody’s
and S&P represent their opinions as to the quality of Municipal Securities. However, ratings are general and are not absolute standards of quality. Municipal Securities with the same maturity, interest rate and rating may have different yields
while Municipal Securities of the same maturity and interest rate with different ratings may have the same yield. Subsequent to its purchase by a Fund, an issue of Municipal Securities may cease to be rated or its rating may be reduced below the
minimum rating required for purchase by the Fund. The Adviser will consider such an event in determining whether the Fund should continue to hold the obligations.
Municipal Securities may
include obligations of municipal housing authorities and single-family mortgage revenue bonds. Weaknesses in Federal housing subsidy programs and their administration may result in a decrease of subsidies available for payment of principal and
interest on housing authority bonds. Economic developments, including fluctuations in interest rates and increasing construction and operating costs, may also adversely impact revenues of housing authorities. In the case of some housing authorities,
inability to obtain additional financing could also reduce revenues available to pay existing obligations.
Single-family mortgage revenue
bonds are subject to extraordinary mandatory redemption at par in whole or in part from the proceeds derived from prepayments of underlying mortgage loans and also from the unused proceeds of the issue within a stated period which may be within a
year from the date of issue.
Municipal leases are
obligations issued by state and local governments or authorities to finance the acquisition of equipment and facilities. They may take the form of a lease, an installment purchase contract, a conditional sales contract, or a participation interest
in any of the above. The Board of Trustees is responsible for determining the credit quality of unrated municipal leases on an ongoing basis, including an assessment of the likelihood that the lease will not be canceled.
Premium Securities. During a period of declining interest rates, many Municipal Securities in which the Funds invest likely will bear coupon rates higher than current market rates, regardless of whether the securities were initially
purchased at a premium.
Risk Factors in Municipal
Securities. The following is a summary of certain risks associated with Municipal Securities
Tax Risk. The Code imposes certain continuing requirements on issuers of tax-exempt bonds regarding the use, expenditure and investment of bond proceeds and the payment of rebates to the U.S. Failure by the issuer to comply
subsequent to the issuance of tax-exempt bonds with certain of these requirements could cause interest on the bonds to become includable in gross income retroactive to the date of issuance.
Housing Authority Tax Risk. The exclusion from gross income for Federal income tax purposes for certain housing authority bonds depends on qualification under relevant provisions of the Code and on other provisions of Federal law. These provisions
of Federal law contain requirements relating to the cost and location of the residences financed with the proceeds of the single-family mortgage bonds and the income levels of tenants of the rental projects financed with the proceeds of the
multi-family housing bonds. Typically, the issuers of the bonds, and other parties, including the originators and servicers of the single-family mortgages and the owners of the rental projects financed with the multi-family housing bonds, covenant
to meet these requirements. However, there is no assurance that the requirements will be met. If such requirements are not met:
•
|
the interest on
the bonds may become taxable, possibly retroactively from the date of issuance;
|
•
|
the value of the
bonds may be reduced;
|
•
|
you and other
Shareholders may be subject to unanticipated tax liabilities;
|
•
|
a Fund may be
required to sell the bonds at the reduced value;
|
•
|
it may be an event
of default under the applicable mortgage;
|
•
|
the holder may be
permitted to accelerate payment of the bond; and
|
•
|
the
issuer may be required to redeem the bond.
|
In addition, if the mortgage
securing the bonds is insured by the Federal Housing Administration (“FHA”), the consent of the FHA may be required before insurance proceeds would become payable.
Information Risk. Information about the financial condition of issuers of Municipal Securities may be less available than that of corporations having a class of securities registered under the SEC.
State and Federal Laws. An issuer’s obligations under its Municipal Securities are subject to the provisions of bankruptcy, insolvency, and other laws affecting the rights and remedies of creditors. These laws may extend the time for
payment of principal or interest, or restrict the Fund’s ability to collect payments due on Municipal Securities. In addition, recent amendments to some statutes governing security interests (e.g., Revised Article 9 of the Uniform Commercial
Code (“UCC”)) change the way in which security interests and liens securing Municipal Securities are perfected. These amendments may have an adverse impact on existing Municipal Securities (particularly issues of Municipal Securities
that do not have a corporate trustee who is responsible for filing UCC financing statements to continue the security interest or lien).
Litigation and Current
Developments. Litigation or other conditions may materially and adversely affect the power or ability of an issuer to meet its obligations for the payment of interest on and principal of its Municipal Securities.
Such litigation or conditions may from time to time have the effect of introducing uncertainties in the market for tax-exempt obligations, or may materially affect the credit risk with respect
to particular bonds or notes. Adverse economic, business, legal
or political developments might affect all or a substantial portion of a Fund’s Municipal Securities in the same manner. Given the recent bankruptcy-type proceedings by the Commonwealth of Puerto Rico, risks associated with municipal
obligations are heightened.
New Legislation. From time to time, proposals have been introduced before Congress for the purpose of restricting or eliminating the federal income tax exemption for interest on tax exempt bonds, and similar proposals may be introduced
in the future. The Supreme Court has held that Congress has the constitutional authority to enact such legislation. It is not possible to determine what effect the adoption of such proposals could have on (i) the availability of Municipal Securities
for investment by the Funds, and (ii) the value of the investment portfolios of the Funds.
Limitations on the Use of
Municipal Securities. Certain Funds may invest in Municipal Securities if the Adviser determines that such Municipal Securities offer attractive yields. The Funds may invest in Municipal Securities either by
purchasing them directly or by purchasing certificates of accrual or similar instruments evidencing direct ownership of interest payments or principal payments, or both, on Municipal Securities, provided that, in the opinion of counsel to the
initial seller of each such certificate or instrument, any discount accruing on such certificate or instrument that is purchased at a yield not greater than the coupon rate of interest on the related Municipal Securities will to the same extent as
interest on such Municipal Securities be exempt from federal income tax and state income tax (where applicable) and not be treated as a preference item for individuals for purposes of the federal alternative minimum tax. The Funds may also invest in
Municipal Securities by purchasing from banks participation interests in all or part of specific holdings of Municipal Securities. Such participation interests may be backed in whole or in part by an irrevocable letter of credit or guarantee of the
selling bank. The selling bank may receive a fee from a Fund in connection with the arrangement.
Each Fund will limit its
investment in municipal leases to no more than 5% of its total assets.
Options and Futures Transactions
A Fund may purchase and sell
(a) exchange traded and OTC put and call options on securities, on indexes of securities and other types of instruments, and on futures contracts on securities and indexes of securities and other instruments such as interest rate futures and global
interest rate futures and (b) futures contracts on securities and other types of instruments and on indexes of securities and other types of instruments. Each of these instruments is a derivative instrument as its value derives from the underlying
asset or index.
Subject to
its investment objective and policies, a Fund may use futures contracts and options for hedging and risk management purposes and to seek to enhance portfolio performance.
Options and futures contracts
may be used to manage a Fund’s exposure to changing interest rates and/or security prices. Some options and futures strategies, including selling futures contracts and buying puts, tend to hedge a Fund’s investments against price
fluctuations. Other strategies, including buying futures contracts and buying calls, tend to increase market exposure. Options and futures contracts may be combined with each other or with forward contracts in order to adjust the risk and return
characteristics of a Fund’s overall strategy in a manner deemed appropriate by the Adviser and consistent with the Fund’s objective and policies. Because combined options positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
The use of options and futures
is a highly specialized activity which involves investment strategies and risks different from those associated with ordinary portfolio securities transactions, and there can be no guarantee that their use will increase a Fund’s return. While
the use of these instruments by a Fund may reduce certain risks associated with owning its portfolio securities, these techniques themselves entail certain other risks. If the Adviser applies a strategy at an inappropriate time or judges market
conditions or trends incorrectly, options and futures strategies may lower a Fund’s return. Certain strategies limit a Fund’s possibilities to realize gains, as well as its exposure to losses. A Fund could also experience losses if the
prices of its options and futures positions were poorly correlated with its other investments, or if it could not close out its positions because of an illiquid secondary market. In addition, the Fund will incur transaction costs, including trading
commissions and option premiums, in connection with its futures and options transactions, and these transactions could significantly increase the Fund’s turnover rate.
Certain Funds have filed a
notice under the Commodity Exchange Act under Regulation 4.5 and are operated by a person that has claimed an exclusion from the definition of the term “commodity pool operator” under the Commodity Exchange Act and, therefore, is not
subject to registration or regulation as
a commodity pool operator under the Commodity Exchange Act.
Certain other Funds may rely on no-action relief issued by the CFTC. For Funds that cannot rely on an exclusion from the definition of commodity pool operator, or no action relief from the CFTC, the Adviser is subject to regulation as a commodity
pool operator.
Purchasing
Put and Call Options. By purchasing a put option, a Fund obtains the right (but not the obligation) to sell the instrument underlying the option at a fixed strike price. In return for this right, a Fund pays the
current market price for the option (known as the option premium). Options have various types of underlying instruments, including specific securities, indexes of securities, indexes of securities prices, and futures contracts. A Fund may terminate
its position in a put option it has purchased by allowing it to expire or by exercising the option. A Fund may also close out a put option position by entering into an offsetting transaction, if a liquid market exists. If the option is allowed to
expire, a Fund will lose the entire premium it paid. If a Fund exercises a put option on a security, it will sell the instrument underlying the option at the strike price. If a Fund exercises an option on an index, settlement is in cash and does not
involve the actual purchase or sale of securities. If an option is American style, it may be exercised on any day up to its expiration date. A European style option may be exercised only on its expiration date.
The buyer of a typical put
option can expect to realize a gain if the value of the underlying instrument falls substantially. However, if the price of the instrument underlying the option does not fall enough to offset the cost of purchasing the option, a put buyer can expect
to suffer a loss (limited to the amount of the premium paid, plus related transaction costs).
The features of call options
are essentially the same as those of put options, except that the purchaser of a call option obtains the right to purchase, rather than sell, the instrument underlying the option at the option’s strike price. A call buyer typically attempts to
participate in potential price increases of the instrument underlying the option with risk limited to the cost of the option if security prices fall. At the same time, the buyer can expect to suffer a loss if security prices do not rise sufficiently
to offset the cost of the option.
Selling (Writing) Put and Call
Options on Securities. When a Fund writes a put option on a security, it takes the opposite side of the transaction from the option’s purchaser. In return for the receipt of the premium, a Fund assumes the
obligation to pay the strike price for the security underlying the option if the other party to the option chooses to exercise it. A Fund may seek to terminate its position in a put option it writes before exercise by purchasing an offsetting option
in the market at its current price. If the market is not liquid for a put option a Fund has written, however, it must continue to be prepared to pay the strike price while the option is outstanding, regardless of price changes, and must continue to
post margin as discussed below. If the market value of the underlying securities does not move to a level that would make exercise of the option profitable to its holder, the option will generally expire unexercised, and the Fund will realize as
profit the premium it received.
If the price of the underlying
securities rises, a put writer would generally expect to profit, although its gain would be limited to the amount of the premium it received. If security prices remain the same over time, it is likely that the writer will also profit, because it
should be able to close out the option at a lower price. If security prices fall, the put writer would expect to suffer a loss. This loss should be less than the loss from purchasing and holding the underlying security directly, however, because the
premium received for writing the option should offset a portion of the decline.
Writing a call option
obligates a Fund to sell or deliver the option’s underlying security in return for the strike price upon exercise of the option. The characteristics of writing call options are similar to those of writing put options, except that writing calls
generally is a profitable strategy if prices remain the same or fall. Through receipt of the option premium a call writer offsets part of the effect of a price decline. At the same time, because a call writer must be prepared to deliver the
underlying instrument in return for the strike price, even if its current value is greater, a call writer gives up some ability to participate in security price increases.
When a Fund writes an exchange
traded put or call option on a security, it will be required to deposit cash or securities or a letter of credit as margin and to make mark to market payments of variation margin as the position becomes unprofitable.
Certain Funds will usually
sell covered call options or cash-secured put options on securities. A call option is covered if the writer either owns the underlying security (or comparable securities satisfying the cover requirements of the securities exchanges) or has the right
to acquire such securities. Alternatively, a Fund will segregate or earmark liquid assets (i) in an amount equal to the Fund’s obligation under the
contract with respect to call options or (ii) an amount greater
of the market value of the instrument underlying the option or the strike price of the contract with respect to call options. A call option is also covered if a Fund (i) acquires a call option on the same security with a strike price equal to or
lower than the strike price of the written call or (ii) acquires a call option on the same security with a strike price higher than the strike price of the written call and segregates liquid assets in an amount equal to the difference between the
strike price of the two options. As the writer of a covered call option, the Fund foregoes, during the option’s life, the opportunity to profit from increases in the market value of the security covering the call option above the sum of the
premium and the strike price of the call, but has retained the risk of loss should the price of the underlying security decline. As the Fund writes covered calls over more of its portfolio, its ability to benefit from capital appreciation becomes
more limited. The writer of an option has no control over the time when it may be required to fulfill its obligation, but may terminate its position by entering into an offsetting option. Once an option writer has received an exercise notice, it
cannot effect an offsetting transaction in order to terminate its obligation under the option and must deliver the underlying security at the exercise price.
A put option is cash-secured if
the writer segregates cash, high-grade short-term debt obligations, or other permissible collateral equity to the exercise price. Alternatively, a put option is covered if a Fund (i) acquires a put option on the same security with a strike price
equal to or higher than the strike price of written put or (ii) acquires a put option on the same security with a strike price lower than the strike price of the written put and segregates liquid assets in the amount equal to the difference between
the strike price of the two options. When the Fund writes cash-secured put options, it bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium. If the option is exercised, the Fund could
incur a loss if it is required to purchase the stock underlying the put option at a price greater than the market price of the stock at the time of exercise plus the put premium the Fund received when it wrote the option. While the Fund’s
potential gain in writing a cash-secured put option is limited to distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, the Fund risks a loss equal to the entire exercise
price of the option minus the put premium.
Engaging in Straddles and
Spreads. In a straddle transaction, a Fund either buys a call and a put or sells a call and a put on the same security. In a spread, a Fund purchases and sells a call or a put. A Fund will sell a straddle when the
Fund’s Adviser believes the price of a security will be stable. The Fund will receive a premium on the sale of the put and the call. A spread permits a Fund to make a hedged investment that the price of a security will increase or
decline.
Options on
Indexes. Certain Funds may purchase and sell options on securities indexes and other types of indexes. Options on indexes are similar to options on securities, except that the exercise of index options may be
settled by cash payments (or in some instances by a futures contract) and does not involve the actual purchase or sale of securities or the instruments in the index. In addition, these options are designed to reflect price fluctuations in a group of
securities or instruments or segment of the securities’ or instruments’ market rather than price fluctuations in a single security or instrument. A Fund, in purchasing or selling index options, is subject to the risk that the value of
its portfolio may not change as much as an index because a Fund’s investments generally will not match the composition of an index. Unlike call options on securities, index options are cash settled, or settled with a futures contract in some
instances, rather than settled by delivery of the underlying index securities or instruments.
Certain Funds purchase and
sell credit options which are options on indexes of derivative instruments such as credit default swap indexes. Like other index options, credit options can be cash settled or settled with a futures contract in some instances. In addition, credit
options can also be settled in some instances by delivery of the underlying index instrument. Credit options may be used for a variety of purposes including hedging, risk management such as positioning a portfolio for anticipated volatility or
increasing income or gain to a Fund. There is no guarantee that the strategy of using options on indexes or credit options in particular will be successful.
Funds that sell (write) call
and put options on indexes are required to segregate or earmark liquid assets in the amount equal to the market value of the obligation. Alternatively, written call options on indexes may be covered if a Fund (i) acquires a call option for the same
securities indexes with a strike price equal to or lower than the strike price of the written call or (ii) acquires a call option on the same securities indexes with a strike price higher than the strike price of the written call and segregates
liquid assets in an amount equal to the difference between the strike price of the two options. Written put options on indexes may be covered if a Fund (i) acquires a put option for the same securities indexes with a strike
price equal to or higher than the strike price of the written
put or (ii) acquires a put option on the same securities indexes with a strike price lower than the strike price of the written put and segregates liquid assets in the amount equal to the difference between the strike price of the two options.
For a number of reasons, a
liquid market may not exist and thus a Fund may not be able to close out an option position that it has previously entered into. When a Fund purchases an OTC option (as defined below), it will be relying on its counterparty to perform its
obligations and the Fund may incur additional losses if the counterparty is unable to perform.
Exchange-Traded and OTC Options. All options purchased or sold by a Fund will be traded on a securities exchange or will be purchased or sold by securities dealers (“OTC options”) that meet the Fund’s creditworthiness standards. While
exchange-traded options are obligations of the Options Clearing Corporation, in the case of OTC options, a Fund relies on the dealer from which it purchased the option to perform if the option is exercised. Thus, when a Fund purchases an OTC option,
it relies on the dealer from which it purchased the option to make or take delivery of the underlying securities. Failure by the dealer to do so would result in the loss of the premium paid by a Fund as well as loss of the expected benefit of the
transaction. Accordingly, these OTC options are subject to heightened credit risk, as well as liquidity and valuation risk depending upon the type of OTC options in which the Fund invests.
Futures Contracts. When a Fund purchases a futures contract, it agrees to purchase a specified quantity of an underlying instrument at a specified future date or, in the case of an index futures contract, to make a cash payment based on
the value of a securities index. When a Fund sells a futures contract, it agrees to sell a specified quantity of the underlying instrument at a specified future date or, in the case of an index futures contract, to receive a cash payment based on
the value of a securities index. The price at which the purchase and sale will take place is fixed when a Fund enters into the contract. Futures can be held until their delivery dates or the position can be (and normally is) closed out before then.
There is no assurance, however, that a liquid market will exist when the Fund wishes to close out a particular position.
When a Fund purchases a futures
contract, the value of the futures contract tends to increase and decrease in tandem with the value of its underlying instrument. Therefore, purchasing futures contracts will tend to increase a Fund’s exposure to positive and negative price
fluctuations in the underlying instrument, much as if it had purchased the underlying instrument directly. When a Fund sells a futures contract, by contrast, the value of its futures position will tend to move in a direction contrary to the value of
the underlying instrument. Selling futures contracts, therefore, will tend to offset both positive and negative market price changes, much as if the underlying instrument had been sold.
The purchaser or seller of a
futures contract is not required to deliver or pay for the underlying instrument unless the contract is held until the delivery date. However, when a Fund buys or sells a futures contract, it will be required to deposit “initial margin”
with a futures commission merchant (“FCM”). Initial margin deposits are typically equal to a small percentage of the contract’s value. If the value of either party’s position declines, that party will be required to make
additional “variation margin” payments equal to the change in value on a daily basis.
The party that has a gain may
be entitled to receive all or a portion of this amount. A Fund may be obligated to make payments of variation margin at a time when it is disadvantageous to do so. Furthermore, it may not always be possible for a Fund to close out its futures
positions. Until it closes out a futures position, a Fund will be obligated to continue to pay variation margin. Initial and variation margin payments do not constitute purchasing on margin for purposes of a Fund’s investment restrictions. In
the event of the bankruptcy of an FCM that holds margin on behalf of a Fund, the Fund may be entitled to return of margin owed to it only in proportion to the amount received by the FCM’s other customers, potentially resulting in losses to the
Fund. For cash-settled futures, the Fund will segregate or earmark liquid assets in an amount equal to the mark-to-market value. For physically settled futures, the Funds generally will earmark or segregate liquid assets in an amount equal to the
notional value. Futures contracts will be treated as cash-settled for asset segregation purposes when a Fund and/or its Cayman subsidiary have entered into a contractual arrangement (each, a side letter”) with a third party FCM or other
counterparty to off-set the Fund’s or Subsidiary’s exposure under the contract and, failing that, to assign its delivery obligation under the contract to the FCM or counterparty. In calculating the segregation amount, netting of similar
contracts is generally permitted. Such assets cannot be sold while the futures contract or option is outstanding unless they are replaced with other suitable assets. By setting aside assets equal only to its net obligation under cash-settled futures
or under physically-settled futures for which the a Fund and/or its Cayman subsidiary have entered into a side letter, a Fund will have the ability to have exposure to such instruments to a greater extent than if a Fund were required to set aside
assets equal to the
full notional value of such contracts. There is a possibility
that earmarking and reservation of a large percentage of a Fund’s assets could impede portfolio management or a Fund’s ability to meet redemption requests or other current obligations.
The Funds only invest in
futures contracts on securities to the extent they could invest in the underlying securities directly. Certain Funds may also invest in index futures where the underlying securities or instruments are not available for direct investments by the
Funds.
Cash Equitization. The objective where equity futures are used to “equitize” cash is to match the notional value of all futures contracts to a Fund’s cash balance. The notional values of the futures contracts and of the
cash are monitored daily. As the cash is invested in securities and/or paid out to participants in redemptions, the Adviser simultaneously adjusts the futures positions. Through such procedures, a Fund not only gains equity exposure from the use of
futures, but also benefits from increased flexibility in responding to client cash flow needs. Additionally, because it can be less expensive to trade a list of securities as a package or program trade rather than as a group of individual orders,
futures provide a means through which transaction costs can be reduced. Such non-hedging risk management techniques involve leverage, and thus present, as do all leveraged transactions, the possibility of losses as well as gains that are greater
than if these techniques involved the purchase and sale of the securities themselves rather than their synthetic derivatives.
Options on Futures Contracts. Futures contracts obligate the buyer to take and the seller to make delivery at a future date of a specified quantity of a financial instrument or an amount of cash based on the value of a securities or other index.
Currently, futures contracts are available on various types of securities, including but not limited to U.S. Treasury bonds, notes and bills, Eurodollar certificates of deposit and on indexes of securities. Unlike a futures contract, which requires
the parties to buy and sell a security or make a cash settlement payment based on changes in a financial instrument or securities or other index on an agreed date, an option on a futures contract entitles its holder to decide on or before a future
date whether to enter into such a contract. If the holder decides not to exercise its option, the holder may close out the option position by entering into an offsetting transaction or may decide to let the option expire and forfeit the premium
thereon. The purchaser of an option on a futures contract pays a premium for the option but makes no initial margin payments or daily payments of cash in the nature of “variation margin” payments to reflect the change in the value of the
underlying contract as does a purchaser or seller of a futures contract. The seller of an option on a futures contract receives the premium paid by the purchaser and may be required to pay initial margin.
Combined Positions. Certain Funds may purchase and write options in combination with futures or forward contracts, to adjust the risk and return characteristics of the overall position. For example, a Fund may purchase a put option and
write a call option on the same underlying instrument, in order to construct a combined position whose risk and return characteristics are similar to selling a futures contract. Another possible combined position would involve writing a call option
at one strike price and buying a call option at a lower price, in order to reduce the risk of the written call option in the event of a substantial price increase. Because combined options positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
Correlation of Price Changes. Because there are a limited number of types of exchange-traded options and futures contracts, it is likely that the standardized options and futures contracts available will not match a Fund’s current or
anticipated investments exactly. A Fund may invest in options and futures contracts based on securities or instruments with different issuers, maturities, or other characteristics from the securities in which it typically invests, which involves a
risk that the options or futures position will not track the performance of a Fund’s other investments.
Options and futures contracts
prices can also diverge from the prices of their underlying instruments, even if the underlying instruments match the Fund’s investments well. Options and futures contracts prices are affected by such factors as current and anticipated short
term interest rates, changes in volatility of the underlying instrument, and the time remaining until expiration of the contract, which may not affect security prices the same way. Imperfect correlation may also result from differing levels of
demand in the options and futures markets and the securities markets, from structural differences in how options and futures and securities are traded, or from imposition of daily price fluctuation limits or trading halts. A Fund may purchase or
sell options and futures contracts with a greater or lesser value than the securities it wishes to hedge or intends to purchase in order to attempt to compensate for differences in volatility between the contract and the securities, although this
may not be successful in all cases. If price changes in a Fund’s options or futures positions are poorly correlated with its other investments, the positions may fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.
Liquidity of Options and Futures
Contracts. There is no assurance that a liquid market will exist for any particular option or futures contract at any particular time even if the contract is traded on an exchange. In addition, exchanges may
establish daily price fluctuation limits for options and futures contracts and may halt trading if a contract’s price moves up or down more than the limit in a given day. On volatile trading days when the price fluctuation limit is reached or
a trading halt is imposed, it may be impossible for a Fund to enter into new positions or close out existing positions. If the market for a contract is not liquid because of price fluctuation limits or otherwise, it could prevent prompt liquidation
of unfavorable positions, and could potentially require a Fund to continue to hold a position until delivery or expiration regardless of changes in its value. As a result, a Fund’s access to other assets held to cover its options or futures
positions could also be impaired. (See “Exchange-Traded and OTC Options” above for a discussion of the liquidity of options not traded on an exchange.)
Foreign Investment Risk. Certain Funds may buy and sell options on interest rate futures including global interest rate futures in which the reference interest rate is tied to currencies other than the U.S. dollar. Such investments are subject
to additional risks including the risks associated with foreign investment and currency risk. See “Foreign Investments (including Foreign Currencies)” in this SAI Part II.
Position Limits. Futures exchanges can limit the number of futures and options on futures contracts that can be held or controlled by an entity. If an adequate exemption cannot be obtained, a Fund or the Adviser may be required to
reduce the size of its futures and options positions or may not be able to trade a certain futures or options contract in order to avoid exceeding such limits.
Asset Coverage for Futures
Contracts and Options Positions. A Fund will comply with guidelines established by the SEC with respect to coverage of options and futures contracts by mutual funds, and if the guidelines so require, will set aside
or earmark appropriate liquid assets in the amount prescribed. For cash settled futures contracts and options on futures contracts, a Fund will segregate an amount equal to the mark-to-market value of the obligation. For physically settled futures
contracts and options on futures contracts, a Fund will segregate an amount equal to the current notional value of the contract or underlying futures contracts, as applicable. Netting is generally permitted of similar contracts. Such assets cannot
be sold while the futures contract or option is outstanding, unless they are replaced with other suitable assets. As a result, there is a possibility that the reservation of a large percentage of a Fund’s assets could impede portfolio
management or a Fund’s ability to meet redemption requests or other current obligations. The Funds may also enter into offsetting transactions on futures contracts and options on futures in accordance with guidelines established by the SEC,
similar to the transactions as described above in “Selling (Writing) Put and Call Options on Securities.”
Real Estate Investment Trusts
(“REITs”)
Certain of the Funds may
invest in equity interests or debt obligations issued by REITs. REITs are pooled investment vehicles which invest primarily in income producing real estate or real estate related loans or interest. REITs are generally classified as equity REITs,
mortgage REITs or a combination of equity and mortgage REITs. Equity REITs invest the majority of their assets directly in real property and derive income primarily from the collection of rents. Equity REITs can also realize capital gains by selling
property that has appreciated in value. Mortgage REITs invest the majority of their assets in real estate mortgages and derive income from the collection of interest payments. Similar to investment companies, REITs are not taxed on income
distributed to shareholders provided they comply with several requirements of the Code. A Fund will indirectly bear its proportionate share of expenses incurred by REITs in which a Fund invests in addition to the expenses incurred directly by a
Fund.
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 and on cash flows, are not diversified, and are subject to default by borrowers and self-liquidation. REITs are also subject to the possibilities of
failing to qualify for tax free pass-through of income under the Code and failing to maintain their exemption from registration under the 1940 Act.
REITs (especially mortgage
REITs) are also subject to interest rate risks. When interest rates decline, the value of a REIT’s investment in fixed rate obligations can be expected to rise. Conversely, when interest rates rise, the value of a REIT’s investment in
fixed rate obligations can be expected to decline. In
contrast, as interest rates on adjustable rate mortgage loans
are reset periodically, yields on a REIT’s investment in such loans will gradually align themselves to fluctuate less dramatically in response to interest rate fluctuations than would investments in fixed rate obligations.
Investment in REITs involves
risks similar to those associated with investing in small capitalization companies. These risks include:
•
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limited financial
resources;
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•
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infrequent or
limited trading; and
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•
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more
abrupt or erratic price movements than larger company securities.
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In addition, small capitalization
stocks, such as certain REITs, historically have been more volatile in price than the larger capitalization stocks included in the S&P 500® Index.
Recent Events Relating to the Overall Economy
The U.S. Government, the
Federal Reserve, the Treasury, the SEC, the FDIC and other governmental and regulatory bodies have taken actions to address the financial crisis. These actions included, in part, the enactment by the United States Congress of the Dodd-Frank Act,
which was signed into law on July 21, 2010 and imposed a new regulatory framework over the U.S. financial services industry and the consumer credit markets in general, and proposed and final regulations by the SEC. Given the broad scope, sweeping
nature, and relatively recent enactment of some of these regulatory measures, the potential impact they could have on securities held by the Funds is unknown. There can be no assurance that these measures will not have an adverse effect on the value
or marketability of securities held by the Funds. Furthermore, no assurance can be made that the U.S. Government or any U.S. regulatory body (or other authority or regulatory body) will not continue to take further legislative or regulatory action,
and the effect of such actions, if taken, cannot be known. However, current efforts by the U.S. Government to reduce the impact of regulations on the U.S. financial services industry could lead to the repeal of certain elements of the regulatory
framework.
Repurchase Agreements
Repurchase agreements may be
entered into with brokers, dealers or banks or other entities that meet the Adviser’s credit guidelines. A Fund will enter into repurchase agreements only with member banks of the Federal Reserve System and securities dealers or other entities
believed by the Adviser to be creditworthy. The Adviser may consider the collateral received and any applicable guarantees in making its determination. In a repurchase agreement, a Fund buys a security from a seller that has agreed to repurchase the
same security at a mutually agreed upon date and price. The resale price normally is in excess of the purchase price, reflecting an agreed upon interest rate. This interest rate is effective for the period of time a Fund is invested in the agreement
and is not related to the coupon rate on the underlying security. A repurchase agreement may also be viewed as a fully collateralized loan of money by a Fund to the seller. The maximum maturity permitted for a non- “putable” repurchase
agreement will be 190 days. In the case of a tri-party agreement, the maximum notice period permitted for a “putable” or “open” repurchase agreement (i.e., where the Fund has a right to put the repurchase agreement to the
counterparty or terminate the transaction at par plus accrued interest at a specified notice period) will be 190 days. The securities which are subject to repurchase agreements, however, may have maturity dates in excess of 190 days from the
effective date of the repurchase agreement. In addition, the maturity of a “putable” or “open” repurchase agreement may be in excess of 190 days. A Fund will always receive securities as collateral during the term of the
agreement whose market value is at least equal to 100% of the dollar amount invested by the Fund in each agreement plus accrued interest. The repurchase agreements further authorize the Fund to demand additional collateral in the event that the
dollar value of the collateral falls below 100%. A Fund will make payment for such securities only upon physical delivery or upon evidence of book entry transfer to the account of the custodian. Repurchase agreements are considered under the 1940
Act to be loans collateralized by the underlying securities.
All of the Funds that are
permitted to invest in repurchase agreements may engage in repurchase agreement transactions that are collateralized fully as defined in Rule 5b-3(c)(1) of the 1940 Act, which has the effect of enabling a Fund to look to the collateral, rather than
the counterparty, for determining whether its assets are “diversified” for 1940 Act purposes. The Adviser may consider the collateral received and any applicable guarantees in making its determination. Certain Funds may, in addition,
engage in repurchase agreement transactions that are collateralized by money market instruments, debt securities, loan participations, equity securities or other securities including securities that are rated below
investment grade by the requisite NRSROs or unrated securities
of comparable quality. For these types of repurchase agreement transactions, the Fund would look to the counterparty, and not the collateral, for determining such diversification.
A repurchase agreement is
subject to the risk that the seller may fail to repurchase the security. In the event of default by the seller under a repurchase agreement construed to be a collateralized loan, the underlying securities would not be owned by the Fund, but would
only constitute collateral for the seller’s obligation to pay the repurchase price. Therefore, a Fund may suffer time delays and incur costs in connection with the disposition of the collateral. The collateral underlying repurchase agreements
may be more susceptible to claims of the seller’s creditors than would be the case with securities owned by the Fund.
Under existing guidance from
the SEC, certain Funds may transfer uninvested cash balances into a joint account, along with cash of other Funds and certain other accounts. These balances may be invested in one or more repurchase agreements and/or short-term money market
instruments.
Reverse Repurchase
Agreements
In a reverse
repurchase agreement, a Fund sells a security and agrees to repurchase the same security at a mutually agreed upon date and price reflecting the interest rate effective for the term of the agreement. For purposes of the 1940 Act, a reverse
repurchase agreement is considered borrowing by a Fund and, therefore, a form of leverage. Leverage may cause any gains or losses for a Fund to be magnified. The Funds will invest the proceeds of borrowings under reverse repurchase agreements. In
addition, except for liquidity purposes, a Fund will enter into a reverse repurchase agreement only when the expected return from the investment of the proceeds is greater than the expense of the transaction. A Fund will not invest the proceeds of a
reverse repurchase agreement for a period which exceeds the duration of the reverse repurchase agreement. A Fund would be required to pay interest on amounts obtained through reverse repurchase agreements, which are considered borrowings under
federal securities laws. The repurchase price is generally equal to the original sales price plus interest. Reverse repurchase agreements are usually for seven days or less and cannot be repaid prior to their expiration dates. Each Fund will earmark
and reserve Fund assets, in cash or liquid securities, in an amount at least equal to its purchase obligations under its reverse repurchase agreements. Reverse repurchase agreements involve the risk that the market value of the portfolio securities
transferred may decline below the price at which a Fund is obliged to purchase the securities. All forms of borrowing (including reverse repurchase agreements) are limited in the aggregate and may not exceed 33 1⁄3% of a Fund’s total assets, except as permitted by law.
Securities Lending
To generate additional income,
certain Funds may lend up to 33 1⁄3% of such Fund’s total assets pursuant to
agreements requiring that the loan be continuously secured by collateral equal to at least 100% of the market value plus accrued interest on the securities lend. The Funds use Citibank, N.A. (“Citibank”) as their securities lending
agent. Pursuant to a Third Party Securities Lending Rider to the Custody Agreement between JPMorgan Chase Bank, Citibank and the Funds (the “Third Party Securities Lending Rider”) approved by the Board of Trustees, Citibank compensates
JPMorgan Chase Bank for certain custodial services provided by JPMorgan Chase Bank in connection with the Funds’ use of Citibank as securities lending agent.
Pursuant to the Global
Securities Lending Agency Agreement approved by the Board of Trustees between Citibank and the Trust on behalf of the applicable Funds, severally and not jointly (the “Securities Lending Agency Agreement”), collateral for loans will
consist only of cash. The Funds receive payments from the borrowers equivalent to the dividends and interest that would have been earned on the securities lent. For loans secured by cash, the Funds seek to earn interest on the investment of cash
collateral in investments permitted by the Securities Lending Agency Agreement. Under the Securities Lending Agency Agreement, cash collateral may be invested in IM Shares of JPMorgan Prime Money Market Fund, JPMorgan U.S. Government Money Market
Fund, and Class Agency SL Shares of the JPMorgan Securities Lending Money Market Fund.
Under the Securities Lending
Agency Agreement, Citibank marks to market the loaned securities on a daily basis. In the event the cash received from the borrower is less than 102% of the value of the loaned securities (105% for non-U.S. securities), Citibank requests additional
cash from the borrower so as to maintain a collateralization level of at least 102% of the value of the loaned securities plus accrued interest (105% for non-U.S. securities) subject to certain de minimis
amounts. Loans are subject to termination by a Fund or the borrower at any time, and are therefore not considered to be illiquid investments. A Fund
does not have the right to vote proxies for securities on loans
over a record date of such proxies. However, if the Fund’s Adviser has notice of the proxy in advance of the record date, a Fund’s Adviser may terminate a loan in advance of the record date if the Fund’s Adviser determines the vote
is considered material with respect to an investment.
Securities lending involves
counterparty risk, including the risk that the loaned securities may not be returned or returned in a timely manner and/or a loss of rights in the collateral if the borrower or the lending agent defaults or fails financially. This risk is increased
when a Fund’s loans are concentrated with a single or limited number of borrowers. The earnings on the collateral invested may not be sufficient to pay fees incurred in connection with the loan. Also, the principal value of the collateral
invested may decline and may not be sufficient to pay back the borrower for the amount of collateral posted. There are no limits on the number of borrowers a Fund may use and a Fund may lend securities to only one or a small group of borrowers. In
addition, loans may be made to affiliates of Citibank. Funds participating in securities lending bear the risk of loss in connection with investments of the cash collateral received from the borrowers, which do not trigger additional collateral
requirements from the borrower.
To the extent that the value or
return of a Fund’s investments of the cash collateral declines below the amount owed to a borrower, the Fund may incur losses that exceed the amount it earned on lending the security. In situations where the Adviser does not believe that it is
prudent to sell the cash collateral investments in the market, a Fund may borrow money to repay the borrower the amount of cash collateral owed to the borrower upon return of the loaned securities. This will result in financial leverage, which may
cause the Fund to be more volatile because financial leverage tends to exaggerate the effect of any increase or decrease in the value of the Fund’s portfolio securities.
Short Selling
In short selling transactions,
a Fund sells a security it does not own in anticipation of a decline in the market value of the security. To complete the transaction, a Fund must borrow the security to make delivery to the buyer. A Fund is obligated to replace the security
borrowed by purchasing it subsequently at the market price at the time of replacement. The price at such time may be more or less than the price at which the security was sold by a Fund, which may result in a loss or gain, respectively. Unlike
taking a long position in a security by purchasing the security, where potential losses are limited to the purchase price, short sales have no cap on maximum losses, and gains are limited to the price of the security at the time of the short
sale.
Short sales of
forward commitments and derivatives do not involve borrowing a security. These types of short sales may include futures, options, contracts for differences, forward contracts on financial instruments and options such as contracts, credit linked
instruments, and swap contracts.
A Fund may not always be able
to borrow a security it wants to sell short. A Fund also may be unable to close out an established short position at an acceptable price and may have to sell long positions at disadvantageous times to cover its short positions. The value of your
investment in a Fund will fluctuate in response to movements in the market. Fund performance also will depend on the effectiveness of the Adviser’s research and the management team’s investment decisions. The SEC and financial industry
regulatory authorities in other countries may impose prohibitions, restrictions or other regulatory requirements on short sales, which could inhibit the ability of the Adviser to sell securities short on behalf of the Fund. For example, in September
2008, in response to spreading turmoil in the financial markets, the SEC temporarily banned short selling in the stocks of numerous financial services companies, and also promulgated new disclosure requirements with respect to short positions held
by investment managers. The SEC’s temporary ban on short selling of such stocks has since expired, but should similar restrictions and/or additional disclosure requirements be promulgated, especially if market turmoil occurs, a Fund may be
forced to cover short positions more quickly than otherwise intended and may suffer losses as a result. Such restrictions may also adversely affect the ability of a Fund (especially if a Fund utilizes short selling as a significant portion of its
investment strategy) to execute its investment strategies generally.
Short sales also involve other
costs. A Fund must repay to the lender an amount equal to any dividends or interest that accrues while the loan is outstanding. To borrow the security, a Fund may be required to pay a premium. A Fund also will incur transaction costs in effecting
short sales. The amount of any ultimate gain for a Fund resulting from a short sale will be decreased and the amount of any ultimate loss will be increased by the amount of premiums, interest or expenses a Fund may be required to pay in
connection
with the short sale. Until a Fund closes the short position, it
will earmark and reserve Fund assets, in cash or liquid securities, in amount at least equal to the current market value of the securities sold short unless the Fund holds the securities sold short. Realized gains from short sales are typically
treated as short-term gains/losses.
Certain of a Fund’s
service providers may have agreed to waive fees and reimburse expenses to limit the Fund’s operating expenses in the amount and for the time period specified in the Fund’s prospectuses. The expense limitation does not include certain
expenses including, to the extent indicated in the Fund’s prospectuses, dividend and interest expense on short sales. In calculating the interest expense on short sales for purposes of this exclusion, the Fund will recognize all economic
elements of interest costs, including premium and discount adjustments.
Short-Term Funding Agreements
Short-term funding agreements
issued by insurance companies are sometimes referred to as Guaranteed Investment Contracts (“GICs”), while those issued by banks are referred to as Bank Investment Contracts (“BICs”). Pursuant to such agreements, a Fund makes
cash contributions to a deposit account at a bank or insurance company. The bank or insurance company then credits to the Fund on a monthly basis guaranteed interest at either a fixed, variable or floating rate. These contracts are general
obligations of the issuing bank or insurance company (although they may be the obligations of an insurance company separate account) and are paid from the general assets of the issuing entity.
Generally, there is no active
secondary market in short-term funding agreements. Therefore, short-term funding agreements may be considered by a Fund to be illiquid investments.
Structured Investments
A structured investment is a
security having a return tied to an underlying index or other security or asset class. Structured investments generally are individually negotiated agreements and may be traded over-the-counter. Structured investments are organized and operated to
restructure the investment characteristics of the underlying security. This restructuring involves the deposit with or purchase by an entity, such as a corporation or trust, or specified instruments (such as commercial bank loans) and the issuance
by that entity or one or more classes of securities (“structured securities”) backed by, or representing interests in, the underlying instruments. The cash flow on the underlying instruments may be apportioned among the newly issued
structured securities to create securities with different investment characteristics, such as varying maturities, payment priorities and interest rate provisions, and the extent of such payments made with respect to structured securities is
dependent on the extent of the cash flow on the underlying instruments. Because structured securities typically involve no credit enhancement, their credit risk generally will be equivalent to that of the underlying instruments. Investments in
structured securities are generally of a class of structured securities that is either subordinated or unsubordinated to the right of payment of another class. Subordinated structured securities typically have higher yields and present greater risks
than unsubordinated structured securities. Structured instruments include structured notes. In addition to the risks applicable to investments in structured investments and debt securities in general, structured notes bear the risk that the issuer
may not be required to pay interest on the structured note if the index rate rises above or falls below a certain level. Structured securities are typically sold in private placement transactions, and there currently is no active trading market for
structured securities. Investments in government and government-related restructured debt instruments are subject to special risks, including the inability or unwillingness to repay principal and interest, requests to reschedule or restructure
outstanding debt and requests to extend additional loan amounts. Structured investments include a wide variety of instruments including, without limitation, CDOs, credit linked notes, and participation notes and participatory notes. Additional
information including risk information is included under Asset-Backed Securities.
Total Annual Fund Operating
Expenses set forth in the fee table and Financial Highlights section of each Fund’s Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the
definition of “investment company” provided by section 3(c)(1) or 3(c)(7) of the 1940 Act.
Swaps and Related Swap Products
Swap transactions may include,
but are not limited to, interest rate swaps, currency swaps, cross-currency interest rate swaps, forward rate agreements, contracts for differences, total return swaps, index swaps, basket swaps, specific security swaps, fixed income sectors swaps,
commodity swaps, asset-backed
swaps (ABX), commercial mortgage-backed securities (CMBS) and
indexes of CMBS (CMBX), credit default swaps, interest rate caps, price lock swaps, floors and collars and swaptions (collectively defined as “swap transactions”).
A Fund may enter into swap
transactions for any legal purpose consistent with its investment objective and policies, such as for the purpose of attempting to obtain or preserve a particular return or spread at a lower cost than obtaining that return or spread through
purchases and/or sales of instruments in cash markets, to protect against currency fluctuations, to protect against any increase in the price of securities a Fund anticipates purchasing at a later date, or to gain exposure to certain markets in the
most economical way possible.
Swap agreements are two-party
contracts entered into primarily by institutional counterparties for periods ranging from a few weeks to several years. They may be bilaterally negotiated between the two parties (referred to as OTC swaps) or traded over an exchange. In a standard
swap transaction, two parties agree to exchange the returns (or differentials in rates of return) that would be earned or realized on specified notional investments or instruments. The gross returns to be exchanged or “swapped” between
the parties are calculated by reference to a “notional amount,” i.e., the return on or increase in value of a particular dollar amount invested at a particular interest rate, in a particular foreign currency or commodity, or in a
“basket” of securities representing a particular index. The purchaser of an interest rate cap or floor, upon payment of a fee, has the right to receive payments (and the seller of the cap or floor is obligated to make payments) to the
extent a specified interest rate exceeds (in the case of a cap) or is less than (in the case of a floor) a specified level over a specified period of time or at specified dates. The purchaser of an interest rate collar, upon payment of a fee, has
the right to receive payments (and the seller of the collar is obligated to make payments) to the extent that a specified interest rate falls outside an agreed upon range over a specified period of time or at specified dates. The purchaser of an
option on an interest rate swap, also known as a “swaption,” upon payment of a fee (either at the time of purchase or in the form of higher payments or lower receipts within an interest rate swap transaction) has the right, but not the
obligation, to initiate a new swap transaction of a pre-specified notional amount with pre-specified terms with the seller of the swaption as the counterparty.
The “notional
amount” of a swap transaction is the agreed upon basis for calculating the payments that the parties have agreed to exchange. For example, one swap counterparty may agree to pay a floating rate of interest (e.g., 3 month LIBOR) calculated
based on a $10 million notional amount on a quarterly basis in exchange for receipt of payments calculated based on the same notional amount and a fixed rate of interest on a semi-annual basis. In the event a Fund is obligated to make payments more
frequently than it receives payments from the other party, it will incur incremental credit exposure to that swap counterparty. This risk may be mitigated somewhat by the use of swap agreements which call for a net payment to be made by the party
with the larger payment obligation when the obligations of the parties fall due on the same date. Under most swap agreements entered into by a Fund, payments by the parties will be exchanged on a “net basis”, and a Fund will receive or
pay, as the case may be, only the net amount of the two payments.
The amount of a Fund’s
potential gain or loss on any swap transaction is not subject to any fixed limit. Nor is there any fixed limit on a Fund’s potential loss if it sells a cap or collar. If a Fund buys a cap, floor or collar, however, the Fund’s potential
loss is limited to the amount of the fee that it has paid. When measured against the initial amount of cash required to initiate the transaction, which is typically zero in the case of most conventional swap transactions, swaps, caps, floors and
collars tend to be more volatile than many other types of instruments.
The use of swap transactions,
caps, floors and collars involves investment techniques and risks that are different from those associated with portfolio security transactions. If a Fund’s Adviser is incorrect in its forecasts of market values, interest rates, and other
applicable factors, the investment performance of the Fund will be less favorable than if these techniques had not been used. These instruments are typically not traded on exchanges. Accordingly, there is a risk that the other party to certain of
these instruments will not perform its obligations to a Fund or that a Fund may be unable to enter into offsetting positions to terminate its exposure or liquidate its position under certain of these instruments when it wishes to do so. Such
occurrences could result in losses to a Fund. A Fund’s Adviser will consider such risks and will enter into swap and other derivatives transactions only when it believes that the risks are not unreasonable.
A Fund will earmark and reserve
Fund assets, in cash or liquid securities, in an amount sufficient at all times to cover its current obligations under its swap transactions, caps, floors and collars. If a Fund enters into a swap agreement on a net basis, it will earmark and
reserve assets with a daily value at least equal to the excess, if any, of a Fund’s accrued obligations under the swap agreement over the accrued
amount a Fund is entitled to receive under the agreement. If a
Fund enters into a swap agreement on other than a net basis, or sells a cap, floor or collar, it will earmark and reserve assets with a daily value at least equal to the full amount of a Fund’s accrued obligations under the agreement. A Fund
will not enter into any swap transaction, cap, floor, or collar, unless the counterparty to the transaction is deemed creditworthy by the Fund’s Adviser. If a counterparty defaults, a Fund may have contractual remedies pursuant to the
agreements related to the transaction. The swap markets in which many types of swap transactions are traded have grown substantially in recent years, with a large number of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. As a result, the markets for certain types of swaps (e.g., interest rate swaps) have become relatively liquid. The markets for some types of caps, floors and collars are less liquid.
The liquidity of swap
transactions, caps, floors and collars will be as set forth in guidelines established by a Fund’s Adviser and approved by the Trustees which are based on various factors, including: (1) the availability of dealer quotations and the estimated
transaction volume for the instrument, (2) the number of dealers and end users for the instrument in the marketplace, (3) the level of market making by dealers in the type of instrument, (4) the nature of the instrument (including any right of a
party to terminate it on demand) and (5) the nature of the marketplace for trades (including the ability to assign or offset a Fund’s rights and obligations relating to the instrument). Such determination will govern whether the instrument
will be deemed within the applicable liquidity restriction on investments in securities that are not readily marketable.
During the term of a swap,
cap, floor or collar, changes in the value of the instrument are recognized as unrealized gains or losses by marking to market to reflect the market value of the instrument. When the instrument is terminated, a Fund will record a realized gain or
loss equal to the difference, if any, between the proceeds from (or cost of) the closing transaction and a Fund’s basis in the contract.
The federal income tax treatment
with respect to swap transactions, caps, floors, and collars may impose limitations on the extent to which a Fund may engage in such transactions.
Under the Dodd-Frank Act,
certain swaps that were historically traded OTC must now be traded on an exchange or facility regulated by the CFTC and/or centrally cleared (central clearing interposes a central clearing house to each participant’s swap). Exchange trading
and central clearing are intended to reduce counterparty credit risk and increase liquidity and transparency, but they do not make swap transactions risk-free. Moving trading to an exchange-type system may increase market transparency and liquidity
but may require Funds to incur increased expenses to access the same types of cleared and uncleared swaps. Moreover, depending on the size of a Fund and other factors, the margin required under the clearinghouse rules and by a clearing member may be
in excess of the collateral required to be posted by the Fund to support its obligations under a similar uncleared swap. But applicable regulators have also adopted rules imposing margin requirements, including minimums, on uncleared swaps, which
may result in a Fund and its counterparties posting higher margin amounts for uncleared swaps as well. Recently adopted rules also require centralized reporting of detailed information about many types of cleared and uncleared swaps. Swaps data
reporting may result in greater market transparency, but may subject a Fund to additional administrative burdens, and the safeguards established to protect trader anonymity may not function as expected. Implementing these new exchange trading,
central clearing, margin and data reporting regulations may increase Fund’s cost of hedging risk and, as a result, may affect returns to Fund investors.
Credit Default Swaps. As described above, 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 the case of a credit default swap
(“CDS”), the contract gives one party (the buyer) the right to recoup the economic value of a decline in the value of debt securities of the reference issuer if the credit event (a downgrade or default) occurs. This value is obtained by
delivering a debt security of the reference issuer to the party in return for a previously agreed payment from the other party (frequently, the par value of the debt security). CDS include credit default swaps, which are contracts on individual
securities, and credit default swap indices (“CDX”), which are contracts on baskets or indices of securities.
Credit default swaps may
require initial premium (discount) payments as well as periodic payments (receipts) related to the interest leg of the swap or to the default of a reference obligation. In cases where a Fund is a seller of a CDS contract including a CDX contract,
the Fund will segregate or earmark liquid assets equal the notional amount of the contract. Furthermore, a Fund will segregate or earmark liquid assets to cover any accrued payment obligations when it is the buyer of a CDS including CDX. In
calculating the amount to be segregated for this purpose, the Fund is not considered to have an accrued payment obligation when it is the buyer of a CDS including a CDX when the contract is in a gain position
as no additional amounts are owed to the counterparty. In cases
where a Fund is a buyer of a CDS contract including a CDX contract, the Fund will segregate or earmark liquid assets equal to the mark-to-market value when the contract is in a loss position.
If a Fund is a seller of
protection under a CDS contract, the Fund would be required to pay the par (or other agreed upon) value of a referenced debt obligation to the counterparty in the event of a default or other credit event by the reference issuer, such as a U.S. or
foreign corporate issuer, with respect to such debt obligations. In return, a Fund would receive from the counterparty a periodic stream of payments over the term of the contract provided that no event of default has occurred. If no default occurs,
a Fund would keep the stream of payments and would have no payment obligations. As the seller, a Fund would be subject to investment exposure on the notional amount of the swap.
If a Fund is a buyer of
protection under a CDS contract, the Fund would have the right to deliver a referenced debt obligation and receive the par (or other agreed-upon) value of such debt obligation from the counterparty in the event of a default or other credit event
(such as a downgrade in credit rating) by the reference issuer, such as a U.S. or foreign corporation, with respect to its debt obligations. In return, the Fund would pay the counterparty a periodic stream of payments over the term of the contract
provided that no event of default has occurred. If no default occurs, the counterparty would keep the stream of payments and would have no further obligations to the Fund.
The use of CDSs, like all swap
agreements, is subject to certain risks. If a counterparty’s creditworthiness declines, the value of the swap would likely decline. Moreover, there is no guarantee that a Fund could eliminate its exposure under an outstanding swap agreement by
entering into an offsetting swap agreement with the same or another party. In addition to general market risks, CDSs involve liquidity, credit and counterparty risks. The recent increase in corporate defaults further raises these liquidity and
credit risks, increasing the possibility that sellers will not have sufficient funds to make payments. As unregulated instruments, CDSs are difficult to value and are therefore susceptible to liquidity and credit risks. Counterparty risks also stem
from the lack of regulation of CDSs. Collateral posting requirements are individually negotiated between counterparties and there is no regulatory requirement concerning the amount of collateral that a counterparty must post to secure its
obligations under a CDS. Because they are unregulated, there is no requirement that parties to a contract be informed in advance when a CDS is sold. As a result, investors may have difficulty identifying the party responsible for payment of their
claims.
If a
counterparty’s credit becomes significantly impaired, multiple requests for collateral posting in a short period of time could increase the risk that the Fund may not receive adequate collateral. There is no readily available market for
trading out of CDS contracts. In order to eliminate a position it has taken in a CDS, the Fund must terminate the existing CDS contract or enter into an offsetting trade. The Fund may only exit its obligations under a CDS contract by terminating the
contract and paying applicable breakage fees, which could result in additional losses to the Fund. Furthermore, the cost of entering into an offsetting CDS position could cause the Fund to incur losses.
Under the Dodd-Frank Act,
certain CDS indices are subject to mandatory central cleaning and exchange trading, which may reduce counterparty credit risk and increase liquidity compared to other credit default swap or CDS index transactions.
Synthetic Variable Rate Instruments
Synthetic variable rate
instruments generally involve the deposit of a long-term tax exempt bond in a custody or trust arrangement and the creation of a mechanism to adjust the long-term interest rate on the bond to a variable short-term rate and a right (subject to
certain conditions) on the part of the purchaser to tender it periodically to a third party at par. A Fund’s Adviser reviews the structure of synthetic variable rate instruments to identify credit and liquidity risks (including the conditions
under which the right to tender the instrument would no longer be available) and will monitor those risks. In the event that the right to tender the instrument is no longer available, the risk to the Fund will be that of holding the long-term bond.
In the case of some types of instruments credit enhancement is not provided, and if certain events occur, which may include (a) default in the payment of principal or interest on the underlying bond, (b) downgrading of the bond below investment
grade or (c) a loss of the bond’s tax exempt status, then the put will terminate and the risk to the Fund will be that of holding a long-term bond.
Total Annual Fund Operating
Expenses set forth in the fee table and Financial Highlights section of each Fund’s Prospectuses do not include any expenses associated with investments in certain structured or synthetic products that may rely on the exception for the
definition of “investment company” provided by section 3(c)(1) or 3(c)(7) of the 1940 Act.
Treasury Receipts
A Fund may purchase interests
in separately traded interest and principal component parts of U.S. Treasury obligations that are issued by banks or brokerage firms and are created by depositing U.S. Treasury notes and U.S. Treasury bonds into a special account at a custodian
bank. Receipts include Treasury Receipts (“TRs”), Treasury Investment Growth Receipts (“TIGRs”), and Certificates of Accrual on Treasury Securities (“CATS”). Receipts in which an entity other than the government
separates the interest and principal components are not considered government securities unless such securities are issued through the Treasury Separate Trading of Registered Interest and Principal of Securities (“STRIPS”) program.
Trust Preferred Securities
Certain Funds may purchase
trust preferred securities, also known as “trust preferreds”, which are preferred stocks issued by a special purpose trust subsidiary backed by subordinated debt of the corporate parent. An issuer creates trust preferred securities by
creating a trust and issuing debt to the trust. The trust in turn issues trust preferred securities. Trust preferred securities are hybrid securities with characteristics of both subordinated debt and preferred stock. Such characteristics include
long maturities (typically 30 years or more), early redemption by the issuer, periodic fixed or variable interest payments, and maturities at face value. In addition, trust preferred securities issued by a bank holding company may allow deferral of
interest payments for up to 5 years. Holders of trust preferred securities have limited voting rights to control the activities of the trust and no voting rights with respect to the parent company.
U.S. Government Obligations
U.S. government obligations may
include direct obligations of the U.S. Treasury, including Treasury bills, notes and bonds, all of which are backed as to principal and interest payments by the full faith and credit of the U.S., and separately traded principal and interest
component parts of such obligations that are transferable through the Federal book-entry system known as STRIPS and Coupon Under Book Entry Safekeeping (“CUBES”). The Funds may also invest in TIPS. U.S. government obligations are subject
to market risk, interest rate risk and credit risk.
The principal and interest
components of U.S. Treasury bonds with remaining maturities of longer than ten years are eligible to be traded independently under the STRIPS program. Under the STRIPS program, the principal and interest components are separately issued by the U.S.
Treasury at the request of depository financial institutions, which then trade the component parts separately. The interest component of STRIPS may be more volatile than that of U.S. Treasury bills with comparable maturities.
Other obligations include
those issued or guaranteed by U.S. government agencies, GSEs or instrumentalities. These obligations may or may not be backed by the “full faith and credit” of the U.S. Securities which are backed by the full faith and credit of the U.S.
include obligations of the Government National Mortgage Association, the Farmers Home Administration, and the Export-Import Bank. In the case of securities not backed by the full faith and credit of the U.S., the Funds must look principally to the
federal agency issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the U.S. itself in the event the agency or instrumentality does not meet its commitments. Securities in which the Funds may
invest that are not backed by the full faith and credit of the U.S. include, but are not limited to: (i) obligations of the Tennessee Valley Authority, the Federal Home Loan Banks and the U.S. Postal Service, each of which has the right to borrow
from the U.S. Treasury to meet its obligations; (ii) securities issued by Freddie Mac and Fannie Mae, which are supported only by the credit of such securities, but for which the Secretary of the Treasury has discretionary authority to purchase
limited amounts of the agency’s obligations; and (iii) obligations of the Federal Farm Credit System and the Student Loan Marketing Association, each of whose obligations may be satisfied only by the individual credits of the issuing
agency.
The total public
debt of the United States and other countries around the globe as a percent of gross domestic product has grown rapidly since the beginning of the 2008 financial downturn. Although high debt levels do not necessarily indicate or cause economic
problems, they may create certain systemic risks if sound debt management practices are not implemented. A high national debt level may increase market pressures to meet government funding needs, which may drive debt cost higher and cause a country
to sell additional debt, thereby increasing refinancing risk. A high national debt also raises concerns that a government will not be able to make principal or interest payments when they are due. Unsustainable debt levels can cause devaluations of
currency, prevent a government from implementing effective counter-cyclical fiscal policy in economic downturns, and contribute to market volatility. From time to time,
uncertainty regarding the status of negotiations in the U.S.
government to increase the statutory debt ceiling could: increase the risk that the U.S. government may default on payments on certain U.S. government securities; cause the credit rating of the U.S. government to be downgraded or increase volatility
in both stock and bond markets; result in higher interest rates; reduce prices of U.S. Treasury securities; and/or increase the costs of certain kinds of debt.
In the past, U.S. sovereign
credit has experienced downgrades and there can be no guarantee that it will not experience further downgrades in the future by rating agencies. The market prices and yields of securities supported by the full faith and credit of the U.S. Government
may be adversely affected by a rating agency’s decision to downgrade the sovereign credit rating of the United States.
When-Issued Securities, Delayed Delivery Securities
and Forward Commitments
Securities may be purchased on
a when-issued or delayed delivery basis. For example, delivery of and payment for these securities can take place a month or more after the date of the purchase commitment. The purchase price and the interest rate payable, if any, on the securities
are fixed on the purchase commitment date or at the time the settlement date is fixed. The value of such securities is subject to market fluctuation, and for money market instruments and other fixed income securities, no interest accrues to a Fund
until settlement takes place. At the time a Fund makes the commitment to purchase securities on a when-issued or delayed delivery basis, it will record the transaction, reflect the value each day of such securities in determining its NAV and, if
applicable, calculate the maturity for the purposes of average maturity from that date. At the time of settlement, a when-issued security may be valued at less than the purchase price. To facilitate such acquisitions, each Fund will earmark and
reserve Fund assets, in cash or liquid securities, in an amount at least equal to such commitments. On delivery dates for such transactions, each Fund will meet its obligations from maturities or sales of the securities earmarked and reserved for
such purpose and/or from cash flow. If a Fund chooses to dispose of the right to acquire a when-issued security prior to its acquisition, it could, as with the disposition of any other portfolio obligation, incur a gain or loss due to market
fluctuation. Also, a Fund may be disadvantaged if the other party to the transaction defaults.
Forward Commitments. Securities may be purchased for delivery at a future date, which may increase their overall investment exposure and involves a risk of loss if the value of the securities declines prior to the settlement date. In order
to invest a Fund’s assets immediately, while awaiting delivery of securities purchased on a forward commitment basis, short-term obligations that offer same-day settlement and earnings will normally be purchased.
When a Fund makes a commitment
to purchase a security on a forward commitment basis, cash or liquid securities equal to the amount of such Fund’s commitments will be reserved for payment of the commitment. For the purpose of determining the adequacy of the securities
reserved for payment of commitments, the reserved securities will be valued at market value. If the market value of such securities declines, additional cash, cash equivalents or highly liquid securities will be reserved for payment of the
commitment so that the value of the Fund’s assets reserved for payment of the commitments will equal the amount of such commitments purchased by the respective Fund.
Purchases of securities on a
forward commitment basis may involve more risk than other types of purchases. Securities purchased on a forward commitment basis and the securities held in the respective Fund’s portfolio are subject to changes in value based upon the
public’s perception of the issuer and changes, real or anticipated, in the level of interest rates. Purchasing securities on a forward commitment basis can involve the risk that the yields available in the market when the delivery takes place
may actually be higher or lower than those obtained in the transaction itself. On the settlement date of the forward commitment transaction, the respective Fund will meet its obligations from then-available cash flow, sale of securities reserved for
payment of the commitment, sale of other securities or, although it would not normally expect to do so, from sale of the forward commitment securities themselves (which may have a value greater or lesser than such Fund’s payment obligations).
The sale of securities to meet such obligations may result in the realization of capital gains or losses. Purchasing securities on a forward commitment basis can also involve the risk of default by the other party on its obligation, delaying or
preventing the Fund from recovering the collateral or completing the transaction.
To the extent a Fund engages in
forward commitment transactions, it will do so for the purpose of acquiring securities consistent with its investment objective and policies and not for the purpose of investment leverage.
ADDITIONAL INFORMATION REGARDING FUND INVESTMENT
PRACTICES
Investments in the Asia Pacific
Region
The economies in
the Asia Pacific region are in all stages of economic development and may be intertwined. The small size of securities markets and the low trading volume in some countries in the Asia Pacific region may lead to a lack of liquidity. The share prices
of companies in the region tend to be volatile and there is a significant possibility of loss. Many of the countries in the region are developing, both politically and economically, and as a result companies in the region may be subject to risks
like nationalization or other forms of government interference, and/or may be heavily reliant on only a few industries or commodities. Investments in the region may also be subject to currency risks, such as restrictions on the flow of money in and
out of the country, extreme volatility relative to the U.S. dollar, and devaluation, all of which could decrease the value of a Fund.
Investments in the European Market
Some of the Funds may invest in
securities in the European Market. A Fund’s performance will be affected by political, social and economic conditions in Europe, such as growth of the economic output (the gross national product), the rate of inflation, the rate at which
capital is reinvested into European economies, the success of governmental actions to reduce budget deficits, the resource self-sufficiency of European countries and interest and monetary exchange rates between European countries. European financial
markets may experience volatility due to concerns about high government debt levels, credit rating downgrades, rising unemployment, the future of the euro as a common currency, possible restructuring of government debt and other government measures
responding to those concerns, and fiscal and monetary controls imposed on member countries of the European Union. The risk of investing in Europe may be heightened due to steps being taken by the United Kingdom to exit the European Union. There is
considerable uncertainty relating to the potential consequences of such a withdrawal. The impact on the United Kingdom and European economies and the broader global economy could be significant, resulting in increased volatility and illiquidity,
currency fluctuations, impacts on arrangements for trading and on other existing cross-border cooperation arrangements (whether economic, tax, fiscal, legal, regulatory or otherwise), and in potentially lower growth for companies in the United
Kingdom, Europe and globally, which could have an adverse effect on the value of a Fund’s investments. In addition, if one or more other countries were to exit the European Union or abandon the use of the euro as a currency, the value of
investments tied to those countries or the euro could decline significantly and unpredictably.
Investments in the Commonwealth of Puerto Rico
The Commonwealth of Puerto Rico
is currently seeking bankruptcy-like protections from debt and unfunded pension obligations. Puerto Rico’s debt restructuring petition was filed by Puerto Rico’s financial oversight board in the U.S. District Court in Puerto Rico on May
3, 2017, and was made under a U.S. Congressional rescue law known as the Puerto Rico Oversight Management, and Economic Stability Act (“PROMESA.”) In addition, Hurricane Maria caused significant damage to Puerto Rico, which could have a
long-lasting impact on Puerto Rico’s economy.
A Fund’s investments in
municipal securities may be affected by political and economic developments within the applicable municipality and by the financial condition of the municipality. Certain of the issuers in which a Fund may invest have recently experienced, or may
experience, significant financial difficulties. For example, Puerto Rico, in particular, has been experiencing significant financial difficulties and has entered bankruptcy-like proceedings. A default by issuers of Puerto Rico municipal securities
on their obligations under securities held by a Fund may adversely affect the Fund and cause the Fund to lose the value of its investment in such securities.
An insolvent municipality may
take steps to reorganize its debt, which might include extending debt maturities, reducing the amount of principal or interest, refinancing the debt or taking other measures that may significantly affect the rights of creditors and the value of the
securities issued by the municipality and the value of a Fund’s investments in those securities. Pursuant to Chapter 9 of the U.S. Bankruptcy Code, certain municipalities that meet specific conditions may be provided protection from creditors
while they develop and negotiate plans for reorganizing their debts. The U.S. Bankruptcy Code provides that individual U.S. states are not permitted to pass their own laws purporting to bind non-consenting creditors to a restructuring of a
municipality’s indebtedness, and thus all such restructurings must be pursuant to Chapter 9 of the Bankruptcy Code.
Municipal bankruptcies are
relatively rare, and certain provisions of the U.S. Bankruptcy Code governing such bankruptcies are unclear and remain untested. Although Puerto Rico is a U.S. Territory, neither Puerto Rico nor its subdivisions or agencies are eligible to file
under the U.S. Bankruptcy Code in order to seek protection from creditors or restructure their debt. In June 2016, the U.S. Supreme Court ruled that Puerto Rico legislation that would have allowed certain Puerto Rico public corporations to seek
protection from creditors and to restructure their debt was unconstitutional. In the same month, the U.S. Congress passed the PROMESA, which established a federally-appointed fiscal oversight board (“Oversight Board”) to oversee Puerto
Rico’s financial operations and possible debt restructuring. On May 3, 2017, the Oversight Board filed a debt restructuring petition in the U.S. District Court in Puerto Rico to seek bankruptcy-like protections from, at the time of the filing,
approximately $74 billion in debt and approximately $48 billion in unfunded pension obligations. In addition to the debt restructuring petition filed on behalf of Puerto Rico, in May 2017, the Oversight Board separately filed debt restructuring
petitions for certain Puerto Rico instrumentalities, including the Puerto Rico Highways and Transportation Authority, Puerto Rico Sales Tax Financing Corporation (“COFINA”), Puerto Rico Electric and Power Authority and Employee
Retirement System. On February 4, 2019, the United District Court for the District of Puerto Rico approved a plan to restructure $17.6 billion of COFINA issued debt. There can be no assurances that these debt restructuring efforts will be effective.
As of June 1, 2019, the mediation process and certain litigation is ongoing with respect to certain municipal securities issued by Puerto Rico and its political subdivisions, instrumentalities and authorities. It is not presently possible to predict
the results of this mediation and litigation, but such outcomes will have a significant impact on bondholders of those municipal securities. Further legislation by the U.S. Congress, or actions by the oversight board established by PROMESA, or court
approval of an unfavorable debt restructuring deal could have a negative impact on the marketability, liquidity or value of certain investments held by a Fund and could reduce a Fund’s performance.
Investments in the China Region
Investing in China, Hong Kong
and Taiwan (collectively, “the China Region”) involves a high degree of risk and special considerations not typically associated with investing in other more established economies or securities markets. Such risks may include: (a) the
risk of nationalization or expropriation of assets or confiscatory taxation; (b) greater social, economic and political uncertainty (including the risk of war); (c) dependency on exports and the corresponding importance of international trade; (d)
the increasing competition from Asia’s other low-cost emerging economies; (e) greater price volatility and significantly smaller market capitalization of securities markets, particularly in China; (f) substantially less liquidity, particularly
of certain share classes of Chinese securities; (g) currency exchange rate fluctuations and the lack of available currency hedging instruments; (h) higher rates of inflation; (i) controls on foreign investment and limitations on repatriation of
invested capital and on a Fund’s ability to exchange local currencies for U.S. dollars; (j) greater governmental involvement in and control over the economy; (k) the risk that the Chinese government may decide not to continue to support the
economic reform programs implemented since 1978 and could return to the prior, completely centrally planned, economy; (l) the fact that China region companies, particularly those located in China, may be smaller, less seasoned and newly-organized
companies; (m) the difference in, or lack of, auditing and financial reporting standards which may result in unavailability of material information about issuers, particularly in China; (n) the fact that statistical information regarding the economy
of China may be inaccurate or not comparable to statistical information regarding the U.S. or other economies; (o) the less extensive, and still developing, regulation of the securities markets, business entities and commercial transactions; (p) the
fact that the settlement period of securities transactions in foreign markets may be longer; (q) the willingness and ability of the Chinese government to support the Chinese and Hong Kong economies and markets is uncertain; (r) the risk that it may
be more difficult, or impossible, to obtain and/or enforce a judgment than in other countries; (s) the rapidity and erratic nature of growth, particularly in China, resulting in inefficiencies and dislocations; and (t) the risk that, because of the
degree of interconnectivity between the economies and financial markets of China, Hong Kong and Taiwan, any sizable reduction in the demand for goods from China, or an economic downturn in China, could negatively affect the economies and financial
markets of Hong Kong and Taiwan, as well.
Investment in the China Region
is subject to certain political risks. Following the establishment of the People’s Republic of China by the Communist Party in 1949, the Chinese government renounced various debt obligations incurred by China’s predecessor governments,
which obligations remain in default, and expropriated assets without compensation. There can be no assurance that the Chinese government will not take similar action in the future. An investment in a Fund involves risk of a total loss. The political
reunification of China and Taiwan is a highly problematic issue and is unlikely to be settled in the near future. This situation poses a threat to Taiwan’s economy and could negatively affect its stock market.
China has committed by treaty to preserve Hong Kong’s
autonomy and its economic, political and social freedoms for fifty years from the July 1, 1997 transfer of sovereignty from Great Britain to China. However, if China would exert its authority so as to alter the economic, political or legal
structures or the existing social policy of Hong Kong, investor and business confidence in Hong Kong could be negatively affected, which in turn could negatively affect markets and business performance.
As with all transition
economies, China’s ability to develop and sustain a credible legal, regulatory, monetary, and socioeconomic system could influence the course of outside investment. Hong Kong is closely tied to China, economically and through China’s
1997 acquisition of the country as a Special Autonomous Region (SAR). Hong Kong’s success depends, in large part, on its ability to retain the legal, financial, and monetary systems that allow economic freedom and market expansion.
In addition to the risks inherent
in investing in the emerging markets, the risks of investing in China, Hong Kong, and Taiwan merit special consideration.
People’s Republic of China. The government of the People’s Republic of China is dominated by the one-party rule of the Chinese Communist Party.
China’s economy has
transitioned from a rigidly central-planned state-run economy to one that has been only partially reformed by more market-oriented policies. Although the Chinese government has implemented economic reform measures, reduced state ownership of
companies and established better corporate governance practices, a substantial portion of productive assets in China are still owned by the Chinese government. The government continues to exercise significant control over regulating industrial
development and, ultimately, control over China’s economic growth through the allocation of resources, controlling payment of foreign currency denominated obligations, setting monetary policy and providing preferential treatment to particular
industries or companies.
Following years of steady
growth, the pace of growth of China’s economy has relatively slowed, partly as a result of the government’s attempts to shift the economy away from export manufacturing and towards domestic consumption and to prevent the overheating of
certain sectors. The slow down subjects China’s economy to significant risks, including economic, social, and political risks. Additionally, China’s economy remains heavily dependent on exports. The imposition of tariffs or other trade
barriers or a downturn in the economy of a significant trading partner could adversely impact Chinese companies. Over the long term, China’s major challenges include dealing with its aging infrastructure, worsening environmental conditions and
rapidly widening urban and rural income gap.
As with all transition
economies, China’s ability to develop and sustain a credible legal, regulatory, monetary, and socioeconomic system could influence the course of outside investment. The Chinese legal system, in particular, constitutes a significant risk factor
for investors. The Chinese legal system is based on statutes. Since the late 1970s, Chinese legislative bodies have promulgated laws and regulations dealing with various economic matters such as foreign investment, corporate organization and
governance, commerce, taxation, and trade. However, despite the expanding body of law in China, legal precedent and published court decisions based on these laws are limited and non-binding. The interpretation and enforcement of these laws and
regulations are uncertain.
Hong Kong. In 1997, Great Britain handed over control of Hong Kong to the Chinese mainland government. Since that time, Hong Kong has been governed by a semi-constitution known as the Basic Law, which guarantees a high degree of
autonomy in certain matters until 2047, while defense and foreign affairs are the responsibility of the central government in Beijing. The chief executive of Hong Kong is appointed by the Chinese government. Hong Kong is able to participate in
international organizations and agreements and it continues to function as an international financial center, with no exchange controls, free convertibility of the Hong Kong dollar and free inward and outward movement of capital. The Basic Law
guarantees existing freedoms, including free speech and assembly, press, religion, and the right to strike and travel. Business ownership, private property, the right of inheritance and foreign investment are also protected by law. China has
committed by treaty to preserve Hong Kong’s autonomy until 2047; however, if China were to exert its authority so as to alter the economic, political, or legal structures or the existing social policy of Hong Kong, investor and business
confidence in Hong Kong could be negatively affected, which in turn could negatively affect markets and business performance. In addition, Hong Kong’s economy has entered a recession as a result of the current global economic crisis. Near term
improvement in its economy appears unlikely.
Taiwan. For decades, a state of hostility has existed between Taiwan and the People’s Republic of China. Beijing has long deemed Taiwan a part of the “one China” and has made a nationalist cause of recovering
it. In the past, China has staged frequent military provocations off the coast of Taiwan and made
threats of full-scale military action. Foreign trade has been
the engine of rapid growth in Taiwan and has transformed the island into one of Asia’s great exporting nations. However, investing in Taiwan involves the possibility of the imposition of exchange controls, such as restrictions on the
repatriation of fund investments or on the conversion of local currency into foreign currencies. As an export-oriented economy, Taiwan depends on an open world trade regime and remains vulnerable to downturns in the world economy. Taiwanese
companies continue to compete mostly on price, producing generic products or branded merchandise on behalf of multinational companies. Accordingly, these businesses can be particularly vulnerable to currency volatility and increasing competition
from neighboring lower-cost countries. Moreover, many Taiwanese companies are heavily invested in mainland China and other countries throughout Southeast Asia, making them susceptible to political events and economic crises in these parts of the
region. Although Taiwan has not yet suffered any major economic setbacks due to the current global economic crisis, it is possible its economy could still be impacted.
Securities are listed on
either the Shanghai and/or Shenzhen stock exchanges. Securities listed on these exchanges are divided into two classes, A shares, which are mostly limited to domestic investors, and B shares, which are allocated for both international and domestic
investors. A Fund’s exposure to securities listed on either the Shanghai or Shenzhen exchanges will initially be through B shares. The government of China has announced plans to exchange B shares for A shares and to merge the two markets. Such
an event may produce greater liquidity and stability for the combined markets. However, it is uncertain whether or the extent to which these plans will be implemented. In addition to B shares, a Fund may also invest in Hong Kong listed H shares,
Hong Kong listed Red chips (which are companies owned by mainland China enterprises, but are listed in Hong Kong), and companies that meet one of the following categories: the company is organized under the laws of, or has a principal office in
China (including Hong Kong and Macau) or Taiwan; the principal securities market for the issuer is China or Taiwan; the issuer derives at least 50% of its total revenues or profits from goods that are produced or sold, investments made, or services
performed in China or Taiwan; or at least 50% of the issuer’s assets are located in China or Taiwan.
Shanghai-Hong Kong Stock Connect
and Shenzhen-Hong Kong Stock Connect. The Funds may invest in certain China A-Shares through the Shanghai-Hong Kong Stock Connect program or the Shenzhen-Hong Kong Stock Connect Program (the “Programs”).
The Programs are securities trading and clearing linked programs developed by Hong Kong Exchanges and Clearing Limited (“HKEx”), the Hong Kong Securities Clearing Company Limited (“HKSCC”), Shanghai Stock Exchange
(“SSE”), Shenzhen Stock Exchange (“SZSE”) and China Securities Depository and Clearing Corporation Limited (“ChinaClear”) with an objective to achieve mutual stock market access between mainland China and Hong
Kong. The Programs will allow foreign investors to trade certain SSE and SZSE listed China A-Shares through Hong Kong based brokers.
Trading through the Programs
are subject to various risks described below, including liquidity risk, currency risk, legal and regulatory uncertainty risk, execution risk, operational risk, tax risk, counterparty risk and credit risk.
Securities purchased under
each Program generally may not be sold, purchased or otherwise transferred other than through that Program in accordance with applicable rules. While each Program is not subject to individual investment quotas, daily investment quotas apply to all
Program participants, which may restrict or preclude the Fund’s ability to purchase particular securities at a particular time. In addition, securities purchased through the Programs are subject to Chinese securities regulations that restrict
the levels of foreign ownership in local securities which could require a Fund to sell securities if ownership of the securities exceeds applicable quotas. Furthermore, additional restrictions may preclude a Fund from being eligible to invest in
certain securities traded through a Program. Because all trades in the Programs must be settled in Renminbi (“RMB”), the Chinese currency, investors must have timely access to a reliable supply of offshore RMB, which cannot be
guaranteed. Trades through each Program are subject to certain requirements prior to trading which may limit the number of brokers that a Fund may use. This may affect the quality of execution received by a Fund. In addition, applicable laws may,
under certain circumstances, require an investor to return profits obtained from the purchase and sale of shares.
The HKSCC provides clearing,
settlement, nominee functions and other related services of the trades executed by Hong Kong market participants through an arrangement with ChinaClear. The People’s Republic of China (the “PRC”) regulations, which include certain
restrictions on selling and buying, will apply to all market participants. In the case of a sale, brokers must have access to certain information about the transaction prior to execution. Because of the various requirements and restrictions
applicable to the Programs, a Fund may not be able to purchase and/or dispose of holdings of China A-Shares in a timely manner.
A Fund will not benefit from
access to local investor compensation funds, which are set up to protect against defaults of trades, when investing through each Program. To the extent that HKSCC is deemed to be performing safekeeping functions with respect to assets held through
it, it should be noted that the Fund will have no legal relationship with HKSCC and no direct legal recourse against HKSCC in the event that the Fund suffers losses resulting from the performance or insolvency of HKSCC.
The Shanghai-Hong Kong Stock
Connect Program began operation in November 2014 and the Shenzhen-Hong Kong Stock Connect Program began operation in December 2016. The relevant regulations relating to the Programs are untested and subject to change. There is no certainty as to how
they will be applied which could adversely affect a Fund. The Programs require use of new information technology systems which may be subject to operational risk due to its cross-border nature. If the relevant systems fail to function properly,
trading in the Shanghai and Shenzhen markets through the Programs could be disrupted.
As in other emerging and less
developed markets, the legislative framework is only beginning to develop the concept of legal/formal ownership and of beneficial ownership or interest in securities in China. Consequently the applicable courts may consider that any nominee or
custodian as registered holder of securities would have full ownership thereof and that a beneficial owner may have no rights whatsoever in respect thereof and may be limited in its ability to pursue claims against the issuer of a security.
Additionally, the securities that a Fund may invest in through the Programs may present illiquidity and price volatility concerns and difficulty in determining market valuations of securities due to limited public information on issuers. Such
securities may also be subject to limited regulatory oversight and an increased risk of being delisted or suspended. Suspensions or delistings may become widespread, and the length of suspension may be significant and difficult to predict.
The Programs utilize an omnibus
clearing structure, and a Fund’s shares will be registered in its custodian’s, subcustodian’s or clearing broker’s name on the HKSCC system and in HKSCC’s name on the ChinaClear system. This may limit a Fund’s
adviser’s or subadviser’s ability to effectively manage a Fund, and may expose a Fund to the credit risk of its custodian or subcustodian or to greater risk of expropriation.
Similarly, HKSCC would be
responsible for the exercise of shareholder rights with respect to corporate actions (including all dividends, rights issues, merger proposals or other shareholder votes). While HKSCC may provide investors with the opportunity to provide voting
instructions, investors may not have sufficient time or the opportunity to consider proposals or provide instructions.
Investments in the Programs
may not be covered by the securities investor protection programs of either exchange and, without the protection of such programs, will be subject to the risk of default by a broker. In the event ChinaClear defaults, HKSCC’s liabilities under
its market contracts with clearing participants will be limited to assisting clearing participants with claims. While it is anticipated that HKSCC will act in good faith to seek recovery of the outstanding stocks and monies from ChinaClear through
available legal channels or the liquidation of ChinaClear, there can be no assurances that it will do so, or that it will be successful in doing so. In this event, the Fund may not fully recover its losses and the process could be delayed.
The Programs will only operate
on days when both the PRC and Hong Kong markets are open for trading and when banks in each applicable market are open on the corresponding settlement days and the Funds will only trade through each Program on days that they are open. There may be
occasions when it is a normal trading day for the PRC market but the Fund cannot carry out any China A-Shares trading. A Fund may be subject to risks of price fluctuations in China A-Shares during the time when each Program is not trading as a
result. Additionally, different fees and costs are imposed on foreign investors acquiring China A-Shares acquired through the Programs, and these fees and costs may be higher than comparable fees and costs imposed on owners of other securities
providing similar investment exposure. There is uncertainty of whether and how certain gains on PRC securities will to be taxed, the possibility of the rules being changed and the possibility of taxes being applied retrospectively. Consequently,
investors may be advantaged or disadvantaged depending upon the final outcome of how such gains will be taxed and when they subscribed and/or redeemed their shares.
Because the Programs are
relatively new, the actual effect on the market for trading China A-Shares with the introduction of large numbers of foreign investors is unknown. The Programs are subject to regulations promulgated by regulatory authorities for the applicable
exchanges and further regulations or restrictions, such as limitations on redemptions or suspension of trading, may adversely impact the Programs, if the authorities believe it necessary to assure orderly markets or for other reasons. There is no
guarantee that the exchanges will continue to support the Programs in the future.
China Interbank Bond Market. The China Interbank Bond Market (“CIBM”) is an OTC market established in 1997, and accounts for approximately 90% of outstanding bond values of the total trading volume in the People’s Republic of
China (“PRC”). On CIBM, domestic institutional investors and certain foreign institutional investors can trade, on a one-to-one quote-driven basis, sovereign bonds, government bonds, corporate bonds, bond repos, bond lending, bills
issued by the People’s Bank of China (“PBOC”) and other financial debt instruments. CIBM is regulated and supervised by the PBOC. The PBOC is responsible for, among others, promulgating the applicable CIBM listing, trading and
operating rules, and supervising the market operators of CIBM. CIBM provides for two trading models: (i) bilateral negotiation and (ii) “click-and-deal.” The China Foreign Exchange Trading System (“CFETS”) is the unified
trading platform for CIBM, on which all products are traded through independent bilateral negotiation on a transaction by transaction basis. A market-making mechanism has also been introduced to improve market liquidity and enhance efficiency with
respect to trading on CIBM.
Once a transaction is agreed,
the parties will, in accordance with the terms of the transaction, promptly send instructions for the delivery of bonds and funds. Parties are required to have sufficient bonds and funds for delivery on the agreed delivery date. China Central
Depository & Clearing Co., Ltd (“CCDC”) will deliver bonds according to the instructions sent by the parties. Clearing banks will handle the transfer of funds and settlement of the payments of the bonds on behalf of the
parties.
Certain Funds,
including Core Plus Bond ETF and Global Bond Opportunities ETF, may invest in certain Chinese fixed income products traded on the CIBM through the “Mutual Bond Market Access between Mainland China and Hong Kong” (“Bond
Connect”) program. The Bond Connect program is a new initiative launched in July 2017 established by CFETS, CCDC, Shanghai Clearing House (“SHCH”), and Hong Kong Exchanges and Clearing Limited (“HKEx”) and Central
Moneymarkets Unit (“CMU”) of the Hong Kong Monetary Authority (“HKMA”) to facilitate investors from Mainland China and Hong Kong to trade in each other’s bond markets through connection between the Mainland China and
Hong Kong financial institutions.
Under the prevailing PRC
regulations, eligible foreign investors are allowed to invest in the bonds available on the CIBM through the northbound trading of Bond Connect (“Northbound Trading Link”). There is no investment quota for the Northbound Trading Link.
Under the Northbound Trading Link, eligible foreign investors are required to appoint the CFETS or other institutions recognized by the PBOC as registration agents to apply for registration with the PBOC.
The Northbound Trading Link
refers to the trading platform that is located outside of Mainland China and is connected to CFETS for eligible foreign investors to submit their trade requests for bonds circulated in the CIBM through Bond Connect. HKEx and CFETS will work together
with offshore electronic bond trading platforms to provide electronic trading services and platforms to allow direct trading between eligible foreign investors and approved onshore dealers in Mainland China through CFETS.
Eligible foreign investors may
submit trade requests for bonds circulated in the CIBM through the Northbound Trading Link provided by offshore electronic bond trading platforms, which will in turn transmit their requests for quotation to CFETS. CFETS will send the requests for
quotation to a number of approved onshore dealers (including market makers and others engaged in the market making business) in Mainland China. The approved onshore dealers will respond to the requests for quotation via CFETS, and CFETS will send
its responses to those eligible foreign investors through the same offshore electronic bond trading platforms. Once the eligible foreign investor accepts the quotation, the trade is concluded on CFETS.
On the other hand, the
settlement and custody of bond securities traded in the CIBM under Bond Connect are conducted through the settlement and custody link between the CMU, as an offshore custody agent, and the CCDC and the SHCH, as onshore custodian and clearing
institutions in Mainland China. Under this settlement and custody link, CCDC or the SHCH will effect gross settlement of confirmed trades onshore and the CMU will process bond settlement instructions from the CMU members on behalf of eligible
foreign investors in accordance with its relevant rules.
Pursuant to the prevailing
regulations in Mainland China, the CMU, being the offshore custody agent recognized by the HKMA, opens omnibus nominee accounts with the onshore custody agent recognized by the PBOC (i.e., the CCDC and Interbank Clearing Company Limited). All bonds
traded by eligible foreign investors will be registered in the name of the CMU, which will hold such bonds as a nominee owner.
A Fund’s investments in
bonds through Bond Connect will be subject to a number of additional risks and restrictions that may affect the Fund’s investments and returns. Bond Connect is relatively new. Laws, rules, regulations, policies, notices, circulars or
guidelines relating to Bond Connect (the “Applicable Bond Connect Regulations”) as published or applied by any of Bond Connect Authorities (as defined below) are untested and are subject to change from time to time. There can be no
assurance that Bond Connect will not be restricted, suspended or abolished. If such event occurs, a Fund’s ability to invest in the CIBM through Bond Connect will be adversely affected. “Bond Connect Authorities” refers to the
exchanges, trading systems, settlement systems, governmental, regulatory or tax bodies which provide services and/or regulate Bond Connect and activities relating to Bond Connect, including, without limitation, the PBOC, the HKMA, the HKEx, the
CFETS, the CMU, the CCDC and the SHCH and any other regulator, agency or authority with jurisdiction, authority or responsibility in respect of Bond Connect.
Hedging activities under Bond
Connect are subject to the Applicable Bond Connect Regulations and any prevailing market practice. There is no guarantee that a Fund will be able to carry out hedging transactions at terms which are satisfactory to the investment manager of the Fund
and to the best interest of the Fund. A Fund may also be required to unwind its hedge in unfavorable market conditions.
Potential lack of liquidity
due to low trading volume of certain fixed income securities in the CIBM may result in prices of certain fixed income securities traded on such market fluctuating significantly, which may expose a Fund to liquidity risks. In addition, the fixed
income securities traded in the CIBM may be difficult or impossible to sell, and this would affect a Fund’s ability to acquire or dispose of such securities at their intrinsic value.
Although
delivery-versus-payment (“DVP”) settlement (e.g., simultaneous delivery of security and payment) is the dominant settlement method adopted by CCDC and SHCH for all bond transactions in the CIBM, there is no assurance that settlement
risks can be eliminated. In addition, DVP settlement practices in the PRC may differ from practices in developed markets. In particular, such settlement may not be instantaneous and be subject to a delay of a period of hours. Where the counterparty
does not perform its obligations under a transaction or there is otherwise a failure due to CCDC or SHCH (as applicable), a Fund may sustain losses.
It is contemplated that the
mainland Chinese authorities will reserve the right to suspend Northbound trading of Bond Connect, if necessary for ensuring an orderly and fair market and that risks are managed prudently. The relevant PRC government authority may also impose
“circuit breakers” and other measures to halt or suspend Northbound trading. Where a suspension in the Northbound trading through Bond Connect is effected, a Fund’s ability to access the CIBM bond market will be adversely
affected.
Under the
prevailing Applicable Bond Connect Regulations, eligible foreign investors who wish to participate in Bond Connect may do so through an onshore settlement agent, offshore custody agent, registration agent or other third parties (as the case may be),
who would be responsible for making the relevant filings and account opening with the relevant authorities. A Fund is therefore subject to the risk of default or errors on the part of such agents.
Trading through Bond Connect
is performed through newly developed trading platforms and operational systems. There is no assurance that such systems will function properly (in particular, under extreme market conditions) or will continue to be adapted to changes and
developments in the market. In the event that the relevant systems fails to function properly, trading through Bond Connect may be disrupted. A Fund’s ability to trade through Bond Connect (and hence to pursue its investment strategy) may
therefore be adversely affected. In addition, where a Fund invests in the CIBM through Bond Connect, it may be subject to risks of delays inherent in the order placing and/or settlement.
For a Fund’s investment
under Bond Connect, although there is no quota restriction under the Applicable Bond Connect Regulations, relevant information about the Fund’s investments needs to be filed with PBOC and an updating filing may be required if there is any
significant change to the filed information. It cannot be predicted whether PBOC will make any comments on or require any changes with respect to such information for the purpose of filing. If so required, a Fund will need to follow PBOC
instructions and make the relevant changes accordingly, which, may not be in the best interests of the Fund and the Fund’s investors from a commercial perspective.
The CMU is the “nominee
holder” of the bonds acquired by a Fund through Bond Connect. Although the Applicable Bond Connect Regulations expressly provide that investors enjoy the rights and interests of the bonds acquired through Bond Connect in accordance with
applicable laws, how a beneficial owner (such as a Fund) of the relevant bonds exercises and enforces its rights over such securities in the courts in China is yet to be tested. Even if the concept of beneficial ownership is recognized under Chinese
law,
those securities may form part of the pool of assets of such
nominee holder, which may be available for distribution to creditors upon liquidation of such nominee holder, and accordingly a beneficial owner may have no rights whatsoever in respect thereof.
Northbound trading through
Bond Connect is able to be undertaken on days upon which the CIBM is open to trade, regardless of whether they are a public holiday in the domicile of a Fund. Accordingly, it is possible that bonds traded through Bond Connect may be subject to
fluctuation at times when a Fund is unable to buy or sell bonds, as its globally-based intermediaries are not available to assist with trades. Accordingly, this may cause a Fund to be unable to realize gains, avoid losses or to benefit from an
opportunity to invest in mainland CIBM bonds at an attractive price.
CIBM bonds under Northbound
Trading of Bond Connect will be traded and settled in RMB. If a Fund issues classes denominated in a currency other than RMB, the Fund will be exposed to currency risk if the Fund invests in a RMB product due to the need for the conversion of the
currency into RMB. A Fund will also incur currency conversion costs. Even if the price of the RMB asset remains the same when a Fund purchases and redeems, the Fund will still incur a loss when it converts the redemption proceeds into local currency
if RMB has depreciated. Also, as a Fund may either settle CIBM bonds using offshore RMB (“CNH”) or by converting offshore currency into onshore RMB (“CNY”), any divergence between CNH and CNY may adversely impact
investors.
Under
prevailing principles of the PRC Corporate Income Tax Law (“CIT Law”) and relevant regulations, non-PRC tax resident enterprises deriving China source interest and capital gains are subject to PRC Corporate Income Tax (“CIT”)
withholding of 10%, subject to any reduction or exemption under an applicable CIT Law, regulation (such as the CIT exemption for interest derived from qualified government bonds) or double taxation treaty or arrangement.
The Ministry of Finance and the
State Administration of Taxation issued a circular that grants a three year exemption from CIT and value-added tax applicable to interest derived from China onshore bond markets (including CIBM) by foreign institutional investors (such as a Fund).
This exemption applies from November 7, 2018 to November 6, 2021. The PRC tax authorities have not issued any guidance on the applicable PRC tax treatment after the expiry of the three year exemption.
Investments in India
Securities of many issuers in
the Indian market may be less liquid and more volatile than securities of comparable domestic issuers, but may offer the potential for higher returns over the long term. Indian securities will generally be denominated in foreign currency, mainly the
rupee. Accordingly, the value of the Fund will fluctuate depending on the rate of exchange between the U.S. dollar and such foreign currency. India has less developed clearance and settlement procedures, and there have been times when settlements
have been unable to keep pace with the volume of securities and have been significantly delayed. The Indian stock exchanges have in the past been subject to closure, broker defaults and broker strikes, and there can be no certainty that this will
not recur. In addition, significant delays are common in registering transfers of securities and the Fund may be unable to sell securities until the registration process is completed and may experience delays in receipt of dividends and other
entitlements.
The value
of investments in Indian securities may also be affected by political and economic developments, social, religious or regional tensions, changes in government regulation and government intervention, high rates of inflation or interest rates and
withholding tax affecting India. The risk of loss may also be increased because there may be less information available about Indian issuers since they are not subject to the extensive accounting, auditing and financial reporting standards and
practices which are applicable in North America. There is also a lower level of regulation and monitoring of the Indian securities market and its participants than in other more developed markets.
Foreign investment in the
securities of issuers in India is usually restricted or controlled to some degree. In addition, the availability of financial instruments with exposure to Indian financial markets may be substantially limited by the restrictions on Foreign
Institutional Investors (“FIIs”). Only registered FIIs and non-Indian mutual funds that comply with certain statutory conditions may make direct portfolio investments in exchange-traded Indian securities. JPMIM is a registered FII. FIIs
are required to observe certain investment restrictions which may limit the Fund’s ability to invest in issuers or to fully pursue its investment objective. Income, gains and initial capital with respect to such investments are freely
repatriable, subject to payment of applicable Indian taxes.
India’s guidelines under
which foreign investors may invest in Indian securities are new and evolving. There can be no assurance that these investment control regimes will not change in a way that makes it more difficult or impossible for a Fund to implement investment
objective or repatriate its income, gains and initial capital from these countries. Similar risks and considerations will be applicable to the extent that a Fund invests in other countries. Recently, certain policies have served to restrict foreign
investment, and such policies may have the effect of reducing demand for such investments.
India may require withholding
on dividends paid on portfolio securities and on realized capital gains. In the past, these taxes have sometimes been substantial. There can be no assurance that restrictions on repatriation of a Fund’s income, gains or initial capital from
India will not occur.
A
high proportion of the shares of many issuers in India may be held by a limited number of persons and financial institutions, which may limit the number of shares available for investment. In addition, further issuances, or the perception that such
issuances may occur, of securities by Indian issuers in which a Fund has invested could dilute the earnings per share of a Fund’s investment and could adversely affect the market price of such securities. Sales of securities by such
issuer’s major shareholders, or the perception that such sales may occur, may also significantly and adversely affect the market price of such securities and, in turn, a Fund’s investment. The prices at which investments may be acquired
may be affected by trading by persons with material non-public information and by securities transactions by brokers in anticipation of transactions by a Fund in particular securities. Similarly, volume and liquidity in the bond markets in India are
less than in the United States and, at times, price volatility can be greater than in the United States. The limited liquidity of securities markets in India may also affect a Fund’s ability to acquire or dispose of securities at the price and
time it wishes to do so. In addition, India’s securities markets are susceptible to being influenced by large investors trading significant blocks of securities.
India’s stock market is
undergoing a period of growth and change which may result in trading volatility and difficulties in the settlement and recording of transactions, and in interpreting and applying the relevant law and regulations. The securities industry in India is
comparatively underdeveloped. Stockbrokers and other intermediaries in India may not perform as well as their counterparts in the United States and other more developed securities markets.
Political and economic
structures in India are undergoing significant evolution and rapid development, and may lack the social, political and economic stability characteristic of the United States. The risks described above, including the risks of nationalization or
expropriation of assets, may be heightened. In addition, unanticipated political or social developments may affect the values of investments in India and the availability of additional investments. The laws in India relating to limited liability of
corporate shareholders, fiduciary duties of officers and directors, and the bankruptcy of state enterprises are generally less well developed than or different from such laws in the United States. It may be more difficult to obtain or enforce a
judgment in the courts in India than it is in the United States. Monsoons and natural disasters also can affect the value of investments.
Religious and border disputes
persist in India. Moreover, India has from time to time experienced civil unrest and hostilities with neighboring countries such as Pakistan. The Indian government has confronted separatist movements in several Indian states. The longstanding
dispute with Pakistan over the bordering Indian state of Jammu and Kashmir, a majority of whose population is Muslim, remains unresolved. If the Indian government is unable to control the violence and disruption associated with these tensions, the
results could destabilize the economy and consequently, adversely affect the Fund’s investments.
A Fund may use P-notes.
Indian-based brokerages may buy Indian-based securities and then issue P-notes to foreign investors. Any dividends or capital gains collected from the underlying securities may be remitted to the foreign investors. However, unlike ADRs, notes are
subject to credit risk based on the uncertainty of the counterparty’s (i.e., the Indian-based brokerage’s) ability to meet its obligations.
Investments in Japan
The Japanese economy may be
subject to economic, political and social instability, which could have a negative impact on Japanese securities. In the past, Japan’s economic growth rate has remained relatively low, and it may remain low in the future. At times, the
Japanese economy has been adversely impacted by government intervention and protectionism, changes in its labor market, and an unstable financial services sector. International trade, government support of the financial services sector and other
troubled sectors, government policy, natural disasters and/or geopolitical developments could significantly affect the Japanese economy. A significant portion of Japan’s trade is conducted with developing nations and can be
affected by conditions in these nations or by currency
fluctuations. Japan is an island state with few natural resources and limited land area and is reliant on imports for its commodity needs. Any fluctuations or shortages in the commodity markets could have a negative impact on the Japanese
economy.
Investments in the Middle East and
Africa
Certain countries
in the region are in early stages of development. As a result, there may be a high concentration of market capitalization and trading volume in a small number of issuers representing a limited number of industries, as well as a high concentration of
investors and financial intermediaries. Brokers may be fewer in number and less well capitalized than brokers in more developed regions. Certain economies in the region depend to a significant degree upon exports of commodities and are vulnerable to
changes in commodity prices, which in turn may be affected by a variety of factors. In addition, certain governments in the region have exercised substantial influence over the private sector, including ownership or control of companies.
Governmental actions in the future could have a significant economic impact. Certain armed conflict, territorial disputes, historical animosities, regional instability, terrorist activities and religious, ethnic and/or socioeconomic unrest. Such
developments could have a negative effect on economic growth and could result in significant disruptions in the securities markets, including securities held by a Fund. Certain Middle Eastern and African countries have currencies pegged to the U.S.
dollar, which, if abandoned, could cause sudden and significant currency adjustments, which could impact the Fund’s investment returns in those countries. The legal systems, and the unpredictability thereof, in certain countries in the region
also may have an adverse impact on the Fund and may expose the Fund to significant or unlimited liabilities. Investment in certain countries in the region by the Fund may be restricted or prohibited under applicable regulation, and the Fund, as a
foreign investor, may be required to obtain approvals and may have to invest on less advantageous terms (including price) than nationals. A Fund’s investments in securities of a country in the region may be subject to economic sanctions or
other government restrictions, which may negatively impact the value or liquidity of the Fund’s investments. Investments in the region may adversely impact the operations of the Fund through the delay of the Fund’s ability to exercise
its rights as a security holder. Substantial limitations may exist in the region with respect to the Fund’s ability to repatriate investment income, capital gains or its investment. Securities which are subject to material legal restrictions
on repatriation of assets will be considered illiquid securities by the Fund and subject to the limitations on illiquid investments.
Saudi Arabia. To the extent a Fund invests in securities issued by Saudi Arabian issuers, the Fund may be subject to the risk of investing in those issuers. Saudi Arabian issuers may be impacted by the Saudi Arabian economy, which is
significantly tied to petroleum exports. As a result, a reduction in petroleum exports with key partners or in petroleum prices could have an overall impact on the Saudi Arabian economy. The Saudi Arabian economy also relies heavily on cheap,
foreign labor, and changes in the availability of this labor supply could have an adverse effect on the economy.
Although liberalization in the
wider Saudi Arabian economy is underway, the government of Saudi Arabia exercises substantial influence over many aspects of the private sector. Political instability in Saudi Arabia or instability in the larger Middle East region could adversely
impact the economy of Saudi Arabia. Instability may be caused by, among other things: military developments; government interventions in the marketplace; terrorism; extremist attitudes; attempted social or political reforms; religious differences;
and other factors. Additionally, anti-Western views held by certain groups in the Middle East may influence the government of Saudi Arabia’s policies regarding foreign investment. In addition, certain issuers located in Saudi Arabia may
operate in, or have dealings with, countries subject to sanctions and/or embargoes imposed by the U.S. government and the United Nations and/or countries identified by the U.S. government as state sponsors of terrorism. As a result, an issuer may
sustain damage to its reputation if it is identified as an issuer that operates in, or has dealings with, such countries. A Fund, as an investor in such issuers, will be indirectly subject to those risks. A Fund is also subject to the risk of
expropriation or nationalization of assets and property or the risk of restrictions on foreign investments and repatriation of capital.
The ability of foreign
investors, including the Funds, to invest in Saudi Arabian issuers is relatively new and untested, and such ability may be revoked or restricted by the government of Saudi Arabia in the future, which may materially affect a Fund. A Fund may be
unable to obtain or maintain the required licenses, which would affect the Fund’s ability to buy and sell securities at full value. Additionally, a Fund’s ownership of any single issuer listed on the Saudi Arabian Stock Exchange may be
limited by the Saudi Arabia Capital Market Authority (“CMA”). Major disruptions or regulatory changes may occur in the Saudi Arabian market, which could negatively impact the Funds.
The securities markets in Saudi
Arabia may not be as developed as those in other countries. As a result, securities markets in Saudi Arabia are subject to greater risks associated with market volatility, lower market capitalization, lower trading volume, illiquidity, inflation,
greater price fluctuations, uncertainty regarding the existence of trading markets, governmental control and heavy regulation of labor and industry. Shares of certain Saudi Arabian companies tend to trade less frequently than those of companies on
exchanges in more developed markets, which may adversely affect the pricing of these securities and a Fund’s ability to sell these securities in the future. Current regulations in the Saudi Arabian securities markets may require a Fund to
execute trades of securities through a single broker. As a result, the investment adviser will have less flexibility to choose among brokers on behalf of a Fund than is typically the case for investment managers.
A Fund’s ability to
achieve its investment objective depends on the ability of the investment adviser to maintain its status as a Qualified Foreign Investor (“QFI”) with the CMA and the Fund as a client of a QFI who has been approved by the CMA (“QFI
Client”). Even if a Fund obtains QFI Client status, the Fund may not have an exclusive investment quota and will be subject to foreign investment limitations and other regulations imposed by the CMA on QFIs and QFI Clients (individually and in
the aggregate), as well as local market participants. QFI regulations and local market infrastructure are relatively new and have not been tested and the CMA may discontinue the QFI regime at any time. Any change in the QFI system generally,
including the possibility of the investment adviser or a Fund losing its QFI or QFI Client status, respectively, may adversely affect the Fund.
A Fund is required to use a
trading account to buy and sell securities in Saudi Arabia. This trading account can be held directly with a broker or a custodian. Under the Independent Custody Model (“ICM”), securities are under the control of the custodian and would
be recoverable in the event of the bankruptcy of the custodian. When a Fund utilizes the ICM approach, the Fund relies on a broker standing instruction letter to authorize the Fund’s sub-custodian to move securities to a trading account for
settlement based on the details supplied by the broker. The risk of a fraudulent or erroneous transaction through the ICM approach is mitigated by the short trading hours in Saudi Arabia, a manual pre-matching process conducted by the custodian,
which validates a Fund’s settlement instructions with the local broker contract note, and the transaction report from the depository. When a Fund utilizes a direct broker trading account, the account is set up in the Fund’s name and the
assets are likely to be separated from any other accounts at the broker. However, if the broker defaults, there may be a delay to recovering the Fund’s assets that are held in the broker account and legal proceedings may need to be initiated
in order to do so.
Investments in Latin
America
As an emerging
market, Latin America has long suffered from political, economic, and social instability. For investors, this has meant additional risk caused by periods of regional conflict, political corruption, totalitarianism, protectionist measures,
nationalization, hyperinflation, debt crises, sudden and large currency devaluation, and intervention by the military in civilian and economic spheres. However, much has changed in the past decade. Democracy is beginning to become well established
in some countries. A move to a more mature and accountable political environment is well under way. Domestic economies have been deregulated, privatization of state-owned companies is almost completed and foreign trade restrictions have been
relaxed. Nonetheless, to the extent that events such as those listed above continue in the future, they could reverse favorable trends toward market and economic reform, privatization, and removal of trade barriers, and result in significant
disruption in securities markets in the region. Investors in the region continue to face a number of potential risks. Governments of many Latin American countries have exercised and continue to exercise substantial influence over many aspects of the
private sector. Governmental actions and political instability in the future could have a significant effect on economic conditions in Latin American countries, which could affect the companies in which a Fund invests and, therefore, the value of
Fund shares.
Certain
Latin American countries may experience sudden and large adjustments in their currency which, in turn, can have a disruptive and negative effect on foreign investors. For example, in late 1994 the Mexican peso lost more than one-third of its value
relative to the U.S. dollar. In 1999, the Brazilian real lost 30% of its value against the U.S. dollar. Certain Latin American countries may impose restrictions on the free conversion of their currency into foreign currencies, including the U.S.
dollar. There is no significant foreign exchange market for many currencies and it would, as a result, be difficult for certain Funds to engage in foreign currency transactions designed to protect the value of the Funds’ interests in
securities denominated in such currencies.
Almost all of the
region’s economies have become highly dependent upon foreign credit and loans from external sources to fuel their state-sponsored economic plans. Government profligacy and ill-conceived plans for modernization have exhausted these resources
with little benefit accruing to the economy and most countries have been forced to restructure their loans or risk default on their debt obligations. In addition, interest on the debt is subject to market conditions and may reach levels that would
impair economic activity and create a difficult and costly environment for borrowers. Accordingly, these governments may be forced to reschedule or freeze their debt repayment, which could negatively affect the stock market. Latin American economies
that depend on foreign credit and loans could fall into recession because of tighter international credit supplies due to the current global economic crisis.
Substantial limitations may
exist in certain countries with respect to a Fund’s ability to repatriate investment income, capital or the proceeds of sales of securities. A Fund could be adversely affected by delays in, or a refusal to grant, any required governmental
approval for repatriation of capital, as well as by the application to the Fund of any restrictions on investments.
Certain Latin American
countries have entered into regional trade agreements that are designed to, among other things, reduce barriers between countries, increase competition among companies and reduce government subsidies in certain industries. No assurance can be given
that these changes will be successful in the long term, or that these changes will result in the economic stability intended. There is a possibility that these trade arrangements will not be fully implemented, or will be partially or completely
unwound. It is also possible that a significant participant could choose to abandon a trade agreement, which could diminish its credibility and influence. Any of these occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of participants’ national currencies and a significant increase in exchange rate volatility, a resurgence in economic protectionism, an undermining of confidence in the
Latin American markets, an undermining of Latin American economic stability, the collapse or slowdown of the drive towards Latin American economic unity, and/or reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of such trade agreements. Such developments could have an adverse impact on a Fund’s investments in Latin America generally or in specific countries participating in such trade agreements.
Terrorism and related
geo-political risks have led, and may in the future lead, to increased short-term market volatility and may have adverse long-term effects on world economies and markets generally.
Investments in Russia
Investing in Russian
securities is highly speculative and involves significant risks and special considerations not typically associated with investing in the securities markets of the U.S. and most other developed countries.
Over the past century, Russia
has experienced political, social and economic turbulence and has endured decades of communist rule under which the property of tens of millions of its citizens was collectivized into state agricultural and industrial enterprises. Since the collapse
of the Soviet Union, Russia’s government has been faced with the daunting task of stabilizing its domestic economy, while transforming it into a modern and efficient structure able to compete in international markets and respond to the needs
of its citizens. However, to date, many of the country’s economic reform initiatives have not been successful. In this environment, there is the risk that the Russian government will alter its political and economic policies in ways that would
be detrimental to the interests of foreign investors.
Recently, the Russian
government has asserted its regional geopolitical influence, which has increased tensions both with Russia’s neighbors and with other countries. The resulting imposition of sanctions by the United States and the European Union has contributed
to the slowing of the Russian economy, as having falling commodity prices and the collapse in the value of Russian exports, and further action by Russia to assert its regional geopolitical influence could result in a greater adverse impact.
Many of Russia’s
businesses have failed to mobilize the available factors of production because the country’s privatization program virtually ensured the predominance of the old management teams that are largely non-market-oriented in their management
approach. Poor accounting standards, inept management, pervasive corruption, insider trading and crime, and inadequate regulatory protection for the rights of investors all pose a significant risk, particularly to foreign investors. In addition,
there is the risk that the Russian tax system will be enforced inconsistently or in an arbitrary manner or that exorbitant taxes will be imposed.
Compared to most national
stock markets, the Russian securities market suffers from a variety of problems not encountered in more developed markets. There is little long-term historical data on the Russian securities market because it is relatively new and a substantial
proportion of securities transactions in Russia are privately negotiated outside of stock exchanges. The inexperience of the Russian securities market and the limited volume of trading in securities in the market may make obtaining accurate prices
on portfolio securities from independent sources more difficult than in more developed markets. Additionally, because of less stringent auditing and financial reporting standards that apply to companies operating in Russia, there is little solid
corporate information available to investors. As a result, it may be difficult to assess the value or prospects of an investment in Russian companies. Stocks of Russian companies also may experience greater price volatility than stocks of U.S.
companies.
Settlement,
clearing and registration of securities transactions in Russia are subject to additional risks because of the recent formation of the Russian securities market, the underdeveloped state of the banking and telecommunications systems, and the overall
legal and regulatory framework. Prior to 2013, there was no central registration system for equity share registration in Russia and registration was carried out by either the issuers themselves or by registrars located throughout Russia. Such
registrars were not necessarily subject to effective state supervision nor were they licensed with any governmental entity, thereby increasing the risk that a Fund could lose ownership of its securities through fraud, negligence, or even mere
oversight. With the implementation of the National Settlement Depository (“NSD”) in Russia as a recognized central securities depository, title to Russian equities is now based on the records of the Depository and not the registrars.
Although the implementation of the NSD has enhanced the efficiency and transparency of the Russian securities market, issues resulting in loss still might occur. In addition, issuers and registrars are still prominent in the validation and approval
of documentation requirements for corporate action processing in Russia. Because the documentation requirements and approval criteria vary between registrars and/or issuers, there remain unclear and inconsistent market standards in the Russian
market with respect to the completion and submission of corporate action elections. To the extent that a Fund suffers a loss relating to title or corporate actions relating to its portfolio securities, it may be difficult for the Fund to enforce its
rights or otherwise remedy the loss.
The Russian economy is heavily
dependent upon the export of a range of commodities including most industrial metals, forestry products, oil, and gas. Accordingly, it is strongly affected by international commodity prices and is particularly vulnerable to any weakening in global
demand for these products.
Foreign investors also face a
high degree of currency risk when investing in Russian securities and a lack of available currency hedging instruments. Recently, the Russian ruble has been subject to significant devaluation pressure as a result of the imposition of sanctions by
the United States and the European Union and the decline in commodity prices and the value of Russian exports. Although the Russian Central Bank has spent a significant amount of its foreign exchange reserves in an attempt to maintain the
ruble’s value, there is a risk of significant future devaluation. In addition, there is a risk that the government may impose capital controls on foreign portfolio investments in the event of extreme financial or political crisis. Such capital
controls would prevent the sale of a portfolio of foreign assets and the repatriation of investment income and capital. These risks may cause flight from the ruble into U.S. dollars and other currencies.
The United States may impose
economic sanctions against companies in various sectors of the Russian economy, including, but not limited to, the financial services, energy, metals and mining, engineering, and defense and defense-related materials sectors. These sanctions, if
imposed, could impair a Fund’s ability to invest in securities it views as attractive investment opportunities. For example, a Fund may be prohibited from investing in securities issued by companies subject to such sanctions. In addition, the
sanctions may require a Fund to freeze its existing investments in Russian companies, prohibiting the Fund from selling or otherwise transacting in these investments. This could impact a Fund’s ability to sell securities or other financial
instruments as needed to meet shareholder redemptions.
Terrorism and related
geo-political risks have led, and may in the future lead, to increased short-term market volatility and may have adverse long-term effects on world economies and markets generally.
RISK MANAGEMENT
Each actively managed Fund may
employ non-hedging risk management techniques. Risk management strategies are used to keep the Funds fully invested and to reduce the transaction costs associated with cash flows into and out of a Fund. The Funds use a wide variety of instruments
and strategies for risk management and the examples below are not meant to be exhaustive.
Examples of risk management
strategies include synthetically altering the duration of a portfolio or the mix of securities in a portfolio. For example, if the Adviser wishes to extend maturities in a fixed income portfolio in order to take advantage of an anticipated decline
in interest rates, but does not wish to purchase the underlying long-term securities, it might cause a Fund to purchase futures contracts on long term debt securities. Likewise, if the Adviser wishes to gain exposure to an instrument but does not
wish to purchase the instrument it may use swaps and related instruments. Similarly, if the Adviser wishes to decrease exposure to fixed income securities or purchase equities, it could cause the Fund to sell futures contracts on debt securities and
purchase futures contracts on a stock index. Such non-hedging risk management techniques involve leverage, and thus, present, as do all leveraged transactions, the possibility of losses as well as gains that are greater than if these techniques
involved the purchase and sale of the securities themselves rather than their synthetic derivatives.
LIQUIDITY RISK MANAGEMENT PROGRAM
The Funds have adopted a
Liquidity Risk Management Program (the “Program”) under Rule 22e-4 under the Investment Company Act of 1940 (the “Liquidity Risk Management Rule”). As required by the Liquidity Risk Management Rule, each Fund limits Illiquid
Investments to 15% of the Fund’s net assets (“Illiquid Limit”) and reports to the Board and SEC within specified time periods of a Fund exceeding its 15% Illiquid Limit. “Illiquid Investments” are defined as any
investment a Fund reasonably expects cannot be sold or disposed of in current market conditions in 7 calendar days or less without the sale or disposition significantly changing the market value of the investment. For purposes of determining
compliance with the Illiquid Limit, only Illiquid Investments that have positive values are used in the numerator, and Illiquid Investments with negative values should not be netted against Illiquid Investments with positive values.
RISK RELATED TO MANAGEMENT OF CERTAIN SIMILAR
FUNDS
The name,
investment objective and policies of certain Funds are similar to other funds advised by the adviser or its affiliates. However, the investment results of a Fund may be higher or lower than, and there is no guarantee that the investment results of
the Fund will be comparable to, any other of these funds.
DIVERSIFICATION
Certain Funds are diversified
funds and as such intend to meet the diversification requirements of the 1940 Act. Please refer to the Funds’ Prospectuses for information about whether a Fund is a diversified or non-diversified Fund. Current 1940 Act diversification
requirements require that with respect to 75% of the assets of a Fund, the Fund may not invest more than 5% of its total assets in the securities of any one issuer or own more than 10% of the outstanding voting securities of any one issuer, except
cash or cash items, obligations of the U.S. government, its agencies and instrumentalities, and securities of other investment companies. As for the other 25% of a Fund’s assets not subject to the limitation described above, there is no
limitation on investment of these assets under the 1940 Act, so that all of such assets may be invested in securities of any one issuer. Investments not subject to the limitations described above could involve an increased risk to a Fund should an
issuer be unable to make interest or principal payments or should the market value of such securities decline.
Certain other Funds are
registered as non-diversified investment companies. A Fund is considered “non-diversified” because a relatively high percentage of the Fund’s assets may be invested in the securities of a single issuer or a limited number of
issuers, primarily within the same economic sector. A non-diversified Fund’s portfolio securities, therefore, may be more susceptible to any single economic, political, or regulatory occurrence than the portfolio securities of a more
diversified investment company.
Regardless of whether a Fund
is diversified under the 1940 Act, all of the Funds will comply with the diversification requirements imposed by the Code for qualification as a regulated investment company. See “Distributions and Tax Matters.”
DISTRIBUTIONS AND TAX MATTERS
The following discussion is a
brief summary of some of the important federal (and, where noted, state) income tax consequences affecting each Fund and its shareholders. There may be other tax considerations applicable to particular shareholders. This section does not address in
detail the tax consequences affecting any shareholder who, as to the U.S., is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership. This section is based on the Code, the regulations thereunder,
published rulings and court decisions, all as currently in effect. These laws are subject to change, possibly
on a retroactive basis. The following tax discussion is very
general; therefore, prospective investors are urged to consult their tax advisors about the impact an investment in a Fund may have on their own tax situations and the possible application of foreign, state and local law.
Each Fund generally will be
treated as a separate entity for federal income tax purposes, and thus the provisions of the Code generally will be applied to each Fund separately. Net long-term and short-term capital gain, net income and operating expenses therefore will be
determined separately for each Fund.
Special tax rules apply to
investments held through defined contribution plans and other tax-qualified plans. Shareholders should consult their tax advisors to determine the suitability of shares of the Fund as an investment through such plans.
Qualification as a Regulated Investment Company
Each Fund intends to elect to
be treated and qualify each year as a regulated investment company under Subchapter M of the Code. In order to qualify for the special tax treatment accorded regulated investment companies and their shareholders, each Fund must, among other
things:
(a)
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derive at least
90% of its gross income for each taxable year from (i) dividends, interest, payments with respect to certain securities loans, and gain from the sale or other disposition of stock, securities, or foreign currencies, or other income (including, but
not limited to, gain from options, swaps, futures, or forward contracts) derived with respect to its business of investing in such stock, securities, or currencies and (ii) net income derived from interests in “qualified publicly traded
partnerships” (“QPTPs”, defined below);
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(b)
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diversify its
holdings so that, at the end of each quarter of the Fund’s taxable year, (i) at least 50% of the market value of the Fund’s total assets is represented by cash and cash items, U.S. government securities, securities of other regulated
investment companies, and other securities, limited in respect of any one issuer to an amount not greater than 5% of the value of the Fund’s total assets and not more than 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of the Fund’s total assets is invested (x) in the securities (other than cash or cash items, or securities issued by the U.S. government or other regulated investment companies) of any one issuer or of two or more
issuers that the Fund controls and that are engaged in the same, similar, or related trades or businesses, or (y) in the securities of one or more QPTPs. In the case of a Fund’s investments in loan participations, the Fund shall treat both the
financial intermediary and the issuer of the underlying loan as an issuer for the purposes of meeting this diversification requirement; and
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(c)
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distribute
with respect to each taxable year at least 90% of the sum of its investment company taxable income (as that term is defined in the Code, without regard to the deduction for dividends paid — generally, taxable ordinary income and any excess of
net short-term capital gain over net long-term capital loss) and net tax-exempt interest income, for such taxable year.
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In general, for purposes of the
90% gross income requirement described in paragraph (a) above, income derived from a partnership will be treated as qualifying income only to the extent such income is attributable to items of income of the partnership which would be qualifying
income if realized by the regulated investment company. However, 100% of the net income derived from an interest in a “qualified publicly traded partnership” (defined as a partnership (x) interests in which are traded on an established
securities markets or readily tradable on a secondary market as the substantial equivalents thereof, (y) that derives at least 90% of its income from passive income sources defined in Section 7704(d) of the Code, and (z) that derives less than 90%
of its income from the qualifying income described in (a)(i) above) will be treated as qualifying income. Although income from a QPTP is qualifying income, as discussed above, investments in QPTPs cannot exceed 25% of the Fund’s assets. In
addition, although in general the passive loss rules of the Code do not apply to regulated investment companies, such rules do apply to a regulated investment company with respect to items attributable to an interest in a QPTP.
Gains from foreign currencies
(including foreign currency options, foreign currency swaps, foreign currency futures and foreign currency forward contracts) currently constitute qualifying income for purposes of the 90% test, described in paragraph (a) above. However, the
Treasury Department has the authority to issue regulations (possibly with retroactive effect) excluding from the definition of “qualifying income” a fund’s foreign currency gains to the extent that such income is not directly
related to the Fund’s principal business of investing in stock or securities.
For purposes of paragraph (b)
above, the term “outstanding voting securities of such issuer” will include the equity securities of a QPTP. A Fund’s investment in MLPs may qualify as an investment in (1) a QPTP, (2) a “regular” partnership, (3) a
“passive foreign investment company” (a “PFIC”) or (4) a corporation for U.S. federal income tax purposes. The treatment of particular MLPs for U.S. federal income tax purposes will affect the extent to which a Fund can
invest in MLPs. The U.S. federal income tax consequences of a Fund’s investments in “PFICs” and “regular” partnerships are discussed in greater detail below.
If a Fund qualifies for a
taxable year as a regulated investment company that is accorded special tax treatment, the Fund will not be subject to federal income tax on income distributed in a timely manner to its shareholders in the form of dividends (including Capital Gain
Dividends, defined below). If a Fund were to fail to qualify as a regulated investment company accorded special tax treatment in any taxable year, the Fund would be subject to taxation on its taxable income at corporate rates, and all distributions
from earnings and profits, including any distributions of net tax-exempt income and net long-term capital gain, would be taxable to shareholders as ordinary income. Some portions of such distributions may be eligible for the dividends-received
deduction in the case of corporate shareholders and for treatment as qualified dividend income in the case of individual shareholders. In addition, the Fund could be required to recognize unrealized gain, pay substantial taxes and interest, and make
substantial distributions before re-qualifying as a regulated investment company that is accorded special tax treatment.
Each Fund intends to distribute
at least annually to its shareholders all or substantially all of its investment company taxable income (computed without regard to the dividends-paid deduction) and may distribute its net capital gain (that is the excess of net long-term capital
gain over net short-term capital loss). Investment company taxable income which is retained by a Fund will be subject to tax at regular corporate tax rates. A Fund might also retain for investment its net capital gain. If a Fund does retain such net
capital gain, such gain will be subject to tax at regular corporate rates on the amount retained, but the Fund may designate the retained amount as undistributed capital gain in a notice to its shareholders who (i) will be required to include in
income for federal income tax purposes, as long-term capital gain, their respective shares of the undistributed amount, and (ii) will be entitled to credit their respective shares of the tax paid by the Fund on such undistributed amount against
their federal income tax liabilities, if any, and to claim refunds to the extent the credit exceeds such liabilities. For federal income tax purposes, the tax basis of shares owned by a shareholder of a Fund will be increased by an amount equal
under current law to the difference between the amount of undistributed capital gain included in the shareholder’s gross income and the tax deemed paid by the shareholder under clause (ii) of the preceding sentence.
In determining its net capital
gain, including in connection with determining the amount available to support a Capital Gain Dividend, its taxable income and its earnings and profits, a Fund may elect to treat part or all of any post-October capital loss (defined as any net
capital loss attributable to the portion of the taxable year after October 31, or if there is no net capital loss, any net long-term capital loss or any net short-term capital loss attributable to the portion of the taxable year after that date) or
late-year ordinary loss (generally, (i) net ordinary loss from the sale, exchange or other taxable disposition of property, attributable to the portion of the taxable year after October 31, plus (ii) other net ordinary loss attributable to the
portion of the taxable year after December 31) as if incurred in the succeeding taxable year.
Excise Tax on Regulated Investment Companies
If a Fund fails to distribute
in a calendar year an amount at least equal to the sum of 98% of its ordinary income (taking into account certain deferrals and elections) for such year and 98.2% of its capital gain net income (adjusted for certain ordinary losses) for the one-year
period ending October 31 (or later if the Fund is permitted to elect and so elects), plus any retained amount from the prior year, the Fund will be subject to a nondeductible 4% excise tax on the undistributed amounts. The Funds intend to make
distributions sufficient to avoid imposition of the 4% excise tax, although each Fund reserves the right to pay an excise tax rather than make an additional distribution when circumstances warrant (e.g., the excise tax amount is deemed by a Fund to
be de minimis). Certain derivative instruments give rise to ordinary income and loss. If a Fund has a taxable year that begins in one calendar year and ends in the next calendar year, the Fund will be required to make this excise tax distribution
during its taxable year. There is a risk that a Fund could recognize income prior to making this excise tax distribution and could recognize losses after making this distribution. As a result, all or a portion of an excise tax distribution could
constitute a return of capital (see discussion below).
Fund Distributions
The Funds anticipate
distributing substantially all of their net investment income for each taxable year. Distributions are taxable to shareholders even if they are paid from income or gain earned by the Fund before a shareholder’s investment (and thus were
included in the price the shareholder paid). Distributions are taxable whether shareholders receive them in cash or reinvest them in additional shares. A shareholder whose distributions are reinvested in shares will be treated as having received a
dividend equal to the amount of cash that the shareholder would have received if such shareholder had elected to receive the distribution in cash.
Dividends and distributions on
a Fund’s shares generally are subject to federal income tax as described herein to the extent they do not exceed the Fund’s realized income and gains, even though such dividends and distributions may represent economically a return of a
particular shareholder’s investment. Such dividends and distributions are likely to occur in respect of shares purchased at a time when the Fund’s NAV reflects gains that are either (i) unrealized, or (ii) realized but not
distributed.
For federal
income tax purposes, distributions of net investment income generally are taxable as ordinary income. Taxes on distributions of capital gain are determined by how long a Fund owned the investment that generated it, rather than how long a shareholder
may have owned shares in the Fund. Distributions of net capital gain from the sale of investments that a Fund owned for more than one year and that are properly designated by the Fund as capital gain dividends (“Capital Gain Dividends”)
will be taxable as long-term capital gain. Distributions of capital gain generally are made after applying any available capital loss carryovers. The maximum individual rate applicable to long-term capital gains is either 15% or 20%, depending on
whether the individual’s income exceeds certain threshold amounts. A distribution of gain from the sale of investments that a Fund owned for one year or less will be taxable as ordinary income. Distributions attributable to gain from the sale
of MLPs that is characterized as ordinary income under the Code’s recapture provisions will be taxable as ordinary income.
Distributions of investment
income designated by a Fund as derived from “qualified dividend income” will be taxed in the hands of individuals at the rates applicable to long-term capital gain. In order for some portion of the dividends received by a Fund
shareholder to be qualified dividend income, the Fund must meet certain holding-period and other requirements with respect to some portion of the dividend-paying stocks in its portfolio, and the shareholder must meet certain holding-period and other
requirements with respect to the Fund’s shares. A dividend will not be treated as qualified dividend income (at either the Fund or shareholder level) (i) if the dividend is received with respect to any share of stock held for fewer than 61
days during the 121-day period beginning on the date which is 60 days before the date on which such share becomes ex-dividend with respect to such dividend (or, in the case of certain preferred stock, 91 days during the 181-day period beginning 90
days before such date), (ii) to the extent that the recipient is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property, (iii) if the
recipient elects to have the dividend income treated as investment interest for purposes of the limitation on deductibility of investment interest, or (iv) if the dividend is received from a foreign corporation that is (a) not eligible for the
benefits of a comprehensive income tax treaty with the U.S. (with the exception of dividends paid on stock of such a foreign corporation readily tradable on an established securities market in the U.S.) or (b) treated as a PFIC. The amount of a
Fund’s distributions that would otherwise qualify for this favorable tax treatment may be reduced as a result of a Fund’s securities lending activities or high portfolio turnover rate.
In general, distributions of
investment income designated by a Fund as derived from qualified dividend income will be treated as qualified dividend income by a non-corporate taxable shareholder so long as the shareholder meets the holding period and other requirements described
above with respect to the Fund’s shares. In any event, if the qualified dividend income received by each Fund during any taxable year is equal to or greater than 95% of its “gross income”, then 100% of the Fund’s dividends
(other than dividends that are properly designated as Capital Gain Dividends) will be eligible to be treated as qualified dividend income. For this purpose, the only gain included in the term “gross income” is the excess of net
short-term capital gain over net long-term capital loss.
If a Fund receives dividends
from an underlying fund, and the underlying fund designates such dividends as “qualified dividend income,” then the Fund may, in turn, designate a portion of its distributions as “qualified dividend income” as well, provided
the Fund meets the holding-period and other requirements with respect to shares of the underlying fund.
Any loss realized upon a
taxable disposition of shares held for six months or less will be treated as long-term capital loss to the extent of any Capital Gain Dividends received by the shareholder with respect to those shares. All or a portion of any loss realized upon a
taxable disposition of Fund shares will be disallowed if other shares of such Fund are purchased within 30 days before or after the disposition. In such a case, the basis of the newly purchased shares will be adjusted to reflect the disallowed
loss.
A distribution paid
to shareholders by a Fund in January of a year generally is deemed to have been received by shareholders on December 31 of the preceding year, if the distribution was declared and payable to shareholders of record on a date in October, November, or
December of that preceding year. The Funds will provide federal tax information annually, including information about dividends and distributions paid during the preceding year to taxable investors and others requesting such information.
If a Fund makes a distribution
to its shareholders in excess of its current and accumulated “earnings and profits” in any taxable year, the excess distribution will be treated as a return of capital to the extent of each shareholder’s basis (for tax purposes) in
its shares, and any distribution in excess of basis will be treated as capital gain. A return of capital is not taxable, but it reduces the shareholder’s basis in its shares, which reduces the loss (or increases the gain) on a subsequent
taxable disposition by such shareholder of the shares.
Dividends of net investment
income received by corporate shareholders (other than shareholders that are S corporations) of a Fund will qualify for the 50% dividends-received deduction generally available to corporations to the extent of the amount of qualifying dividends
received by the Fund from domestic corporations for the taxable year. A dividend received by a Fund will not be treated as a qualifying dividend (1) if the stock on which the dividend is paid is considered to be “debt-financed”
(generally, acquired with borrowed funds), (2) if it has been received with respect to any share of stock that the Fund has held less than 46 days (91 days in the case of certain preferred stock) during the 91-day period beginning on the date which
is 45 days before the date on which such share becomes ex-dividend with respect to such dividend (during the 181-day period beginning 90 days before such date in the case of certain preferred stock) or (3) to the extent that the Fund is under an
obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property. Moreover, the dividends-received deduction may be disallowed or reduced (1) if the corporate
shareholder fails to satisfy the foregoing requirements with respect to its shares of a Fund or (2) by application of the Code. However, any distributions received by a Fund from REITs and PFICs will not qualify for the corporate dividends-received
deduction. The amount eligible for the dividends received deduction may also be reduced as a result of a Fund’s securities lending activities or high portfolio turnover rate.
An additional 3.8% Medicare tax
is imposed on certain net investment income (including ordinary dividends and capital gain distributions received from a Fund and net gains from redemptions or other taxable dispositions of Fund shares, but excluding any exempt interest dividends
from a Fund) of U.S. individuals, estates and trusts to the extent that such person’s “modified adjusted gross income” (in the case of an individual) or “adjusted gross income” (in the case of an estate or trust)
exceeds certain threshold amounts.
Sale or
Redemption of Shares
The
sale, exchange, or redemption of Fund shares may give rise to a gain or loss. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the Fund will be considered capital gain or loss and will be
long-term capital gain or loss if the shares were held for more than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the
amount of capital gain dividends received on (or undistributed capital gains credited with respect to) such shares. Additionally, any loss realized upon the sale or exchange of Fund shares with a tax holding period of six months or less may be
disallowed to the extent of any distributions treated as exempt interest dividends with respect to such shares. The maximum individual rate applicable to long-term capital gains is either 15% or 20%, depending on whether the individual’s
income exceeds certain threshold amounts. Capital gain of a corporate shareholder is taxed at the same rate as ordinary income.
Fund Investments
Certain investments of the
Funds, including transactions in options, swaptions, futures contracts, forward contracts, straddles, swaps, short sales, foreign currencies, inflation-linked securities and foreign securities, including for hedging purposes, will be subject to
special tax rules (including mark-to-market, constructive sale, straddle, wash sale and short sale rules). In a given case, these rules may accelerate
income to a Fund, defer losses to a Fund, cause adjustments in
the holding periods of a Fund’s securities, convert long-term capital gain into short-term capital gain, convert short-term capital losses into long-term capital loss, or otherwise affect the character of a Fund’s income. These rules
could therefore affect the amount, timing and character of distributions to shareholders and cause differences between a Fund’s book income and its taxable income. If a Fund’s book income exceeds its taxable income, the distribution (if
any) of such excess generally will be treated as (i) a dividend to the extent of the Fund’s remaining earnings and profits (including earnings and profits arising from tax-exempt income), (ii) thereafter, as a return of capital to the extent
of the recipient’s basis in its shares, and (iii) thereafter, as gain from the sale or exchange of a capital asset. If a Fund’s book income is less than taxable income, the Fund could be required to make distributions exceeding book
income to qualify as a regulated investment company that is accorded special tax treatment. Income earned as a result of these transactions would, in general, not be eligible for the dividends-received deduction or for treatment as exempt-interest
dividends when distributed to shareholders. The Funds will endeavor to make any available elections pertaining to such transactions in a manner believed to be in the best interest of each Fund and its shareholders.
The Fund’s participation
in loans of securities may affect the amount, timing, and character of distributions to shareholders. With respect to any security subject to a securities loan, any (i) amounts received by the Fund in place of dividends earned on the security during
the period that such security was not directly held by the Fund will not give rise to qualified dividend income and (ii) withholding taxes accrued on dividends during the period that such security was not directly held by the Fund will not qualify
as a foreign tax paid by the Fund and therefore cannot be passed through to shareholders even if the Fund meets the requirements described in “Foreign Taxes,” below.
Certain debt securities
purchased by the Funds are sold at an original issue discount and thus do not make periodic cash interest payments. Similarly, zero-coupon bonds do not make periodic interest payments. Generally, the amount of the original issue discount is treated
as interest income and is included in taxable income (and required to be distributed) over the term of the debt security even though payment of that amount is not received until a later time, usually when the debt security matures. In addition,
payment-in-kind securities will give rise to income that is required to be distributed and is taxable even though the Fund holding the security receives no interest payment in cash on the security during the year. Because each Fund distributes
substantially all of its net investment income to its shareholders (including such imputed interest), a Fund may have to sell portfolio securities in order to generate the cash necessary for the required distributions. Such sales may occur at a time
when the Adviser would not otherwise have chosen to sell such securities and may result in a taxable gain or loss. Some of the Funds may invest in inflation-linked debt securities. Any increase in the principal amount of an inflation-linked debt
security will be original issue discount, which is taxable as ordinary income and is required to be distributed, even though the Fund will not receive the principal, including any increase thereto, until maturity. A Fund investing in such securities
may be required to liquidate other investments, including at times when it is not advantageous to do so, in order to satisfy its distribution requirements and to eliminate any possible taxation at the Fund level. Certain debt securities that may be
acquired by a Fund in the secondary market may be treated as having market discount. Generally, any gain recognized on the disposition of, and any partial payment of principal on, a debt security having market discount is treated as ordinary income
to the extent the gain, or principal payment, does not exceed the “accrued market discount” on such debt security. Market discount generally accrues in equal daily installments. A Fund may make one or more of the elections applicable to
debt securities having market discount, which could affect the character and timing of recognition of income.
A Fund may invest to a
significant extent in debt obligations that are in the lowest rated categories (or are unrated), including debt obligations of issuers that are not currently paying interest or that are in default. Investments in debt obligations that are at risk of
being in default (or are presently in default) present special tax issues for a Fund. Tax rules are not entirely clear about issues such as when a Fund may cease to accrue interest, original issue discount or market discount, when and to what extent
deductions may be taken for bad debts or worthless securities and how payments received on obligations in default should be allocated between principal and income. These and other related issues will be addressed by each Fund when, as and if it
invests in such securities, in order to seek to ensure that it distributes sufficient income to preserve its status as a regulated investment company and does not become subject to U.S. federal income taxation or any excise tax.
A Fund’s investments in
foreign currencies, foreign currency denominated debt securities and certain options, futures or forward foreign currency contracts (and similar instruments) will be subject to special tax rules. Generally, transactions in foreign currencies give
rise to ordinary income or loss. An election under Section 988(a)(1)(B) may be available to treat foreign currency gain or loss attributable to certain
forward, futures and option contracts as capital, including
certain “foreign currency contracts.” A “foreign currency contract” is a contract that (1) requires delivery of, or settlement of, a foreign currency that is a currency in which positions are also traded through regulated
futures contracts, (2) is traded in the interbank market, and (3) is entered into at an arm’s-length price determined by reference to the price in the interbank market. If this Section 988(a)(1)(B) election is made, foreign currency contracts
are treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss under the Section 1256 mark-to-market rules. All other forward contracts under this 988(a)(1)(B) election would be characterized as capital and generally gain
or loss would be recognized when the contract is closed and completed. Other rules apply to options, futures or forward foreign currency contracts that may be part of a straddle or a Section 988 hedging transaction within the meaning of Code Section
988(d).
Special tax
considerations apply if a Fund invests in investment companies that are taxable as partnerships for federal income tax purposes. In general, the Fund will not recognize income earned by such an investment company until the close of the investment
company’s taxable year. But the Fund will recognize such income as it is earned by the investment company for purposes of determining whether it is subject to the 4% excise tax. Therefore, if the Fund and such an investment company have
different taxable years, the Fund may be compelled to make distributions in excess of the income recognized from such an investment company in order to avoid the imposition of the 4% excise tax. A Fund’s receipt of a non-liquidating cash
distribution from an investment company taxable as a partnership generally will result in recognized gain (but not loss) only to the extent that the amount of the distribution exceeds the Fund’s adjusted basis in shares of such investment
company before the distribution. A Fund that receives a liquidating cash distribution from an investment company taxable as a partnership will recognize capital gain or loss to the extent of the difference between the proceeds received by the Fund
and the Fund’s adjusted tax basis in shares of such investment company; however, the Fund will recognize ordinary income, rather than capital gain, to the extent that the Fund’s allocable share of “unrealized receivables”
(including any accrued but untaxed market discount) exceeds the shareholder’s share of the basis in those unrealized receivables.
Some amounts received by each
Fund with respect to its investments in MLPs will likely be treated as a return of capital because of accelerated deductions available with respect to the activities of such MLPs. On the disposition of an investment in such an MLP, the Fund will
likely realize taxable income in excess of economic gain with respect to that asset (or, if the Fund does not dispose of the MLP, the Fund likely will realize taxable income in excess of cash flow with respect to the MLP in a later period), and the
Fund must take such income into account in determining whether the Fund has satisfied its distribution requirements. The Fund may have to borrow or liquidate securities to satisfy its distribution requirements and to meet its redemption requests,
even though investment considerations might otherwise make it undesirable for the Fund to sell securities or borrow money at such time.
Some of the Funds may invest in
REITs. Such investments in REIT equity securities may require a Fund to accrue and distribute income not yet received. In order to generate sufficient cash to make the requisite distributions, the Fund may be required to sell securities in its
portfolio (including when it is not advantageous to do so) that it otherwise would have continued to hold. A Fund’s investments in REIT equity securities may at other times result in the Fund’s receipt of cash in excess of the
REIT’s earnings; if the Fund distributes such amounts, such distribution could constitute a return of capital to Fund shareholders for federal income tax purposes. Dividends received by a Fund from a REIT generally will not constitute
qualified dividend income.
Tax reform legislation enacted
on December 22, 2017, informally known as the Tax Cuts and Jobs Act (the “Tax Act”), established a 20% deduction for qualified business income. Under this provision, which is effective for taxable years beginning in 2018 and, without
further legislation, will sunset for taxable years beginning after 2025, individuals, trusts, and estates generally may deduct (the “Deduction”) 20% of “qualified business income,” which includes all ordinary REIT dividends
(“Qualifying REIT Dividends”) and certain income from investments in MLPs (“MLP Income”). The IRS has recently issued proposed regulations permitting a RIC to pass through to its shareholders Qualifying REIT Dividends
eligible for the deduction. However, the proposed regulations do not provide a mechanism for a RIC to pass through to its shareholders MLP Income that would be eligible for such deduction. It is uncertain whether future legislation or other guidance
will enable a RIC to pass through the special character of MLP Income to the RIC’s shareholders.
A Fund might invest directly or
indirectly in residual interests in real estate mortgage investment conduits (“REMICs”) or equity interests in taxable mortgage pools (“TMPS”). Under a notice issued by the IRS in October 2006 and Treasury regulations that
have not yet been issued (but may apply with retroactive effect) a portion of a Fund’s income from a REIT that is attributable to the REIT’s residual
interest in a REMIC or a TMP (referred to in the Code as an
“excess inclusion”) will be subject to federal income taxation in all events. This notice also provides, and the regulations are expected to provide, that excess inclusion income of a regulated investment company, such as each of the
Funds, will generally be allocated to shareholders of the regulated investment company in proportion to the dividends received by such shareholders, with the same consequences as if the shareholders held the related REMIC or TMP residual interest
directly.
In general,
excess inclusion income allocated to shareholders (i) cannot be offset by net operating losses (subject to a limited exception for certain thrift institutions) and (ii) will constitute unrelated business taxable income (“UBTI”) to
entities (including a qualified pension plan, an individual retirement account, a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on UBTI, thereby potentially requiring such an entity that is allocated excess inclusion income,
and otherwise might not be required to file a tax return, to file a tax return and pay tax on such income. In addition, because the Code provides that excess inclusion income is ineligible for treaty benefits, a regulated investment company must
withhold tax on excess inclusions attributable to its foreign shareholders at a 30% rate of withholding, regardless of any treaty benefits for which a shareholder is otherwise eligible.
Any investment in residual
interests of a CMO that has elected to be treated as a REMIC can create complex tax problems, especially if the Fund has state or local governments or other tax-exempt organizations as shareholders. Under current law, the Fund serves to block UBTI
from being realized by its tax-exempt shareholders. Notwithstanding the foregoing, a tax-exempt shareholder will recognize UBTI by virtue of its investment in the Fund if shares in the Fund constitute debt-financed property in the hands of the
tax-exempt shareholder within the meaning of Section 514(b) of the Code. Furthermore, a tax-exempt shareholder may recognize UBTI if the Fund recognizes “excess inclusion income” derived from direct or indirect investments in REMIC
residual interests or TMPs if the amount of such income recognized by the Fund exceeds the Fund’s investment company taxable income (after taking into account deductions for dividends paid by the Fund).
In addition, special tax
consequences apply to charitable remainder trusts (“CRTs”) that invest in regulated investment companies that invest directly or indirectly in residual interests in REMICs or in TMPs. Under legislation enacted in December 2006, a CRT, as
defined in Section 664 of the Code, that realizes UBTI for a taxable year must pay an excise tax annually of an amount equal to such UBTI. Under IRS guidance issued in October 2006, a CRT will not recognize UBTI solely as a result of investing in a
Fund that recognizes “excess inclusion income.” Rather, if at any time during any taxable year a CRT (or one of certain other tax-exempt shareholders, such as the U.S., a state or political subdivision, or an agency or instrumentality
thereof, and certain energy cooperatives) is a record holder of a share in a Fund that recognizes “excess inclusion income,” then the Fund will be subject to a tax on that portion of its “excess inclusion income” for the
taxable year that is allocable to such shareholders at the highest federal corporate income tax rate. The extent to which this IRS guidance remains applicable in light of the December 2006 legislation is unclear. To the extent permitted under the
1940 Act, each Fund may elect to specially allocate any such tax to the applicable CRT, or other shareholder, and thus reduce such shareholder’s distributions for the year by the amount of the tax that relates to such shareholder’s
interest in the Fund. The Funds have not yet determined whether such an election will be made. CRTs are urged to consult their tax advisors concerning the consequences of investing in a Fund.
If a Fund invests in PFICs,
certain special tax consequences may apply. A PFIC is any foreign corporation in which (i) 75% or more of the gross income for the taxable year is passive income, or (ii) the average percentage of the assets (generally by value, but by adjusted tax
basis in certain cases) that produce or are held for the production of passive income is at least 50%. Generally, passive income for this purpose includes dividends, interest (including income equivalent to interest), royalties, rents, annuities,
the excess of gains over losses from certain property transactions and commodities transactions, and foreign currency gains. Passive income for this purpose does not include rents and royalties received by the foreign corporation from active
business and certain income received from related persons. A Fund’s investments in certain PFICs could subject the Fund to a U.S. federal income tax (including interest charges) on distributions received from the company or on proceeds
received from the disposition of shares in the company. This tax cannot be eliminated by making distributions to Fund shareholders. In addition, certain interest charges may be imposed on the Fund as a result of such distributions.
If a Fund is in a position to
treat a PFIC as a “qualified electing fund” (“QEF”), the Fund will be required to include in its gross income its share of the company’s income and net capital gain annually, regardless of whether it receives any
distributions from the company. Alternately, a Fund may make an election to mark the gains (and to a limited extent losses) in such holdings “to the market” as though it had sold and repurchased its holdings in those PFICs on the last
day of the Fund’s taxable year. Such gain and
loss are treated as ordinary income and loss. The QEF and
mark-to-market elections may have the effect of accelerating the recognition of income (without the receipt of cash) and increasing the amount required to be distributed by the Fund to avoid taxation. Making either of these elections, therefore, may
require the Fund to liquidate other investments (including when it is not advantageous to do so) to meet its distribution requirement, which also may accelerate the recognition of gain and affect the Fund’s total return. A fund that invests
indirectly in PFICs by virtue of the fund’s investment in other investment companies that qualify as “U.S. persons” within the meaning of the Code may not make a QEF election; rather, such underlying investment companies investing
directly in the PFICs would decide whether to make such election. Furthermore, the IRS recently issued final regulations that generally treat a Fund’s income inclusion with respect to a PFIC with respect to which the Fund has made a qualified
electing fund, or “QEF”, election, as qualifying income for purposes of determining the Fund’s ability to be subject to tax as a RIC if either if (A) there is a current distribution out of the earnings and profits of the PFIC that
are attributable to such income inclusion or (B) such inclusion is derived with respect to the Fund’s business of investing in stock, securities, or currencies. Dividends paid by PFICs will not be eligible to be treated as “qualified
dividend income.”
Certain Funds have
wholly-owned subsidiaries organized under the laws of the Cayman Islands, which are classified as corporations for U.S. federal income tax purposes (each, a “Subsidiary”). With respect to such Funds, a Fund may invest a portion of its
assets in its Subsidiary. A foreign corporation, such as a Subsidiary, will generally not be subject to U.S. federal income taxation unless it is deemed to be engaged in a U.S. trade or business. It is expected that each Subsidiary will conduct its
activities in a manner so as to meet the requirements of a safe harbor provided under Section 864(b)(2) of the Code under which the Subsidiary may engage in trading in stocks or securities or certain commodities without being deemed to be engaged in
a U.S. trade or business. However, if certain of a Subsidiary’s activities were determined not to be of the type described in the safe harbor (which is not expected), then the activities of the Subsidiary may constitute a U.S. trade or
business, and subject to U.S. taxation as such.
In general, a foreign
corporation, such as a Subsidiary, that does not conduct a U.S. trade or business is nonetheless subject to tax at a flat rate of 30 percent (or lower tax treaty rate), generally payable through withholding, on the gross amount of certain
U.S.-source income that is not effectively connected with a U.S. trade or business. There is presently no tax treaty in force between the U.S. and the Cayman Islands that would reduce this rate of withholding tax. It is not expected that a
Subsidiary will derive meaningful income subject to such withholding tax.
Each Subsidiary will be treated
as a controlled foreign corporation (“CFC”) and the Fund investing in its Subsidiary will be treated as a “U.S. shareholder” of that Subsidiary. As a result, a Fund will be required to include in gross income for U.S. federal
income tax purposes all of its Subsidiary’s “subpart F income,” whether or not such income is distributed by the Subsidiary. It is expected that all of the Subsidiary’s income will be “subpart F income.” A
Fund’s recognition of its Subsidiary’s “subpart F income” will increase the Fund’s tax basis in the Subsidiary. Distributions by the Subsidiary to a Fund will be tax-free, to the extent of its previously undistributed
“subpart F income,” and will correspondingly reduce the Fund’s tax basis in the Subsidiary. “Subpart F income” is generally treated as ordinary income, regardless of the character of the Subsidiary’s underlying
income. If a net loss is realized by the Subsidiary, such loss is not generally available to offset the income earned by a Fund and such loss cannot be carried forward to offset taxable income of a Fund or the Subsidiary in future periods. The IRS
recently issued final regulations that generally treat a Fund’s income inclusion with respect to a CFC as qualifying income for purposes of determining the Fund’s ability to be subject to tax as a RIC either if (A) there is a
distribution out of the earnings and profits of the CFC that are attributable to such income inclusion or (B) such inclusion is derived with respect to the Fund’s business of investing in stock, securities, or currencies.
The ability of a Fund to invest
directly in commodities, and in certain commodity-related securities and other instruments, is subject to significant limitations in order to enable a Fund to maintain its status as a regulated investment company under the Code.
Investment in Other Funds
If a Fund invests in shares of
mutual funds, other ETFs or other companies that are taxable as regulated investment companies, as well as certain investments in REITs (collectively, “underlying funds”), its distributable income and gains will normally consist, in
part, of distributions from the underlying funds and gains and losses on the disposition of shares of the underlying funds. To the extent that an underlying fund realizes net losses on its investments for a given taxable year, the Fund will not be
able to recognize its share of those losses (so as to offset distributions of net income or capital gains from other underlying funds) until it disposes of shares of the underlying fund. Moreover, even when the Fund
does make such a disposition, a portion of its loss may be
recognized as a long-term capital loss, which will not be treated as favorably for federal income tax purposes as a short-term capital loss or an ordinary deduction. In particular, the Fund will not be able to offset any capital losses from its
dispositions of underlying fund shares against its ordinary income (including distributions of any net short-term capital gain realized by an underlying fund).
In addition, in certain
circumstances, the “wash sale” rules under Section 1091 of the Code may apply to a Fund’s sales of underlying fund shares that have generated losses. A wash sale occurs if shares of an underlying fund are sold by the Fund at a loss
and the Fund acquires substantially identical shares of that same underlying fund 30 days before or after the date of the sale. The wash-sale rules could defer losses in the Fund’s hands on sales of underlying fund shares (to the extent such
sales are wash sales) for extended (and, in certain cases, potentially indefinite) periods of time.
As a result of the foregoing
rules, and certain other special rules, the amount of net investment income and net capital gain that each Fund will be required to distribute to shareholders may be greater than what such amounts would have been had the Fund directly invested in
the securities held by the underlying funds, rather than investing in shares of the underlying funds. For similar reasons, the character of distributions from the Fund (e.g., long-term capital gain, exempt interest, eligibility for
dividends-received deduction, etc.) will not necessarily be the same as it would have been had the Fund invested directly in the securities held by the underlying funds.
If a Fund received dividends
from an underlying fund that qualifies as a regulated investment company, and the underlying fund designates such dividends as “qualified dividend income”, then the Fund is permitted in turn to designate a portion of its distributions as
“qualified dividend income”, provided the Fund meets holding period and other requirements with respect to shares of the underlying fund.
Depending on a Fund’s
percentage ownership in an underlying fund, both before and after a redemption, a redemption of shares of an underlying fund by a Fund may cause the Fund to be treated as receiving a Section 301 distribution taxable as a dividend under Section 307
of the Code, to the extent of its allocable shares of earnings and profits, on the full amount of the distribution instead of receiving capital gain income on the shares of the underlying fund. Such a distribution may be treated as qualified
dividend income and thus eligible to be taxed at the rates applicable to long-term capital gain. If qualified dividend income treatment is not available, the distribution may be taxed as ordinary income. This could cause shareholders of the Fund to
recognize higher amounts of ordinary income than if the shareholders had held the shares of the underlying funds directly.
A Fund may elect to pass
through to shareholders foreign tax credits from an underlying fund and exempt-interest dividends from an underlying fund, provided that at least 50% of the Fund’s total assets are invested in other regulated investment companies at the end of
each quarter of the taxable year.
Backup
Withholding
Each Fund
generally is required to backup withhold and remit to the U.S. Treasury a percentage of the taxable dividends and other distributions paid to, and the proceeds of share sales, exchanges, or redemptions made by, any individual shareholder who fails
to properly furnish the Fund with a correct taxpayer identification number (“TIN”), who has under-reported dividend or interest income, or who fails to certify to the Fund that he or she is not subject to backup withholding. The backup
withholding rules may also apply to distributions that are properly designated as exempt-interest dividends. The backup withholding tax rate is 24%.
Foreign Shareholders
Distributions properly
designated as Capital Gain Dividends and exempt-interest dividends generally will not be subject to withholding of federal income tax. However, exempt-interest dividends may be subject to backup withholding (as discussed above). In general,
dividends other than Capital Gain Dividends and exempt-interest dividends paid by a Fund to a shareholder that is not a “U.S. person” within the meaning of the Code (a “foreign person”) are subject to withholding of U.S.
federal income tax at a rate of 30% (or lower applicable treaty rate) even if they are funded by income or gains (such as portfolio interest, short-term capital gains, or foreign-source dividend and interest income) that, if paid to a foreign person
directly, would not be subject to withholding. However, the Fund will not be required to withhold any amounts (i) with respect to distributions (other than distributions to a foreign person (w) that has not provided a satisfactory statement that the
beneficial owner is not a U.S. person, (x) to the extent that the dividend is attributable to certain interest on an obligation if the foreign person is the issuer or is a 10%
shareholder of the issuer, (y) that is within certain foreign
countries that have inadequate information exchange with the United States, or (z) to the extent the dividend is attributable to interest paid by a person that is a related person of the foreign person and the foreign person is a controlled foreign
corporation) from U.S.-source interest income of types similar to those not subject to U.S. federal income tax if earned directly by an individual foreign person, to the extent such distributions are properly designated by the Fund
(“interest-related dividends”), and (ii) with respect to distributions (other than (a) distributions to an individual foreign person who is present in the United States for a period or periods aggregating 183 days or more during the year
of the distribution and (b) distributions subject to special rules regarding the disposition of U.S. real property interests (as described below)) of net short-term capital gains in excess of net long-term capital losses to the extent such
distributions are properly designated by the Fund (“short-term capital gain dividends”). Depending on the circumstances, a Fund may make designations of interest-related and/or short-term capital gain dividends with respect to all, some
or none of its potentially eligible dividends and/or treat such dividends, in whole or in part, as ineligible for these exemptions from withholding. In the case of shares held through an intermediary, the intermediary may withhold even if a Fund
makes a designation with respect to a payment. Foreign persons should contact their intermediaries regarding the application of these rules to their accounts.
A beneficial holder of shares
who is a foreign person is not, in general, subject to U.S. federal income tax on gains (and is not allowed a deduction for losses) realized on the sale of shares of the Fund or on Capital Gain Dividends or exempt-interest dividends unless (i) such
gain or dividend is effectively connected with the conduct of a trade or business carried on by such holder within the United States or (ii) in the case of an individual holder, the holder is present in the United States for a period or periods
aggregating 183 days or more during the year of the sale or the receipt of the Capital Gain Dividend and certain other conditions are met or (iii) the shares constitute “U.S. real property interests” (“USRPIs”) or the Capital
Gain Dividends are attributable to gains from the sale or exchange of USRPIs in accordance with the rules set forth below.
Special rules apply to
distributions to foreign shareholders from a Fund that is either a “U.S. real property holding corporation” (“USRPHC”) or would be a USRPHC but for the operation of the exceptions to the definition thereof described below.
Additionally, special rules apply to the sale of shares in a Fund that is a USRPHC. Very generally, a USRPHC is a domestic corporation that holds U.S. real property interests (“USRPIs”) — USRPIs are defined as any interest in U.S.
real property or any equity interest in a USRPHC — the fair market value of which equals or exceeds 50% of the sum of the fair market values of the corporation’s USRPIs, interests in real property located outside the United States and
certain other assets. A Fund that holds (directly or indirectly) significant interests in REITs may be a USRPHC. The special rules discussed in the next paragraph will also generally apply to distributions from a Fund that would be a USRPHC absent
exclusions from USRPI treatment for interests in domestically controlled REITs or regulated investment companies and not-greater-than-10% or interests in publicly traded classes of stock in REITs or regulated investment companies,
respectively.
In the case
of a Fund that is a USRPHC or would be a USRPHC but for the exceptions from the definition of USRPI (described immediately above), distributions by the Fund that are attributable to (a) gains realized on the disposition of USRPIs by the Fund and (b)
distributions received by the Fund from a lower-tier regulated investment company or REIT that the Fund is required to treat as USRPI gain in its hands will retain their character as gains realized from USRPIs in the hands of the Fund’s
foreign shareholders. If the foreign shareholder holds (or has held in the prior year) more than a 5% interest in the Fund, such distributions will be treated as gains “effectively connected” with the conduct of a “U.S. trade or
business,” and subject to tax at graduated rates. Moreover, such shareholders will be required to file a U.S. income tax return for the year in which the gain was recognized and the Fund will be required to withhold 21% of the amount of such
distribution. In the case of all other foreign shareholders (i.e., those whose interest in the Fund did not exceed 5% at any time during the prior year), the USRPI distribution will be treated as ordinary income (regardless of any designation by the
Fund that such distribution is a short-term capital gain dividend or a Capital Gain Dividend), and the Fund must withhold 30% (or a lower applicable treaty rate) of the amount of the distribution paid to such foreign shareholder. Foreign
shareholders of a Fund are also subject to “wash sale” rules to prevent the avoidance of the tax-filing and -payment obligations discussed above through the sale and repurchase of Fund shares.
In addition, a Fund that is a
USRPHC must typically withhold 15% of the amount realized in a redemption by a greater-than-5% foreign shareholder, and that shareholder must file a U.S. income tax return for the year of the disposition of the USRPI and pay any additional tax due
on the gain. No withholding is generally required with respect to amounts paid in redemption of shares of a Fund if the
Fund is a domestically controlled USRPHC or, in certain limited
cases, if the Fund (whether or not domestically controlled) holds substantial investments in regulated investment companies that are domestically controlled USRPHCs.
In order to qualify for any
exemptions from withholding described above or for lower withholding tax rates under income tax treaties, or to establish an exemption from backup withholding, the foreign investor must comply with special certification and filing requirements
relating to its non-US status (including, in general, furnishing an applicable IRS Form W-8 or substitute form). Foreign investors in a Fund should consult their tax advisers in this regard.
If a shareholder is eligible
for the benefits of a tax treaty, any effectively connected income or gain will generally be subject to U.S. federal income tax on a net basis only if it is also attributable to a permanent establishment maintained by the shareholder in the United
States.
A beneficial
holder of shares who is a foreign person may be subject to state and local tax and to the U.S. federal estate tax in addition to the federal tax on income referred to above. Foreign shareholders in a Fund should consult their tax advisors with
respect to the potential application of the above rules.
A Fund is required to withhold
U.S. tax (at a 30% rate) on payments of taxable dividends made to certain non-U.S. entities that fail to comply (or be deemed compliant) with extensive new reporting and withholding requirements designed to inform the U.S. Department of the Treasury
of U.S.-owned foreign investment accounts. Shareholders may be requested to provide additional information to a Fund to enable the Fund to determine whether withholding is required.
Foreign Taxes
Certain Funds may be subject
to foreign withholding taxes or other foreign taxes with respect to income (possibly including, in some cases, capital gain) received from sources within foreign countries. Tax conventions between certain countries and the U.S. may reduce or
eliminate such taxes. If more than 50% of a Fund’s assets at year-end consists of the securities of foreign corporations, the Fund may elect to permit shareholders to claim a credit or deduction on their income tax returns for their pro rata
portion of qualified taxes paid by the Fund to foreign countries in respect of foreign securities the Fund has held for at least the minimum period specified in the Code. In such a case, shareholders will include in gross income from foreign sources
their pro rata shares of such taxes. A shareholder’s ability to claim a foreign tax credit or deduction in respect of foreign taxes paid by a Fund may be subject to certain limitations imposed by the Code and the Treasury Regulations issued
thereunder, as a result of which a shareholder may not get a full credit or deduction for the amount of such taxes. In particular, shareholders must hold their Fund shares (without protection from risk of loss) on the ex-dividend date and for at
least 15 additional days during the 30-day period surrounding the ex-dividend date to be eligible to claim a foreign tax credit with respect to a given dividend. Shareholders who do not itemize on their federal income tax returns may claim a credit
(but no deduction) for such foreign taxes. Any foreign taxes withheld on payments made “in lieu of” dividends or interest with respect to loaned securities will not qualify for the pass-through of foreign tax credits to
shareholders.
If a Fund
does not make the above election or if more than 50% of its assets at the end of the year do not consist of securities of foreign corporations, the Fund’s net income will be reduced by the foreign taxes paid or withheld. In such cases,
shareholders will not be entitled to claim a credit or deduction with respect to foreign taxes.
The foregoing is only a general
description of the treatment of foreign source income or foreign taxes under the U.S. federal income tax laws. Because the availability of a credit or deduction depends on the particular circumstances of each shareholder, shareholders are advised to
consult their own tax advisors.
Exempt-Interest
Dividends
Some of the
Funds intend to qualify to pay exempt-interest dividends to their respective shareholders. In order to qualify to pay exempt-interest dividends, at least 50% of the value of a Fund’s total assets must consist of tax-exempt municipal bonds at
the close of each quarter of the Fund’s taxable year. An exempt-interest dividend is that part of a dividend that is properly designated as an exempt-interest dividend and that consists of interest received by a Fund on such tax-exempt
securities. Shareholders of a Fund that pays exempt-interest dividends would not incur any regular federal income tax on the amount of exempt-interest dividends received by them from a Fund, but an investment in such a Fund may result in liability
for federal and state alternative minimum taxation and may be subject to state and local taxes.
Interest on indebtedness
incurred or continued by a shareholder, whether a corporation or an individual, to purchase or carry shares of a Fund is not deductible to the extent it relates to exempt-interest dividends received by the shareholder from that Fund. Any loss
incurred on the sale or redemption of a Fund’s shares held for six months or less may be disallowed to the extent of exempt-interest dividends received with respect to such shares.
Interest on certain tax-exempt
bonds that are private activity bonds within the meaning of the Code is treated as a tax preference item for purposes of the alternative minimum tax, and any such interest received by a Fund and distributed to shareholders will be so treated for
purposes of any alternative minimum tax liability of shareholders to the extent of the dividend’s proportionate share of a Fund’s income consisting of such interest.
The exemption from federal
income tax for exempt-interest dividends does not necessarily result in exemption for such dividends under the income or other tax laws of any state or local authority. Shareholders that receive social security or railroad retirement benefits should
consult their tax advisors to determine what effect, if any, an investment in a Fund may have on the federal taxation of their benefits.
From time to time legislation
may be introduced or litigation may arise that would change the tax treatment of exempt-interest dividends. Such legislation or litigation may have the effect of raising the state or other taxes payable by shareholders on such dividends.
Shareholders should consult their tax advisors for the current federal, state and local law on exempt-interest dividends.
Creation Units
As a result of U.S. federal
income tax requirements, the Trust on behalf of a Fund, has the right to reject an order for a creation of Shares if the creator (or group of creators) would, upon obtaining the Shares so ordered, own 80% or more of the outstanding Shares of a Fund
and if, pursuant to Section 351 of the Code, the Fund would have a basis in the Deposit Instruments different from the market value of such securities on the date of deposit. The Trust also has the right to require information necessary to determine
beneficial share ownership for purposes of the 80% determination. See “Creation and Redemption of Creation Units—Procedures for Creation of Creation Units” in Appendix A.
State and Local Tax Matters
Depending on the residence of
the shareholders for tax purposes, distributions may also be subject to state and local taxation. Rules of state and local taxation regarding qualified dividend income, ordinary income dividends and capital gain dividends from regulated investment
companies may differ from the rules of U.S. federal income tax in many respects. Shareholders are urged to consult their tax advisors as to the consequences of these and other state and local tax rules affecting investment in the Funds.
Most states provide that a
regulated investment company may pass through (without restriction) to its shareholders state and local income tax exemptions available to direct owners of certain types of U.S. government securities (such as U.S. Treasury obligations). Thus, for
residents of these states, distributions derived from a Fund’s investment in certain types of U.S. government securities should be free from state and local income taxation to the extent that the interest income from such investments would
have been exempt from state and local taxes if such securities had been held directly by the respective shareholders. Certain states, however, do not allow a regulated investment company to pass through to its shareholders the state and local income
tax exemptions available to direct owners of certain types of U.S. government securities unless a Fund holds at least a required amount of U.S. government securities. Accordingly, for residents of these states, distributions derived from a
Fund’s investment in certain types of U.S. government securities may not be entitled to the exemptions from state and local income taxes that would be available if the shareholders had purchased U.S. government securities directly. The
exemption from state and local income taxes does not preclude states from asserting other taxes on the ownership of U.S. government securities. To the extent that a Fund invests to a substantial degree in U.S. government securities which are subject
to favorable state and local tax treatment, shareholders of the Fund will be notified as to the extent to which distributions from the Fund are attributable to interest on such securities.
Tax Shelter Reporting Regulations
If a shareholder realizes a
loss on disposition of a Fund’s shares of $2 million or more for an individual shareholder or $10 million or more for a corporate shareholder, the shareholder must file with the Internal Revenue Service a disclosure statement on Form 8886.
Direct shareholders of portfolio securities are in many cases excepted from this reporting requirement, but under current guidance, shareholders of a regulated investment company are not excepted. Future guidance may extend the current
exception from this reporting requirement to shareholders of
most or all regulated investment companies. The fact that a loss is reportable under these regulations does not affect the legal determination whether the taxpayer’s treatment of the loss is proper. Shareholders should consult their tax
advisers to determine the applicability of these regulations in light of their individual circumstances.
General Considerations
The federal income tax
discussion set forth above is for general information only. Prospective investors should consult their tax advisers regarding the specific federal tax consequences of purchasing, holding, and disposing of shares of each of the Funds, as well as the
effects of state, local and foreign tax law and any proposed tax law changes.
TRUSTEES
The names of the Trustees of
the Trust, together with information regarding their year of birth, the year each Trustee became a Board member of the Trust, principal occupations and other board memberships, including those in any company with a class of securities registered
pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the “Securities Exchange Act”) or subject to the requirements of Section 15(d) of the Securities Exchange Act or any company registered as an investment company
under the 1940 Act, are shown below. The contact address for each of the Trustees is 277 Park Avenue, New York, NY 10172.
Name
(Year of Birth; Positions
with the Funds since)
|
|
Principal
Occupation
During Past 5 Years
|
|
Number
of Funds
in Fund Complex
Overseen by
Trustee(1)
|
|
Other
Directorships Held
During the Past 5 Years
|
Independent
Trustees
|
|
|
|
|
|
|
Gary
L. French
(1951); Trustee of the Trust since 2014
|
|
Real
Estate Investor (2011–present); Consultant to the Mutual Fund Industry (2011-present); Senior Consultant for The Regulatory Fundamentals Group LLC (2011–2017); Senior Vice President–
Fund Administration, State Street
Corporation (2002–
2010).
|
|
35
|
|
Independent
Trustee, The China Fund, Inc. (2013–
2019); Exchange Traded Concepts Trust II (2012– 2014); Exchange Traded Concepts Trust I (2011–
2014).
|
Robert
J. Grassi
(1957); Trustee of the Trust since 2014
|
|
Sole
Proprietor, Academy Hills Advisors LLC (2012– present); Pension Director, Corning Incorporated (2002–
2012).
|
|
35
|
|
None.
|
Name
(Year of Birth; Positions
with the Funds since)
|
|
Principal
Occupation
During Past 5 Years
|
|
Number
of Funds
in Fund Complex
Overseen by
Trustee(1)
|
|
Other
Directorships Held
During the Past 5 Years
|
Thomas
P. Lemke
(1954); Trustee of the Trust since 2014
|
|
Retired;
Executive Vice President and General Counsel, Legg Mason (2005–2013).
|
|
35
|
|
SEI
family of funds (Independent Trustee of Advisors’ Inner Circle Fund III (20 portfolios) (from February 2014 to present); Independent Trustee of Winton Diversified Opportunities Fund (from December 2014 to 2018); Independent Trustee of Gallery
Trust (from August 2015 to present); Independent Trustee of Schroder Series Trust (from February 2017 to present); Independent Trustee of Schroder Global Series Trust (from February 2017 to present); Independent Trustee of O’Connor EQUUS (May
2014–
April 2016); Independent Trustee of Winton Series Trust (December 2014–
March 2017); Independent Trustee of AXA Premier VIP Trust (2014–June 2017); Independent Director of The Victory Funds (or their predecessor
funds) (35 portfolios) (2014–
March 2015); Symmetry Panoramic Trust (16 portfolios) (2018-present).
|
Lawrence
R. Maffia
(1950); Trustee of the Trust since 2014
|
|
Retired;
Director and President, ICI Mutual Insurance Company (2006– 2013).
|
|
35
|
|
Director,
ICI Mutual Insurance Company (1999–2013).
|
Name
(Year of Birth; Positions
with the Funds since)
|
|
Principal
Occupation
During Past 5 Years
|
|
Number
of Funds
in Fund Complex
Overseen by
Trustee(1)
|
|
Other
Directorships Held
During the Past 5 Years
|
Emily
A. Youssouf
(1951); Trustee of the Trust since 2014
|
|
Clinical
Professor, NYU Schack Institute of Real Estate (2009–
present); Board Member (2005– present), Chair of Capital Committee (2006–2016), Chair of Audit Committee (2005–present), and Chair of IT Committee (2016–
present), NYC Health and Hospitals Corporation; Board Member and Member of the Audit Committee and Related Parties Committee (2013–
2018) and Member of the Risk Management Committee (2017–
2018), PennyMac Financial Services, Inc.
|
|
35
|
|
Trustee,
NYC School Construction Authority (2009–present); Board Member, NYS Job Development Authority (2008–present); Trustee (2015–present) and Chair of the Audit and Finance Committee (2015–present) of the TransitCenter
Foundation; Vice Chair (2011–2013) and Board Member (2013–2014) of New York City Housing Authority.
|
Interested
Trustee
|
|
|
|
|
|
|
Robert
F. Deutsch(2)
(1957); Chairman and Trustee of the Trust since 2014
|
|
Retired;
Head of the Global ETF Business for JPMorgan Asset Management (2013– 2017); Head of the Global Liquidity Business for JPMorgan Asset Management (2003–2013).
|
|
35
|
|
Board
of Directors of the JUST Capital Foundation (2017–present).
|
(1)
|
A Fund Complex
means two or more registered investment companies that hold themselves out to investors as related companies for purposes of investment and investor services or have a common investment adviser or have an investment adviser that is an affiliated
person of the investment adviser of any of the other registered investment companies. Thirty three series of the Trust have commenced operations, but two additional series have been created and are expected to commence operations in the future.
|
(2)
|
Mr. Deutsch is an
interested trustee because he was an employee of the Adviser until August 2017.
|
The Trustees serve for an
indefinite term. The Board of Trustees decides upon general policies and is responsible for overseeing the business affairs of the Trust.
Qualifications of Trustees
The Board believes that each
Trustee’s experience, qualifications, attributes or skills on an individual basis and in combination with those of the other Trustees lead to the conclusion that the Board possesses the requisite skills and attributes to carry out its
oversight responsibilities with respect to the Trust. The Board believes that the significance of each Trustee’s experience, qualifications, attributes or skills is an individual matter (meaning that experience that is important for one
Trustee may not have the same value for another) and that these factors are best evaluated at the Board level, with no single Trustee, or particular factor, being indicative of Board effectiveness. However, the Board believes that Trustees need to
be able to critically review, evaluate, question and discuss information provided to them, and to interact effectively with Trust management, service providers and counsel, in order to exercise effective business judgment in the performance of their
duties. The Board believes that each of its members has these abilities.
The summaries below, relating
to the experience, qualifications, attributes and skills of the each Trustee, are required by the registration form adopted by the SEC, do not constitute holding out the Board or any Trustee as having any special expertise or experience, and do not
impose any greater responsibility or liability on any such person or on the Board as a whole than would otherwise be the case. The following is a summary of specific experience, qualifications, attributes and/or skills of each Trustee:
Gary L. French. Mr. French has over 30 years of experience in the financial services industry and related fields, including serving in various leadership roles with large financial institutions that operated and administered services
to investment companies. He has familiarity with a variety of financial, accounting, investment, regulatory and operational matters through his prior experience (including as Senior Vice President and Business Head in the Fund Administration
Division at State Street Bank) and through other positions held during his career in the investment management industry. He also gained experience serving as an independent director and officer of several other registered investment companies, and
in his prior position as an independent director with The China Fund, Inc.
Robert J. Grassi. Mr. Grassi has over 25 years of experience in a variety of business and financial matters, including experience in senior management positions. He has familiarity with a variety of financial, accounting, investment and
regulatory matters through his prior experience (including as Director of Pensions and Investments at Corning Incorporated) and through his current position as Sole Proprietor of Academy Hills Advisors LLC, an investment consulting
firm.
Thomas P.
Lemke. Mr. Lemke has over 35 years of experience in the financial services industry, including experience in various senior management positions with financial services firms in addition to multiple years of service
with a regulatory agency and major law firms. In addition, he has a background in internal controls, including legal, compliance, internal audit, risk management and fund administration, and has served as general counsel for several financial
services firms. He has familiarity with a variety of financial, accounting, investment, regulatory and operational matters through his prior experience (including as Executive Vice President, General Counsel, and Head of the Governance Group of Legg
Mason, Inc.). He has also gained experience as an independent director of other registered investment companies, including his current position with each of AXA Premier VIP Trust, The Advisors’ Inner Circle III Funds and Symmetry Panoramic
Trust, and his prior positions as an independent director of ICI Mutual Insurance Company and as independent trustee of The Victory Funds (or their predecessor funds).
Lawrence R. Maffia. Mr. Maffia has over 30 years of experience in the financial services industry, including positions held at a public auditing firm and various other positions in the mutual fund industry. He has familiarity with a
variety of financial, accounting, investment and regulatory matters through his prior experience (including as President and Company Director at ICI Mutual Insurance Company, a provider of D&O/E&O liability insurance and fidelity bonding for
the U.S. mutual fund industry, and his prior positions as chief financial officer of Stein Roe & Farnham Mutual Funds and chief operations officer of Stein Roe & Farnham Mutual Funds’ transfer agent).
Emily A. Youssouf. Ms. Youssouf has over 25 years of business experience in the financial services industry and related fields, including serving in several executive level positions within the investment banking and housing finance
industries. In addition, she has an extensive background in strategic planning and financial analysis based on her prior positions as a Board Member of the NYC Health and Hospitals Corporation (where she served as the Chair of the Audit Committee,
Chair of the IT Committee and Member of the Finance Committee), as a Board Member of PennyMac Financial Services, Inc. (where she serves as a member of the Related Party Committee, the Risk Management Committee and the Audit Committee), as a Board
Member of the NYC School Construction Authority, as a Board Member of the NYS Job Development Authority (where she also serves as a member of the Audit Committee) and as a Trustee of the TransitCenter Foundation (where she also serves as Chair of
the Audit and Finance Committee), and as a Clinical Professor at NYU Schack Institute of Real Estate. She has familiarity with a variety of financial, accounting, investment and regulatory matters through her prior experience and through her prior
positions described above.
Robert F. Deutsch. Mr. Deutsch has over 30 years of experience in the financial services industry. He has substantial mutual fund background and is experienced with financial, accounting, investment and regulatory matters through his
tenure at J.P. Morgan Asset Management (“JPMAM”), including his prior positions as head of the Global ETF Business and as head of the Global Liquidity Business. Prior roles also include National Sales Manager for JPMorgan Funds and
Client Advisor at Goldman Sachs Asset Management.
Board Leadership Structure and Oversight
The Board has structured itself
in a manner that allows it to effectively perform its oversight function. Although the Chairman of the Board is not an Independent Trustee, Mr. Lemke serves as the Lead Independent Trustee to the Board and provides leadership to the other Trustees
and acts as a liaison with the Adviser’s management.
The Board has adopted a
committee structure that allows it to effectively perform its oversight function for all of the Funds in the complex. As described under “Qualification of Trustees” and “Standing Committees,” the Board has two committees: the
Audit and Valuation Committee and the Governance and Nominating Committee. The Board has determined that the leadership and committee structure is appropriate for the Funds and allows the Board to effectively and efficiently evaluate issues that
impact the Trust as a whole as well, as issues that are unique to each Fund.
The Board takes an active role
in risk oversight including the risks associated with exchange-traded funds, including investment risk, compliance and valuation. In connection with its oversight, the Board receives regular reports from the Chief Compliance Officer
(“CCO”), the Adviser and the Administrator. The Board also receives periodic reports from the Chief Risk Officer of JPMAM, including reports concerning operational controls that are designed to address market risk, credit risk, and
liquidity risk among others. The Board also receives regular reports from personnel responsible for JPMAM’s business resiliency and disaster recovery.
In addition, the Board and its
Committees work on an ongoing basis in fulfilling the oversight function. Additional information about the functions of each of the Committees is included below in “Standing Committees.” After each meeting of the Committee, each
committee reports its committee proceedings to the full Board. This committee structure allows the Board to efficiently evaluate a large amount of material and effectively fulfill its oversight function. Annually, the Board considers the efficiency
of this committee structure.
Standing
Committees
The Board of
Trustees has two standing committees: the Audit and Valuation Committee and the Governance and Nominating Committee.
The members of each Committee are set forth
below:
Name
of Committee
|
|
Members
|
|
Committee
Chair
|
Audit
and Valuation Committee
|
|
Mr.
French
Mr. Lemke
Mr. Grassi
Mr. Maffia
Ms. Youssouf
|
|
Mr.
French
|
Governance
and Nominating Committee
|
|
Ms.
Youssouf
Mr. French
Mr. Grassi
Mr. Lemke
Mr. Maffia
|
|
Ms. Youssouf
|
Audit
and Valuation Committee. The primary purposes of the Audit and Valuation Committee are: (i) appointment, retention, compensation and oversight of the
Funds’ independent accountants; (ii) oversight of the Funds’ audit, accounting and financial reporting policies, practices and internal controls; (iii) approval of non-audit services, as required by the statutes and regulations
administered by the SEC, including the 1940 Act and the Sarbanes-Oxley Act of 2002 (the “Sarbanes Act”); (iv) oversight of the valuation process in accordance with procedures adopted by the Trust; (v) conduct of such other business
and/or attention to such other matters as the Board may specifically assign to the Audit and Valuation Committee from time to time. The Audit and Valuation Committee will oversee the quality and objectivity of the Funds’ independent audit and
the financial statements of the Funds, act as a liaison between the Boards of Trustees and the Funds’ independent accountants and periodically report to the Boards of Trustees.
The Audit and Valuation
Committee’s responsibilities include the following: (i) approve and recommend to the Board the selection, appointment, retention and compensation of the Funds’ independent accountants; (ii) evaluate the independence of the independent
accountants; (iii) review the arrangements for and scope of the annual audits of the Funds and for any non- audit services for which the
independent accountants may be engaged; (iv) review the
Funds’ financial statements contained in the annual and other periodic reports to shareholders with Fund management and the independent accountants, and determine whether the independent accountants are satisfied with the disclosure and
content of the annual financial statements; (v) meet with independent counsel for the Independent Trustees and Fund Counsel in order to be informed on legal issues having the possibility of impacting the financial reporting process; (vi) review the
form of opinion the independent accountants propose to render on the Fund’s annual financial statements; (vii) receive information from the Adviser regarding the state of the Funds’ internal controls; (viii) discuss policies with respect
to risk assessment and risk management; (ix) oversee the implementation of the Funds’ valuation policies by the Administrator and recommend and approve changes in the Funds’ valuation policies from time to time; and (x) review and act on
such other matters as referred to the Audit and Valuation Committee by the Board.
Governance and Nominating
Committee. The primary purposes of the Governance and Nominating Committee are to: (1) oversee the Board’s governance processes; (2) evaluate and
recommend individuals to serve as Independent Trustees; and (3) review and recommend changes to the compensation paid to the Board.
The Governance and Nominating
Committee shall have such responsibilities as may be assigned to it by the Board, including the following responsibilities: (i) identify, consider and recommend to the Board candidates for election as Independent Trustees of the Board. The Committee
shall review periodically the composition of the Board and the backgrounds and skill sets of the Trustees to determine whether it may be appropriate to recommend adding additional individuals to the Board; (ii) recommend to the Board a successor to
the Chair of the Board, the Lead Independent Trustee or Chair of any committee when determined to be appropriate or necessary; (iii) recommend to the Board selections for membership on each committee of the Board, including committee chairperson
assignments, review periodically all committee assignments, the responsibilities of each committee, whether there is a continuing need for each committee, whether there is a need for additional committees, and whether committees should be combined
or reorganized, and make and discuss recommendations for any such action to and with the Board; (iv) review periodically Board governance practices and procedures and make recommendations to the Board regarding any appropriate changes; (v) consider,
implement and oversee the annual self-assessment process of the Board; (vi) review periodically the adequacy of this charter and evaluate the Committee’s performance of its duties and responsibilities hereunder, and make recommendations to the
Board regarding any appropriate changes; (vii) review periodically the compensation of the Trustees and make recommendations to the Board regarding any appropriate changes; (viii) review periodically the Trust’s retirement policies regarding
Trustees and make recommendations to the Board regarding any appropriate changes; and (ix) consider and evaluate any other matter the Committee deems necessary or appropriate or as may be delegated to the Committee by the Board from time to
time.
When evaluating a
person as a potential nominee to serve as an Independent Trustee, the Governance and Nominating Committee may consider, among other factors, (i) whether or not the person is “independent” and whether the person is otherwise qualified
under applicable laws and regulations to serve as a Trustee; (ii) whether or not the person is willing to serve, and willing and able to commit the time necessary for the performance of the duties of an Independent Trustee; (iii) the contribution
that the person can make to the Board and the Funds, with consideration being given to the person’s business experience, education and such other factors as the Committee may consider relevant; (iv) the character and integrity of the person;
(v) the desirable personality traits, including independence, leadership and the ability to work with the other members of the Board; and (vi) to the extent consistent with the 1940 Act, such recommendations from management as are deemed
appropriate. The process of identifying nominees involves the consideration of candidates recommended by one or more of the following: current Independent Trustees, officers, shareholders and other sources that the Governance and Nominating
Committee deems appropriate. The Governance and Nominating Committee will review nominees recommended to the Board by shareholders and will evaluate such nominees in the same manner as it evaluates nominees identified by the Governance and
Nominating Committee. Nominee recommendations may be submitted to the Secretary of the Trust at the Trust’s principal business address.
For details of the number of times
the Audit and Valuation Committee met during the most recent fiscal year, see “TRUSTEES — Standing Committees” in Part I of this SAI.
For details of the dollar range of
equity securities owned by each Trustee in the Funds, see “TRUSTEES — Ownership of Securities” in Part I of this SAI.
Trustee Compensation
Prior to January 1, 2019, the
Funds overseen by the Trustees paid each Trustee an annual fee of $80,000 and will reimburse each Trustee for expenses incurred in connection with service as a Trustee. In addition, the Funds pay the lead Independent Trustee an additional annual fee
of $8,000, Audit and Valuation Committee Chair an additional annual fee of $7,500 and Governance and Nominating Committee Chair an additional annual fee of $6,000. The Trustees may hold various other directorships unrelated to the Trust.
Beginning January 1, 2019, The
Funds overseen by the Trustees will pay each Trustee an annual fee of $120,000 and will reimburse each Trustee for expenses incurred in connection with service as a Trustee. In addition, the Funds pay the lead Independent Trustee an additional
annual fee of $8,000, Audit and Valuation Committee Chair an additional annual fee of $7,500 and Governance and Nominating Committee Chair an additional annual fee of $6,000. The Trustees may hold various other directorships unrelated to the
Trust.
The Declaration of
Trust provides that the Trust will indemnify its Trustees and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with the Trust, unless, as to liability to the
Trust or its shareholders, it is finally adjudicated that they engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in their offices (collectively, “disabling conduct”). In the case of
settlement, such indemnification will not be provided unless it has been determined by a court or other body approving the settlement or disposition, or in the absence of such a determination, there has been a dismissal of the proceeding by the
court or other body before it was brought for insufficiency of evidence of any disabling conduct with which the Trustee or officer has been charged, or by a reasonable determination based upon a review of readily available facts, by vote of a
majority of disinterested Trustees or in a written opinion of independent counsel, that such officers or Trustees did not engage in disabling conduct.
For details of Trustee compensation
paid by the Funds, including deferred compensation, see “TRUSTEES — Trustee Compensation” in Part I of this SAI.
OFFICERS
The Trust’s executive
officers (listed below) generally are employees of the Adviser or one of its affiliates. The officers conduct and supervise the business operations of the Trust. The officers hold office until a successor has been elected and duly qualified. The
Trust has no employees. The names of the officers of the Funds, together with their year of birth, information regarding their positions held with the Trust and principal occupations are shown below. The contact address for each of the officers,
unless otherwise noted, is 277 Park Avenue, New York, NY 10172.
Name
(Year of Birth),
Positions Held with the Trusts (Since)
|
|
Principal
Occupations During Past 5 Years
|
Joanna
Gallegos (1975),
President and Principal Executive Officer (2017)
|
|
Managing
Director, Head of J.P. Morgan Asset Management’s U.S. Exchange Traded Funds business. Previously, Head of J.P. Morgan Asset Management’s ETF Product Development team from August 2013 to July 2017.
|
Lauren
Paino (1973),
Treasurer and Principal Financial Officer (2016)*
|
|
Executive
Director, J.P. Morgan Investment Management Inc. (formerly JPMorgan Funds Management, Inc.) since August 2013.
|
Brian
S. Shlissel (1964),
Vice President (2016)
|
|
Managing
Director and Chief Administrative Officer for J.P. Morgan pooled vehicles, J.P. Morgan Investment Management Inc. (formerly JPMorgan Funds Management, Inc.) (from 2014 to present); Managing Director and Head of Mutual Fund Services, Allianz Global
Investors; President and Chief Executive Officer, Allianz Global Investors Mutual Funds and PIMCO Closed-End Funds (from 1999 to 2014).
|
Paul
Shield (1960),
Vice President and Assistant Treasurer (2016)
|
|
Managing
Director and head of Business Management for JPMorgan Asset Management’s Exchange Traded Fund platform since 2013.
|
Elizabeth
A. Davin (1964),
Secretary (2018)**
|
|
Executive
Director and Assistant General Counsel, JPMorgan Chase. Ms. Davin has been with JPMorgan Chase (formerly Bank One Corporation) since 2004.
|
Name
(Year of Birth),
Positions Held with the Trusts (Since)
|
|
Principal
Occupations During Past 5 Years
|
Stephen
M. Ungerman (1953),
Chief Compliance Officer (2014)
|
|
Managing
Director, JPMorgan Chase & Co.; Mr. Ungerman has been with JPMorgan Chase & Co. since 2000.
|
Jessica
K. Ditullio (1962),
Assistant Secretary (2014)**
|
|
Executive
Director and Assistant General Counsel. Ms. Ditullio has been with JPMorgan Chase (formerly Bank One Corporation) since 1990.
|
Anthony
Geron (1971),
Assistant Secretary (2019)*
|
|
Vice
President and Assistant General Counsel, JPMorgan Chase since September 2018; Lead Director and Counsel, AXA Equitable Life Insurance Company from 2015 to 2018 and Senior Director and Counsel, AXA Equitable Life Insurance Company from 2014 to 2015;
Associate, Willkie Farr & Gallagher (law firm) from 2007 to 2014.
|
Carmine
Lekstutis (1980),
Assistant Secretary (2014)*
|
|
Executive
Director and Assistant General Counsel, JPMorgan Chase since February 2015; formerly Vice President and Assistant General Counsel, JPMorgan Chase from 2011 to February 2015.
|
Keri
E. Riemer (1976),
Assistant Secretary (2019)*
|
|
Executive
Director and Assistant General Counsel, JPMorgan Chase since February 2019; Counsel, Seward & Kissel LLP (2016-2019); Associate, Seward & Kissel LLP (2011-2016).
|
Gregory
S. Samuels (1980),
Assistant Secretary (2014)*
|
|
Executive
Director and Assistant General Counsel, JPMorgan Chase since February 2014; formerly Vice President and Assistant General Counsel, JPMorgan Chase from 2010.
|
Zachary
E. Vonnegut-Gabovitch (1986),
Assistant Secretary (2017)*
|
|
Vice
President and Assistant General Counsel, JPMorgan Chase since September 2016; Associate, Morgan, Lewis & Bockius (law firm) from 2012 to 2016.
|
Frederick
J. Cavaliere (1978),
Assistant Treasurer (2015)*
|
|
Executive
Director, J.P. Morgan Investment Management Inc. since February 2016; formerly, Vice President, J.P. Morgan Investment Management Inc. (formerly JPMorgan Funds Management, Inc.) since September 2010 to February 2016. Mr. Cavaliere has been with
JPMorgan since May 2006.
|
Michael
M. D’Ambrosio (1969),
Assistant Treasurer (2014)
|
|
Managing
Director, J.P. Morgan Investment Management Inc. (formerly JPMorgan Funds Management, Inc.) since May 2014; formerly Executive Director, J.P. Morgan Investment Management Inc. (formerly JPMorgan Funds Management, Inc.) from 2012 to May 2014.
|
Shannon
Gaines (1977),
Assistant Treasurer (2019)**
|
|
Vice
President, J.P. Morgan Investment Management Inc. (formerly JPMorgan Funds Management, Inc.) since January 2014.
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Jason
Ronca (1978),
Assistant Treasurer (2014)***
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Executive
Director, Assistant Treasurer and ETF Platform Manager for J.P. Morgan Asset Management since February 2017; formerly Vice President, Assistant Treasurer and ETF Platform Manager for J.P. Morgan Asset Management from May 2014 to February 2017. ETF
Product Manager for Corporate Investment Bank responsible for setting the strategy and control agenda for the ETF servicing business from 2010 to May 2014; Prior to 2010, a Vice President in Fund Accounting within J.P. Morgan Investor Services,
supporting a series of U.S. registered mutual funds.
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*
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The contact address
for the officer is 4 New York Plaza, New York, NY 10004.
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**
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The contact address
for the officer is 1111 Polaris Parkway, Columbus, OH 43240.
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***
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The contact address
for the officer is 50 Rowes Wharf, Floor 03, Boston, MA 02110.
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For details of the percentage of
shares of the Funds owned by the officers and Trustees, as a group, see “SHARE OWNERSHIP — Trustees and Officers” in Part I of this SAI.
INVESTMENT ADVISER
J.P. Morgan Investment Management Inc.
(“JPMIM” or the “Adviser”)
JPMIM serves
as investment adviser and administrator to the Funds. For each Fund, JPMIM provides investment advisory and administrative services under a management agreement (the “JPMIM Management Agreement”).
JPMIM is a wholly-owned
subsidiary of JPMorgan Asset Management Holdings Inc., which is a wholly-owned subsidiary of JPMorgan Chase & Co. (“JPMorgan Chase”). JPMIM is a registered investment adviser under the Investment Advisers Act of 1940, as amended.
JPMIM is located at 383 Madison Avenue, New York, NY 10179.
The Trust’s Shares are
not sponsored, endorsed or guaranteed by, and do not constitute obligations or deposits of JPMorgan Chase, any bank affiliate of JPMIM or any other bank, and are not insured by the FDIC or issued or guaranteed by the U.S. government or any of its
agencies.
Under the
terms of the JPMIM Management Agreement, the investment advisory services JPMIM provides to the Funds are not exclusive. JPMIM is free to and does render similar investment advisory services to others. JPMIM serves as investment adviser to personal
investors and other investment companies and acts as fiduciary for trusts, estates and employee benefit plans. Certain of the assets of trusts and estates under management are invested in common trust funds for which JPMIM serves as trustee. The
accounts which are managed or advised by JPMIM have varying investment objectives, and JPMIM invests assets of such accounts in investments substantially similar to, or the same as, those which are expected to constitute the principal investments of
the Fund. Such accounts are supervised by employees of JPMIM who may also be acting in similar capacities for the Fund. See “Portfolio Transactions.”
Each Fund is managed by
employees of JPMIM who, in acting for their customers, including each Fund, do not discuss their investment decisions with any personnel of JPMorgan Chase or any personnel of other divisions of JPMIM or with any of their affiliated persons, with the
exception of certain other investment management affiliates of JPMorgan Chase which execute transactions on behalf of a Fund.
For details of the dollar range
of shares of the Funds beneficially owned by the portfolio managers who serve on a teams that manage the Funds, see “PORTFOLIO MANAGERS — Portfolio Managers’ Other Accounts Managed” in Part I of this SAI.
JPMIM Management Agreement
Pursuant to the
JPMIM Management Agreement, JPMIM provides investment advisory and administrative services to the Funds.
Subject to the supervision of
the Trust’s Board of Trustees, JPMIM provides or will cause to be provided a continuous investment program for a Fund, including investment research and management with respect to all securities and investments and cash equivalents. JPMIM may
delegate its responsibilities to a sub-adviser. Any subadvisory agreements must be approved by the Trust’s Board of Trustees and the applicable Fund’s shareholders, to the extent required by the 1940 Act.
Pursuant to
the JPMIM Management Agreement, JPMIM also performs or supervises all operations of the Funds (other than those services performed under the custody and fund accounting agreement and the transfer agency agreement for the Funds). JPMIM has agreed to
maintain the necessary office space for these Funds, and to furnish certain other services required by each of these Funds. JPMIM prepares annual and semi-annual reports to the SEC, prepares federal and state tax returns and generally assists in all
aspects of a Fund’s operations other than those performed under any sub-advisory agreements, the custody and fund accounting agreement, and the transfer agency agreement. JPMIM may, at its expense, subcontract with any entity or person
concerning the provision of the administrative services. JPMorgan Chase Bank serves as the Funds’ sub-administrator (the “Sub-administrator”).
Pursuant to JPMIM Management
Agreement, JPMIM is entitled to a management fee, computed daily and payable monthly equal to the annual rate of each Fund’s average daily net assets as described in the Funds’ Prospectuses. Under the JPMIM Management Agreement, JPMIM is
responsible for substantially all the expenses of the Trust relating to each Fund and each Fund (inclusive of any subsidiary expenses), except for the management fees, payments under a Fund’s 12b-1 plan (if any), interest expenses, dividend
and interest expenses related to short sales, taxes, acquired fund fees and expenses (other than fees for funds advised by the Adviser and/or its affiliates), costs of holding shareholder meetings, and litigation
and potential litigation and
other extraordinary expenses not incurred in the ordinary course of a Fund’s business. Each Fund shall be responsible for its non-operating expenses, including brokerage commissions and fees and expenses associated with a Fund’s
securities lending program, if applicable.
After an initial period,
ending February 28, 2021, the JPMIM Management Agreement will continue in effect for successive annual periods only if specifically approved thereafter annually in the same manner as the Distribution Agreement; except that for any new funds, the
initial approval will continue for up to two years, after which annual approvals are required. See the “Distributor” section for additional information. The JPMIM Management Agreement will terminate with respect to a Fund automatically
if assigned and is terminable at any time without penalty by a vote of a majority of the Trustees, or by a vote of the holders of a majority of a Fund’s outstanding voting securities (as defined in the 1940 Act), on 60 days’ written
notice to JPMIM and by JPMIM on 90 days’ written notice to the Trust.
The JPMIM Management Agreement
provides that JPMIM shall not be liable for any error of judgment or mistake of law or for any loss suffered by any Fund in connection with the matters to which the JPMIM Management Agreement relates, except a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of JPMIM in the performance of its duties or from reckless disregard by it of its duties and obligations thereunder, or, a loss resulting from a breach of fiduciary duty with respect to the
receipt of compensation for services covered by the agreement.
For details of the fees paid under
the management agreement, see “INVESTMENT ADVISER AND ADMINSTRATOR — Management Fees” in Part I of the SAI for the applicable Fund.
Under separate agreements,
JPMorgan Chase Bank provides certain custodial, fund accounting and recordkeeping services to the Trust. JPMorgan Chase Bank is a subsidiary of JPMorgan Chase and an affiliate of JPMIM. See the “Custodian” and “Transfer
Agent” sections for additional information.
JPMIM Investment Advisory
Agreements
Prior to
November 1, 2019, JPMIM provided investment advisory services to the Funds, other than the BetaBuilders 1-5 Year U.S. Aggregate Bond ETF and the BetaBuilders U.S. Equity ETF, under Investment Advisory Agreements whereby JPMIM provided investment
advisory services substantially similar to those provided under the JPMIM Management Agreement.
For details of the investment
advisory fees paid under the prior advisory agreements, see “INVESTMENT ADVISER—Investment Advisory Fees” in Part I of the SAI for the applicable Fund.
POTENTIAL CONFLICTS OF INTEREST
JPMIM
JPMIM and/or its affiliates
(the “Affiliates” and, together, “JPMorgan”) provide an array of discretionary and non-discretionary investment management services and products to institutional clients and individual investors. In addition, JPMorgan is a
diversified financial services firm that provides a broad range of services and products to its clients and is a major participant in the global currency, equity, commodity, fixed-income and other markets in which a Fund invests or will invest.
Investors should carefully review the following, which describes potential and actual conflicts of interest that JPMorgan can face in the operation of its investment management services. JPMorgan and the Funds have adopted policies and procedures
reasonably designed to appropriately prevent, limit or mitigate the conflicts of interest described below. In addition, many of the activities that create these conflicts of interest are limited and/or prohibited by law, unless an exception is
available.
This section
is not, and is not intended to be, a complete enumeration or explanation of all of the potential conflicts of interest that may arise. Additional information about potential conflicts of interest regarding JPMIM and JPMorgan is set forth in
JPMIM’s Form ADV. A copy of Part 1 and Part 2A of JPMIM’s Form ADV is available on the SEC’s website (www.adviserinfo.sec.gov).
Acting for Multiple Clients. In general, JPMIM faces conflicts of interest when it renders investment advisory services to several clients and, from time to time, provides dissimilar investment advice to different clients. For example, when funds
or accounts managed by JPMIM (“Other Accounts”) engage in short sales of the same securities held by a Fund, JPMIM could be seen as harming the performance of a Fund for the benefit of the Other Accounts engaging in short sales, if the
short sales cause the market value of the securities to fall. In addition, a conflict could arise when one or more Other Accounts invest in different instruments or classes of securities of the same issuer than those in which a Fund invests.
In
certain circumstances, Other Accounts have different investment
objectives or could pursue or enforce rights with respect to a particular issuer in which a Fund has also invested and these activities could have an adverse effect on the Fund. For example, if a Fund holds debt instruments of an issuer and an Other
Account holds equity securities of the same issuer, then if the issuer experiences financial or operational challenges, the Fund (which holds the debt instrument) may seek a liquidation of the issuer, whereas the Other Account (which holds the
equity securities) may prefer a reorganization of the issuer. In addition, an issuer in which the Fund invests may use the proceeds of the Fund’s investment to refinance or reorganize its capital structure which could result in repayment of
debt held by JPMorgan or an Other Account. If the issuer performs poorly following such refinancing or reorganization, the Fund’s results will suffer whereas the Other Account’s performance will not be affected because the Other Account
no longer has an investment in the issuer. Conflicts are magnified with respect to issuers that become insolvent. It is possible that in connection with an insolvency, bankruptcy, reorganization, or similar proceeding, a Fund will be limited (by
applicable law, courts or otherwise) in the positions or actions it will be permitted to take due to other interests held or actions or positions taken by JPMorgan or Other Accounts.
Positions taken by Other
Accounts may also dilute or otherwise negatively affect the values, prices or investment strategies associated with positions held by a Fund. For example, this may occur when investment decisions for the Fund are based on research or other
information that is also used to support portfolio decisions by JPMIM for Other Accounts following different investment strategies or by Affiliates in managing their clients’ accounts. When an Other Account or an account managed by an
Affiliate implements a portfolio decision or strategy ahead of, or contemporaneously with, similar portfolio decisions or strategies for a Fund (whether or not the portfolio decisions emanate from the same research analysis or other information),
market impact, liquidity constraints, or other factors could result in the Fund receiving less favorable investment results, and the costs of implementing such portfolio decisions or strategies could be increased or the Fund could otherwise be
disadvantaged.
Investment opportunities that
are appropriate for a Fund may also be appropriate for Other Accounts and there is no assurance the Fund will receive an allocation of all or a portion of those investments it wishes to pursue. JPMIM’s management of an Other Account that pays
it a performance fee or a higher management fee and follows the same or similar strategy as a Fund or invests in substantially similar assets as a Fund, creates an incentive for JPMIM to favor the account paying it the potentially higher fee, e.g.,
in placing securities trades.
JPMIM and its Affiliates, and
any of their directors, officers or employees, also buy, sell, or trade securities for their own accounts or the proprietary accounts of JPMIM and/or an Affiliate. JPMIM or its Affiliates, within their discretion, may make different investment
decisions and take other actions with respect to their own proprietary accounts than those made for client accounts, including the timing or nature of such investment decisions or actions. Further, JPMIM is not required to purchase or sell for any
client account securities that it, an Affiliate or any of its or their employees may purchase or sell for their own accounts or the proprietary accounts of JPMIM or an Affiliate or its clients. JPMIM, its Affiliates and their respective directors,
officers and employees face a conflict of interest as they will have income or other incentives to favor their own accounts or proprietary accounts.
The portfolio managers of
certain Funds-of-Funds have access to the holdings and may have knowledge of the investment strategies and techniques of certain underlying Funds because they are portfolio managers of separately managed accounts following similar strategies as a
Fund-of-Funds. They therefore face conflicts of interest in the timing and amount of allocations to an underlying Fund, as well as in the choice of an underlying fund. JPMorgan also faces conflicts of interest when waiving certain fees if those
waivers enhance performance.
The chart in Part I of this SAI
entitled “Portfolio Managers’ Other Accounts Managed” shows the number, type and market value as of a specified date of the accounts and other Funds managed by each Fund’s (excluding the Money Market Funds’) portfolio
managers.
Acting in
Multiple Commercial Capacities. JPMorgan is a diversified financial services firm that provides a broad range of services and products to its clients and is a major participant in the global currency, equity,
commodity, fixed-income and other markets in which a Fund invests or may invest. JPMorgan is typically entitled to compensation in connection with these activities and the Funds will not be entitled to any such compensation. In providing services
and products to clients other than the Funds, JPMorgan, from time to time, faces conflicts of interest with respect to activities recommended to or performed for a Fund on one hand and for JPMorgan’s other clients on the other hand. For
example, JPMorgan has, and continues to seek to develop, banking and other financial and advisory relationships with numerous U.S. and non-U.S. persons and governments. JPMorgan also advises and represents
potential buyers and sellers of businesses worldwide. The Funds
have invested in, or may wish to invest in, such entities represented by JPMorgan or with which JPMorgan has a banking or other financial relationship. In addition, certain clients of JPMorgan may invest in entities in which JPMorgan holds an
interest, including a Fund. In providing services to its clients, JPMorgan from time to time recommends activities that compete with or otherwise adversely affect a Fund or the Fund’s investments. It should be recognized that such
relationships may also preclude the Fund from engaging in certain transactions and may constrain the Fund’s investment flexibility. For example, Affiliates that are broker dealers cannot deal with the Funds as principal in the purchase and
sale of securities unless an exemptive order allowing such transactions is obtained from the SEC. Certain of the Funds have received exemptive orders permitting the Funds to engage in principal transactions with Affiliates involving taxable and tax
exempt money market instruments. However, for the purchase and sale of longer term fixed income securities, which are generally principal transactions, the Funds cannot use broker dealer Affiliates. Or, if an Affiliate is the sole underwriter of an
initial or secondary offering, the Funds could not purchase in the offering. In both cases the number of securities and counterparties available to the Funds will be fewer than are available to mutual funds that are not affiliated with major broker
dealers.
JPMorgan
derives ancillary benefits from providing investment advisory, custody, administration, fund accounting and shareholder servicing and other services to the Funds, and providing such services to the Funds may enhance JPMorgan’s relationships
with various parties, facilitate additional business development and enable JPMorgan to obtain additional business and generate additional revenue.
Participations Adverse to the
Funds. JPMorgan’s participation in certain markets or its actions for certain clients may also restrict or affect a Fund’s ability to transact in those markets and JPMorgan may face conflicts with
respect to the interests involved. For example, when a Fund and another JPMorgan client invest in different parts of an issuer’s capital structure, decisions over whether to trigger an event of default, over the terms of any workout, or how to
exit an investment implicate conflicts of interest. See also “Acting for Multiple Clients”.
Preferential Treatment. JPMIM receives more compensation with respect to certain Funds or Other Accounts than it receives with respect to a Fund, or receives compensation based in part on the performance of certain accounts. This creates a
conflict of interest for JPMIM and its portfolio managers by providing an incentive to favor those accounts. Actual or potential conflicts of interest also arise when a portfolio manager has management responsibilities to more than one account or
Fund, such as devotion of unequal time and attention to the management of the Funds or accounts.
Allocation and Aggregation. Potential conflicts of interest also arise with both the aggregation of trade orders and allocation of securities transactions or investment opportunities. Allocations of aggregated trades, particularly trade orders
that were only partially filled due to limited availability, and allocation of investment opportunities raise a potential conflict of interest because JPMorgan has an incentive to allocate trades or investment opportunities to certain accounts or
Funds. For example, JPMorgan has an incentive to cause accounts it manages to participate in an offering where such participation could increase JPMorgan’s overall allocation of securities in that offering. When JPMorgan serves as adviser to
the Funds, as well as certain Funds-of-Funds, it faces certain potential conflicts of interest when allocating the assets of the Funds-of-Funds among its underlying Funds. For example, JPMorgan has an incentive to allocate assets of the
Fund-of-Funds to seed a new Fund or to allocate to an underlying Fund that is small, pays higher fees to JPMorgan or to which JPMorgan has provided seed capital.
Overall Position Limits. Potential conflicts of interest also exist when JPMorgan maintains certain overall investment limitations on positions in securities or other financial instruments due to, among other things, investment restrictions
imposed upon JPMorgan by law, regulation, contract or internal policies. These limitations have precluded and, in the future could preclude, a Fund from purchasing particular securities or financial instruments, even if the securities or financial
instruments would otherwise meet the Fund’s objectives. For example, there are limits on the aggregate amount of investments by affiliated investors in certain types of securities that may not be exceeded without additional regulatory or
corporate consent. There also are limits on the writing of options by a Fund that could be triggered based on the number of options written by JPMIM on behalf of other investment advisory clients. If certain aggregate ownership thresholds are
reached or certain transactions are undertaken, the ability of a Fund to purchase or dispose of investments, or exercise rights or undertake business transactions, will be restricted.
Soft Dollars. JPMIM pays certain broker-dealers with “soft” or commission dollars generated by client brokerage transactions in exchange for access to statistical information and other research services. JPMIM faces
conflicts of interest because the statistical information and other research services may benefit certain other clients of JPMIM more than a Fund and can be used in connection with the management of accounts other than the accounts whose trades
generated the commissions.
Additionally, when JPMIM uses
client brokerage commissions to obtain statistical information and other research services, JPMIM receives a benefit because it does not have to produce or pay for the information or other research services itself. As a result, JPMIM may have an
incentive to select a particular broker-dealer in order to obtain such information and other research services from that broker-dealer, rather than to obtain the lowest price for execution.
Redemptions. JPMorgan, as a seed investor, has significant ownership in certain of the Funds. In addition, JPMorgan Funds of Funds and JPMorgan on behalf of its discretionary clients could make significant investments in the Funds.
JPMorgan faces conflicts of interest when considering the effect of redemptions on such Funds and on other shareholders in deciding whether and when to redeem its shares. A large redemption of shares by JPMorgan, by a JPMorgan Fund of Funds or by
JPMorgan acting on behalf of its discretionary clients could result in the Fund selling securities when it otherwise would not have done so, accelerating the realization of capital gains and increasing transaction costs. A large redemption could
significantly reduce the assets of a Fund, causing decreased liquidity and, depending on any applicable expense caps, a higher expense ratio.
Affiliated Transactions. The Funds are subject to conflicts of interest if they engage in principal or agency transactions with other Funds or with JPMorgan. To the extent permitted by law, the Funds can enter into transactions in which
JPMorgan acts as principal on its own behalf (principal transactions), advises both sides of a transaction (cross transactions) and acts as broker for, and receives a commission from, the Funds (agency transactions). Principal and agency
transactions create the opportunity for JPMorgan to engage in self-dealing. JPMorgan faces a conflict of interest when it engages in a principal or agency transaction on behalf of a Fund, because such transactions result in additional compensation
to JPMorgan. JPMorgan faces a potentially conflicting division of loyalties and responsibilities to the parties in these transactions.
In addition, Affiliates of
JPMIM have direct or indirect interests in electronic communication networks and alternative trading systems (collectively “ECNs”). JPMIM, in accordance with its fiduciary obligation to seek to obtain best execution, from time to time
executes client trades through ECNs in which an Affiliate has, or may acquire, an interest. In such case, the Affiliate will be indirectly compensated based upon its ownership percentage in relation to the transaction fees charged by the ECNs.
JPMorgan also faces conflicts
of interest if a Fund purchases securities during the existence of an underwriting syndicate for such securities, of which JPMorgan is a member because JPMorgan typically receives fees for certain services that it provides to the syndicate and, in
certain cases, will be relieved directly or indirectly of certain financial obligations as a result of a Fund’s purchase of securities.
Affiliated Service Providers. JPMorgan faces conflicts of interest when the Funds use service providers affiliated with JPMorgan because JPMorgan receives greater overall fees when they are used. Affiliates provide investment advisory,
administration, fund accounting, custody, and transfer agency services to the Funds for which they are compensated by the Funds. Similarly, JPMIM faces a conflict of interest if it decides to use or negotiate the terms of a credit facility for a
Fund if the facility is provided by an Affiliate. In addition, if a JPMorgan Fund of Funds is investing in actively managed underlying funds, JPMIM limits its selection to Funds in the JPMorgan family of mutual funds. JPMIM does not consider or
canvass the universe of unaffiliated investment companies available, even though there may be unaffiliated investment companies that may be more appropriate for the JPMorgan Fund of Funds or that have superior returns. The JPMorgan affiliates
providing services to the Funds benefit from additional fees when a Fund is included as an underlying Fund in a JPMorgan Fund of Funds.
Indexes. JPMIM or one of its affiliates may develop or own and operate stock market and other indexes based on investment and trading strategies developed by JPMIM or its affiliates or assist unaffiliated entities in creating
indexes that are tracked by certain Funds utilized by JPMIM. Some of the Funds seek to track the performance of these indexes. JPMIM may, from time to time, manage client accounts that invest in the Funds. In addition, JPMIM may manage client
accounts which track the same indexes used by the Funds or which may be based on the same, or substantially similar, strategies that are used in the operation of the indexes and the Funds. The operation of the indexes, the Funds and client accounts
in this manner may give rise to potential conflicts of interest. For example, client accounts that track the same indexes used by the Funds may engage in purchases and sales of securities relating to index
changes prior to the implementation of index updates or the time
as of which the Funds engage in similar transactions because the client accounts may be managed and rebalanced on an ongoing basis, whereas the Funds’ portfolios are only rebalanced on a periodic basis corresponding with the rebalancing of an
index. These differences may result in the client accounts having more favorable performance relative to that of the index and the Funds or other client accounts that track the index. Other potential conflicts include the potential for unauthorized
access to index information, allowing index changes that benefit JPMIM or other client accounts and not the investors in the Funds. JPMIM has established certain information barriers and other policies to address the sharing of information between
different businesses within JPMIM and its affiliates, including with respect to personnel responsible for maintaining the indexes and those involved in decision-making for the Funds.
Proxy Voting. Potential conflicts of interest can arise when JPMIM votes proxies for securities held by a Fund. A conflict is deemed to exist when the proxy is for JPMorgan Chase & Co. stock or for J.P. Morgan Funds, or when the
proxy administrator has actual knowledge indicating that an Affiliate is an investment banker or rendered a fairness opinion with respect to the matter that is the subject of the proxy vote. When such conflicts are identified, the proxy will be
voted by an independent third party either in accordance with JPMIM’s proxy voting guidelines or by the third party using its own guidelines. Potential conflicts of interest can arise when JPMIM invests Fund assets in securities of companies
that are also clients of JPMIM or that have material business relationships with JPMIM or an Affiliate and a vote against management could harm or otherwise affect JPMIM’s or the Affiliate’s business relationship with that company. See
the Proxy Voting section in this SAI.
Personal Trading. JPMorgan and any of its directors, officers, agents or employees, face conflicts of interest when transacting in securities for their own accounts because they could benefit by trading in the same securities as a Fund,
which could have an adverse effect on a Fund.
Valuation. JPMIM acting in its capacity as the Funds’ administrator is the primary valuation agent of the Funds. JPMIM values securities and assets in the Funds according to the Funds’ valuation policies. From time to
time JPMIM will value an asset differently than an Affiliate values the identical asset, including because the Affiliate has information regarding valuation techniques and models or other information that it does not share with JPMIM. This arises
particularly in connection with securities or other assets for which market quotations are not readily available or for which market quotations do not represent the value at the time of pricing (e.g., startup companies) and which are fair valued. JPMIM will also face a conflict with respect to valuations as they affect the amount of JPMIM’s
compensation as investment adviser and administrator.
Information Access. As a result of JPMorgan’s various other businesses, Affiliates, from time to time, come into possession of information about certain markets and investments which, if known to JPMIM, could cause JPMIM to seek to
dispose of, retain or increase interests in investments held by a Fund or acquire certain positions on behalf of a Fund. However, JPMorgan’s internal information barriers restrict JPMIM’s ability to access such information even when it
would be relevant to its management of the Funds. Such Affiliates can trade differently from the Funds potentially based on information not available to JPMIM. If JPMIM acquires or is deemed to acquire material non-public information regarding an
issuer, JPMIM will be restricted from purchasing or selling securities of that issuer for its clients, including a Fund, until the information has been publicly disclosed or is no longer deemed material. (Such an issuer could include an underlying
Fund in a Fund-of-Funds.)
Gifts and Entertainment. From time to time, employees of JPMIM receive gifts and/or entertainment from clients, intermediaries, or service providers to the Funds or JPMIM, which could have the appearance of affecting or may potentially affect
the judgment of the employees, or the manner in which they conduct business.
For details of the dollar range
of shares of each Fund beneficially owned by the portfolio managers, see “PORTFOLIO MANAGERS — Portfolio Managers’ Ownership of Securities” in Part I of this SAI.
PORTFOLIO MANAGER COMPENSATION
The Adviser’s portfolio
managers participate in a competitive compensation program that is designed to attract, retain and motivate talented people and closely link the performance of investment professionals to client investment objectives. The total compensation program
includes a base salary fixed from year to year and incentive compensation. Base salaries are reviewed annually and awarded based on individual performance and business results taking into account level and scope of position, experience and market
competitiveness. Incentive compensation consists of cash incentives and deferred compensation, which
includes Firm restricted stock units and/or mandatory notional
investments (as described below) in selected mutual funds advised by the Adviser or its affiliates (“Mandatory Investment Plan”). These elements reflect individual performance and the performance of the Adviser’s business as a
whole, amongst other factors.
Each portfolio manager’s
performance is formally evaluated annually based on a variety of factors including the aggregate size and blended performance of the portfolios such portfolio manager manages, individual contribution relative to client risk and return objectives,
and adherence with the Adviser’s compliance, risk and regulatory procedures. In evaluating each portfolio manager’s performance with respect to the mutual funds and/or ETFs he or she manages, a Fund’s pre-tax performance (or the
portion of the funds managed by the portfolio manager) is compared to the appropriate market peer group and to the Fund’s benchmark index listed in the Fund’s Prospectus over one, three and five year periods (or such shorter time as the
portfolio manager has managed the Fund). Investment performance is generally more heavily weighted to the long-term.
Deferred compensation granted
as part of an employee’s annual incentive compensation comprises from 0% to 60% of a portfolio manager’s total performance-based incentives. As the level of incentive compensation increases, the percentage of compensation awarded in
deferred incentives also increases. The Adviser’s portfolio managers are required to notionally invest 50% of their deferred compensation into the selected Funds they manage. The remaining portion of the non-cash incentive is elective and may
be notionally invested in any of the mutual funds available in the Mandatory Investment Plan or can be placed in restricted stock units. When these awards vest over time, the portfolio manager receives cash equal to the market value of the notional
investment in the selected mutual funds.
CODES OF ETHICS
The Trust, the Adviser and the
Distributor have each adopted codes of ethics pursuant to Rule 17j-1 under the 1940 Act (and pursuant to Rule 204A-1 under the Advisers Act with respect to the Adviser).
The Trust’s code of
ethics includes policies which require “access persons” (as defined in Rule 17j-1) to: (i) place the interest of Trust shareholders first; (ii) conduct personal securities transactions in a manner that avoids any actual or potential
conflict of interest or any abuse of a position of trust and responsibility; and (iii) refrain from taking inappropriate advantage of his or her position with the Trust or a Fund. The Trust’s code of ethics prohibits any access person from:
(i) employing any device, scheme or artifice to defraud the Trust or a Fund; (ii) making to the Trust or a Fund any untrue statement of a material fact or omit to state to the Trust or a Fund a material fact necessary in order to make the statements
made, in light of the circumstances under which they are made, not misleading; (iii) engaging in any act, practice, or course of business which operates or would operate as a fraud or deceit upon the Trust or a Fund; or (iv) engaging in any
manipulative practice with respect to the Trust or a Fund. The Trust’s code of ethics permits personnel subject to the code to invest in securities, including securities that may be purchased or held by a Fund so long as such investment
transactions are not in contravention of the above noted policies and prohibitions.
The code of ethics adopted by
the Adviser requires that all employees must: (i) place the interest of the accounts which are managed by the Adviser first; (ii) conduct all personal securities transactions in a manner that is consistent with the code of ethics and the individual
employee’s position of trust and responsibility; and (iii) refrain from taking inappropriate advantage of their position. Employees of the Adviser are also prohibited from certain mutual fund trading activity including excessive trading of
shares of a mutual fund and effecting or facilitating a mutual fund transaction to engage in market timing. The Adviser’s code of ethics permits personnel subject to the code to invest in securities, including securities that may be purchased
or held by a Fund subject to certain restrictions. However, all employees are required to preclear securities trades (except for certain types of securities such as non-proprietary mutual fund shares and U.S. government securities).
The Distributor’s code of
ethics requires that all employees of the Distributor must: (i) place the interest of the accounts which are managed by affiliates of the Distributor first; (ii) conduct all personal securities transactions in a manner that is consistent with the
code of ethics and the individual employee’s position of trust and responsibility; and (iii) refrain from taking inappropriate advantage of their positions. The Distributor’s code of ethics permits personnel subject to the code to invest
in securities, including securities that may be purchased or held by a Fund subject to the policies and restrictions in such code of ethics.
PORTFOLIO TRANSACTIONS
Investment Decisions and Portfolio Transactions
Pursuant to the JPMIM Advisory
Agreement, the Adviser determines, subject to the general supervision of the Board of Trustees of the Trust and in accordance with a Fund’s investment objective and restrictions, which securities are to be purchased and sold by a Fund and
which brokers are to be eligible to execute its portfolio transactions. The Adviser operates independently in providing services to their respective clients. Investment decisions are the product of many factors in addition to basic suitability for
the particular client involved. Thus, for example, a particular security may be bought or sold for certain clients even though it could have been bought or sold for other clients at the same time. Likewise, a particular security may be bought for
one or more clients when one or more other clients are selling the security. In some instances, one client may sell a particular security to another client. It also happens that two or more clients may simultaneously buy or sell the same security,
in which event each day’s transactions in such security are, insofar as possible, averaged as to price and allocated between such clients in a manner which in the opinion of the Adviser is equitable to each and in accordance with the amount
being purchased or sold by each. There may be circumstances when purchases or sales of portfolio securities for one or more clients will have an adverse effect on other clients.
Brokerage and Research Services
On behalf of a Fund, the
Adviser places orders for all purchases and sales of portfolio securities, enters into repurchase agreements, and may enter into reverse repurchase agreements and execute loans of portfolio securities on behalf of a Fund unless otherwise prohibited.
See “Investment Strategies and Policies.”
Fixed income and debt
securities and municipal bonds and notes are generally traded at a net price with dealers acting as principal for their own accounts without a stated commission. The price of the security usually includes profit to the dealers. In underwritten
offerings, securities are purchased at a fixed price, which includes an amount of compensation to the underwriter, generally referred to as the underwriter’s concession or discount. Transactions on stock exchanges (other than foreign stock
exchanges) involve the payment of negotiated brokerage commissions. Such commissions vary among different brokers. Also, a particular broker may charge different commissions according to such factors as the difficulty and size of the transaction.
Transactions in foreign securities generally involve payment of fixed brokerage commissions, which are generally higher than those in the U.S. On occasion, certain securities may be purchased directly from an issuer, in which case no commissions or
discounts are paid.
In
connection with portfolio transactions, the overriding objective is to obtain the best execution of purchase and sales orders. In making this determination, the Adviser considers a number of factors including, but not limited to: the price per unit
of the security, the broker’s execution capabilities, the commissions charged, the broker’s reliability for prompt, accurate confirmations and on-time delivery of securities, the broker-dealer firm’s financial condition, the
broker’s ability to provide access to public offerings, as well as the quality of research services provided. As permitted by Section 28(e) of the Securities Exchange Act, the Adviser may cause the Funds to pay a broker-dealer which provides
brokerage and research services to the Adviser, or the Funds and/or other accounts for which the Adviser exercises investment discretion an amount of commission for effecting a securities transaction for a Fund in excess of the amount other
broker-dealers would have charged for the transaction if the Adviser determines in good faith that the greater commission is reasonable in relation to the value of the brokerage and research services provided by the executing broker-dealer viewed in
terms of either a particular transaction or the Adviser’s overall responsibilities to accounts over which it exercises investment discretion. Not all such services are useful or of value in advising the Funds. The Adviser reports to the Board
of Trustees regarding overall commissions paid by the Funds and their reasonableness in relation to the benefits to the Funds. In accordance with Section 28(e) of the Securities Exchange Act and consistent with applicable SEC guidance and
interpretation, the term “brokerage and research services” includes (i) advice as to the value of securities; (ii) the advisability of investing in, purchasing or selling securities; (iii) the availability of securities or of purchasers
or sellers of securities; (iv) furnishing analyses and reports concerning issues, industries, securities, economic factors and trends, portfolio strategy and the performance of accounts; and (v) effecting securities transactions and performing
functions incidental thereto (such as clearance, settlement, and custody) or required by rule or regulation in connection with such transactions.
Brokerage and research
services received from such broker-dealers will be in addition to, and not in lieu of, the services required to be performed by an Adviser under the Advisory Agreement. The fees that the Funds pay to the Adviser are not reduced as a consequence of
the Adviser’s receipt of brokerage and research services. To the extent the Funds’ portfolio transactions are used to obtain such services, the brokerage commissions paid by the Funds may exceed those that might otherwise be paid by an
amount that cannot be presently determined. Such services generally would be useful and of value to the Adviser in serving one or more of its other clients and, conversely, such services obtained by the placement of brokerage business of other
clients generally would be useful to the Adviser in carrying out its obligations to the Funds. While such services are not expected to reduce the expenses of the Adviser, the Adviser would, through use of the services, avoid the additional expenses
that would be incurred if it should attempt to develop comparable information through its own staff.
Subject to the overriding
objective of obtaining the best execution of orders, the Adviser may allocate a portion of a Fund’s brokerage transactions to affiliates of the Adviser. Under the 1940 Act, persons affiliated with a Fund and persons who are affiliated with
such persons are prohibited from dealing with the Fund as principal in the purchase and sale of securities unless an exemptive order allowing such transactions is obtained from the SEC. The SEC has granted an exemptive order permitting each Fund to
engage in principal transactions with J.P. Morgan Securities LLC, an affiliated broker, involving taxable and tax exempt money market instruments (including commercial paper, banker acceptances and medium term notes) and repurchase agreements. The
orders are subject to certain conditions. An affiliated person of a Fund may serve as its broker in listed or over-the-counter 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 JPMorgan Chase Bank or an affiliate is a member or in a private placement in which JPMorgan Chase Bank or an affiliate serves as placement agent,
except pursuant to procedures adopted by the Board of Trustees that either comply with rules adopted by the SEC or with interpretations of the SEC’s staff. Each Fund expects to purchase securities from underwriting syndicates of which certain
affiliates of JPMorgan Chase act as a member or manager. Such purchases will be effected in accordance with the conditions set forth in Rule 10f-3 under the 1940 Act and related procedures adopted by the Trustees, including a majority of the
Trustees who are not “interested persons” of a Fund. Among the conditions are that the issuer of any purchased securities will have been in operation for at least three years, that not more than 25% of the underwriting will be purchased
by a Fund and all other accounts over which the same investment adviser has discretion, and that no shares will be purchased from the Distributor or any of its affiliates.
On those occasions when the
Adviser deems the purchase or sale of a security to be in the best interests of a Fund as well as other customers, including other Funds, the Adviser, to the extent permitted by applicable laws and regulations, may, but is not obligated to,
aggregate the securities to be sold or purchased for a Fund with those to be sold or purchased for other customers in order to obtain best execution, including lower brokerage commissions if appropriate. In such event, allocation of the securities
so purchased or sold as well as any expenses incurred in the transaction will be made by the Adviser in the manner it considers to be most equitable and consistent with its fiduciary obligations to its customers, including the Funds. In some
instances, the allocation procedure might not permit a Fund to participate in the benefits of the aggregated trade.
If a Fund that writes options
effects a closing purchase transaction with respect to an option written by it, normally such transaction will be executed by the same broker-dealer who executed the sale of the option. The writing of options by a Fund will be subject to limitations
established by each of the exchanges governing the maximum number of options in each class which may be written by a single investor or group of investors acting in concert, regardless of whether the options are written on the same or different
exchanges or are held or written in one or more accounts or through one or more brokers. The number of options that a Fund may write may be affected by options written by the Adviser for other investment advisory clients. An exchange may order the
liquidation of positions found to be in excess of these limits, and it may impose certain other sanctions.
Allocation of transactions,
including their frequency, to various broker-dealers is determined by a Fund’s Adviser based on its best judgment and in a manner deemed fair and reasonable to Shareholders and consistent with the Adviser’s obligation to obtain the best
execution of purchase and sales orders. In making this determination, the Adviser considers the same factors for the best execution of purchase and sales orders listed above. Accordingly, in selecting broker-dealers to execute a particular
transaction, and in
evaluating the best overall terms available, the Adviser is
authorized to consider the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act) provided to the Funds and/or other accounts over which the Adviser exercises investment discretion. The Adviser
may cause a Fund to pay a broker-dealer that furnishes brokerage and research services a higher commission than that which might be charged by another broker-dealer for effecting the same transaction, provided that the Adviser determines in good
faith that such commission is reasonable in relation to the value of the brokerage and research services provided by such broker-dealer, viewed in terms of either the particular transaction or the overall responsibilities of the Adviser to the
Funds. To the extent such services are permissible under the safe harbor requirements of Section 28(e) of the Securities Exchange Act and consistent with applicable SEC guidance and interpretation, such brokerage and research services might consist
of advice as to the value of securities, the advisability of investing in, purchasing, or selling securities, the availability of securities or purchasers or sellers of securities; analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of accounts, market data, stock quotes, last sale prices, and trading volumes. Shareholders of the Funds should understand that the services provided by such brokers may be useful
to the Adviser in connection with its services to other clients and not all the services may be used by the Adviser in connection with the Fund.
Under the policy for JPMIM,
“soft dollar” services refer to arrangements that fall within the safe harbor requirements of Section 28(e) of the Securities Exchange Act, as amended, which allow JPMIM to allocate client brokerage transactions to a broker-dealer in
exchange for products or services that are research and brokerage-related and provide lawful and appropriate assistance in the performance of the investment decision-making process. These services include third party research, market data services,
and proprietary broker-dealer research. The Funds receive proprietary research where broker-dealers typically incorporate the cost of such research into their commission structure. Many brokers do not assign a hard dollar value to the research they
provide, but rather bundle the cost of such research into their commission structure. It is noted in this regard that some research that is available only under a bundled commission structure is particularly important to the investment process.
However, the Funds do not participate in soft dollar arrangements for market data services and third-party research.
Investment decisions for each
Fund are made independently from those for the other Funds or any other investment company or account managed by the Adviser. Any such other investment company or account may also invest in the same securities as the Trust. When a purchase or sale
of the same security is made at substantially the same time on behalf of a given Fund and another investment company or account, the transaction will be averaged as to price, and available investments allocated as to amount, in a manner which the
Adviser of the given Fund believes to be equitable to the Fund(s) and such other investment company or account. In some instances, this procedure may adversely affect the price paid or received by a Fund or the size of the position obtained by a
Fund. To the extent permitted by law, the Adviser may aggregate the securities to be sold or purchased by it for a Fund with those to be sold or purchased by it for other Funds or for other investment companies or accounts in order to obtain best
execution. In making investment recommendations for the Trust, the Adviser will not inquire or take into consideration whether an issuer of securities proposed for purchase or sale by the Trust is a customer of the Adviser or their parents or
subsidiaries or affiliates and in dealing with its commercial customers, the Adviser and their respective parent, subsidiaries, and affiliates will not inquire or take into consideration whether securities of such customers are held by the
Trust.
Effective January
2018, pursuant to the second Markets in Financial Instruments Directive (“MiFID II”), investment managers in the European Union (“EU”), including a segment of the operations of the Adviser, are required to either pay for
research out of their own resources or agree with clients to have research costs paid by clients through research payment accounts that are funded out of trading commissions or by a specific client research charge, provided that the payments for
research are unbundled from the payments for execution. Where such a restriction applies, the Adviser will pay for any research out of its own resources and not through soft dollars. Additionally, MiFID II may have practical ramifications outside
the EU. For example, U.S. asset managers acting under the delegated authority of an EU-based asset manager and U.S. asset managers that are part of a global asset management group with one or more EU affiliates may, in practice, have to restructure
the way they procure, value and pay for research under U.S. laws and regulations to more closely align with the requirements under MiFID II. It is difficult to predict the full impact of MiFID II on the Funds, the Adviser and any sub-advisers, but
it could increase the overall costs of entering into investments, increase the overall price of research and/or reduce access to research.
Portfolio Trading by Authorized Participants
When creation or redemption
transactions consist of cash, the transactions may require a Fund to contemporaneously transact with broker-dealers for purchases or sales of portfolio securities, as applicable. Depending on the timing of the transactions and certain other factors,
such transactions may be placed with the purchasing or redeeming Authorized Participant in its capacity as a broker-dealer or with its affiliated broker-dealer and conditioned upon an agreement with the Authorized Participant or its affiliated
broker-dealer to transact at guaranteed prices in order to reduce transaction costs incurred as a consequence of settling creations or redemptions in cash rather than in-kind.
Specifically, following a
Fund’s receipt of a creation or redemption order, to the extent such purchases or redemptions consist of a cash portion, the Fund may enter an order with the Authorized Participant or its affiliated broker-dealer to purchase or sell the
portfolio securities, as applicable. Such Authorized Participant or its affiliated broker-dealer will be required to guarantee that the Fund will achieve execution of its order at a price at least as favorable to the Fund as the Fund’s
valuation of the portfolio securities used for purposes of calculating the NAV applied to the creation or redemption transaction giving rise to the order. Whether the execution of the order is at a price at least as favorable to the Fund will depend
on the results achieved by the executing firm and will vary depending on market activity, timing and a variety of other factors.
An Authorized Participant is
required to deposit an amount with the Fund in order to ensure that the execution of the order on the terms noted above will be honored on orders arising from creation transactions executed by an Authorized Participant or its affiliate as
broker-dealer. If the broker-dealer executing the order achieves executions in market transactions at a price equal to or more favorable than a Fund’s valuation of the portfolio securities, the Fund receives the benefit of the favorable
executions and the deposit is returned to the Authorized Participant. If, however, the broker-dealer executing the order is unable to achieve a price at least equal to a Fund’s valuation of the securities, the Fund retains the portion of the
deposit equal to the full amount of the execution shortfall (including any taxes, brokerage commissions or other costs) and may require the Authorized Participant to deposit any additional amount required to cover the full amount of the actual
execution transaction.
An
Authorized Participant agrees to pay the shortfall amount in order to ensure that a guarantee on execution will be honored for brokerage orders arising from redemption transactions executed by an Authorized Participant or its affiliate as
broker-dealer. If the broker-dealer executing the order achieves executions in market transactions at a price equal to or more favorable than the Fund’s valuation of the portfolio securities, the Fund receives the benefit of the favorable
executions. If, however, the broker-dealer is unable to achieve executions in market transactions at a price at least equal to the Fund’s valuation of the securities, the Fund will be entitled to the portion of the offset equal to the full
amount of the execution shortfall (including any taxes, brokerage commissions or other costs).
For details of brokerage commissions
paid by the Funds, see “BROKERAGE AND RESEARCH SERVICES — Brokerage Commissions” in Part I of this SAI.
For details of the Funds’
ownership of securities of the Funds’ regular broker dealers, see “BROKERAGE AND RESEARCH SERVICES — Securities of Regular Broker-Dealers” in Part I of this SAI.
ADMINISTRATOR
Prior to
November 1, 2019, JPMIM1 served as the administrator to the Funds, except the BetaBuilders 1-5 Year U.S. Aggregate Bond ETF and the BetaBuilders U.S.
Equity ETF, pursuant to an Administration Agreement (the “Administration Agreement”), between the Trust, on behalf of each Fund, and JPMIM. Under the Administration Agreement, JPMIM provided administrative services that were
substantially similar to the administrative services now provided under the JPMIM Management Agreement (refer to the “INVESTMENT ADVISER — JPMIM Management Agreement” section of the SAI Part
II for additional information).
For details of the administration
fees paid or accrued prior to November 1, 2019, see “ADMINISTRATOR—Administrator Fees” in Part I of the SAI for the applicable Fund.
1
|
JPMorgan Funds
Management, Inc., the former Administrator, was merged with and into JPMIM effective April 1, 2016.
|
DISTRIBUTOR
Shares will be continuously
offered for sale by the Distributor only. The Distributor will deliver the Prospectus and, upon request, this SAI to persons purchasing Creation Unit Aggregations and will maintain records of both orders placed with it and confirmations of
acceptance furnished by it. The Distributor, an indirect, wholly owned subsidiary of JPMorgan Chase, is a broker-dealer registered under the Securities Exchange Act and a member of the Financial Industry Regulatory Authority (“FINRA”).
Although the Distributor does not receive any fees under the Distribution Agreement with the Trust, JPMIM pays the Distributor for certain distribution related services.
Unless otherwise terminated,
the Distribution Agreement will continue in effect for successive one-year terms after the initial two year term if approved at least annually by: (a) the vote of the Board of Trustees, including the vote of a majority of those members of the Board
of Trustees who are not parties to the Distribution Agreement or interested persons of any such party, cast in person at a meeting for the purpose of voting on such approval, or (b) the vote of a majority of the outstanding voting securities of the
Fund. The Distribution Agreement for the Funds provides that it may be terminated as to a Fund at any time, without the payment of any penalty (i) by vote of the Trustees; (ii) by vote of a majority of the outstanding voting securities (as defined
in the 1940 Act) of the Fund; or (iii) by the Distributor upon not less than 60 days’ prior written notice to the Trust. The Distribution Agreement will terminate automatically in the event of its assignment (as defined in the 1940 Act).
The Distributor may also enter
into agreements with securities dealers (“Soliciting Dealers”) who will solicit purchases of Creation Unit Aggregations of Fund Shares. Such Soliciting Dealers may also be Participating Parties (as defined in “Procedures for
Creation of Creation Unit Aggregations” below) and DTC Participants (as defined in “DTC Acts as Securities Depository” below).
CUSTODIAN
Pursuant to the Global Custody
and Fund Accounting Agreement with JPMorgan Chase Bank, 383 Madison Avenue, New York, New York 10179 (the “JPMorgan Custody Agreement”), JPMorgan Chase Bank serves as the custodian and fund accounting agent for each Fund. Pursuant to the
JPMorgan Custody Agreement, JPMorgan Chase Bank is responsible for holding portfolio securities and cash and maintaining the books of account and records of portfolio transactions. JPMorgan Chase Bank is an affiliate of the Adviser, the
Administrator and the Distributor.
With respect the Diversified
Alternatives ETF and Managed Futures Strategy ETF, JPMorgan Chase Bank serves as custodian for both the Fund’s and the Subsidiary’s portfolio securities and cash, and in that capacity, maintains certain financial accounting books and
records pursuant to agreements with the Fund and the Subsidiary.
CUSTODY AND FUND ACCOUNTING FEES AND EXPENSES
Fees prior to December 1, 2019
For custodian services prior to
December 1, 2019, JPMorgan Chase Bank was paid annual safekeeping fees of between 0.0006% and 0.35% of a Fund’s assets held by JPMorgan Chase Bank (depending on the domicile in which the asset is held), calculated monthly in arrears and fees
between $2.50 and $80 for securities trades (depending on the domicile in which the trade is settled), as well as transaction fees on certain activities of $2.50 to $20 per transaction. JPMorgan Chase Bank is also reimbursed for its reasonable
out-of-pocket or incidental expenses, including, but not limited to, registration and transfer fees and related legal fees.
JPMorgan Chase Bank may also
be paid $15, $35 or $60 per proxy (depending on the country where the issuer is located) for its service which helps facilitate the voting of proxies throughout the world. For securities in the U.S. market, this fee is waived if the Adviser votes
the proxies directly.
With respect
to fund accounting services, the following schedule was employed in the calculation of the fees payable for the services provided under the JPMorgan Custody Agreement. For purposes of determining the asset levels at which a tier applies, assets for
all the Funds (including any Cayman subsidiaries) were used.
Tier
One
|
First
$75 billion
|
0.0025%
|
Tier
Two
|
Next
$25 billion
|
0.0020%
|
Tier
Three
|
Over
$100 billion
|
0.0015%
|
|
|
|
Other
Fees:
|
|
|
Annual
Base Fee (in addition to asset based fee)
|
|
$20,000
per Fund
|
In addition,
JPMorgan Chase Bank provides derivative servicing. The fees for these services include a transaction fee of $5 or $75 per new contract (depending on whether the transaction is electronic or manual), a fee of up to $5 or $75 per contract amendment
(including transactions such as trade amendments, cancellations, terminations, novations, option exercises, option expiries, maturities or credit events) and a daily fee of $1.00 per contract for position management services. In addition, JPMorgan
Chase Bank was paid a fee of $3.00 to $12.25 per day for the valuation of the derivative positions covered by these services.
Pursuant to an arrangement with
JPMorgan Chase Bank, custodian fees may be reduced by amounts calculated as a percentage of uninvested balances for certain Funds.
A Fund and/or its Cayman
subsidiary, as applicable, may at times hold some of their assets in cash, which may subject the Fund and/or the Cayman subsidiary, as applicable, to additional risks and costs, such as increased credit exposure to the custodian bank and fees
imposed for cash balances. Cash positions may also hurt a Fund’s and/or the Cayman subsidiary’s performance.
Beginning
November 1, 2019, JPMIM is responsible for paying the fees under the JPMorgan Custody Agreement to JPMorgan Chase Bank.
Fees Beginning December 1, 2019
For custodian services
beginning December 1, 2019, JPMorgan Chase Bank will be paid annual safekeeping fees of between 0.0005% and 0.50% of a Fund’s assets held by JPMorgan Chase Bank (depending on the domicile in which the asset is held), calculated monthly in
arrears and fees between $2.25 and $100 for securities trades (depending on the domicile in which the trade is settled), as well as additional transaction fees on certain activities of $2.25 to $50 per transaction. JPMorgan Chase Bank is also
reimbursed for its reasonable out-of-pocket or incidental expenses, including, but not limited to, registration and transfer fees and related legal fees.
JPMorgan Chase Bank may also be
paid for the following additional custody services:
•
|
$15 or $45 per
proxy (depending on the country where the issuer is located) for its service which helps facilitate the voting of proxies throughout the world. For securities in the U.S. market, this fee is waived if the Adviser votes the proxies directly;
|
•
|
$2,000 per year
for account maintenance for each custody collateral control account;
|
•
|
$2.25 or $15 for
income or redemption processing (depending on whether the security is held book entry or physically); and
|
•
|
$2.50
to $53.50 for each cash payment or receipt transaction.
|
With respect to fund accounting
services, the following schedule shall be employed in the calculation of the fees payable for the services provided under the JPMorgan Custody Agreement. For purposes of determining the asset levels at which a tier applies, assets for all the Funds
(including any Cayman subsidiaries) shall be used.
Tier
One
|
Up
to $50 billion
|
0.0030%
|
Tier
Two
|
Next
$75 billion
|
0.0025%
|
Tier
Three
|
Over
$125 billion
|
0.0015%
|
Other
Fees:
|
|
|
Minimum
|
|
$22,500
per Fund per year
|
In addition, JPMorgan Chase
Bank provides additional servicing for certain types of more complex assets. The fees for these services include a transaction fee of $50 for each manual trade and an annual fee of $500 for each bank loan position held by a Fund. In addition,
JPMorgan Chase Bank will be paid fees of $0.50 to $4.50 per position per day for the valuation and processing of certain asset positions covered by these services.
If agreed-upon by the Trust and
JPMorgan Chase Bank, custodian fees may, from time to time, be reduced by amounts calculated as a percentage of uninvested balances for certain Funds.
A Fund
and/or its Cayman subsidiary, as applicable, may at times hold some of their assets in cash, which may subject the Fund and/or the Cayman subsidiary, as applicable, to additional risks and costs, such as increased credit exposure to the custodian
bank and fees imposed for cash balances. Cash positions may also hurt a Fund’s and/or the Cayman subsidiary’s performance.
JPMIM will be responsible for
paying the fees under the JPMorgan Custody Agreement to JPMorgan Chase Bank.
TRANSFER AGENT
JPMorgan Chase Bank also
serves as the Funds’ transfer agent. As transfer agent, JPMorgan Chase Bank is also responsible for maintaining account records, detailing the ownership of Fund shares and for crediting income, capital gains and other changes in share
ownership to shareholder accounts. JPMorgan Chase Bank will be paid $250 per creation or redemption transaction. The Trust may be reimbursed for all or part of this fee by the Authorized Participant placing the creation or redemption order.
JPMIM is
responsible for paying the fees under this agreement to JPMorgan Chase Bank.
SECURITIES LENDING AGENT
To generate additional income,
the Funds may lend up to 33 1⁄3% of their total assets pursuant to agreements
(“Borrower Agreements”) requiring that the loan be continuously secured by cash. Citibank serves as securities lending agent pursuant to the Securities Lending Agency Agreement effective June 18, 2018, as amended from time to time. For
Funds that engaged in securities lending during the last fiscal year, information concerning the amounts of income and fees/compensation related to securities lending activities for the Fund’s most recent fiscal year is include in Part I under
Securities Lending Activities. The remaining Funds did not engage in securities lending during the last fiscal year. To the extent that the Funds engage in securities lending during the current fiscal year,
information concerning the amounts of income and fees/compensation related to securities lending activities will be included in the SAI in the Funds’ next annual update to its registration statement.
Under the Securities Lending
Agency Agreement, Citibank acting as agent for the Funds, loans securities to approved borrowers pursuant to Borrower Agreements substantially in the form approved by the Board of Trustees in exchange for collateral. During the term of the loan, the
Fund receives payments from borrowers equivalent to the dividends and interest that would have been earned on securities lent while simultaneously seeking to earn loan fees and income on the investment of cash collateral in accordance with
investment guidelines contained in the Securities Lending Agency Agreement. The Fund retains loan fees and the interest on cash collateral investments but is required to pay the borrower a rebate for the use of cash collateral. In cases where the
lent security is of high value to borrowers, there may be a negative rebate (i.e., a net payment to the Funds). The net income earned on the securities lending (after payment of rebates and the lending agent’s fee) is included in the Statement
of Operations as income from securities lending (net in the Fund’s financial statements). Information on the investment of cash collateral is shown in the Schedule of Portfolio Investments (in the Fund’s financial statements).
Under the Securities Lending
Agency Agreement, Citibank is entitled to (i) a fee equal to 8% of the investment income (net of rebates) on cash collateral delivered to Citibank on the Fund’s behalf in respect of any loans by the Borrowers; and (ii) fees paid by a Borrower
with respect to a loan for which non-cash collateral is provided (to the extent that the Funds subsequently authorize Citibank to accept non-cash collateral for securities loans).
EXPENSES
Prior to the
adoption of the Management Agreement by the Funds, the Funds paid the expenses incurred in their operations, including their pro-rata share of expenses of the Trust. These expenses include: investment advisory and administrative fees; the
compensation of the Trustees; registration fees; interest charges; taxes; expenses connected with the execution, recording and settlement of security transactions; fees and expenses of the Funds’ custodian for all services to the Funds,
including safekeeping of funds and securities and maintaining required books and accounts; expenses of preparing and mailing reports to investors and to government offices and commissions; expenses of meetings of investors; listing fees; fees and
expenses of independent accountants, legal counsel and any transfer agent, registrar or dividend disbursing agent of the Trust; insurance premiums; and expenses of calculating the NAV of, and the net income on, shares of the Funds. With the adoption
of the Management Agreement as described
above, JPMIM is responsible for substantially all of the
expenses of the Trust relating to each Fund and each Fund’s expenses. Service providers to the Funds may, from time to time, voluntarily waive all or a portion of any fees to which they are entitled.
The Adviser may agree that it will
waive fees or reimburse the Funds as may be described in the Funds’ Prospectuses.
COMPENSATION TO INTERMEDIARIES
JPMIM and/or its affiliates
(“JPMorgan Entities”) may pay certain broker-dealers, banks and other financial intermediaries (“Intermediaries”) for certain activities related to the Funds (“Compensation”). Any Compensation by JPMorgan Entities
will be paid at their own expense out of their legitimate profits and not from the assets of the Funds. Although a portion of JPMorgan Entities’ revenue comes directly or indirectly in part from fees paid by the Funds, Compensation does not
increase the price paid by investors for the purchase of Shares of, or the cost of owning, a Fund. JPMorgan Entities may pay Compensation for Intermediaries’ participating in activities that are designed to make registered representatives,
other professionals and individual investors more knowledgeable about the Funds or for other activities, such as participation in marketing activities and presentations, educational training programs, the support of technology platforms and/or
reporting systems. In addition, JPMorgan Entities may pay Compensation to Intermediaries that make Shares available to their clients or for otherwise promoting the Funds. These may include Compensation to Intermediaries that agree not to charge
their customers any trading commissions when those customers purchase or sell shares of the Funds online and/or that promote the availability of commission-free ETF trading to their customers. Compensation payments of this type are sometimes
referred to as revenue-sharing payments. Compensation will only be paid to the Intermediary, never to individuals other than occasional gifts and entertainment that are permitted by rules of the Financial Industry Regulatory Authority (also known as
FINRA). JPMIM has entered into written agreements to pay Compensation to Charles Schwab & Co., Inc., E*TRADE Saving Bank (d/b/a TCA by E*TRADE), E*TRADE Securities LLC, CLS Investments, LLC, Morgan Stanley Smith Barney LLC, TD Ameritrade, Inc.,
Fidelity Brokerage Services LLC and National Financial Services LLC.
The JPMorgan Entities may be
motivated to pay Compensation to promote the purchase of Fund shares by clients of Intermediaries and the retention of those investments by those clients. To the extent clients of Intermediaries purchase more shares of the Funds or retain shares of
the Funds in their clients’ accounts, the JPMorgan Entities benefit from the incremental management and other fees paid by the Funds with respect to those assets.
Compensation to an
Intermediary may be significant to the Intermediary, and amounts that Intermediaries pay to your salesperson or other investment professional may also be significant for your salesperson or other investment professional. Because an Intermediary may
make decisions about which investment options it will recommend or make available to its clients or what services to provide for various products based on payments it receives or is eligible to receive, Compensation creates conflicts of interest
between the Intermediary and its clients and these financial incentives may cause the Intermediary to recommend the Funds over other investments. The same conflict of interest exists with respect to your salesperson or other investment professional
if he or she receives similar payments from his or her Intermediary firm.
JPMorgan Entities may
determine to pay Compensation based on any number of metrics. For example, JPMorgan Entities may pay Compensation at year-end or other intervals in a fixed amount, an amount based upon an Intermediary’s services at defined levels or an amount
based on the Intermediary’s net sales of one or more Funds in a year or other period or calculated in basis points based on average net assets attributed to the Intermediary. Please contact your salesperson or other investment professional or
visit the Intermediary’s website for more information regarding any Compensation his or her Intermediary firm may receive. Any Compensation paid by the JPMorgan Entities to an Intermediary may create the incentive for an Intermediary to
encourage customers to buy shares of the Funds.
TRUST COUNSEL
The law firm of Dechert LLP, 1095
Avenue of the Americas, New York, NY 10036-6797, is counsel to the Trust.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The independent registered
public accounting firm for the Trust and the Funds is PricewaterhouseCoopers LLP (“PWC”), 300 Madison Avenue, New York NY 10017. PWC conducts an annual audit of the financial statements of each of the Funds and assists in the preparation
and/or review of each Fund’s federal and state income tax returns.
DIVIDENDS AND DISTRIBUTIONS
Each Fund declares and pays
dividends and distributions as described under “Distribution and Tax Matters” in the Prospectuses.
NET ASSET VALUE
The NAV per share of a Fund is
equal to the value of all the assets, minus the liabilities, divided by the number of outstanding shares. NAV of each Fund is calculated each business day as of the close of the New York Stock Exchange (“NYSE”) which is typically 4:00
p.m. ET. On occasion, the NYSE will close before 4:00 p.m. ET. When that happens, NAV will be calculated as of the time the NYSE closes. The Funds will not treat an intraday unscheduled disruption or closure in NYSE trading as a closure of the NYSE
and will calculate NAV as of 4:00 p.m. ET if the particular disruption or closure directly affects only the NYSE. The following is a discussion of the procedures used by a Fund in valuing its assets.
Securities for which market
quotations are readily available are generally valued at their current market value. Other securities and assets, including securities for which market quotations are not readily available; market quotations are determined not to be reliable; or,
their value has been materially affected by events occurring after the close of trading on the exchange or market on which the security is principally traded (for example, a natural disaster affecting an entire country or region, or an event that
affects an individual company) but before a Fund’s NAV is calculated, may be valued at its fair value in accordance with policies and procedures adopted by the Trust’s Board of Trustees. Fair value represents a good faith determination
of the value of a security or other asset based upon specifically applied procedures. Fair valuation determinations may require subjective determinations. There can be no assurance that the fair value of an asset is the price at which the asset
could have been sold during the period in which the particular fair value was used in determining the Fund’s NAV.
Equity securities listed on a
North American, Central American, South American or Caribbean (“Americas”) securities exchange are generally valued at the last sale price on the exchange on which the security is principally traded that is reported before the time when
the net assets of a Fund are valued. The value of securities listed on the NASDAQ Stock Market, Inc. is generally the NASDAQ official closing price.
Generally, trading of foreign
securities on most foreign markets is completed before the close in trading in U.S. markets. The Funds have implemented fair value pricing on a daily basis for all equity securities other than Americas equity securities. The fair value pricing
utilizes the quotations of an independent pricing service. Trading on foreign markets may also take place on days on which the U.S. markets and the Funds are closed.
Shares of exchange-traded funds
(ETFs) are generally valued at the last sale price on the exchange on which the ETF is principally traded. Shares of open-end mutual funds are valued at their respective NAVs.
Fixed income securities are
valued using market quotations supplied by approved independent third party pricing services, affiliated pricing services or broker/dealers. In determining security prices, pricing services and broker/dealers may consider a variety of inputs and
factors, including, but not limited to proprietary models that may take into account market transactions in securities with comparable characteristics, yield curves, option-adjusted spreads, credit spreads, estimated default rates, coupon rates,
underlying collateral and estimated cash flows.
Assets and liabilities initially
expressed in foreign currencies will be converted into U.S. dollars at the prevailing market rates from an approved independent pricing service as of 4:00 PM ET.
Options (e.g., on stock
indices or equity securities) traded on U.S. equity securities exchanges are valued at the composite mean price, using the National Best Bid and Offer quotes at the close of options trading on such exchanges.
Options traded on foreign
exchanges or U.S. commodities exchanges are valued at the settled price, or if no settled price is available, at the last sale price available prior to the calculation of a Fund’s NAV and will be fair valued by applying fair value factor
provided by independent pricing services, as applicable, for any options involving equity reference obligations listed on exchanges other than North American, Central American, South American or Caribbean securities exchanges.
Exchange traded futures (e.g.,
on stock indices, debt securities or commodities) are valued at the settled price, or if no settled price is available, at the last sale price as of the close of the exchanges on which they trade. Any futures involving equity reference obligations
listed on exchanges other than North American, Central American, South American or Caribbean securities exchanges will be fair valued by applying fair value factor provided by independent pricing services, as applicable.
Non-listed over-the-counter
options and futures are valued utilizing market quotations provided by approved pricing service.
Swaps and structured notes are
priced generally by an approved independent third party or affiliated pricing service or at an evaluated price provided by a counterparty or broker/dealer.
Any derivatives involving
equity reference obligations listed on exchanges other than North American, Central American, South American or Caribbean securities exchanges will be fair valued by applying fair value factor provided by independent pricing services, as
applicable.
Certain
fixed income securities and swaps may be valued using market quotations or valuations provided by pricing services affiliated with the Adviser. Valuations received by a Fund from affiliated pricing services are the same as those provided to other
affiliated and unaffiliated entities by these affiliated pricing services.
Securities or other assets for
which market quotations are not readily available or for which market quotations do not represent the value at the time of pricing (including certain illiquid securities) are fair valued in accordance with procedures established by and under the
supervision and responsibility of the Trustees. The Board of Trustees has established an Audit and Valuation Committee to assist the Board of Trustees in its oversight of the valuation of the Fund’s securities. The Fund’s Administrator
has created a Valuation Committee (“VC”) to (1) make fair value determinations in certain predetermined situations as outlined in the procedures approved by the Board of Trustees and (2) provide recommendations to the Board of
Trustee’s in other situations. The VC includes senior representatives from the Fund’s management as well as the Fund’s investment adviser. Fair value situations could include, but are not limited to: (1) a significant event that
affects the value of a Fund’s securities (e.g., news relating to natural disasters affecting an issuer’s operations or earnings announcements); (2) illiquid securities; (3) securities that may be defaulted or de-listed from an exchange
and are no longer trading; or (4) any other circumstance in which the VC believes that market quotations do not accurately reflect the value of a security.
From time to time, there may be
errors in the calculation of the NAV of the Fund or the processing of creations and redemptions. Shareholders will generally not be notified of the occurrence of an error or the resolution thereof.
DELAWARE TRUST
The Trust was formed as a Delaware
statutory trust on February 25, 2010 pursuant to a Declaration of Trust.
Under Delaware law,
shareholders of a statutory trust shall have the same limitation of personal liability that is extended to stockholders of private corporations for profit organized under Delaware law, unless otherwise provided in the trust’s governing trust
instrument. The Trust’s Declaration of Trust provides that shareholders of the Trust shall not be personally liable for the debts, liabilities, obligations and expenses incurred by, contracted for, or otherwise existing with respect to the
Trust or any series thereof. In addition, the Declaration of Trust provides that neither the Trust, nor the Trustees, officers, employees, nor agents thereof shall have any power to bind personally any shareholders nor to call upon any shareholder
for payment of any sum of money or assessment other than such as the shareholder may personally agree to pay. Moreover, the Trust’s Declaration of Trust expressly provides that the shareholders shall have the same limitation of personal
liability that is extended to shareholders of a private corporation for profit organized under the General Corporation Law of in the State of Delaware.
The Trust’s Declaration
of Trust provides for the indemnification out of the assets held with respect to a particular series of shares of any shareholder or former shareholder held personally liable solely by reason of a claim or demand relating to the person being or
having been a shareholder and not because of
the shareholder’s acts or omissions. The Trust’s
Declaration of Trust also provides that the Trust, on behalf of the applicable series, may, at its option with prior written notice, assume the defense of any claim made against a shareholder.
The Trust’s Declaration
of Trust provides that the Trust will indemnify its Trustees and officers against liabilities and expenses incurred in connection with any proceeding in which they may be involved because of their offices with the Trust, unless, as to liability to
the Trust or the shareholders thereof, the Trustees engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of their offices. In addition, the Declaration of Trust provides that any
Trustee who has been determined to be an “audit committee financial expert” shall not be subject to a greater liability or duty of care because of such determination.
The Trust shall continue
without limitation of time subject to the provisions in the Declaration of Trust concerning termination by action of the shareholders or by action of the Trustees upon written notice to the shareholders.
DESCRIPTION OF SHARES
The Trust is an open-end,
management investment company organized as a Delaware statutory trust. Each Fund represents a separate series of shares of beneficial interest. See “Delaware Trust.”
The Trust’s Declaration
of Trust permits the Trustees to issue an unlimited number of full and fractional shares (par value $0.0001 per share (or such other value as the Trustees may determine from time to time)) of one or more series and classes within any series and to
divide or combine the shares of any series or class without materially changing the proportionate beneficial interest of such shares of such series or class in the assets held with respect to that series. Each share represents an equal beneficial
interest in the net assets of a Fund with each other share of that Fund. The Trustees of the Trust may authorize the issuance of shares of additional series and the creation of classes of shares within any series with such preferences, voting
powers, rights, duties and privileges as the Trustees may determine; however, the Trustees may not classify or change outstanding shares in a manner materially adverse to shareholders of each share. Upon liquidation of a Fund, shareholders are
entitled to share pro rata in the net assets of a Fund available for distribution to such shareholders. The rights of redemption and exchange are described in the Prospectus and elsewhere in this SAI.
The shareholders of a Fund are
entitled to one vote for each dollar of NAV (or a proportionate fractional vote with respect to the remainder of the NAV of shares, if any), on matters on which shares of a Fund shall be entitled to vote. Subject to the 1940 Act, the Trustees
themselves have the power to alter the number and the terms of office of the Trustees, to lengthen their own terms, or to make their terms of unlimited duration subject to certain removal procedures, and appoint their own successors, provided,
however, that immediately after such appointment the requisite majority of the Trustees have been elected by the shareholders. The voting rights of shareholders are not cumulative with respect to the election of Trustees. It is the intention of the
Trust not to hold meetings of shareholders annually. The Trustees may call meetings of shareholders for action by shareholder vote as may be required by either the 1940 Act or the Declaration of Trust of the Trust.
Each share of a series
represents an equal proportionate interest in the assets in that series with each other share of that series. The shares of each series participate equally in the earnings, dividends and assets of the particular series. Expenses of the Trust which
are not attributable to a specific series are allocated among all of their series in a manner deemed by the Trustees to be fair and equitable. Shares have no pre-emptive or conversion rights, and when issued, are fully paid and non-assessable.
Shares of each series generally vote together, except when required under federal securities laws to vote separately on matters that may affect a particular class, such as the approval of distribution plans for a particular class.
The Trustees of the Trust may,
without shareholder approval (unless otherwise required by applicable law): (i) cause the Trust to merge or consolidate with or into one or more trusts (or series thereof to the extent permitted by law, partnerships, associations, corporations or
other business entities (including trusts, partnerships, associations, corporations, or other business entities created by the Trustees to accomplish such merger or consolidation) so long as the surviving or resulting entity is an investment company
as defined in the 1940 Act, or is a series thereof, that will succeed to or assume the Trust’s registration under the 1940 Act and that is formed, organized, or existing under the laws of the U.S. or of a state, commonwealth, possession or
territory of the U.S., unless otherwise permitted under the 1940 Act; (ii) cause the shares to be exchanged under or pursuant to any state or federal statute to the extent
permitted by law; or (iii) cause the Trust to reorganize as a
corporation, limited liability company or limited liability partnership under the laws of Delaware or any other state or jurisdiction. However, the exercise of such authority may be subject to certain restrictions under the 1940 Act.
The Trustees may, without
shareholder vote, generally restate, amend or otherwise supplement the Trust’s governing instruments, including the Declaration of Trust and the By-Laws, without the approval of shareholders, subject to limited exceptions, such as the right to
elect Trustees.
The
Trustees, without obtaining any authorization or vote of shareholders, may change the name of any series or dissolve or terminate any series.
Shares have no subscription or
preemptive rights and only such conversion or exchange rights as the Board may grant in its discretion. When issued for payment as described in the Prospectus and this SAI, Shares will be fully paid and non-assessable. In the event of a liquidation
or dissolution of the Trust, Shares of a Fund are entitled to receive the assets available for distribution belonging to the Fund, and a proportionate distribution, based upon the relative asset values of a Fund, of any general assets not belonging
to any particular Fund which are available for distribution.
Rule 18f-2 under the 1940 Act
provides that any matter required to be submitted to the holders of the outstanding voting securities of an investment company such as the Trust shall not be deemed to have been effectively acted upon unless approved by the holders of a majority of
the outstanding Shares of a Fund affected by the matter. For purposes of determining whether the approval of a majority of the outstanding Shares of a Fund will be required in connection with a matter, a Fund will be deemed to be affected by a
matter unless it is clear that the interests of a Fund in the matter are identical, or that the matter does not affect any interest of the Fund. Under Rule 18f-2, the approval of an investment advisory agreement or any change in investment policy
would be effectively acted upon with respect to a Fund only if approved by a majority of the outstanding Shares of a Fund. However, Rule 18f-2 also provides that the ratification of independent public accountants, the approval of principal
underwriting contracts, and the election of Trustees may be effectively acted upon by Shareholders of the Trust voting without regard to series.
PORTFOLIO HOLDINGS DISCLOSURE
The Trust has adopted a policy
regarding the disclosure of information about each Fund’s portfolio holdings. The Board of Trustees of the Trust must approve all material amendments to this policy. A Fund’s complete portfolio holdings are publicly disseminated each day
the Fund is open for business through financial reporting and news services, including publicly accessible Internet web sites. In addition, a basket composition file, which includes the security names and share quantities to deliver in exchange for
Fund shares, together with estimates and actual cash components, is publicly disseminated daily prior to the opening of the Exchange via the National Securities Clearing Corporation (“NSCC”). The basket represents one Creation Unit of a
Fund. The Trust, the Adviser and the Distributor will not disseminate non-public information concerning the Trust, except: (i) to a party for a legitimate business purpose related to the day-to-day operations of the Funds or (ii) to any other party
for a legitimate business or regulatory purpose, upon waiver or exception.
PROXY VOTING PROCEDURES AND GUIDELINES
The Board of Trustees has
delegated to the Adviser and its affiliated advisers, proxy voting authority with respect to the Funds’ portfolio securities. To ensure that the proxies of portfolio companies are voted in the best interests of the Funds, the Funds’
Board of Trustees has adopted the Adviser’s detailed proxy voting procedures (the “Procedures”) that incorporate guidelines (“Guidelines”) for voting proxies on specific types of issues.
The Adviser and its affiliated
advisers are part of a global asset management organization with the capability to invest in securities of issuers located around the globe. Because the regulatory framework and the business cultures and practices vary from region to region, the
Guidelines are customized for each region to take into account such variations. Separate Guidelines cover the regions of (1) North America, (2) Europe, Middle East, Africa, Central America and South America, (3) Asia (ex-Japan) and (4) Japan,
respectively.
Notwithstanding the variations
among the Guidelines, all of the Guidelines have been designed with the uniform objective of encouraging corporate action that enhances shareholder value. As a general rule, in voting proxies of a particular security, the Adviser and its affiliated
advisers will apply the Guidelines of the region in which the issuer of such security is organized. Except as noted below, proxy voting decisions
will be made in accordance with the Guidelines covering a
multitude of both routine and non-routine matters that the Adviser and its affiliated advisers have encountered globally, based on many years of collective investment management experience.
To oversee and monitor the
proxy-voting process, the Adviser has established a proxy committee and appointed a proxy administrator in each global location where proxies are voted. The primary function of each proxy committee is to review periodically general proxy-voting
matters, review and approve the Guidelines annually, and provide advice and recommendations on general proxy-voting matters as well as on specific voting issues. The procedures permit an independent voting service to perform certain services
otherwise carried out or coordinated by the proxy administrator.
Although for many matters the
Guidelines specify the votes to be cast, for many others, the Guidelines contemplate case-by-case determinations. In addition, there will undoubtedly be proxy matters that are not contemplated by the Guidelines. For both of these categories of
matters and to override the Guidelines, the Procedures require a certification and review process to be completed before the vote is cast. That process is designed to identify actual or potential material conflicts of interest (between the Fund on
the one hand, and the Fund’s Adviser, principal underwriter or an affiliate of any of the foregoing, on the other hand) and ensure that the proxy vote is cast in the best interests of the Fund. A conflict is deemed to exist when the proxy is
for JPMorgan Chase & Co. stock or for the Fund, or when the proxy administrator has actual knowledge indicating that a JPMorgan affiliate is an investment banker or rendered a fairness opinion with respect to the matter that is the subject of
the proxy vote. When such conflicts are identified, the proxy will be voted by an independent third party either in accordance with JPMorgan proxy voting guidelines or by the third party using its own guidelines.
When other types of potential
material conflicts of interest are identified, the proxy administrator and, as necessary and a legal representative from the proxy committee will evaluate the potential conflict of interest and determine whether such conflict actually exists, and if
so, will recommend how the Adviser will vote the proxy. In addressing any material conflict, the Adviser may take one or more of the following measures (or other appropriate action): removing or “walling off” from the proxy voting
process certain Adviser personnel with knowledge of the conflict, voting in accordance with any applicable Guideline if the application of the Guideline would objectively result in the casting of a proxy vote in a predetermined manner, or deferring
the vote to or obtaining a recommendation from an third independent party, in which case the proxy will be voted by, or in accordance with the recommendation of, the independent third party.
The following summarizes some of
the more noteworthy types of proxy voting policies of the non-U.S. Guidelines:
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Corporate
governance procedures differ among the countries. Because of time constraints and local customs, it is not always possible for the Adviser to receive and review all proxy materials in connection with each item submitted for a vote. Many proxy
statements are in foreign languages. Proxy materials are generally mailed by the issuer to the sub-custodian which holds the securities for the client in the country where the portfolio company is organized, and there may not be sufficient time for
such materials to be transmitted to the Adviser in time for a vote to be cast. In some countries, proxy statements are not mailed at all, and in some locations, the deadline for voting is two to four days after the initial announcement that a vote
is to be solicited and it may not always be possible to obtain sufficient information to make an informed decision in good time to vote.
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Certain markets
require that shares being tendered for voting purposes are temporarily immobilized from trading until after the shareholder meeting has taken place. Elsewhere, notably emerging markets, it may not always be possible to obtain sufficient information
to make an informed decision in good time to vote. Some markets require a local representative to be hired in order to attend the meeting and vote in person on our behalf, which can result in considerable cost. The Adviser also considers the cost of
voting in light of the expected benefit of the vote. In certain instances, it may sometimes be in the Fund’s best interests to intentionally refrain from voting in certain overseas markets from time to time.
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Where
proxy issues concern corporate governance, takeover defense measures, compensation plans, capital structure changes and so forth, the Adviser pays particular attention to management’s arguments for promoting the prospective change. The
Adviser’s sole criterion in determining its voting stance is whether such changes will be to the economic benefit of the beneficial owners of the shares.
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The Adviser is
in favor of a unitary board structure of the type found in the United Kingdom as opposed to tiered board structures. Thus, the Adviser will generally vote to encourage the gradual phasing out of tiered board structures, in favor of unitary boards.
However, since tiered boards are still very prevalent in markets outside of the United Kingdom, local market practice will always be taken into account.
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The Adviser will
use its voting powers to encourage appropriate levels of board independence, taking into account local market practice.
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The Adviser will
usually vote against discharging the board from responsibility in cases of pending litigation, or if there is evidence of wrongdoing for which the board must be held accountable.
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The Adviser
will vote in favor of increases in capital which enhance a company’s long-term prospects. The Adviser will also vote in favor of the partial suspension of preemptive rights if they are for purely technical reasons (e.g., rights offers which
may not be legally offered to shareholders in certain jurisdictions). However, the Adviser will vote against increases in capital which would allow the company to adopt “poison pill” takeover defense tactics, or where the increase in
authorized capital would dilute shareholder value in the long term.
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The Adviser
will vote in favor of proposals which will enhance a company’s long-term prospects. The Adviser will vote against an increase in bank borrowing powers which would result in the company reaching an unacceptable level of financial leverage,
where such borrowing is expressly intended as part of a takeover defense, or where there is a material reduction in shareholder value.
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The Adviser will
generally vote against anti-takeover devices.
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Where
social or environmental issues are the subject of a proxy vote, the Adviser will consider the issue on a case-by-case basis, keeping in mind at all times the best economic interests of its clients.
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The following summarizes some of
the more noteworthy types of proxy voting policies of the U.S. Guidelines:
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The Adviser
considers votes on director nominees on a case-by-case basis. Votes generally will be withheld from directors who: (a) attend less than 75% of board and committee meetings without a valid excuse; (b) adopt or renew a poison pill without shareholder
approval; (c) are affiliated directors who serve on audit, compensation or nominating committees or are affiliated directors and the full board serves on such committees or the company does not have such committees; (d) ignore a shareholder proposal
that is approved by a majority of either the shares outstanding or the votes cast based on a review over a consecutive two year time frame; (e) are insiders and affiliated outsiders on boards that are not at least majority independent; or (f) are
CEOs of publicly-traded companies who serve on more than three public boards or serve on more than four public company boards. In addition, votes are generally withheld for directors who serve on committees in certain cases. For example, the Adviser
generally withholds votes from audit committee members in circumstances in which there is evidence that there exists material weaknesses in the company’s internal controls. Votes generally are also withheld from directors when there is a
demonstrated history of poor performance or inadequate risk oversight or when the board adopts changes to the company’s governing documents without shareholder approval if the changes materially diminish shareholder rights.
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The Adviser
votes proposals to classify boards on a case-by-case basis, but normally will vote in favor of such proposal if the issuer’s governing documents contain each of eight enumerated safeguards (for example, a majority of the board is composed of
independent directors and the nominating committee is composed solely of such directors).
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The Adviser also
considers management poison pill proposals on a case-by-case basis, looking for shareholder-friendly provisions before voting in favor.
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The Adviser votes
against proposals for a super-majority vote to approve a merger.
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The Adviser
considers proposals to increase common and/or preferred shares and to issue shares as part of a debt restructuring plan on a case-by-case basis, taking into account such factors as the extent of dilution and whether the transaction will result in a
change in control.
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The
Adviser considers vote proposals with respect to compensation plans on a case-by-case basis. The analysis of compensation plans focuses primarily on the transfer of shareholder wealth (the dollar cost of pay plans to shareholders) and includes an
analysis of the structure of the plan and
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pay practices
of other companies in the relevant industry and peer companies. Other matters included in the analysis are the amount of the company’s outstanding stock to be reserved for the award of stock options, whether the exercise price of an option is
less than the stock’s fair market value at the date of the grant of the options, and whether the plan provides for the exchange of outstanding options for new ones at lower exercise prices.
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The Adviser
also considers on a case-by-case basis proposals to change an issuer’s state of incorporation, mergers and acquisitions and other corporate restructuring proposals and certain social issue proposals.
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The Adviser
generally votes for management proposals which seek shareholder approval to make the state of incorporation the exclusive forum for disputes if the company is a Delaware corporation; otherwise, the Adviser votes on a case by case basis.
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The Adviser
generally encourages a level of reporting on environmental matters that is not unduly costly or burdensome and which does not place the company at a competitive disadvantage, but which provides meaningful information to enable shareholders to
evaluate the impact of the company’s environmental policies and practices on its financial performance. In general, the Adviser supports management disclosure practices that are overall consistent with the goals and objective expressed above.
Proposals with respect to companies that have been involved in controversies, fines or litigation are expected to be subject to heightened review and consideration.
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In evaluating
how to vote environmental proposals, key considerations may include, but are not limited to, issuer considerations such as asset profile of company, including whether it is exposed to potentially secularly potentially declining demand for the
company’s products or services due to environmental considerations; cash deployments; cost structure of the company, including its position on the cost curve, expected impact of future carbon tax and exposure to high fixed operating costs;
corporate behavior of the company; demonstrated capabilities of the company, its strategic planning process, and past performance; current level of disclosure of the company and consistency of disclosure across its industry; and whether the company
incorporates environmental or social issues in a risk assessment or risk reporting framework. The Adviser may also consider whether peers have received similar proposals and if so, were the responses transparent and insightful; would adoption of the
proposal inform and educate shareholders; and have companies that adopted the proposal provided insightful and meaningful information that would allow shareholders to evaluate the long-term risks and performance of the company; does the proposal
require disclosure that is already addressed by existing and proposed mandated regulatory requirements or formal guidance at the local, state, or national level or the company’s existing disclosure practices; and does the proposal create the
potential for unintended consequences such as a competitive disadvantage.
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With regard to
social issues, among other factors, the Adviser considers the company’s labor practices, supply chain, how the company supports and monitors those issues, what types of disclosure the company and its peers currently provide, and whether the
proposal would result in a competitive disadvantage for the company.
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The
Adviser reviews Say on Pay proposals on a case by case basis with additional review of proposals where the issuer’s previous year’s proposal received a low level of support.
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Bank and Bank Holding Company
Securities. The Board of Trustees has further authorized the Adviser to further delegate proxy voting for certain bank and bank holding company securities (“Bank Securities”), that are
held in the JPMorgan BetaBuilders U.S. Equity ETF and JPMorgan Diversified Return Global Equity ETF and identified from time to time by the Adviser, to Institutional Shareholder Services, Inc. (“ISS”) to be voted in accordance with ISS
policies and procedures (“ISS Guidelines”). This delegation may occur where the Adviser is restricted under applicable laws from voting a particular security or to permit the Adviser to utilize exemptions from limitations arising under
the Bank Holding Company Act that might otherwise prevent the Adviser from acquiring Bank Securities on behalf of a Fund. A Copy of ISS Guidelines are attached to the SAI Part II as Appendix B.
Proxy Voting Record. In accordance with regulations of the SEC, the Fund’s proxy voting records for the most recent 12-month period ended June 30 are on file with the SEC and are available on the Funds’ website
at www.jpmorganfunds.com and are on the SEC’s website at www.sec.gov.
ADDITIONAL INFORMATION
The Trust is not required to
hold a meeting of Shareholders for the purpose of electing Trustees except that (i) the Trust is required to hold a Shareholders’ meeting for the election of Trustees at such time as less than a majority of the Trustees holding office have
been elected by Shareholders and (ii) if, as a result of a vacancy on the Board of Trustees, less than two-thirds of the Trustees holding office have been elected by the Shareholders, that vacancy may only be filled by a vote of the Shareholders. In
addition, Trustees may be removed from office by a written consent signed by the holders of Shares representing two-thirds of the outstanding Shares of a Trust at a meeting duly called for the purpose, which meeting shall be called and held in
accordance with the By-Laws of the Trust. Except as set forth above, the Trustees may continue to hold office and may appoint successor Trustees.
As used in the Trust’s
Prospectuses and in this SAI, “assets belonging to a Fund” means the consideration received by the Trust upon the issuance or sale of Shares in that Fund, together with all income, earnings, profits, and proceeds derived from the
investment thereof, including any proceeds from the sale, exchange, or liquidation of such investments, and any funds or payments derived from any reinvestment of such proceeds, and any general assets of the Trust not readily identified as belonging
to a particular Fund that are allocated to that Fund by the Trust’s Board of Trustees. The Board of Trustees may allocate such general assets in any manner it deems fair and equitable. It is anticipated that the factor that will be used by the
Board of Trustees in making allocations of general assets to particular Funds will be the relative NAV of the respective Funds at the time of allocation. Assets belonging to a particular Fund are charged with the direct liabilities and expenses in
respect of that Fund, and with a share of the general liabilities and expenses of the Trust not readily identified as belonging to a particular Fund that are allocated to that Fund in proportion to the relative NAV of the respective Funds at the
time of allocation. The timing of allocations of general assets and general liabilities and expenses of the Trust to a particular Fund will be determined by the Board of Trustees of the Trust and will be in accordance with generally accepted
accounting principles. Determinations by the Board of Trustees of the Trust as to the timing of the allocation of general liabilities and expenses and as to the timing and allocable portion of any general assets with respect to a particular Fund are
conclusive.
As used in
this SAI and the Prospectuses, the term “majority of the outstanding voting securities” of the Trust, a particular Fund means the following when the 1940 Act governs the required approval: the affirmative vote of the lesser of (a) more
than 50% of the outstanding shares of the Trust, such Fund or such class of such Fund, or (b) 67% or more of the shares of the Trust, such Fund or such class of such Fund present at a meeting at which the holders of more than 50% of the outstanding
shares of the Trust, such Fund or such class of such Fund are represented in person or by proxy. Otherwise, the declaration of trust, articles of incorporation or by-laws usually govern the needed approval and generally require that if a quorum is
present at a meeting, the vote of a majority of the shares of the Trust, such Fund or such class of such Fund, as applicable, shall decide the question.
Telephone calls to the Funds,
the Funds’ service providers or a Financial Intermediary as Financial Intermediary may be recorded. With respect to the securities offered hereby, this SAI and the Prospectuses do not contain all the information included in the Registration
Statements of the Trust filed with the SEC under the 1933 Act and the 1940 Act. Pursuant to the rules and regulations of the SEC, certain portions have been omitted. The Registration Statement, including the exhibits filed therewith, may be examined
at the office of the SEC in Washington, D.C.
Statements contained in this
SAI and the Prospectuses concerning the contents of any contract or other document are not necessarily complete, and in each instance, reference is made to the copy of such contract or other document filed as an exhibit to the Registration
Statements of the Trusts. Each such statement is qualified in all respects by such reference.
No dealer, salesman or any
other person has been authorized to give any information or to make any representations, other than those contained in the Prospectuses and this SAI, in connection with the offer contained therein and, if given or made, such other information or
representations must not be relied upon as having been authorized by the Trust, the Fund or the Distributor. The Prospectuses and this SAI do not constitute an offer by any Fund or by the Distributor to sell or solicit any offer to buy any of the
securities offered hereby in any jurisdiction to any person to whom it is unlawful for the Funds or the Distributor to make such offer in such jurisdictions.
APPENDIX A — PURCHASES AND REDEMPTIONS
BOOK ENTRY ONLY SYSTEM
The
following information supplements and should be read in conjunction with the section in the Funds’ Prospectus entitled “Buying and Selling Shares.”
The Depository Trust Company
(“DTC”) acts as securities depositary for the Shares. Shares of a Fund are represented by securities registered in the name of DTC or its nominee and deposited with, or on behalf of, DTC. Certificates will not be issued for Shares.
DTC, a limited-purpose trust
company, was created to hold securities of its participants (the “DTC Participants”) and to facilitate the clearance and settlement of securities transactions among the DTC Participants in such securities through electronic book-entry
changes in accounts of the DTC Participants, thereby eliminating the need for physical movement of securities certificates. DTC Participants include securities brokers and dealers, banks, trust companies, clearing corporations and certain other
organizations, some of whom (and/or their representatives) own DTC. More specifically, DTC is owned by a number of its DTC Participants and by the New York Stock Exchange (“NYSE”) and FINRA. Access to the DTC system is also available to
others such as banks, brokers, dealers and trust companies that clear through or maintain a custodial relationship with a DTC Participant, either directly or indirectly (the “Indirect Participants”).
Beneficial ownership of Shares
is limited to DTC Participants, Indirect Participants and persons holding interests through DTC Participants and Indirect Participants. Ownership of beneficial interests in Shares (owners of such beneficial interests are referred to herein as
“Beneficial Owners”) is shown on, and the transfer of ownership is effected only through, records maintained by DTC (with respect to DTC Participants) and on the records of DTC Participants (with respect to Indirect Participants and
Beneficial Owners that are not DTC Participants). Beneficial Owners will receive from or through the DTC Participant a written confirmation relating to their purchase of Shares.
Conveyance of all notices,
statements and other communications to Beneficial Owners is effected as follows. Pursuant to the Depositary Agreement between the Trust and DTC, DTC is required to make available to the Trust upon request and for a fee to be charged to the Trust a
listing of the Shares holdings of each DTC Participant. The Trust shall inquire of each such DTC Participant as to the number of Beneficial Owners holding Shares, directly or indirectly, through such DTC Participant. The Trust shall provide each
such DTC Participant with copies of such notice, statement or other communication, in such form, number and at such place as such DTC Participant may reasonably request, in order that such notice, statement or communication may be transmitted by
such DTC Participant, directly or indirectly, to such Beneficial Owners. In addition, the Trust shall pay to each such DTC Participant a fair and reasonable amount as reimbursement for the expenses attendant to such transmittal, all subject to
applicable statutory and regulatory requirements.
Share distributions shall be
made to DTC or its nominee, Cede & Co., as the registered holder of all Shares. DTC or its nominee, upon receipt of any such distributions, shall credit immediately DTC Participants’ accounts with payments in amounts proportionate to their
respective beneficial interests in Shares as shown on the records of DTC or its nominee. Payments by DTC Participants to Indirect Participants and Beneficial Owners of Shares held through such DTC Participants will be governed by standing
instructions and customary practices, as is now the case with securities held for the accounts of customers in bearer form or registered in a “street name,” and will be the responsibility of such DTC Participants.
The Trust has no responsibility
or liability for any aspects of the records relating to or notices to Beneficial Owners, or payments made on account of beneficial ownership interests in such Shares, or for maintaining, supervising or reviewing any records relating to such
beneficial ownership interests or for any other aspect of the relationship between DTC and the DTC Participants or the relationship between such DTC Participants and the Indirect Participants and Beneficial Owners owning through such DTC
Participants.
DTC may
determine to discontinue providing its service with respect to the Shares at any time by giving reasonable notice to the Trust and discharging its responsibilities with respect thereto under applicable law. Under such circumstances, the Trust shall
take action either to find a replacement for DTC to perform its functions at a comparable cost or, if such a replacement is unavailable, to issue and deliver printed certificates representing ownership of Shares, unless the Trust makes other
arrangements with respect thereto satisfactory to the Exchange.
CREATION AND REDEMPTION OF CREATION UNITS
General
The Trust issues and sells
Shares of the Funds only in Creation Units on a continuous basis through the Distributor, without an initial sales load, at their NAV next determined after receipt, on any Business Day (as defined herein), of an order in proper form. An Authorized
Participant (defined below) that is not a “qualified institutional buyer,” as such term is defined under Rule 144A of the Securities Act of 1933, will not be able to receive, as part of a redemption, restricted securities eligible for
resale under Rule 144A.
A
“Business Day” with respect to the Fund is any day on which the Exchange is open for business. As of the date of this SAI, the Exchange observes the following holidays: New Year’s Day, Martin Luther King, Jr. Day, President’s
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Continuous Offering
The method by which Creation
Units are created and traded may raise certain issues under applicable securities laws. Because new Creation Units are issued and sold by a Fund on an ongoing basis, at any point a “distribution,” as such term is used in the 1933 Act,
may occur. Broker-dealers and other persons are cautioned that some activities on their part may, depending on the circumstances, result in their being deemed participants in a distribution in a manner that could render them statutory underwriters
and subject them to the prospectus delivery requirement and liability provisions of the 1933 Act.
For example, a broker-dealer
firm or its client may be deemed a statutory underwriter if it takes Creation Units after placing an order with the Distributor, breaks them down into constituent shares and sells such shares directly to customers or if it chooses to couple the
creation of new shares with an active selling effort involving solicitation of secondary market demand for shares. A determination of whether one is an underwriter for purposes of the 1933 Act must take into account all the facts and circumstances
pertaining to the activities of the broker-dealer or its client in the particular case and the examples mentioned above should not be considered a complete description of all the activities that could lead to a categorization as an
underwriter.
Broker-dealer firms should
also note that dealers who are not “underwriters” but are effecting transactions in Shares, whether or not participating in the distribution of Shares, generally are required to deliver a prospectus. This is because the prospectus
delivery exemption in Section 4(a)(3) of the 1933 Act is not available in respect of such transactions as a result of Section 24(d) of the 1940 Act. Firms that incur a prospectus delivery obligation with respect to Shares of a Fund are reminded
that, pursuant to Rule 153 under the 1933 Act, a prospectus delivery obligation under Section 5(b)(2) of the 1933 Act owed to an exchange member in connection with a sale on the Exchange is satisfied by the fact that the prospectus is available at
the Exchange upon request. The prospectus delivery mechanism provided in Rule 153 is available only with respect to transactions on an exchange.
Portfolio Deposit
The consideration for a
purchase of Creation Units (except with respect to certain Funds) generally consists of the in-kind deposit of a portfolio of securities and other investments (the “Deposit Instruments”) included in each Fund and an amount of cash
computed as described below (the “Cash Amount”). The Cash Amount together with the Deposit Instruments, as applicable, are referred to as the “Portfolio Deposit,” which represents the minimum initial and subsequent investment
amount for a Creation Unit of a Fund. For certain Funds, Creation Units are issued partially or principally for cash, as specified in the Fund’s Prospectus and Part I of this SAI.
In the event a Fund requires
Deposit Instruments in consideration for purchasing a Creation Unit, the portfolio of securities required may, in certain limited circumstances (such as in connection with pending changes to the Fund’s Underlying Index), be different than the
portfolio of securities the Fund will deliver upon redemption of Fund Shares.
In the event a Fund requires
Deposit Instruments and a Cash Amount in consideration for purchasing a Creation Unit, the function of the Cash Amount is to compensate for any differences between the NAV per Creation Unit and the Deposit Amount (as defined below). The Cash Amount
would be an amount equal to the difference between the NAV of the Shares (per Creation Unit) and the “Deposit Amount,” which is an amount equal to the aggregate market value of the Deposit Instruments. If the Cash Amount is a positive
number (the NAV per Creation Unit exceeds the Deposit Amount), the Authorized Participant will deliver
the Cash Amount. If the Cash Amount is a negative number (the
NAV per Creation Unit is less than the Deposit Amount), the Authorized Participant will receive the Cash Amount. Computation of the Cash Amount excludes any stamp duty or other similar fees and expenses payable upon transfer of beneficial ownership
of the Deposit Instruments, which shall be the sole responsibility of the Authorized Participant.
The Administrator, through the
NSCC, makes available on each Business Day, immediately prior to the opening of business on the Exchange (currently 9:30 a.m. Eastern time), the list of the names and the required number of shares of each Deposit Instrument to be included in the
current Portfolio Deposit (based on information at the end of the previous Business Day), as well as information regarding the Cash Amount for a Fund. Such Portfolio Deposit is applicable, subject to any adjustments as described below, in order to
effect creations of Creation Units of a Fund until such time as the next-announced Portfolio Deposit composition is made available.
In addition, the Trust reserves
the right to accept a basket of securities or cash that differs from Deposit Instruments or to permit the substitution of an amount of cash (i.e., a “cash in lieu” amount) to be added to the Cash Amount to replace any Deposit Instrument
which may, among other reasons, not be available in sufficient quantity for delivery, not be permitted to be re-registered in the name of the Trust as a result of an in-kind creation order pursuant to local law or market convention or which may not
be eligible for transfer through the Clearing Process (described below), or which may not be eligible for trading by a Participating Party (defined below). In light of the foregoing, in order to seek to replicate the in-kind creation order process,
the Trust expects to purchase the Deposit Instruments represented by the cash in lieu amount in the secondary market (“Market Purchases”). In such cases where the Trust makes Market Purchases because a Deposit Instrument may not be
permitted to be re-registered in the name of the Trust as a result of an in-kind creation order pursuant to local law or market convention, or for other reasons, the Authorized Participant will reimburse the Trust for, among other things, any
difference between the market value at which the securities were purchased by the Trust and the cash in lieu amount (which amount, at the Adviser’s discretion, may be capped), applicable registration fees and taxes. Brokerage commissions
incurred in connection with the Trust’s acquisition of Deposit Instruments may be at the expense of a Fund and will affect the value of all Shares of the Fund; but the Adviser may adjust the transaction fee to the extent the composition of the
Deposit Instruments changes or cash in lieu is added to the Cash Amount to protect ongoing shareholders.
In addition to the list of
names and numbers of securities constituting the current Deposit Instruments of a Portfolio Deposit, the Administrator, through the NSCC, also makes available on each Business Day, the estimated Cash Component adjusted through the close of the
trading day. In addition, on a continuous basis throughout the day, the intra-day indicative value will be calculated and disseminated by the third party in accordance with relevant listing standards.
Procedures for Creation of Creation Units
To be eligible to place orders
with the Distributor to create Creation Units of a Fund, an entity or person either must be (1) a “Participating Party,” i.e., a broker-dealer or other participant in the clearing process through the Continuous Net Settlement System of
the NSCC; or (2) a DTC Participant (see “Book Entry Only System”); which, in either case, must have executed an agreement with the Distributor (as it may be amended from time to time in accordance with its terms) (“Participant
Agreement”) (discussed below). A Participating Party and DTC Participant are collectively referred to as an “Authorized Participant.” All Creation Units of a Fund, however created, will be entered on the records of DTC in the name
of Cede & Co. for the account of a DTC Participant.
All orders to create Creation
Units must be placed in multiples of a certain number of Shares of a Fund, as disclosed under “PURCHASE AND REDEMPTION OF CREATION UNITS” in Part I of this SAI. Except as described below, and in all
cases subject to the terms of the applicable Participant Agreement, all orders to create Creation Units, whether through the NSCC Clearing Process or outside the NSCC Clearing Process through DTC or otherwise, must be received by the Distributor no
later than the closing time of the regular trading session on the Exchange (“Closing Time”) (ordinarily 4:00 p.m. Eastern time or, for Custom Orders (discussed below), such earlier time set forth in the Participant Agreement or disclosed
herein), in each case on the date such order is placed in order for creation of Creation Units to be effected based on the NAV of a Fund as determined on such date. A “Custom Order” may be placed by an Authorized Participant in the event
that the Trust permits or requires the substitution of an amount of cash to be added to the Cash Amount to replace any Deposit Instrument which may not be available in sufficient quantity for delivery or which may not be eligible for trading by such
Authorized Participant or the investor for which it is acting, or other relevant reason. With respect to Custom Orders for Creation Units of JPMorgan Diversified Alternatives ETF, JPMorgan Event Driven ETF, JPMorgan Long/Short ETF and
JPMorgan Managed Futures Strategy ETF, all orders to create
Creation Units, whether through the NSCC Clearing Process or outside the NSCC Clearing Process through DTC or otherwise, must be received by the Distributor no later than 10:00 a.m. Eastern time. With respect to Custom Orders for Creation Units of
JPMorgan BetaBuilders 1-5 Year U.S. Aggregate Bond ETF, all orders to create Creation Units, whether through the NSCC Clearing Process or outside the NSCC Clearing Process through DTC or otherwise, must be received by the Distributor no later than 1
p.m. Eastern time. The Business Day on which a creation order (or order to redeem as discussed below) is placed is herein referred to as the “Transmittal Date.” Orders must be transmitted by telephone or other transmission method
acceptable to the Distributor pursuant to procedures set forth in the Participant Agreement, as described below (see “Placement of Creation Orders Using NSCC Clearing Process”). Severe economic or market disruptions or changes, or
telephone or other communication failure, may impede the ability to reach the Distributor, a Participating Party or a DTC Participant. Creation Units may be created in advance of the receipt by the Trust of all or a portion of the Portfolio Deposit.
In such cases, the Authorized Participant will remain liable for the full deposit of the missing portion(s) of the Portfolio Deposit and will be required to post collateral with the Trust consisting of cash at least equal to a percentage of the
marked-to-market value of such missing portion(s) that is specified in the Participant Agreement. The Trust may use such collateral to buy the missing portion(s) of the Portfolio Deposit at any time and will subject such Authorized Participant to
liability for any shortfall between the cost to the Trust of purchasing such securities and the value of such collateral. The Trust will have no liability for any such shortfall. The Trust will return any unused portion of the collateral to the
Authorized Participant once the entire Fund Deposit has been properly received by the Distributor and deposited into the Trust.
Orders to create Creation
Units of a Fund shall be placed with a Participating Party or DTC Participant, as applicable, in the form required by such Participating Party or DTC Participant. Investors should be aware that their particular broker may not have executed a
Participant Agreement, and that, therefore, orders to create Creation Units of a Fund may have to be placed by the investor’s broker through a Participating Party or a DTC Participant who has executed a Participant Agreement. At any given time
there may be only a limited number of broker-dealers that have executed a Participant Agreement. Those placing orders to create Creation Units of the Fund through the NSCC Clearing Process should afford sufficient time to permit proper submission of
the order to the Distributor prior to the Closing Time on the Transmittal Date.
Orders for creation that are
effected outside the NSCC Clearing Process are likely to require transmittal by the DTC Participant earlier on the Transmittal Date than orders effected using the NSCC Clearing Process. Those persons placing orders outside the NSCC Clearing Process
should ascertain the deadlines applicable to DTC and the Federal Reserve Bank wire system by contacting the operations department of the broker or depository institution effectuating such transfer of Deposit Instruments and Cash Amount.
Orders to create Creation
Units of a Fund may be placed through the Clearing Process utilizing procedures applicable to domestic funds for domestic securities (“Domestic Funds”) (see “Placement of Creation Orders Using NSCC Clearing Process”) or
outside the NSCC Clearing Process utilizing the procedures applicable to either Domestic Funds or Foreign Funds for foreign securities (“Foreign Funds”) (see “ Placement of Creation Orders Outside NSCC Clearing Process —
Domestic Funds” and “Placement of Creation Orders Outside NSCC Clearing Process — Foreign Funds”). In the event that the Fund includes both domestic and foreign securities, the time for submitting orders is as stated in the
“Placement of Creation Orders Outside NSCC Clearing Process — Foreign Funds” and “Placement of Redemption Orders Outside NSCC Clearing Process — Foreign Funds” sections below shall operate.
Placement of Creation Orders Using NSCC Clearing
Process
Portfolio Deposits
created through the NSCC Clearing Process, if available, must be delivered through a Participating Party that has executed a Participant Agreement.
The Participant Agreement
authorizes the Distributor to transmit to the NSCC on behalf of the Participating Party such trade instructions as are necessary to effect the Participating Party’s creation order. Pursuant to such trade instructions from the Distributor to
the NSCC, the Participating Party agrees to transfer the requisite Deposit Instruments (or contracts to purchase such Deposit Instruments that are expected to be delivered in a “regular way” manner by the second (2nd) Business Day
(“T+2” basis)) and the Cash Amount to the Trust, together with such additional information as may be required by the Distributor. Each Fund reserves the right to settle Creation Unit transactions on a basis other than T+2 if necessary or
appropriate under the circumstances and compliant with applicable law. An order to create
Creation Units of a Fund through the NSCC Clearing Process is
deemed received by the Distributor on the Transmittal Date if (i) such order is received by the Distributor not later than the Closing Time on such Transmittal Date and (ii) all other procedures set forth in the Participant Agreement are properly
followed.
Placement of Creation Orders Outside
NSCC Clearing Process — Domestic Funds
Portfolio Deposits created
outside the NSCC Clearing Process must be delivered through a DTC Participant that has executed a Participant Agreement. A DTC Participant who wishes to place an order creating Creation Units of a Fund to be effected outside the NSCC Clearing
Process need not be a Participating Party, but such orders must state that the DTC Participant is not using the NSCC Clearing Process and that the creation of Creation Units will instead be effected through a transfer of securities and cash. The
Portfolio Deposit transfer must be ordered by the DTC Participant in a timely fashion so as to ensure the delivery of the requisite number of Deposit Instruments through DTC to the account of the Trust by no later than 11:00 a.m. Eastern time, of
the next Business Day immediately following the Transmittal Date. All questions as to the number of Deposit Instruments to be delivered, and the validity, form and eligibility (including time of receipt) for the deposit of any tendered securities,
will be determined by the Trust, whose determination shall be final and binding. The cash equal to the Cash Component must be transferred directly to the Custodian through the Federal Reserve wire system in a timely manner so as to be received by
the Custodian no later than 2:00 p.m. Eastern time, on the next Business Day immediately following the Transmittal Date. An order to create Creation Units of a Fund outside the NSCC Clearing Process is deemed received by the Distributor on the
Transmittal Date if (i) such order is received by the Distributor not later than the Closing Time on such Transmittal Date; and (ii) all other procedures set forth in the Participant Agreement are properly followed. However, if the Distributor does
not receive both the requisite Deposit Instruments and the Cash Amount in a timely fashion on the next Business Day immediately following the Transmittal Date, such order may be cancelled. Upon written notice to the Distributor, such cancelled order
may be resubmitted the following Business Day using the Portfolio Deposit as newly constituted to reflect the current NAV of the applicable Fund. The delivery of Creation Units so created will occur no later than the second (2nd) Business Day
following the day on which the creation order is deemed received by the Distributor. Each Fund reserves the right to settle Creation Unit transactions on a basis other T+2 if necessary or appropriate under the circumstances and compliant with
applicable law.
Additional transaction fees
may be imposed with respect to transactions effected outside the NSCC Clearing Process (through a DTC Participant) and in circumstances in which any cash can be used in lieu of Deposit Instruments to create Creation Units. (See “Creation
Transaction Fee” section below.)
Placement of Creation Orders Outside NSCC Clearing
Process — Foreign Funds
The Distributor will inform the
Transfer Agent, the Adviser and the Custodian upon receipt of a Creation Order. The Custodian will then provide such information to the appropriate subcustodian. For each Fund, the Custodian will cause the subcustodian of such Fund to maintain an
account into which the Deposit Instruments (or the cash value of all or part of such securities, in the case of a permitted or required cash purchase or “cash in lieu” amount) will be delivered. Deposit Instruments must be delivered to
an account maintained at the applicable local custodian. The Trust must also receive, on or before the contractual settlement date, immediately available or same day funds estimated by the Custodian to be sufficient to pay the Cash Amount next
determined after receipt in proper form of the purchase order, together with the creation transaction fee described below.
Once the Transfer Agent has
accepted a creation order, the Transfer Agent will confirm the issuance of a Creation Unit of the Fund against receipt of payment, at such NAV as will have been calculated after receipt in proper form of such order. The Transfer Agent will then
transmit a confirmation of acceptance of such order.
Creation Units will not be
issued until the transfer of good title to the Trust of the Deposit Instruments and the payment of the Cash Component have been completed. When the subcustodian has delivered to the account of the relevant subcustodian, the Distributor and the
Adviser will be notified of such delivery and the Transfer Agent will issue and cause the delivery of the Creation Units.
Acceptance of Creation Orders
The Trust and the Distributor
reserve the absolute right to reject or revoke acceptance of a creation order transmitted to it in respect of a Fund, for example, if (a) the order is not in proper form; (b) the purchaser or group of related purchasers, upon obtaining the Creation
Units of Shares, would own 80% or
more of the outstanding Shares of such Fund; (c) the acceptance
of the Portfolio Deposit would have certain adverse tax consequences, such as causing the Fund no longer to meet RIC status under the Code for federal tax purposes; (d) the acceptance of the Portfolio Deposit would, in the opinion of the Fund, be
unlawful, as in the case of a purchaser who was banned from trading in securities (e) the acceptance of the Portfolio Deposit would otherwise, in the discretion of the Fund, the Adviser and/or sub-advisers, have an adverse effect on the Fund or on
the rights of the Fund’s beneficial owners; or; or (f) there exist circumstances outside the control of the Fund that make it impossible to process purchases of Creation Units of Shares for all practical purposes. Examples of such
circumstances include: acts of God or public service or utility problems such as fires, floods, extreme weather conditions and power outage resulting in telephone, telecopy and computer failures; market conditions or activities causing trading
halts; systems failures involving computer or other information systems affecting the Funds, the Adviser, any sub-adviser, the Transfer Agent, the Custodian, the Distributor, DTC, NSCC or any other participant in the purchase process; and similar
extraordinary events. The Transfer Agent will notify a prospective creator of its rejection of the order of such person. The Trust, the Custodian, any subcustodian and the Distributor are under no duty, however, to give notification of any defects
or irregularities in the delivery of Fund Deposits to Authorized Participants nor shall either of them incur any liability to Authorized Participants for the failure to give any such notification. All questions as to the number of shares of each
security in the Deposit Instruments and the validity, form, eligibility and acceptance for deposit of any securities to be delivered shall be determined by the Trust, and the Trust’s determination shall be final and binding.
Creation Units of a Fund may
be created in advance of receipt by the Trust of all or a portion of the applicable Deposit Instruments as described below. In these circumstances, the initial deposit will have a value greater than the NAV of the Shares on the date the order is
placed in proper form since, in addition to available Deposit Instruments, cash must be deposited in an amount equal to the sum of (i) the Cash Amount, plus (ii) at least 105%, which the Trust may change from time to time, of the market value of the
undelivered Deposit Instruments (the “Additional Cash Deposit”) with the Fund pending delivery of any missing Deposit Instruments.
If an Authorized Participant
determines to post an Additional Cash Deposit as collateral for any undelivered Deposit Instruments, such Authorized Participant must deposit with the Custodian the appropriate amount of federal funds by 10:00 a.m. New York, (or such other time as
specified by the Trust) on the date of requested settlement. If the Custodian does not receive the Additional Cash Deposit in the appropriate amount by such time, then the order may be deemed to be rejected and the AP shall be liable to a fund for
losses, if any, resulting therefrom. An additional amount of cash shall be required to be deposited with the Custodian, pending delivery of the missing Deposit Instruments to the extent necessary to maintain the Additional Cash Deposit with the
Trust in an amount at least equal to 105% as required, which the Trust may change from time to time, of the daily marked to market value of the missing Deposit Instruments. To the extent that missing Deposit Securities are not received by the
specified time on the settlement date, or in the event a marked-to market payment is not made within one Business Day following notification by the Distributor that such a payment is required, the Trust may use the cash on deposit to purchase the
missing Deposit Instruments. The Authorized Participant will be liable to the Trust for the costs incurred by the Trust in connection with any such purchases. These costs will be deemed to include the amount by which the actual purchase price of the
Deposit Instruments exceeds the market value of such Deposit Instruments on the transmittal date plus the brokerage and related transaction costs associated with such purchases. The Trust will return any unused portion of the Additional Cash Deposit
once all of the missing Deposit Instruments have been properly received by the Custodian or purchased by the Trust and deposited into the Trust. In addition, a transaction fee will be charged in all cases.
Creation Transaction Fee
A fixed creation transaction
fee is imposed on each creation transaction regardless of the number of Creation Units purchased in the transaction. The amount of the creation transaction fee for a Fund is disclosed under “PURCHASE AND
REDEMPTION OF CREATION UNITS” in Part I of this SAI. In addition, a variable charge for cash creations or for creations outside the NSCC Clearing Process currently of up to four times the basic creation transaction fee will be imposed.
In the case of cash creations or where the Trust permits a creator to substitute cash in lieu of depositing a portion of the Deposit Instruments, the creator may be assessed an additional variable charge to compensate a Fund for the costs associated
with purchasing the applicable securities. (See “Portfolio Deposit” section above.) As a result, in order to seek to replicate the in-kind creation order process, the Trust expects to purchase, in the secondary market or otherwise gain
exposure to, the portfolio securities that could have been delivered as a result of an in-kind creation order pursuant to local law or market convention, or for other reasons (“Market Purchases”). In such cases where the Trust makes
Market Purchases, the Authorized Participant
will reimburse the Trust for, among other things, any difference
between the market value at which the securities and/or financial instruments were purchased by the Trust and the cash in lieu amount (which amount, at the Adviser’s discretion, may be capped), applicable registration fees, brokerage
commissions and certain taxes. The Adviser may adjust the transaction fee to the extent the composition of the creation securities changes or cash in lieu is added to the Cash Amount to protect ongoing shareholders. Creators of Creation Units are
responsible for the costs of transferring the securities constituting the Deposit Instruments to the account of the Trust.
Redemption of Creation Units
Shares may be redeemed only in
Creation Units at their NAV next determined after receipt of a redemption request in proper form by the Distributor, only on a Business Day and only through a Participating Party or DTC Participant who has executed a Participant Agreement. The Trust will not redeem Shares in amounts less than Creation Units. Beneficial owners also may sell Shares in the secondary market, but must accumulate enough Shares to constitute a Creation Unit in order to have
such Shares redeemed by the Trust. There can be no assurance, however, that there will be sufficient liquidity in the public trading market at any time to permit assembly of a Creation Unit. Investors should expect to incur brokerage and other costs
in connection with assembling a sufficient number of Shares to constitute a redeemable Creation Unit. See with respect to each Fund, the section entitled “Summary Information — The Fund’s Main Risks” and “More About the
Fund — Investment Risks” in the applicable Prospectus.
The Administrator, through
NSCC, makes available immediately prior to the opening of business on the Exchange (currently 9:30 a.m. Eastern time) on each day that the Exchange is open for business, the identity of a Fund’s securities and/or an amount of cash that will be
applicable (subject to possible amendment or correction) to redemption requests received in proper form (as defined below) on that day. A Fund’s securities received on redemption (“Redemption Instruments”) may include, with respect
to a passively managed Fund, securities in different proportions than securities of the Underlying Index or may include securities not currently represented in the Underlying Index. Redemption Instruments received on redemption may not be identical
to Deposit Instruments that are applicable to creations of Creation Units. An Authorized Participant submitting a redemption request is deemed to represent to the Trust that it (or its client) (i) owns outright or has full legal authority and legal
beneficial right to tender for redemption the requisite number of Shares to be redeemed and can receive the entire proceeds of the redemption, and (ii) the Shares to be redeemed have not been loaned or pledged to another party nor are they the
subject of a repurchase agreement, securities lending agreement or such other arrangement which would preclude the delivery of such Shares to the Trust. The Trust reserves the right to verify these representations at its discretion, but will
typically require verification with respect to a redemption request from a Fund in connection with higher levels of redemption activity and/or short interest in the Fund. If the Authorized Participant, upon receipt of a verification request, does
not provide sufficient verification of its representations as determined by the Trust, the redemption request will not be considered to have been received in proper form and may be rejected by the Trust. Unless cash redemptions are permitted or
required for a Fund, the redemption proceeds for a Creation Unit generally consist of Redemption Instruments as announced by the Administrator on the Business Day of the request for redemption, plus cash in an amount equal to the difference between
the NAV of the Shares being redeemed, as next determined after a receipt of a request in proper form, and the value of the Redemption Instruments, less the redemption transaction fee and variable fees described below. Should the Redemption
Instruments have a value greater than the NAV of the Shares being redeemed, a compensating cash payment to the Trust equal to the differential plus the applicable redemption transaction fee will be required to be arranged for by or on behalf of the
redeeming shareholder.
The
Trust may suspend the right of redemption or postpone the date of payment for Shares for more than seven days when:
(a)
|
trading on the
Exchange is broadly restricted by the applicable rules and regulations of the SEC;
|
(b)
|
the Exchange is
closed for other than customary weekend and holiday closing;
|
(c)
|
the SEC has by
order permitted such suspension; or
|
(d)
|
the
SEC has declared a market emergency.
|
Redemption Transaction Fee
The basic redemption
transaction fee (as described in “PURCHASE AND REDEMPTION OF CREATION UNITS” in Part I of this SAI) is the same no matter how many Creation Units are being redeemed pursuant to any one redemption request. An additional charge up to four
times the redemption transaction fee will be charged with respect to cash redemptions or redemptions outside of the NSCC Clearing Process. An additional variable charge for cash redemptions or partial cash redemptions (when cash redemptions are
permitted or required for a Fund) may also be imposed to compensate each applicable Fund for the costs associated with selling the applicable securities. As a result, in order to seek to replicate the in-kind redemption order process, the Trust
expects to sell, in the secondary market, the portfolio securities or settle any financial instruments that may not be permitted to be re-registered in the name of the Participating Party as a result of an in-kind redemption order pursuant to local
law or market convention, or for other reasons (“Market Sales”). In such cases where the Trust makes Market Sales, the Authorized Participant will reimburse the Trust for, among other things, any difference between the market value at
which the securities and/or financial instruments were sold or settled by the Trust and the cash in lieu amount (which amount, at the Adviser’s discretion, may be capped), applicable registration fees, brokerage commissions and certain taxes
(“Transaction Costs”). The Adviser may adjust the transaction fee to the extent the composition of the redemption securities changes or cash in lieu is added to the Cash Amount to protect ongoing shareholders. In no event will
transaction fees charged by a Fund in connection with a redemption exceed 2% of the value of each Creation Unit. Investors who use the services of a broker or other such intermediary may be charged a fee for such services. To the extent a Fund
cannot recoup the amount of Transaction Costs incurred in connection with a redemption from the redeeming shareholder because of the 2% cap or otherwise, those Transaction Costs will be borne by the Fund’s remaining shareholders and negatively
affect the Fund’s performance.
Placement
of Redemption Orders Using NSCC Clearing Process
Orders to redeem Creation
Units of the Fund through the NSCC Clearing Process, if available, must be delivered through a Participating Party that has executed the Participant Agreement. An order to redeem Creation Units of a Fund using the Clearing Process is deemed received
on the Transmittal Date if (i) such order is received by the Distributor not later than 4:00 p.m. Eastern time on such Transmittal Date (or, for custom orders where cash replaces any Redemption Instrument, such earlier time set forth in the
Participant Agreement or disclosed herein); and (ii) all other procedures set forth in the Participant Agreement are properly followed; such order will be effected based on the NAV of the Fund as next determined. An order to redeem Creation Units of
the Fund using the NSCC Clearing Process made in proper form but received by the Fund after 4:00 p.m. Eastern time (or, for certain custom orders, such earlier time set forth in the Participant Agreement or disclosed herein), will be deemed received
on the next Business Day immediately following the Transmittal Date. With respect to custom orders where cash replaces any Redemption Instrument of JPMorgan Diversified Alternatives ETF, JPMorgan Event Driven ETF, JPMorgan Long/Short ETF, JPMorgan
Managed Futures Strategy ETF and JPMorgan BetaBuilders 1-5 Year U.S. Aggregate Bond ETF, an order to redeem Creation Units of a Fund is deemed received on the Transmittal Date if (i) such order is received by the Distributor not later than 3:00 p.m.
Eastern time on such Transmittal Date; and (ii) all other procedures set forth in the Participant Agreement are properly followed; such order will be effected based on the NAV of the Fund as next determined. An order to redeem Creation Units of such
Funds using the NSCC Clearing Process made in proper form but received after 3:00 p.m. Eastern time, will be deemed received on the next Business Day immediately following the Transmittal Date. The requisite Redemption Instruments (or contracts to
purchase such Redemption Instruments which are expected to be delivered in a “regular way” manner) and the applicable cash payment will be transferred by the second (2nd) Business Day following the date on which such request for
redemption is deemed received. Each Fund reserves the right to settle Creation Unit transactions on a basis other than T+2 if necessary or appropriate under the circumstances and compliant with applicable law.
Placement of Redemption Orders Outside NSCC Clearing
Process — Domestic Funds
Orders to redeem Creation
Units of a Fund outside the NSCC Clearing Process must be delivered through a DTC Participant that has executed the Participant Agreement. A DTC Participant who wishes to place an order for redemption of Creation Units of a Fund to be effected
outside the NSCC Clearing Process need not be a Participating Party, but such orders must state that the DTC Participant is not using the Clearing Process and that redemption of Creation Units of the Fund will instead be effected through transfer of
Creation Units of the Fund directly through DTC. An order to redeem Creation Units of a Fund outside the Clearing Process is deemed received by the Distributor on the Transmittal Date if (i) such order
is received by the Distributor not later than 4:00 p.m. Eastern
time on such Transmittal Date (or, for certain custom orders, such earlier time disclosed herein); (ii) such order is preceded or accompanied by the requisite number of Shares of Creation Units specified in such order, which delivery must be made
through DTC to the Custodian no later than 11:00 a.m. Eastern time, on such Transmittal Date (the “DTC Cut-Off-Time”); and (iii) all other procedures set forth in the Participant Agreement are properly followed. With respect to custom
orders where cash replaces any Redemption Instrument of JPMorgan Diversified Alternatives ETF, JPMorgan Event Driven ETF, JPMorgan Long/Short ETF, JPMorgan Managed Futures Strategy ETF and JPMorgan BetaBuilders 1-5 Year U.S. Aggregate Bond ETF, an
order to redeem Creation Units of a Fund outside of the Clearing Process is deemed received on the Transmittal Date if (i) such order is received by the Distributor not later than 3:00 p.m. Eastern time on such Transmittal Date; (ii) such order is
preceded or accompanied by the requisite number of Shares of Creation Units specified in such order, which delivery must be made through DTC to the Custodian no later than the DTC Cut-Off Time; and (iii) all other procedures set forth in the
Participant Agreement are properly followed.
After the Distributor has
deemed an order for redemption outside the NSCC Clearing Process received, the Custodian will initiate procedures to transfer the requisite Redemption Instruments (or contracts to purchase such Redemption Instruments) which are expected to be
delivered within two Business Days and the cash redemption payment to the redeeming Beneficial Owner by the second Business Day following the Transmittal Date on which such redemption order is deemed received by the Custodian. Each Fund reserves the
right to settle Creation Unit transactions on a basis other than T+2 if necessary or appropriate under the circumstances and compliant with applicable law. An additional variable redemption transaction fee of up to four times the basic transaction
fee is applicable to redemptions outside the NSCC Clearing Process.
To the extent contemplated by
an Authorized Participant’s agreement, in the event the Authorized Participant has submitted a redemption request in proper form but is unable to transfer all or part of the Creation Unit to be redeemed to the Fund’s Transfer Agent, the
Transfer Agent will nonetheless accept the redemption request in reliance on the undertaking by the Authorized Participant to deliver the missing shares as soon as possible. Such undertaking shall be secured by the Authorized Participant’s
delivery and maintenance of collateral consisting of cash having a value (marked to market daily) of at least 105%, which the Trust may change from time to time, of the value of the missing shares.
The current procedures for
collateralization of missing shares require, among other things, that any cash collateral shall be in the form of U.S. dollars in immediately available funds and shall be held by the Custodian and marked to market daily, and that the fees of the
Custodian and any sub-custodians in respect of the delivery, maintenance and redelivery of the cash collateral shall be payable by the Authorized Participant. The Authorized Participant’s agreement will permit the Trust, on behalf of the Fund,
to purchase the missing shares or acquire the Deposit Instruments and the Cash Amount underlying such shares at any time and will subject the Authorized Participant to liability for any shortfall between the cost to the Trust of purchasing such
shares, Deposit Instruments or Cash Amount and the value of the collateral.
Placement of Redemption Orders Outside NSCC Clearing
Process — Foreign Funds
Arrangements satisfactory to
the Trust must be in place for the Participating Party to transfer the Creation Units through DTC on or before the settlement date. Redemptions of Shares for Redemption Instruments will be subject to compliance with applicable U.S. federal and state
securities laws and a Fund (whether or not it otherwise permits or requires cash redemptions) reserves the right to redeem Creation Units for cash to the extent that the Fund could not lawfully deliver specific Redemption Instruments upon
redemptions or could not do so without first registering the Deposit Securities under such laws.
In connection with taking
delivery of Shares for Redemption Instruments upon redemption of Creation Units, a redeeming shareholder or entity acting on behalf of a redeeming shareholder must maintain appropriate custody arrangements with a qualified broker-dealer, bank or
other custody providers in each jurisdiction in which any of the Redemption Instruments are customarily traded, to which account such Redemption Instruments will be delivered. If neither the redeeming shareholder nor the entity acting on behalf of a
redeeming shareholder has appropriate arrangements to take delivery of the Redemption Instruments in the applicable foreign jurisdiction and it is not possible to make other such arrangements, or if it is not possible to effect deliveries of the
Redemption Instruments in such jurisdictions, the Trust may, in its discretion, exercise its option to redeem such Shares in cash, and the redeeming shareholder will be required to receive its redemption proceeds in cash.
Deliveries of redemption
proceeds generally will be made within two business days. Due to the schedule of holidays in certain countries or for other reasons, however, the delivery of redemption proceeds may take longer than two business days after the day on which the
redemption request is received in proper form. In such cases, the local market settlement procedures will not commence until the end of the local holiday periods.
The holidays applicable to the
Foreign Funds (including the Funds) are listed below. The proclamation of new holidays, the treatment by market participants of certain days as “informal holidays” (e.g., days on which no or
limited securities transactions occur, as a result of substantially shortened trading hours), the elimination of existing holidays or changes in local securities delivery practices, could affect the information set forth herein at some time in the
future.
In calendar year
2019 and 2020, the dates of regular holidays affecting the relevant securities markets in which the Funds invest are as follows (please note these holiday schedules are subject to potential changes in the relevant securities markets):
2019
AUSTRALIA
|
|
|
|
January
1
|
April
22
|
August
5
|
December
25
|
January
28
|
April
25
|
October
7
|
|
April
19
|
May
6
|
November
5
|
|
AUSTRIA
|
|
|
|
January
1
|
May
30
|
August
15
|
December
8
|
January
6
|
June
10
|
October
26
|
December
25
|
April
22
|
June
20
|
November
1
|
December
26
|
May
1
|
|
|
|
BELGIUM
|
|
|
|
January
1
|
May
30
|
August
15
|
December
25
|
April
22
|
June
10
|
November
1
|
|
May
1
|
July
21
|
November
11
|
|
DENMARK
|
|
|
|
January
1
|
April
22
|
June
5
|
December
25
|
April
18
|
May
17
|
June
10
|
December
26
|
April
19
|
May
30
|
December
24
|
December
31
|
FINLAND
|
|
|
|
January
1
|
April
22
|
December
6
|
December
26
|
January
6
|
May
1
|
December
24
|
|
April
19
|
May
30
|
December
25
|
|
FRANCE
|
|
|
|
January
1
|
May
8
|
July
15
|
November
11
|
April
22
|
May
30
|
August
15
|
December
25
|
May
1
|
June
10
|
November
1
|
December
26
|
GERMANY
|
|
|
|
January
1
|
May
1
|
October
3
|
|
April
19
|
May
30
|
December
25
|
|
April
22
|
June
10
|
December
26
|
|
HONG
KONG
|
|
|
|
January
1
|
April
5
|
May
13
|
October
1
|
February
5
|
April
19
|
June
7
|
October
7
|
February
6
|
April
22
|
July
1
|
December
25
|
February
7
|
May
1
|
September
14
|
December
26
|
IRELAND
|
|
|
|
January
1
|
April
22
|
August
5
|
December
26
|
March
18
|
May
6
|
October
28
|
December
27
|
April
19
|
May
3
|
December
25
|
|
ISRAEL
|
|
|
|
March
21
|
June
9
|
October
1
|
October
14
|
April
26
|
August
11
|
October
8
|
October
21
|
May
9
|
September
30
|
October
9
|
|
*The
Israeli market is closed every Friday.
|
ITALY
|
|
|
|
January
1
|
April
22
|
June
2
|
December
8
|
January
6
|
April
25
|
August
15
|
December
25
|
April
19
|
May
1
|
November
1
|
December
26
|
JAPAN
|
|
|
|
January
1
|
April
30
|
July
15
|
October
22
|
January
14
|
May
1
|
August
12
|
November
4
|
February
11
|
May
2
|
September
16
|
November
25
|
March
21
|
May
3
|
September
23
|
December
23
|
April
19
|
May
6
|
October
14
|
|
NETHERLANDS
|
|
|
|
January
1
|
April
27
|
May
30
|
December
25
|
April
19
|
May
4
|
May
30
|
December
26
|
April
22
|
May
5
|
June
10
|
|
NORWAY
|
|
|
|
January
1
|
April
22
|
May
30
|
December
25
|
April
18
|
May
1
|
June
10
|
December
26
|
April
19
|
May
17
|
December
24
|
|
PORTUGAL
|
|
|
|
January
1
|
April
22
|
December
25
|
|
April
19
|
May
1
|
December
26
|
|
SINGAPORE
|
|
|
|
January
1
|
April
19
|
June
5
|
October
27
|
February
5
|
May
1
|
August
9
|
December
25
|
February
6
|
May
19
|
August
12
|
|
SPAIN
|
|
|
|
January
1
|
April
22
|
September
11
|
December
8
|
January
6
|
May
1
|
October
12
|
December
25
|
April
18
|
July
25
|
November
1
|
|
April
19
|
August
15
|
December
6
|
|
SWEDEN
|
|
|
|
January
1
|
May
1
|
June
22
|
December
26
|
January
6
|
May
30
|
November
2
|
December
31
|
April
19
|
June
6
|
December
24
|
|
April
22
|
June
21
|
December
25
|
|
SWITZERLAND
|
|
|
|
January
1
|
April
22
|
June
10
|
December
25
|
April
19
|
May
30
|
August
1
|
December
26
|
UNITED
KINGDOM
|
|
|
|
January
1
|
May
6
|
August
6
|
|
April
19
|
May
27
|
December
25
|
|
April
22
|
August
5
|
December
26
|
|
2020
AUSTRALIA
|
|
|
|
January
1
|
April
10
|
April
13
|
December
25
|
January
26
|
April
11
|
April
25
|
December
26
|
January
27
|
April
12
|
April
27
|
December
28
|
AUSTRIA
|
|
|
|
January
1
|
May
21
|
October
26
|
December
26
|
January
6
|
June
1
|
November
1
|
|
April
13
|
June
11
|
November
8
|
|
May
1
|
August
15
|
December
25
|
|
BELGIUM
|
|
|
|
January
1
|
May
1
|
June
1
|
November
1
|
April
12
|
May
21
|
July
21
|
November
11
|
April
13
|
May
31
|
August
15
|
December
25
|
DENMARK
|
|
|
|
January
1
|
April
12
|
May
21
|
December
24
|
April
9
|
April
13
|
May
31
|
December
25
|
April
10
|
May
8
|
June
1
|
December
26
|
FINLAND
|
|
|
|
January
1
|
May
1
|
November
1
|
December
26
|
January
6
|
May
21
|
December
6
|
|
April
10
|
June
19
|
December
24
|
|
April
13
|
June
20
|
December
25
|
|
FRANCE
|
|
|
|
January
1
|
May
8
|
July
14
|
November
11
|
April
13
|
May
21
|
August
15
|
December
25
|
May
1
|
June
1
|
November
1
|
|
GERMANY
|
|
|
|
January
1
|
May
1
|
October
3
|
|
April
10
|
May
21
|
December
25
|
|
April
13
|
June
1
|
December
26
|
|
HONG
KONG
|
|
|
|
January
1
|
April
10
|
June
25
|
October
26
|
January
25
|
April
11
|
July
1
|
December
25
|
January
27
|
April
13
|
October
1
|
December
28
|
January
28
|
April
30
|
October
2
|
|
April
4
|
May
1
|
October
25
|
|
IRELAND
|
|
|
|
January
1
|
May
4
|
October
26
|
December
28
|
March
17
|
June
1
|
December
25
|
|
April
13
|
August
3
|
December
26
|
|
ISRAEL
|
|
|
|
March
10
|
April
16
|
July
30
|
September
28
|
March
11
|
April
29
|
August
19
|
October
3
|
April
4
|
May
8
|
August
20
|
October
10
|
April
9
|
May
29
|
September
19
|
October
11
|
April
15
|
May
31
|
September
20
|
|
*The
Israeli market is closed every Friday.
|
ITALY
|
|
|
|
January
1
|
April
25
|
August
15
|
December
25
|
January
6
|
May
1
|
November
1
|
December
26
|
April
13
|
June
2
|
December
8
|
|
JAPAN
|
|
|
|
January
1
|
April
30
|
July
15
|
October
22
|
January
14
|
May
1
|
August
12
|
November
4
|
February
11
|
May
2
|
September
16
|
November
25
|
March
21
|
May
3
|
September
23
|
December
23
|
April
19
|
May
6
|
October
14
|
|
NETHERLANDS
|
|
|
|
January
1
|
April
27
|
May
31
|
December
26
|
April
12
|
May
5
|
June
1
|
|
April
13
|
May
21
|
December
25
|
|
NORWAY
|
|
|
|
January
1
|
April
13
|
May
21
|
December
26
|
April
9
|
May
1
|
June
1
|
|
April
10
|
May
17
|
December
25
|
|
PORTUGAL
|
|
|
|
January
1
|
May
1
|
October
5
|
December
25
|
April
10
|
June
10
|
November
1
|
|
April
12
|
June
11
|
December
1
|
|
April
25
|
August
15
|
December
8
|
|
SINGAPORE
|
|
|
|
January
1
|
May
1
|
August
9
|
October
28
|
February
5
|
May
19
|
August
11
|
December
25
|
February6
|
May
20
|
August
12
|
|
April
19
|
June
5
|
October
27
|
|
SPAIN
|
|
|
|
January
1
|
May
1
|
November
1
|
December
25
|
January
6
|
August
15
|
December
6
|
|
April
19
|
October
12
|
December
8
|
|
SWEDEN
|
|
|
|
January
1
|
April
13
|
June
6
|
December
24
|
January
6
|
May
1
|
June
19
|
December
25
|
April
10
|
May
21
|
June
20
|
December
26
|
April
12
|
May
31
|
November
1
|
December
31
|
SWITZERLAND
|
|
|
|
January
1
|
May
21
|
August
1
|
December
26
|
April
10
|
May
31
|
September
20
|
|
April
13
|
June
1
|
December
25
|
|
UNITED
KINGDOM
|
|
|
|
January
1
|
May
4
|
August
31
|
December
26
|
April
10
|
May
25
|
December
25
|
December
28
|
The longest redemption cycle for
Foreign Funds is a function of the longest redemption cycle among the countries whose securities comprise the Funds.
For the period
November 2019 — October 2020, the dates of regular holidays affecting the following securities markets present the worst-case (longest) redemption cycle* for Foreign Funds as follows:
SETTLEMENT PERIODS GREATER THAN SEVEN DAYS FOR
THE PERIOD NOVEMBER 2019 — OCTOBER 2020
|
Beginning
of
Settlement Period
|
|
End
of Settlement
Period
|
|
Number
of Days in
Settlement Period
|
AUSTRALIA
|
12/24/2019
|
|
1/2/2020
|
|
8
|
|
1/24/2020
|
|
2/3/2020
|
|
9
|
|
|
|
|
|
|
|
Beginning
of
Settlement Period
|
|
End
of Settlement
Period
|
|
Number
of Days in
Settlement Period
|
BELGIUM
|
10/31/2019
|
|
11/13/2019
|
|
13
|
|
11/1/2019
|
|
11/13/2019
|
|
12
|
|
11/4/2019
|
|
11/15/2019
|
|
10
|
|
11/5/2019
|
|
11/18/2019
|
|
12
|
|
11/6/2019
|
|
11/19/2019
|
|
12
|
|
11/7/2019
|
|
11/20/2019
|
|
12
|
|
11/8/2019
|
|
11/21/2019
|
|
12
|
|
12/18/2019
|
|
12/27/2019
|
|
9
|
|
12/19/2019
|
|
12/30/2019
|
|
10
|
|
12/20/2019
|
|
12/31/2019
|
|
10
|
|
12/23/2019
|
|
1/3/2020
|
|
11
|
|
12/24/2019
|
|
1/6/2020
|
|
12
|
|
4/2/2020
|
|
4/14/2020
|
|
11
|
|
4/3/2020
|
|
4/15/2020
|
|
11
|
|
4/6/2020
|
|
4/16/2020
|
|
9
|
|
4/7/2020
|
|
4/17/2020
|
|
9
|
|
4/8/2020
|
|
4/20/2020
|
|
10
|
|
4/9/2020
|
|
4/21/2020
|
|
10
|
|
4/10/2020
|
|
4/22/2020
|
|
10
|
|
4/22/2020
|
|
5/4/2020
|
|
11
|
|
4/23/2020
|
|
5/5/2020
|
|
11
|
|
4/24/2020
|
|
5/6/2020
|
|
11
|
|
4/27/2020
|
|
5/7/2020
|
|
9
|
|
4/28/2020
|
|
5/8/2020
|
|
9
|
|
4/29/2020
|
|
5/11/2020
|
|
11
|
|
4/30/2020
|
|
5/12/2020
|
|
11
|
|
5/12/2020
|
|
5/22/2020
|
|
9
|
|
5/13/2020
|
|
5/25/2020
|
|
11
|
|
5/14/2020
|
|
5/26/2020
|
|
11
|
|
5/15/2020
|
|
5/27/2020
|
|
11
|
|
5/18/2020
|
|
5/28/2020
|
|
10
|
|
5/19/2020
|
|
5/29/2020
|
|
10
|
|
5/20/2020
|
|
6/2/2020
|
|
12
|
|
5/22/2020
|
|
6/3/2020
|
|
11
|
|
5/25/2020
|
|
6/4/2020
|
|
9
|
|
5/26/2020
|
|
6/5/2020
|
|
9
|
|
5/27/2020
|
|
6/8/2020
|
|
11
|
|
5/28/2020
|
|
6/9/2020
|
|
11
|
|
5/29/2020
|
|
6/10/2020
|
|
11
|
|
|
|
|
|
|
|
Beginning
of
Settlement Period
|
|
End
of Settlement
Period
|
|
Number
of Days in
Settlement Period
|
DENMARK
|
12/16/2016
|
|
12/27/2019
|
|
11
|
|
12/17/2019
|
|
12/30/2019
|
|
13
|
|
12/18/2019
|
|
1/2/2020
|
|
13
|
|
12/19/2019
|
|
1/3/2020
|
|
13
|
|
12/20/2019
|
|
1/6/2020
|
|
16
|
|
12/23/2019
|
|
1/7/2020
|
|
15
|
|
4/1/2020
|
|
4/14/2020
|
|
12
|
|
4/2/2020
|
|
4/15/2020
|
|
12
|
|
4/3/2020
|
|
4/16/2020
|
|
12
|
|
4/6/2020
|
|
4/17/2020
|
|
10
|
|
4/7/2020
|
|
4/20/2020
|
|
12
|
|
4/8/2020
|
|
4/21/2020
|
|
12
|
|
4/30/2020
|
|
5/11/2020
|
|
10
|
|
5/1/2020
|
|
5/12/2020
|
|
10
|
|
5/4/2020
|
|
5/13/2020
|
|
9
|
|
5/5/2020
|
|
5/14/2020
|
|
9
|
|
5/6/2020
|
|
5/15/2020
|
|
9
|
|
5/7/2020
|
|
5/18/2020
|
|
10
|
|
5/13/2020
|
|
5/22/2020
|
|
8
|
|
5/14/2020
|
|
5/25/2020
|
|
10
|
|
5/15/2020
|
|
5/26/2020
|
|
10
|
|
5/18/2020
|
|
5/27/2020
|
|
8
|
|
5/19/2020
|
|
5/28/2020
|
|
8
|
|
5/20/2020
|
|
5/29/2020
|
|
8
|
|
4/22/2020
|
|
5/2/2020
|
|
10
|
|
4/25/2020
|
|
5/3/2020
|
|
8
|
|
4/26/2020
|
|
5/4/2020
|
|
8
|
|
4/27/2020
|
|
5/5/2020
|
|
8
|
|
4/28/2020
|
|
5/8/2020
|
|
10
|
|
4/29/2020
|
|
5/9/2020
|
|
10
|
|
|
|
|
|
|
FRANCE
|
12/24/2019
|
|
1/2/2020
|
|
8
|
|
|
|
|
|
|
GERMANY
|
12/18/2019
|
|
12/27/2019
|
|
8
|
|
12/19/2019
|
|
12/30/2019
|
|
10
|
|
12/20/2019
|
|
12/31/2019
|
|
10
|
|
12/23/2019
|
|
1/2/2020
|
|
9
|
|
12/24/2019
|
|
1/3/2020
|
|
9
|
|
4/3/2020
|
|
4/15/2020
|
|
11
|
|
4/6/2020
|
|
4/16/2020
|
|
9
|
|
4/7/2020
|
|
4/17/2020
|
|
9
|
|
4/8/2020
|
|
4/20/2020
|
|
11
|
|
4/9/2020
|
|
4/21/2020
|
|
11
|
|
|
|
|
|
|
|
Beginning
of
Settlement Period
|
|
End
of Settlement
Period
|
|
Number
of Days in
Settlement Period
|
ISRAEL
|
3/3/2020
|
|
3/12/2020
|
|
9
|
|
3/4/2020
|
|
3/16/2020
|
|
12
|
|
3/5/2020
|
|
3/17/2020
|
|
12
|
|
3/9/2020
|
|
3/18/2020
|
|
9
|
|
4/22020
|
|
4/13/2020
|
|
11
|
|
4/6/2020
|
|
4/14/2020
|
|
8
|
|
4/7/2020
|
|
4/20/2020
|
|
13
|
|
4/8/2020
|
|
4/21/2020
|
|
13
|
|
7/23/2020
|
|
8/3/2020
|
|
11
|
|
8/12/2020
|
|
8/24/2020
|
|
12
|
|
8/13/2020
|
|
8/25/2020
|
|
12
|
|
8/17/2020
|
|
8/26/2020
|
|
9
|
|
8/18/2020
|
|
8/27/2020
|
|
9
|
|
9/23/2020
|
|
10/1/2020
|
|
8
|
|
9/24/2020
|
|
10/5/2020
|
|
11
|
|
|
|
|
|
|
JAPAN
|
11/1/2019
|
|
11/11/2019
|
|
9
|
|
11/23/2019
|
|
12/2/2019
|
|
9
|
|
12/24/2019
|
|
1/2/2020
|
|
8
|
|
1/10/2020
|
|
1/20/2020
|
|
9
|
|
4/28/2020
|
|
5/7/2020
|
|
9
|
|
4/30/2020
|
|
5/8/2020
|
|
8
|
|
5/1/2020
|
|
5/11/2020
|
|
10
|
|
4/28/2020
|
|
5/5/2020
|
|
8
|
|
4/29/2020
|
|
5/7/2020
|
|
9
|
|
4/30/2020
|
|
5/8/2020
|
|
9
|
|
9/15/2020
|
|
9/23/2020
|
|
8
|
|
|
|
|
|
|
NETHERLANDS
|
12/18/2019
|
|
12/30/2019
|
|
11
|
|
12/19/2019
|
|
12/31/2019
|
|
11
|
|
12/20/2019
|
|
1/2/2020
|
|
12
|
|
12/23/2019
|
|
1/3/2020
|
|
10
|
|
12/24/2019
|
|
1/6/2019
|
|
12
|
|
|
|
|
|
|
NORWAY
|
12/16/2019
|
|
12/27/2019
|
|
11
|
|
12/17/2019
|
|
12/30/2019
|
|
12
|
|
12/18/2019
|
|
12/31/2019
|
|
12
|
|
12/19/2019
|
|
1/2/2020
|
|
13
|
|
12/20/2019
|
|
1/3/2020
|
|
13
|
|
12/23/2019
|
|
2/6/2020
|
|
10
|
|
4/1/2020
|
|
4/14/2020
|
|
12
|
|
4/2/2020
|
|
4/15/2020
|
|
12
|
|
4/3/2020
|
|
4/16/2020
|
|
12
|
|
4/6/2020
|
|
4/17/2020
|
|
10
|
|
4/7/2020
|
|
4/20/2020
|
|
12
|
|
4/8/2020
|
|
4/21/2020
|
|
12
|
|
4/23/2020
|
|
5/4/2020
|
|
10
|
|
4/24/2020
|
|
5/5/2020
|
|
10
|
|
4/27/2020
|
|
5/6/2020
|
|
8
|
|
4/28/2020
|
|
5/7/2020
|
|
8
|
|
4/29/2020
|
|
5/8/2020
|
|
8
|
|
4/30/2020
|
|
5/11/2020
|
|
10
|
|
|
|
|
|
|
|
Beginning
of
Settlement Period
|
|
End
of Settlement
Period
|
|
Number
of Days in
Settlement Period
|
PORTUGAL
|
12/18/2019
|
|
12/27/2019
|
|
8
|
|
12/19/2019
|
|
12/30/2019
|
|
10
|
|
12/20/2019
|
|
12/31/2019
|
|
10
|
|
12/23/2019
|
|
1/2/2020
|
|
8
|
|
12/24/2019
|
|
1/3/2020
|
|
9
|
|
6/3/2020
|
|
6/12/2020
|
|
8
|
|
6/4/2020
|
|
6/15/2020
|
|
10
|
|
6/5/2020
|
|
6/16/2020
|
|
10
|
|
6/8/2020
|
|
6/17/2020
|
|
8
|
|
6/9/2020
|
|
6/18/2020
|
|
8
|
|
|
|
|
|
|
SPAIN
|
10/23/2019
|
|
11/5/2019
|
|
12
|
|
10/24/2019
|
|
11/6/2019
|
|
12
|
|
10/25/2019
|
|
11/7/2019
|
|
12
|
|
10/28/2019
|
|
11/8/2019
|
|
10
|
|
10/29/2019
|
|
11/11/2019
|
|
12
|
|
10/31/2019
|
|
11/13/2019
|
|
12
|
|
11/26/2019
|
|
10/9/2019
|
|
12
|
|
11/27/2019
|
|
10/10/2019
|
|
12
|
|
11/28/2019
|
|
10/11/2019
|
|
12
|
|
11/29/2019
|
|
10/12/2019
|
|
12
|
|
12/2/2019
|
|
10/13/2019
|
|
10
|
|
12/3/2019
|
|
10/16/2019
|
|
12
|
|
12/4/2019
|
|
10/17/2019
|
|
12
|
|
12/5/2019
|
|
12/18/2019
|
|
11
|
|
12/13/2019
|
|
12/26/2019
|
|
12
|
|
12/16/2019
|
|
12/27/2019
|
|
10
|
|
12/17/2019
|
|
12/30/2019
|
|
12
|
|
12/18/2019
|
|
12/31/2019
|
|
12
|
|
12/19/2019
|
|
1/2/2020
|
|
13
|
|
12/20/2019
|
|
1/3/2020
|
|
13
|
|
12/23/2019
|
|
1/7/2020
|
|
14
|
|
12/24/2019
|
|
1/8/2020
|
|
14
|
|
12/31/2019
|
|
1/14/2020
|
|
13
|
|
12/26/2019
|
|
1/9/2020
|
|
13
|
|
12/27/2019
|
|
1/10/2020
|
|
13
|
|
12/30/2019
|
|
1/13/2020
|
|
13
|
|
1/2/2020
|
|
1/14/2020
|
|
13
|
|
1/3/2020
|
|
1/15/2020
|
|
12
|
|
1/3/2020
|
|
1/16/2020
|
|
12
|
|
4/23/2020
|
|
5/4/2020
|
|
11
|
|
4/24/2020
|
|
5/5/2020
|
|
11
|
|
4/27/2020
|
|
5/6/2020
|
|
9
|
|
4/28/2020
|
|
5/7/2020
|
|
9
|
|
4/29/2020
|
|
5/8/2020
|
|
11
|
|
4/30/2020
|
|
5/11/2020
|
|
11
|
|
10/1/2020
|
|
10/13/2020
|
|
12
|
|
10/2/2020
|
|
10/14/2020
|
|
12
|
|
10/5/2020
|
|
10/15/2020
|
|
10
|
|
10/6/2020
|
|
10/16/2020
|
|
10
|
|
10/7/2020
|
|
10/19/2020
|
|
12
|
|
10/8/2020
|
|
10/20/2020
|
|
12
|
|
10/9/2020
|
|
10/21/2020
|
|
12
|
|
|
|
|
|
|
|
Beginning
of
Settlement Period
|
|
End
of Settlement
Period
|
|
Number
of Days in
Settlement Period
|
SWEDEN
|
12/17/2019
|
|
12/27/2019
|
|
9
|
|
12/18/2019
|
|
12/30/2019
|
|
11
|
|
12/19/2019
|
|
1/2/2020
|
|
13
|
|
12/20/2019
|
|
1/3/2020
|
|
13
|
|
12/23/2019
|
|
1/6/2020
|
|
13
|
|
4/3/2020
|
|
4/15/2020
|
|
11
|
|
4/6/2020
|
|
4/16/2020
|
|
9
|
|
4/7/2020
|
|
4/17/2020
|
|
9
|
|
4/8/2020
|
|
4/20/2020
|
|
11
|
|
4/9/2020
|
|
4/21/2020
|
|
11
|
|
|
|
|
|
|
SWITZERLAND
|
12/17/2019
|
|
12/27/2019
|
|
9
|
|
12/18/2019
|
|
12/30/2019
|
|
11
|
|
12/19/2019
|
|
12/31/2019
|
|
11
|
|
12/20/2019
|
|
1/2/2020
|
|
12
|
|
12/23/2019
|
|
1/3/2020
|
|
10
|
|
12/24/2019
|
|
1/6/2020
|
|
12
|
|
4/3/2020
|
|
4/15/2020
|
|
11
|
|
4/6/2020
|
|
4/16/2020
|
|
9
|
|
4/7/2020
|
|
4/17/2020
|
|
9
|
|
4/8/2020
|
|
4/20/2020
|
|
11
|
|
4/9/2020
|
|
4/21/2020
|
|
11
|
*
|
These worst-case
redemption cycles are based on information regarding regular holidays, which may be out of date. Based on changes in holidays, longer (worse) redemption cycles are possible.
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APPENDIX B — PROXY VOTING GUIDELINES
The Board of Trustees has
further authorized the Adviser to delegate proxy voting for certain Bank Securities that: (1) are held in such ETFs as identified in the SAI Part II from time to time and (2) are designated from time to time by the Adviser, to ISS to be voted in
accordance with ISS Guidelines.
United States
Proxy Voting Guidelines
Benchmark Policy Recommendations
Effective for Meetings on or after February 1,
2019
Published December 6, 2018
www.issgovernance.com
©
2018 ISS | Institutional Shareholder Services
U.S. Proxy Voting Guidelines
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COVERAGE
The U.S. research team provides proxy analyses and
voting recommendations for common shareholder meetings of publicly - traded U.S. - incorporated companies that are held in our institutional investor clients’ portfolios and includes all S&P 1500 and Russell 3000 companies that are
considered U.S. Domestic Issuers by the SEC. Coverage generally includes corporate actions for common equity holders, such as written consents and bankruptcies. ISS’ U.S. coverage includes investment companies (including open-end funds,
closed-end funds, exchange-traded funds, and unit investment trusts), limited partnerships (“LPs”), master limited partnerships (“MLPs”), limited liability companies (“LLCs”), and business development companies.
ISS reviews its universe of coverage on an annual basis, and the coverage is subject to change based on client need and industry trends.
The U.S. research team also produces, for
subscribing clients, research and recommendations for fixed income meetings, and meetings of certain preferred securities, including Auction Rate Preferred Securities (“ARPS”) and Variable Rate Municipal Term Preferred securities
(“VMTPs”).
Foreign-incorporated
companies
In addition to U.S. - incorporated
companies, U.S. policies are applied to certain foreign-incorporated company analyses. Like the SEC, ISS distinguishes two types of companies that list but are not incorporated in the U.S.:
〉
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U.S. Domestic
Issuers – which have a majority of outstanding shares held in the U.S. and meet other criteria, as determined by the SEC, and are subject to the same disclosure and listing standards as U.S. incorporated companies – are generally covered
under standard U.S. policy guidelines.
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〉
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Foreign Private
Issuers (FPIs) – which do not meet the Domestic Issuer criteria and are exempt from most disclosure requirements (e.g., they do not file DEF14A reports) and listing standards (e.g., for required levels of board and committee independence)
– are covered under a combination of policy guidelines:
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〉
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FPI Guidelines
(see the Americas Regional Proxy Voting Guidelines), which apply certain minimum independence and disclosure standards in the evaluation of key proxy ballot items, such as the election of directors and
approval of financial reports; and
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〉
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For other issues,
guidelines for the market that is responsible for, or most relevant to, the item on the ballot.
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In all cases – including with respect to
other companies with cross-market features that may lead to ballot items related to multiple markets – items that are on the ballot solely due to the requirements of another market (listing, incorporation, or national code) may be evaluated
under the policy of the relevant market, regardless of the “assigned” market coverage.
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1. BOARD OF DIRECTORS
Voting on Director Nominees in Uncontested
Elections
Four fundamental principles apply
when determining votes on director nominees:
Independence:
Boards should be sufficiently independent from management (and significant shareholders) to ensure that they are able and motivated to effectively supervise management’s performance for the benefit of all
shareholders, including in setting and monitoring the execution of corporate strategy, with appropriate use of shareholder capital, and in setting and monitoring executive compensation programs that support that strategy. The chair of the board
should ideally be an independent director, and all boards should have an independent leadership position or a similar role in order to help provide appropriate counterbalance to executive management, as well as having sufficiently independent
committees that focus on key governance concerns such as audit, compensation, and nomination of directors.
Composition:
Companies should ensure that directors add value to the board through their specific skills and expertise and by having sufficient time and commitment to serve effectively. Boards should be of a size appropriate to
accommodate diversity, expertise, and independence, while ensuring active and collaborative participation by all members. Boards should be sufficiently diverse to ensure consideration of a wide range of perspectives.
Responsiveness:
Directors should respond to investor input, such as that expressed through significant opposition to management proposals, significant support for shareholder proposals (whether binding or non-binding), and tender
offers where a majority of shares are tendered.
Accountability:
Boards should be sufficiently accountable to shareholders, including through transparency of the company’s governance practices and regular board elections, by the provision of sufficient information for
shareholders to be able to assess directors and board composition, and through the ability of shareholders to remove directors.
General Recommendation: Generally vote for director nominees, except under the following circumstances:
Independence
Vote against1 or withhold from non-independent directors (Executive Directors and Non-Independent Non-Executive Directors per ISS’ Classification of Directors) when:
〉
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Independent
directors comprise 50 percent or less of the board;
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〉
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The
non-independent director serves on the audit, compensation, or nominating committee;
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〉
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The company lacks
an audit, compensation, or nominating committee so that the full board functions as that committee; or
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〉
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The company lacks
a formal nominating committee, even if the board attests that the independent directors fulfill the functions of such a committee.
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1 In general, companies with a plurality vote standard use “Withhold” as the
contrary vote option in director elections; companies with a majority vote standard use “Against”. However, it will vary by company and the proxy must be checked to determine the valid contrary vote option for the particular
company.
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ISS Classification of Directors – U.S.
1.1.
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Current employee
or current officer1 of the company or one of its
affiliates2.
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2.
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Non-Independent
Non-Executive Director
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Board Identification
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2.1.
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Director
identified as not independent by the board.
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Controlling/Significant
Shareholder
2.2.
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Beneficial owner
of more than 50 percent of the company’s voting power (this may be aggregated if voting power is distributed among more than one member of a group).
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Former
CEO/Interim Officer
2.3.
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Former CEO of the
company.3, 4
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2.4.
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Former CEO of an
acquired company within the past five years.4
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2.5.
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Former interim
officer if the service was longer than 18 months. If the service was between 12 and 18 months an assessment of the interim officer’s employment agreement will be made.5
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Non-CEO
Executives
2.6.
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Former officer1 of the company, an affiliate2, or an acquired firm within
the past five years.
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2.7.
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Officer1 of a former parent or predecessor firm at the time the company was sold or split off from the parent/predecessor within the past five years.
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2.8.
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Officer1, former officer, or general or limited partner of a joint venture or partnership with the company.
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Family
Members
2.9.
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Immediate family
member6 of a current or former officer1 of the company or
its affiliates2 within the last five years.
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2.10.
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Immediate family
member6 of a current employee of company or its
affiliates2 where additional factors raise concern (which may include, but are not limited to, the following: a director related to numerous employees;
the company or its affiliates employ relatives of numerous board members; or a non- Section 16 officer in a key strategic role).
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Transactional,
Professional, Financial, and Charitable Relationships
2.11.
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Currently provides
(or an immediate family member6 provides) professional
services7 to the company, to an affiliate2 of the company
or an individual officer of the company or one of its affiliates in excess of $10,000 per year.
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2.12.
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Is (or an
immediate family member6 is) a partner in, or a controlling shareholder or an employee of, an organization which provides professional services7 to the company, to an affiliate2 of the company, or an
individual officer of the company or one of its affiliates in excess of $10,000 per year.
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2.13.
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Has (or an
immediate family member6 has) any material transactional relationship8 with the company or its affiliates2 (excluding investments
in the company through a private placement).
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2.14.
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Is (or an
immediate family member6 is) a partner in, or a controlling shareholder or an executive officer of, an organization which has any material transactional
relationship8 with the company or its affiliates2
(excluding investments in the company through a private placement).
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2.15.
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Is (or an
immediate family member6 is) a trustee, director, or employee of a charitable or non-profit organization that receives material grants or endowments8 from the company or its affiliates2.
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Other
Relationships
2.16.
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Party to a voting
agreement9 to vote in line with management on proposals being brought to shareholder vote.
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2.17.
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Has (or an
immediate family member6 has) an interlocking relationship as defined by the SEC involving members of the board of directors or its Compensation
Committee.10
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2.18.
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Founder11 of the company but not currently an employee.
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2.19.
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Any material12 relationship with the company.
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3.1.
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No material12 connection to the company other than a board seat.
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Footnotes:
1. The definition of officer will generally follow that of a “Section 16 officer” (officers subject to Section 16 of the Securities and Exchange Act of 1934) and includes the chief executive, operating,
financial, legal, technology, and accounting officers of a company (including the president, treasurer, secretary, controller, or any vice president in charge of a principal business unit, division, or policy function). Current interim officers are
included in this category. For private companies, the equivalent positions are applicable. A non-employee director serving as an officer due to statutory requirements (e.g. corporate secretary) will generally be classified as a Non-Independent
Non-Executive Director under 2.19: “Any material relationship with the company.” However, if the company provides explicit disclosure that the director is not receiving additional compensation exceeding $10,000 per year for serving in
that capacity, then the director will be classified as an Independent Director.
2. “Affiliate” includes a subsidiary, sibling company, or parent company. ISS uses 50 percent control ownership by the parent company as the standard for applying its affiliate designation.
3. Includes any former CEO of the company prior to the company’s initial public offering (IPO).
4. When there is a former CEO of a special purpose acquisition company (SPAC) serving on the board of an acquired company, ISS will generally classify such directors as independent unless determined otherwise taking into
account the following factors: the applicable listing standards determination of such director’s independence; any operating ties to the firm; and the existence of any other conflicting relationships or related party transactions.
5. ISS will look at the terms of the interim officer’s employment contract to determine if it contains severance pay, long-term health and pension benefits, or other such standard provisions typically contained in
contracts of permanent, non-temporary CEOs. ISS will also consider if a formal search process was under way for a full-time officer at the time.
6. “Immediate family member” follows the SEC’s definition of such and covers spouses, parents, children, step-parents, step-children, siblings, in-laws, and any person (other than a tenant or employee)
sharing the household of any director, nominee for director, executive officer, or significant shareholder of the company.
7. Professional services can be characterized as advisory in nature, generally involve access to sensitive company information or to strategic decision-making, and typically have a commission- or fee-based payment structure.
Professional services generally include but are not limited to the following: investment banking/financial advisory services, commercial banking (beyond deposit services), investment services, insurance services, accounting/audit services,
consulting services, marketing services, legal services, property management services, realtor services, lobbying services, executive search services, and IT consulting services. The following would generally be considered transactional
relationships and not professional services: deposit services, IT tech support services, educational services, and construction services. The case of participation in a banking syndicate by a non-lead bank should be considered a transactional (and
hence subject to the associated materiality test) rather than a professional relationship. “Of Counsel” relationships are only considered immaterial if the individual does not receive any form of compensation (in excess of $10,000 per
year) from, or is a retired partner of, the firm providing the professional service. The case of a company providing a professional service to one of its directors or to an entity with which one of its directors is affiliated, will be considered a
transactional rather than a professional relationship. Insurance services and marketing services are assumed to be professional services unless the company explains why such services are not advisory.
8. A material transactional relationship, including grants to non-profit organizations, exists if the company makes annual payments to, or receives annual payments from, another entity, exceeding the greater of: $200,000 or
5 percent of the recipient’s gross revenues, for a company that follows NASDAQ listing standards; or the greater of $1,000,000 or 2 percent of the recipient’s gross revenues, for a company that follows NYSE listing standards. For a
company that follows neither of the preceding standards, ISS will apply the NASDAQ-based materiality test. (The recipient is the party receiving the financial proceeds from the transaction).
9. Dissident directors who are parties to a voting agreement pursuant to a settlement or similar arrangement may be classified as Independent Directors if an analysis of the following factors indicates that the voting
agreement does not compromise their alignment with all shareholders’ interests: the terms of the agreement; the duration of the standstill provision in the agreement; the limitations and requirements of actions that are agreed upon; if the
dissident director nominee(s) is subject to the standstill; and if there any conflicting relationships or related party transactions.
10. Interlocks include: executive officers serving as directors on each other’s compensation or similar committees (or, in the absence of such a committee, on the board); or executive officers sitting on each
other’s boards and at least one serves on the other’s compensation or similar committees (or, in the absence of such a committee, on the board).
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11. The operating involvement of the founder with the company will be considered; if the founder was never employed by the company, ISS may deem him or her an Independent Director.
12. For purposes of ISS’s director independence classification, “material” will be defined as a standard of relationship (financial, personal or otherwise) that a reasonable person might conclude could
potentially influence one’s objectivity in the boardroom in a manner that would have a meaningful impact on an individual’s ability to satisfy requisite fiduciary standards on behalf of shareholders.
Composition
Attendance at Board and Committee Meetings: Generally vote against or withhold from directors (except new nominees, who should be considered case-by-case2) who attend
less than 75 percent of the aggregate of their board and committee meetings for the period for which they served, unless an acceptable reason for absences is disclosed in the proxy or another SEC filing. Acceptable reasons for director absences are
generally limited to the following:
〉
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Medical
issues/illness;
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〉
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Family
emergencies; and
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〉
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Missing only one
meeting (when the total of all meetings is three or fewer).
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In cases of chronic poor attendance without
reasonable justification, in addition to voting against the director(s) with poor attendance, generally vote against or withhold from appropriate members of the nominating/governance committees or the full board.
If the proxy disclosure is unclear and insufficient
to determine whether a director attended at least 75 percent of the aggregate of his/her board and committee meetings during his/her period of service, vote against or withhold from the director(s) in question.
Overboarded Directors: Generally vote against or withhold from individual directors who:
〉
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Sit on more than
five public company boards; or
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〉
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Are CEOs of public
companies who sit on the boards of more than two public companies besides their own — withhold only at their outside boards3.
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Diversity:
Highlight boards with no gender diversity. For 2019 meetings, no adverse vote recommendations will be made due to a lack of gender diversity.
For companies in the Russell 3000 or S&P 1500
indices, effective for meetings on or after Feb. 1, 2020, generally vote against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) at companies when there are no women on the company’s board.
Mitigating factors include:
〉
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A firm commitment,
as stated in the proxy statement, to appoint at least one female to the board in the near term;
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〉
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The presence of a
female on the board at the preceding annual meeting; or
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〉
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Other relevant
factors as applicable.
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2 New nominees who served for only part
of the fiscal year are generally exempted from the attendance policy.
3 Although all of a CEO’s
subsidiary boards with publicly-traded common stock will be counted as separate boards, ISS will not recommend a withhold vote for the CEO of a parent company board or any of the controlled (>50 percent ownership) subsidiaries of that parent but
may do so at subsidiaries that are less than 50 percent controlled and boards outside the parent/subsidiary relationships.
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U.S. Proxy Voting Guidelines
Responsiveness
Vote case-by-case on individual directors,
committee members, or the entire board of directors as appropriate if:
〉
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The board failed
to act on a shareholder proposal that received the support of a majority of the shares cast in the previous year or failed to act on a management proposal seeking to ratify an existing charter/bylaw provision that received opposition of a majority
of the shares cast in the previous year. Factors that will be considered are:
|
〉
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Disclosed outreach
efforts by the board to shareholders in the wake of the vote;
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〉
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Rationale provided
in the proxy statement for the level of implementation;
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〉
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The subject matter
of the proposal;
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〉
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The level of
support for and opposition to the resolution in past meetings;
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〉
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Actions taken by
the board in response to the majority vote and its engagement with shareholders;
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〉
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The continuation
of the underlying issue as a voting item on the ballot (as either shareholder or management proposals); and
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〉
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Other factors as
appropriate.
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〉
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The board failed
to act on takeover offers where the majority of shares are tendered;
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〉
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At the previous
board election, any director received more than 50 percent withhold/against votes of the shares cast and the company has failed to address the issue(s) that caused the high withhold/against vote.
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Vote case-by-case on Compensation Committee members
(or, in exceptional cases, the full board) and the Say on Pay proposal if:
〉
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The
company’s previous say-on-pay received the support of less than 70 percent of votes cast. Factors that will be considered are:
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〉
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The
company’s response, including:
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〉
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Disclosure of
engagement efforts with major institutional investors, including the frequency and timing of engagements and the company participants (including whether independent directors participated);
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〉
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Disclosure of the
specific concerns voiced by dissenting shareholders that led to the say-on-pay opposition;
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〉
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Disclosure of
specific and meaningful actions taken to address shareholders’ concerns;
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〉
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Other recent
compensation actions taken by the company;
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〉
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Whether the issues
raised are recurring or isolated;
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〉
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The
company’s ownership structure; and
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〉
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Whether the
support level was less than 50 percent, which would warrant the highest degree of responsiveness.
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〉
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The board
implements an advisory vote on executive compensation on a less frequent basis than the frequency that received the plurality of votes cast.
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U.S. Proxy Voting Guidelines
Accountability
Vote against or withhold from the entire board of
directors (except new nominees4, who should be considered case-by-case) for the following:
Problematic Takeover Defenses/Governance
Structure
Poison Pills: Vote against or withhold from all nominees (except new nominees, who should be considered case-by-case) if:
〉
|
The company has a
poison pill that was not approved by shareholders5. However, vote case-by-case on nominees if the board adopts an initial pill with a term of one year or
less, depending on the disclosed rationale for the adoption, and other factors as relevant (such as a commitment to put any renewal to a shareholder vote).
|
〉
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The board makes a
material adverse modification to an existing pill, including, but not limited to, extension, renewal, or lowering the trigger, without shareholder approval.
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Classified Board Structure: The board is classified, and a continuing director responsible for a problematic governance issue at the board/committee level that would warrant a withhold/against vote recommendation is not up for election. All
appropriate nominees (except new) may be held accountable.
Removal of Shareholder Discretion on Classified
Boards: The company has opted into, or failed to opt out of, state laws requiring a classified board structure.
Director Performance Evaluation: The board lacks mechanisms to promote accountability and oversight, coupled with sustained poor performance relative to peers. Sustained poor performance is measured by one-, three-, and five-year total shareholder
returns in the bottom half of a company’s four-digit GICS industry group (Russell 3000 companies only). Take into consideration the company’s operational metrics and other factors as warranted. Problematic provisions include but are not
limited to:
〉
|
A classified board
structure;
|
〉
|
A supermajority
vote requirement;
|
〉
|
Either a plurality
vote standard in uncontested director elections, or a majority vote standard in contested elections;
|
〉
|
The inability of
shareholders to call special meetings;
|
〉
|
The inability of
shareholders to act by written consent;
|
〉
|
A multi-class
capital structure; and/or
|
〉
|
A
non-shareholder-approved poison pill.
|
Unilateral Bylaw/Charter Amendments and Problematic
Capital Structures: Generally vote against or withhold from directors individually, committee members, or the entire board (except new nominees, who should be considered case-by-case) if the board amends the
company’s bylaws or charter without shareholder approval in a manner that materially diminishes shareholders’ rights or that could adversely impact shareholders, considering the following factors:
〉
|
The board’s
rationale for adopting the bylaw/charter amendment without shareholder ratification;
|
4 A “new nominee” is any current nominee who has not already been elected by
shareholders and who joined the board after the problematic action in question transpired. If ISS cannot determine whether the nominee joined the board before or after the problematic action transpired, the nominee will be considered a “new
nominee” if he or she joined the board within the 12 months prior to the upcoming shareholder meeting.
5 Public shareholders only, approval prior to a company’s becoming public is
insufficient.
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〉
|
Disclosure by the
company of any significant engagement with shareholders regarding the amendment;
|
〉
|
The level of
impairment of shareholders’ rights caused by the board’s unilateral amendment to the bylaws/ charter;
|
〉
|
The board’s
track record with regard to unilateral board action on bylaw/charter amendments or other entrenchment provisions;
|
〉
|
The
company’s ownership structure;
|
〉
|
The
company’s existing governance provisions;
|
〉
|
The timing of the
board’s amendment to the bylaws/charter in connection with a significant business development; and
|
〉
|
Other factors, as
deemed appropriate, that may be relevant to determine the impact of the amendment on shareholders.
|
Unless the adverse amendment is reversed or
submitted to a binding shareholder vote, in subsequent years vote case-by-case on director nominees. Generally vote against (except new nominees, who should be considered case-by-case) if the directors:
〉
|
Adopted
supermajority vote requirements to amend the bylaws or charter; or
|
〉
|
Eliminated
shareholders’ ability to amend bylaws.
|
Problematic Governance Structure - Newly public
companies: For newly public companies, generally vote against or withhold from directors individually, committee members, or the entire board (except new nominees, who should be considered case-by-case) if, prior to
or in connection with the company’s public offering, the company or its board adopted bylaw or charter provisions materially adverse to shareholder rights, or implemented a multi-class capital structure in which the classes have unequal voting
rights considering the following factors:
〉
|
The level of
impairment of shareholders’ rights;
|
〉
|
The disclosed
rationale;
|
〉
|
The ability to
change the governance structure (e.g., limitations on shareholders’ right to amend the bylaws or charter, or supermajority vote requirements to amend the bylaws or charter);
|
〉
|
The ability of
shareholders to hold directors accountable through annual director elections, or whether the company has a classified board structure;
|
〉
|
Any reasonable
sunset provision; and
|
〉
|
Other relevant
factors.
|
Unless the
adverse provision and/or problematic capital structure is reversed or removed, vote case-by-case on director nominees in subsequent years.
Management Proposals to Ratify Existing Charter or
Bylaw Provisions: Vote against/withhold from individual directors, members of the governance committee, or the full board, where boards ask shareholders to ratify existing charter or bylaw provisions considering the
following factors:
〉
|
The presence of a
shareholder proposal addressing the same issue on the same ballot;
|
〉
|
The board’s
rationale for seeking ratification;
|
〉
|
Disclosure of
actions to be taken by the board should the ratification proposal fail;
|
〉
|
Disclosure of
shareholder engagement regarding the board’s ratification request;
|
〉
|
The level of
impairment to shareholders’ rights caused by the existing provision;
|
〉
|
The history of
management and shareholder proposals on the provision at the company’s past meetings;
|
〉
|
Whether the current
provision was adopted in response to the shareholder proposal;
|
〉
|
The company’s
ownership structure; and
|
〉
|
Previous use of
ratification proposals to exclude shareholder proposals.
|
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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Restrictions on Shareholders’ Rights
Restricting Binding Shareholder Proposals: Generally vote against or withhold from the members of the governance committee if:
〉
|
The
company’s governing documents impose undue restrictions on shareholders’ ability to amend the bylaws. Such restrictions include but are not limited to: outright prohibition on the submission of binding shareholder proposals or share
ownership requirements or time holding requirements in excess of SEC Rule 14a-8. Vote against on an ongoing basis.
|
Problematic Audit-Related Practices
Generally vote against or withhold from the members
of the Audit Committee if:
〉
|
The non-audit fees
paid to the auditor are excessive;
|
〉
|
The company
receives an adverse opinion on the company’s financial statements from its auditor; or
|
〉
|
There is
persuasive evidence that the Audit Committee entered into an inappropriate indemnification agreement with its auditor that limits the ability of the company, or its shareholders, to pursue legitimate legal recourse against the audit firm.
|
Vote case-by-case on
members of the Audit Committee and potentially the full board if:
〉
|
Poor accounting
practices are identified that rise to a level of serious concern, such as: fraud; misapplication of GAAP; and material weaknesses identified in Section 404 disclosures. Examine the severity, breadth, chronological sequence, and duration, as well as
the company’s efforts at remediation or corrective actions, in determining whether withhold/against votes are warranted.
|
Problematic Compensation Practices
In the absence of an Advisory Vote on Executive
Compensation (Say on Pay) ballot item or in egregious situations, vote against or withhold from the members of the Compensation Committee and potentially the full board if:
〉
|
There is an
unmitigated misalignment between CEO pay and company performance (pay for performance);
|
〉
|
The company
maintains significant problematic pay practices; or
|
〉
|
The board exhibits
a significant level of poor communication and responsiveness to shareholders.
|
Generally vote against or withhold from the
Compensation Committee chair, other committee members, or potentially the full board if:
〉
|
The company fails
to include a Say on Pay ballot item when required under SEC provisions, or under the company’s declared frequency of say on pay; or
|
〉
|
The company fails
to include a Frequency of Say on Pay ballot item when required under SEC provisions.
|
Generally vote against members of the board
committee responsible for approving/setting non-employee director compensation if there is a pattern (i.e. two or more years) of awarding excessive non-employee director compensation without disclosing a compelling rationale or other mitigating
factors.
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governance risk for the benefit of shareholders.
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Problematic Pledging of Company Stock:
Vote against the members of the committee that
oversees risks related to pledging, or the full board, where a significant level of pledged company sto1ck by executives or directors raises concerns. The following factors will be considered:
〉
|
The presence of an
anti-pledging policy, disclosed in the proxy statement, that prohibits future pledging activity;
|
〉
|
The magnitude of
aggregate pledged shares in terms of total common shares outstanding, market value, and trading volume;
|
〉
|
Disclosure of
progress or lack thereof in reducing the magnitude of aggregate pledged shares over time;
|
〉
|
Disclosure in the
proxy statement that shares subject to stock ownership and holding requirements do not include pledged company stock; and
|
〉
|
Any other relevant
factors.
|
Governance
Failures
Under extraordinary circumstances,
vote against or withhold from directors individually, committee members, or the entire board, due to:
〉
|
Material failures
of governance, stewardship, risk oversight6, or fiduciary responsibilities at the company;
|
〉
|
Failure to replace
management as appropriate; or
|
〉
|
Egregious actions
related to a director’s service on other boards that raise substantial doubt about his or her ability to effectively oversee management and serve the best interests of shareholders at any company.
|
Voting on Director Nominees in Contested
Elections
Vote-No Campaigns
General Recommendation: In cases where companies are targeted in connection with public “vote-no” campaigns, evaluate director nominees under the existing governance policies for voting on director nominees in uncontested elections.
Take into consideration the arguments submitted by shareholders and other publicly available information.
Proxy Contests/Proxy Access — Voting for
Director Nominees in Contested Elections
General Recommendation: Vote case-by-case on the election of directors in contested elections, considering the following factors:
〉
|
Long-term
financial performance of the company relative to its industry;
|
〉
|
Management’s
track record;
|
〉
|
Background to the
contested election;
|
〉
|
Nominee
qualifications and any compensatory arrangements;
|
〉
|
Strategic plan of
dissident slate and quality of the critique against management;
|
〉
|
Likelihood that
the proposed goals and objectives can be achieved (both slates); and
|
〉
|
Stock ownership
positions.
|
6 Examples of failure of risk oversight include but are not limited to: bribery; large or
serial fines or sanctions from regulatory bodies; significant adverse legal judgments or settlement; or hedging of company stock.
Enabling the financial community to manage
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In the case of candidates nominated pursuant to
proxy access, vote case-by-case considering any applicable factors listed above or additional factors which may be relevant, including those that are specific to the company, to the nominee(s) and/or to the nature of the election (such as whether
there are more candidates than board seats).
Other Board-Related Proposals
Adopt Anti-Hedging/Pledging/Speculative Investments
Policy
General Recommendation: Generally vote for proposals seeking a policy that prohibits named executive officers from engaging in derivative or speculative transactions involving company stock, including hedging, holding stock in a margin account,
or pledging stock as collateral for a loan. However, the company’s existing policies regarding responsible use of company stock will be considered.
Age/Term Limits
General Recommendation: Vote against management and shareholder proposals to limit the tenure of outside directors through mandatory retirement ages.
Vote against management proposals to limit the
tenure of outside directors through term limits. However, scrutinize boards where the average tenure of all directors exceeds 15 years for independence from management and for sufficient turnover to ensure that new perspectives are being added to
the board.
Board Size
General Recommendation: Vote for proposals seeking to fix the board size or designate a range for the board size.
Vote against proposals that give management the
ability to alter the size of the board outside of a specified range without shareholder approval.
Classification/Declassification of the Board
General Recommendation: Vote against proposals to classify (stagger) the board. Vote for proposals to repeal classified boards and to elect all directors annually.
CEO Succession Planning
General Recommendation: Generally vote for proposals seeking disclosure on a CEO succession planning policy, considering, at a minimum, the following factors:
〉
|
The
reasonableness/scope of the request; and
|
〉
|
The
company’s existing disclosure on its current CEO succession planning process.
|
Cumulative Voting
General Recommendation: Generally vote against management proposals to eliminate cumulate voting, and for shareholder proposals to restore or provide for cumulative voting, unless:
〉
|
The company has
proxy access7, thereby allowing shareholders to nominate directors to the company’s ballot; and
|
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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〉
|
The company has
adopted a majority vote standard, with a carve-out for plurality voting in situations where there are more nominees than seats, and a director resignation policy to address failed elections.
|
Vote for proposals for cumulative voting at
controlled companies (insider voting power > 50%).
Director and Officer Indemnification and Liability
Protection
General Recommendation: Vote case-by-case on proposals on director and officer indemnification and liability protection.
Vote against proposals that would:
〉
|
Eliminate entirely
directors’ and officers’ liability for monetary damages for violating the duty of care.
|
〉
|
Expand coverage
beyond just legal expenses to liability for acts that are more serious violations of fiduciary obligation than mere carelessness.
|
〉
|
Expand the scope
of indemnification to provide for mandatory indemnification of company officials in connection with acts that previously the company was permitted to provide indemnification for, at the discretion of the company’s board (i.e., “permissive indemnification”), but that previously the company was not required to indemnify.
|
Vote for only those proposals providing such
expanded coverage in cases when a director’s or officer’s legal defense was unsuccessful if both of the following apply:
〉
|
If the director was
found to have acted in good faith and in a manner that s/he reasonably believed was in the best interests of the company; and
|
〉
|
If only the
director’s legal expenses would be covered.
|
Establish/Amend Nominee Qualifications
General Recommendation: Vote case-by-case on proposals that establish or amend director qualifications. Votes should be based on the reasonableness of the criteria and the degree to which they may preclude dissident nominees from joining the
board.
Vote case-by-case on
shareholder resolutions seeking a director nominee who possesses a particular subject matter expertise, considering:
〉
|
The
company’s board committee structure, existing subject matter expertise, and board nomination provisions relative to that of its peers;
|
〉
|
The
company’s existing board and management oversight mechanisms regarding the issue for which board oversight is sought;
|
〉
|
The
company’s disclosure and performance relating to the issue for which board oversight is sought and any significant related controversies; and
|
〉
|
The scope and
structure of the proposal.
|
7 A proxy access right that meets the
recommended guidelines.
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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Establish Other Board Committee Proposals
General Recommendation: Generally vote against shareholder proposals to establish a new board committee, as such proposals seek a specific oversight mechanism/structure that potentially limits a company’s flexibility to determine an
appropriate oversight mechanism for itself. However, the following factors will be considered:
〉
|
Existing oversight
mechanisms (including current committee structure) regarding the issue for which board oversight is sought;
|
〉
|
Level of
disclosure regarding the issue for which board oversight is sought;
|
〉
|
Company
performance related to the issue for which board oversight is sought;
|
〉
|
Board committee
structure compared to that of other companies in its industry sector; and
|
〉
|
The scope and
structure of the proposal.
|
Filling Vacancies/Removal of Directors
General Recommendation: Vote against proposals that provide that directors may be removed only for cause.
Vote for proposals to restore shareholders’
ability to remove directors with or without cause.
Vote against proposals that provide that only
continuing directors may elect replacements to fill board vacancies. Vote for proposals that permit shareholders to elect directors to fill board vacancies.
Independent Chair (Separate Chair/CEO)
General Recommendation: Generally vote for shareholder proposals requiring that the chairman’s position be filled by an independent director, taking into consideration the following:
〉
|
The scope of the
proposal;
|
〉
|
The
company’s current board leadership structure;
|
〉
|
The
company’s governance structure and practices;
|
〉
|
Company
performance; and
|
〉
|
Any other relevant
factors that may be applicable.
|
Regarding the scope of the proposal, consider
whether the proposal is precatory or binding and whether the proposal is seeking an immediate change in the chairman role or the policy can be implemented at the next CEO transition.
Under the review of the company’s board
leadership structure, ISS may support the proposal under the following scenarios absent a compelling rationale: the presence of an executive or non-independent chair in addition to the CEO; a recent recombination of the role of CEO and chair; and/or
departure from a structure with an independent chair. ISS will also consider any recent transitions in board leadership and the effect such transitions may have on independent board leadership as well as the designation of a lead director
role.
When considering the governance
structure, ISS will consider the overall independence of the board, the independence of key committees, the establishment of governance guidelines, board tenure and its relationship to CEO tenure, and any other factors that may be relevant. Any
concerns about a company’s governance structure will weigh in favor of support for the proposal.
The review of the company’s governance
practices may include, but is not limited to, poor compensation practices, material failures of governance and risk oversight, related-party transactions or other issues putting director independence at risk, corporate or management scandals, and
actions by management or the board with potential
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or realized negative impact on shareholders. Any such practices may
suggest a need for more independent oversight at the company thus warranting support of the proposal.
ISS’ performance assessment will generally
consider one-, three-, and five-year TSR compared to the company’s peers and the market as a whole. While poor performance will weigh in favor of the adoption of an independent chair policy, strong performance over the long term will be
considered a mitigating factor when determining whether the proposed leadership change warrants support.
Majority of Independent Directors/Establishment of
Independent Committees
General Recommendation: Vote for shareholder proposals asking that a majority or more of directors be independent unless the board composition already meets the proposed threshold by ISS’ definition of Independent Director (See ISS’ Classification of Directors.)
Vote for shareholder proposals asking that board
audit, compensation, and/or nominating committees be composed exclusively of independent directors unless they currently meet that standard.
Majority Vote Standard for the Election of
Directors
General Recommendation: Generally vote for management proposals to adopt a majority of votes cast standard for directors in uncontested elections. Vote against if no carve-out for a plurality vote standard in contested elections is
included.
Generally vote for precatory
and binding shareholder resolutions requesting that the board change the company’s bylaws to stipulate that directors need to be elected with an affirmative majority of votes cast, provided it does not conflict with the state law where the
company is incorporated. Binding resolutions need to allow for a carve-out for a plurality vote standard when there are more nominees than board seats.
Companies are strongly encouraged to also adopt a
post-election policy (also known as a director resignation policy) that will provide guidelines so that the company will promptly address the situation of a holdover director.
Proxy Access
General Recommendation: Generally vote for management and shareholder proposals for proxy access with the following provisions:
〉
|
Ownership threshold: maximum requirement not more than three percent (3%) of the voting power;
|
〉
|
Ownership duration: maximum requirement not longer than three (3) years of continuous ownership for each member of the nominating group;
|
〉
|
Aggregation: minimal or no limits on the number of shareholders permitted to form a nominating group;
|
〉
|
Cap: cap on nominees of generally twenty-five percent (25%) of the board.
|
Review for reasonableness any other restrictions on
the right of proxy access. Generally vote against proposals that are more restrictive than these guidelines.
Require More Nominees than Open Seats
General Recommendation: Vote against shareholder proposals that would require a company to nominate more candidates than the number of open board seats.
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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Shareholder Engagement Policy (Shareholder Advisory
Committee)
General Recommendation: Generally vote for shareholder proposals requesting that the board establish an internal mechanism/process, which may include a committee, in order to improve communications between directors and shareholders, unless the
company has the following features, as appropriate:
〉
|
Established a
communication structure that goes beyond the exchange requirements to facilitate the exchange of information between shareholders and members of the board;
|
〉
|
Effectively
disclosed information with respect to this structure to its shareholders;
|
〉
|
Company has not
ignored majority-supported shareholder proposals or a majority withhold vote on a director nominee; and
|
〉
|
The company has an
independent chairman or a lead director, according to ISS’ definition. This individual must be made available for periodic consultation and direct communication with major shareholders.
|
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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2. AUDIT-RELATED
Auditor Indemnification and Limitation of
Liability
General Recommendation: Vote case-by-case on the issue of auditor indemnification and limitation of liability. Factors to be assessed include, but are not limited to:
〉
|
The terms of the
auditor agreement—the degree to which these agreements impact shareholders’ rights;
|
〉
|
The motivation and
rationale for establishing the agreements;
|
〉
|
The quality of the
company’s disclosure; and
|
〉
|
The
company’s historical practices in the audit area.
|
Vote against or withhold from members of an audit
committee in situations where there is persuasive evidence that the audit committee entered into an inappropriate indemnification agreement with its auditor that limits the ability of the company, or its shareholders, to pursue legitimate legal
recourse against the audit firm.
Auditor
Ratification
General Recommendation: Vote for proposals to ratify auditors unless any of the following apply:
〉
|
An auditor has a
financial interest in or association with the company, and is therefore not independent;
|
〉
|
There is reason to
believe that the independent auditor has rendered an opinion that is neither accurate nor indicative of the company’s financial position;
|
〉
|
Poor accounting
practices are identified that rise to a serious level of concern, such as fraud or misapplication of GAAP; or
|
〉
|
Fees for non-audit
services (“Other” fees) are excessive.
|
Non-audit fees are excessive if:
〉
|
Non-audit
(“other”) fees > audit fees + audit-related fees + tax compliance/preparation fees
|
Tax compliance and preparation include the
preparation of original and amended tax returns and refund claims, and tax payment planning. All other services in the tax category, such as tax advice, planning, or consulting, should be added to “Other” fees. If the breakout of tax
fees cannot be determined, add all tax fees to “Other” fees.
In circumstances where “Other” fees
include fees related to significant one-time capital structure events (such as initial public offerings, bankruptcy emergence, and spin-offs) and the company makes public disclosure of the amount and nature of those fees that are an exception to the
standard “non-audit fee” category, then such fees may be excluded from the non-audit fees considered in determining the ratio of non-audit to audit/audit-related fees/tax compliance and preparation for purposes of determining whether
non-audit fees are excessive.
Shareholder
Proposals Limiting Non-Audit Services
General
Recommendation: Vote case-by-case on shareholder proposals asking companies to prohibit or limit their auditors from engaging in non-audit services.
Shareholder Proposals on Audit Firm Rotation
General Recommendation: Vote case-by-case on shareholder proposals asking for audit firm rotation, taking into account:
〉
|
The tenure of the
audit firm;
|
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〉
|
The length of
rotation specified in the proposal;
|
〉
|
Any significant
audit-related issues at the company;
|
〉
|
The number of
Audit Committee meetings held each year;
|
〉
|
The number of
financial experts serving on the committee; and
|
〉
|
Whether the
company has a periodic renewal process where the auditor is evaluated for both audit quality and competitive price.
|
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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3. SHAREHOLDER RIGHTS & DEFENSES
Advance Notice Requirements for Shareholder
Proposals/Nominations
General Recommendation: Vote case-by-case on advance notice proposals, giving support to those proposals which allow shareholders to submit proposals/nominations as close to the meeting date as reasonably possible and within the broadest window
possible, recognizing the need to allow sufficient notice for company, regulatory, and shareholder review.
To be reasonable, the company’s deadline for
shareholder notice of a proposal/nominations must not be more than 60 days prior to the meeting, with a submittal window of at least 30 days prior to the deadline. The submittal window is the period under which a shareholder must file his
proposal/nominations prior to the deadline.
In general, support additional efforts by companies
to ensure full disclosure in regard to a proponent’s economic and voting position in the company so long as the informational requirements are reasonable and aimed at providing shareholders with the necessary information to review such
proposals.
Amend Bylaws without Shareholder
Consent
General Recommendation: Vote against proposals giving the board exclusive authority to amend the bylaws.
Vote case-by-case on proposals giving the board the
ability to amend the bylaws in addition to shareholders, taking into account the following:
〉
|
Any impediments to
shareholders’ ability to amend the bylaws (i.e. supermajority voting requirements);
|
〉
|
The
company’s ownership structure and historical voting turnout;
|
〉
|
Whether the board
could amend bylaws adopted by shareholders; and
|
〉
|
Whether
shareholders would retain the ability to ratify any board-initiated amendments.
|
Control Share Acquisition Provisions
Control share acquisition statutes function by
denying shares their voting rights when they contribute to ownership in excess of certain thresholds. Voting rights for those shares exceeding ownership limits may only be restored by approval of either a majority or supermajority of disinterested
shares. Thus, control share acquisition statutes effectively require a hostile bidder to put its offer to a shareholder vote or risk voting disenfranchisement if the bidder continues buying up a large block of shares.
General Recommendation: Vote for proposals to opt out of control share acquisition statutes unless doing so would enable the completion of a takeover that would be detrimental to shareholders.
Vote against proposals to amend the charter to
include control share acquisition provisions.
Vote for proposals to restore voting rights to the
control shares.
Control Share Cash-Out
Provisions
Control share cash-out statutes
give dissident shareholders the right to “cash-out” of their position in a company at the expense of the shareholder who has taken a control position. In other words, when an investor crosses a preset threshold level, remaining
shareholders are given the right to sell their shares to the acquirer, who must buy them at the highest acquiring price.
General Recommendation: Vote for proposals to opt out of control share cash-out statutes.
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Disgorgement Provisions
Disgorgement provisions require an acquirer or
potential acquirer of more than a certain percentage of a company’s stock to disgorge, or pay back, to the company any profits realized from the sale of that company’s stock purchased 24 months before achieving control status. All sales
of company stock by the acquirer occurring within a certain period of time (between 18 months and 24 months) prior to the investor’s gaining control status are subject to these recapture-of-profits provisions.
General Recommendation: Vote for proposals to opt out of state disgorgement provisions.
Fair Price Provisions
General Recommendation: Vote case-by-case on proposals to adopt fair price provisions (provisions that stipulate that an acquirer must pay the same price to acquire all shares as it paid to acquire the control shares), evaluating factors such
as the vote required to approve the proposed acquisition, the vote required to repeal the fair price provision, and the mechanism for determining the fair price.
Generally vote against fair price provisions with
shareholder vote requirements greater than a majority of disinterested shares.
Freeze-Out Provisions
General Recommendation: Vote for proposals to opt out of state freeze-out provisions. Freeze-out provisions force an investor who surpasses a certain ownership threshold in a company to wait a specified period of time before gaining control of
the company.
Greenmail
Greenmail payments are targeted share repurchases
by management of company stock from individuals or groups seeking control of the company. Since only the hostile party receives payment, usually at a substantial premium over the market value of its shares, the practice discriminates against all
other shareholders.
General Recommendation: Vote for proposals to adopt anti-greenmail charter or bylaw amendments or otherwise restrict a company’s ability to make greenmail payments.
Vote case-by-case on anti-greenmail proposals when
they are bundled with other charter or bylaw amendments.
Litigation Rights (including Exclusive Venue and
Fee-Shifting Bylaw Provisions)
Bylaw
provisions impacting shareholders’ ability to bring suit against the company may include exclusive venue provisions, which provide that the state of incorporation shall be the sole venue for certain types of litigation, and fee-shifting
provisions that require a shareholder who sues a company unsuccessfully to pay all litigation expenses of the defendant corporation.
General Recommendation: Vote case-by-case on bylaws which impact shareholders’ litigation rights, taking into account factors such as:
〉
|
The
company’s stated rationale for adopting such a provision;
|
〉
|
Disclosure of past
harm from shareholder lawsuits in which plaintiffs were unsuccessful or shareholder lawsuits outside the jurisdiction of incorporation;
|
〉
|
The breadth of
application of the bylaw, including the types of lawsuits to which it would apply and the definition of key terms; and
|
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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|
Governance
features such as shareholders’ ability to repeal the provision at a later date (including the vote standard applied when shareholders attempt to amend the bylaws) and their ability to hold directors accountable through annual director
elections and a majority vote standard in uncontested elections.
|
Generally vote against bylaws that mandate
fee-shifting whenever plaintiffs are not completely successful on the merits (i.e., in cases where the plaintiffs are partially successful).
Unilateral adoption by the board of bylaw
provisions which affect shareholders’ litigation rights will be evaluated under ISS’ policy on Unilateral Bylaw/Charter Amendments.
Net Operating Loss (NOL) Protective Amendments
General Recommendation: Vote against proposals to adopt a protective amendment for the stated purpose of protecting a company’s net operating losses (NOL) if the effective term of the protective amendment would exceed the shorter of three
years and the exhaustion of the NOL.
Vote case-by-case, considering the following
factors, for management proposals to adopt an NOL protective amendment that would remain in effect for the shorter of three years (or less) and the exhaustion of the NOL:
〉
|
The ownership
threshold (NOL protective amendments generally prohibit stock ownership transfers that would result in a new 5-percent holder or increase the stock ownership percentage of an existing 5-percent holder);
|
〉
|
Shareholder
protection mechanisms (sunset provision or commitment to cause expiration of the protective amendment upon exhaustion or expiration of the NOL);
|
〉
|
The
company’s existing governance structure including: board independence, existing takeover defenses, track record of responsiveness to shareholders, and any other problematic governance concerns; and
|
〉
|
Any other factors
that may be applicable.
|
Poison Pills (Shareholder Rights Plans)
Shareholder Proposals to Put Pill to a Vote and/or
Adopt a Pill Policy
General Recommendation: Vote for shareholder proposals requesting that the company submit its poison pill to a shareholder vote or redeem it unless the company has: (1) A shareholder approved poison pill in place; or (2) The company has adopted
a policy concerning the adoption of a pill in the future specifying that the board will only adopt a shareholder rights plan if either:
〉
|
Shareholders have
approved the adoption of the plan; or
|
〉
|
The board, in its
exercise of its fiduciary responsibilities, determines that it is in the best interest of shareholders under the circumstances to adopt a pill without the delay in adoption that would result from seeking stockholder approval (i.e., the
“fiduciary out” provision). A poison pill adopted under this fiduciary out will be put to a shareholder ratification vote within 12 months of adoption or expire. If the pill is not approved by a majority of the votes cast on this issue,
the plan will immediately terminate.
|
If the shareholder proposal calls for a time period
of less than 12 months for shareholder ratification after adoption, vote for the proposal, but add the caveat that a vote within 12 months would be considered sufficient implementation.
Enabling the financial community to manage
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Management Proposals to Ratify a Poison Pill
General Recommendation: Vote case-by-case on management proposals on poison pill ratification, focusing on the features of the shareholder rights plan. Rights plans should contain the following attributes:
〉
|
No lower than a 20
percent trigger, flip-in or flip-over;
|
〉
|
A term of no more
than three years;
|
〉
|
No dead-hand,
slow-hand, no-hand, or similar feature that limits the ability of a future board to redeem the pill;
|
〉
|
Shareholder
redemption feature (qualifying offer clause); if the board refuses to redeem the pill 90 days after a qualifying offer is announced, 10 percent of the shares may call a special meeting or seek a written consent to vote on rescinding the pill.
|
In addition, the
rationale for adopting the pill should be thoroughly explained by the company. In examining the request for the pill, take into consideration the company’s existing governance structure, including: board independence, existing takeover
defenses, and any problematic governance concerns.
Management Proposals to Ratify a Pill to Preserve Net
Operating Losses (NOLs)
General Recommendation:
Vote against proposals to adopt a poison pill for the stated purpose of protecting a company’s net operating losses (NOL) if the term of the pill would exceed the shorter of three years and the exhaustion of
the NOL.
Vote case-by-case on
management proposals for poison pill ratification, considering the following factors, if the term of the pill would be the shorter of three years (or less) and the exhaustion of the NOL:
〉
|
The ownership
threshold to transfer (NOL pills generally have a trigger slightly below 5 percent);
|
〉
|
Shareholder
protection mechanisms (sunset provision, or commitment to cause expiration of the pill upon exhaustion or expiration of NOLs);
|
〉
|
The
company’s existing governance structure including: board independence, existing takeover defenses, track record of responsiveness to shareholders, and any other problematic governance concerns; and
|
〉
|
Any other factors
that may be applicable.
|
Proxy Voting Disclosure, Confidentiality, and
Tabulation
General Recommendation: Vote case-by-case on proposals regarding proxy voting mechanics, taking into consideration whether implementation of the proposal is likely to enhance or protect shareholder rights. Specific issues covered under the
policy include, but are not limited to, confidential voting of individual proxies and ballots, confidentiality of running vote tallies, and the treatment of abstentions and/or broker non-votes in the company’s vote-counting
methodology.
While a variety of
factors may be considered in each analysis, the guiding principles are: transparency, consistency, and fairness in the proxy voting process. The factors considered, as applicable to the proposal, may include:
〉
|
The scope and
structure of the proposal;
|
〉
|
The
company’s stated confidential voting policy (or other relevant policies) and whether it ensures a “level playing field” by providing shareholder proponents with equal access to vote information prior to the annual meeting;
|
〉
|
The
company’s vote standard for management and shareholder proposals and whether it ensures consistency and fairness in the proxy voting process and maintains the integrity of vote results;
|
Enabling the financial community to manage
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〉
|
Whether the
company’s disclosure regarding its vote counting method and other relevant voting policies with respect to management and shareholder proposals are consistent and clear;
|
〉
|
Any recent
controversies or concerns related to the company’s proxy voting mechanics;
|
〉
|
Any unintended
consequences resulting from implementation of the proposal; and
|
〉
|
Any other factors
that may be relevant.
|
Ratification Proposals: Management Proposals to
Ratify Existing Charter or Bylaw Provisions
General Recommendation: Generally vote against management proposals to ratify provisions of the company’s existing charter or bylaws, unless these governance provisions align with best practice.
In addition, voting against/withhold from
individual directors, members of the governance committee, or the full board may be warranted, considering:
〉
|
The presence of a
shareholder proposal addressing the same issue on the same ballot;
|
〉
|
The board’s
rationale for seeking ratification;
|
〉
|
Disclosure of
actions to be taken by the board should the ratification proposal fail;
|
〉
|
Disclosure of
shareholder engagement regarding the board’s ratification request;
|
〉
|
The level of
impairment to shareholders’ rights caused by the existing provision;
|
〉
|
The history of
management and shareholder proposals on the provision at the company’s past meetings;
|
〉
|
Whether the
current provision was adopted in response to the shareholder proposal;
|
〉
|
The
company’s ownership structure; and
|
〉
|
Previous use of
ratification proposals to exclude shareholder proposals.
|
Reimbursing Proxy Solicitation Expenses
General Recommendation: Vote case-by-case on proposals to reimburse proxy solicitation expenses.
When voting in conjunction with support of a
dissident slate, vote for the reimbursement of all appropriate proxy solicitation expenses associated with the election.
Generally vote for shareholder proposals calling
for the reimbursement of reasonable costs incurred in connection with nominating one or more candidates in a contested election where the following apply:
〉
|
The election of
fewer than 50 percent of the directors to be elected is contested in the election;
|
〉
|
One or more of the
dissident’s candidates is elected;
|
〉
|
Shareholders are
not permitted to cumulate their votes for directors; and
|
〉
|
The election
occurred, and the expenses were incurred, after the adoption of this bylaw.
|
Reincorporation Proposals
General Recommendation: Management or shareholder proposals to change a company’s state of incorporation should be evaluated case-by-case, giving consideration to both financial and corporate governance concerns including the
following:
〉
|
Reasons for
reincorporation;
|
〉
|
Comparison of
company’s governance practices and provisions prior to and following the reincorporation; and
|
〉
|
Comparison of
corporation laws of original state and destination state.
|
Vote for reincorporation when the economic factors
outweigh any neutral or negative governance changes.
Enabling the financial community to manage
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Shareholder Ability to Act by Written Consent
General Recommendation: Generally vote against management and shareholder proposals to restrict or prohibit shareholders’ ability to act by written consent.
Generally vote for management and shareholder
proposals that provide shareholders with the ability to act by written consent, taking into account the following factors:
〉
|
Shareholders’ current
right to act by written consent;
|
〉
|
The inclusion of
exclusionary or prohibitive language;
|
〉
|
Investor ownership
structure; and
|
〉
|
Shareholder
support of, and management’s response to, previous shareholder proposals.
|
Vote case-by-case on shareholder proposals if, in
addition to the considerations above, the company has the following governance and antitakeover provisions:
〉
|
An unfettered8 right for shareholders to call special meetings at a 10 percent threshold;
|
〉
|
A majority vote
standard in uncontested director elections;
|
〉
|
No
non-shareholder-approved pill; and
|
〉
|
An annually
elected board.
|
Shareholder
Ability to Call Special Meetings
General
Recommendation: Vote against management or shareholder proposals to restrict or prohibit shareholders’ ability to call special meetings.
Generally vote for management or shareholder
proposals that provide shareholders with the ability to call special meetings taking into account the following factors:
〉
|
Shareholders’ current
right to call special meetings;
|
〉
|
Minimum ownership
threshold necessary to call special meetings (10 percent preferred);
|
〉
|
The inclusion of
exclusionary or prohibitive language;
|
〉
|
Investor ownership
structure; and
|
〉
|
Shareholder
support of, and management’s response to, previous shareholder proposals.
|
Stakeholder Provisions
General Recommendation: Vote against proposals that ask the board to consider non-shareholder constituencies or other non-financial effects when evaluating a merger or business combination.
State Antitakeover Statutes
General Recommendation: Vote case-by-case on proposals to opt in or out of state takeover statutes (including fair price provisions, stakeholder laws, poison pill endorsements, severance pay and labor contract provisions, and anti-greenmail
provisions).
8 “Unfettered” means no restrictions on agenda items, no restrictions on the
number of shareholders who can group together to reach the 10 percent threshold, and only reasonable limits on when a meeting can be called: no greater than 30 days after the last annual meeting and no greater than 90 prior to the next annual
meeting.
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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Supermajority Vote Requirements
General Recommendation: Vote against proposals to require a supermajority shareholder vote.
Vote for management or shareholder proposals to
reduce supermajority vote requirements. However, for companies with shareholder(s) who have significant ownership levels, vote case-by-case, taking into account:
〉
|
Quorum
requirements; and
|
Enabling the financial community to manage
governance risk for the benefit of shareholders.
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4. CAPITAL/RESTRUCTURING
Capital
Adjustments to Par Value of Common Stock
General Recommendation: Vote for management proposals to reduce the par value of common stock unless the action is being taken to facilitate an anti-takeover device or some other negative corporate governance action.
Vote for management proposals to eliminate par
value.
Common Stock Authorization
General Recommendation: Vote for proposals to increase the number of authorized common shares where the primary purpose of the increase is to issue shares in connection with a transaction on the same ballot that warrants support.
Vote against proposals at companies with more than
one class of common stock to increase the number of authorized shares of the class of common stock that has superior voting rights.
Vote against proposals to increase the number of
authorized common shares if a vote for a reverse stock split on the same ballot is warranted despite the fact that the authorized shares would not be reduced proportionally.
Vote case-by-case on all other proposals to
increase the number of shares of common stock authorized for issuance. Take into account company-specific factors that include, at a minimum, the following:
〉
|
Past Board
Performance:
|
〉
|
The
company’s use of authorized shares during the last three years;
|
〉
|
Disclosure in the
proxy statement of the specific purposes of the proposed increase;
|
〉
|
Disclosure in the
proxy statement of specific and severe risks to shareholders of not approving the request; and
|
〉
|
The dilutive
impact of the request as determined relative to an allowable increase calculated by ISS (typically 100 percent of existing authorized shares) that reflects the company’s need for shares and total shareholder returns.
|
ISS will apply the relevant allowable increase
below to requests to increase common stock that are for general corporate purposes (or to the general corporate purposes portion of a request that also includes a specific need):
A.
|
Most companies: 100 percent of existing authorized shares.
|
B.
|
Companies with less
than 50 percent of existing authorized shares either outstanding or reserved for issuance: 50 percent of existing authorized shares.
|
C.
|
Companies with one-
and three-year total shareholder returns (TSRs) in the bottom 10 percent of the U.S. market as of the end of the calendar quarter that is closest to their most recent fiscal year end: 50 percent of existing
authorized shares.
|
D.
|
Companies
at which both conditions (B and C) above are both present: 25 percent of existing authorized shares.
|
If there is an acquisition, private placement, or
similar transaction on the ballot (not including equity incentive plans) that ISS is recommending FOR, the allowable increase will be the greater of (i) twice the amount needed to support the transactions on the ballot, and (ii) the allowable
increase as calculated above.
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Dual Class Structure
General Recommendation: Generally vote against proposals to create a new class of common stock unless:
〉
|
The company
discloses a compelling rationale for the dual-class capital structure, such as:
|
〉
|
The
company’s auditor has concluded that there is substantial doubt about the company’s ability to continue as a going concern; or
|
〉
|
The new class of
shares will be transitory;
|
〉
|
The new class is
intended for financing purposes with minimal or no dilution to current shareholders in both the short term and long term; and
|
〉
|
The new class is
not designed to preserve or increase the voting power of an insider or significant shareholder.
|
Issue Stock for Use with Rights Plan
General Recommendation: Vote against proposals that increase authorized common stock for the explicit purpose of implementing a non-shareholder-approved shareholder rights plan (poison pill).
Preemptive Rights
General Recommendation: Vote case-by-case on shareholder proposals that seek preemptive rights, taking into consideration:
〉
|
The size of the
company;
|
〉
|
The shareholder
base; and
|
〉
|
The liquidity of
the stock.
|
Preferred Stock
Authorization
General Recommendation: Vote for proposals to increase the number of authorized preferred shares where the primary purpose of the increase is to issue shares in connection with a transaction on the same ballot that warrants
support.
Vote against proposals at
companies with more than one class or series of preferred stock to increase the number of authorized shares of the class or series of preferred stock that has superior voting rights.
Vote case-by-case on all other proposals to
increase the number of shares of preferred stock authorized for issuance. Take into account company-specific factors that include, at a minimum, the following:
〉
|
Past Board
Performance:
|
〉
|
The
company’s use of authorized preferred shares during the last three years;
|
〉
|
Disclosure in the
proxy statement of the specific purposes for the proposed increase;
|
〉
|
Disclosure in the
proxy statement of specific and severe risks to shareholders of not approving the request;
|
〉
|
In cases where the
company has existing authorized preferred stock, the dilutive impact of the request as determined by an allowable increase calculated by ISS (typically 100 percent of existing authorized shares) that reflects the company’s need for shares and
total shareholder returns; and
|
〉
|
Whether the shares
requested are blank check preferred shares that can be used for antitakeover purposes.
|
Enabling the financial community to manage
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Recapitalization Plans
General Recommendation: Vote case-by-case on recapitalizations (reclassifications of securities), taking into account the following:
〉
|
More simplified
capital structure;
|
〉
|
Fairness of
conversion terms;
|
〉
|
Impact on voting
power and dividends;
|
〉
|
Reasons for the
reclassification;
|
〉
|
Conflicts of
interest; and
|
〉
|
Other alternatives
considered.
|
Reverse Stock
Splits
General Recommendation: Vote for management proposals to implement a reverse stock split if:
〉
|
The number of
authorized shares will be proportionately reduced; or
|
〉
|
The effective
increase in authorized shares is equal to or less than the allowable increase calculated in accordance with ISS’ Common Stock Authorization policy.
|
Vote case-by-case on proposals that do not meet
either of the above conditions, taking into consideration the following factors:
〉
|
Stock exchange
notification to the company of a potential delisting;
|
〉
|
Disclosure of
substantial doubt about the company’s ability to continue as a going concern without additional financing;
|
〉
|
The
company’s rationale; or
|
〉
|
Other factors as
applicable.
|
Share
Repurchase Programs
General Recommendation: Vote for management proposals to institute open-market share repurchase plans in which all shareholders may participate on equal terms.
Stock Distributions: Splits and Dividends
General Recommendation: Generally vote for management proposals to increase the common share authorization for stock split or stock dividend, provided that the effective increase in authorized shares is equal to or is less than the allowable
increase calculated in accordance with ISS’ Common Stock Authorization policy.
Tracking Stock
General Recommendation: Vote case-by-case on the creation of tracking stock, weighing the strategic value of the transaction against such factors as:
〉
|
Adverse governance
changes;
|
〉
|
Excessive
increases in authorized capital stock;
|
〉
|
Unfair method of
distribution;
|
〉
|
Diminution of
voting rights;
|
〉
|
Adverse conversion
features;
|
〉
|
Negative impact on
stock option plans; and
|
Enabling the financial community to manage
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|
Alternatives such
as spin-off.
|
Restructuring
Appraisal Rights
General Recommendation: Vote for proposals to restore or provide shareholders with rights of appraisal.
Asset Purchases
General Recommendation: Vote case-by-case on asset purchase proposals, considering the following factors:
〉
|
Financial and
strategic benefits;
|
〉
|
How the deal was
negotiated;
|
〉
|
Other alternatives
for the business;
|
Asset Sales
General Recommendation: Vote case-by-case on asset sales, considering the following factors:
〉
|
Impact on the
balance sheet/working capital;
|
〉
|
Potential
elimination of diseconomies;
|
〉
|
Anticipated
financial and operating benefits;
|
〉
|
Anticipated use of
funds;
|
〉
|
Value received for
the asset;
|
〉
|
How the deal was
negotiated;
|
Bundled
Proposals
General Recommendation: Vote case-by-case on bundled or “conditional” proxy proposals. In the case of items that are conditioned upon each other, examine the benefits and costs of the packaged items. In instances when the joint
effect of the conditioned items is not in shareholders’ best interests, vote against the proposals. If the combined effect is positive, support such proposals.
Conversion of Securities
General Recommendation: Vote case-by-case on proposals regarding conversion of securities. When evaluating these proposals, the investor should review the dilution to existing shareholders, the conversion price relative to market value,
financial issues, control issues, termination penalties, and conflicts of interest.
Vote for the conversion if it is expected that the
company will be subject to onerous penalties or will be forced to file for bankruptcy if the transaction is not approved.
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Corporate Reorganization/Debt
Restructuring/Prepackaged Bankruptcy Plans/Reverse Leveraged Buyouts/Wrap Plans
General Recommendation: Vote case-by-case on proposals to increase common and/or preferred shares and to issue shares as part of a debt restructuring plan, after evaluating:
〉
|
Dilution to
existing shareholders’ positions;
|
〉
|
Terms of the offer
- discount/premium in purchase price to investor, including any fairness opinion; termination penalties; exit strategy;
|
〉
|
Financial issues -
company’s financial situation; degree of need for capital; use of proceeds; effect of the financing on the company’s cost of capital;
|
〉
|
Management’s
efforts to pursue other alternatives;
|
〉
|
Control issues -
change in management; change in control, guaranteed board and committee seats; standstill provisions; voting agreements; veto power over certain corporate actions; and
|
〉
|
Conflict of
interest - arm’s length transaction, managerial incentives.
|
Vote for the debt restructuring if it is expected
that the company will file for bankruptcy if the transaction is not approved.
Formation of Holding Company
General Recommendation: Vote case-by-case on proposals regarding the formation of a holding company, taking into consideration the following:
〉
|
The reasons for
the change;
|
〉
|
Any financial or
tax benefits;
|
〉
|
Increases in
capital structure; and
|
〉
|
Changes to the
articles of incorporation or bylaws of the company.
|
Absent compelling financial reasons to recommend
for the transaction, vote against the formation of a holding company if the transaction would include either of the following:
〉
|
Increases in
common or preferred stock in excess of the allowable maximum (see discussion under “Capital”); or
|
〉
|
Adverse changes in
shareholder rights.
|
Going
Private and Going Dark Transactions (LBOs and Minority Squeeze-outs)
General Recommendation: Vote case-by-case on going private transactions, taking into account the following:
〉
|
How the deal was
negotiated;
|
〉
|
Other
alternatives/offers considered; and
|
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Vote case-by-case on going dark transactions,
determining whether the transaction enhances shareholder value by taking into consideration:
〉
|
Whether the company
has attained benefits from being publicly-traded (examination of trading volume, liquidity, and market research of the stock);
|
〉
|
Balanced interests
of continuing vs. cashed-out shareholders, taking into account the following:
|
〉
|
Are all
shareholders able to participate in the transaction?
|
〉
|
Will there be a
liquid market for remaining shareholders following the transaction?
|
〉
|
Does the company
have strong corporate governance?
|
〉
|
Will insiders reap
the gains of control following the proposed transaction?
|
〉
|
Does the state of
incorporation have laws requiring continued reporting that may benefit shareholders?
|
Joint Ventures
General Recommendation: Vote case-by-case on proposals to form joint ventures, taking into account the following:
〉
|
Percentage of
assets/business contributed;
|
〉
|
Financial and
strategic benefits;
|
〉
|
Other
alternatives; and
|
Liquidations
General Recommendation: Vote case-by-case on liquidations, taking into account the following:
〉
|
Management’s
efforts to pursue other alternatives;
|
〉
|
Appraisal value of
assets; and
|
〉
|
The compensation
plan for executives managing the liquidation.
|
Vote for the liquidation if the company will file
for bankruptcy if the proposal is not approved.
Mergers and Acquisitions
General Recommendation: Vote case-by-case on mergers and acquisitions. Review and evaluate the merits and drawbacks of the proposed transaction, balancing various and sometimes countervailing factors including:
〉
|
Valuation - Is the value to be received by the target shareholders (or paid by the acquirer) reasonable? While the fairness opinion may provide an initial starting point for assessing valuation reasonableness, emphasis is placed on
the offer premium, market reaction, and strategic rationale.
|
〉
|
Market reaction - How has the market responded to the proposed deal? A negative market reaction should cause closer scrutiny of a deal.
|
〉
|
Strategic rationale
- Does the deal make sense strategically? From where is the value derived? Cost and revenue synergies should not be overly aggressive or optimistic, but reasonably achievable. Management should also have a favorable
track record of successful integration of historical acquisitions.
|
〉
|
Negotiations and
process - Were the terms of the transaction negotiated at arm’s-length? Was the process fair and equitable? A fair process helps to ensure the best price for shareholders. Significant negotiation
“wins” can also signify the deal makers’ competency. The comprehensiveness of the sales process (e.g., full auction, partial auction, no auction) can also affect shareholder value.
|
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|
Conflicts of
interest - Are insiders benefiting from the transaction disproportionately and inappropriately as compared to non-insider shareholders? As the result of potential conflicts, the directors and officers of the company
may be more likely to vote to approve a merger than if they did not hold these interests. Consider whether these interests may have influenced these directors and officers to support or recommend the merger. The CIC figure presented in the
“ISS Transaction Summary” section of this report is an aggregate figure that can in certain cases be a misleading indicator of the true value transfer from shareholders to insiders. Where such figure appears to be excessive, analyze the
underlying assumptions to determine whether a potential conflict exists.
|
〉
|
Governance - Will the combined company have a better or worse governance profile than the current governance profiles of the respective parties to the transaction? If the governance profile is to change for the worse, the burden is
on the company to prove that other issues (such as valuation) outweigh any deterioration in governance.
|
Private Placements/Warrants/Convertible
Debentures
General Recommendation: Vote case-by-case on proposals regarding private placements, warrants, and convertible debentures taking into consideration:
〉
|
Dilution to
existing shareholders’ position: The amount and timing of shareholder ownership dilution should be weighed against the needs and proposed shareholder benefits of the capital infusion. Although newly issued common stock, absent preemptive
rights, is typically dilutive to existing shareholders, share price appreciation is often the necessary event to trigger the exercise of “out of the money” warrants and convertible debt. In these instances from a value standpoint, the
negative impact of dilution is mitigated by the increase in the company’s stock price that must occur to trigger the dilutive event.
|
|
|
〉
|
Terms of the offer
(discount/premium in purchase price to investor, including any fairness opinion, conversion features, termination penalties, exit strategy):
|
|
|
〉
|
The terms of the
offer should be weighed against the alternatives of the company and in light of company’s financial condition. Ideally, the conversion price for convertible debt and the exercise price for warrants should be at a premium to the then prevailing
stock price at the time of private placement.
|
〉
|
When evaluating
the magnitude of a private placement discount or premium, consider factors that influence the discount or premium, such as, liquidity, due diligence costs, control and monitoring costs, capital scarcity, information asymmetry, and anticipation of
future performance.
|
|
|
〉
|
The
company’s financial condition;
|
〉
|
Degree of need for
capital;
|
〉
|
Use of proceeds;
|
〉
|
Effect of the
financing on the company’s cost of capital;
|
〉
|
Current and
proposed cash burn rate;
|
〉
|
Going concern
viability and the state of the capital and credit markets.
|
〉
|
Management’s
efforts to pursue alternatives and whether the company engaged in a process to evaluate alternatives: A fair, unconstrained process helps to ensure the best price for shareholders. Financing alternatives can include joint ventures, partnership,
merger, or sale of part or all of the company.
|
|
|
〉
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Change in
management;
|
〉
|
Change in control;
|
〉
|
Guaranteed board
and committee seats;
|
〉
|
Standstill
provisions;
|
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|
Voting agreements;
|
〉
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Veto power over
certain corporate actions; and
|
〉
|
Minority versus
majority ownership and corresponding minority discount or majority control premium.
|
|
|
〉
|
Conflicts of
interest should be viewed from the perspective of the company and the investor.
|
〉
|
Were the terms of
the transaction negotiated at arm’s length? Are managerial incentives aligned with shareholder interests?
|
〉
|
The market’s
response to the proposed deal. A negative market reaction is a cause for concern. Market reaction may be addressed by analyzing the one day impact on the unaffected stock price.
|
Vote for the private placement, or for the issuance
of warrants and/or convertible debentures in a private placement, if it is expected that the company will file for bankruptcy if the transaction is not approved.
Reorganization/Restructuring Plan (Bankruptcy)
General Recommendation: Vote case-by-case on proposals to common shareholders on bankruptcy plans of reorganization, considering the following factors including, but not limited to:
〉
|
Estimated value
and financial prospects of the reorganized company;
|
〉
|
Percentage
ownership of current shareholders in the reorganized company;
|
〉
|
Whether
shareholders are adequately represented in the reorganization process (particularly through the existence of an Official Equity Committee);
|
〉
|
The cause(s) of
the bankruptcy filing, and the extent to which the plan of reorganization addresses the cause(s);
|
〉
|
Existence of a
superior alternative to the plan of reorganization; and
|
〉
|
Governance of the
reorganized company.
|
Special Purpose Acquisition Corporations
(SPACs)
General Recommendation: Vote case-by-case on SPAC mergers and acquisitions taking into account the following:
〉
|
Valuation - Is the value being paid by the SPAC reasonable? SPACs generally lack an independent fairness opinion and the financials on the target may be limited. Compare the conversion price with the intrinsic value of the target
company provided in the fairness opinion. Also, evaluate the proportionate value of the combined entity attributable to the SPAC IPO shareholders versus the pre-merger value of SPAC. Additionally, a private company discount may be applied to the
target, if it is a private entity.
|
〉
|
Market reaction - How has the market responded to the proposed deal? A negative market reaction may be a cause for concern. Market reaction may be addressed by analyzing the one-day impact on the unaffected stock price.
|
〉
|
Deal timing - A main driver for most transactions is that the SPAC charter typically requires the deal to be complete within 18 to 24 months, or the SPAC is to be liquidated. Evaluate the valuation, market reaction, and potential
conflicts of interest for deals that are announced close to the liquidation date.
|
〉
|
Negotiations and
process - What was the process undertaken to identify potential target companies within specified industry or location specified in charter? Consider the background of the sponsors.
|
〉
|
Conflicts of
interest - How are sponsors benefiting from the transaction compared to IPO shareholders? Potential conflicts could arise if a fairness opinion is issued by the insiders to qualify the deal rather than a third party
or if management is encouraged to pay a higher price for the target because of an 80 percent rule (the charter requires that the fair market value of the target is at least equal to 80 perecnt of net assets of the
|
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SPAC). Also, there
may be sense of urgency by the management team of the SPAC to close the deal since its charter typically requires a transaction to be completed within the 18-24 month timeframe.
|
〉
|
Voting agreements - Are the sponsors entering into enter into any voting agreements/tender offers with shareholders who are likely to vote against the proposed merger or exercise conversion rights?
|
〉
|
Governance - What is the impact of having the SPAC CEO or founder on key committees following the proposed merger?
|
Special Purpose Acquisition Corporations (SPACs) -
Proposals for Extensions
General
Recommendation: Vote case-by-case on SPAC extension proposals taking into account the length of the requested extension, the status of any pending transaction(s) or progression of the acquisition process, any added
incentive for non-redeeming shareholders, and any prior extension requests.
〉
|
Length of request: Typically, extension requests range from two to six months, depending on the progression of the SPAC’s acquistion process.
|
〉
|
Pending
transaction(s) or progression of the acquisition process: Sometimes an intial business combination was already put to a shareholder vote, but, for varying reasons, the
transaction could not be consummated by the termination date and the SPAC is requesting an extension. Other times, the SPAC has entered into a definitive transaction agreement, but needs additional time to consummate or hold the shareholder
meeting.
|
〉
|
Added incentive for
non-redeeming shareholders: Sometimes the SPAC sponsor (or other insiders) will contribute, typically as a loan to the company, additional funds that will be added to the redemption value of each public share as long
as such shares are not redeemed in connection with the extension request. The purpose of the “equity kicker” is to incentivize shareholders to hold their shares through the end of the requested extension or until the time the transaction
is put to a shareholder vote, rather than electing redeemption at the extension proposal meeting.
|
〉
|
Prior extension
requests: Some SPACs request additional time beyond the extension period sought in prior extension requests.
|
Spin-offs
General Recommendation: Vote case-by-case on spin-offs, considering:
〉
|
Tax and regulatory
advantages;
|
〉
|
Planned use of the
sale proceeds;
|
〉
|
Benefits to the
parent company;
|
〉
|
Corporate
governance changes;
|
〉
|
Changes in the
capital structure.
|
Value
Maximization Shareholder Proposals
General
Recommendation: Vote case-by-case on shareholder proposals seeking to maximize shareholder value by:
〉
|
Hiring a financial
advisor to explore strategic alternatives;
|
〉
|
Selling the
company; or
|
〉
|
Liquidating the
company and distributing the proceeds to shareholders.
|
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These proposals should be evaluated based on the
following factors:
〉
|
Prolonged poor
performance with no turnaround in sight;
|
〉
|
Signs of entrenched
board and management (such as the adoption of takeover defenses);
|
〉
|
Strategic plan in
place for improving value;
|
〉
|
Likelihood of
receiving reasonable value in a sale or dissolution; and
|
〉
|
The company
actively exploring its strategic options, including retaining a financial advisor.
|
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5. COMPENSATION
Executive Pay Evaluation
Underlying all evaluations are five global
principles that most investors expect corporations to adhere to in designing and administering executive and director compensation programs:
1.
|
Maintain
appropriate pay-for-performance alignment, with emphasis on long-term shareholder value: This principle encompasses overall executive pay practices, which must be designed to attract, retain, and appropriately motivate the key employees who drive
shareholder value creation over the long term. It will take into consideration, among other factors, the link between pay and performance; the mix between fixed and variable pay; performance goals; and equity-based plan costs;
|
2.
|
Avoid arrangements
that risk “pay for failure”: This principle addresses the appropriateness of long or indefinite contracts, excessive severance packages, and guaranteed compensation;
|
3.
|
Maintain an
independent and effective compensation committee: This principle promotes oversight of executive pay programs by directors with appropriate skills, knowledge, experience, and a sound process for compensation decision-making (e.g., including access to independent expertise and advice when needed);
|
4.
|
Provide
shareholders with clear, comprehensive compensation disclosures: This principle underscores the importance of informative and timely disclosures that enable shareholders to evaluate executive pay practices fully and fairly;
|
5.
|
Avoid
inappropriate pay to non-executive directors: This principle recognizes the interests of shareholders in ensuring that compensation to outside directors is reasonable and does not compromise their independence and ability to make appropriate
judgments in overseeing managers’ pay and performance. At the market level, it may incorporate a variety of generally accepted best practices.
|
Advisory Votes on Executive
Compensation—Management Proposals (Management Say-on-Pay)
General Recommendation: Vote case-by-case on ballot items related to executive pay and practices, as well as certain aspects of outside director compensation.
Vote against Advisory Votes on Executive
Compensation (Say-on-Pay or “SOP”) if:
〉
|
There is an
unmitigated misalignment between CEO pay and company performance (pay for performance);
|
〉
|
The company
maintains significant problematic pay practices;
|
〉
|
The board exhibits
a significant level of poor communication and responsiveness to shareholders.
|
Vote against or withhold from the members of the
Compensation Committee and potentially the full board if:
〉
|
There is no SOP on
the ballot, and an against vote on an SOP would otherwise be warranted due to pay-for- performance misalignment, problematic pay practices, or the lack of adequate responsiveness on compensation issues raised previously, or a combination thereof;
|
〉
|
The board fails to
respond adequately to a previous SOP proposal that received less than 70 percent support of votes cast;
|
〉
|
The company has
recently practiced or approved problematic pay practices, such as option repricing or option backdating; or
|
〉
|
The situation is
egregious.
|
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Primary Evaluation Factors for Executive Pay
Pay-for-Performance Evaluation
ISS annually conducts a pay-for-performance
analysis to identify strong or satisfactory alignment between pay and performance over a sustained period. With respect to companies in the S&P1500, Russell 3000, or Russell 3000E Indices9, this analysis considers the following:
1.
|
Peer Group10 Alignment:
|
〉
|
The degree of
alignment between the company’s annualized TSR rank and the CEO’s annualized total pay rank within a peer group, each measured over a three-year period.
|
〉
|
The rankings of
CEO total pay and company financial performance within a peer group, each measured over a three-year period.
|
〉
|
The multiple of
the CEO’s total pay relative to the peer group median in the most recent fiscal year.
|
|
|
2.
|
Absolute Alignment11 – the absolute alignment between the trend in CEO pay and company TSR over the prior five fiscal years – i.e., the difference between the
trend in annual pay changes and the trend in annualized TSR during the period.
|
If the above analysis demonstrates significant
unsatisfactory long-term pay-for-performance alignment or, in the case of companies outside the Russell indices, misaligned pay and performance are otherwise suggested, our analysis may include any of the following qualitative factors, as relevant
to evaluating how various pay elements may work to encourage or to undermine long-term value creation and alignment with shareholder interests:
〉
|
The ratio of
performance- to time-based incentive awards;
|
〉
|
The overall ratio
of performance-based compensation;
|
〉
|
The completeness
of disclosure and rigor of performance goals;
|
〉
|
The
company’s peer group benchmarking practices;
|
〉
|
Actual results of
financial/operational metrics, both absolute and relative to peers;
|
〉
|
Special
circumstances related to, for example, a new CEO in the prior FY or anomalous equity grant practices (e.g., bi-annual awards);
|
〉
|
Realizable pay12 compared to grant pay; and
|
〉
|
Any other factors
deemed relevant.
|
Problematic
Pay Practices
The focus is on executive
compensation practices that contravene the global pay principles, including:
〉
|
Problematic
practices related to non-performance-based compensation elements;
|
〉
|
Incentives that may
motivate excessive risk-taking or present a windfall risk; and
|
〉
|
Pay decisions that
circumvent pay-for-performance, such as options backdating or waiving performance requirements.
|
9 The Russell 3000E Index includes
approximately 4,000 of the largest U.S. equity securities.
10 The revised peer group is generally
comprised of 14-24 companies that are selected using market cap, revenue (or assets for certain financial firms), GICS industry group, and company’s selected peers’ GICS industry group, with size constraints, via a process designed to
select peers that are comparable to the subject company in terms of revenue/assets and industry, and also within a market-cap bucket that is reflective of the company’s. For Oil, Gas & Consumable Fuels companies, market cap is the only
size determinant.
11 Only Russell 3000 Index companies
are subject to the Absolute Alignment analysis.
12 ISS research reports include realizable pay for S&P1500 companies.
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Problematic Pay Practices related to
Non-Performance-Based Compensation Elements
Pay elements that are not directly based on
performance are generally evaluated case-by-case considering the context of a company’s overall pay program and demonstrated pay-for-performance philosophy. Please refer to ISS’ U.S. Compensation
Policies FAQ document for detail on specific pay practices that have been identified as potentially problematic and may lead to negative recommendations if they are deemed to be inappropriate or unjustified relative to executive pay best
practices. The list below highlights the problematic practices that carry significant weight in this overall consideration and may result in adverse vote recommendations:
〉
|
Repricing or
replacing of underwater stock options/SARS without prior shareholder approval (including cash buyouts and voluntary surrender of underwater options);
|
〉
|
Extraordinary
perquisites or tax gross-ups;
|
〉
|
New or materially
amended agreements that provide for:
|
〉
|
Excessive
termination or CIC severance payments (generally exceeding 3 times base salary and average/ target/most recent bonus);
|
〉
|
CIC severance
payments without involuntary job loss or substantial diminution of duties (“single” or “modified single” triggers) or in connection with a problematic Good Reason definition;
|
〉
|
CIC excise tax
gross-up entitlements (including “modified” gross-ups);
|
〉
|
Multi-year
guaranteed awards that are not at risk due to rigorous performance conditions;
|
〉
|
Liberal CIC
definition combined with any single-trigger CIC benefits;
|
〉
|
Insufficient
executive compensation disclosure by externally-managed issuers (EMIs) such that a reasonable assessment of pay programs and practices applicable to the EMI’s executives is not possible;
|
〉
|
Any other provision
or practice deemed to be egregious and present a significant risk to investors.
|
Options Backdating
The following factors should be examined
case-by-case to allow for distinctions to be made between “sloppy” plan administration versus deliberate action or fraud:
〉
|
Reason and motive
for the options backdating issue, such as inadvertent vs. deliberate grant date changes;
|
〉
|
Duration of
options backdating;
|
〉
|
Size of
restatement due to options backdating;
|
〉
|
Corrective actions
taken by the board or compensation committee, such as canceling or re-pricing backdated options, the recouping of option gains on backdated grants; and
|
〉
|
Adoption of a
grant policy that prohibits backdating, and creates a fixed grant schedule or window period for equity grants in the future.
|
Compensation Committee Communications and
Responsiveness
Consider the following factors
case-by-case when evaluating ballot items related to executive pay on the board’s responsiveness to investor input and engagement on compensation issues:
〉
|
Failure to respond
to majority-supported shareholder proposals on executive pay topics; or
|
〉
|
Failure to
adequately respond to the company’s previous say-on-pay proposal that received the support of less than 70 percent of votes cast, taking into account:
|
〉
|
The company’s
response, including:
|
〉
|
Disclosure of
engagement efforts with major institutional investors, including the frequency and timing of engagements and the company participants (including whether independent directors participated);
|
〉
|
Disclosure of the
specific concerns voiced by dissenting shareholders that led to the say-on-pay opposition;
|
〉
|
Disclosure of
specific and meaningful actions taken to address shareholders’ concerns;
|
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〉
|
Other recent
compensation actions taken by the company;
|
〉
|
Whether the issues
raised are recurring or isolated;
|
〉
|
The
company’s ownership structure; and
|
〉
|
Whether the
support level was less than 50 percent, which would warrant the highest degree of responsiveness.
|
Frequency of Advisory Vote on Executive Compensation
(“Say When on Pay”)
General
Recommendation: Vote for annual advisory votes on compensation, which provide the most consistent and clear communication channel for shareholder concerns about companies’ executive pay programs.
Voting on Golden Parachutes in an Acquisition,
Merger, Consolidation, or Proposed Sale
General
Recommendation: Vote case-by-case on say on Golden Parachute proposals, including consideration of existing change-in-control arrangements maintained with named executive officers rather than focusing primarily on
new or extended arrangements.
Features
that may result in an “against” recommendation include one or more of the following, depending on the number, magnitude, and/or timing of issue(s):
〉
|
Single- or
modified-single-trigger cash severance;
|
〉
|
Single-trigger
acceleration of unvested equity awards;
|
〉
|
Full acceleration
of equity awards granted shortly before the change in control;
|
〉
|
Acceleration of
performance awards above the target level of performance without compelling rationale;
|
〉
|
Excessive cash
severance (generally >3x base salary and bonus);
|
〉
|
Excise tax
gross-ups triggered and payable;
|
〉
|
Excessive golden
parachute payments (on an absolute basis or as a percentage of transaction equity value); or
|
〉
|
Recent amendments
that incorporate any problematic features (such as those above) or recent actions (such as extraordinary equity grants) that may make packages so attractive as to influence merger agreements that may not be in the best interests of shareholders; or
|
〉
|
The
company’s assertion that a proposed transaction is conditioned on shareholder approval of the golden parachute advisory vote.
|
Recent amendment(s) that incorporate problematic
features will tend to carry more weight on the overall analysis. However, the presence of multiple legacy problematic features will also be closely scrutinized.
In cases where the golden parachute vote is
incorporated into a company’s advisory vote on compensation (management say-on-pay), ISS will evaluate the say-on-pay proposal in accordance with these guidelines, which may give higher weight to that component of the overall evaluation.
Equity-Based and Other Incentive Plans
Please refer to ISS’ U.S. Equity Compensation Plans FAQ document for additional details on the Equity Plan Scorecard policy.
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General Recommendation: Vote case-by-case on certain equity-based compensation plans13 depending on a
combination of certain plan features and equity grant practices, where positive factors may counterbalance negative factors, and vice versa, as evaluated using an “Equity Plan Scorecard” (EPSC) approach with three pillars:
〉
|
Plan Cost: The total estimated cost of the company’s equity plans relative to industry/market cap peers, measured by the company’s estimated Shareholder Value Transfer (SVT) in relation to peers and considering
both:
|
〉
|
SVT based on new
shares requested plus shares remaining for future grants, plus outstanding unvested/ unexercised grants; and
|
〉
|
SVT based only on
new shares requested plus shares remaining for future grants.
|
〉
|
Quality of
disclosure around vesting upon a change in control (CIC);
|
〉
|
Discretionary
vesting authority;
|
〉
|
Liberal share
recycling on various award types;
|
〉
|
Lack of minimum
vesting period for grants made under the plan;
|
〉
|
Dividends payable
prior to award vesting.
|
〉
|
The company’s
three-year burn rate relative to its industry/market cap peers;
|
〉
|
Vesting
requirements in CEO’s recent equity grants (3-year look-back);
|
〉
|
The estimated
duration of the plan (based on the sum of shares remaining available and the new shares requested, divided by the average annual shares granted in the prior three years);
|
〉
|
The proportion of
the CEO’s most recent equity grants/awards subject to performance conditions;
|
〉
|
Whether the company
maintains a sufficient claw-back policy;
|
〉
|
Whether the company
maintains sufficient post-exercise/vesting share-holding requirements.
|
Generally vote against the plan proposal if the
combination of above factors indicates that the plan is not, overall, in shareholders’ interests, or if any of the following egregious factors (“overriding factors”) apply:
〉
|
Awards may vest in
connection with a liberal change-of-control definition;
|
〉
|
The plan would
permit repricing or cash buyout of underwater options without shareholder approval (either by expressly permitting it – for NYSE and Nasdaq listed companies – or by not prohibiting it when the company has a history of repricing –
for non-listed companies);
|
〉
|
The plan is a
vehicle for problematic pay practices or a significant pay-for-performance disconnect under certain circumstances;
|
〉
|
The plan is
excessively dilutive to shareholders’ holdings; or
|
〉
|
Any other plan
features are determined to have a significant negative impact on shareholder interests.
|
Further Information on certain EPSC Factors:
Shareholder Value Transfer (SVT)
The cost of the equity plans is expressed as
Shareholder Value Transfer (SVT), which is measured using a binomial option pricing model that assesses the amount of shareholders’ equity flowing out of the company to employees and directors. SVT is expressed as both a dollar amount and as a
percentage of market value, and includes the new shares proposed, shares available under existing plans, and shares granted but unexercised (using two measures, in the case of plans subject to the Equity Plan Scorecard evaluation, as noted above).
All award
13 Proposals evaluated under the EPSC
policy generally include those to approve or amend (1) stock option plans for employees and/or employees and directors, (2) restricted stock plans for employees and/or employees and directors, and (3) omnibus stock incentive plans for employees
and/or employees and directors; amended plans will be further evaluated case-by-case.
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types are valued. For omnibus plans, unless limitations are placed
on the most expensive types of awards (for example, full-value awards), the assumption is made that all awards to be granted will be the most expensive types. See discussion of specific types of awards.
Except for proposals subject to Equity Plan
Scorecard evaluation, Shareholder Value Transfer is reasonable if it falls below a company-specific benchmark. The benchmark is determined as follows: The top quartile performers in each industry group (using the Global Industry Classification
Standard: GICS) are identified. Benchmark SVT levels for each industry are established based on these top performers’ historic SVT. Regression analyses are run on each industry group to identify the variables most strongly correlated to SVT.
The benchmark industry SVT level is then adjusted upwards or downwards for the specific company by plugging the company-specific performance measures, size and cash compensation into the industry cap equations to arrive at the company’s
benchmark14.
Three-Year Burn Rate
Burn-rate benchmarks (utilized in Equity Plan
Scorecard evaluations) are calculated as the greater of: (1) the mean (µ) plus one standard deviation (σ) of the company’s GICS group segmented by S&P 500, Russell 3000 index (less the S&P500), and non-Russell 3000 index; and
(2) two percent of weighted common shares outstanding. In addition, year-over-year burn-rate benchmark changes will be limited to a maximum of two (2) percentage points plus or minus the prior year’s burn-rate benchmark. See the U.S. Equity
Compensation Plans FAQ for the benchmarks.
Egregious Factors
Liberal Change in Control Definition
Generally vote against equity plans if the plan has
a liberal definition of change in control and the equity awards could vest upon such liberal definition of change in control, even though an actual change in control may not occur. Examples of such a definition include, but are not limited to,
announcement or commencement of a tender offer, provisions for acceleration upon a “potential” takeover, shareholder approval of a merger or other transactions, or similar language.
Repricing Provisions
Vote against plans that expressly permit the
repricing or exchange of underwater stock options/stock appreciate rights (SARs) without prior shareholder approval. “Repricing” typically includes the ability to do any of the following:
〉
|
Amend the terms of
outstanding options or SARs to reduce the exercise price of such outstanding options or SARs;
|
〉
|
Cancel outstanding
options or SARs in exchange for options or SARs with an exercise price that is less than the exercise price of the original options or SARs;
|
〉
|
The cancellation
of underwater options in exchange for stock awards; or
|
〉
|
Cash buyouts of
underwater options.
|
While
the above cover most types of repricing, ISS may view other provisions as akin to repricing depending on the facts and circumstances.
14 For plans evaluated under the Equity
Plan Scorecard policy, the company’s SVT benchmark is considered along with other factors.
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Also, vote against or withhold from members of the
Compensation Committee who approved repricing (as defined above or otherwise determined by ISS), without prior shareholder approval, even if such repricings are allowed in their equity plan.
Vote against plans that do not expressly prohibit
repricing or cash buyout of underwater options without shareholder approval if the company has a history of repricing/buyouts without shareholder approval, and the applicable listing standards would not preclude them from doing so.
Problematic Pay Practices or Significant
Pay-for-Performance Disconnect
If the equity
plan on the ballot is a vehicle for problematic pay practices, vote against the plan.
ISS may recommend a vote against the equity plan if
the plan is determined to be a vehicle for pay-for-performance misalignment. Considerations in voting against the equity plan may include, but are not limited to:
〉
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Severity of the
pay-for-performance misalignment;
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〉
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Whether problematic
equity grant practices are driving the misalignment; and/or
|
〉
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Whether equity plan
awards have been heavily concentrated to the CEO and/or the other NEOs.
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Amending Cash and Equity Plans (including Approval
for Tax Deductibility (162(m))
General
Recommendation: Vote case-by-case on amendments to cash and equity incentive plans.
Generally vote for proposals to amend executive
cash, stock, or cash and stock incentive plans if the proposal:
〉
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Addresses
administrative features only; or
|
〉
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Seeks approval for
Section 162(m) purposes only, and the plan administering committee consists entirely of independent directors, per ISS’ Classification of
Directors. Note that if the company is presenting the plan to shareholders for the first time for any reason (including after the company’s initial public offering), or if the proposal is bundled with other material plan amendments,
then the recommendation will be case-by-case (see below).
|
Vote against proposals to amend executive cash,
stock, or cash and stock incentive plans if the proposal:
〉
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Seeks approval for
Section 162(m) purposes only, and the plan administering committee does not consist entirely of independent directors, per ISS’ Classification of Directors.
|
Vote case-by-case on all other proposals to amend cash incentive plans. This includes plans presented to shareholders for the first time after the company’s IPO and/or proposals that bundle material amendment(s) other than those for Section 162(m)
purposes.
Vote case-by-case on all other
proposals to amend equity incentive plans, considering the following:
〉
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If the proposal
requests additional shares and/or the amendments include a term extension or addition of full value awards as an award type, the recommendation will be based on the Equity Plan Scorecard evaluation as well as an analysis of the overall impact of the
amendments.
|
〉
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If the plan is
being presented to shareholders for the first time (including after the company’s IPO), whether or not additional shares are being requested, the recommendation will be based on the Equity Plan Scorecard evaluation as well as an analysis of
the overall impact of any amendments.
|
〉
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If there is no
request for additional shares and the amendments do not include a term extension or addition of full value awards as an award type, then the recommendation will be based entirely on an analysis of the overall impact of the amendments, and the EPSC
evaluation will be shown only for informational purposes.
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In the first two case-by-case evaluation scenarios,
the EPSC evaluation/score is the more heavily weighted consideration.
Specific Treatment of Certain Award Types in Equity
Plan Evaluations
Dividend Equivalent
Rights
Options that have Dividend Equivalent
Rights (DERs) associated with them will have a higher calculated award value than those without DERs under the binomial model, based on the value of these dividend streams. The higher value will be applied to new shares, shares available under
existing plans, and shares awarded but not exercised per the plan specifications. DERS transfer more shareholder equity to employees and non-employee directors and this cost should be captured.
Operating Partnership (OP) Units in Equity Plan
Analysis of Real Estate Investment Trusts (REITs)
For Real Estate Investment Trusts (REITS), include
the common shares issuable upon conversion of outstanding Operating Partnership (OP) units in the share count for the purposes of determining: (1) market capitalization in the Shareholder Value Transfer (SVT) analysis and (2) shares outstanding in
the burn rate analysis.
Other Compensation
Plans
401(k) Employee Benefit Plans
General Recommendation: Vote for proposals to implement a 401(k) savings plan for employees.
Employee Stock Ownership Plans (ESOPs)
General Recommendation: Vote for proposals to implement an ESOP or increase authorized shares for existing ESOPs, unless the number of shares allocated to the ESOP is excessive (more than five percent of outstanding shares).
Employee Stock Purchase Plans—Qualified
Plans
General Recommendation: Vote case-by-case on qualified employee stock purchase plans. Vote for employee stock purchase plans where all of the following apply:
〉
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Purchase price is
at least 85 percent of fair market value;
|
〉
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Offering period is
27 months or less; and
|
〉
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The number of
shares allocated to the plan is 10 percent or less of the outstanding shares.
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Vote against qualified employee stock purchase
plans where any of the following apply:
〉
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Purchase price is
less than 85 percent of fair market value; or
|
〉
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Offering period is
greater than 27 months; or
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〉
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The number of
shares allocated to the plan is more than 10 percent of the outstanding shares.
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Employee Stock Purchase Plans—Non-Qualified
Plans
General Recommendation: Vote case-by-case on nonqualified employee stock purchase plans. Vote for nonqualified employee stock purchase plans with all the following features:
〉
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Broad-based
participation (i.e., all employees of the company with the exclusion of individuals with 5 percent or more of beneficial ownership
of the company);
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〉
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Limits on employee
contribution, which may be a fixed dollar amount or expressed as a percent of base salary;
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〉
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Company matching
contribution up to 25 percent of employee’s contribution, which is effectively a discount of 20 percent from market value; and
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〉
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No discount on the
stock price on the date of purchase when there is a company matching contribution.
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Vote against nonqualified employee stock purchase
plans when the plan features do not meet all of the above criteria. If the matching contribution or effective discount exceeds the above, ISS may evaluate the SVT cost of the plan as part of the assessment.
Option Exchange Programs/Repricing Options
General Recommendation: Vote case-by-case on management proposals seeking approval to exchange/reprice options taking into consideration:
〉
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Historic trading
patterns--the stock price should not be so volatile that the options are likely to be back “in-the-money” over the near term;
|
〉
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Rationale for the
re-pricing--was the stock price decline beyond management’s control?;
|
〉
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Is this a
value-for-value exchange?;
|
〉
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Are surrendered
stock options added back to the plan reserve?;
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〉
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Timing—repricing
should occur at least one year out from any precipitous drop in company’s stock price;
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〉
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Option
vesting—does the new option vest immediately or is there a black-out period?;
|
〉
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Term of the
option--the term should remain the same as that of the replaced option;
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〉
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Exercise
price—should be set at fair market or a premium to market;
|
〉
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Participants—executive
officers and directors must be excluded.
|
If the surrendered options are added back to the
equity plans for re-issuance, then also take into consideration the company’s total cost of equity plans and its three-year average burn rate.
In addition to the above considerations, evaluate
the intent, rationale, and timing of the repricing proposal. The proposal should clearly articulate why the board is choosing to conduct an exchange program at this point in time. Repricing underwater options after a recent precipitous drop in the
company’s stock price demonstrates poor timing and warrants additional scrutiny. Also, consider the terms of the surrendered options, such as the grant date, exercise price and vesting schedule. Grant dates of surrendered options should be far
enough back (two to three years) so as not to suggest that repricings are being done to take advantage of short-term downward price movements. Similarly, the exercise price of surrendered options should be above the 52-week high for the stock
price.
Vote for shareholder proposals to put
option repricings to a shareholder vote.
Stock
Plans in Lieu of Cash
General Recommendation: Vote case-by-case on plans that provide participants with the option of taking all or a portion of their cash compensation in the form of stock.
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Vote for non-employee director-only equity plans
that provide a dollar-for-dollar cash-for-stock exchange.
Vote case-by-case on plans which do not provide a
dollar-for-dollar cash for stock exchange. In cases where the exchange is not dollar-for-dollar, the request for new or additional shares for such equity program will be considered using the binomial option pricing model. In an effort to capture the
total cost of total compensation, ISS will not make any adjustments to carve out the in-lieu-of cash compensation.
Transfer Stock Option (TSO) Programs
General Recommendation: One-time Transfers: Vote against or withhold from compensation committee members if they fail to submit one-time transfers to shareholders for approval.
Vote case-by-case on one-time transfers. Vote for
if:
〉
|
Executive officers
and non-employee directors are excluded from participating;
|
〉
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Stock options are
purchased by third-party financial institutions at a discount to their fair value using option pricing models such as Black-Scholes or a Binomial Option Valuation or other appropriate financial models; and
|
〉
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There is a
two-year minimum holding period for sale proceeds (cash or stock) for all participants.
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Additionally, management should provide a clear
explanation of why options are being transferred to a third-party institution and whether the events leading up to a decline in stock price were beyond management’s control. A review of the company’s historic stock price volatility
should indicate if the options are likely to be back “in-the-money” over the near term.
Ongoing TSO program: Vote against equity plan
proposals if the details of ongoing TSO programs are not provided to shareholders. Since TSOs will be one of the award types under a stock plan, the ongoing TSO program, structure and mechanics must be disclosed to shareholders. The specific
criteria to be considered in evaluating these proposals include, but not limited, to the following:
〉
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Cost of the
program and impact of the TSOs on company’s total option expense; and
|
〉
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Option repricing
policy.
|
Amendments to
existing plans that allow for introduction of transferability of stock options should make clear that only options granted post-amendment shall be transferable.
Director Compensation
Shareholder Ratification of Director Pay
Programs
General Recommendation: Vote case-by-case on management proposals seeking ratification of non-employee director compensation, based on the following factors:
〉
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If the equity plan
under which non-employee director grants are made is on the ballot, whether or not it warrants support; and
|
〉
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An assessment of
the following qualitative factors:
|
〉
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The relative
magnitude of director compensation as compared to companies of a similar profile;
|
〉
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The presence of
problematic pay practices relating to director compensation;
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〉
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Director stock
ownership guidelines and holding requirements;
|
〉
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Equity award
vesting schedules;
|
〉
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The mix of cash
and equity-based compensation;
|
〉
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Meaningful limits
on director compensation;
|
〉
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The availability
of retirement benefits or perquisites; and
|
〉
|
The quality of
disclosure surrounding director compensation.
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Equity Plans for Non-Employee Directors
General Recommendation: Vote case-by-case on compensation plans for non-employee directors, based on:
〉
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The total
estimated cost of the company’s equity plans relative to industry/market cap peers, measured by the company’s estimated Shareholder Value Transfer (SVT) based on new shares requested plus shares remaining for future grants, plus
outstanding unvested/unexercised grants;
|
〉
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The
company’s three-year burn rate relative to its industry/market cap peers (in certain circumstances); and
|
〉
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The presence of
any egregious plan features (such as an option repricing provision or liberal CIC vesting risk).
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On occasion, non-employee director stock plans will
exceed the plan cost or burn-rate benchmarks when combined with employee or executive stock plans. In such cases, vote case-by-case on the plan taking into consideration the following qualitative factors:
〉
|
The relative
magnitude of director compensation as compared to companies of a similar profile;
|
〉
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The presence of
problematic pay practices relating to director compensation;
|
〉
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Director stock
ownership guidelines and holding requirements;
|
〉
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Equity award
vesting schedules;
|
〉
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The mix of cash
and equity-based compensation;
|
〉
|
Meaningful limits
on director compensation;
|
〉
|
The availability
of retirement benefits or perquisites; and
|
〉
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The quality of
disclosure surrounding director compensation.
|
Non-Employee Director Retirement Plans
General Recommendation: Vote against retirement plans for non-employee directors. Vote for shareholder proposals to eliminate retirement plans for non-employee directors.
Shareholder Proposals on Compensation
Bonus Banking/Bonus Banking “Plus”
General Recommendation: Vote case-by-case on proposals seeking deferral of a portion of annual bonus pay, with ultimate payout linked to sustained results for the performance metrics on which the bonus was earned (whether for the named
executive officers or a wider group of employees), taking into account the following factors:
〉
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The
company’s past practices regarding equity and cash compensation;
|
〉
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Whether the
company has a holding period or stock ownership requirements in place, such as a meaningful retention ratio (at least 50 percent for full tenure); and
|
〉
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Whether the
company has a rigorous claw-back policy in place.
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Compensation Consultants—Disclosure of Board or
Company’s Utilization
General
Recommendation: Generally vote for shareholder proposals seeking disclosure regarding the Company,
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Board, or Compensation Committee’s use of
compensation consultants, such as company name, business relationship(s), and fees paid.
Disclosure/Setting Levels or Types of Compensation
for Executives and Directors
General
Recommendation: Generally vote for shareholder proposals seeking additional disclosure of executive and director pay information, provided the information requested is relevant to shareholders’ needs, would
not put the company at a competitive disadvantage relative to its industry, and is not unduly burdensome to the company.
Generally vote against shareholder proposals
seeking to set absolute levels on compensation or otherwise dictate the amount or form of compensation (such as types of compensation elements or specific metrics) to be used for executive or directors.
Generally vote against shareholder proposals that
mandate a minimum amount of stock that directors must own in order to qualify as a director or to remain on the board.
Vote case-by-case on all other shareholder
proposals regarding executive and director pay, taking into account relevant factors, including but not limited to: company performance, pay level and design versus peers, history of compensation concerns or pay-for-performance disconnect, and/or
the scope and prescriptive nature of the proposal.
Golden Coffins/Executive Death Benefits
General Recommendation: Generally vote for proposals calling for companies to adopt a policy of obtaining shareholder approval for any future agreements and corporate policies that could oblige the company to make payments or awards following
the death of a senior executive in the form of unearned salary or bonuses, accelerated vesting or the continuation in force of unvested equity grants, perquisites and other payments or awards made in lieu of compensation. This would not apply to any
benefit programs or equity plan proposals for which the broad-based employee population is eligible.
Hold Equity Past Retirement or for a Significant
Period of Time
General Recommendation: Vote case-by-case on shareholder proposals asking companies to adopt policies requiring senior executive officers to retain a portion of net shares acquired through compensation plans. The following factors will be taken
into account:
〉
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The
percentage/ratio of net shares required to be retained;
|
〉
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The time period
required to retain the shares;
|
〉
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Whether the
company has equity retention, holding period, and/or stock ownership requirements in place and the robustness of such requirements;
|
〉
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Whether the
company has any other policies aimed at mitigating risk taking by executives;
|
〉
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Executives’
actual stock ownership and the degree to which it meets or exceeds the proponent’s suggested holding period/retention ratio or the company’s existing requirements; and
|
〉
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Problematic pay
practices, current and past, which may demonstrate a short-term versus long-term focus.
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Non-Deductible Compensation
General Recommendation: Generally vote for proposals seeking disclosure of the extent to which the company paid non-deductible compensation to senior executives due to Internal Revenue Code Section 162(m), while considering the company’s
existing disclosure practices.
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Pay Disparity
General Recommendation: Vote case-by-case on proposals calling for an analysis of the pay disparity between corporate executives and other non-executive employees. The following factors will be considered:
〉
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The
company’s current level of disclosure of its executive compensation setting process, including how the company considers pay disparity;
|
〉
|
If any problematic
pay practices or pay-for-performance concerns have been identified at the company; and
|
〉
|
The level of
shareholder support for the company’s pay programs.
|
Generally vote against proposals calling for the
company to use the pay disparity analysis or pay ratio in a specific way to set or limit executive pay.
Pay for Performance/Performance-Based Awards
General Recommendation: Vote case-by-case on shareholder proposals requesting that a significant amount of future long-term incentive compensation awarded to senior executives shall be performance-based and requesting that the board adopt and
disclose challenging performance metrics to shareholders, based on the following analytical steps:
〉
|
First, vote for
shareholder proposals advocating the use of performance-based equity awards, such as performance contingent options or restricted stock, indexed options or premium-priced options, unless the proposal is overly restrictive or if the company has
demonstrated that it is using a “substantial” portion of performance-based awards for its top executives. Standard stock options and performance-accelerated awards do not meet the criteria to be considered as performance-based awards.
Further, premium-priced options should have a meaningful premium to be considered performance-based awards.
|
〉
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Second, assess the
rigor of the company’s performance-based equity program. If the bar set for the performance- based program is too low based on the company’s historical or peer group comparison, generally vote for the proposal. Furthermore, if target
performance results in an above target payout, vote for the shareholder proposal due to program’s poor design. If the company does not disclose the performance metric of the performance- based equity program, vote for the shareholder proposal
regardless of the outcome of the first step to the test.
|
In general, vote for the shareholder proposal if
the company does not meet both of the above two steps.
Pay for Superior Performance
General Recommendation: Vote case-by-case on shareholder proposals that request the board establish a pay-for-superior performance standard in the company’s executive compensation plan for senior executives. These proposals generally
include the following principles:
〉
|
Set compensation
targets for the plan’s annual and long-term incentive pay components at or below the peer group median;
|
〉
|
Deliver a majority
of the plan’s target long-term compensation through performance-vested, not simply time- vested, equity awards;
|
〉
|
Provide the
strategic rationale and relative weightings of the financial and non-financial performance metrics or criteria used in the annual and performance-vested long-term incentive components of the plan;
|
〉
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Establish
performance targets for each plan financial metric relative to the performance of the company’s peer companies;
|
〉
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Limit payment
under the annual and performance-vested long-term incentive components of the plan to when the company’s performance on its selected financial performance metrics exceeds peer group median performance.
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Consider the following factors in evaluating this
proposal:
〉
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What aspects of the
company’s annual and long-term equity incentive programs are performance driven?
|
〉
|
If the annual and
long-term equity incentive programs are performance driven, are the performance criteria and hurdle rates disclosed to shareholders or are they benchmarked against a disclosed peer group?
|
〉
|
Can shareholders
assess the correlation between pay and performance based on the current disclosure?
|
〉
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What type of
industry and stage of business cycle does the company belong to?
|
Pre-Arranged Trading Plans (10b5-1 Plans)
General Recommendation: Generally vote for shareholder proposals calling for certain principles regarding the use of prearranged trading plans (10b5-1 plans) for executives. These principles include:
〉
|
Adoption,
amendment, or termination of a 10b5-1 Plan must be disclosed within two business days in a Form 8-K;
|
〉
|
Amendment or early
termination of a 10b5-1 Plan is allowed only under extraordinary circumstances, as determined by the board;
|
〉
|
Ninety days must
elapse between adoption or amendment of a 10b5-1 Plan and initial trading under the plan;
|
〉
|
Reports on Form 4
must identify transactions made pursuant to a 10b5-1 Plan;
|
〉
|
An executive may
not trade in company stock outside the 10b5-1 Plan;
|
〉
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Trades under a
10b5-1 Plan must be handled by a broker who does not handle other securities transactions for the executive.
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Prohibit Outside CEOs from Serving on Compensation
Committees
General Recommendation: Generally vote against proposals seeking a policy to prohibit any outside CEO from serving on a company’s compensation committee, unless the company has demonstrated problematic pay practices that raise concerns
about the performance and composition of the committee.
Recoupment of Incentive or Stock Compensation in
Specified Circumstances
General Recommendation:
Vote case-by-case on proposals to recoup incentive cash or stock compensation made to senior executives if it is later determined that the figures upon which incentive compensation is earned turn out to have been in
error, or if the senior executive has breached company policy or has engaged in misconduct that may be significantly detrimental to the company’s financial position or reputation, or if the senior executive failed to manage or monitor risks
that subsequently led to significant financial or reputational harm to the company. Many companies have adopted policies that permit recoupment in cases where an executive’s fraud, misconduct, or negligence significantly contributed to a
restatement of financial results that led to the awarding of unearned incentive compensation. However, such policies may be narrow given that not all misconduct or negligence may result in significant financial restatements. Misconduct, negligence
or lack of sufficient oversight by senior executives may lead to significant financial loss or reputational damage that may have long-lasting impact.
In considering whether to support such shareholder
proposals, ISS will take into consideration the following factors:
〉
|
If the company has
adopted a formal recoupment policy;
|
〉
|
The rigor of the
recoupment policy focusing on how and under what circumstances the company may recoup incentive or stock compensation;
|
〉
|
Whether the
company has chronic restatement history or material financial problems;
|
〉
|
Whether the
company’s policy substantially addresses the concerns raised by the proponent;
|
〉
|
Disclosure of
recoupment of incentive or stock compensation from senior executives or lack thereof; or
|
〉
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Any other relevant
factors.
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Severance Agreements for Executives/Golden
Parachutes
General Recommendation: Vote for shareholder proposals requiring that golden parachutes or executive severance agreements be submitted for shareholder ratification, unless the proposal requires shareholder approval prior to entering into employment contracts.
Vote case-by-case on proposals to ratify or cancel
golden parachutes. An acceptable parachute should include, but is not limited to, the following:
〉
|
The triggering
mechanism should be beyond the control of management;
|
〉
|
The amount should
not exceed three times base amount (defined as the average annual taxable W-2 compensation during the five years prior to the year in which the change of control occurs);
|
〉
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Change-in-control
payments should be double-triggered, i.e., (1) after a change in control has taken place, and (2) termination of the executive as a result of the change in control. Change in control is defined as a change in the company ownership structure.
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Share Buyback
Proposals
General Recommendation: Generally vote against shareholder proposals prohibiting executives from selling shares of company stock during periods in which the company has announced that it may or will be repurchasing shares of its stock. Vote for
the proposal when there is a pattern of abuse by executives exercising options or selling shares during periods of share buybacks.
Vote case-by-case on proposals requesting the
company exclude the impact of share buybacks from the calculation of incentive program metrics, considering the following factors:
〉
|
The frequency and
timing of the company’s share buybacks;
|
〉
|
The use of
per-share metrics in incentive plans;
|
〉
|
The effect of
recent buybacks on incentive metric results and payouts; and
|
〉
|
Whether there is
any indication of metric result manipulation.
|
Supplemental Executive Retirement Plans (SERPs)
General Recommendation: Generally vote for shareholder proposals requesting to put extraordinary benefits contained in SERP agreements to a shareholder vote unless the company’s executive pension plans do not contain excessive benefits
beyond what is offered under employee-wide plans.
Generally vote for shareholder proposals requesting
to limit the executive benefits provided under the company’s supplemental executive retirement plan (SERP) by limiting covered compensation to a senior executive’s annual salary or those pay elements covered for the general employee
population.
Tax Gross-Up Proposals
General Recommendation: Generally vote for proposals calling for companies to adopt a policy of not poviding tax gross-up payments to executives, except in situations where gross-ups are provided pursuant to a plan, policy, or arrangement
applicable to management employees of the company, such as a relocation or expatriate tax equalization policy.
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Termination of Employment Prior to Severance
Payment/Eliminating Accelerated Vesting of Unvested Equity
General Recommendation: Vote case-by-case on shareholder proposals seeking a policy requiring termination of employment prior to severance payment and/or eliminating accelerated vesting of unvested equity.
The following factors will be considered:
〉
|
The
company’s current treatment of equity upon employment termination and/or in change-in-control situations (i.e., vesting is double triggered and/or pro rata, does it allow for the assumption of equity by acquiring company, the treatment of
performance shares, etc.);
|
〉
|
Current employment
agreements, including potential poor pay practices such as gross-ups embedded in those agreements.
|
Generally vote for proposals seeking a policy that
prohibits automatic acceleration of the vesting of equity awards to senior executives upon a voluntary termination of employment or in the event of a change in control (except for pro rata vesting considering the time elapsed and attainment of any
related performance goals between the award date and the change in control).
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6. ROUTINE/MISCELLANEOUS
Adjourn Meeting
General Recommendation: Generally vote against proposals to provide management with the authority to adjourn an annual or special meeting absent compelling reasons to support the proposal.
Vote for proposals that relate specifically to
soliciting votes for a merger or transaction if supporting that merger or transaction. Vote against proposals if the wording is too vague or if the proposal includes “other business.”
Amend Quorum Requirements
General Recommendation: Vote against proposals to reduce quorum requirements for shareholder meetings below a majority of the shares outstanding unless there are compelling reasons to support the proposal.
Amend Minor Bylaws
General Recommendation: Vote for bylaw or charter changes that are of a housekeeping nature (updates or corrections).
Change Company Name
General Recommendation: Vote for proposals to change the corporate name unless there is compelling evidence that the change would adversely impact shareholder value.
Change Date, Time, or Location of Annual
Meeting
General Recommendation: Vote for management proposals to change the date, time, or location of the annual meeting unless the proposed change is unreasonable.
Vote against shareholder proposals to change the
date, time, or location of the annual meeting unless the current scheduling or location is unreasonable.
Other Business
General Recommendation: Vote against proposals to approve other business when it appears as a voting item.
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7. SOCIAL AND ENVIRONMENTAL ISSUES
Global Approach
Issues covered under the policy include a wide
range of topics, including consumer and product safety, environment and energy, labor standards and human rights, workplace and board diversity, and corporate political issues. While a variety of factors goes into each analysis, the overall
principle guiding all vote recommendations focuses on how the proposal may enhance or protect shareholder value in either the short or long term.
General Recommendation: Generally vote case-by-case, examining primarily whether implementation of the proposal is likely to enhance or protect shareholder value. The following factors will be considered:
〉
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If the issues
presented in the proposal are more appropriately or effectively dealt with through legislation or government regulation;
|
〉
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If the company has
already responded in an appropriate and sufficient manner to the issue(s) raised in the proposal;
|
〉
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Whether the
proposal’s request is unduly burdensome (scope or timeframe) or overly prescriptive;
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〉
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The
company’s approach compared with any industry standard practices for addressing the issue(s) raised by the proposal;
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〉
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Whether there are
significant controversies, fines, penalties, or litigation associated with the company’s environmental or social practices;
|
〉
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If the proposal
requests increased disclosure or greater transparency, whether reasonable and sufficient information is currently available to shareholders from the company or from other publicly available sources; and
|
〉
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If the proposal
requests increased disclosure or greater transparency, whether implementation would reveal proprietary or confidential information that could place the company at a competitive disadvantage.
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Endorsement of Principles
General Recommendation: Generally vote against proposals seeking a company’s endorsement of principles that support a particular public policy position. Endorsing a set of principles may require a company to take a stand on an issue that
is beyond its own control and may limit its flexibility with respect to future developments. Management and the board should be afforded the flexibility to make decisions on specific public policy positions based on their own assessment of the most
beneficial strategies for the company.
Animal Welfare
Animal Welfare Policies
General Recommendation: Generally vote for proposals seeking a report on a company’s animal welfare standards, or animal welfare-related risks, unless:
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The company has
already published a set of animal welfare standards and monitors compliance;
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〉
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The
company’s standards are comparable to industry peers; and
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There are no
recent significant fines, litigation, or controversies related to the company’s and/or its suppliers’ treatment of animals.
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Animal Testing
General Recommendation: Generally vote against proposals to phase out the use of animals in product testing, unless:
〉
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The company is
conducting animal testing programs that are unnecessary or not required by regulation;
|
〉
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The company is
conducting animal testing when suitable alternatives are commonly accepted and used by industry peers; or
|
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There are recent,
significant fines or litigation related to the company’s treatment of animals.
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Animal Slaughter
General Recommendation: Generally vote against proposals requesting the implementation of Controlled Atmosphere Killing (CAK) methods at company and/or supplier operations unless such methods are required by legislation or generally accepted as
the industry standard.
Vote
case-by-case on proposals requesting a report on the feasibility of implementing CAK methods at company and/ or supplier operations considering the availability of existing research conducted by the company or industry groups on this topic and any
fines or litigation related to current animal processing procedures at the company.
Consumer Issues
Genetically Modified Ingredients
General Recommendation: Generally vote against proposals requesting that a company voluntarily label genetically engineered (GE) ingredients in its products. The labeling of products with GE ingredients is best left to the appropriate
regulatory authorities.
Vote
case-by-case on proposals asking for a report on the feasibility of labeling products containing GE ingredients, taking into account:
〉
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The potential
impact of such labeling on the company’s business;
|
〉
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The quality of the
company’s disclosure on GE product labeling, related voluntary initiatives, and how this disclosure compares with industry peer disclosure; and
|
〉
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Company’s
current disclosure on the feasibility of GE product labeling.
|
Generally vote against proposals seeking a report
on the social, health, and environmental effects of genetically modified organisms (GMOs). Studies of this sort are better undertaken by regulators and the scientific community.
Generally vote against proposals to eliminate GE
ingredients from the company’s products, or proposals asking for reports outlining the steps necessary to eliminate GE ingredients from the company’s products. Such decisions are more appropriately made by management with consideration
of current regulations.
Reports on Potentially
Controversial Business/Financial Practices
General Recommendation: Vote case-by-case on requests for reports on a company’s potentially controversial business or financial practices or products, taking into account:
〉
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Whether the
company has adequately disclosed mechanisms in place to prevent abuses;
|
〉
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Whether the
company has adequately disclosed the financial risks of the products/practices in question;
|
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Whether the
company has been subject to violations of related laws or serious controversies; and
|
〉
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Peer
companies’ policies/practices in this area.
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Pharmaceutical Pricing, Access to Medicines, and
Prescription Drug Reimportation
General
Recommendation: Generally vote against proposals requesting that companies implement specific price restraints on pharmaceutical products unless the company fails to adhere to legislative guidelines or industry
norms in its product pricing practices.
Vote case-by-case on proposals requesting that a
company report on its product pricing or access to medicine policies, considering:
〉
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The potential for
reputational, market, and regulatory risk exposure;
|
〉
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Existing
disclosure of relevant policies;
|
〉
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Deviation from
established industry norms;
|
〉
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Relevant company
initiatives to provide research and/or products to disadvantaged consumers;
|
〉
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Whether the
proposal focuses on specific products or geographic regions;
|
〉
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The potential
burden and scope of the requested report;
|
〉
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Recent significant
controversies, litigation, or fines at the company.
|
Generally vote for proposals requesting that a
company report on the financial and legal impact of its prescription drug reimportation policies unless such information is already publicly disclosed.
Generally vote against proposals requesting that
companies adopt specific policies to encourage or constrain prescription drug reimportation. Such matters are more appropriately the province of legislative activity and may place the company at a competitive disadvantage relative to its
peers.
Product Safety and Toxic/Hazardous
Materials
General Recommendation: Generally vote for proposals requesting that a company report on its policies, initiatives/procedures, and oversight mechanisms related to toxic/hazardous materials or product safety in its supply chain,
unless:
〉
|
The company
already discloses similar information through existing reports such as a supplier code of conduct and/or a sustainability report;
|
〉
|
The company has
formally committed to the implementation of a toxic/hazardous materials and/or product safety and supply chain reporting and monitoring program based on industry norms or similar standards within a specified time frame; and
|
〉
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The company has
not been recently involved in relevant significant controversies, fines, or litigation.
|
Vote case-by-case on resolutions requesting that
companies develop a feasibility assessment to phase-out of certain toxic/hazardous materials, or evaluate and disclose the potential financial and legal risks associated with utilizing certain materials, considering:
〉
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The
company’s current level of disclosure regarding its product safety policies, initiatives, and oversight mechanisms;
|
〉
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Current
regulations in the markets in which the company operates; and
|
〉
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Recent significant
controversies, litigation, or fines stemming from toxic/hazardous materials at the company.
|
Generally vote against resolutions requiring that a
company reformulate its products.
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Tobacco-Related Proposals
General Recommendation: Vote case-by-case on resolutions regarding the advertisement of tobacco products, considering:
〉
|
Recent related
fines, controversies, or significant litigation;
|
〉
|
Whether the
company complies with relevant laws and regulations on the marketing of tobacco;
|
〉
|
Whether the
company’s advertising restrictions deviate from those of industry peers;
|
〉
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Whether the
company entered into the Master Settlement Agreement, which restricts marketing of tobacco to youth; and
|
〉
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Whether
restrictions on marketing to youth extend to foreign countries.
|
Vote case-by-case on proposals regarding
second-hand smoke, considering;
〉
|
Whether the
company complies with all laws and regulations;
|
〉
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The degree that
voluntary restrictions beyond those mandated by law might hurt the company’s competitiveness; and
|
〉
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The risk of any
health-related liabilities.
|
Generally vote against resolutions to cease
production of tobacco-related products, to avoid selling products to tobacco companies, to spin-off tobacco-related businesses, or prohibit investment in tobacco equities. Such business decisions are better left to company management or portfolio
managers.
Generally vote against proposals
regarding tobacco product warnings. Such decisions are better left to public health authorities.
Climate Change
Climate Change/Greenhouse Gas (GHG) Emissions
General Recommendation: Generally vote for resolutions requesting that a company disclose information on the financial, physical, or regulatory risks it faces related to climate change on its operations and investments or on how the company
identifies, measures, and manages such risks, considering:
〉
|
Whether the
company already provides current, publicly-available information on the impact that climate change may have on the company as well as associated company policies and procedures to address related risks and/or opportunities;
|
〉
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The
company’s level of disclosure compared to industry peers; and
|
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Whether there are
significant controversies, fines, penalties, or litigation associated with the company’s climate change-related performance.
|
Generally vote for proposals requesting a report on
greenhouse gas (GHG) emissions from company operations and/ or products and operations, unless:
〉
|
The company
already discloses current, publicly-available information on the impacts that GHG emissions may have on the company as well as associated company policies and procedures to address related risks and/or opportunities;
|
〉
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The
company’s level of disclosure is comparable to that of industry peers; and
|
〉
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There are no
significant, controversies, fines, penalties, or litigation associated with the company’s GHG emissions.
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Vote case-by-case on proposals that call for the
adoption of GHG reduction goals from products and operations, taking into account:
〉
|
Whether the company
provides disclosure of year-over-year GHG emissions performance data;
|
〉
|
Whether company
disclosure lags behind industry peers;
|
〉
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The company’s
actual GHG emissions performance;
|
〉
|
The company’s
current GHG emission policies, oversight mechanisms, and related initiatives; and
|
〉
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Whether the company
has been the subject of recent, significant violations, fines, litigation, or controversy related to GHG emissions.
|
Energy Efficiency
General Recommendation: Generally vote for proposals requesting that a company report on its energy efficiency policies, unless:
〉
|
The company
complies with applicable energy efficiency regulations and laws, and discloses its participation in energy efficiency policies and programs, including disclosure of benchmark data, targets, and performance measures; or
|
〉
|
The proponent
requests adoption of specific energy efficiency goals within specific timelines.
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Renewable Energy
General Recommendation: Generally vote for requests for reports on the feasibility of developing renewable energy resources unless the report would be duplicative of existing disclosure or irrelevant to the company’s line of
business.
Generally vote against
proposals requesting that the company invest in renewable energy resources. Such decisions are best left to management’s evaluation of the feasibility and financial impact that such programs may have on the company.
Generally vote against proposals that call for the
adoption of renewable energy goals, taking into account:
〉
|
The scope and
structure of the proposal;
|
〉
|
The
company’s current level of disclosure on renewable energy use and GHG emissions; and
|
〉
|
The
company’s disclosure of policies, practices, and oversight implemented to manage GHG emissions and mitigate climate change risks.
|
Diversity
Board Diversity
General Recommendation: Generally vote for requests for reports on a company’s efforts to diversify the board, unless:
〉
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The gender and
racial minority representation of the company’s board is reasonably inclusive in relation to companies of similar size and business; and
|
〉
|
The board already
reports on its nominating procedures and gender and racial minority initiatives on the board and within the company.
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Vote case-by-case on proposals asking a company to
increase the gender and racial minority representation on its board, taking into account:
〉
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The degree of
existing gender and racial minority diversity on the company’s board and among its executive officers;
|
〉
|
The level of gender
and racial minority representation that exists at the company’s industry peers;
|
〉
|
The company’s
established process for addressing gender and racial minority board representation;
|
〉
|
Whether the
proposal includes an overly prescriptive request to amend nominating committee charter language;
|
〉
|
The independence of
the company’s nominating committee;
|
〉
|
Whether the company
uses an outside search firm to identify potential director nominees; and
|
〉
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Whether the company
has had recent controversies, fines, or litigation regarding equal employment practices.
|
Equality of Opportunity
General Recommendation: Generally vote for proposals requesting a company disclose its diversity policies or initiatives, or proposals requesting disclosure of a company’s comprehensive workforce diversity data, including requests for
EEO-1 data, unless:
〉
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The company
publicly discloses equal opportunity policies and initiatives in a comprehensive manner;
|
〉
|
The company
already publicly discloses comprehensive workforce diversity data; and
|
〉
|
The company has no
recent significant EEO-related violations or litigation.
|
Generally vote against proposals seeking
information on the diversity efforts of suppliers and service providers. Such requests may pose a significant burden on the company.
Gender Identity, Sexual Orientation, and Domestic
Partner Benefits
General Recommendation: Generally vote for proposals seeking to amend a company’s EEO statement or diversity policies to prohibit discrimination based on sexual orientation and/or gender identity, unless the change would be unduly
burdensome.
Generally vote against
proposals to extend company benefits to, or eliminate benefits from, domestic partners. Decisions regarding benefits should be left to the discretion of the company.
Gender Pay Gap
General Recommendation: Generally vote case-by-case on requests for reports on a company’s pay data by gender, or a report on a company’s policies and goals to reduce any gender pay gap, taking into account:
〉
|
The
company’s current policies and disclosure related to both its diversity and inclusion policies and practices and its compensation philosophy and fair and equitable compensation practices;
|
〉
|
Whether the
company has been the subject of recent controversy, litigation, or regulatory actions related to gender pay gap issues; and
|
〉
|
Whether the
company’s reporting regarding gender pay gap policies or initiatives is lagging its peers.
|
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Environment and Sustainability
Facility and Workplace Safety
General Recommendation: Vote case-by-case on requests for workplace safety reports, including reports on accident risk reduction efforts, taking into account:
〉
|
The
company’s current level of disclosure of its workplace health and safety performance data, health and safety management policies, initiatives, and oversight mechanisms;
|
〉
|
The nature of the
company’s business, specifically regarding company and employee exposure to health and safety risks;
|
〉
|
Recent significant
controversies, fines, or violations related to workplace health and safety; and
|
〉
|
The
company’s workplace health and safety performance relative to industry peers.
|
Vote case-by-case on resolutions requesting that a
company report on safety and/or security risks associated with its operations and/or facilities, considering:
〉
|
The
company’s compliance with applicable regulations and guidelines;
|
〉
|
The
company’s current level of disclosure regarding its security and safety policies, procedures, and compliance monitoring; and
|
〉
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The existence of
recent, significant violations, fines, or controversy regarding the safety and security of the company’s operations and/or facilities.
|
General Environmental Proposals and Community Impact
Assessments
General Recommendation: Vote case-by-case on requests for reports on policies and/or the potential (community) social and/or environmental impact of company operations, considering:
〉
|
Current disclosure
of applicable policies and risk assessment report(s) and risk management procedures;
|
〉
|
The impact of
regulatory non-compliance, litigation, remediation, or reputational loss that may be associated with failure to manage the company’s operations in question, including the management of relevant community and stakeholder relations;
|
〉
|
The nature,
purpose, and scope of the company’s operations in the specific region(s);
|
〉
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The degree to
which company policies and procedures are consistent with industry norms; and
|
〉
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The scope of the
resolution.
|
Hydraulic
Fracturing
General Recommendation: Generally vote for proposals requesting greater disclosure of a company’s (natural gas) hydraulic fracturing operations, including measures the company has taken to manage and mitigate the potential community and
environmental impacts of those operations, considering:
〉
|
The
company’s current level of disclosure of relevant policies and oversight mechanisms;
|
〉
|
The
company’s current level of such disclosure relative to its industry peers;
|
〉
|
Potential relevant
local, state, or national regulatory developments; and
|
〉
|
Controversies,
fines, or litigation related to the company’s hydraulic fracturing operations.
|
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Operations in Protected Areas
General Recommendation: Generally vote for requests for reports on potential environmental damage as a result of company operations in protected regions, unless:
〉
|
Operations in the
specified regions are not permitted by current laws or regulations;
|
〉
|
The company does
not currently have operations or plans to develop operations in these protected regions; or
|
〉
|
The
company’s disclosure of its operations and environmental policies in these regions is comparable to industry peers.
|
Recycling
General Recommendation: Vote case-by-case on proposals to report on an existing recycling program, or adopt a new recycling program, taking into account:
〉
|
The nature of the
company’s business;
|
〉
|
The current level
of disclosure of the company’s existing related programs;
|
〉
|
The timetable and
methods of program implementation prescribed by the proposal;
|
〉
|
The
company’s ability to address the issues raised in the proposal; and
|
〉
|
How the
company’s recycling programs compare to similar programs of its industry peers.
|
Sustainability Reporting
General Recommendation: Generally vote for proposals requesting that a company report on its policies, initiatives, and oversight mechanisms related to social, economic, and environmental sustainability, unless:
〉
|
The company
already discloses similar information through existing reports or policies such as an environment, health, and safety (EHS) report; a comprehensive code of corporate conduct; and/or a diversity report; or
|
〉
|
The company has
formally committed to the implementation of a reporting program based on Global Reporting Initiative (GRI) guidelines or a similar standard within a specified time frame.
|
Water Issues
General Recommendation: Vote case-by-case on proposals requesting a company report on, or adopt a new policy on, water-related risks and concerns, taking into account:
〉
|
The
company’s current disclosure of relevant policies, initiatives, oversight mechanisms, and water usage metrics;
|
〉
|
Whether or not the
company’s existing water-related policies and practices are consistent with relevant internationally recognized standards and national/local regulations;
|
〉
|
The potential
financial impact or risk to the company associated with water-related concerns or issues; and
|
〉
|
Recent,
significant company controversies, fines, or litigation regarding water use by the company and its suppliers.
|
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General Corporate Issues
Charitable Contributions
General Recommendation: Vote against proposals restricting a company from making charitable contributions. Charitable contributions are generally useful for assisting worthwhile causes and for creating goodwill in the community. In the absence
of bad faith, self-dealing, or gross negligence, management should determine which, and if, contributions are in the best interests of the company.
Data Security, Privacy, and Internet Issues
General Recommendation: Vote case-by-case on proposals requesting the disclosure or implementation of data security, privacy, or information access and management policies and procedures, considering:
〉
|
The level of
disclosure of company policies and procedures relating to data security, privacy, freedom of speech, information access and management, and Internet censorship;
|
〉
|
Engagement in
dialogue with governments or relevant groups with respect to data security, privacy, or the free flow of information on the Internet;
|
〉
|
The scope of
business involvement and of investment in countries whose governments censor or monitor the Internet and other telecommunications;
|
〉
|
Applicable
market-specific laws or regulations that may be imposed on the company; and
|
〉
|
Controversies,
fines, or litigation related to data security, privacy, freedom of speech, or Internet censorship.
|
Environmental, Social, and Governance (ESG)
Compensation-Related Proposals
General
Recommendation: Vote case-by-case on proposals to link, or report on linking, executive compensation to sustainability (environmental and social) criteria, considering:
〉
|
The scope and
prescriptive nature of the proposal;
|
〉
|
Whether the
company has significant and/or persistent controversies or regulatory violations regarding social and/or environmental issues;
|
〉
|
Whether the
company has management systems and oversight mechanisms in place regarding its social and environmental performance;
|
〉
|
The degree to
which industry peers have incorporated similar non-financial performance criteria in their executive compensation practices; and
|
〉
|
The
company’s current level of disclosure regarding its environmental and social performance.
|
Human Rights, Labor Issues, and International
Operations
Human Rights Proposals
General Recommendation: Generally vote for proposals requesting a report on company or company supplier labor and/or human rights standards and policies unless such information is already publicly disclosed.
Vote case-by-case on proposals to implement company
or company supplier labor and/or human rights standards and policies, considering:
〉
|
The degree to
which existing relevant policies and practices are disclosed;
|
〉
|
Whether or not
existing relevant policies are consistent with internationally recognized standards;
|
〉
|
Whether company
facilities and those of its suppliers are monitored and how;
|
〉
|
Company
participation in fair labor organizations or other internationally recognized human rights initiatives;
|
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〉
|
Scope and nature
of business conducted in markets known to have higher risk of workplace labor/human rights abuse;
|
〉
|
Recent,
significant company controversies, fines, or litigation regarding human rights at the company or its suppliers;
|
〉
|
The scope of the
request; and
|
〉
|
Deviation from
industry sector peer company standards and practices.
|
Vote case-by-case on proposals requesting that a
company conduct an assessment of the human rights risks in its operations or in its supply chain, or report on its human rights risk assessment process, considering:
〉
|
The degree to
which existing relevant policies and practices are disclosed, including information on the implementation of these policies and any related oversight mechanisms;
|
〉
|
The
company’s industry and whether the company or its suppliers operate in countries or areas where there is a history of human rights concerns;
|
〉
|
Recent significant
controversies, fines, or litigation regarding human rights involving the company or its suppliers, and whether the company has taken remedial steps; and
|
〉
|
Whether the
proposal is unduly burdensome or overly prescriptive.
|
Operations in High Risk Markets
General Recommendation: Vote case-by-case on requests for a report on a company’s potential financial and reputational risks associated with operations in “high-risk” markets, such as a terrorism-sponsoring state or
politically/socially unstable region, taking into account:
〉
|
The nature,
purpose, and scope of the operations and business involved that could be affected by social or political disruption;
|
〉
|
Current disclosure
of applicable risk assessment(s) and risk management procedures;
|
〉
|
Compliance with
U.S. sanctions and laws;
|
〉
|
Consideration of
other international policies, standards, and laws; and
|
〉
|
Whether the
company has been recently involved in recent, significant controversies, fines, or litigation related to its operations in “high-risk” markets.
|
Outsourcing/Offshoring
General Recommendation: Vote case-by-case on proposals calling for companies to report on the risks associated with outsourcing/plant closures, considering:
〉
|
Controversies
surrounding operations in the relevant market(s);
|
〉
|
The value of the
requested report to shareholders;
|
〉
|
The
company’s current level of disclosure of relevant information on outsourcing and plant closure procedures; and
|
〉
|
The
company’s existing human rights standards relative to industry peers.
|
Weapons and Military Sales
General Recommendation: Vote against reports on foreign military sales or offsets. Such disclosures may involve sensitive and confidential information. Moreover, companies must comply with government controls and reporting on foreign military
sales.
Generally vote against
proposals asking a company to cease production or report on the risks associated with the use of depleted uranium munitions or nuclear weapons components and delivery systems, including disengaging from current and proposed contracts. Such contracts
are monitored by government agencies, serve multiple
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military and non-military uses, and withdrawal from these contracts
could have a negative impact on the company’s business.
Political Activities
Lobbying
General Recommendation: Vote case-by-case on proposals requesting information on a company’s lobbying (including direct, indirect, and grassroots lobbying) activities, policies, or procedures, considering:
〉
|
The
company’s current disclosure of relevant lobbying policies, and management and board oversight;
|
〉
|
The
company’s disclosure regarding trade associations or other groups that it supports, or is a member of, that engage in lobbying activities; and
|
〉
|
Recent significant
controversies, fines, or litigation regarding the company’s lobbying-related activities.
|
Political Contributions
General Recommendation: Generally vote for proposals requesting greater disclosure of a company’s political contributions and trade association spending policies and activities, considering:
〉
|
The
company’s policies, and management and board oversight related to its direct political contributions and payments to trade associations or other groups that may be used for political purposes;
|
〉
|
The
company’s disclosure regarding its support of, and participation in, trade associations or other groups that may make political contributions; and
|
〉
|
Recent significant
controversies, fines, or litigation related to the company’s political contributions or political activities.
|
Vote against proposals barring a company from
making political contributions. Businesses are affected by legislation at the federal, state, and local level; barring political contributions can put the company at a competitive disadvantage.
Vote against proposals to publish in newspapers and
other media a company’s political contributions. Such publications could present significant cost to the company without providing commensurate value to shareholders.
Political Ties
General Recommendation: Generally vote against proposals asking a company to affirm political nonpartisanship in the workplace, so long as:
〉
|
There are no
recent, significant controversies, fines, or litigation regarding the company’s political contributions or trade association spending; and
|
〉
|
The company has
procedures in place to ensure that employee contributions to company-sponsored political action committees (PACs) are strictly voluntary and prohibit coercion.
|
Vote against proposals asking for a list of company
executives, directors, consultants, legal counsels, lobbyists, or investment bankers that have prior government service and whether such service had a bearing on the business of the company. Such a list would be burdensome to prepare without
providing any meaningful information to shareholders.
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8. MUTUAL FUND PROXIES
Election of Directors
General Recommendation: Vote case-by-case on the election of directors and trustees, following the same guidelines for uncontested directors for public company shareholder meetings. However, mutual fund boards do not usually have compensation
committees, so do not withhold for the lack of this committee.
Converting Closed-end Fund to Open-end Fund
General Recommendation: Vote case-by-case on conversion proposals, considering the following factors:
〉
|
Past performance
as a closed-end fund;
|
〉
|
Market in which
the fund invests;
|
〉
|
Measures taken by
the board to address the discount; and
|
〉
|
Past shareholder
activism, board activity, and votes on related proposals.
|
Proxy Contests
General Recommendation: Vote case-by-case on proxy contests, considering the following factors:
〉
|
Past performance
relative to its peers;
|
〉
|
Market in which
the fund invests;
|
〉
|
Measures taken by
the board to address the issues;
|
〉
|
Past shareholder
activism, board activity, and votes on related proposals;
|
〉
|
Strategy of the
incumbents versus the dissidents;
|
〉
|
Independence of
directors;
|
〉
|
Experience and
skills of director candidates;
|
〉
|
Governance profile
of the company;
|
〉
|
Evidence of
management entrenchment.
|
Investment Advisory Agreements
General Recommendation: Vote case-by-case on investment advisory agreements, considering the following factors:
〉
|
Proposed and
current fee schedules;
|
〉
|
Fund
category/investment objective;
|
〉
|
Performance
benchmarks;
|
〉
|
Share price
performance as compared with peers;
|
〉
|
Resulting fees
relative to peers;
|
〉
|
Assignments (where
the advisor undergoes a change of control).
|
Approving New Classes or Series of Shares
General Recommendation: Vote for the establishment of new classes or series of shares.
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Preferred Stock Proposals
General Recommendation: Vote case-by-case on the authorization for or increase in preferred shares, considering the following factors:
〉
|
Stated specific
financing purpose;
|
〉
|
Possible dilution
for common shares;
|
〉
|
Whether the shares
can be used for antitakeover purposes.
|
1940 Act Policies
General Recommendation: Vote case-by-case on policies under the Investment Advisor Act of 1940, considering the following factors:
〉
|
Potential
competitiveness;
|
〉
|
Regulatory
developments;
|
〉
|
Current and
potential returns; and
|
〉
|
Current and
potential risk.
|
Generally
vote for these amendments as long as the proposed changes do not fundamentally alter the investment focus of the fund and do comply with the current SEC interpretation.
Changing a Fundamental Restriction to a
Nonfundamental Restriction
General
Recommendation: Vote case-by-case on proposals to change a fundamental restriction to a non-fundamental restriction, considering the following factors:
〉
|
The fund’s
target investments;
|
〉
|
The reasons given
by the fund for the change; and
|
〉
|
The projected
impact of the change on the portfolio.
|
Change Fundamental Investment Objective to
Nonfundamental
General Recommendation: Vote against proposals to change a fund’s fundamental investment objective to non-fundamental.
Name Change Proposals
General Recommendation: Vote case-by-case on name change proposals, considering the following factors:
〉
|
Political/economic
changes in the target market;
|
〉
|
Consolidation in
the target market; and
|
〉
|
Current asset
composition.
|
Change in
Fund’s Subclassification
General
Recommendation: Vote case-by-case on changes in a fund’s sub-classification, considering the following factors:
〉
|
Potential
competitiveness;
|
〉
|
Current and
potential returns;
|
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〉
|
Consolidation in
target industry.
|
Business
Development Companies—Authorization to Sell Shares of Common Stock at a Price below Net Asset Value
General Recommendation: Vote for proposals authorizing the board to issue shares below Net Asset Value (NAV) if:
〉
|
The proposal to
allow share issuances below NAV has an expiration date no more than one year from the date shareholders approve the underlying proposal, as required under the Investment Company Act of 1940;
|
〉
|
The sale is deemed
to be in the best interests of shareholders by (1) a majority of the company’s independent directors and (2) a majority of the company’s directors who have no financial interest in the issuance; and
|
〉
|
The company has
demonstrated responsible past use of share issuances by either:
|
〉
|
Outperforming
peers in its 8-digit GICS group as measured by one- and three-year median TSRs; or
|
〉
|
Providing
disclosure that its past share issuances were priced at levels that resulted in only small or moderate discounts to NAV and economic dilution to existing non-participating shareholders.
|
Disposition of Assets/Termination/Liquidation
General Recommendation: Vote case-by-case on proposals to dispose of assets, to terminate or liquidate, considering the following factors:
〉
|
Strategies
employed to salvage the company;
|
〉
|
The fund’s
past performance;
|
〉
|
The terms of the
liquidation.
|
Changes to the
Charter Document
General Recommendation: Vote case-by-case on changes to the charter document, considering the following factors:
〉
|
The degree of
change implied by the proposal;
|
〉
|
The efficiencies
that could result;
|
〉
|
The state of
incorporation;
|
〉
|
Regulatory
standards and implications.
|
Vote against any of the following changes:
〉
|
Removal of
shareholder approval requirement to reorganize or terminate the trust or any of its series;
|
〉
|
Removal of
shareholder approval requirement for amendments to the new declaration of trust;
|
〉
|
Removal of
shareholder approval requirement to amend the fund’s management contract, allowing the contract to be modified by the investment manager and the trust management, as permitted by the 1940 Act;
|
〉
|
Allow the trustees
to impose other fees in addition to sales charges on investment in a fund, such as deferred sales charges and redemption fees that may be imposed upon redemption of a fund’s shares;
|
〉
|
Removal of
shareholder approval requirement to engage in and terminate subadvisory arrangements;
|
〉
|
Removal of
shareholder approval requirement to change the domicile of the fund.
|
Changing the Domicile of a Fund
General Recommendation: Vote case-by-case on re-incorporations, considering the following factors:
〉
|
Regulations of
both states;
|
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〉
|
Required
fundamental policies of both states;
|
〉
|
The increased
flexibility available.
|
Authorizing the Board to Hire and Terminate
Subadvisers Without Shareholder Approval
General Recommendation: Vote against proposals authorizing the board to hire or terminate subadvisers without shareholder approval if the investment adviser currently employs only one subadviser.
Distribution Agreements
General Recommendation: Vote case-by-case on distribution agreement proposals, considering the following factors:
〉
|
Fees charged to
comparably sized funds with similar objectives;
|
〉
|
The proposed
distributor’s reputation and past performance;
|
〉
|
The
competitiveness of the fund in the industry;
|
〉
|
The terms of the
agreement.
|
Master-Feeder
Structure
General Recommendation: Vote for the establishment of a master-feeder structure.
Mergers
General Recommendation: Vote case-by-case on merger proposals, considering the following factors:
〉
|
Resulting fee
structure;
|
〉
|
Performance of
both funds;
|
〉
|
Continuity of
management personnel;
|
〉
|
Changes in
corporate governance and their impact on shareholder rights.
|
Shareholder Proposals for Mutual Funds
Establish Director Ownership Requirement
General Recommendation: Generally vote against shareholder proposals that mandate a specific minimum amount of stock that directors must own in order to qualify as a director or to remain on the board.
Reimburse Shareholder for Expenses Incurred
General Recommendation: Vote case-by-case on shareholder proposals to reimburse proxy solicitation expenses. When supporting the dissidents, vote for the reimbursement of the proxy solicitation expenses.
Terminate the Investment Advisor
General Recommendation: Vote case-by-case on proposals to terminate the investment advisor, considering the following factors:
〉
|
Performance of the
fund’s Net Asset Value (NAV);
|
〉
|
The fund’s
history of shareholder relations;
|
〉
|
The performance of
other funds under the advisor’s management.
|
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This document and all of the information contained
in it, including without limitation all text, data, graphs, and charts (collectively, the “Information”) is the property of Institutional Shareholder Services Inc. (ISS), its subsidiaries, or, in some cases third party suppliers.
The Information has not been submitted to, nor
received approval from, the United States Securities and Exchange Commission or any other regulatory body. None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), or a promotion or recommendation of, any
security, financial product or other investment vehicle or any trading strategy, and ISS does not endorse, approve, or otherwise express any opinion regarding any issuer, securities, financial products or instruments or trading strategies.
The user of the Information assumes the entire risk
of any use it may make or permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR
REPRESENTATIONS WITH RESPECT TO THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS, NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY, AND FITNESS
for A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the
maximum extent permitted by law, in no event shall ISS have any liability regarding any of the Information for any direct, indirect, special, punitive, consequential (including lost profits), or any other damages even if notified of the possibility
of such damages. The foregoing shall not exclude or limit any liability that may not by applicable law be excluded or limited.
The Global Leader In Corporate Governance
www.issgovernance.com
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APPENDIX C — DESCRIPTION OF RATINGS
The following is a summary of
published ratings by major credit rating agencies. Credit ratings evaluate only the safety of principal and interest payments, not the market value risk of lower quality securities. Credit rating agencies may fail to change credit ratings to reflect
subsequent events on a timely basis. Although the investment adviser considers security ratings when making investment decisions, it also performs its own investment analysis and does not rely solely on the ratings assigned by credit agencies.
Unrated securities will be
treated as non-investment grade securities unless the investment adviser determines that such securities are the equivalent of investment grade securities. Securities that have received different ratings from more than one agency are considered
investment grade if at least one agency has rated the security investment grade, unless otherwise indicated in a Fund’s prospectus or SAI.
Certain Funds are rated by NRSROs.
In order to maintain a rating from a rating organization, the Funds may be subject to additional investment restrictions.
DESCRIPTION OF SHORT-TERM CREDIT RATINGS
Standard & Poor’s Financial Services LLC
(“S&P”)
A
S&P Global Ratings issue credit rating is a forward-looking opinion about the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial program (including
ratings on medium-term note programs and commercial paper programs). It takes into consideration the creditworthiness of guarantors, insurers, or other forms of credit enhancement on the obligation and takes into account the currency in which the
obligation is denominated. The opinion reflects S&P’s view of the obligor’s capacity and willingness to meet its financial commitments as they come due, and may assess terms, such as collateral security and subordination, which could
affect ultimate payment in the event of default.
Issuer credit ratings can be
either long-term or short-term. Short-term ratings are generally assigned to those obligations considered short-term in the relevant market. Short-term ratings are also used to indicate the creditworthiness of an obligor with respect to put features
on long-term obligations. Medium-term notes are assigned long-term ratings.
A-1
|
A short-term
obligation rated ‘A-1’ is rated in the highest category by S&P. The obligor’s capacity to meet its financial commitment on the obligation is strong. Within this category, certain obligations are designated with a plus sign (+).
This indicates that the obligor’s capacity to meet its financial commitment on these obligations is extremely strong.
|
A-2
|
A
short-term obligation rated ‘A-2’ is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher rating categories. However, the obligor’s capacity to meet its
financial commitment on the obligation is satisfactory.
|
A-3
|
A
short-term obligation rated ‘A-3’ exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on
the obligation.
|
B
|
A
short-term obligation rated ‘B’ is regarded as having significant speculative characteristics. The obligor currently has the capacity to meet its financial commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor’s inadequate capacity to meet its financial commitment on the obligation.
|
C
|
A
short-term obligation rated ‘C’ is currently vulnerable to nonpayment and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation.
|
D
|
A
short-term obligation rated ‘D’ is in default or in breach of an imputed promise. For non-hybrid capital instruments, the ‘D’ rating category is used when payments on an obligation are not made on the due date, unless
S&P Global Ratings believes that such payments will be made with any stated grace period. However, any stated grace period longer than five business days will be treated as five business days. The ‘D’ rating also will be used upon
the filing of a bankruptcy petition or the taking of a similar action and where default on an obligation is a virtual certainty, for example due to automatic stay provisions. A rating on an obligation is lowered to ‘D’ if it subject to a
distressed exchange offer.
|
Dual Ratings
Dual ratings may be assigned
to debt issues that have a put option or demand feature. The first component of the rating addresses the likelihood of repayment of principal and interest as due, and the second component of the rating addresses only the demand feature. The first
component of the rating can relate to either a short-term or long-term transaction and accordingly use either short-term or long-term rating symbols. The second component of the rating relates to the put option and is assigned a short-term rating
symbol (for example, ‘AAA/A-1’ or ‘A-1+/A-1’). With U.S. municipal short-term demand debt, the U.S. municipal short-term note rating symbols are used for the first component of the dating (for example,
‘SP-1+/A-1+’).
Active Qualifiers (Currently
applied and/or outstanding)
L: Ratings qualified with
‘L’ apply only to amounts invested up to federal deposit insurance limits.
P: This suffix is used for
issues in which the credit factors, the terms, or both, that determine the likelihood of receipt of payment of principal are different from the credit factors, terms or both that determine the likelihood of receipt of interest on the obligation. The
‘p’ suffix indicates that the rating addresses the principal portion of the obligation only and that the interest is not rated.
Preliminary: Preliminary
ratings, with the “prelim” suffix, may be assigned to obligors or obligations, including financial programs, in the circumstances described below. Assignment of a final rating is conditional on the receipt by S&P of appropriate
documentation. S&P reserves the right not to issue a final rating. Moreover, if a final rating is issued, it may differ from the preliminary rating.
•
|
Preliminary
ratings may be assigned to obligations, most commonly structured and project finance issues, pending receipt of final documentation and legal opinions.
|
•
|
Preliminary
ratings may be assigned to obligations that will likely be issued upon the obligor’s emergence from bankruptcy or similar reorganization, based on late-stage reorganization plans, documentation and discussions with the obligor. Preliminary
ratings may also be assigned to the obligors. These ratings consider the anticipated general credit quality of the reorganized or post-bankruptcy issuer as well as attributes of the anticipated obligation(s).
|
•
|
Preliminary
ratings may be assigned to entities that are being formed or that are in the process of being independently established when, in S&P’s opinion, documentation is close to final. Preliminary ratings may also be assigned to these
entities’ obligations.
|
•
|
Preliminary
ratings may be assigned when a previously unrated entity is undergoing a well-formulated restructuring, recapitalization, significant financing or other transformative event, generally at the point that investor or lender commitments are invited.
The preliminary rating may be assigned to the entity and to its proposed obligation(s). These preliminary ratings consider the anticipated general credit quality of the obligor, as well as attributes of the anticipated obligation(s), assuming
successful completion of the transformative event. Should the transformative event not occur, S&P would likely withdraw these preliminary ratings.
|
•
|
A
preliminary recovery rating may be assigned to an obligation that has a preliminary issue credit rating.
|
t: This symbol indicates
termination structures that are designed to honor their contracts to full maturity or, should certain events occur, to terminate and cash settle all their contracts before their final maturity date.
cir: This symbol indicates a
counterparty instrument rating (CIR), which is a forward-looking opinion about the creditworthiness of an issuer in a securitization structure with respect to a specific financial obligation to a counterparty (including interest rate swaps, currency
swaps, and liquidity facilities). The CIR is determined on an ultimate payment basis; these opinions do not take into account timeliness of payment.
Inactive Qualifiers (No longer
applied or outstanding)
*: This symbol indicated
continuance of the ratings is contingent upon S&P’s receipt of an executed copy of the escrow agreement or closing documentation confirming investments and cash flows. Discontinued use in August 1998.
c: This qualifier was used to
provide additional information to investors that the bank may terminate its obligation to purchase tendered bonds if the long-term credit rating of the issuer is below an investment-grade level and/or the issuer’s bonds are deemed taxable.
Discontinued use in January 2001.
G: The letter ‘G’
followed the rating symbol when a fund’s portfolio consisted primarily of direct U.S. government securities.
pi: This qualifier was used to
indicate ratings that were based on analysis of an issuer’s published financial information, as well as additional information in the public domain. Such ratings did not, however, reflect in-depth meetings with an issuer’s management and
therefore could have been based on less comprehensive information than ratings without a ‘pi’ suffix. Discontinued use as of December 2014 and as of August 2015 for Lloyd’s Syndicate Assessments.
pr: The letters
‘pr’ indicate that the rating is provisional. A provisional rating assumed the successful completion of a project financed by the debt being rated and indicates that payment of debt service requirements was largely or entirely dependent
upon the successful, timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, made no comment on the likelihood of or the risk of default upon failure of such completion.
q: A ‘q’ subscript
indicates that the rating is based solely on quantitative analysis of publicly available information. Discontinued use in April 2001.
r: The ‘r’ modifier
was assigned to securities containing extraordinary risks, particularly market risks, that are not covered in the credit rating. The absence of an ‘r’ modifier should not be taken as an indication that an obligation will not exhibit
extraordinary non-credit related risks. S&P discontinued the use of the ‘r’ modifier for most obligations in June 2000 and for the balance of obligations (mainly structured finance transactions) in November 2002.
Fitch Ratings (“Fitch”)
A short-term issuer or
obligation rating is based in all cases on the short-term vulnerability to default of the rated entity and relates to the capacity to meet financial obligations in accordance with the documentation governing the relevant obligation. Short-term
deposit ratings may be adjusted for loss severity. Short-Term Ratings are assigned to obligations whose initial maturity is viewed as “short term” based on market convention. Typically, this means up to 13 months for corporate,
sovereign, and structured obligations, and up to 36 months for obligations in U.S. public finance markets.
F1
|
HIGHEST SHORT-TERM
CREDIT QUALITY. Indicates the strongest intrinsic capacity for timely payment of financial commitments; may have an added “+” to denote any exceptionally strong credit feature.
|
F2
|
GOOD
SHORT-TERM CREDIT QUALITY. Good intrinsic capacity for timely payment of financial commitments.
|
F3
|
FAIR
SHORT-TERM CREDIT QUALITY. The intrinsic capacity for timely payment of financial commitments is adequate.
|
B
|
SPECULATIVE
SHORT-TERM CREDIT QUALITY. Minimal capacity for timely payment of financial commitments, plus heightened vulnerability to near term adverse changes in financial and economic conditions.
|
C
|
HIGH
SHORT-TERM DEFAULT RISK. Default is a real possibility.
|
RD
|
RESTRICTED
DEFAULT. Indicates an entity that has defaulted on one or more of its financial commitments, although it continues to meet other financial obligations. Typically applicable to entity ratings only.
|
D
|
DEFAULT.
Indicates a broad-based default event for an entity, or the default of a short-term obligation.
|
Limitations of the Credit Ratings Scale
Specific limitations relevant
to the Credit Ratings scale include:
•
|
The ratings do not
predict a specific percentage of default likelihood or failure likelihood over any given time period.
|
•
|
The
ratings do not opine on the market value of any issuer’s securities or stock, or the likelihood that this value may change.
|
•
|
The ratings do not
opine on the liquidity of the issuer’s securities or stock.
|
•
|
The ratings do
not opine on the possible loss severity on an obligation should an issuer (or an obligation with respect to structured finance transactions) default, except in the following two cases:
|
•
|
Ratings assigned
to individual obligations of issuers in corporate finance, banks, non-bank financial institutions, insurance and covered bonds.
|
•
|
In limited
circumstances for U.S. public finance obligations where Chapter 9 of the Bankruptcy Code provides reliably superior prospects for ultimate recovery to local government obligations that benefit from a statutory lien on revenues or during the pendency
of a bankruptcy proceeding under the Code if there is sufficient visibility on potential recovery prospects.
|
•
|
The ratings do not
opine on the suitability of an issuer as a counterparty to trade credit.
|
•
|
The ratings do
not opine on any quality related to an issuer’s business, operational or financial profile other than the agency‘s opinion on its relative vulnerability to default or in the case of bank Viability Ratings on its relative vulnerability to
failure. For the avoidance of doubt, not all defaults will be considered a default for rating purposes. Typically, a default relates to a liability payable to an unaffiliated, outside investor.
|
•
|
The ratings do not
opine on any quality related to a transaction’s profile other than the agency’s opinion on the relative vulnerability to default of an issuer and/or of each rated tranche or security.
|
•
|
The ratings do not
predict a specific percentage of extraordinary support likelihood over any given period.
|
•
|
In the case of
bank Support Ratings and Support Rating Floors, the ratings do not opine on any quality related to an issuer’s business, operational or financial profile other than the agency’s opinion on its relative likelihood of receiving external
extraordinary support.
|
•
|
The
ratings do not opine on the suitability of any security for investment or any other purposes.
|
Moody’s Investors Service, Inc.
(“Moody’s”)
Moody’s global
short-term ratings are forward-looking opinions of the relative credit risks of financial obligations issued by non-financial corporates, financial institutions, structured finance vehicles, project finance vehicles and public sector entities.
Short-term ratings are assigned to obligations with an original maturity of thirteen months or less and reflect both on the likelihood of a default or impairment on contractual financial obligations and the expected financial loss suffered in the
event of default or impairment.
Moody’s employs the
following designations to indicate the relative repayment ability of rated issuers:
P-1
|
Issuers (or
supporting institutions) rated Prime-1 have a superior ability to repay short-term debt obligations.
|
P-2
|
Issuers
(or supporting institutions) rated Prime-2 have a strong ability to repay short-term debt obligations.
|
P-3
|
Issuers
(or supporting institutions) rated Prime-3 have an acceptable ability to repay short-term obligations.
|
NP
|
Issuers
(or supporting institutions) rated Not Prime do not fall within any of the Prime rating categories.
|
Dominion Bond Rating Service
(“DBRS”)
The DBRS
short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner. Ratings are based on quantitative and qualitative considerations relevant to the issuer and the
relative ranking of claims. The R-1 and R-2 rating categories are further denoted by the subcategories “(high),” “(middle),” and “(low).”
R-1
(high)
|
Highest credit
quality. The capacity for the payment of short-term financial obligations as they fall due is exceptionally high. Unlikely to be adversely affected by future events.
|
R-1
(middle)
|
Superior
credit quality. The capacity for the payment of short-term financial obligations as they fall due is very high. Differs from R-1 (high) by a relatively modest degree. Unlikely to be significantly vulnerable to future events.
|
R-1
(low)
|
Good credit
quality. The capacity for the payment of short-term financial obligations as they fall due is substantial. Overall strength is not as favorable as higher rating categories. May be vulnerable to future events, but qualifying negative factors are
considered manageable.
|
R-2
(high)
|
Upper
end of adequate credit quality. The capacity for the payment of short-term financial obligations as they fall due is acceptable. May be vulnerable to future events.
|
R-2
(middle)
|
Adequate
credit quality. The capacity for the payment of short-term financial obligations as they fall due is acceptable. May be vulnerable to future events or may be exposed to other factors that could reduce credit quality.
|
R-2
(low)
|
Lower
end of adequate credit quality. The capacity for the payment of short-term financial obligations as they fall due is acceptable. May be vulnerable to future events. A number of challenges are present that could affect the issuer’s ability to
meet such obligations.
|
R-3
|
Lowest
end of adequate credit quality. There is a capacity for the payment of short-term financial obligations as they fall due. May be vulnerable to future events and the certainty of meeting such obligations could be impacted by a variety of
developments.
|
R-4
|
Speculative
credit quality. The capacity for the payment of short-term financial obligations as they fall due is uncertain.
|
R-5
|
Highly
speculative credit quality. There is a high level of uncertainty as to the capacity to meet short-term financial obligations as they fall due.
|
D
|
When
the issuer has filed under any applicable bankruptcy, insolvency or winding up statute or there is a failure to satisfy and obligation after the exhaustion of grace periods, a downgrade to D may occur. DBRS may also use SD (Selective Default) in
cases where only some securities are impacted, such as the case of a “distressed exchange.”
|
DESCRIPTION OF LONG-TERM CREDIT RATINGS
S&P
Long-Term Issue Credit
Ratings
Issue credit
ratings are based, in varying degrees, on S&P analysis of the following considerations:
•
|
Likelihood of
payment — capacity and willingness of the obligor to meet its financial commitment on an obligation in accordance with the terms of the obligation;
|
•
|
Nature of and
provisions of the obligation, and the promise we impute; and
|
•
|
Protection
afforded by, and relative position of, the obligation in the event of bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors’ rights.
|
Issue ratings are an
assessment of default risk, but may incorporate an assessment of relative seniority or ultimate recovery in the event of default. Junior obligations are typically rated lower than senior obligations, to reflect lower priority in bankruptcy, as noted
above. (Such differentiation may apply when an entity has both senior and subordinated obligations, secured and unsecured obligations, or operating company and holding company obligations.)
AAA
|
An obligation
rated ‘AAA’ has the highest rating assigned by S&P. The obligor’s capacity to meet its financial commitments on the obligation is extremely strong.
|
AA
|
An
obligation rated ‘AA’ differs from the highest-rated obligations only to a small degree. The obligor’s capacity to meet its financial commitments on the obligation is very strong.
|
A
|
An
obligation rated ‘A’ is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor’s capacity to meet its financial
commitment on the obligation is still strong.
|
BBB
|
An
obligation rated ‘BBB’ exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to weaken the obligor’s capacity to meet its financial commitments on the obligation.
|
Obligations rated
‘BB’, ‘B’, ‘CCC’, ‘CC’, and ‘C’ are regarded as having significant speculative characteristics. ‘BB’ indicates the least degree of speculation and ‘C’ the highest.
While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposure to adverse conditions.
BB
|
An obligation
rated ‘BB’ is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to the obligor’s
inadequate capacity to meet its financial commitments on the obligation.
|
B
|
An
obligation rated ‘B’ is more vulnerable to nonpayment than obligations rated ‘BB’, but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor’s capacity or willingness to meet its financial commitments on the obligation.
|
CCC
|
An
obligation rated ‘CCC’ is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse
business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitments on the obligation.
|
CC
|
An
obligation rated ‘CC’ is currently highly vulnerable to nonpayment. The ‘CC’ rating is used when a default has not yet occurred but S&P expects default to be a virtual certainty, regardless of the anticipated time to
default.
|
C
|
An
obligation rated ‘C; is currently highly vulnerable to nonpayment, and the obligation is expected to have lower relative seniority or lower ultimate recovery compared with obligations that are rated higher.
|
D
|
An
obligation rated ‘D’ is in default or in breach of an imputed promise. For non-hybrid capital instruments, the ‘D’ rating category is used when payments on an obligation are not made on the due date, unless S&P Global
Ratings believes that such payments will be made within five business days in the absence of a stated grace period or within the earlier of the stated grace period or 30 calendar days. The ‘D” rating also will be used upon the filing of
a bankruptcy petition or the taking of similar action and where default on an obligation is a virtual certainty, for example due to automatic stay provisions. A rating on an obligation is lowered to ‘D’ if it is subject to a distressed
exchange offer.
|
Plus(+) or Minus (-): The
ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories.
Fitch
Rated entities in a number of
sectors, including financial and non-financial corporations, sovereigns, insurance companies, and certain sectors within public finance are generally assigned Issuer Default Ratings (IDRs). IDRs are also assigned to certain entities or enterprises
in global infrastructure, project finance and public finance. IDRs opine on an entity’s relative vulnerability to default (including by way of a distressed debt exchange) on financial obligation. The threshold default risk addressed by the IDR
is generally that of the financial obligations whose non-payment would best reflect the uncured failure of that entity. As such, IDRs also address relative vulnerability to bankruptcy, administrative receivership or similar concepts.
In aggregate, IDRs provide an
ordinal ranking of issuers based on the agency’s view of their relative vulnerability to default, rather than a prediction of a specific percentage likelihood of default.
AAA
|
HIGHEST CREDIT
QUALITY. ‘AAA’ ratings denote the lowest expectation of default risk. They are assigned only in case of exceptionally strong capacity for payment of financial commitments. This capacity is highly unlikely to be adversely affected by
foreseeable events.
|
AA
|
VERY
HIGH CREDIT QUALITY. ‘AA’ ratings denote expectations of very low default risk. They indicate very strong capacity for payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events.
|
A
|
HIGH
CREDIT QUALITY. ‘A’ ratings denote expectations of low default risk. The capacity for payment of financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to adverse business economic conditions
than is the case for higher ratings.
|
BBB
|
GOOD CREDIT
QUALITY. ‘BBB’ ratings indicate that expectations of default risk are currently low. The capacity for payment of financial commitments is considered adequate, but adverse business or economic conditions are more likely to impair this
capacity.
|
BB
|
SPECULATIVE.
‘BB’ ratings indicate an elevated vulnerability to default risk, particularly in the event of adverse changes in business or economic conditions over time; however, business or financial flexibility exists that supports the servicing of
financial commitments.
|
B
|
HIGHLY
SPECULATIVE. ‘B’ ratings indicate that material default risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is vulnerable to deterioration in
the business and economic environment.
|
CCC
|
SUBSTANTIAL
CREDIT RISK. Default is a real possibility.
|
CC
|
VERY
HIGH LEVELS OF CREDIT RISK. Default of some kind appears probable.
|
C
|
NEAR
DEFAULT. A default or default-like process has begun, or the issuer is in standstill, or for a closed funding vehicle, payment capacity is irrevocably impaired. Conditions that are indicative of a ‘C’ category rating for an issuer
include:
|
|
•
the issuer has entered into a grace or cure period following non-payment of a material financial obligation;
• the issuer has entered
into a temporary negotiated waiver or standstill agreement following a payment default on a material financial obligation; or
• the formal announcement by the issuer or their agent of a
distressed debt exchange;
• a closed financing vehicle where payment capacity is irrevocably impaired such that it is not expected to pay interest and/or principal in full during the
life of the transaction, but where no payment default is imminent.
|
RD
|
RESTRICTED
DEFAULT. ‘RD’ ratings indicate an issuer that in Fitch’s opinion has experienced:
|
|
•
an uncured payment default or distressed debt exchange on a bond, loan or other material financial obligation, but
• has not entered into
bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure, and
• has not otherwise ceased operating. This would include:
• the selective payment default on a specific class or currency of debt;
• the uncured expiry of any applicable grace period, cure period or
default forbearance period following a payment default on a bank loan, capital markets security or other material financial obligation;
• the extension of multiple waivers or
forbearance periods upon a payment default on one or more material financial obligations, either in series or in parallel;
• ordinary execution of a distressed debt exchange on one or
more material financial obligations.
|
D
|
DEFAULT.
‘D’ ratings indicate an issuer that in Fitch Ratings’ opinion has entered into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure, or which has otherwise ceased business.
|
Default ratings are not
assigned prospectively to entities or their obligations; within this context, non-payment on an instrument that contains a deferral feature or grace period will generally not be considered a default until after the expiration of the deferral or
grace period, unless a default is otherwise driven by bankruptcy or other similar circumstance, or by a distressed debt exchange.
In all cases, the assignment of
a default rating reflects the agency’s opinion as to the most appropriate rating category consistent with the rest of its universe of ratings, and may differ from the definition of default under the terms of an issuer’s financial
obligations or local commercial practice.
Limitations of the Credit Rating Scale:
Specific limitations relevant to
the credit rating scale are listed under Description of Short-Term Credit Ratings section.
Moody’s
Long-Term Obligation
Ratings
Moody’s
long-term ratings are forward-looking opinions of the relative credit risks of financial obligations issued by non-financial corporates, financial institutions, structured finance vehicles, project finance vehicles and public sector entities.
Long-term ratings are assigned to issuers or obligations with an original maturity of one year or more and reflect both on the likelihood of a default or impairment on contractual financial obligations and the expected financial loss suffered in the
event of default or impairment.
Aaa
|
Obligations rated
Aaa are judged to be of the highest quality, subject to the lowest level of credit risk.
|
Aa
|
Obligations
rated Aa are judged to be of high quality and are subject to very low credit risk.
|
A
|
Obligations
rated A are considered upper-medium grade and are subject to low credit risk.
|
Baa
|
Obligations
rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.
|
Ba
|
Obligations
rated Ba are judged to be speculative and are subject to substantial credit risk.
|
B
|
Obligations
rated B are considered speculative and are subject to high credit risk.
|
Caa
|
Obligations
rated Caa are judged to be speculative of poor standing and are subject to very high credit risk.
|
Ca
|
Obligations
rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest.
|
C
|
Obligations
rated C are the lowest rated and are typically in default, with little prospect for recovery of principal or interest.
|
Moody’s applies
numerical modifiers, 1, 2, and 3 to each generic rating classified from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates a ranking in the lower end of that generic rating category. Additionally, a “(hyb)” indicator is appended to all ratings of hybrid securities issued by banks, insurers, finance companies, and securities firms.*
*By their terms, hybrid securities allow for the
omission of scheduled dividends, interest, or principal payments, which can potentially result in impairment if such an omission occurs. Hybrid securities may also be subject to contractually allowable write-downs of principal that could result in
impairment. Together with the hybrid indicator, the long-term obligation rating assigned to a hybrid security is an expression of the relative credit risk associated with that security.
DBRS
Long-Term Obligations
The DBRS
long-term rating scale provides an opinion on the risk of default. That is, the risk that an issuer will fail to satisfy its financial obligations in accordance with the terms under which an obligations has been issued. Ratings are based on
quantitative and qualitative considerations relevant to the issuer, and the relative ranking of claims. All rating categories other than AAA and D also contain subcategories “(high)” and “(low).” The absence of either a
“(high)” or “(low)” designation indicates the rating is in the middle of the category.
AAA
|
Highest credit
quality. The capacity for the payment of financial obligations is exceptionally high and unlikely to be adversely affected by future events.
|
AA
|
Superior
credit quality. The capacity for the payment of financial obligations is considered high. Credit quality differs from AAA only to a small degree. Unlikely to be significantly vulnerable to future events.
|
A
|
Good
credit quality. The capacity for the payment of financial obligations is substantial, but of lesser credit quality than AA. May be vulnerable to future events, but qualifying negative factors are considered manageable.
|
BBB
|
Adequate
credit quality. The capacity for the payment of financial obligations is considered acceptable. May be vulnerable to future events.
|
BB
|
Speculative,
non-investment grade credit quality. The capacity for the payment of financial obligations is uncertain. Vulnerable to future events.
|
B
|
Highly
speculative credit quality. There is a high level of uncertainty as to the capacity to meet financial obligations.
|
CCC/CC/C
|
Very
highly speculative credit quality. In danger of defaulting on financial obligations. There is little difference between these three categories, although CC and C ratings are normally applied to obligations that are seen as highly likely to default,
or subordinated to obligations rated in the CCC to B range. Obligations in respect of which default has not technically taken place but is considered inevitable may be rated in the C category.
|
D
|
When
the issuer has filed under any applicable bankruptcy, insolvency or winding up statute or there is a failure to satisfy an obligation after the exhaustion of grace periods, a downgrade to D may occur. DBRS may also use SD (Selective Default) in
cases where only some securities are impacted, such as the case of a “distressed exchange.”
|
DESCRIPTION OF INSURANCE RATINGS
S&P
Insurer Financial Strength
Rating Definitions
An
S&P Global Ratings insurer financial strength rating is a forward-looking opinion about the financial security characteristics of an insurance organization with respect to its ability to pay under its insurance policies and contracts in
accordance with their terms. Insurer financial strength ratings are also assigned to health maintenance organizations and similar health plans with respect to their ability to pay under their policies and contracts in accordance with their
terms.
This opinion is
not specific to any particular policy or contract, nor does it address the suitability of a particular policy or contract for a specific purpose or purchaser. Furthermore, the opinion does not take into account deductibles, surrender or cancellation
penalties, timeliness of payment, nor the likelihood of the use of a defense such as fraud to deny claims.
Insurer financial strength
ratings do not refer to an organization’s ability to meet nonpolicy (i.e. debt) obligations. Assignment of ratings to debt issued by insurers or to debt issues that are fully or partially supported by insurance policies, contracts, or
guarantees is a separate process from the determination of insurer financial strength ratings, and it follows procedures consistent with those used to assign an issue credit rating. An insurer financial strength rating is not a recommendation to
purchase or discontinue any policy or contract issued by an insurer.
Insurer Financial Strength
Ratings
AAA
|
An insurer rated
‘AAA’ has extremely strong financial security characteristics. ‘AAA’ is the highest insurer financial strength rating assigned by S&P.
|
AA
|
An
insurer rated ‘AA’ has very strong financial security characteristics, differing only slightly from those rated higher.
|
A
|
An
insurer rated ‘A’ has strong financial security characteristics, but is somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings.
|
BBB
|
An
insurer rated ‘BBB’ has good financial security characteristics, but is more likely to be affected by adverse business conditions than are higher-rated insurers.
|
An insurer rated ‘BB’
or lower is regarded as having vulnerable characteristics that may outweigh its strengths; ‘BB’ indicates the least degree of vulnerability within the range; and ‘CC’ the highest.
BB
|
An insurer rated
‘BB’ has marginal financial security characteristics. Positive attributes exist, but adverse business conditions could lead to insufficient ability to meet financial commitments.
|
B
|
An
insurer rated ‘B’ has weak financial security characteristics. Adverse business conditions will likely impair its ability to meet financial commitments.
|
CCC
|
An
insurer rated ‘CCC’ has very weak financial security characteristics, and is dependent on favorable business conditions to meet financial commitments.
|
CC
|
An
insurer rated ‘CC’ has extremely weak financial security characteristics and is likely not to meet some of its financial commitments.
|
R
|
An insurer rated
‘R’ is under regulatory supervision owing to its financial condition. During the pendency of the regulatory supervision, the regulators may have the power to favor one class of obligations over others or pay some obligations and not
others. The rating does not apply to insurers subject only to nonfinancial actions such as market conduct violations.
|
SD
or D
|
An
insurer rated ‘SD’ (selective default) or ‘D” is in default on one or more of its insurance policy obligations but is not under regulatory supervision that would involve a rating of ‘R’.
The ‘D’
rating also will be used upon the filing of a bankruptcy petition or the taking of similar action if payments on a policy obligation are at risk. A ‘D’ rating is assigned when S&P Global Ratings believes that the default will be a
general default and that the obligor will fail to pay substantially all of its obligations in full in accordance with the policy terms.
An ‘SD’ rating is assigned when S&P Global Ratings believes that the insurer has selectively
defaulted on a specific class of policies but it will continue to meet its payment obligations on other classes of obligations. An ‘SD’ includes the completion of a distressed exchange offer. Claim denials due to lack of coverage or
other legally permitted defenses are not considered defaults.
|
Ratings from ‘AA’ to
‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the rating categories.
Fitch
Insurer Financial Strength
Ratings
The Insurer
Financial Strength (IFS) Rating provides an assessment of the financial strength of an insurance organization. The IFS Rating is assigned to the insurance company’s policyholder obligations, including assumed reinsurance obligations and
contract holder obligations, such as guaranteed investment contracts. The IFS Rating reflects both the ability of the insurer to meet these obligations on a timely basis, and expected recoveries received by claimants in the event the insurer stops
making payments or payments are interrupted, due to either the failure of the insurer or some form of regulatory intervention. In the context of the IFS Rating, the timeliness of payments is considered relative to both contract and/or policy terms
but also recognizes the possibility of reasonable delays caused by circumstances common to the insurance industry, including claims reviews, fraud investigations and coverage disputes.
The IFS Rating does not
encompass policyholder obligations residing in separate accounts, unit-linked products or segregated funds, for which the policyholder bears investment or other risks. However, any guarantees provided to the policyholder with respect to such
obligations are included in the IFS Rating.
Expected recoveries are based
on the agency’s assessments of the sufficiency of an insurance company’s assets to fund policyholder obligations, in a scenario in which payments have ceased or been interrupted. Accordingly, expected recoveries exclude the impact of
recoveries obtained from any government sponsored guaranty or policyholder protection funds. Expected recoveries also exclude the impact of collateralization or security, such as letters of credit or trusteed assets, supporting select reinsurance
obligations.
IFS Ratings
can be assigned to insurance and reinsurance companies in any insurance sector, including the life & annuity, non-life, property/casualty, health, mortgage, financial guaranty, residual value and title insurance sectors, as well as to managed
care companies such as health maintenance organizations.
The IFS Rating uses the same
symbols used by the agency for its International and National credit ratings of long-term or short-term debt issues. However, the definitions associated with the ratings reflect the unique aspects of the IFS Rating within an insurance industry
context.
Obligations for
which a payment interruption has occurred due to either the insolvency or failure of the insurer or some form of regulatory intervention will generally be rated between ‘B’ and ‘C’ on the Long-Term IFS Rating scales (both
International and National). International Short-Term IFS Ratings assigned under the same circumstances will align with the insurer’s International Long-Term IFS Rating.
Long-Term International IFS
Ratings
The following
rating scale applies to foreign currency and local currency ratings. Ratings of ‘BBB-’ and higher are considered to be “secure,” and those of ‘BB+’ and lower are considered to be “vulnerable.”
AAA
|
EXCEPTIONALLY
STRONG. ‘AAA’ IFS Ratings denote the lowest expectation of ceased or interrupted payments. They are assigned only in the case of exceptionally strong capacity to meet policyholder and contract obligations. This capacity is highly
unlikely to be adversely affected by foreseeable events.
|
AA
|
VERY
STRONG. ‘AA’ IFS Ratings denote a very low expectation of ceased or interrupted payments. They indicate very strong capacity to meet policyholder and contract obligations. This capacity is not significantly vulnerable to foreseeable
events.
|
A
|
STRONG.
‘A’ IFS Ratings denote a low expectation of ceased or interrupted payments. They indicate strong capacity to meet policyholder and contract obligations. This capacity may, nonetheless, be more vulnerable to changes in circumstances or
in economic conditions than is the case for higher ratings.
|
BBB
|
GOOD.
‘BBB’ IFS Ratings indicate that there is currently a low expectation of ceased or interrupted payments. The capacity to meet policyholder and contract obligations on a timely basis is considered adequate, but adverse changes in
circumstances and economic conditions are more likely to impact this capacity.
|
BB
|
MODERATELY
WEAK. ‘BB’ IFS Ratings indicate that there is an elevated vulnerability to ceased or interrupted payments, particularly as the result of adverse economic or market changes over time. However, business or financial alternatives may be
available to allow for policyholder and contract obligations to be met in a timely manner.
|
B
|
WEAK.
‘B’ IFS Ratings indicate two possible conditions. If obligations are still being met on a timely basis, there is significant risk that ceased or interrupted payments could occur in the future, but a limited margin of safety remains.
Capacity for continued timely payments is contingent upon a sustained, favorable business and economic environment, and favorable market conditions. Alternatively, a ‘B’ IFS Rating is assigned to obligations that have experienced ceased
or interrupted payments, but with the potential for extremely high recoveries. Such obligations would possess a recovery assessment of ‘RR1’ (Outstanding).
|
CCC
|
VERY
WEAK. ‘CCC’ IFS Ratings indicate two possible conditions. If obligations are still being met on a timely basis, there is a real possibility that ceased or interrupted payments could occur in the future. Capacity for continued timely
payments is solely reliant upon a sustained, favorable business and economic environment, and favorable market conditions. Alternatively, a ‘CCC’ IFS Rating is assigned to obligations that have experienced ceased or interrupted payments,
and with the potential for average to superior recoveries. Such obligations would possess a recovery assessment of ‘RR2’ (Superior), ‘RR3’ (Good), and ‘RR4’ (Average).
|
CC
|
EXTREMELY
WEAK. ‘CC’ IFS Ratings indicate two possible conditions. If obligations are still being met on a timely basis, it is probable that ceased or interrupted payments will occur in the future. Alternatively, a ‘CC’ IFS Rating is
assigned to obligations that have experienced ceased or interrupted payments, with the potential for average to below-average recoveries. Such obligations would possess a recovery assessment of ‘RR4’ (Average) or ‘RR5’ (Below
Average).
|
C
|
DISTRESSED.
‘C’ IFS Ratings indicate two possible conditions. If obligations are still being met on a timely basis, ceased or interrupted payments are imminent. Alternatively, a ‘C’ IFS Rating is assigned to obligations that have
experienced ceased or interrupted payments, and with the potential for below average to poor recoveries. Such obligations would possess a recovery assessment of ‘RR5’ (Below Average) or ‘RR6’ (Poor).
|
Short-Term IFS Ratings
A Short-Term Insurer Financial
Strength Rating (ST-IFS Rating) provides an assessment of the near-term financial health of an insurance organization, and its capacity to meet senior obligations to policyholders and contract-holders that would be expected to be due within one
year. The analysis
supporting the ST-IFS Rating encompasses all of the factors
considered within the context of the IFS Rating, but with greater weight given to an insurer’s near-term liquidity, financial flexibility and regulatory solvency characteristics, and less weight given to longer-term issues such as
competitiveness and earnings trends.
The agency will only assign a
ST-IFS Rating to insurers that also have been assigned an IFS Rating. Currently, ST-IFS Ratings are used primarily by U.S. life insurance companies that sell short-term funding agreements.
The ST-IFS Rating uses the same
international ratings scale used by the agency for short-term debt and issuer ratings.
F1
|
Insurers are
viewed as having a strong capacity to meet their near-term obligations. When an insurer rated in this rating category is designated with a (+) sign, it is viewed as having a very strong capacity to meet near-term obligations.
|
F2
|
Insurers
are viewed as having a good capacity to meet their near-term obligations.
|
F3
|
Insurers
are viewed as having an adequate capacity to meet their near-term obligations.
|
B
|
Insurers
are viewed as having a weak capacity to meet their near-term obligations.
|
C
|
Insurers
are viewed as having a very weak capacity to meet their near-term obligations.
|
Recovery Ratings
Recovery Ratings are assigned to
selected individual securities and obligations, most frequently for individual obligations of corporate finance issuers with IDRs in speculative grade categories.
Among the factors that affect
recovery rates for securities are the collateral, the seniority relative to other obligations in the capital structure (where appropriate), and the expected value of the company or underlying collateral in distress.
The Recovery Rating scale is
based on the expected relative recovery characteristics of an obligation upon the curing of a default, emergence from insolvency or following the liquidation or termination of the obligor or its associated collateral.
Recovery Ratings are an
ordinal scale and do not attempt to precisely predict a given level of recovery. As a guideline in developing the rating assessments, the agency employs broad theoretical recovery bands in its ratings approach based on historical averages and
analytical judgement, but actual recoveries for a given security may deviate materially from historical averages.
RR1
|
OUTSTANDING
RECOVERY PROSPECTS GIVEN DEFAULT. ‘RR1’ rated securities have characteristics consistent with securities historically recovering 91%–100% of current principal and related interest.
|
RR2
|
SUPERIOR
RECOVERY PROSPECTS GIVEN DEFAULT. ‘RR2’ rated securities have characteristics consistent with securities historically recovering 71%–90% of current principal and related interest.
|
RR3
|
GOOD
RECOVERY PROSPECTS GIVEN DEFAULT. ‘RR3’ rated securities have characteristics consistent with securities historically recovering 51%–70% of current principal and related interest.
|
RR4
|
AVERAGE
RECOVERY PROSPECTS GIVEN DEFAULT. ‘RR4’ rated securities have characteristics consistent with securities historically recovering 31%–50% of current principal and related interest.
|
RR5
|
BELOW
AVERAGE RECOVERY PROSPECTS GIVEN DEFAULT. ‘RR5’ rated securities have characteristics consistent with securities historically recovering 11%–
30% of current principal and related interest.
|
RR6
|
POOR
RECOVERY PROSPECTS GIVEN DEFAULT. ‘RR6’ rated securities have characteristics consistent with securities historically recovering 0%–10% of current principal and related interest.
|
Limitations of the Recovery Ratings Scale
Specific limitations relevant
to the Recovery Ratings scale include:
•
|
The ratings do not
predict a specific percentage of recovery should a default occur.
|
•
|
The ratings do not
opine on the market value of any issuer’s securities or stock, or the likelihood that this value may change.
|
•
|
The ratings do not
opine on the liquidity of the issuer’s securities or stock.
|
•
|
The ratings do not
opine on any quality related to an issuer or transaction’s profile other than the agency’s opinion on the relative loss severity of the rated obligation should the obligation default.
|
•
|
Recovery
Ratings, in particular, reflect a fundamental analysis of the underlying relationship between financial claims on an entity or transaction and potential sources to meet those claims. The size of such sources and claims is subject to a wide variety
of dynamic factors outside the agency’s analysis that will influence actual recovery rates.
|
•
|
Out-of-court
settlements are not contemplated by Fitch’s Recovery Ratings, other than in broad concession payments for some classes of junior-ranking bonds in some specific scenarios. In reality, out-of-court settlements will be influenced heavily by
creditor composition and local political and economic imperatives, and Fitch does not attempt to factor these into its Recovery Ratings.
|
•
|
Creditor
composition is outside the scope of Recovery Ratings. Concentration of creditors at a certain level of the capital structure, common ownership of claims at different levels in a capital structure or even differing entry prices of investors within a
creditor class can have a profound effect on actual recovery rates.
|
•
|
Information flows
for companies close to default can become erratic, which may reduce Fitch’s visibility on its Recovery Ratings.
|
•
|
Enterprise
valuations play a key role in the allocation of recoveries across credit classes. Recovery Ratings assume cash-flow multiples or advance rates, which are driven by subjective forecasts of Fitch analysts of post-restructuring cash flow, achievable
exit multiples and appropriate advance rates. All these parameters are subject to volatility before and during the restructuring process.
|
•
|
Recovery
rates are strongly influenced by legal decisions. Potential legal decisions are not factored into Fitch’s Recovery Ratings.
|
Moody’s
Insurance Financial Strength
Ratings
Moody’s
Insurance Financial Strength Ratings are opinions of the ability of insurance companies to pay punctually senior policyholder claims and obligations and also reflect the expected financial loss suffered in the event of default.
Aaa
|
Insurance
companies rated Aaa are judged to be of the highest quality, subject to the lowest level of credit risk.
|
Aa
|
Insurance
companies rated Aa are judged to be of high quality and are subject to very low credit risk.
|
A
|
Insurance
companies rated A are judged to be of upper-medium grade and are subject to low credit risk.
|
Baa
|
Insurance
companies rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.
|
Ba
|
Insurance
companies rated Ba are judged to be speculative and are subject to substantial credit risk.
|
B
|
Insurance
companies rated B are considered speculative and are subject to high credit risk.
|
Caa
|
Insurance
companies rated Caa are judged to be speculative of poor standing and are subject to very high credit risk.
|
Ca
|
Insurance
companies rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest.
|
C
|
Insurance
companies rated C are the lowest rated and are typically in default, with little prospect for recovery of principal or interest.
|
Note: Moody’s appends
numerical modifiers 1, 2, and 3 to each generic rating classification from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates a ranking in the lower end of that generic rating category. Additionally, a “(hyb)” indicator is appended to all ratings of hybrid securities issued by banks, insurers, finance companies, and securities firms.*
*By their terms, hybrid
securities allow for the omission of scheduled dividends, interest, or principal payments, which can potentially result in impairment if such an omission occurs. Hybrid securities may also be subject to contractually allowable write-downs of
principal that could result in impairment. Together with the hybrid indicator, the long-term obligation rating assigned to a hybrid security is an expression of the relative credit risk associated with that security.
Short-Term Insurance Financial
Strength Ratings
P-1
|
Issuers (or
supporting institutions) rated Prime-1 have a superior ability to repay short-term debt obligations.
|
P-2
|
Issuers
(or supporting institutions) rated Prime-2 have a strong ability to repay short-term debt obligations.
|
P-3
|
Issuers
(or supporting institutions) rated Prim-3 have an acceptable ability to repay short-term obligations.
|
P-4
|
Issuers
(or supporting institutions) rated Not Prime do not fall within any of the Prime rating categories.
|
DESCRIPTION OF SHORT-TERM MUNICIPAL BOND
RATINGS
S&P
Municipal Short-Term Note
Ratings
An S&P
Global Ratings U.S. municipal note rating reflects S&P Global Ratings opinion about the liquidity factors and market access risks unique to the notes. Notes due in three years or less will likely receive a note rating. Notes with an original
maturity of more than three years will most likely receive a long-term debt rating. In determining which type of rating, if any, to assign, S&P’s analysis will review the following considerations:
•
|
Amortization
schedule — the larger the final maturity relative to other maturities, the more likely it will be treated as a note; and
|
•
|
Source
of payment — the more dependent the issue is on the market for its refinancing, the more likely it will be treated as a note.
|
Note rating symbols are as
follows:
SP-1
|
Strong capacity to
pay principal and interest. An issue determined to possess a very strong capacity to pay debt service is given a plus (+) designation.
|
SP-2
|
Satisfactory
capacity to pay principal and interest, with some vulnerability to adverse financial and economic changes over the term of the notes.
|
SP-3
|
Speculative
capacity to pay principal and interest.
|
D
|
‘D’
is assigned upon failure to pay the note when due, completion of a distressed exchange offer, or the filing of a bankruptcy petition or the taking of similar action and where default on an obligation is a virtual certainty, for example, due to
automatic stay provisions.
|
Moody’s
Short-Term Obligation
Ratings
The Municipal
Investment Grade (MIG) scale is used to rate US municipal bond anticipation notes of up to five years maturity. Municipal notes rated on the MIG scale may be secured by either pledged revenues or proceeds of a take-out financing received prior to
note maturity. MIG ratings expire at the
maturity of the obligation, and the issuer’s long-term
rating is only one consideration in assigning the MIG rating. MIG ratings are divided into three levels—MIG 1 through MIG 3—while speculative grade short-term obligations are designated SG.
MIG
1
|
This designation
denotes superior credit quality. Excellent protection is afforded by established cash flows, highly reliable liquidity support or demonstrated broad-based access to the market for refinancing.
|
MIG
2
|
This
designation denotes strong credit quality. Margins of protection are ample although not so large as in the preceding group.
|
MIG
3
|
This
designation denotes acceptable credit quality. Liquidity and cash-flow protection may be narrow, and market access for refinancing is likely to be less well-established.
|
SG
|
This
designation denotes speculative-grade credit quality. Debt instruments in this category may lack sufficient margins of protection.
|
Demand Obligation Ratings
In the case of variable rate
demand obligations (VRDOs), a two-component rating is assigned: a long or short-term debt rating and a demand obligation rating. The first element represents Moody’s evaluation of the degree of risk associated with scheduled principal and
interest payments. The second element represents Moody’s evaluation of the degree of risk associated with the ability to receive purchase price upon demand (“demand feature”). The second element uses a rating from a variation of
the MIG scale called the Variable Municipal Investment Grade (VMIG) scale. VMIG ratings of demand obligations with unconditional liquidity support are mapped from the short-term debt rating (or counterparty assessment) of the support provider, or
the underlying obligor in the absence of third party liquidity support, with VMIG1 corresponding to P-1, VMIG 2 to P-2, VMIG 3 to P-3 and SG to not prime. For example, the VMIG rating for an industrial revenue bond with Company XYZ as the underlying
obligor would normally have the same numerical modifier as Company XYZ’s prime rating. Transitions of VMIG ratings of demand obligations with conditional liquidity support, as shown in the diagram below, differ from transitions on the Prime
scale to reflect the risk that external liquidity support will terminate if the issuer’s long-term rating drops below investment grade.
VMIG
1
|
This designation
denotes superior credit quality. Excellent protection is afforded by the superior short-term credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of purchase price upon demand.
|
VMIG
2
|
This
designation denotes strong credit quality. Good protection is afforded by the strong short-term credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of purchase price upon demand.
|
VMIG
3
|
This
designation denotes acceptable credit quality. Adequate protection is afforded by the satisfactory short-term credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of purchase price upon
demand.
|
SG
|
This
designation denotes speculative-grade credit quality. Demand features rated in this category may be supported by a liquidity provider that does not have an investment grade short-term rating or may lack the structural and/or legal protections
necessary to ensure the timely payment of purchase price upon demand.
|
*For VRDBs supported with
conditional liquidity support, short-term transition down at higher long-term ratings to reflect the risk of termination of liquidity support as a result of a downgrade below investment grade. VMIG ratings of VRDBs with unconditional liquidity
support reflect the short-term debt rating (or counterparty assessment) of the liquidity support provider with VMIG 1 corresponding to P-1, VMIG 2 to P-2, VMIG 3 to P-3 and SG to not prime.
DESCRIPTION OF PREFERRED STOCK RATINGS
DBRS
Preferred Share Rating
Scale
The DBRS preferred
share rating scale is used in the Canadian securities market and is meant to give an indication of the risk that a borrower will not fulfill its full obligations in a timely manner, with respect to both dividend and principal commitments. Every DBRS
rating is based on quantitative and qualitative
considerations relevant to the
borrowing entity. Each rating category is denoted by the subcategories “high” and “low.” The absence of either a “high” or “low” designation indicates the rating is in the middle of the category.
Pfd-1
|
Preferred shares
rated Pfd-1 are of superior credit quality, and are supported by entities with strong earnings and balance sheet characteristics. Pfd-1 securities generally correspond with companies whose senior bonds are rated in the AAA or AA categories. As is
the case with all rating categories, the relationship between senior debt ratings and preferred share ratings should be understood as one where the senior debt rating effectively sets a ceiling for the preferred shares issued by the entity. However,
there are cases where the preferred share rating could be lower than the normal relationship with the issuer’s senior debt rating.
|
Pfd-2
|
Preferred
shares rated Pfd-2 are of satisfactory credit quality. Protection of dividends and principal is still substantial, but earnings, the balance sheet and coverage ratios are not as strong as Pfd-1 rated companies. Generally, Pfd-2 ratings correspond
with companies whose senior bonds are rated in the “A” category.
|
Pfd-3
|
Preferred
shares rated Pfd-3 are of adequate credit quality. While protection of dividends and principal is still considered acceptable, the issuing entity is more susceptible to adverse changes in financial and economic conditions, and there may be other
adverse conditions present which detract from debt protection. Pfd-3 ratings generally correspond with companies whose senior bonds are rated in the higher end of the BBB category.
|
Pfd-4
|
Preferred
shares rated Pfd-4 are speculative, where the degree of protection afforded to dividends and principal is uncertain, particularly during periods of economic adversity. Companies with preferred shares rated Pfd-4 generally coincide with entities
that have senior bond ratings ranging from the lower end of the BBB category through the BB category.
|
Pfd-5
|
Preferred
shares rated Pfd-5 are highly speculative and the ability of the entity to maintain timely dividend and principal payments in the future is highly uncertain. Entities with a Pfd-5 rating generally have senior bond ratings of B or lower. Preferred
shares rated Pfd-5 often have characteristics that, if not remedied, may lead to default.
|
D
|
When
the issuer has filed under any applicable bankruptcy, insolvency or winding up statute or there is failure to satisfy an obligation after the exhaustion of grace periods, a downgrade to D may occur. DBRS may also use SD (Selective Default) in cases
where only some securities are impacted, such as in the case of a “distressed exchange.”
|
PART C: OTHER INFORMATION
(a)(1)
|
Certificate of
Trust dated February 25, 2010. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on October 21, 2013 (Accession Number 0001193125-13-405484).
|
(a)(2)
|
Amended
and Restated Declaration of Trust dated February 19, 2014. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on February 25, 2014 (Accession Number
0001193125-14-067429).
|
(a)(3)
|
Amended
Schedule A to the Amended and Restated Declaration of Trust as of September 10, 2019. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on September 16, 2019
(Accession Number 0001193125-19-245861).
|
(a)(4)
|
Memorandum
of Association and Articles of Association of Diversified Alternatives Fund CS Ltd. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on March 15, 2017 (Accession
Number 0001193125-17-083544).
|
(a)(5)
|
Memorandum
of Association and Articles of Association of Managed Futures Fund CS Ltd. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on December 4, 2017 (Accession Number
0001193125-17-360066).
|
(b)
|
Amended
and Restated By-Laws dated March 6, 2019. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on June 26, 2019 (Accession Number 0001193125-18-205847).
|
(c)
|
Instruments
Defining Rights of Security Holders. Incorporated by reference to Exhibits (a) and (b).
|
(d)(1)
|
Investment
Advisory Agreement dated May 9, 2014 for JPMorgan Diversified Return Global Equity ETF, JPMorgan Diversified Return International Equity ETF and JPMorgan Diversified Return Emerging Markets Equity ETF. Incorporated herein by reference to the
Registrant’s Registration Statement as filed with the Securities and Exchange Commission on May 14, 2014 (Accession Number 0001193125-14-198331).
|
(d)(2)
|
Form
of Amended Schedule A to the Investment Advisory Agreement for JPMorgan Diversified Return Global Equity ETF, JPMorgan Diversified Return International Equity ETF and JPMorgan Diversified Return Emerging Markets Equity ETF, dated December 24, 2014.
Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on December 24, 2014 (Accession Number 0001193125-14-453627).
|
(d)(3)
|
Investment
Advisory Agreement for JPMorgan Diversified Return U.S. Equity ETF, dated September 9, 2015. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on September 25,
2015 (Accession Number 0001193125-15-328882).
|
(d)(4)
|
Amended
Schedule A to the Investment Advisory Agreement as of January 23, 2019. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on February 28, 2019 (Accession Number
0001193125-19-057241).
|
(d)(5)
|
Form
of Investment Advisory Agreement for Diversified Alternatives Fund CS Ltd. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on June 14, 2016 (Accession Number
0001193125-16-621353).
|
(d)(6)
|
Form
of Investment Management Agreement for Managed Futures Fund CS Ltd. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on December 4, 2017 (Accession Number
0001193125-17-360066).
|
(d)(7)
|
Management
Agreement for JPMorgan BetaBuilders 1-5 Year U.S. Aggregate Bond ETF and JPMorgan BetaBuilders U.S. Equity ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission
on June 26, 2019 (Accession Number 0001193125-18-205847).
|
(d)(8)
|
Management
Agreement dated November 1, 2019. Filed herewith.
|
(d)(9)
|
Amended
Schedule A to the Management Agreement as of November 12, 2019. Filed herewith.
|
(e)(1)
|
Distribution
Agreement dated October 1, 2017. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on November 3, 2017 (Accession Number 0001193125-17-332834).
|
(e)(2)
|
Amended
Schedule A to the Distribution Agreement as of September 10, 2019. Filed herewith.
|
(f)
|
Not
applicable.
|
(g)(1)(a)
|
Amended and
Restated Global Custody and Fund Accounting Agreement dated October 1, 2017, between J.P. Morgan Exchange-Traded Fund Trust and JPMorgan Chase Bank, N.A. Incorporated herein by reference to the Registrant’s Registration Statement as filed with
the Securities and Exchange Commission on November 3, 2017 (Accession Number 0001193125-17-332834).
|
(g)(1)(b)
|
Amendment
to the Amended and Restated Global Custody and Fund Accounting Agreement as of September 10, 2019, including Amended Schedule A. Filed herewith.
|
(g)(2)(a)
|
Third
Party Securities Lending Rider, dated June 18, 2018 to the Amended and Restated Global Custody and Fund Accounting Agreement, dated October 1, 2017 among J.P. Morgan Exchange-Traded Fund Trust, JPMorgan Chase Bank, N.A. and Citibank, N.A.
Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on January 22, 2019 (Accession Number 0001193125-19-013831).
|
(g)(2)(b)
|
Amendment
to Third Party Securities Lending Rider as of December 11, 2018. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on January 22, 2019 (Accession Number
0001193125-19-013831).
|
(g)(2)(c)
|
Amendment
to Third Party Securities Lending Rider as of November 14, 2019. Filed herewith.
|
(h)(1)(a)
|
Administration
Agreement dated May 9, 2014. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on May 14, 2014 (Accession Number 0001193125-14-198331).
|
(h)(1)(b)
|
Amendment
to Administration Agreement as of December 4, 2018. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on January 22, 2019 (Accession Number 0001193125-19-013831).
|
(h)(1)(c)
|
Amended
Schedule A to the Administration Agreement as of December 4, 2018. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on January 22, 2019 (Accession Number
0001193125-19-013831).
|
(h)(2)(a)
|
Agency
Services Agreement dated May 8, 2014. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on May 14, 2014 (Accession Number 0001193125-14-198331).
|
(h)(2)(b)
|
Amendment
to the Agency Services Agreement as of September 10, 2019, including Amended Exhibit A. Filed herewith.
|
(h)(3)(a)
|
Fee
Waiver Agreement dated March 1, 2019 for certain ETFs with FYE of 10/31/18. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on February 28, 2019 (Accession
Number 0001193125-19-057241)
|
(h)(3)(b)
|
Fee
Waiver Agreement dated March 1, 2019 for JPMorgan Diversified Alternatives ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on February 28, 2019 (Accession
Number 0001193125-19-057241).
|
(h)(3)(c)
|
Fee
Waiver Agreement dated May 11, 2017 for JPMorgan Ultra-Short Income ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on June 28, 2017 (Accession Number
0001193125-17-216521).
|
(h)(3)(d)
|
Fee
Waiver Agreement dated November 3, 2017 for JPMorgan U.S. Dividend ETF, JPMorgan U.S. Minimum Volatility ETF, JPMorgan U.S. Momentum Factor ETF, JPMorgan U.S. Quality Factor ETF and JPMorgan U.S. Value Factor ETF. Incorporated herein by reference
to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on November 27, 2017 (Accession Number 0001193125-17-352154).
|
(h)(3)(e)
|
Fee
Waiver Agreement dated November 27, 2017 for JPMorgan Event Driven ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on January 17, 2018 (Accession Number
0001193125-18- 012121).
|
(h)(3)(f)
|
Fee
Waiver Agreement dated March 1, 2019 for JPMorgan Managed Futures Strategy ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on February 28, 2019 (Accession
Number 0001193125-19-057241).
|
(h)(3)(g)
|
Fee
Waiver Agreement dated January 17, 2018 for JPMorgan Long/Short ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on January 25, 2018 (Accession Number
0001193125- 18-019391).
|
(h)(3)(h)
|
Fee
Waiver Agreement dated January 26, 2018 for JPMorgan USD Emerging Markets Sovereign Bond ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on March 1, 2018.
(Accession Number 0001193125-18-066254).
|
(h)(3)(i)
|
Fee Waiver
Agreement dated May 1, 2018 for JPMorgan Diversified Return Europe Currency Hedged ETF, JPMorgan Diversified Return Europe Equity ETF, JPMorgan Diversified Return International Currency Hedged ETF and JPMorgan Diversified Return International Equity
ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on June 27, 2018 (Accession Number 0001193125-18-205847).
|
(h)(3)(j)
|
Fee
Waiver Agreement dated June 13, 2018 for JPMorgan BetaBuilders Europe ETF, JPMorgan BetaBuilders Japan ETF and JPM BetaBuilders MSCI US REIT ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the
Securities and Exchange Commission on June 27, 2018 (Accession Number 0001193125-18-205847).
|
(h)(3)(k)
|
Fee
Waiver Agreement dated July 1, 2018 for Funds with a FYE as of the last day of February. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on December 6, 2018
(Accession Number 0001193125-18-343231).
|
(h)(3)(l)
|
Fee
Waiver Agreement dated June 29, 2018 for JPMorgan BetaBuilders Canada ETF and JPM BetaBuilders Developed Asia ex-Japan ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange
Commission on December 6, 2018 (Accession Number 0001193125-18-343231).
|
(h)(3)(m)
|
Fee
Waiver Agreement dated October 15, 2018 for JPMorgan Ultra-Short Municipal ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on October 19, 2018 (Accession
Number 0001193125-18-302915).
|
(h)(3)(n)
|
Fee
Waiver Agreement dated October 22, 2018 for JPMorgan Municipal ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on December 6, 2018 (Accession Number
0001193125- 18-343231).
|
(h)(3)(o)
|
Fee
Waiver Agreement dated December 6, 2018 for JPMorgan Corporate Bond Research Enhanced ETF and JPMorgan U.S. Aggregate Bond ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and
Exchange Commission on January 22, 2019 (Accession Number 0001193125-19-013831).
|
(h)(3)(p)
|
Fee
Waiver Agreement dated January 23, 2019 for JPMorgan Core Plus Bond ETF. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on February 28, 2019 (Accession Number
0001193125-19-057241).
|
(h)(3)(q)
|
Fee
Waiver Agreement dated July 1, 2019 for certain ETFs with FYE of 2/28/19. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on September 4, 2019 (Accession Number
0001193125-19-237404).
|
(h)(4)(a)
|
Accounting
Services Agreement dated June 12, 2014. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on July 14, 2014 (Accession Number 0001193125-14-267514).
|
(h)(4)(b)
|
Amendment
No. 1 to Accounting Services Agreement dated September 14, 2016. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on May 11, 2017 (Accession Number 0001193125-17-
167076).
|
(h)(5)
|
Sublicense
Agreement. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on June 27, 2018 (Accession Number 0001193125-18-205847).
|
(h)(6)(a)
|
Global
Securities Lending Agency Agreement, dated June 18, 2018, between J.P. Morgan Exchange-Traded Fund Trust and Citibank, N.A. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange
Commission on January 22, 2019 (Accession Number 0001193125-19-013831).
|
(h)(6)(b)
|
Amendment
to the Global Securities Lending Agency Agreement as of October 4, 2018. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on January 22, 2019 (Accession Number
0001193125-19-013831).
|
(h)(6)(c)
|
Amendment
to the Global Securities Lending Agency Agreement as of December 11, 2018. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on January 22, 2019 (Accession Number
0001193125-19-013831).
|
(h)(6)(d)
|
Amendment
to the Global Securities Lending Agency Agreement as of November 14, 2019. Filed herewith.
|
(i)
|
Opinion
and consent of counsel. Filed herewith.
|
(j)
|
Not
applicable.
|
(k)
|
Not
applicable.
|
(l)
|
Not
applicable.
|
(m)
|
Not applicable.
|
(n)
|
Not
applicable.
|
(o)
|
Reserved.
|
(p)(1)
|
Code
of Ethics of the Trust. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on May 14, 2014 (Accession Number 0001193125-14-198331).
|
(p)(2)
|
Code
of Ethics of J.P. Morgan Asset Management, Inc., including JPMIM, effective February 1, 2005; Revised November 8, 2018. Filed herewith.
|
(p)(3)
|
Code
of Ethics of the Distributor dated February 1, 2005, as amended. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on November 3, 2017 (Accession Number
0001193125-17-332834).
|
(99)(a)
|
Power
of Attorney for the Trustees. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on September 16, 2019 (Accession Number 0001193125-19-245861).
|
(99)(b)
|
Power
of Attorney for Lauren A. Paino. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on September 16, 2019 (Accession Number 0001193125-19-245861).
|
(99)(c)
|
Power
of Attorney for Joanna Gallegos. Incorporated herein by reference to the Registrant’s Registration Statement as filed with the Securities and Exchange Commission on September 16, 2019 (Accession Number 0001193125-19-245861).
|
Item 29.
|
Persons Controlled
by or Under Common Control with the Fund
|
Not applicable.
Reference is made to
Article VII, Section 4 of Registrant’s Declaration of Trust. Registrant, its Trustees and officers are insured against certain expenses in connection with the defense of claims, demands, actions, suits, or proceedings, and certain liabilities
that might be imposed as a result of such actions, suits or proceedings.
Insofar as indemnification for liabilities arising
under the Securities Act of 1933, as amended (the “1933 Act”), may be permitted to directors, trustees, officers and controlling persons of the Registrant and the principal underwriter pursuant to the foregoing provisions or otherwise,
the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the 1933 Act and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, trustee, officer, or controlling person of the Registrant and the principal underwriter in connection with the successful defense of any
action, suite or proceeding) is asserted against the Registrant by such director, trustee, officer or controlling person or principal underwriter in connection with the shares being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the 1933 Act and will be governed by the final
adjudication of such issue.
Item 31.
|
Business and Other
Connections of the Investment Adviser
|
See “Management of the Trust” in Part B.
The business or other connections of each director and officer of J.P. Morgan Investment Management Inc. is currently listed in the investment advisor registration on Form ADV for J.P. Morgan Investment Management Inc. (File No. 801-21011) and is
incorporated herein by reference.
Item 32.
|
Principal
Underwriters
|
(a) JPMorgan
Distribution Services, Inc. is the principal underwriter of the Registrant’s shares. JPMorgan Distribution Services, Inc. is registered with the Securities and Exchange Commission as a broker-dealer and is a member of the National Association
of Securities Dealers. JPMorgan Distribution Services, Inc. is located at 1111 Polaris Parkway, Columbus, Ohio 43240. JPMorgan Distribution Services, Inc. acts as the principal underwriter for the following additional investment companies:
J.P. Morgan Fleming Mutual Fund Group, Inc.
J.P. Morgan Mutual Fund Investment Trust
JPMorgan Trust I
JPMorgan Trust II
JPMorgan Trust III
JPMorgan Trust IV
Undiscovered Managers Funds
JPMorgan
Insurance Trust
J.P. Morgan Exchange-Traded Fund Trust
(b) The directors and officers of JPMorgan
Distribution Services, Inc. are set forth below. The business address of each director or officer is 1111 Polaris Parkway, Columbus, Ohio 43240.
Name
with Registrant
|
|
Positions
and Office with JPMorgan Distribution Services, Inc.
|
|
Positions
and Offices with the Funds
|
Brian
Bergere
|
|
Director,
Managing Director & President
|
|
None
|
Andrea
Lisher
|
|
Director
& Managing Director
|
|
None
|
Joseph
F. Sanzone
|
|
Director
& Managing Director
|
|
None
|
Wendy
Barta
|
|
Director
& Executive Director
|
|
None
|
Omar
F. Altahawi
|
|
Managing
Director & Treasurer
|
|
None
|
Gary
C. Krivo
|
|
Managing
Director & Chief Risk Officer
|
|
None
|
Michael
R. Machulski
|
|
Director
& Managing Director
|
|
None
|
Brian
S. Shlissel
|
|
Managing
Director
|
|
Vice
President
|
James
A. Hoffman
|
|
Executive
Director
|
|
None
|
Carmine
Lekstutis
|
|
Executive
Director & Chief Legal Officer
|
|
Assistant
Secretary
|
Jessica
K. Ditullio
|
|
Executive
Director & Assistant Secretary
|
|
Assistant
Secretary
|
Kevin
Kloza
|
|
Executive
Director and Chief Compliance Officer
|
|
None
|
Andrea
Lang
|
|
Vice
President & Anti-Money Laundering Compliance Officer
|
|
None
|
Frank
J. Drozek
|
|
Executive
Director & Assistant Treasurer
|
|
None
|
Christopher
J. Mohr
|
|
Executive
Director & Assistant Treasurer
|
|
None
|
Joanna
Corey
|
|
Executive
Director & Assistant Secretary
|
|
None
|
Marcela
Castro
|
|
Executive
Director & Assistant Secretary
|
|
None
|
Afiya
M. Jordan
|
|
Vice
President & Secretary
|
|
None
|
Amee
Kantesaria
|
|
Vice
President & Assistant Secretary
|
|
None
|
Amy
Hsu
|
|
Vice
President & Assistant Secretary
|
|
None
|
Andris
Alexander
|
|
Vice
President & Assistant Secretary
|
|
None
|
Theodore
Weisman
|
|
Vice
President & Assistant Secretary
|
|
None
|
(c) Not
applicable.
Item 33.
|
Location of Accounts
and Records
|
All accounts,
books, records and documents required pursuant to Section 31(a) of the Investment Company Act of 1940, as amended, and the rules promulgated thereunder will be maintained at the offices of:
J.P. Morgan Investment Management Inc., the
Registrant’s investment adviser, at 383 Madison Avenue, New York, NY 10179 (records relating to its functions as investment adviser).
Effective October 1, 2017, JPMorgan Distribution
Services, Inc., the Registrant’s distributor, at 1111 Polaris Parkway, Columbus, OH 43240 (records relating to its functions as distributor).
Prior to October 1, 2017, SEI Investments
Distribution Co., the Registrant’s distributor, at One Freedom Valley Drive, Oaks, PA 19456 (records relating to its functions as distributor).
JPMorgan Chase Bank, N.A. at 383 Madison Avenue,
New York, NY 10179 (records relating to its functions as custodian and sub-administrator).
J.P. Morgan Investment Management Inc., the
Registrant’s administrator, at 383 Madison Avenue, New York, NY 10179 (relating to its functions as administrator).
Item 34.
|
Management Services
|
Not applicable.
Not applicable.
SIGNATURES
Pursuant to the requirements of the Securities Act
of 1933, as amended, and the Investment Company Act of 1940, as amended, the Registrant, J.P. Morgan Exchange-Traded Fund Trust, has duly caused this registration statement to be signed on its behalf by the undersigned, duly authorized, in the City
of New York and State of New York on the 22nd day of November, 2019.
J.P.
Morgan Exchange-Traded Fund Trust
|
By:
|
Joanna
Gallegos*
|
|
Name:
Joanna Gallegos
|
|
Title:
President and Principal Executive Officer
|
Pursuant to the requirements of the Securities Act,
this registration statement has been signed below by the following persons in the capacities indicated on November 22, 2019.
Gary
L. French*
|
Gary
L. French
|
Trustee
|
Thomas
P. Lemke*
|
Thomas
P. Lemke
|
Trustee
|
Emily
Youssouf*
|
Emily
Youssouf
|
Trustee
|
Lauren
A. Paino*
|
Lauren
A. Paino
|
Treasurer
and Principal Financial Officer
|
*By:
|
/s/
Anthony Geron
|
|
Anthony
Geron
|
|
Attorney-in-fact
|
Robert
J. Grassi*
|
Robert
J. Grassi
|
Trustee
|
Lawrence
Maffia*
|
Lawrence
Maffia
|
Trustee
|
Robert
Deutsch*
|
Robert
Deutsch
|
Trustee
|
Joanna
Gallegos*
|
Joanna
Gallegos
|
President
and Principal Executive Officer
|
EXHIBIT INDEX
Exhibit
No.
|
Description
|
(d)(8)
|
Management
Agreement dated November 1, 2019.
|
(d)(9)
|
Amended
Schedule A to the Management Agreement as of November 12, 2019.
|
(e)(2)
|
Amended
Schedule A to the Distribution Agreement as of September 10, 2019.
|
(g)(1)(b)
|
Amendment
to the Amended and Restated Global Custody and Fund Accounting Agreement as of September 10, 2019, including Amended Schedule A.
|
(g)(2)(c)
|
Amendment
to Third Party Securities Lending Rider as of November 14, 2019.
|
(h)(2)(b)
|
Amendment
to the Agency Services Agreement as of September 10, 2019, including Amended Exhibit A.
|
(h)(6)(d)
|
Amendment
to the Global Securities Lending Agency Agreement as of November 14, 2019.
|
(i)
|
Opinion
and consent of counsel.
|
(p)(2)
|
Code
of Ethics of J.P. Morgan Asset Management, Inc., including JPMIM, effective February 1, 2005; Revised November 8, 2018.
|
J.P. MORGAN EXCHANGE-TRADED FUND TRUST
MANAGEMENT AGREEMENT
AGREEMENT, made this 1st day of November 2019, between J.P. Morgan Exchange-Traded Fund Trust, a statutory trust organized under the
laws of the State of Delaware (the Trust), on behalf of the series of the Trust set forth in Schedule A (each, a Fund), and J.P. Morgan Investment Management Inc., a Delaware corporation (the Adviser). This
Agreement shall be effective as of November 1, 2019.
WHEREAS, the Trust is an
open-end management investment company registered with the Securities and Exchange Commission (the Commission) under the Investment Company Act of 1940, as amended (the 1940 Act); and
WHEREAS, the Trust desires to retain the Adviser to render investment advisory and administration services to the Funds as agreed
to from time to time between the Trust and the Adviser, and the Adviser is willing to render such services;
WHEREAS, the Adviser
agrees to assume certain additional expenses of the Trust pursuant to the Agreement;
WHEREAS, for the Funds that will be added to
the Agreement, the Agreement replaces the separate Investment Advisory Agreements for the Trust dated May 9, 2014 and September 9, 2015 and the Administration Agreement for the Trust dated May 9, 2014.
NOW, THEREFORE, in consideration of the premises and mutual promises hereinafter set forth, the parties hereto agree as follows:
1. APPOINTMENT. The Trust hereby appoints the Adviser to act as investment adviser to the Funds for the period
and on the terms set forth in this Agreement. The Adviser accepts such appointment and agrees to render the services herein set forth, for the compensation herein provided.
2. INVESTMENT ADVISORY SERVICES. Subject to the general supervision and review of the Trustees of the Trust, the
Adviser shall manage the investment operations of each Fund and the composition of the Funds holdings of securities and investments, including cash, the purchase, retention and disposition thereof and agreements relating thereto, in accordance
with the Funds investment objectives and policies as stated in the Trusts registration statement on Form N-1A, as such may be amended from time to time (the Registration Statement),
with respect to the Fund, under the 1940 Act, and subject to the following understandings:
a) the Adviser shall
furnish a continuous investment program for each Fund and determine from time to time what investments or securities will be purchased, retained, sold or lent by the Fund, and what portion of the assets will be invested or held uninvested as cash;
b) the Adviser shall use the same skill and care in the management of each Funds investments as it uses in
the administration of other accounts for which it has investment responsibility as agent;
1
c) the Adviser, in the performance of its duties and obligations under
this Agreement, shall act in conformity with the Trusts Declaration of Trust (such Declaration of Trust, as presently in effect and as amended from time to time, is herein called the Declaration of Trust), the Trusts By-Laws (such By-Laws, as presently in effect and as amended from time to time, are herein called the By-Laws) and the
Registration Statement and with the instructions and directions of the Trustees of the Trust and will conform to and comply with the requirements of the 1940 Act and all other applicable federal and state laws and regulations;
d) the Adviser shall determine the securities to be purchased, sold or lent by each Fund and as agent for the Fund will
effect portfolio transactions pursuant to its determinations either directly with the issuer or with any broker and/or dealer in such securities; in placing orders with brokers and/or dealers the Adviser intends to seek best price and execution for
purchases and sales; the Adviser shall also determine whether the Fund shall enter into repurchase or reverse repurchase agreements;
On
occasions when the Adviser deems the purchase or sale of a security to be in the best interest of one of the Funds as well as other customers of the Adviser, including any other of the Funds, the Adviser may, to the extent permitted by applicable
laws and regulations, but shall not be obligated to, aggregate the securities to be so sold or purchased in order to obtain best execution, including lower brokerage commissions, if applicable. In such event, allocation of the securities so
purchased or sold, as well as the expenses incurred in the transaction, will be made by the Adviser in the manner it considers to be the most equitable and consistent with its fiduciary obligations to the Fund;
e) the Adviser shall maintain books and records with respect to each Funds securities transactions and shall
render to the Trusts Trustees such periodic and special reports as the Trustees may reasonably request; and
f) it is understood and agreed that the Adviser may from time to time employ or associate with such other entities or
persons as the Adviser believes appropriate to assist in the performance of this Agreement with respect to a particular Fund or Funds (each a Subadviser), and that any such Subadviser shall have all of the rights and powers of the
Adviser set forth in this Agreement as with respect to such Fund; provided, that a Fund shall not pay any additional compensation for the services provided by any Subadviser and the Adviser shall be responsible for the supervision of the
activities of each Subadviser so engaged, and the Adviser shall be responsible for all acts or omissions of any Subadviser or other persons or entities, in connection with the performance of the Advisers duties hereunder unless otherwise
agreed by the parties. The retention of any Subadviser shall be approved in advance by (i) the Board of Trustees of the Trust and (ii) the shareholders of the relevant Fund if required under any applicable provisions of the 1940 Act. The
Adviser will review, monitor and report to the Trusts Board of Trustees regarding the performance and investment procedures of any Subadviser. In the event that the services of any Subadviser are terminated, the Adviser may provide investment
advisory services pursuant to this Agreement to the Fund without a Subadviser and without further shareholder approval to the extent consistent with the 1940 Act. A Subadviser may be an affiliate of the Adviser.
3. ADMINISTRATIVE SERVICES. Subject to the direction and control of the Trustees, the Adviser shall, to the
extent applicable, perform or supervise the performance by others of administrative services in connection with the operations of the Funds.
2
Without limiting the generality of the foregoing, the Adviser shall:
|
a)
|
Provide all necessary office facilities (which may be in the offices of the Adviser or an affiliate),
equipment, and personnel for handling the affairs of the Funds;
|
|
b)
|
Subject to supervision by counsel to the Trust, prepare amendments to, file (to the extent necessary), and
maintain the Trusts governing documents, including the Declaration of Trust (or charter as the case may be), the Bylaws, and minutes of meetings of shareholders;
|
|
c)
|
Provide individuals reasonably acceptable to the Trusts Trustees to serve as officers of the Trust, who
will be responsible for the management of certain of the Trusts affairs as determined by the Trusts Trustees;
|
|
d)
|
Prepare agenda and prepare and compile board materials for all Trustee meetings and review, file, and maintain
minutes of meetings of Trustees;
|
|
e)
|
Provide appropriate personnel for Board of Trustees meetings;
|
|
f)
|
Subject to supervision by counsel to the Trust, prepare, review and file the Trusts Registration
Statement, any registration statement on Form N-14 (or any replacements therefor), periodic supplements to the Registration Statement, proxy materials and other filings with the Commission;
|
|
g)
|
Prepare and file, or supervise the preparation and filing of, Form
N-CSR and provide any sub-certifications which may reasonably be requested by the Trusts Principal Executive Officer or Principal Financial Officer in connection
with the required certification of those filings and coordinate receipt of similar sub-certifications from other service providers that provide information to be included in such filings;
|
|
h)
|
Prepare or supervise the preparation of, all press releases and notices to the relevant listing exchange, as
necessary;
|
|
i)
|
Prepare and file, or supervise the preparation and filing of, all necessary Blue Sky filings to the extent
necessary;
|
|
j)
|
Prepare and file, or supervise the preparation and filing of, annual Form
N-PX;
|
|
k)
|
Arrange for and coordinate the layout and printing of summary prospectuses, prospectuses, statements of
additional information, semi-annual and annual reports to shareholders, and proxy materials;
|
|
l)
|
Prepare, with the assistance of personnel of the Adviser and any Subadviser, as applicable, communications to
shareholders;
|
|
m)
|
Coordinate any necessary dissemination of prospectuses, notices, proxy statements, proxies, semi-annual and
annual reports to shareholders, and other reports to Fund shareholders, and supervise and facilitate the proxy solicitation process for all shareholder meetings, including the tabulation of shareholder votes;
|
3
|
n)
|
Prepare for and conduct shareholder meetings, if necessary;
|
|
o)
|
Assist with the design, development, and operation of Funds for the Trust, including new classes, investment
objectives, policies and structure;
|
|
p)
|
Prepare semi-annual and annual financial statements;
|
|
q)
|
Prepare and file periodic reports to shareholders and the Commission on Form
N-PORT or Form N-CEN or any replacement forms therefor;
|
|
r)
|
Prepare and file Notices to the Commission required pursuant to Rule 24f-2 of the 1940 Act;
|
|
s)
|
Compile data for, assist the Trust or its designee in the preparation of, and file, all of the Funds
federal and state tax returns and required tax filings other than those required to be made by the Trusts custodian and transfer agent;
|
|
t)
|
Prepare and distribute year-end shareholder tax information letters and
Forms 1099-MISC for trustee fees and vendor payments;
|
|
u)
|
Identify and track book-tax differences;
|
|
v)
|
Prepare quarterly tax compliance checklist for use by Fund managers;
|
|
w)
|
Calculate declaration of income/capital gain distributions in compliance with income/excise tax distribution
requirements of the Internal Revenue Code;
|
|
x)
|
Review reports produced by, and the operations and performance of, the various organizations providing services
to the Trust or any Fund of the Trust, including, without limitation, the Adviser in its capacity as investment adviser, the Trusts distributor, custodian, any Subadviser, fund accountant, transfer agent, outside legal counsel, independent
public accountants, and other entities providing services to the Trust, and at the request of the Trustees, report to the Trustees on the performance of such organizations;
|
|
y)
|
Prepare, negotiate, and administer contracts on behalf of the Trust with, among others, the Adviser in its
capacity as investment adviser, the Trusts custodian, any Subadviser, fund accountant, shareholder servicing agent, and transfer agent and oversee expense disbursement and any service provider conversions;
|
|
z)
|
Calculate contractual Trust expenses and control all disbursements for the Trust, and as appropriate compute
the Trusts yields, total return, expense ratios, portfolio turnover rate and, if required, portfolio average dollar weighted maturity;
|
|
aa)
|
Prepare annual Trust expense budget and monthly accrual analyses, perform various expense savings analysis and
expense benchmarking analysis;
|
|
bb)
|
Prepare expense authorizations and review or prepare for management review all invoices for Trust expenses;
|
4
|
cc)
|
Calculate performance data of the Funds for dissemination to information service providers covering the
investment company industry;
|
|
dd)
|
Review marketing material to verify that Fund information is accurate;
|
|
ee)
|
Prepare and file proofs of claims in connection with Class Action notices;
|
|
ff)
|
Monitor the Trusts compliance with the Internal Revenue Code, and the regulations promulgated thereunder,
so as to enable the Trust to maintain its status as a regulated investment company;
|
|
gg)
|
Monitor the Trusts compliance with all applicable federal securities and other regulatory requirements;
|
|
hh)
|
Monitor the Trusts compliance with its Registration Statement;
|
|
ii)
|
Obtain and keep in effect fidelity bonds and directors and officers/errors and omissions insurance policies for
the Trust in accordance with the requirements of Rules 17g-1 and 17d-1(d)(7) under the 1940 Act as such bonds and policies are approved by the Trusts Trustees;
|
|
jj)
|
Provide information and assistance with inspections by the Commission;
|
|
kk)
|
Coordinate annual audit activities, including providing information and assistance with respect to audits
conducted by the Trusts independent auditors;
|
|
ll)
|
Assist management with the administration of the trustees deferred compensation plans, if any;
|
|
mm)
|
Design, implement and maintain a disaster recovery program for the Trusts records;
|
|
nn)
|
Assist the Trusts Chief Compliance Officer with issues regarding the Trusts compliance program (as
approved by the Board of Trustees of the Trust in accordance with Rule 38a-1 under the 1940 Act) as reasonably requested;
|
|
oo)
|
Create and maintain the Funds website;
|
|
pp)
|
Administer the implementation and required distribution of the Privacy Policy of the Trust as required under
Regulation S-P, as applicable; and
|
|
qq)
|
Perform all administrative services and functions of the Trust and each Fund to the extent administrative
services and functions are not provided to the Trust or such Fund pursuant to the Trusts or such Funds custodian agreement, fund accounting agreement, any shareholder servicing agreement, and transfer agent agreement.
|
The Adviser shall perform such other administrative services for the Trust and the Funds as are mutually agreed upon by
the parties from time to time. The Adviser may provide additional reports and services upon the request of the Trust. The Adviser may delegate some or all of its administrative responsibilities under this Agreement. Furthermore, the Adviser may, at
its expense, subcontract with any entity or person concerning the provision of the administrative services
5
contemplated hereunder. The Adviser shall not, however, be relieved of any of its obligations under this Agreement by the appointment of such delegate or subcontractor and provided further, that
the Adviser shall be responsible, to the extent provided in paragraph 10 hereof, for all acts of such delegate or subcontractor as if such acts were its own.
4. COMPLIANCE WITH RULE 38a-1. The Adviser shall maintain policies and
procedures that are reasonably designed to prevent violations of the federal securities laws, and shall employ personnel to administer the policies and procedures who have the same requisite level of skill and competence required to effectively
discharge its responsibilities. The Adviser shall also provide the Trusts chief compliance officer with periodic reports regarding its compliance with the federal securities laws, and shall promptly provide special reports in the event of any
material violation of the federal securities laws.
5. DOCUMENTS. The Trust has
delivered copies of each of the following documents to the Adviser and will promptly notify and deliver to it all future amendments and supplements, if any:
|
a)
|
The Declaration of Trust;
|
|
c)
|
Resolutions of the Board of Trustees of the Trust authorizing the appointment of the Adviser and approving the
form of this Agreement; and
|
|
d)
|
The Trusts Notification of Registration on Form N-8A and
Registration Statement as filed with the Commission.
|
6. BOOKS AND RECORDS. With respect
to its role as investment adviser, the Adviser shall keep each Funds books and records required to be maintained by it pursuant to paragraph 2(e). With respect to its role as administrator, the Adviser shall maintain customary records in
connection with its duties as specified in this Agreement.
The Adviser agrees that all records which it maintains for any Fund are the
property of the Trust and it will promptly surrender any of such records to the Trust upon the Trusts request. The Adviser further agrees to preserve for the periods prescribed by Rule 3la-2 under the
1940 Act any such records as are required to be prepared or maintained by the Adviser with respect to any Fund by Rule 31a-1 under the 1940 Act.
In case of any request or demand for the inspection of such records by another party, the Adviser shall notify the Trust and follow the
Trusts instructions as to permitting or refusing such inspection; provided that the Adviser may exhibit such records to any person in any case where it is advised by its counsel that it may be held liable for failure to do so.
7. CONFLICT OF INTEREST PROVISIONS. The Adviser and/or its affiliates (JPMorgan Chase) perform
investment services, including rendering investment advice, to varied clients. The Adviser, JPMorgan Chase and its or their directors, officers, agents, and/or employees may render similar or differing investment advisory services to clients and may
give advice or exercise investment responsibility and take such other action with respect to any of its other clients that differs from the advice given or the timing or nature of action taken with respect to another client or group of clients,
provided that such activities will not adversely affect or otherwise impair the performance by the Adviser of its duties and obligations under this Agreement and such activities are not otherwise prohibited by applicable law. It is the
Advisers policy, to the extent practicable, to allocate, within its reasonable discretion, investment opportunities among clients over a period
6
of time on a fair and equitable basis. One or more of the Advisers other client accounts may at any time hold, acquire, increase, decrease, dispose, or otherwise deal with positions in
investments in which another client account may have an interest from time-to-time.
The Adviser, JPMorgan Chase, and any of its or their directors, partners, officers, agents or employees, may also buy, sell, or trade
securities for their own accounts or the proprietary accounts of the Adviser and/or JPMorgan Chase. The Adviser and/or JPMorgan Chase, within their discretion, may make different investment decisions and other actions with respect to their own
proprietary accounts than those made for client accounts, including the timing or nature of such investment decisions or actions. Further, the Adviser is not required to purchase or sell for any client account securities that it, JPMorgan Chase, and
any of its or their employees, principals, or agents may purchase or sell for their own accounts or the proprietary accounts of the Adviser, or JPMorgan Chase or its clients.
The Adviser will maintain a written code of ethics (the Code of Ethics) that it reasonably believes complies with the requirements
of Rule 17j-1 under the 1940 Act (Rule 17j-1), a copy of which will be provided to the Trust, and will institute procedures reasonably necessary to prevent
any Access Person (as defined in Rule 17j-1) from violating its Code of Ethics. The Adviser will follow such Code of Ethics in performing its services under this Agreement. Further, the Adviser
represents that it has policies and procedures regarding the detection and prevention of the misuse of material, nonpublic information by the Adviser and its employees, a copy of which it will provide to the Trust upon any reasonable request. The
Adviser shall ensure that its employees will comply in all material respects with the provisions of Section 16 of the Exchange Act, and to cooperate reasonably with the Trust for purposes of filing any required reports with the SEC or such
other regulator having appropriate jurisdiction.
8. EXPENSES. During the term of this Agreement the Adviser
will pay all expenses incurred by it in connection with its activities under this Agreement, other than the cost of securities and investments purchased for a Fund (including taxes and brokerage commissions, if any). The Adviser shall pay, among
other things, (i) all expenses relating to its registration under the Investment Advisers Act of 1940; and (ii) all other general business overhead expenses incurred in connection with the distribution services provided to the Trust,
including office space, equipment, and personnel as may be necessary or convenient to provide the services.
During the term of this
Agreement, the Adviser will pay all of the expenses of the Trust relating to each Fund covered by this Agreement and each Fund (inclusive of any expenses of a wholly-owned subsidiary of a Fund), except for (i) the fee payment under this
Agreement as described in paragraph 9, (ii) payments under the Funds 12b-1 plan (if any), (iii) interest expenses, (iv) dividend and interest expenses related to short sales,
(v) taxes, (vi) acquired fund fees and expenses other than fees for funds advised by the Adviser and/or its affiliates, (vii) brokers commissions and any other transaction-related expenses and fees arising out of transactions
effected on behalf of the Fund, (viii) costs of holding shareholder meetings, (ix) the costs of any securities lending program, and (x) litigation and potential litigation and other extraordinary expenses not incurred in the ordinary
course of the Funds business. For the avoidance of doubt, the Advisers payment of such expenses may be accomplished through the Funds payment of such expenses and a corresponding reduction in the fee payable to the Adviser pursuant
to paragraph 9 hereof; provided, however, that if the amount of expenses paid by the Fund exceeds the fee payable to the Adviser pursuant to paragraph 9 hereof, the Adviser will reimburse the Fund for such excess amount.
7
9. COMPENSATION. For the services provided and the expenses borne
pursuant to this Agreement, each Fund will pay to the Adviser as full compensation therefore, a fee at an annual rate set forth on Schedule A attached hereto. Such fee will be computed based on the average daily net assets and payable as agreed by
the Trust and the Adviser, but no more frequently than monthly. If this Agreement terminates with respect to any Fund or the Trust before the last day of a month, the Advisers compensation for that part of the month in which this Agreement is
in effect shall be prorated according to the proportion which such period bears to the full monthly period and shall be payable upon the date of termination of this Agreement.
10. LIMITATION OF ADVISERS LIABILITY. The Adviser shall not be liable for any error of judgment or mistake
of law or for any loss suffered by any Fund in connection with the matters to which this Agreement relates, except a loss resulting from a breach of fiduciary duty with respect to the receipt of compensation for services (in which case any award of
damages shall be limited to the period and the amount set forth in Section 36(b)(3) of the 1940 Act) or a loss resulting from willful misfeasance, bad faith or gross negligence on its part in the performance of its duties or from reckless
disregard by it of its obligations and duties under this Agreement.
11. NON-EXCLUSIVE ACTIVITIES OF THE ADVISER. The services of the Adviser
provided to the Trust or any of the Funds under this Agreement are not to be deemed exclusive, and the Adviser shall be free to render similar services to others.
12. TERM. This Agreement will become effective as to an initial Fund as of the date first written above and,
unless sooner terminated as provided herein, shall continue in effect until February 28, 2021. Thereafter, if not terminated, this Agreement shall continue in effect as to an initial Fund for successive periods of twelve months each ending on
the last day of February of each year, only so long as such continuance is specifically approved at least annually in conformity with the requirements of the 1940 Act. With respect to each new Fund added to the Agreement, each such Fund shall have
an initial term of up to two years ending on the date indicated on Schedule A and thereafter, if not terminated, shall continue in effect for successive periods each ending on the last day of February of each year, only so long as such continuance
is specifically approved at least annually in conformity with the requirements of the 1940 Act. With respect to all Funds, however, this Agreement may be terminated with respect to any Fund at any time, without the payment of any penalty, by vote of
a majority of all the Trustees of the Trust or by vote of a majority of the outstanding voting securities of that Fund on 60 days written notice to the Adviser, or by the Adviser at any time, without the payment of any penalty, on 90
days written notice to the Trust. The termination of this Agreement with respect to one Fund shall not result in the termination of this Agreement with respect to any other Fund. This Agreement will automatically and immediately terminate in
the event of its assignment (as defined in the 1940 Act), provided that an assignment to a corporate successor to all or substantially all of the Advisers business or to a wholly-owned subsidiary of such corporate successor
which does not result in a change of actual control of the Advisers business shall not be deemed to be an assignment for the purposes of this Agreement.
13. INDEPENDENT CONTRACTOR. The Adviser shall for all purposes herein be deemed to be an independent contractor
and shall, unless otherwise expressly provided herein or authorized by the Trustees of the Trust from time to time, have no authority to act for or represent the Trust in any way or otherwise be deemed an agent of the Funds.
8
14. AMENDMENT. This Agreement may be amended, with respect to any
Fund, by mutual consent, subject to any requirements for approval by the vote of a majority of the outstanding voting securities of the Fund by the provisions of Section 15 of the 1940 Act, as modified by or interpreted by any applicable order
or orders of the Commission or any rules or regulations adopted by, or interpretative releases or no-action letters of, the Commission or its staff. In addition to the requirements of this paragraph 14, the
terms of any amendment of this Agreement must be approved by vote of a majority of those Trustees of the Trust who are not parties to this Agreement or interested persons (as defined in the 1940 Act) of any such party, cast in person at
a meeting called for the purpose of voting on such amendment.
15. NOTICES. Notices of any kind to be given
to the Adviser by the Trust shall be in writing and shall be duly given if mailed or delivered to the Adviser at 277 Park Avenue, New York, New York 10172, Attention: J.P. Morgan Investment Management Inc., or at such other address or to such other
individual as shall be specified by the Adviser to the Trust. Notices of any kind to be given to the Trust by the Adviser shall be in writing and shall be duly given if mailed or delivered to the J.P. Morgan Exchange-Traded Fund Trust, 277 Park
Avenue, New York, New York 10172, Attention: President, with a copy to the Secretary at the same address, or at such other address or to such other individual as shall be specified by the Trust to the Adviser.
16. LIMITATION OF LIABILITY OF THE TRUSTEES. The Trustees of the Trust have authorized the execution of this
Agreement in their capacity as Trustees and not individually, and the Adviser agrees that neither the past, present or future Trustees nor any officer or employee of the Trust nor any Funds investors nor any representative or agent of the
Trust or of the Fund(s) shall be personally liable upon, or shall resort be had to their private property for the satisfaction of, obligations given, executed or delivered on behalf of or by the Trust or the Fund(s), that such past, present or
future Trustees, officers, employees, investors, representatives and agents shall not be personally liable hereunder, and that it shall look solely to the Trust property for the satisfaction of any claim hereunder.
17. NO THIRD PARTY BENEFICIARIES. There are no third party beneficiaries to this Agreement.
18. COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to
be an original.
19. GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the
laws of the State of New York.
20. CONFIDENTIAL INFORMATION. Notwithstanding anything in this Agreement to
the contrary:
The Adviser shall treat as confidential and shall not use or disclose to any other party any nonpublic information that it
receives in connection with this Agreement (Confidential Information), unless such use or disclosure (i) is necessary to fulfill the Advisers obligations under this Agreement (subject to any conditions set forth elsewhere in
the Agreement), (ii) as may be required by law, or (iii) as otherwise authorized in writing by the Trust. Confidential Information shall include Nonpublic Personal Information (as defined below).
To the extent the Adviser receives or has access to any Nonpublic Personal Information (as that term is defined in Title V of the
Gramm-Leach-Bliley Act of 1999, and the relevant rules and
9
regulations issued thereunder (the GLBA)) pursuant to this Agreement, the Adviser agrees that it shall not disclose any such Nonpublic Personal Information except in a manner
permitted by the GLBA or as otherwise required by law. The Adviser agrees that it will comply with all applicable requirements under the GLBA.
The Adviser acknowledges that it has received and reviewed a copy of the Trusts privacy policy applicable to Nonpublic Personal
Information and it agrees that it will not act in a manner that is inconsistent with such policy.
IN WITNESS WHEREOF, the parties
hereto have caused this instrument to be executed by their officers designated below as of date first listed above.
|
|
|
J.P. MORGAN EXCHANGE-TRADED FUND TRUST
|
|
|
|
|
/s/ Paul Shield
|
By:
|
|
Paul Shield
|
Title:
|
|
Vice President & Assistant Treasurer
|
|
J.P. MORGAN INVESTMENT MANAGEMENT INC.
|
|
|
|
|
/s/ Brian S. Shlissel
|
By:
|
|
Brian S. Shlissel
|
Title:
|
|
Managing Director
|
10
Schedule A
to
Management Agreement
for
J.P. Morgan
Exchange-Traded Fund Trust
Fee Rates
|
|
|
|
|
Name
|
|
Fee Rate
|
|
JPMorgan BetaBuilders Canada ETF
|
|
|
0.19
|
%
|
JPMorgan BetaBuilders Developed Asia ex-Japan ETF
|
|
|
0.19
|
%
|
JPMorgan BetaBuilders Europe ETF
|
|
|
0.09
|
%
|
JPMorgan BetaBuilders Japan ETF
|
|
|
0.19
|
%
|
JPMorgan BetaBuilders MSCI US REIT ETF
|
|
|
0.11
|
%
|
JPMorgan Core Plus Bond ETF
|
|
|
0.40
|
%
|
JPMorgan Corporate Bond Research Enhanced ETF
|
|
|
0.14
|
%
|
JPMorgan Diversified Alternatives ETF
|
|
|
0.85
|
%
|
JPMorgan Diversified Return Emerging Markets Equity ETF
|
|
|
0.44
|
%
|
JPMorgan Diversified Return Europe Equity ETF
|
|
|
0.37
|
%
|
JPMorgan Diversified Return Global Equity ETF
|
|
|
0.29
|
%
|
JPMorgan Diversified Return International Equity ETF
|
|
|
0.37
|
%
|
JPMorgan Diversified Return U.S. Equity ETF
|
|
|
0.18
|
%
|
JPMorgan Diversified Return U.S. Mid Cap Equity ETF
|
|
|
0.24
|
%
|
JPMorgan Diversified Return U.S. Small Cap Equity ETF
|
|
|
0.29
|
%
|
JPMorgan Event Driven ETF
|
|
|
0.85
|
%
|
JPMorgan Global Bond Opportunities ETF
|
|
|
0.50
|
%
|
JPMorgan High Yield Research Enhanced ETF
|
|
|
0.24
|
%
|
JPMorgan Long/Short ETF
|
|
|
0.69
|
%
|
JPMorgan Managed Futures Strategy ETF
|
|
|
0.59
|
%
|
JPMorgan Municipal ETF
|
|
|
0.24
|
%
|
JPMorgan U.S. Aggregate Bond ETF
|
|
|
0.07
|
%
|
JPMorgan U.S. Dividend ETF
|
|
|
0.12
|
%
|
JPMorgan U.S. Minimum Volatility ETF
|
|
|
0.12
|
%
|
JPMorgan U.S. Momentum Factor ETF
|
|
|
0.12
|
%
|
JPMorgan U.S. Quality Factor ETF
|
|
|
0.12
|
%
|
JPMorgan U.S. Value Factor ETF
|
|
|
0.12
|
%
|
JPMorgan Ultra-Short Income ETF
|
|
|
0.18
|
%
|
JPMorgan Ultra-Short Municipal Income ETF
|
|
|
0.18
|
%
|
JPMorgan USD Emerging Markets Sovereign Bond ETF
|
|
|
0.39
|
%
|
A-1
Code of Ethics for JPMAM
Last Revision Date: November 8, 2018
Last Review Date: November 8, 2018
Effective Date: 02/01/2005
TABLE OF CONTENTS
|
|
|
|
|
1. Summary
|
|
|
3
|
|
2. Amendments to Previous Version Distributed July 8, 2016
|
|
|
4
|
|
3. Scope
|
|
|
4
|
|
4. Reporting Requirements
|
|
|
4
|
|
4.1. Holdings Reports
|
|
|
4
|
|
4.2. Transaction Reports
|
|
|
5
|
|
4.3 Exceptions from Transaction Reporting Requirements
|
|
|
5
|
|
5. Personal Trading Requirements
|
|
|
6
|
|
5.1 Approved Broker Requirement
|
|
|
6
|
|
5.2 Blackout Provisions
|
|
|
6
|
|
5.3 Minimum Investment Holding Period and Market Timing Prohibition
|
|
|
6
|
|
5.4 Trade Reversals and Disciplinary Action
|
|
|
6
|
|
6. Books and Records to be maintained by Investment Advisers
|
|
|
7
|
|
7. Privacy
|
|
|
7
|
|
8. Anti-Corruption
|
|
|
8
|
|
9. Conflicts of Interest
|
|
|
8
|
|
9.1 Trading in Securities of Clients
|
|
|
8
|
|
9.2 Trading in Securities of Suppliers
|
|
|
8
|
|
9.3 Pre-clearance Procedures for Value-Added Investors
|
|
|
8
|
|
9.4 Gifts & Entertainment
|
|
|
8
|
|
9.5 Political Contributions
|
|
|
10
|
|
9.6 Charitable Contributions
|
|
|
11
|
|
9.7 Outside Business Activities
|
|
|
11
|
|
10. Training
|
|
|
11
|
|
11.1 Violation Prior to Material Violation
|
|
|
12
|
|
11.2 Material Violations
|
|
|
12
|
|
12. Defined Terms
|
|
|
12
|
|
|
|
|
2
|
|
|
This Code of Ethics for JPMAM (the Code) has been adopted by the registered investment advisers of JPMAM in accordance with Rule 204A-1 under the
Investment Advisers Act of 1940 (the Advisers Act). Rule 204A-1 requires an investment adviser registered under section 203 of the Advisers Act to establish, maintain and enforce a written Code of Ethics.
This Code establishes our standards for ethical conduct which are premised on fundamental principles of openness, integrity, honesty and trust. JPMAM hereby
adopts the message from Jamie Dimon that was included in the JPMC Code of Conduct because it embodies JPMAMs ethical standards:
JPMorgan
Chase would not be the respected financial institution it is today without our steadfast commitment to integrity, fairness and responsibility. We strive each day to meet our obligations to all our constituents customers, employees, the Board,
shareholders, regulators and to ourselves.
We recognize that in business, as in every other arena, ethical behavior does not just happen.
It needs to be cultivated and repeatedly affirmed throughout the organization. Our Code of Conduct lays out the firms expectations for each employee, providing the necessary information and resources to conduct business ethically. Each of us
is responsible for understanding and abiding by the Code.
please make it a priority to complete the training and affirm that
you are in compliance. We require you to do this each year so the firm can continue to operate with the highest levels of transparency and accountability.
A company is only as good as its people and our people are the best. Thank you for your attention to this years training and for continuing to
make JPMorgan Chase a company of which we can all be proud.
Additionally, it is the duty of all Supervised Persons to act in the best
interests of their clients, place the interests of JPMAM Clients before their own personal interests at all times and to avoid any actual or potential conflicts of interest. Supervised Persons are the officers, directors (or other persons
occupying a similar status or performing similar functions) or employees of JPMAM (including those authorized to act in an official capacity on behalf of JPMAM entities, sometimes referred to as dual hatted employees) or any other person who
provides investment advice on JPMAMs behalf and is subject to JPMAMs supervision or control.
Supervised Persons must comply with
applicable Federal Securities Laws and promptly report any known or suspected violations of the Code promptly to the Code of Conduct Reporting Hotline, the Compliance Department, which shall report any such violation promptly to the Chief
Compliance Officer (CCO), or through the various reporting channels as provided in the How To Report A Violation page of the Code of Conduct intranet site. Your reporting obligations do not prevent you from reporting to the
government or regulators conduct that you believe to be in violation of law and it does not require you notifying JPMAM prior to reporting to the government or regulators. JPMAM strictly prohibits intimidation or retaliation against anyone who makes
a good faith report about a known or suspected violation of the Code, or any law or regulation.
Compliance with the Code, and other applicable policies
and procedures, is a condition of employment. The rules, procedures, reporting and recordkeeping requirements set forth in the Code are hereby adopted and certified as reasonably necessary to prevent Supervised Persons from violating the provisions
of the Code and applicable Federal Securities Rules.
|
|
|
3
|
|
|
The Compliance Department provides a link to this Code and any amendments to all Supervised Persons in
their Access Persons Report and requires their attestation of compliance with this Code at least annually. These records are maintained by the Compliance Department as part of its Books and Records as required by the Advisers Act.
Annually, the CCO of each registered investment adviser must review that the Code adequately reflects the advisers fiduciary obligations and those of
its supervised persons.
2.
|
Amendments to Previous Version Distributed July 8, 2016
|
Updated Summary to include Jamie Dimons 2018 message
Updated Section 5.1 to the Link for JPMC Approved Brokers
Updated Section 11.2 to align with current HR practices
This Code applies to all Supervised Persons of JPMAM.
In the
event that a difference exists between any of the standards identified in JPMC Code of Conduct and the JPMAM Code of Ethics, the more restrictive provision shall apply.
4.
|
Reporting Requirements
|
Access Persons must submit holdings reports to the Compliance Department documenting current securities holdings:
|
a)
|
Content of Holdings Reports
|
Each holdings report must contain, at a minimum:
The name of any broker, dealer or bank with which the Access Person maintains an Associated Account in which any Reportable
Securities are held for the Access Persons direct or indirect benefit, as well as all pertinent Associated Account details (e.g., account title, account number, etc.).
The title and type of security, and as applicable the exchange ticker symbol or CUSIP number, number of shares, and principal amount of each
Reportable Security in which the Access Person has any direct or indirect beneficial ownership.
The date the Access Person submits the report to the Compliance Department.
|
b)
|
Submission of Holdings Reports
|
Access Persons must submit both an Initial and Annual holdings report:
Must be submitted no later than 10 days after the person becomes an Access Person and the information must be current as of a date no
more than 45 days prior to the date the person becomes an Access Person.
|
|
|
4
|
|
|
Must be submitted at least once each 12-month period thereafter on January 30, and the information
must be current as of a date no more than 45 days prior to the date the report was submitted, unless notified by Compliance that this is no longer required due to electronic position reporting received from Approved Brokers.
Access Persons must submit to the Compliance Department securities transactions reports on a quarterly basis, in the form designated by
the Compliance Department. Securities transaction reports must meet the following requirements:
|
a)
|
Content of Transaction Reports
|
Each transaction report must contain, at a minimum, the following information about each transaction involving a Reportable Security in
which the Access Person had, or as a result of the transaction acquired, any direct or indirect beneficial ownership:
|
1)
|
The date of the transaction, the title, and as applicable the exchange ticker symbol or CUSIP number, interest
rate and maturity date, number of shares, and principal amount of each Reportable Security involved;
|
|
2)
|
The nature of the transaction (i.e., purchase, sale or any other type of acquisition or disposition);
|
|
3)
|
The price of the security at which the transaction was effected;
|
|
4)
|
The name of the broker, dealer or bank with or through which the transaction was effected; and
|
|
5)
|
The date the Access Person submits the report to the Compliance Department.
|
|
b)
|
Timing of Transaction Reports
|
Each Access Person must submit a transaction report no later than 30 days after the end of each calendar quarter, which report must
cover, at a minimum, all transactions during the quarter.
|
4.3
|
Exceptions from Transaction Reporting Requirements
|
An Access Person need not submit:
|
a)
|
Any report with respect to securities held in accounts over which the Access Person had no direct or
indirect influence or control;
|
|
b)
|
A transaction report with respect to transactions effected pursuant to an Automatic Investment Plan;
|
|
c)
|
Transaction Reports are not required for accounts maintained at Approved or Preferred Brokers or for accounts
which are approved for statement tracking
|
|
|
|
5
|
|
|
|
d)
|
Any report with respect to transactions in Reportable Funds.
|
|
5.
|
Personal Trading Requirements
|
Supervised Persons must obtain approval from the Compliance Department before directly or indirectly acquiring Beneficial Ownership
in any Reportable Security, including initial public offerings and limited offerings. Given the potential access to Proprietary and Client information that Supervised Persons may have, JPMAM and its Supervised
Persons must avoid even the appearance of impropriety with respect to personal trading, which must be oriented toward investment rather than short-term or speculative trading. JPMAMs policies are designed to help prevent and detect
violations of securities laws and industry conduct standards and to minimize actual or perceived conflicts of interest that could arise due to personal investing activities.
|
5.1
|
Approved Broker Requirement
|
All self directed Associated Accounts must be maintained with a JPMC Approved Broker. Please see attached link to list of Approved
Brokers by Region.https://portal.jpmchase.net/sites/Compliance/PersonalAccountDealing/Documents/Approved%20Broker%20Grid.pdf
The personal trading and investment activities of Supervised Persons are subject to particular scrutiny due to the fiduciary nature of
the business. Specifically, JPMAM must avoid even the appearance that its Supervised Persons conduct personal transactions in a manner that conflicts with the firms investment activities on behalf of Clients. Accordingly, certain
Supervised Persons are restricted from conducting personal investment transactions during certain periods (called Blackout Periods), and may be instructed to reverse previously completed personal investment transactions. Additionally,
the Compliance Department may restrict the personal trading activity of any Supervised Person if it is determined that such activity has the appearance of a possible conflict of interest.
These Blackout Periods applies varying levels of restrictions appropriate for different categories of Supervised Persons based upon
their level of access to non-public Client or Proprietary information.
|
5.3
|
Minimum Investment Holding Period and Market Timing Prohibition
|
Supervised Persons are subject to a minimum holding period, generally 60 days, for all transactions in Reportable Securities and
Reportable Funds.
Supervised Persons are not permitted to conduct transactions for the purpose of market timing in any
Reportable Security or Reportable Fund. Market timing is defined as an investment strategy using frequent purchases, redemptions, and/or exchanges in an attempt to profit from short-term market movements.
|
5.4
|
Trade Reversals and Disciplinary Action
|
Transactions by Supervised Persons are subject to reversal due to a conflict (or appearance of a conflict) with the firms
fiduciary responsibility or a violation of the firm policy. Such a reversal may be required even for a pre-cleared transaction that results in an inadvertent conflict or a breach of blackout period
requirements.
|
|
|
6
|
|
|
Disciplinary actions resulting from a violation of the Code will be administered in accordance
with related JPMAM guidelines governing disciplinary action and escalation. All violations and disciplinary actions will be reported promptly by the Compliance Department to the employees group head and senior management. Violations will be
reported quarterly to the affected Funds Board of Directors.
Violations by Supervised Persons of the Code, the JPMC Code of
Conduct or any laws or regulations that relate to JPMAMs operation of its business or any failure to cooperate with an internal investigation may result in disciplinary action up to and including immediate dismissal including termination of
regulatory registration where applicable.
6.
|
Books and Records to be maintained by Investment Advisers
|
The Compliance Department is responsible for maintaining books and records, including:
|
a)
|
A copy of this Code and any other code of ethics adopted by JPMAM pursuant to Rule 204A-1 that is in effect or
has been in effect at any time within the past five years;
|
|
b)
|
A record of any violation of the Code, and any action taken as a result of that violation;
|
|
c)
|
A record of all written acknowledgments for each person who is currently, or within the past five years was, a
Supervised Person of JPMAM;
|
|
d)
|
A record of each report made by Access Persons required under the Reporting Requirements;
|
|
e)
|
A record of the names of persons who are currently, or within the past five years were, Access Persons;
|
|
f)
|
A record of any decision, and the reasons supporting the decision, to approve the acquisition or sale of
securities by Supervised Persons under section 6. Pre-approval records of certain investments will be maintained for at least five years after the end of the fiscal year in which the approval is granted; and
|
|
g)
|
Any other such record as may be required under the Code.
|
Supervised Persons have a responsibility to protect the confidentiality of information related to Clients. This responsibility may be imposed by
law, may arise out of agreements with Clients, or may be based on policies or practices adopted by the firm. Certain jurisdictions have regulations relating specifically to the privacy of individuals and/or business and institutional
customers. Various business units and geographic areas within JPMC have internal policies regarding customer privacy.
The restriction on disclosing
confidential information is not intended to prevent Supervised Persons from reporting to the government or a regulator any conduct Supervised Persons believe to be in violation of the law, or from responding truthfully to questions or requests from
the government, a regulator or in a court of law.
|
|
|
7
|
|
|
It is the policy of JPMC to comply with the anti-corruption laws that apply to the firms Operations (and investments where the firm is deemed to have
control), which includes the United States Foreign Corrupt Practices Act (FCPA), the United Kingdom Bribery Act of 2010 (UKBA), as well as anti-corruption laws and regulations of other countries in which the firm conducts business. We must never
compromise our reputation by engaging in, or appearing to engage in, bribery or any form of corruption. Bribery and corruption are crimes with potentially severe penalties to JPMC and its employees and directors. The firm has zero tolerance for such
activity.
The following is a summary of commonly identified employee conflicts of interest:
9.1
|
Trading in Securities of Clients
|
Supervised Persons shall not transact in any securities of a Client with which the Supervised Person has or recently had
significant dealings or responsibility on behalf of JPMAM if such investment could be perceived as effected based on confidential information, including material non-public information.
9.2
|
Trading in Securities of Suppliers
|
Supervised Persons in possession of information regarding, or directly involved in negotiating, a contract material to a supplier of
JPMAM may not invest in the securities of such supplier. If you own the securities of a company with which we are dealing and you are asked to represent JPMorgan Chase in such dealings you must:
|
a)
|
Disclose this fact to your department head and the Compliance Department; and
|
|
b)
|
Obtain prior approval from the Compliance Department before selling such securities.
|
9.3
|
Pre-clearance Procedures for Value-Added Investors
|
Prior to any telephone calls, video, and in-person meetings between a
Portfolio Manager, or employee arranging the meeting, and a Value-Added Investor who is meeting to discuss his/her personal investment (or prospective investment) in the JPMAM Private Investment Fund managed by the Portfolio Manager, the
Portfolio Manager must obtain pre-clearance from Compliance. In order to obtain pre-clearance approval, the following information must be provided to Compliance prior to
the meeting:
|
a)
|
Date and place of meeting;
|
|
b)
|
Name of Value-Added Investor, their employer, and job title;
|
|
c)
|
Name of private fund the Value-Added Investor is invested in (or may invest in);
|
|
d)
|
Names of all J.P. Morgan employees in attendance at the meeting and job titles;
|
|
e)
|
Purpose of the meeting.
|
Compliance will review the pre-clearance request and respond via email and will ensure that appropriate
controls are instituted.
9.4
|
Gifts & Entertainment
|
Supervised Persons must avoid circumstances that may cause, or create the appearance of, a conflict of interest between JPMAM and its clients
or other business/commercial contacts. Supervised Persons may not give or receive anything of value, directly or indirectly, to influence improper action or obtain an improper advantage. Furthermore, the giving and receiving of gifts, including
entertainment and hospitality, to or from persons who do or seek to do business with JPMAM have the potential to create actual conflicts or the appearance of conflicts, and may negatively impact JPMAM.
|
|
|
8
|
|
|
Gifts and entertainment can take many forms, including but not limited to: goods or services for
which employees are not required to pay the retail or usual and customary cost; meals or refreshments; tickets to entertainment or sporting events; the use of a residence, vacation home or other accommodation; travel expenses; or charitable
contributions or organization sponsorships. In addition to gifts and entertainment, JPMAM Supervised Persons may not make, direct or solicit any other person to make, any political contribution or provide anything else of value to anyone for the
purpose of influencing or inducing the awarding or retention of investment advisory services business.
Gifts
Supervised Persons are only permitted to give gifts valued up to 100 USD to a client or business counterparty on occasions when gifts are
customary, such as life events and major holidays. AM employees must pre-clear giving any gifts to a client or business counterparty that exceeds 100 USD.
When giving gifts to clients or business counterparties, AM employees are strongly encouraged to give items with a JPMorgan Chase logo or
books from the JPMorgan Chase Reading list whenever appropriate. Gifting books from the JPMorgan Chase Reading List are limited to one book per campaign. Repetitive gifting to a client or business counterparty of Firm logo items in a calendar year
is not permitted.
AM employees who are FINRA Registered Representatives have a 100 USD annual maximum limit for gifts provided to clients
or business counterparties.
Entertainment
Entertainment includes business-related activities at which a host and guest are both present (e.g., meals, refreshments, golf games, sporting
events, or other leisure and entertainment). Entertainment is considered a prohibited gift unless both the employee and business contact are present and the employees participation is related to his or her position and duties within JPMAM.
Spouses, family members and personal acquaintances should not participate in entertainment activities unless such participation is customary under the circumstances.
Supervised Persons may act as a host for business entertainment to clients and prospects that are business related, is not prohibited by law,
and whose cost is reasonable and customary. Frequent and/or lavish business entertainment is prohibited.
Supervised Persons are limited
to accepting $250 in meals and entertainment from a client or counterparty per calendar year, with limited exceptions. Once the $250 limit is reached, employees are required to pay for their own expenses. In addition, Supervised Persons are
prohibited from accepting invitations to ticketed events; limited exceptions may be granted with pre-approval from senior management and Compliance.
|
|
|
9
|
|
|
All gifts and entertainment provided to U.S. Government Officials must be pre-cleared by Compliance to ensure that they comply with jurisdictional restrictions.
Supervised
Persons are required to log all entertainment subject to reporting into Reliances Gift and Entertainment Module for approval. Violations are subject to the Escalation Guidelines.
Sponsorships and Events
Both
sponsoring distributor events and JPMAM hosting educational events for financial advisors who sell our funds require review by Compliance and regional governance committees or designees to meet criteria below.
Events
|
Events
|
are 30 people or more to build relationships, train/educate attendees on products or services etc.
|
|
Requires
|
an Event Coordinator
|
|
Requires
|
80% training content in an event
|
|
Requires
|
client correspondence from distributor home office when per person benefits exceeds $1000
|
|
Preclearance
|
thresholds for Compliance vs. recordkeeping
|
Sponsorship
|
Requires
|
a Sponsorship Coordinator
|
Risk based approach to preclearing Sponsorships regionally
|
9.5
|
Political Contributions and Activities
|
In accordance with Advisers Act Rule 206(4)-5, Supervised Persons are prohibited from making
political contributions for the purpose of obtaining or retaining advisory contracts with government entities.
To ensure compliance with
this federal pay-to-play rule and various state and local laws, JPMAM Supervised Persons must receive pre-clearance before they
or any members of their household make or solicit political contributions or engage in political activities in connection with any election in the United States or the Republic of Colombia. Contributions to JPMC Political Action Committees are
excluded from pre-clearance and reporting requirements. New hires must also disclose their history of making and soliciting political contributions.
An employee cannot be reimbursed or otherwise compensated by JPMC for any political contribution. JPMC policies prohibit contributions of
corporate funds to candidates, political party committees and political action committees. Supervised Persons are strictly prohibited from using JPMC resources to conduct personal political activities.
Violations of these requirements are subject to the Escalation Guidelines.
|
|
|
10
|
|
|
9.6
|
Charitable Contributions
|
Charitable contributions made on behalf of JPMC must adhere to the requirements of the AM Expense Procedures and be precleared with Compliance.
9.7
|
Outside Business Activities
|
A Supervised Persons outside activities must not reflect adversely on the firm or give rise to a real or apparent conflict of
interest with the Supervised Persons duties to the firm or its Clients. Supervised Persons must be aware of potential conflicts of interest and be aware that they may be asked to discontinue any outside activity if a
potential conflict arises. Supervised Persons may not, directly or indirectly:
|
a)
|
Accept a business opportunity from someone doing business or seeking to do business with JPMAM that is made
available to the Supervised Person because of the individuals position with the firm.
|
|
b)
|
Take for oneself a business opportunity belonging to the firm.
|
|
c)
|
Engage in a business opportunity that competes with any of the firms businesses.
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More specific guidelines are set forth under the JPMC Code of Conduct.
https://portal.jpmchase.net/sites/codeofconduct/read/toc/Documents/OA%20and%20Second%20Job%20Pr ocedures.pdf Procedures for pre-clearance of Outside Activities and Second Jobs are available on
the JPMC Code of Conduct intranet site. Employees are reminded of their responsibility to obtain preclearance of their Outside Business Activities periodically in their Access Persons Report. If any material change in relevant circumstances
occurs, Supervised Persons must seek clearance for a previously approved activity. A material change may arise from a change in your job or association with JPMAM or in your role with respect to that activity or organization. JPMAM employees
are required to be continually alert to any real or apparent conflicts of interest with respect to investment management activities and promptly disclose any such conflicts to their manager and Compliance. Employees must also notify Compliance when
any approved outside activity terminates.
Regardless of whether an activity is specifically addressed under JPMAM policies or the JPMC
Code of Conduct, Supervised Persons should disclose any personal interest that might present a conflict of interest or harm the reputation of the firm.
All employees of the firm are required to take several mandatory training courses given each year by Compliance (e.g., Code of Conduct).
11.
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Escalation Guidelines
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JPMCs Violation and Escalation Guidelines is an internal Compliance document and is used to notify Group Heads, Managers and/or Human Resources (HR) of
employee violations of Compliance Policies along with the assigned severity of the applicable violations.
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11
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11.1
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Violation Prior to Material Violation
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While the Group Head is notified of all violations, he/she is required to have a meeting with the employee when the Supervised Persons
next violation would be considered material, in order to stress the importance of the requirement and inform the employee about the ramifications for not following the policy. The employee is also required to acknowledge, in writing, (form to be
provided by Compliance) that he/she is aware of the ramifications for noncompliance and he/she will be compliant going forward. The written acknowledgement is signed by both the employee and Group Head, and returned to Compliance for record keeping.
All material violations require the Group Head (MD level) and Compliance to have a meeting with the employee and document in writing that the
employee acknowledges the material nature of the violation and that he/she will be compliant going forward. The written acknowledgement, signed by the employee and Group Head, will be stored in Compliances Violations records. Additionally, HR
is notified of all material violations and follows their established guidelines for disciplining the employee and recording that event in the employees personnel file.
There will be a mandated suspension of personal trading privileges for six months for all material violations of the personal trading or access
persons requirements. Compliance and the Group Head may allow transactions for hardship reasons, but require documentation for pre-clearance.
An employees receipt of a material violation is considered when determining the employees annual compensation and eligibility for
promotion.
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Access Persons
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Access Persons of AM include:
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(1) Employees of any legal entities that fall under the JPMIM business in the Americas.
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(2) Certain persons of other affiliated entities that have access to Proprietary information of AM and persons that have been identified by Compliance as having access to AM Proprietary information
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(4) All persons of entities affiliated with JPMAM that have been authorized by the Office of the Corporate Secretary to act in an official capacity on behalf of the JPMAM Registered Investment, sometimes referred to as
dual-hatted employees
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(5) Certain consultants, agents, and temporary workers who are involved in the investment management process or have access to Proprietary information regarding Client recommendations or transactions on a pre-trade or
same-day basis.
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Associated Account
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Is an account in the name of or for the direct or indirect benefit of a Supervised Person or a Supervised Persons spouse, domestic partner, minor children and any other person for whom the Supervised Person provides
significant financial support, as well as to any other account over which the Supervised Person or any of these other persons exercise investment discretion, regardless of beneficial interest. Excluded from Associated Accounts are any 401(k) and
deferred compensation plan accounts for which the Supervised Person has no investment discretion.
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Automatic Investment Plan
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Is a program in which regular periodic purchases (or withdrawals) are made automatically in (or from) investment accounts in accordance with a predetermined schedule and allocation. An automatic investment plan includes a dividend
reinvestment plan.
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Beneficial ownership
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Is interpreted to mean any interest held directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, or any pecuniary interest in equity securities held or shared directly or indirectly,
subject to the terms and
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12
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conditions set forth under Rule 16a-1(a)(2) of the Securities Exchange Act of 1934. A Supervised Person who has questions regarding the definition of this term should consult the Compliance Department. Please note: Any report
required under section 5. Reporting Requirements may contain a statement that the report will not be construed as an admission that the person making the report has any direct or indirect beneficial ownership in the security to which
the report relates.
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Client
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Is any entity (e.g. person, corporation or Fund) for which JPMAM provides a service or has a fiduciary responsibility.
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Federal Securities Laws
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Are the Securities Act of 1933, the Securities Exchange Act of 1934, the Sarbanes- Oxley Act of 2002, the Investment Company Act of 1940 (1940 Act), the Advisers Act, Title V of the Gramm-Leach-Bliley Act (1999), any
rules adopted by the Securities and Exchange Commission (SEC) under any of these statutes, the Bank Secrecy Act as it applies to funds and investment advisers, and any rules adopted there under by the SEC or the Department of the
Treasury.
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Fund
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Is an investment company registered under the Investment Company Act of 1940.
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Initial Public Offering
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Is an offering of securities registered under the Securities Act of 1933, the issuer of which, immediately before the registration, was not subject to the reporting requirements of sections 13 or 15(d) of the Securities Exchange Act
of 1934.
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JPMAM
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Is the abbreviation for JPMorgan Asset Management, a marketing name for the Asset Management subsidiaries of JPMorgan Chase & Co. Within the context of this document, JPMAM refers to the following U.S. registered investment
advisers of JPMorgan Asset Management:
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J.P. Morgan Alternative Asset Management, Inc.
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JPMorgan Asset Management (UK) Ltd.
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J.P. Morgan Investment Management Inc.
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Security Capital Research & Management Inc.
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Bear Stearns Asset Management Inc.
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JF International Management, Inc.
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JPMorgan Funds Limited
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Limited Offering
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Is an offering that is exempt from registration under the Securities Act of 1933 pursuant to section 4(2) or section 4(6) or pursuant to Rules 504, 505 or 506 there under.
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Proprietary
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Within the context of this Code of Ethics is:
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(1) any research conducted by AM or its affiliates
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(2) any non-public information pertaining to AM or its affiliates
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(3) all JPM managed and sub-advised mutual funds
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Reportable Fund
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Is any JPMorgan Proprietary Fund, including sub-advised funds
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Reportable Security
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Is a security as defined under section 202(a)(18) of the Advisers Act held for the direct or indirect benefit of an Access Person, including any note, stock, treasury stock, security future, bond, debenture, evidence of
indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of
deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any
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security (including a certificate of deposit) or on any group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national
securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a security, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guaranty
of, or warrant or right to subscribe to or purchase any of the foregoing. Excluded from this definition are:
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1) Direct obligations of the Government of the United States;
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2) Bankers acceptances, bank certificates of deposit, commercial paper and high
quality short-term debt instruments, including repurchase agreements;
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3) Shares issued by money market funds; and
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4) Shares issued by open-end funds other than reportable funds
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Supervised Persons
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1) Any partner, officer, director (or other person occupying a similar status or
performing similar functions) and employees of JPMAM;
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2) All employees of entities affiliated with JPMAM that have been authorized by the
Office of the Corporate Secretary to act in an official capacity on behalf of a legal entity within JPMAM, sometimes referred to as dual hatted employees;
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3) Certain consultants, as well as any other persons who provide advice on behalf of
JPMAM and are subject to JPMAMs supervision and control; and
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4) All Access Persons
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ValueAdded Investor
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Is an executive level officer (i.e., president, Chief Executive Officer, Chief Financial Officer, Chief Operating Officer or Partner) or director of a company, who, due to the nature of his/her position, may obtain material,
non-public information.
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14
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