Management
Franklin Advisers,
Inc. (Advisers), One Franklin Parkway, San Mateo, CA 94403-1906, is the Fund's
investment manager. Advisers is a wholly owned subsidiary of Franklin
Resources, Inc. (Resources). Together, Advisers and its affiliates manage, as
of [_____, 2019], over $[___] billion in assets, and have been in the
investment management business since 1947.
Under a
separate agreement with Advisers, Franklin Templeton Portfolio Advisors, Inc.
(FT Portfolio Advisors), One Franklin Parkway, San Mateo, CA 94403, serves as the
Fund’s sub-advisor. The sub-advisor provides Advisers with investment
management advice (which may include research and analysis services). FT
Portfolio Advisors is a wholly owned subsidiary of Resources. For purposes of
the Fund’s investment strategies, techniques and risks, the term “investment
manager” includes the sub-advisor.
The Fund is
managed by a team of dedicated professionals. The portfolio managers of the
team are as follows:
David Yuen, CFA, FRM Portfolio
Manager of Advisers
Mr. Yuen has been
a portfolio manager of the Fund since its inception. He joined Franklin
Templeton in 2000.
Shawn Lyons, CFA Portfolio
Manager of Advisers
Mr. Lyons has
been a portfolio manager of the Fund since its inception. He joined Franklin
Templeton Investments in 1996.
Thomas
Runkel, CFA Portfolio
Manager of FT Portfolio Advisors
Mr. Runkel has
been a portfolio manager of the Fund since its inception. He first joined
Franklin Templeton in 1983 and rejoined again in 2006.
Kent Burns, CFA Portfolio
Manager of Advisers
Mr. Burns has
been a portfolio manager of the Fund since its inception. He joined Franklin
Templeton Investments in 1994.
The portfolio
managers of the Fund are jointly and primarily responsible for the day-to-day
management of the Fund's portfolio. They have equal authority over all aspects
of the Fund's investment portfolio, including but not limited to, purchases and
sales of individual securities, portfolio risk assessment, and the management
of daily cash balances in accordance with anticipated investment management
requirements. The degree to which each portfolio manager may perform these
functions, and the nature of these functions, may change from time to time.
CFA®
and Chartered Financial Analyst® are trademarks owned by CFA
Institute.
The Fund’s SAI
provides additional information about portfolio manager compensation, other
accounts that they manage and their ownership of Fund shares.
The Fund pays
Advisers a fee for managing the Fund’s assets. The fee is equal to the annual
rate of [___]% of the average daily net assets of the Fund.
Advisers pays
the sub-advisor for its services.
Advisers has
agreed to waive or limit its fees and to assume as its own certain expenses
otherwise payable by the Fund so that expenses (including acquired fund fees
and expenses (such as those associated with the Fund's investment in a Franklin
Templeton money fund), but excluding certain non-routine expenses or costs) do
not exceed [___]% until [____], 2021. Non-routine expenses or costs include
those relating to litigation, indemnification, reorganizations and
liquidations.
A
discussion regarding the basis for the board of trustees approving the
investment management contract of the Fund will be available in the Fund’s
initial annual or semi-annual report to shareholders.
Manager of Managers
Structure
The board of
trustees has authorized the Fund to operate in a “manager of managers”
structure whereby the investment manager can appoint and replace both
affiliated and unaffiliated sub-advisors, and enter into, amend and terminate
sub-advisory agreements with such sub-advisors, each subject to board approval
but without obtaining prior shareholder approval (Manager of Managers
Structure). The Fund will, however, inform shareholders of the hiring of any
new sub-advisor within 90 days after the hiring. The Manager of Managers
Structure provides the Fund with greater flexibility and efficiency by
preventing the Fund from incurring the expense and delays associated with
obtaining shareholder approval of such sub-advisory agreements.
The use of the
Manager of Managers Structure with respect to the Fund is subject to certain
conditions that are set forth in SEC exemptive relief and no-action letter
guidance issued by the SEC staff. Under the Manager of Managers Structure, the
investment manager has the ultimate responsibility, subject to oversight by the
Fund’s board of trustees, to oversee sub-advisors and recommend their hiring,
termination and replacement. The investment manager will also, subject to the
review and oversight of the Fund’s board of trustees: set the Fund’s overall
investment strategy; evaluate, select and recommend sub-advisors to manage all
or a portion of the Fund’s assets; and implement procedures reasonably designed
to ensure that each sub-advisor complies with the Fund’s investment goal,
policies and restrictions. Subject to review and oversight by the Fund’s board
of trustees, the investment manager will allocate and, when appropriate,
reallocate the Fund’s assets among sub-advisors and monitor and evaluate the
sub-advisors’ performance.
Distributions and Taxes
[TO BE
UPDATED IN 485(B) FILING]
Income and Capital Gain
Distributions
The Fund
intends to qualify as a regulated investment company under the Internal Revenue
Code. As a regulated investment company, the Fund generally pays no federal
income tax on the income and gains it distributes to you. The Fund intends to
pay income dividends monthly from its net investment income. Capital gains, if
any, may be paid at least annually. The Fund may distribute income dividends
and capital gains more frequently, if necessary, in order to reduce or
eliminate federal excise or income taxes on the Fund. The amount of any
distribution will vary, and there is no guarantee the Fund will pay either
income dividends or capital gain distributions. Distributions in cash may be
reinvested automatically in additional whole Fund shares only if the broker
through whom you purchased the shares makes such option available.
Annual
statements.
After the close of each calendar year, you will receive tax information
from the broker with respect to the federal income tax treatment of the Fund’s
distributions and any taxable sales of Fund shares occurring during the prior
calendar year. You may receive revised tax information if the Fund must
reclassify its distributions or the broker must adjust the cost basis of any
covered shares sold after you receive your tax information. Distributions
declared in December to shareholders of record in such month and paid in
January are taxable as if they were paid in December. Additional tax
information about the Fund’s distributions is available at
franklintempleton.com.
Avoid
"buying a dividend." At the time you purchase your Fund
shares, the price of the shares may reflect undistributed income, undistributed
capital gains, or net unrealized appreciation in the value of the portfolio
securities held by the Fund. For taxable investors, a subsequent distribution
to you of such amounts, although constituting a return of your investment, would
be taxable. Buying shares in the Fund just before it declares an income
dividend or capital gain distribution is sometimes known as “buying a
dividend.”
Tax Considerations
If
you are a taxable investor, Fund distributions are generally taxable to you as ordinary
income, capital gains or some combination of both. This is the case whether you
reinvest your distributions in additional Fund shares or receive them in cash.
Dividend
income.
Income dividends are generally subject to tax at ordinary rates. Income
dividends reported by the Fund as qualified dividend income may be subject to
tax by individuals at reduced long-term capital gains tax rates provided
certain holding period requirements are met. Because the Fund invests primarily
in debt securities, it is expected that either none or only a small portion of
the Fund’s income dividends may be qualified dividends. A return-of-capital
distribution is generally not taxable but will reduce the cost basis of your
shares, and will result in a higher capital gain or a lower capital loss when
you later sell your shares.
Capital
gains.
Fund distributions of short-term capital gains are also subject to tax
at ordinary rates. Fund distributions of long-term capital gains are taxable at
the reduced long-term capital gains rates no matter how long you have owned
your Fund shares. For single individuals with taxable income not in excess of
$39,375 in 2019 ($78,750 for married individuals filing jointly), the long-term
capital gains tax rate is 0%. For single individuals and joint filers with
taxable income in excess of these amounts but not more than $434,550 or
$488,850, respectively, the long-term capital gains tax rate is 15%. The rate
is 20% for single individuals with taxable income in excess of $434,550 and married
individuals filing jointly with taxable income in excess of $488,850. An
additional 3.8% Medicare tax may also be imposed as discussed below.
Sales of
exchange-listed shares. Currently, any capital gain or loss realized on the
sale of Fund shares generally is 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.
Cost basis
reporting.
Contact the broker through whom you purchased your Fund shares to obtain
information with respect to the available cost basis reporting methods and
elections for your account.
Taxes on
creation and redemption of creation units. An Authorized Participant who
exchanges 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 of purchase and the exchanger’s aggregate
basis in the securities surrendered plus any cash paid for the Creation Units.
An Authorized Participant who exchanges Creation Units for securities will
generally recognize a gain or loss equal to the difference between the
exchanger’s basis in the Creation Units and the aggregate market value of the
securities and the amount of cash received. 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,” or on the basis that there has been no significant change in economic
position. Authorized Participants exchanging securities should consult their
own tax advisor with respect to whether wash sale rules apply and when a loss
might be deductible.
Authorized
Participants that create or redeem Creation Units will be sent a confirmation
statement showing how many shares they purchased or sold and at what price.
Under current
federal tax laws, any capital gain or loss realized upon a 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 the Fund
redeems Creation Units in part or entirely in cash, it may recognize more capital
gains than it will if it redeems Creation Units in-kind.
Medicare
tax.
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 the sales of Fund shares) 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 a threshold amount. Any liability for this
additional Medicare tax is reported on, and paid with, your federal income tax
return.
Backup
withholding.
A shareholder may be subject to backup withholding on any distributions
of income, capital gains, or proceeds from the sale of Fund shares if the
shareholder has provided either an incorrect tax identification number or no
number at all, is subject to backup withholding by the IRS for failure to
properly report payments of interest or dividends, has failed to certify that the shareholder is not subject to backup
withholding, or has not certified that the shareholder is a U.S. person
(including a U.S. resident alien). The backup withholding rate is currently
24%. State backup withholding may also apply.
State and
local taxes.
Distributions of ordinary income and capital gains, and gains from the
sale of your Fund shares, are generally subject to state and local taxes.
Non-U.S.
investors.
Non-U.S. investors may be subject to U.S. withholding tax at 30% or a
lower treaty rate on Fund dividends of ordinary income. Non-U.S. investors may
be subject to U.S. estate tax on the value of their shares. They are subject to
special U.S. tax certification requirements to avoid backup withholding, claim
any exemptions from withholding and claim any treaty benefits. Exemptions from
U.S. withholding tax are generally provided for capital gains realized on the
sale of Fund shares, capital gain dividends paid by the Fund from net long-term
capital gains, short-term capital gain dividends paid by the Fund from net
short-term capital gains and interest-related dividends paid by the Fund from
its qualified net interest income from U.S. sources. However, notwithstanding
such exemptions from U.S. withholding tax at source, any such dividends and
distributions of income and capital gains will be subject to backup withholding
at a rate of 24% if you fail to properly certify that you are not a U.S.
person.
Other
reporting and withholding requirements. Payments to a shareholder that is
either a foreign financial institution or a non-financial foreign entity within
the meaning of the Foreign Account Tax Compliance Act (FATCA) may be subject to
a 30% withholding tax on income dividends paid by the Fund. The FATCA
withholding tax generally can be avoided by such foreign entity if it provides
the broker, and in some cases, the IRS, information concerning the ownership of
certain foreign financial accounts or other appropriate certifications or
documentation concerning its status under FATCA. In order to comply with these
requirements, information about a shareholder in the Fund may be disclosed to
the IRS, non-U.S. taxing authorities or other parties as necessary to comply
with FATCA.
Other tax
information.
This discussion of "Distributions and Taxes" is for general
information only and is not tax advice. You should consult your own tax advisor
regarding your particular circumstances, and about any federal, state, local
and foreign tax consequences before making an investment in the Fund.
Additional information about the tax consequences of investing in the Fund may
be found in the Statement of Additional Information.
Financial Highlights
There is no
financial information for the Fund because it is a new fund.
Shareholder Information
Buying and Selling Shares
Shares of the
Fund may be acquired or redeemed directly from the Fund only in Creation Units
or multiples thereof, as discussed in the Creations and Redemptions section of
this prospectus. Only an Authorized Participant may engage in creation or
redemption transactions directly with the Fund. Once created, shares of the
Fund generally trade in the secondary market in amounts less than a Creation
Unit.
Shares of the
Fund are listed on a national securities exchange for trading during the
trading day. Shares can be bought and sold throughout the trading day like
shares of other publicly traded companies. The Franklin Templeton ETF Trust
(Trust) does not impose any minimum investment for shares of the Fund purchased
on an exchange. Shares of the Fund trade under the following symbol: [____]
Buying
or selling Fund shares on an exchange involves two types of costs that may
apply to all securities transactions. When buying or selling shares of the Fund
through a broker, you will likely incur a brokerage commission or other charges
determined by your broker. The commission is frequently a fixed amount and may
be a significant proportional cost for investors seeking to buy or sell small
amounts of shares. In addition, you may incur the cost of the “spread,” that is,
any difference between the bid price and the ask price. The spread varies over
time for shares of the Fund based on the Fund’s trading volume and market
liquidity, and is generally lower if the Fund has a lot of trading volume and
market liquidity, and higher if the Fund has little trading volume and market
liquidity.
The Board of
Trustees has not adopted a policy of monitoring for frequent purchases and
redemptions of Fund shares (frequent trading) that appear to attempt to take
advantage of a potential arbitrage opportunity presented by a lag between a
change in the value of the Fund’s portfolio securities after the close of the
primary markets for the Fund’s portfolio securities and the reflection of that
change in the Fund’s NAV (market timing), because the Fund generally sells and
redeems its shares directly through transactions that are in-kind and/or for
cash, subject to the conditions described below under Creations and
Redemptions. The Board of Trustees has not adopted a policy of monitoring for
frequent trading activity because shares of the Fund are listed for trading on
a national securities exchange.
The Fund’s
primary listing exchange is [____], Inc., which is open for trading Monday
through Friday and is closed on weekends and the following holidays: New Year’s
Day, Martin Luther King, Jr. Day, Presidents’ Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Section
12(d)(1) of the Investment Company Act of 1940 (1940 Act) restricts investments
by investment companies in the securities of other investment companies.
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 SEC rules or in an SEC exemptive order issued to the Trust. In
order for a registered investment company to invest in shares of the Fund
beyond the limitations of Section 12(d)(1) pursuant to the exemptive relief
obtained by the Trust, the registered investment company must enter into an
agreement with the Trust.
Book Entry
Shares of the
Fund are held in book-entry form, which means that no share certificates are
issued. The Depository Trust Company (DTC) or its nominee is the record owner
of all outstanding shares of the Fund and is recognized as the owner of all
shares for all purposes.
Investors
owning shares of the Fund are beneficial owners as shown on the records of DTC
or its participants. DTC serves as the securities depository for shares of the
Fund. DTC participants include securities brokers and dealers, banks, trust
companies, clearing corporations and other institutions that directly or
indirectly maintain a custodial relationship with DTC. As a beneficial owner of
shares, you are not entitled to receive physical delivery of stock certificates
or to have shares registered in your name, and you are not considered a
registered owner of shares. Therefore, to exercise any right as an owner of
shares, you must rely upon the procedures of DTC and its participants. These procedures
are the same as those that apply to any other securities that you hold in
book-entry or “street name” form.
Share Prices
The trading
prices of the Fund’s shares in the secondary market generally differ from the
Fund’s daily NAV and are affected by market forces such as supply and demand,
economic conditions and other factors. Information regarding the intraday value
of shares of the Fund, also known as the “indicative optimized portfolio value”
(IOPV), is disseminated every 15 seconds throughout the trading day by the
national securities exchange on which the Fund’s shares are listed or by market
data vendors or other information providers. The IOPV is based on the current
market value of the securities and/or cash contained in the portfolio at the
beginning of the trading day. The IOPV does not necessarily reflect the best
possible valuation of the current portfolio of securities held
by the Fund, and may not be calculated in the same manner as the NAV.
Therefore, the IOPV should not be viewed as a “real-time” update of the Fund’s
NAV, which is computed only once a day. The IOPV is generally determined by
using both current market quotations and/or price quotations obtained from
broker-dealers that may trade in the portfolio securities held by the Fund. The
Fund is not involved in, or responsible for, the calculation or dissemination
of the IOPV and makes no representation or warranty as to its accuracy.
Calculating NAV
The NAV of the
Fund is determined by deducting the Fund’s liabilities from the total assets of
the portfolio. The NAV per share is determined by dividing the total NAV of the
Fund by the number of shares outstanding.
The Fund
calculates the NAV per share each business day as of 1 p.m. Pacific time which
normally coincides with the close of trading on the New York Stock Exchange
(NYSE). The Fund does not calculate the NAV on days the NYSE is closed for
trading, which include 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. If the NYSE has a scheduled early close or unscheduled early
close, the Fund’s share price would still be determined as of 1 p.m. Pacific
time/4 p.m. Eastern time. The Fund’s NAV per share is readily available online
at franklintempleton.com.
When
determining its NAV, the Fund values cash and receivables at their realizable
amounts, and records interest as accrued and dividends on the ex-dividend date.
The Fund generally utilizes two independent pricing services to assist in
determining a current market value for each security. If market quotations are
readily available for portfolio securities listed on a securities exchange, the
Fund values those securities at the last quoted sale price or the official
closing price of the day, respectively, or, if there is no reported sale,
within the range of the most recent quoted bid and ask prices. The Fund values
over-the-counter portfolio securities within the range of the most recent bid
and ask prices. If portfolio securities trade both in the over-the-counter
market and on a stock exchange, the Fund values them according to the broadest
and most representative market. Prices received by the Fund for securities may
be based on institutional “round lot” sizes, but the Fund may hold smaller,
“odd lot” sizes. Odd lots may trade at lower prices than round lots.
Generally,
trading in corporate bonds, U.S. government securities and money market
instruments is substantially completed each day at various times before 1 p.m.
Pacific time. The value of these securities used in computing the NAV is
determined as of such times. Occasionally, events affecting the values of these
securities may occur between the times at which they are determined and 1 p.m.
Pacific time that will not be reflected in the computation of the NAV. The Fund
relies on third-party pricing vendors to provide evaluated prices that reflect
current fair market value at 1 p.m. Pacific time.
Fair Valuation – Individual
Securities
The Fund has
procedures, approved by the Board of Trustees, to determine the fair value of
individual securities and other assets for which market prices are not readily
available (such as certain restricted or unlisted securities and private
placements) or which may not be reliably priced (such as in the case of trade
suspensions or halts, price movement limits set by certain foreign markets, and
thinly traded or illiquid securities). Some methods for valuing these
securities may include: fundamental analysis (earnings multiple, etc.), matrix
pricing, discounts from market prices of similar securities, or discounts
applied due to the nature and duration of restrictions on the disposition of
the securities. The Board of Trustees oversees the application of fair value
pricing procedures.
The application
of fair value pricing procedures represents a good faith determination based
upon specifically applied procedures. There can be no assurance that the Fund
could obtain the fair value assigned to a security if it were able to sell the
security at approximately the time at which the Fund determines its NAV per
share.
Security
Valuation – Corporate Debt Securities Corporate debt securities generally
trade in the over-the-counter market rather than on a securities exchange. The
Fund may value these portfolio securities by utilizing quotations from bond
dealers, information with respect to bond and note transactions and may rely on
independent pricing services to assist in determining a current
market value for each security. The Fund’s pricing services may utilize
independent quotations from bond dealers and bond market activity to determine
current value.
Security
Valuation – Pass-Through Securities, CMO, ABS, MBS Mortgage
pass-through securities (such as Ginnie Mae, Fannie Mae and Freddie Mac), other
mortgage-backed securities (MBS), collateralized mortgage obligations (CMOs)
and asset-backed securities (ABS) generally trade in the over-the-counter
market rather than on a securities exchange. The Fund may value these portfolio
securities by utilizing quotations from bond dealers, information with respect
to bond and note transactions and may rely on independent pricing services, in
accordance with valuation procedures approved by the Fund’s Board of Trustees.
The Fund’s pricing services use valuation models or matrix pricing to determine
current value. In general, they use information with respect to comparable bond
and note transactions, quotations from bond dealers or by reference to other
securities that are considered comparable in such characteristics as rating,
interest rate, maturity date, option adjusted spread models, prepayment
projections, interest rate spreads and yield curves. Matrix pricing is
considered a form of fair value pricing.
Creations and Redemptions
Prior to
trading in the secondary market, shares of the Fund are “created” at NAV by
market makers, large investors and institutions only in block-size Creation
Units of [50,000] shares or multiples thereof. All orders to purchase Creation
Units must be placed by or through an “Authorized Participant” that has entered
into an authorized participant agreement (AP Agreement) with Franklin Templeton
Distributors, Inc. (Distributors), an affiliate of Advisers. Only an Authorized
Participant may create or redeem Creation Units directly with the Fund.
A creation
transaction, which is subject to acceptance by Distributors or its agents,
generally takes place when an Authorized Participant deposits into the Fund a
designated portfolio of securities and/or cash (which may include cash in lieu
of certain securities) in exchange for a specified number of Creation Units.
With respect to the Fund, these deposits are generally in cash.
Similarly,
shares can be redeemed only in Creation Units, generally for a designated
portfolio of securities and/or cash (which may include cash in lieu of certain
securities). With respect to the Fund, redemptions are generally in cash,
although the Fund reserves the right to meet redemptions on an in-kind basis.
Except when aggregated in Creation Units, shares are not redeemable by the
Fund.
The prices at
which creations and redemptions occur are based on the next calculation of NAV
after a creation or redemption order is received in an acceptable form under
the AP Agreement. The portfolio of securities required for purchase of a
Creation Unit is generally the same as the portfolio of securities the Fund
will deliver upon redemption of Fund shares, except under certain
circumstances. The designated portfolio of securities in connection with a
purchase or redemption of a Creation Unit generally will correspond pro rata,
except under certain circumstances, to the securities held by the Fund. As a
result of any system failure or other interruption, creation or redemption
orders either may not be executed according to the Fund’s instructions or may
not be executed at all, or the Fund may not be able to place or change such
orders.
Creations and
redemptions must be made through a firm that is either a broker-dealer or other
participant in the Continuous Net Settlement System of the National Securities
Clearing Corporation or a DTC participant and, in either case, has executed an
AP Agreement with Distributors. Information about the procedures regarding
creations and redemptions of Creation Units (including the cut-off times for receipt
of creation and redemption orders) is included in the Fund’s SAI.
Because new
shares may be created and issued on an ongoing basis, at any point during the
life of the Fund a “distribution,” as such term is used in the 1933 Act, may be
occurring. 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 to the prospectus delivery and liability provisions of
the 1933 Act. Any determination of whether one is an underwriter must take into
account all the relevant facts and circumstances of each particular case.
Broker-dealers
should also note that dealers who are not “underwriters” but are participating
in a distribution (as contrasted to ordinary secondary transactions), and thus
dealing with shares that are part of an “unsold allotment” within the meaning
of Section 4(a)(3)(C) of the 1933 Act, would be unable
to take advantage of the prospectus delivery exemption provided by Section
4(a)(3) of the 1933 Act. For delivery of prospectuses to exchange members, the
prospectus delivery mechanism of Rule 153 under the 1933 Act is available only
with respect to transactions on a national securities exchange.
Premium/Discount Information
Information
regarding how often the shares of the Fund traded on [____] at a price above
(at a premium) or below (at a discount) the NAV of the Fund can be found at
franklintempleton.com.
Delivery of Shareholder
Documents - Householding
You will
receive the Fund's financial reports every six months as well as an annual
updated prospectus. Householding for the Fund is available through certain
broker-dealers. Householding is a process in which related shareholders in a
household will be sent only one copy of the financial reports and prospectus.
You may contact your broker-dealer to enroll in householding. Once enrolled,
this process will continue indefinitely unless you instruct your broker-dealer
otherwise. If you prefer not to have these documents householded, please
contact your broker-dealer. At any time you may view current prospectuses and
financial reports on our website.
Distribution
Distributors
or its agents distribute Creation Units for the Fund on an agency basis.
Distributors does not maintain a secondary market in shares of the Fund.
Distributors is an affiliate of Advisers.
Distribution
and Service (12b-1) Fees
The Board of
Trustees has adopted a distribution plan, sometimes known as a Rule 12b-1 plan,
that allows the Fund to pay distribution fees of up to 0.25% per year, to those
who sell and distribute Fund shares and provide other services to shareholders.
However, the Board of Trustees has determined not to authorize payment of a
Rule 12b-1 plan fee at this time.
Because these
fees are paid out of the Fund’s assets on an ongoing basis, to the extent that
a fee is authorized, over time these fees will increase the cost of your
investment and may cost you more than paying other types of sales charges.
For More Information
You can learn
more about the Fund in the following documents:
Annual/Semiannual
Report to Shareholders
Includes
a discussion of recent market conditions and Fund strategies that significantly
affected Fund performance during its last fiscal year, financial statements,
detailed performance information, portfolio holdings and, in the annual report
only, the independent registered public accounting firm’s report.
Statement
of Additional Information (SAI)
Contains more
information about the Fund, its investments and policies. It is incorporated by
reference (is legally a part of this prospectus).
For a free
copy of the current annual/semiannual report, when available or the SAI, please
contact your investment representative or call us at the number below. You also
can view the current annual/semiannual report, when available and the SAI
online through franklintempleton.com.
Reports and other
information about the Fund are available on the EDGAR Database on the SEC's
Internet site at http://www.sec.gov, and copies of this information may be
obtained, after paying a duplicating fee, by electronic request at the
following email address: publicinfo@sec.gov.
Individual investors should contact their financial advisor or broker dealer
representative for more information about Franklin Templeton ETFs.
Financial Professionals should call (800) DIAL BEN®/342-5236.
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One Franklin Parkway
San Mateo, CA 94403-1906
franklintempleton.com
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For hearing impaired assistance, please
contact us via a Relay Service.
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Investment
Company Act file #811-23124
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© 2019
Franklin Templeton. All rights reserved.
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Statement of Additional Information
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Franklin Liberty ultra short bond ETF
Franklin Templeton ETF Trust
[_____], 2020
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SUBJECT TO
COMPLETION, PRELIMINARY STATEMENT OF ADDITIONAL INFORMATION
THE
INFORMATION IN THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT COMPLETE AND MAY
BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT
FILED WITH THE SEC IS EFFECTIVE. THIS STATEMENT OF ADDITIONAL INFORMATION IS
NOT AN OFFER TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY
THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
Ticker:
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Exchange:
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[____]
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[__________]
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This
Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the Fund's (hereafter the
“Fund”) prospectus. The Fund's prospectus, dated [_____], 2020, which we may
amend from time to time, contains the basic information you should know
before investing in the Fund. You should read this SAI together with the
Fund's prospectus.
For
a free copy of the current prospectus or annual report when available,
contact your investment representative or call (800) DIAL BEN/342-5236.
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CONTENTS
General Description of the Trust and the Fund
Exchange Listing and Trading
Goal, Strategies and Risks
Officers and Trustees
Fair Valuation and Liquidity
Proxy Voting Policies and Procedures
Management and Other Services
Portfolio Transactions
Distributions and Taxes
Organization, Voting Rights, Principal Holders and Additional Information
Concerning the Trust
Creation and Redemption of Creation Units
The Underwriter
Miscellaneous Information
Description of Ratings
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ETFs, annuities, and
other investment products:
·
are
not insured by the Federal Deposit Insurance Corporation, the Federal Reserve
Board, or any other agency of the U.S. government;
·
are
not deposits or obligations of, or guaranteed or endorsed by, any bank; and
·
are
subject to investment risks, including the possible loss of principal.
P.O.
Box 997151
Sacramento, CA 95899-7151
Individual investors should contact their financial advisor or broker dealer
representative for more information about Franklin Templeton ETFs.
Financial Professionals should call (800) DIAL BEN®/342-5236.
[___________]
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General Description of the Trust and the
Fund
The
Fund is a diversified series of Franklin Templeton ETF Trust (Trust), an
open-end management investment company. The Trust was organized as a Delaware
statutory trust effective October 9, 2015 and is registered with the U.S.
Securities and Exchange Commission (SEC).
The
Fund's investment manager is Franklin Advisers, Inc. (Advisers). Advisers is a
wholly owned subsidiary of Franklin Resources, Inc. (Resources), a publicly
owned company engaged in the financial services industry through its
subsidiaries.
The
Fund offers and issues shares at their net asset value per share (NAV) only in
aggregations of a specified number of shares (Creation Unit). The Fund may
offer Creation Units of its shares in exchange for a designated portfolio of
securities (including any portion of such securities for which cash may be
substituted) (Deposit Securities), together with the deposit of a specified
cash payment (Cash Component). Currently, the Fund generally offers Creation
Units of its shares solely for cash. Shares of the Fund are listed for trading
on [___________] (Listing Exchange or [___________]), a national securities
exchange. Shares of the Fund are traded in the secondary market and elsewhere
at market prices that may be at, above or below the Fund’s NAV. Shares of the
Fund are redeemable only in Creation Units. The Fund may redeem Creation Units
of its shares in exchange for portfolio securities and a Cash Component.
Currently, the Fund generally redeems Creation Units of its shares solely for
cash. Creation Units typically are a specified number of shares, generally
[50,000] or multiples thereof.
The
Trust reserves the right to permit or require that creations and redemptions of
shares are effected fully or partially in cash. Shares may be issued in advance
of receipt of Deposit Securities, subject to various conditions, including a
requirement to maintain with the Trust a cash deposit equal to at least 105%
and up to 115%, which percentage the Trust may change from time to time, of the
market value of the omitted Deposit Securities. See the “Creation and
Redemption of Creation Units” section of this SAI. Transaction fees and other
costs associated with creations or redemptions that include a cash portion may
be higher than the transaction fees and other costs associated with in-kind
creations or redemptions. In all cases, transaction fees will be limited in
accordance with the requirements of SEC rules and regulations applicable to
management investment companies offering redeemable securities.
Exchange Listing and Trading
A
discussion of exchange listing and trading matters associated with an
investment in the Fund is contained in the “Shareholder Information” section of
the Fund’s prospectus. The discussion below supplements, and should be read in
conjunction with, that section of the prospectus.
Shares
of the Fund are listed for trading, and trade throughout the day, on the
Listing Exchange and in other secondary markets. Shares of the Fund may also be
listed on certain non-U.S. exchanges. There can be no assurance that the
requirements of the Listing Exchange necessary to maintain the listing of
shares of the Fund will continue to be met. The Listing Exchange may, but is
not required to, remove the shares of the Fund from listing if (i) following
the initial 12-month period beginning upon the commencement
of trading of Fund shares, there are fewer than 50 beneficial owners of shares
of the Fund, (ii) the “indicative optimized portfolio value” (IOPV) of the Fund
is no longer calculated or available, or (iii) any other event shall occur or
condition shall exist that, in the opinion of the Listing Exchange, makes
further dealings on the Listing Exchange inadvisable. The Listing Exchange will
also remove shares of the Fund from listing and trading upon termination of the
Fund.
As
in the case of other publicly traded securities, when you buy or sell shares
through a broker, you will incur a brokerage commission determined by that
broker.
In
order to provide additional information regarding the indicative value of
shares of the Fund, the Listing Exchange or a market data vendor disseminates
information every 15 seconds through the facilities of the Consolidated Tape
Association, or through other widely disseminated means, an updated IOPV for
the Fund as calculated by an information provider or market data vendor. The
Trust is not involved in or responsible for any aspect of the calculation or
dissemination of the IOPVs and makes no representation or warranty as to the accuracy
of the IOPVs.
The
IOPV is based on the current market value of the securities and/or cash
contained in the portfolio at the beginning of the trading day. The IOPV does
not necessarily reflect the best possible valuation of the current portfolio of
securities held by the Fund and may not be calculated in the same manner as the
NAV. Therefore, the Fund’s IOPV disseminated during the Listing Exchange
trading hours should not be viewed as a real-time update of the Fund’s NAV,
which is calculated only once a day. The Fund’s IOPV is not calculated by the
Fund.
The
cash component included in an IOPV may consist of other assets held by the
Fund, including cash, estimated accrued interest, dividends and other income,
less expenses. If applicable, each IOPV also reflects changes in currency
exchange rates between the U.S. dollar and the applicable currency.
The
Trust reserves the right to adjust the share prices of the Fund in the future
to maintain convenient trading ranges for investors. Any adjustments would be
accomplished through stock splits or reverse stock splits, which would have no
effect on the net assets of the Fund or an investor’s equity interest in the
Fund.
Goal, Strategies and Risks
The
following information provided with respect to the Fund is in addition to that
included in the Fund’s prospectus. The Fund is an actively managed
exchange-traded fund (ETF) that does not seek to replicate the performance of a
specified index.
In
addition to the main types of investments and strategies undertaken by the Fund
as described in the prospectus, the Fund also may invest in other types of
instruments and engage in and pursue other investment strategies, which are
described in this SAI. Investments and investment strategies with respect to
the Fund are discussed in greater detail in the section below entitled "Glossary
of Investments, Techniques, Strategies and Their Risks."
Generally,
the policies and restrictions discussed in this SAI and in the prospectus apply
when the Fund makes an investment. In most cases, the Fund is not required to
sell an investment because circumstances change and the investment no longer
meets one or more of the Fund's policies or restrictions. If a percentage
restriction or limitation is met at the time of investment, a later increase or
decrease in the percentage due to a change in the value of portfolio
investments will not be considered a violation of the restriction or
limitation, with the exception of the Fund's limitations on borrowing as
described herein or unless otherwise noted herein.
Incidental
to the Fund’s other investment activities, including in connection with a
bankruptcy, restructuring, workout, or other extraordinary events concerning a
particular investment the Fund owns, the Fund may receive securities (including
convertible securities, warrants and rights), real estate or other investments
that the Fund normally would not, or could not, buy. If this happens, the Fund
may, although it is not required to, sell such investments as soon as
practicable while seeking to maximize the return to shareholders.
The
Fund has adopted certain investment restrictions as fundamental and
non-fundamental policies. A fundamental policy may only be changed if the
change is approved by (i) more than 50% of the Fund's outstanding shares or
(ii) 67% or more of the Fund's shares present at a
shareholder meeting if more than 50% of the Fund's outstanding shares are
represented at the meeting in person or by proxy, whichever is less. A
non-fundamental policy may be changed without the approval of shareholders.
For
more information about the restrictions of the Investment Company Act of 1940
(1940 Act) on the Fund with respect to borrowing and senior securities, see “Glossary
of Investments, Techniques, Strategies and Their Risks - Borrowing” below.
Fundamental
Investment Policies
The
Fund has adopted the following restrictions as fundamental investment policies:
The
Fund may not:
1.
Borrow money, except to the extent permitted by the 1940 Act, or any rules,
exemptions or interpretations thereunder that may be adopted, granted or issued
by the SEC.
2.
Act as an underwriter, except to the extent the Fund may be deemed to be an
underwriter when disposing of securities it owns or when selling its own
shares.
3.
Make loans if, as a result, more than 33 1/3% of its total assets would be lent
to other persons, including other investment companies to the extent permitted
by the 1940 Act or any rules, exemptions or interpretations thereunder that may
be adopted, granted or issued by the SEC. This limitation does not apply to (i)
the lending of portfolio securities, (ii) the purchase of debt securities,
other debt instruments, loan participations and/or engaging in direct corporate
loans in accordance with its investment goals and policies, and (iii)
repurchase agreements to the extent the entry into a repurchase agreement is
deemed to be a loan.
4.
Purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments and provided that this restriction does not
prevent the Fund from (i) purchasing or selling securities or instruments
secured by real estate or interests therein, securities or instruments
representing interests in real estate or securities or instruments of issuers
that invest, deal or otherwise engage in transactions in real estate or
interests therein, and (ii) making, purchasing or selling real estate mortgage
loans.
5.
Purchase or sell commodities, except to the extent permitted by the 1940 Act or
any rules, exemptions or interpretations thereunder that may be adopted,
granted or issued by the SEC.
6.
Issue senior securities, except to the extent permitted by the 1940 Act or any
rules, exemptions or interpretations thereunder that may be adopted, granted or
issued by the SEC.
7.
Invest more
than 25% of its net assets in securities of issuers in any one industry (other
than securities issued or guaranteed by the U.S. government or any of its
agencies or instrumentalities), except that, under normal market conditions,
the Fund will invest more than 25% of its net assets in securities issued by
companies operating within financials related industries.1
8.
Purchase the securities of any one issuer (other than the U.S. government or
any of its agencies or instrumentalities or securities of other investment
companies, whether registered or excluded from registration under Section 3(c)
of the 1940 Act) if immediately after such investment (i) more than 5% of the
value of the Fund’s total assets would be invested in such issuer or (ii) more
than 10% of the outstanding voting securities of such issuer would be owned by
the Fund, except that up to 25% of the value of the Fund’s total assets may be
invested without regard to such 5% and 10% limitations.
1.
Although not part of the Fund’s fundamental investment restriction, for
illustration purposes, companies operating within financials related industries
currently include, but are not limited to, companies within industries in the
financials sector, as well as financials related companies operating in other
sectors, including in companies in the following industries: banks, thrifts and
mortgage finance, diversified financial services, consumer finance, capital
markets, mortgage real estate investment trusts and insurance.
Non-Fundamental
Investment Policies
The Fund’s investment goal is to seek to
provide a high level of current income as is consistent with prudent investing,
while seeking preservation of capital. Under normal market conditions, the Fund
invests at least 80% of its net assets in bonds and investments that provide
exposure to bonds. Bonds include, but are not limited to, a variety of fixed
and variable rate debt obligations, including government and corporate debt
securities; money market instruments, mortgage-and asset-backed securities and
municipal securities. The Fund's investment goal and 80% policy are
non-fundamental, which means that they may be changed by the board of trustees
without the approval of shareholders. Shareholders will be given at least 60
days' advance notice of any change to the Fund's investment goal or 80% policy.
Net assets for purposes of the 80% policy include the amount of any borrowings
for investment purposes.
Additional Strategies
In
trying to achieve its investment goal, the Fund may invest in the types of
instruments or engage in the types of transactions identified below and in the
section “Glossary of Investments, Techniques, Strategies and Their Risks,”
which also describes the risks associated with these investment policies. The
Fund may or may not use all of these techniques at any one time.
The
Fund may invest, buy or engage in:
-
corporate loans,
assignments and participations
-
preferred
securities
-
callable
securities
-
credit-linked
notes
-
securities rated
below investment grade
-
when-issued, delayed
delivery and to-be-announced transactions
-
zero coupon,
deferred interest and pay-in-kind bonds
-
interest rate,
bond, U.S. Treasury and fixed income index futures contracts
-
equity securities
and investments (including convertible securities, preferred stock,
warrants and rights), including those acquired in connection with or
incidental to the Fund’s other investment activities, such as a result of
the restructuring of corporate loans and/or debt securities
-
securities of
other investment companies, including Franklin Templeton money market
funds and ETFs
Glossary
of Investments, Techniques, Strategies and Their Risks
Certain
words or phrases may be used in descriptions of Fund investment policies and
strategies to give investors a general sense of the Fund's levels of
investment. They are broadly identified with, but not limited to, the following
percentages of Fund total assets:
"small
portion"
|
less
than 10%
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"portion"
|
10%
to 25%
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"significant"
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25%
to 50%
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"substantial"
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50%
to 66%
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"primary"
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66%
to 80%
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"predominant"
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80%
or more
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If the Fund intends to limit particular
investments or strategies to no more than specific percentages of Fund assets,
the prospectus or SAI will clearly identify such limitations. The percentages
above are not limitations unless specifically stated as such in the Fund's
prospectus or elsewhere in this SAI.
The
Fund may invest in securities that are rated by various rating agencies such as
Moody's Investors Service (Moody's) and S&P® Global Ratings
(S&P®), as well as securities that are unrated.
For
purposes of the Fund’s investment policies, strategies and risks, the term
“investment manager” includes the Fund’s sub-advisor.
The
NAV and trading price of your shares in the Fund will increase as the value of
the investments owned by the Fund increases and will decrease as the value of
the Fund's investments decreases. In this way, you participate in any change in
the value of the investments owned by the Fund. In addition to the factors that
affect the value of any particular investment that the Fund owns, the NAV and
trading price of the Fund's shares may also change with movements in the
investment markets as a whole.
The
following is a description of various types of securities, instruments and
techniques that may be purchased and/or used by the Fund:
Asset-backed
securities
Asset-backed securities represent interests in a pool of loans,
leases or other receivables. The assets underlying asset-backed securities may
include receivables on home equity loans, credit card loans, and automobile,
mobile home and recreational vehicle loans and leases and other assets.
Asset-backed securities are often backed by a pool of assets representing the
obligations of a number of different parties and may have adjustable interest
rates that reset at periodic intervals.
The
credit quality of most asset-backed securities depends primarily on the credit
quality of the underlying assets, how well the issuers of the securities are
insulated from the credit risk of the originator or affiliated entities, and
the amount of credit support (if any) provided to the securities. Credit
support for asset-backed securities is intended to lessen the effect of
failures by obligors (such as individual borrowers or leasers) on the
underlying assets to make payments. Credit support generally falls into two categories:
(i) liquidity protection; and (ii) protection against losses from the default
by an obligor on the underlying assets.
Liquidity
protection refers to advances, generally provided by the entity administering
the pool of assets, intended to ensure that the receipt of payments due on the
underlying pool is timely. Protection against losses from the default by an
obligor can enhance the likelihood of payments of the obligations on at least
some of the assets in the pool. Protection against losses from default may be
provided through guarantees, insurance policies or letters of credit obtained
by the issuer or sponsor from third parties. Alternatively, this protection may
be provided through various means of structuring the transaction, or through a
combination of these approaches.
Examples
of credit support arising out of the structure of the transaction include
"senior subordinated securities" (securities with one or more classes
that are subordinate to the other classes with respect to the payment of principal
and interest, with the result that defaults on the underlying assets should be
borne first by the holders of the subordinated class), creation of
"reserve funds" (where cash or investments, sometimes funded from a
portion of the payments on the underlying assets, are held in reserve against
future losses), and "over-collateralization" (where the scheduled
payments on, or the principal amount of, the underlying assets exceeds that
required to make payments on the securities and pay any servicing or other
fees).
The
degree of credit support provided is generally based on historical information
about the level of credit risk associated with the underlying assets.
Historical information may not adequately reflect present or future credit
risk. Delinquencies or losses in excess of those anticipated could occur and
could adversely affect the return on an investment in the securities. There is
no guarantee that the type of credit support selected will be effective at
reducing the illiquidity or losses to investors in the event of certain
defaults. Where credit support is provided by a third party, the Fund will be
exposed to the credit risk of that third party in addition to the credit risk
of the issuer or sponsor of the asset-backed security and the underlying
obligors.
Asset-backed
securities also have risk due to a characteristic known as early amortization,
or early payout, risk. Built into the structure of certain asset-backed
securities are triggers for early payout, designed to protect investors from losses.
These triggers are unique to each transaction and can include, among other
things: a significant rise in defaults on the underlying loans, a sharp drop in the credit enhancement level, or the bankruptcy of
the issuer or sponsor. Once early amortization begins, all incoming loan
payments are used to pay investors as quickly as possible. Prepayment risk also
arises when the underlying obligations may be satisfied or "prepaid"
before due. Certain asset-backed securities backed by automobile receivables may
be affected by such early prepayment of principal on the underlying vehicle
sales contract. When amortization or prepayment occurs, the Fund may have to
reinvest the proceeds at a rate of interest that is lower than the rate on the
existing asset-backed security. In addition, the Fund may suffer a loss if it
paid a premium for the asset-backed security as cash flows from the early
amortization reduce the value of the premium paid.
Alternatively,
if prepayments occur at a slower rate than the investment manager expected, or
if payment on the underlying assets is delayed or defaulted upon, the Fund will
experience extension risk.
The
income received by the Fund on an asset-backed security generally fluctuates
more than the income on fixed income debt securities. This is because
asset-backed securities are usually structured as pass-through or pay-through
securities (similar to mortgage-backed securities and collateralized mortgage
obligations). Cash flow generated by payments on the underlying obligations in
these structures is shared with the investor as it is received. The rate of
payment on asset-backed securities generally depends on the rate of principal
and interest payments received on the underlying assets. Payments on underlying
assets will be affected by various economic and other factors that shape the
market for those underlying assets. Therefore, the income on asset-backed
securities will be difficult to predict, and actual yield to maturity will be
more or less than the anticipated yield to maturity.
Asset-backed
securities have certain risks that stem from the characteristics of the
underlying assets. For example, asset-backed securities do not have the benefit
of the same type of security interests in the underlying collateral that mortgage-backed
securities have, and there may be a limited ability to enforce any security
interests that exist. Credit enhancements provided to support asset-backed
securities, if any, may be inadequate to protect investors in the event of
default. For example, credit card receivables are generally unsecured and a
number of state and federal consumer credit laws give debtors the right to set
off certain amounts owed on the credit cards, thereby reducing the outstanding
balance, which can negatively affect the yield and/or value of related
asset-backed securities. Issuers of asset-backed securities for which
automobile receivables are the underlying assets may be prevented from
realizing the full amount due on an automobile sales contract because of state law
requirements and restrictions relating to sales of vehicles following their
repossession and the obtaining of deficiency judgments following such sales or
because of depreciation, damage or loss of a vehicle, the application of
bankruptcy and insolvency laws, or other factors. The absence of, or difficulty
enforcing, such security interests in the underlying assets may result in
additional expenses, delays and losses to the Fund. The Fund's exposure to the
credit risk of the credit support provider will also be greater if recourse is
limited to the credit support provider in the event of widespread defaults on
the underlying obligations.
Bank
obligations
Bank obligations include fixed, floating or variable rate
certificates of deposit (CDs), letters of credit, time and savings deposits,
bank notes and bankers' acceptances. CDs are negotiable certificates issued
against funds deposited in a commercial bank for a definite period of time and
earning a specified return. Time deposits are non-negotiable deposits that are
held in a banking institution for a specified period of time at a stated
interest rate. Savings deposits are deposits that do not have a specified
maturity and may be withdrawn by the depositor at any time. Bankers'
acceptances are negotiable drafts or bills of exchange normally drawn by an
importer or exporter to pay for specific merchandise. When a bank
"accepts" a bankers' acceptance, the bank, in effect, unconditionally
agrees to pay the face value of the instrument upon maturity. The full amount
of the Fund's investment in time and savings deposits or CDs may not be
guaranteed against losses resulting from the default of the commercial or
savings bank or other institution insured by the Federal Deposit Insurance
Corporation (FDIC).
Bank
obligations are exempt from registration with the SEC if issued by U.S. banks
or foreign branches of U.S. banks. As a result, the Fund will not receive the
same investor protections when investing in bank obligations as opposed to
registered securities. Bank notes and other unsecured bank obligations are not
guaranteed by the FDIC, so the Fund will be exposed to the credit risk of the
bank or institution. In the event of liquidation, bank notes and unsecured bank
obligations generally rank behind time deposits, savings deposits and CDs,
resulting in a greater potential for losses to the Fund.
The
Fund’s investments in bank obligations may be negatively impacted if adverse
economic conditions prevail in the banking industry (such as substantial losses
on loans, increases in non-performing assets and charge-offs and declines in
total deposits). The activities of U.S. banks and most foreign banks are
subject to comprehensive regulations which, in the case of U.S. regulations,
have undergone substantial changes in the past decade. The enactment of new
legislation or regulations, as well as changes in interpretation and
enforcement of current laws, may affect the manner of operations and
profitability of domestic and foreign banks.
Significant developments in the U.S. banking industry have included increased
competition from other types of financial institutions, increased acquisition
activity and geographic expansion. Banks may be particularly susceptible to
certain economic factors, such as interest rate changes and adverse
developments in the market for real estate. Fiscal and monetary policy and
general economic cycles can affect the availability and cost of funds, loan
demand and asset quality and thereby impact the earnings and financial
conditions of banks.
Borrowing The 1940
Act and the SEC's current rules, exemptions and interpretations thereunder,
permit the Fund to borrow up to one-third of the value of its total assets
(including the amount borrowed, but less all liabilities and indebtedness not represented
by senior securities) from banks. The Fund is required to maintain continuous
asset coverage of at least 300% with respect to such borrowings and to reduce
the amount of its borrowings (within three days excluding Sundays and holidays)
to restore such coverage if it should decline to less than 300% due to market
fluctuations or otherwise. In the event that the Fund is required to reduce its
borrowings, it may have to sell portfolio holdings, even if such sale of the
Fund's holdings would be disadvantageous from an investment standpoint.
If
the Fund makes additional investments while borrowings are outstanding, this
may be considered a form of leverage. Leveraging by means of borrowing may
exaggerate the effect of any increase or decrease in the value of portfolio
securities on the Fund's net asset value, and money borrowed will be subject to
interest and other costs (which may include commitment fees and/or the cost of
maintaining minimum average balances), which may or may not exceed the income
or gains received from the securities purchased with borrowed funds.
In
addition to borrowings that are subject to 300% asset coverage and are
considered by the SEC to be permitted "senior securities," the Fund
is also permitted under the 1940 Act to borrow for temporary purposes in an
amount not exceeding 5% of the value of its total assets at the time when the
loan is made. A loan will be presumed to be for temporary purposes if it is
repaid within 60 days and is not extended or renewed.
Segregation
of assets.
Consistent with SEC staff guidance, financial instruments that
involve the Fund's obligation to make future payments to third parties will not
be viewed as creating any senior security provided that the Fund covers its
obligations as described below. Those financial instruments can include, among
others, (i) securities purchased or sold on a when-issued, delayed delivery, or
to be announced basis, (ii) futures contracts, (iii) forward currency
contracts, (iv) swaps, (v) written options, (vi) unfunded commitments, (vii)
securities sold short, and (viii) reverse repurchase agreements.
Consistent
with SEC staff guidance, the Fund will consider its obligations involving such
a financial instrument as “covered” when the Fund (1) maintains an offsetting
financial position, or (2) segregates liquid assets (constituting cash, cash
equivalents or other liquid portfolio securities) equal to the Fund’s exposures
relating to the financial instrument, as determined on a daily basis. Dedicated
Fund compliance policies and procedures, which the Fund's board has approved,
govern the kinds of transactions that can be deemed to be offsetting positions
for purposes of (1) above, and the amounts of assets that need to be segregated
for purposes of (2) above (Asset Segregation Policies).
In
the case of forward currency contracts, the Fund may offset the contracts for
purposes of (1) above when the counterparties, terms and amounts match;
otherwise an appropriate amount of assets will be segregated consistent with
(2) above. Segregated assets for purposes of (2) above are not required to be
physically segregated from other Fund assets, but are segregated through
appropriate notation on the books of the Fund or the Fund’s custodian.
The
Fund’s Asset Segregation Policies may require the Fund to sell a portfolio
security or exit a transaction, including a transaction in a financial
instrument, at a disadvantageous time or price in order for the Fund to be able
to segregate the required amount of assets. If segregated assets decline in value,
the Fund will need to segregate additional assets or reduce its position in the
financial instruments. In addition, segregated assets may not be available to
satisfy redemptions or for other purposes, until the Fund’s obligations under
the financial instruments have been satisfied. In addition, the Fund’s ability
to use the financial instruments identified above may under some circumstances
depend on the nature of the instrument and amount of assets that the Asset
Segregation Policies require the Fund to segregate.
The
Asset Segregation Policies provide, consistent with current SEC staff
positions, that for futures and forward contracts that require only cash
settlement, and swap agreements that call for periodic netting between the Fund
and its counterparty, the segregated amount is the net amount due under the
contract, as determined daily on a mark-to-market basis. For other kinds of futures, forwards and swaps, the Fund must segregate a
larger amount of assets to cover its obligations, which essentially limits the
Fund’s ability to use these instruments. If the SEC staff changes its positions
concerning the segregation of the net amount due under certain forwards,
futures and swap contracts, the ability of the Fund to use the financial
instruments could be negatively affected.
Callable
securities
Callable securities give the issuer the right to redeem the
security on a given date or dates (known as the call dates) prior to maturity.
In return, the call feature is factored into the price of the debt security,
and callable debt securities typically offer a higher yield than comparable
non-callable securities. Certain securities may be called only in whole (the
entire security is redeemed), while others may be called in part (a portion of
the total face value is redeemed) and possibly from time to time as determined
by the issuer. There is no guarantee that the Fund will receive higher yields
or a call premium on an investment in callable securities.
The
period of time between the time of issue and the first call date, known as call
protection, varies from security to security. Call protection provides the
investor holding the security with assurance that the security will not be
called before a specified date. As a result, securities with call protection
generally cost more than similar securities without call protection. Call
protection will make a callable security more similar to a long-term debt
security, resulting in an associated increase in the callable security's
interest rate sensitivity.
Documentation
for callable securities usually requires that investors be notified of a call
within a prescribed period of time. If a security is called, the Fund will
receive the principal amount and accrued interest, and may receive a small
additional payment as a call premium. Issuers are more likely to exercise call
options in periods when interest rates are below the rate at which the original
security was issued, because the issuer can issue new securities with lower
interest payments. Callable securities are subject to the risks of other debt
securities in general, including prepayment risk, especially in falling
interest rate environments.
Collateralized
debt obligations
Collateralized debt obligations and similarly structured
securities, sometimes known generally as CDOs, are interests in a trust or
other special purpose entity (SPE) and are typically backed by a diversified
pool of bonds, loans or other debt obligations. CDOs are not limited to
investments in one type of debt and, accordingly, a CDO may be collateralized
by corporate bonds, commercial loans, asset-backed securities, residential
mortgage-backed securities, real estate investment trusts (REITs), commercial
mortgage-backed securities, emerging market debt, and municipal bonds. Certain
CDOs may use derivatives contracts, such as credit default swaps, to create
“synthetic” exposure to assets rather than holding such assets directly, which
entails the risks of derivative instruments described elsewhere in this SAI.
Common
varieties of CDOs include the following:
Collateralized
loan obligations.
Collateralized loan obligations (CLOs) are interests in a trust
typically collateralized substantially by a pool of loans, which may include,
among others, domestic and foreign senior secured loans, senior unsecured
loans, and subordinate corporate loans made to domestic and foreign borrowers,
including loans that may be rated below investment grade or equivalent unrated
loans.
Collateralized
bond obligations.
Collateralized bond obligations (CBOs) are interests in a trust
typically backed substantially by a diversified pool of high risk, below
investment grade fixed income securities.
Structured
finance CDOs.
Structured finance CDOs are interests in a trust typically backed
substantially by structured investment products such as asset-backed securities
and commercial mortgage-backed securities.
Synthetic
CDOs.
In contrast to CDOs that directly own the underlying debt
obligations, referred to as cash CDOs, synthetic CDOs are typically collateralized
substantially by derivatives contracts, such as credit default swaps, to create
“synthetic” exposure to assets rather than holding such assets directly, which
entails the risks of derivative instruments described elsewhere in this SAI,
principally counterparty risk.
CDOs
are similar in structure to collateralized mortgage obligations, described
elsewhere in this SAI. Unless the context indicates otherwise, the discussion
of CDOs below also applies to CLOs, CBOs and other similarly structured securities.
In CDOs, the cash flows from the SPE are split
into two or more portions, called tranches (or classes), that vary in risk and
yield. The riskiest portion is the “equity” tranche which bears the first loss
from defaults on the bonds or loans in the SPE and is intended to protect the
other, more senior tranches from severe, and potentially unforeseen, defaults
or delinquent collateral payments (though such protection is not complete).
Because they may be partially protected from defaults, senior tranches from a
CDO typically have higher ratings and lower yields than the underlying
collateral securities held by the trust, and may be rated investment grade.
Despite protection from the equity tranche, more senior tranches can
experience, and may have experienced in the past, substantial losses due to
actual defaults, increased sensitivity to defaults due to collateral default,
downgrades of the underlying collateral by rating agencies, forced liquidation
of a collateral pool due to a failure of coverage tests, disappearance of
protecting tranches, market anticipation of defaults, as well as a market
aversion to CDO securities as a class.
The
risks of an investment in a CDO depend largely on the type of collateral held
by the SPE and the tranche of the CDO in which the Fund invests. Investment
risk may also be affected by the performance of a CDO’s collateral manager (the
entity responsible for selecting and managing the pool of collateral securities
held by the SPE trust), especially during periods of market volatility.
Normally, CDOs are privately offered and sold, and thus, are not registered
under the securities laws and traded in a public market. As a result,
investments in CDOs may be characterized by the Fund as illiquid securities.
However, an active dealer market may exist for CDOs allowing the Fund to trade
CDOs with other qualified institutional investors under Rule 144A. To the
extent such investments are characterized as illiquid, they will be subject to
the Fund’s restrictions on investments in illiquid securities. The Fund’s
investment in unregistered securities such as CDOs will not receive the same
investor protection as an investment in registered securities.
All
tranches of CDOs, including senior tranches with high credit ratings, can experience,
and at times many have experienced, substantial losses due to actual defaults,
increased sensitivity to future defaults due to the disappearance of protecting
tranches, market anticipation of defaults, as well as market aversion to CDO
securities as a class. In the past, prices of CDO tranches have declined
considerably. The drop in prices was initially triggered by the subprime
mortgage crisis. Subprime mortgages make up a significant portion of the
mortgage securities that collateralize many CDOs. As floating interest rates
and mortgage default rates increased, the rating agencies that had rated the
mortgage securities and CDO transactions backed by such mortgages realized
their default assumptions were too low and began to downgrade the credit rating
of these transactions. There can be no assurance that additional losses of
equal or greater magnitude will not occur in the future.
In
addition to the normal risks associated with debt securities and asset backed
securities (e.g., interest rate risk, credit risk and default risk) described
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 quality of the
collateral may decline in value or quality or go into default or be downgraded;
(iii) the Fund may invest in tranches of a CDO that are subordinate to other
classes; and (iv) the complex structure of the security may not be fully
understood at the time of investment and may produce disputes with the issuer,
difficulty in valuing the security or unexpected investment results.
Certain
issuers of CDOs may be deemed to be “investment companies” as defined in the
1940 Act. As a result, the Fund’s investment in these structured investments
from these issuers may be limited by the restrictions contained in the 1940
Act. CDOs generally charge management fees and administrative expenses that the
shareholders of the Fund would pay indirectly.
Convertible
securities
A convertible security is generally a debt obligation, preferred
stock or other security that may be converted within a specified period of time
into a certain amount of common stock of the same or of a different issuer. The
conversion may occur at the option of the investor in or issuer of the
security, or upon a predetermined event. A convertible security typically
provides a fixed-income stream and the opportunity, through its conversion
feature, to participate in the capital appreciation resulting from a market
price advance in its underlying common stock. As with a straight fixed-income
security, a convertible security tends to increase in market value when
interest rates decline and decrease in value when interest rates rise. Like a
common stock, the value of a convertible security also tends to increase as the
market value of the underlying stock rises, and it tends to decrease as the
market value of the underlying stock declines. Because both interest rate and
market movements can influence its value, a convertible security is usually not
as sensitive to interest rate changes as a similar fixed-income security, nor
is it as sensitive to changes in share price as its underlying stock.
Convertible securities are also subject to risks that affect debt securities in
general.
Although
less than an investment in the underlying stock, the potential for gain on an
investment in a convertible security is greater than for similar
non-convertible securities. As a result, a lower yield is generally offered on
convertible securities than on otherwise equivalent
non-convertible securities. There is no guarantee that the Fund will realize
gains on a convertible security in excess of the foregone yield it accepts to
invest in such convertible security.
A
convertible security is usually issued either by an operating company or by an
investment bank. When issued by an operating company, a convertible security
tends to be senior to the company's common stock, but may be subordinate to
other types of fixed-income securities issued by that company. When a
convertible security issued by an operating company is "converted,"
the operating company often issues new stock to the holder of the convertible
security. However, if the convertible security is redeemable and the parity
price of the convertible security is less than the call price, the operating
company may pay out cash instead of common stock.
If
the convertible security is issued by an investment bank or other sponsor, the
security is an obligation of and is convertible through, the issuing investment
bank. However, the common stock received upon conversion is of a company other
than the investment bank or sponsor. The issuer of a convertible security may
be important in determining the security's true value. This is because the
holder of a convertible security will have recourse only to the issuer.
Contingent
convertible securities (CoCos). A contingent convertible security, or
CoCo, is a hybrid debt security typically issued by a non-U.S. bank that, upon
the occurrence of a specified trigger event, may be (i) convertible into equity
securities of the issuer at a predetermined share price; or (ii) written down
in liquidation value. Trigger events are identified in the documents that
govern the CoCo and may include a decline in the issuer’s capital below a
specified threshold level, an 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, such as a change in regulatory
capital requirements. CoCos are designed to behave like bonds in times of
economic health yet absorb losses when the trigger event occurs.
With
respect to CoCos that provide for conversion of the CoCo into common shares of the
issuer in the event of a trigger event, the conversion would deepen the
subordination of the investor, subjecting the Fund to a greater risk of loss in
the event of bankruptcy. In addition, because the common stock of the issuer
may not pay a dividend, investors in such instruments could experience reduced
yields (or no yields at all). With respect to CoCos that provide for the write
down in liquidation value of the CoCo in the event of a trigger event, it is
possible that the liquidation value of the CoCo may be adjusted downward to
below the original par value or written off entirely under certain
circumstances. For instance, if losses have eroded the issuer’s capital levels
below a specified threshold, the liquidation value of the CoCo may be reduced in
whole or in part. The write-down of the CoCo’s par value may occur
automatically and would not entitle holders to institute bankruptcy proceedings
against the issuer. In addition, an automatic write-down could result in a
reduced income rate if the dividend or interest payment associated with the
CoCo is based on par value. Coupon payments on CoCos may be discretionary and
may be cancelled by the issuer for any reason or may be subject to approval by
the issuer’s regulator and may be suspended in the event there are insufficient
distributable reserves.
CoCos
are subject to the credit, interest rate, high yield securities, foreign
securities and market risks associated with bonds and equity securities, and to
the risks specific to convertible securities in general. They are also subject
to other specific risks. CoCos typically are structurally subordinated to
traditional convertible bonds in the issuer’s capital structure, which
increases the risk that the Fund may experience a loss. In certain scenarios, investors
in CoCos may suffer a loss of capital ahead of equity holders or when equity
holders do not. CoCos are generally speculative and the prices of CoCos may be
volatile. There is no guarantee that the Fund will receive return of principal
on CoCos.
Convertible
preferred stock.
A convertible preferred stock is usually treated like a preferred
stock for the Fund's financial reporting, credit rating and investment policies
and limitations purposes. A preferred stock is subordinated to all debt obligations
in the event of insolvency, and an issuer's failure to make a dividend payment
is generally not an event of default entitling the preferred shareholder to
take action. A preferred stock generally has no maturity date, so that its
market value is dependent on the issuer's business prospects for an indefinite
period of time. Distributions from preferred stock are dividends, rather than
interest payments, and are usually treated as such for tax purposes.
Investments in convertible preferred stock, as compared to the debt obligations
of an issuer, generally increase the Fund's exposure to the credit risk of the
issuer and market risk generally, because convertible preferred stock will fare
more poorly if the issuer defaults or markets suffer.
Enhanced
convertible securities. In addition to “plain vanilla” convertible
securities, a number of different structures have been created to fit the
characteristics of specific investors and issuers. Examples of these features
include yield enhancement, increased equity exposure or enhanced downside
protection. From an issuer’s perspective, enhanced structures are designed to meet balance sheet criteria, maximize interest/dividend
payment deductibility and reduce equity dilution. Examples of enhanced
convertible securities include mandatory convertible securities, convertible
trust preferred securities, exchangeable securities, and zero coupon and deep
discount convertible bonds.
Risks. An
investment in a convertible security may involve risks. The Fund may have
difficulty disposing of such securities because there may be a thin trading
market for a particular security at any given time. Reduced liquidity may have
an adverse impact on market price and the Fund's ability to dispose of a
security when necessary to meet the Fund's liquidity needs or in response to a
specific economic event, such as the deterioration in the creditworthiness of
an issuer. Reduced liquidity in the secondary market for certain securities may
also make it more difficult for the Fund to obtain market quotations based on
actual trades for purposes of valuing the Fund's portfolio. Although the Fund
intends to acquire convertible securities that the investment manager considers
to be liquid (i.e., those securities that the investment manager determines may
be sold on an exchange, or an institutional or other substantial market), there
can be no assurances that this will be achieved. Certain securities and markets
can become illiquid quickly, resulting in liquidity risk for the Fund. The Fund
will also encounter difficulty valuing convertible securities due to
illiquidity or other circumstances that make it difficult for the Fund to
obtain timely market quotations based on actual trades for convertible
securities. Convertible securities may have low credit ratings, which generally
correspond with higher credit risk to an investor like the Fund.
Synthetic
convertible securities. A synthetic convertible is created by combining
distinct securities that together possess the two principal characteristics of
a true convertible security, i.e., fixed income payments in the form of
interest or dividends and the right to acquire the underlying equity security.
This combination is achieved by investing in nonconvertible debt securities and
in warrants or stock or stock index call options which grant the holder the
right to purchase a specified quantity of securities within a specified period
of time at a specified price (or to receive cash, in the case of stock index
options). Synthetic convertibles are typically offered by financial
institutions and investment banks in private placement transactions. Upon
conversion, the Fund generally receives an amount in cash equal to the
difference between the conversion price and the then-current value of the underlying
security. Synthetic convertible instruments may also include structured notes,
equity-linked notes, mandatory convertibles and combinations of securities and
instruments.
In
addition to the general risks of convertible securities and the special risks
of enhanced convertible securities, there are risks unique to synthetic
convertible securities. Synthetic convertible securities differ from true
convertible securities in several respects. The value of a synthetic
convertible security is the sum of the values of its debt security component
and its convertibility component. Thus, the values of a synthetic convertible
and a true convertible security will respond differently to market
fluctuations. Although the investment manager expects normally to create synthetic
convertible securities whose two components provide exposure to the same
issuer, the character of a synthetic convertible allows the Fund to combine
components representing distinct issuers, or to combine a debt security with a
call option on a stock index. In addition, the component parts of a synthetic
convertible security may be purchased simultaneously or separately; and the
holder of a synthetic convertible faces the risk that the price of the stock,
or the level of the market index underlying the convertibility component will
decline. Exposure to more than one issuer or participant will increase the
number of parties upon which the investment depends and the complexity of that
investment and, as a result, increase the Fund’s credit risk and valuation risk.
Corporate
Loans, Assignments and Participations
Corporate
loans.
Corporate loans typically are structured and negotiated by a
group of financial institutions and other investors, including in some cases,
the Fund, that provide capital to the borrowers. In return, the borrowers pay
interest and repay the loan's principal. Such corporate loans often pay
interest rates that are reset periodically on the basis of a floating base
lending rate, such as the London Interbank Offered Rate (LIBOR) plus a premium.
The Fund may invest in corporate loans directly at the time of the loan's
closing or by buying an assignment of all or a portion of the corporate loan
from a lender. The Fund may also invest indirectly in a corporate loan by
buying a loan participation from a lender or other purchaser of a
participation. Corporate loans may include term loans and, to the extent
permissible for the Fund, revolving credit facilities, prefunded letters of
credit term loans, delayed draw term loans and receivables purchase facilities.
With
LIBOR expected to be discontinued by the end of 2021, the loan market will
undergo a significant change in the benchmark that forms a key component of
loan returns. Concerted industry efforts are underway to identify and establish
a replacement rate to LIBOR. At this point, it is unclear what form this
replacement rate will take, and whether it will mirror the risk and return
profile of LIBOR. While this work is ongoing, agent banks have included
provisions in documents in the current market that allow them to replace the
rate with less or no affirmative consent from lenders, which could potentially
change the income that investors receive.
The Fund limits the amount of total assets that
it will invest in any one issuer. For purposes of these limitations, the Fund
generally will treat the borrower as the "issuer" of indebtedness
held by the Fund. In loan participations, a bank or other lending institution
serves as financial intermediary between the Fund and the borrower, the participation
may not shift to the Fund the direct debtor-creditor relationship with the
borrower. In this case, SEC interpretations require the Fund, in appropriate
circumstances, to treat both the lending bank or other lending institution and
the borrower as "issuers" for these purposes. Treating a financial
intermediary as an issuer of indebtedness may restrict the Fund's ability to
invest in indebtedness related to a single financial intermediary, or
intermediaries engaged in the same industry, even if the underlying borrowers
represent different companies and industries.
Negotiation
and administration of loans. Each type of corporate loan in
which the Fund may invest typically is structured by a group of lenders and
other investors. This means that the lenders and other investors, which may
include other Franklin Templeton funds and accounts, participate in the
negotiations with the corporate borrower and in the drafting of the terms of
the corporate loan. The group of lenders and other investors often consists of
commercial banks, thrift institutions, insurance companies, finance companies,
other financial institutions, or in some cases other investors, including
investment companies such as the Fund. Typically, the Fund will not act as the
sole negotiator or sole investor for a corporate loan. One or more of the
lenders usually administers the corporate loan on behalf of all the lenders and
other investors; this lender is referred to as the Agent Bank.
Three
ways to invest in corporate loans. The Fund may invest in corporate
loans in any of three ways. The Fund may: (i) make a direct investment by
purchasing an assignment of part or all of a corporate loan; (ii) make an
indirect investment by purchasing a participation interest in a corporate loan;
or (iii) make a direct investment in a corporate loan by participating as one
of the initial investors. Participation interests are interests sold by a
lender or other holders of participation interests, which usually represent a
fractional interest in a corporate loan. An assignment represents a direct
interest in a corporate loan or portion of a corporate loan previously owned by
a different investor. Unlike where the Fund purchases a participation interest,
the Fund will generally become an investor for the purposes of the relevant
corporate loan agreement by purchasing an assignment.
1. Assignments of corporate loans. If the Fund
purchases an assignment of a corporate loan, the Fund will assume the position
of the original investor. The Fund will have the right to receive payments
directly from the corporate borrower and to enforce its contractual rights directly
against the corporate borrower. The purchase may be made at a discount to par.
This means that the Fund receives a return at the full interest rate for the
corporate loan rather than a discounted rate.
2. Participation interests in corporate
loans.
In contrast to the purchase of an assignment, if the Fund purchases a
participation interest either from a lender or a participant, the Fund
typically will have established a direct contractual relationship with the
seller of the participation interest, but not with the corporate borrower.
Consequently, the Fund is subject to the credit risk of the lender or
participant who sold the participation interest to the Fund, in addition to the
usual credit risk of the corporate borrower. Therefore, when the Fund considers
an investment in corporate loans through the purchase of participation
interests, its investment manager will take into account the creditworthiness
of the Agent Bank and any lenders and participants interposed between the Fund
and the corporate borrower. These parties are referred to as Intermediate
Participants. Additionally, the Fund will consider that there may be
limitations on the Fund's ability to vote on amendments to the borrower's
underlying loan agreement.
3. Direct investments in corporate loans. When the Fund
invests as an initial investor in a new corporate loan, the investment may be
made at a discount to par. This means that the Fund receives a return at the
full interest rate for the corporate loan, which incorporates the discount.
Because
secondary purchases of loans may be made at par, at a premium from par or at a
discount from par, the Fund's return on such an investment may be lower or
higher than it would have been if the Fund had made a direct initial
investment. While loan participations generally trade at a discount, the Fund
may buy participations trading at par or at a premium. At certain times when
reduced opportunities for direct initial investment in corporate loans may
exist, however, the Fund may be able to invest in corporate loans only through
participation interests or assignments.
Loan
participations.
Loan participations may enable the Fund to acquire an interest in
a corporate loan from a borrower, which it could not do directly. Because the
Fund establishes a direct contractual relationship with the lender or
Participant, the Fund is subject to the credit risk of the lender or
Participant in addition to the usual credit risk of the corporate borrower and
any Agent Bank. Under normal market conditions, loan participations that sell
at a discount to the secondary loan price may indicate the borrower
has credit problems or other issues associated with the credit risk of the
loan. To the extent the credit problems are resolved, loan participations may
appreciate in value.
In
the event the corporate borrower fails to pay principal and interest when due,
the Fund may have to assert rights against the borrower through an Intermediate
Participant. This may subject the Fund to delays, expenses and risks that are
greater than those that would be involved if the Fund could enforce its rights
directly against the corporate borrower. Also, in the event of the insolvency
of the lender or Intermediate Participant who sold the participation interest
to the Fund, the Fund may not have any exclusive or senior claim with respect
to the lender's interest in the corporate loan, or in the collateral securing
the corporate loan. Consequently, the Fund might not benefit directly from the
collateral supporting the underlying corporate loan. If the Intermediate
Participant becomes insolvent, payments of principal and/or interest may be
held up or not paid by such Participant or such Participant may not have the
resources to assert its and the Fund's rights against the corporate borrower. Similar
risks may arise with respect to the Agent Bank.
Obligations
to make future advances. Certain revolving credit facility corporate
loans (revolvers) and some types of delayed draw loans require that the lenders
and other investors, including the Fund, and Intermediate Participants make
future advances to the corporate borrower at the demand of the borrower. Other
continuing obligations may also exist pursuant to the terms of these types of
corporate loans. If the Fund's future obligations are not met for any reason,
including the failure of an Intermediate Participant to fulfill its
obligations, the Fund's interests may be harmed.
Delayed
draw term loans.
Delayed draw term loans have characteristics of both revolvers
and term loans, in that, before they are drawn upon by the borrower, they are
similar to a revolver; however when they are drawn upon, they become fully and
permanently drawn and are in essence term loans. Upon funding, when a loan is
drawn upon, the loan becomes permanently funded, repaid principal amounts may
not be reborrowed and interest accrues on the amount outstanding. The borrower
pays a fee during the commitment period. Because these loans involve forward
obligations, they are subject to the Fund's asset segregation policies.
Prefunded
L/C term loan.
A prefunded L/C term loan (Pre L/C Loan) is sometimes referred to
as a funded letter of credit facility. For these loans, the Agent Bank (or
another bank) issues letters of credit (each letter, an L/C) to guarantee the
repayment of the borrowings by the borrower, as the ultimate debtor under these
loans. Each lender or other investor, such as the Fund, transfers to the Agent
Bank the amount of money the lender or other investor, has committed under the
Pre L/C Loan agreement. The Agent Bank holds the monies solely to satisfy the
lenders' or other investors' obligations under the loan agreement.
Whenever
the borrower needs funds, it draws against the Pre L/C Loan. Consequently, the
lenders or other investors do not have to advance any additional monies at the
time the borrower draws against the Pre L/C Loan. To the extent that the
borrower does not draw down these monies as borrowings during the term of the
Pre L/C Loan, the Agent Bank invests these monies as deposits that pay
interest, usually approximating a benchmark rate, such as LIBOR. This interest
is paid to the borrower. Generally, the borrower, via the Agent Bank, pays the
lenders or other investors interest at a rate equivalent to the fully drawn
spread plus a benchmark rate, usually LIBOR. The borrower pays this interest
during the term of the loan whether or not the borrower borrows monies from the
amounts held and invested by the Agent Bank. The principal and any unpaid
accrued interest will be returned to the lenders and other investors upon
termination of the Pre L/C loan (and upon satisfaction of all obligations).
The
risks of investing in corporate loans include all the general risks of
investing in debt securities. For example, investments in corporate loans are
exposed to the credit risk of the borrowing corporation and any Intermediate
Participants, the valuation risk of pricing corporate loans and collateral, and
the illiquidity risk associated with holding unregistered, non-exchange traded
securities. There are also additional risks associated with an investment in
corporate loans, including those described below.
Additional
credit risks.
Corporate loans may be issued in leveraged or highly leveraged
transactions (such as mergers, acquisitions, consolidations, liquidations,
spinoffs, reorganizations or financial restructurings), or involving distressed
companies or those in bankruptcy (including debtor-in-possession transactions).
This means that the borrower is assuming large amounts of debt in order to have
large amounts of financial resources to attempt to achieve its business
objectives; there is no guarantee, however, that the borrower will achieve its
business objectives. Loans issued in leveraged or highly leveraged transactions
are subject to greater credit risks than other loans, including an increased
possibility that the borrower might default or go into bankruptcy.
Insufficient collateral. The
terms of most senior secured corporate loans and corporate debt securities in
which the Fund invests generally provide that the collateral provided by the
corporate borrower have a fair market value at least equal to 100% of the
amount of such corporate loan at the time of the loan. The investment manager
generally will determine the value of the collateral by customary valuation
techniques that it considers appropriate. The collateral may consist of various
types of assets or interests including working capital assets, such as accounts
receivable or inventory, tangible fixed assets, such as real property,
buildings and equipment, tangible or intangible assets, such as trademarks,
copyrights and patent rights, or security interests in securities of
subsidiaries or affiliates. The borrower's owners or other parties may provide
additional security.
The
Fund may encounter difficulty valuing the collateral, especially less tangible
assets. The value of the collateral may decline following investment by the
Fund in the corporate loan. Also, collateral may be difficult to sell or
liquidate and insufficient in the event of a default. Consequently, there can
be no assurance that the liquidation of any collateral securing a corporate
loan would satisfy the borrower's obligation in the event of nonpayment of
scheduled interest or principal payments, or that such collateral could be
readily liquidated. In the event of bankruptcy of a borrower, the Fund could
experience delays or limitations with respect to its ability to realize the
benefits of any collateral securing a corporate loan. Collateral securing a
corporate loan may lose all or substantially all of its value in the event of
bankruptcy of a borrower. Some corporate loans are subject to the risk that a
court, pursuant to fraudulent conveyance or other similar laws, could order
currently existing or future indebtedness of the corporate borrower to be paid
ahead of the corporate loans. This order could make repayment of the corporate
loans in part or in full less likely. The court could take other action
detrimental to the holders of the corporate loans including, in certain
circumstances, invalidating such corporate loans or causing interest previously
paid to be refunded to the borrower.
Potential
lack of investor protections under federal and state securities laws. If a
corporate loan purchased by the Fund is not considered to be a “security,” the
Fund will not receive the same investor protections with respect to such
investment that are available to purchasers of investments that are considered
“securities” under federal and state securities laws, including any lack of
recourse against an underwriter.
Lack
of publicly available information and ratings. Many
corporate loans in which the Fund may invest may not be rated by a rating
agency, will not be registered with the SEC or any state securities commission
and will not be listed on any national securities exchange. The amount of
public information available with respect to corporate loans will generally be
less than that available for registered or exchange listed securities. In
evaluating the creditworthiness of borrowers, the investment manager may
consider, and may rely in part, on analyses performed by others. Corporate
loans held by the Fund directly or as a participation interest or assignment of
the loan may be assigned ratings below investment grade by a rating agency, or
be unrated but judged by the investment manager to be of comparable quality.
Non-public
information and limitations on its use. From time to time, the
investment manager may elect to receive material non-public information (MNPI)
about an individual loan that is not available to other lenders of such loan
who may be unwilling to enter into a non-disclosure agreement (NDA) with the
borrower or company and restrict themselves from trading in the loan for a
specified period of time. If the Fund elects to become restricted on any
individual loan as a result of agreeing to receive MNPI about the loan and
signing an NDA, such loan will be deemed illiquid and the Fund might be unable
to enter into a transaction in a security of that borrower until the MNPI is
made public, when it would otherwise be advantageous to do so.
Liquidity
of corporate loans.
The investment manager generally considers corporate loans, loan
participations and assignments of corporate loans to be liquid. To the extent
such investments are deemed to be liquid by the investment manager, they will
not be subject to the Fund's restrictions on investments in illiquid securities.
Generally, a liquid market with institutional buyers exists for such interests.
The investment manager monitors each type of loan and/or loan interest in which
the Fund is invested to determine whether it is liquid consistent with the
liquidity procedures adopted by the Fund.
No
active trading market may exist for some corporate loans and some corporate
loans may be subject to restrictions on resale. A secondary market in corporate
loans may be subject to irregular trading activity, wide bid/ask spreads and
extended trade settlement periods (sometimes longer than seven days), which may
impair the ability to accurately value existing and prospective investments and
to realize in a timely fashion the full value on sale of a corporate loan. In
addition, the Fund may not be able to readily sell its corporate loans at
prices that approximate those at which the Fund could sell such loans if they
were more widely held and traded. As a result of such potential illiquidity,
the Fund may have to sell other investments or engage in borrowing transactions
if necessary to raise cash to meet its obligations.
Risks based on Agent Banks and/or Intermediate
Participants.
The Agent Bank typically administers the corporate loan. The
Agent Bank typically is responsible for collecting principal, interest and fee
payments from the corporate borrower. The Agent Bank then distributes these
payments to all lenders and other investors that are parties to the corporate
loan or own participation interests therein. The Fund will not act as an Agent
Bank under normal circumstances. The Fund generally will rely on the Agent Bank
or an Intermediate Participant to collect its portion of the payments. The Fund
will also rely on the Agent Bank to take appropriate actions against a corporate
borrower that is not making payments as scheduled. Typically, the Agent Bank is
given broad discretion in enforcing the terms of the corporate loan, and is
required to use only the same care it would use in the management of its own
property. The corporate borrower compensates the Agent Bank for these services
and this could create an incentive for the Agent Bank to exercise its
discretion to the advantage of the corporate borrower to a greater extent than
might otherwise be the case. Such compensation may include special fees paid at
the start of corporate loans and fees paid on a continuing basis for ongoing
services.
In
the event that a corporate borrower becomes bankrupt or insolvent, the borrower
may attempt to assert certain legal defenses as a result of improper conduct by
the Agent Bank or Intermediate Participant. Asserting the Fund's legal rights
against the Agent Bank or Intermediate Participant could be expensive and
result in the delay or loss to the Fund of principal and/or interest payments.
There
is a risk that an Agent Bank may have financial difficulty. An Agent Bank could
even declare bankruptcy, or have a receiver, conservator, or similar official
appointed for it by a regulatory authority. If this happens, assets held by the
Agent Bank under the corporate loan should remain available to holders of
corporate loans, including the Fund. However, a regulatory authority or court
may determine that assets held by the Agent Bank for the benefit of the Fund
are subject to the claims of the Agent Bank's general or secured creditors. The
Fund might incur costs and delays in realizing payment on a corporate loan or
might suffer a loss of principal or interest. Similar risks arise in situations
involving Intermediate Participants, as described above.
Covenants. The
borrower or issuer under a corporate loan or debt security generally must
comply with various restrictive covenants contained in any corporate loan
agreement between the borrower and the lending syndicate or in any trust
indenture or comparable document in connection with a corporate debt security.
A restrictive covenant is a promise by the borrower to take certain actions
that protect, or not to take certain actions that may impair, the rights of
lenders. These covenants, in addition to requiring the scheduled payment of
interest and principal, may include restrictions on dividend payments and other
distributions to shareholders, provisions requiring the borrower to maintain
specific financial ratios or relationships regarding, and/or limits on, total
debt. In addition, a covenant may require the borrower to prepay the corporate
loan or corporate debt security with any excess cash flow. Excess cash flow
generally includes net cash flow (after scheduled debt service payments and
permitted capital expenditures) as well as the proceeds from asset dispositions
or sales of securities. A breach of a covenant (after giving effect to any cure
period) in a corporate loan agreement which is not waived by the Agent Bank and
the lending syndicate normally is an event of acceleration. This means that the
Agent Bank has the right to demand immediate repayment in full of the
outstanding corporate loan. Acceleration may also occur in the case of the
breach of a covenant in a corporate debt security document. If acceleration
occurs and the Fund receives repayment before expected, the Fund will
experience prepayment risk.
Covenants
and covenant lite loans and debt securities. Some covenant lite loans
may be in the market from time to time which tend to have fewer or no financial
maintenance covenants and restrictions. A covenant lite loan typically contains
fewer clauses which allow an investor to proactively enforce financial
covenants or prevent undesired actions by the borrower/issuer. Covenant lite
loans also generally provide fewer investor protections if certain criteria are
breached. The Fund may experience losses or delays in enforcing its rights on
its holdings of covenant lite loans.
Credit-linked
notes
Credit-linked notes (CLNs) are typically set-up as a
“pass-through” note structure created by a broker or bank as an alternative
investment for funds or other purchasers to directly buying a bond or group of
bonds. CLNs are typically issued at par, with a one to one relationship with
the notional value to the underlying bond(s). The performance of the CLN,
however, including maturity value, is linked to the performance of the
specified underlying bond(s) as well as that of the issuing entity. In addition
to the risk of loss of its principal investment, the Fund bears the risk that
the issuer of the CLN will default or become bankrupt. In such an event, the
Fund may have difficulty being repaid, or fail to be repaid, the principal
amount of its investment. A downgrade or impairment to the credit rating of the
issuer will also likely impact negatively the price of the CLN, regardless of
the price of the bond(s) underlying the CLNs. A CLN is typically structured as
a limited recourse, unsecured obligation of the issuer of such security such
that the security will usually be the obligation solely of the issuer and will
not be an obligation or responsibility of any other person, including the
issuer of the underlying bond(s).
Most CLNs are structured as Rule 144A
securities so that they may be freely traded among institutional buyers.
However, the market for CLNs may be, or suddenly can become, illiquid. The
other parties to the transaction may be the only investors with sufficient
understanding of the CLN to be interested in bidding for it. Changes in
liquidity may result in significant, rapid and unpredictable changes in the
prices of CLNs. In certain cases, a market price for a CLN may not be available
or may not be reliable, and the Fund could experience difficulty in selling
such security at a price the investment manager believes is fair.
Credit-linked
securities
Credit-linked securities, which may be considered to be a type of
structured investment, are debt securities that represent an interest in a pool
of, or are otherwise collateralized by, one or more corporate debt obligations
or credit default swaps on corporate debt or bank loan obligations. Such debt
obligations may represent the obligations of one or more corporate issuers. The
Fund has the right to receive periodic interest payments from the issuer of the
credit-linked security (usually the seller of the underlying credit default
swap(s)) at an agreed-upon interest rate, and a return of principal at the
maturity date. The Fund bears the risk of loss of its principal investment, and
the periodic interest payments expected to be received for the duration of its
investment in the credit-linked security, in the event that one or more of the
debt obligations underlying bonds or debt obligations underlying the credit
default swaps go in to default or otherwise become non-performing. Upon the
occurrence of such a credit event (including bankruptcy, failure to timely pay
interest or principal, or a restructuring) with respect to an underlying debt
obligation (which may represent a credit event of one or more underlying
obligors), the Fund will generally reduce the principal balance of the related
credit-linked security by the Fund's pro rata interest in the par amount of the
defaulted underlying debt obligation in exchange for the actual value of the
defaulted underlying obligation or the defaulted underlying obligation itself,
thereby causing the Fund to lose a portion of its investment. As a result, on
an ongoing basis, interest on the credit-linked security will accrue on a
smaller principal balance and a smaller principal balance will be returned at
maturity. To the extent a credit-linked security represents an interest in
underlying obligations of a single corporate issuer, a credit event with respect
to such issuer presents greater risk of loss to the Fund than if the
credit-linked security represented an interest in underlying obligations of
multiple corporate issuers.
In
addition, the Fund bears the risk that the issuer of the credit-linked security
will default or become bankrupt. In such an event, the Fund may have difficulty
being repaid, or fail to be repaid, the principal amount of its investment and
the remaining periodic interest payments thereon.
An
investment in credit-linked securities also involves reliance on the
counterparty to the swap entered into with the issuer to make periodic payments
to the issuer under the terms of the credit default swap. Any delay or
cessation in the making of such payments may be expected in certain instances to
result in delays or reductions in payments to the Fund as an investor in such
credit-linked securities. Additionally, credit-linked securities are typically
structured as limited recourse obligations of the issuer of such securities
such that the securities issued will usually be obligations solely of the
issuer and will not be obligations or responsibilities of any other person.
Most
credit-linked securities are structured as Rule 144A securities so that they
may be freely traded among institutional buyers. The Fund will generally only
purchase credit-linked securities which are determined to be liquid in
accordance with the Fund's liquidity guidelines. However, the market for
credit-linked securities may be, or suddenly can become, illiquid. The other parties
to the transaction may be the only investors with sufficient understanding of
the securities to be interested in bidding for them. Changes in liquidity may
result in significant, rapid and unpredictable changes in the prices for
credit-linked securities. In certain cases, a market price for a credit-linked
security may not be available or may not be reliable, and the Fund could
experience difficulty in selling such security at a price the investment
manager believes is fair. In the event a credit-linked security is deemed to be
illiquid, the Fund will include such security in calculating its limitation on
investments in illiquid securities.
The
value of a credit-linked security will typically increase or decrease with any
change in value of the underlying debt obligations, if any, held by the issuer
and the credit default swap. Further, in cases where the credit-linked security
is structured such that the payments to the Fund are based on amounts received
in respect of, or the value of performance of, any underlying debt obligations
specified in the terms of the relevant credit default swap, fluctuations in the
value of such obligation may affect the value of the credit-linked security.
The
collateral of a credit-linked security may be one or more credit default swaps,
which are subject to additional risks.
Debt
securities - general description In general, a debt security
represents a loan of money to the issuer by the purchaser of the security. A
debt security typically has a fixed payment schedule that obligates the issuer
to pay interest to the lender and to return the
lender's money over a certain time period. A company typically meets its
payment obligations associated with its outstanding debt securities before it
declares and pays any dividend to holders of its equity securities. Bonds,
notes and commercial paper are examples of debt securities and differ in the
length of the issuer's principal repayment schedule, with bonds carrying the
longest repayment schedule and commercial paper the shortest:
Bonds. A bond
is a debt security in which investors lend money to an entity that borrows for
a defined period of time, usually a period of more than five years, at a
specified interest rate.
Commercial
paper.
Commercial paper is an unsecured, short-term loan to a
corporation, typically for financing accounts receivable and inventory with
maturities of up to 270 days.
Debentures. A
debenture is an unsecured debt security backed only by the creditworthiness of
the borrower, not by collateral.
Bills. A bill
is a short-term debt instrument, usually with a maturity of two years or less.
Notes. A note
is a debt security usually with a maturity of up to ten years.
For
purposes of the discussion in this SAI of the risks of investing in debt
securities generally, loans or other short-term instruments, which otherwise
may not technically be considered securities, are included.
Debt
securities are all generally subject to interest rate, credit, income and
prepayment risks and, like all investments, are subject to liquidity and market
risks to varying degrees depending upon the specific terms and type of
security. The Fund's investment manager attempts to reduce credit and market
risk through diversification of the Fund's portfolio and ongoing credit
analysis of each issuer, as well as by monitoring economic developments, but
there can be no assurance that it will be successful at doing so.
Defaulted
debt securities
If the issuer of a debt security in the Fund's portfolio
defaults, the Fund may have unrealized losses on the security, which may lower
the Fund's net asset value. Defaulted securities tend to lose much of their
value before they default. Thus, the Fund's net asset value may be adversely
affected before an issuer defaults. The Fund will incur additional expenses if
it tries to recover principal or interest payments on a defaulted security.
Defaulted debt securities often are illiquid. An investment in defaulted debt
securities will be considered speculative and may expose the Fund to similar
risks as an investment in high-yield debt.
The
Fund may not buy defaulted debt securities. However, the Fund is not required
to sell a debt security that has defaulted if the investment manager believes
it is advantageous to continue holding the security.
Derivative
instruments
Generally, derivatives are financial instruments whose value
depends on or is derived from, the value of one or more underlying assets,
reference rates, or indices or other market factors (a "reference
instrument") and may relate to stocks, bonds, interest rates, credit,
currencies, commodities or related indices. Derivative instruments can provide
an efficient means to gain or reduce exposure to the value of a reference
instrument without actually owning or selling the instrument. Some common types
of derivatives include options, futures, forwards and swaps.
Derivative
instruments may be used for “hedging,” which means that they may be used when
the investment manager seeks to protect the Fund's investments from a decline
in value resulting from changes to interest rates, market prices, currency
fluctuations or other market factors. Derivative instruments may also be used
for other purposes, including to seek to increase liquidity, provide efficient
portfolio management, broaden investment opportunities (including taking short
or negative positions), implement a tax or cash management strategy, gain
exposure to a particular security or segment of the market, modify the
effective duration of the Fund's portfolio investments and/or enhance total
return. However derivative instruments are used, their successful use is not
assured and will depend upon, among other factors, the investment manager's
ability to gauge relevant market movements.
Derivative
instruments may be used for purposes of direct hedging. Direct hedging means
that the transaction must be intended to reduce a specific risk exposure of a
portfolio security or its denominated currency and must also be directly
related to such security or currency. The Fund’s use
of derivative instruments may be limited from time to time by policies adopted
by the board of trustees or the Fund’s investment manager.
Because
some derivative instruments used by the Fund may oblige the Fund to make
payments or incur additional obligations in the future, the SEC requires
investment companies to “cover” or segregate liquid assets equal to the
potential exposure created by such derivatives. The obligation to cover or
segregate such assets is described more fully under "Borrowing" in
this SAI.
Exclusion
of investment manager from commodity pool operator definition. With
respect to the Fund, the investment manager has claimed an exclusion from the
definition of “commodity pool operator” (CPO) under the Commodity Exchange Act
(CEA) and the rules of the Commodity Futures Trading Commission (CFTC) and,
therefore, is not subject to CFTC registration or regulation as a CPO. In addition,
with respect to the Fund, the investment manager is relying upon a related
exclusion from the definition of “commodity trading advisor” (CTA) under the
CEA and the rules of the CFTC.
The
terms of the CPO exclusion require the Fund, among other things, to adhere to
certain limits on its investments in “commodity interests.” Commodity interests
include commodity futures, commodity options and swaps, which in turn include
non-deliverable currency forward contracts, as further described below. Because
the investment manager and the Fund intend to comply with the terms of the CPO
exclusion, the Fund may, in the future, need to adjust its investment
strategies, consistent with its investment goal, to limit its investments in
these types of instruments. The Fund is not intended as a vehicle for trading
in the commodity futures, commodity options or swaps markets. The CFTC has
neither reviewed nor approved the investment manager’s reliance on these
exclusions, or the Fund, its investment strategies or this SAI.
Generally,
the exclusion from CPO regulation on which the investment manager relies
requires the Fund to meet one of the following tests for its commodity interest
positions, other than positions entered into for bona fide hedging purposes (as
defined in the rules of the CFTC): either (1) the aggregate initial margin and
premiums required to establish the Fund’s positions in commodity interests may
not exceed 5% of the liquidation value of the Fund’s portfolio (after taking
into account unrealized profits and unrealized losses on any such positions);
or (2) the aggregate net notional value of the Fund’s commodity interest
positions, determined at the time the most recent such position was
established, may not exceed 100% of the liquidation value of the Fund’s
portfolio (after taking into account unrealized profits and unrealized losses
on any such positions). In addition to meeting one of these trading
limitations, the Fund may not be marketed as a commodity pool or otherwise as a
vehicle for trading in the commodity futures, commodity options or swaps
markets. If, in the future, the Fund can no longer satisfy these requirements,
the investment manager would withdraw its notice claiming an exclusion from the
definition of a CPO, and the investment manager would be subject to
registration and regulation as a CPO with respect to the Fund, in accordance
with CFTC rules that apply to CPOs of registered investment companies.
Generally, these rules allow for substituted compliance with CFTC disclosure
and shareholder reporting requirements, based on the investment manager’s
compliance with comparable SEC requirements. However, as a result of CFTC
regulation with respect to the Fund, the Fund may incur additional compliance
and other expenses.
Futures
contracts.
Generally, a futures contract is a standard binding agreement to
buy or sell a specified quantity of an underlying reference instrument, such as
a specific security, currency or commodity, at a specified price at a specified
later date. A “sale” of a futures contract means the acquisition of a
contractual obligation to deliver the underlying reference instrument called
for by the contract at a specified price on a specified date. A “purchase” of a
futures contract means the acquisition of a contractual obligation to acquire
the underlying reference instrument called for by the contract at a specified
price on a specified date. The purchase or sale of a futures contract will
allow the Fund to increase or decrease its exposure to the underlying reference
instrument without having to buy the actual instrument.
The
underlying reference instruments to which futures contracts may relate include
non-U.S. currencies, interest rates, stock and bond indices and debt
securities, including U.S. government debt obligations. In certain types of
futures contracts, the underlying reference instrument may be a swap agreement.
For more information about swap agreements generally, see “Swaps” below. In
most cases the contractual obligation under a futures contract may be offset, or
“closed out,” before the settlement date so that the parties do not have to
make or take delivery. The closing out of a contractual obligation is usually
accomplished by buying or selling, as the case may be, an identical, offsetting
futures contract. This transaction, which is effected through a member of an
exchange, cancels the obligation to make or take delivery of the underlying
instrument or asset. Although some futures contracts by their terms require the
actual delivery or acquisition of the underlying instrument or asset, some
require cash settlement.
Futures contracts may be bought and sold on
U.S. and non-U.S. exchanges. Futures contracts in the U.S. have been designed
by exchanges that have been designated “contract markets” by the CFTC and must
be executed through a futures commission merchant (FCM), which is a brokerage
firm that is a member of the relevant contract market. Each exchange guarantees
performance of the contracts as between the clearing members of the exchange,
thereby reducing the risk of counterparty default. Futures contracts may also
be entered into on certain exempt markets, including exempt boards of trade and
electronic trading facilities, available to certain market participants.
Because all transactions in the futures market are made, offset or fulfilled by
an FCM through a clearinghouse associated with the exchange on which the
contracts are traded, the Fund will incur brokerage fees when it buys or sells
futures contracts.
The
Fund generally buys and sells futures contracts only on contract markets
(including exchanges or boards of trade) where there appears to be an active
market for the futures contracts, but there is no assurance that an active
market will exist for any particular contract or at any particular time. An
active market makes it more likely that futures contracts will be liquid and
bought and sold at competitive market prices. In addition, many of the futures
contracts available may be relatively new instruments without a significant
trading history. As a result, there can be no assurance that an active market
will develop or continue to exist.
When
the Fund enters into a futures contract, it must deliver to an account
controlled by the FCM (that has been selected by the Fund), an amount referred
to as “initial margin” that is typically calculated as an amount equal to the
volatility in market value of a contract over a fixed period. Initial margin
requirements are determined by the respective exchanges on which the futures
contracts are traded and the FCM. Thereafter, a “variation margin” amount may
be required to be paid by the Fund or received by the Fund in accordance with
margin controls set for such accounts, depending upon changes in the
marked-to-market value of the futures contract. The account is marked-to-market
daily and the variation margin is monitored by the Fund’s investment manager
and custodian on a daily basis. When the futures contract is closed out, if the
Fund has a loss equal to or greater than the margin amount, the margin amount is
paid to the FCM along with any loss in excess of the margin amount. If the Fund
has a loss of less than the margin amount, the excess margin is returned to the
Fund. If the Fund has a gain, the full margin amount and the amount of the gain
is paid to the Fund.
Some
futures contracts provide for the delivery of securities that are different
than those that are specified in the contract. For a futures contract for
delivery of debt securities, on the settlement date of the contract,
adjustments to the contract can be made to recognize differences in value
arising from the delivery of debt securities with a different interest rate
from that of the particular debt securities that were specified in the
contract. In some cases, securities called for by a futures contract may not
have been issued when the contract was written.
Risks
of futures contracts.
The Fund’s use of futures contracts is subject to the risks
associated with derivative instruments generally. In addition, a purchase or
sale of a futures contract may result in losses to the Fund in excess of the
amount that the Fund delivered as initial margin. Because of the relatively low
margin deposits required, futures trading involves a high degree of leverage;
as a result, a relatively small price movement in a futures contract may result
in immediate and substantial loss, or gain, to the Fund. In addition, if the
Fund has insufficient cash to meet daily variation margin requirements or close
out a futures position, it may have to sell securities from its portfolio at a
time when it may be disadvantageous to do so. Adverse market movements could
cause the Fund to experience substantial losses on an investment in a futures
contract.
There
is a risk of loss by the Fund of the initial and variation margin deposits in
the event of bankruptcy of the FCM with which the Fund has an open position in
a futures contract. The assets of the Fund may not be fully protected in the
event of the bankruptcy of the FCM or central counterparty because the Fund
might be limited to recovering only a pro rata share of all available funds and
margin segregated on behalf of an FCM’s customers. If the FCM does not provide
accurate reporting, the Fund is also subject to the risk that the FCM could use
the Fund’s assets, which are held in an omnibus account with assets belonging
to the FCM’s other customers, to satisfy its own financial obligations or the
payment obligations of another customer to the central counterparty.
The
Fund may not be able to properly hedge or effect its strategy when a liquid
market is unavailable for the futures contract the Fund wishes to close, which
may at times occur. In addition, when futures contracts are used for hedging,
there may be an imperfect correlation between movements in the prices of the
underlying reference instrument on which the futures contract is based and
movements in the prices of the assets sought to be hedged.
If
the investment manager’s investment judgment about the general direction of
market prices or interest or currency exchange rates is incorrect, the Fund’s
overall performance will be poorer than if it had not entered into a futures
contract. For example, if the Fund has purchased
futures to hedge against the possibility of an increase in interest rates that
would adversely affect the price of bonds held in its portfolio and interest
rates instead decrease, the Fund will lose part or all of the benefit of the
increased value of the bonds which it has hedged. This is because its losses in
its futures positions will offset some or all of its gains from the increased
value of the bonds.
The
difference (called the “spread”) between prices in the cash market for the
purchase and sale of the underlying reference instrument and the prices in the
futures market is subject to fluctuations and distortions due to differences in
the nature of those two markets. First, all participants in the futures market
are subject to initial deposit and variation margin requirements. Rather than
meeting additional variation margin requirements, investors may close futures
contracts through offsetting transactions that could distort the normal pricing
spread between the cash and futures markets. Second, the liquidity of the
futures markets depends on participants entering into offsetting transactions
rather than making or taking delivery of the underlying instrument. To the
extent participants decide to make or take delivery, liquidity in the futures
market could be reduced, resulting in pricing distortion. Third, from the point
of view of speculators, the margin deposit requirements that apply in the
futures market are less onerous than similar margin requirements in the
securities market. Therefore, increased participation by speculators in the
futures market may cause temporary price distortions. When such distortions
occur, a correct forecast of general trends in the price of an underlying
reference instrument by the investment manager may still not necessarily result
in a profitable transaction.
Futures
contracts that are traded on non-U.S. exchanges may not be as liquid as those
purchased on CFTC-designated contract markets. In addition, non-U.S. futures
contracts may be subject to varied regulatory oversight. The price of any
non-U.S. futures contract and, therefore, the potential profit and loss thereon,
may be affected by any change in the non-U.S. exchange rate between the time a
particular order is placed and the time it is liquidated, offset or exercised.
The
CFTC and the various exchanges have established limits referred to as
“speculative position limits” on the maximum net long or net short position
that any person, such as the Fund, may hold or control in a particular futures
contract. Trading limits are also imposed on the maximum number of contracts
that any person may trade on a particular trading day. An exchange may order
the liquidation of positions found to be in violation of these limits and it
may impose other sanctions or restrictions. The regulation of futures, as well
as other derivatives, is a rapidly changing area of law. For more information,
see “Developing government regulation of derivatives” below.
Futures
exchanges may also limit the amount of fluctuation permitted in certain futures
contract prices during a single trading day. This daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day’s settlement price. Once the daily limit has been reached
in a futures contract subject to the limit, no more trades may be made on that
day at a price beyond that limit. The daily limit governs only price movements
during a particular trading day and does not limit potential losses because the
limit may prevent the liquidation of unfavorable positions. For example,
futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses.
Developing
government regulation of derivatives. The regulation of cleared and
uncleared swaps, as well as other derivatives, is a rapidly changing area of
law and is subject to modification by government and judicial action. In
addition, the SEC, CFTC and the exchanges are authorized to take extraordinary
actions in the event of a market emergency, including, for example, the
implementation or reduction of speculative position limits, the implementation
of higher margin requirements, the establishment of daily price limits and the
suspension of trading.
It
is not possible to predict fully the effects of current or future regulation.
However, it is possible that developments in government regulation of various
types of derivative instruments, such as speculative position limits on certain
types of derivatives, or limits or restrictions on the counterparties with
which the Fund engages in derivative transactions, may limit or prevent the
Fund from using or limit the Fund’s use of these instruments effectively as a
part of its investment strategy, and could adversely affect the Fund’s ability
to achieve its investment goal(s). The investment manager will continue to
monitor developments in the area, particularly to the extent regulatory changes
affect the Fund’s ability to enter into desired swap agreements. New
requirements, even if not directly applicable to the Fund, may increase the
cost of the Fund’s investments and cost of doing business.
Equity
securities
Equity securities represent a proportionate share of the
ownership of a company; their value is based on the success of the company's
business and the value of its assets, as well as general market conditions. The
purchaser of an equity security typically receives an ownership interest in the
company as well as certain voting rights. The owner of an equity security may participate in a company's success through the
receipt of dividends, which are distributions of earnings by the company to its
owners. Equity security owners may also participate in a company's success or
lack of success through increases or decreases in the value of the company's
shares. Equity securities generally take the form of common stock or preferred
stock, as well as securities convertible into common stock. Preferred
stockholders typically receive greater dividends but may receive less
appreciation than common stockholders and may have different voting rights as
well. Equity securities may also include convertible securities, warrants,
rights or equity interests in trusts, partnerships, joint ventures or similar
enterprises. Warrants or rights give the holder the right to buy a common stock
at a given time for a specified price.
Financial
services companies risk. To the extent that the Fund invests its
assets in investments of financial services companies, the Fund’s investments
and performance will be affected by general market and economic conditions as
well as other risk factors particular to the financial services industry.
Financial services companies are subject to extensive government regulation.
This regulation may limit both the amount and types of loans and other
financial commitments a financial services company can make, and the interest
rates and fees it can charge. Such limitations may have a significant impact on
the profitability of a financial services company since that profitability is
attributable, at least in part, to the company’s ability to make financial
commitments such as loans. Profitability of a financial services company is
largely dependent upon the availability and cost of the company’s funds, and
can fluctuate significantly when interest rates change. The financial
difficulties of borrowers can negatively impact the industry to the extent that
borrowers may not be able to repay loans made by financial services companies.
In
response to the recent economic instability, the United States and other
governments have taken actions designed to support the financial markets. The
withdrawal of this support could negatively affect the value and liquidity of
certain securities. Moreover, the implications of government ownership
interests in financial institutions, by virtue of aging distressed assets, is
unforeseeable.
In
addition, the financial services industry is an evolving and competitive
industry that is undergoing significant change, as existing distinctions
between financial segments become less clear. Such changes have resulted from
various consolidations as well as the continual development of new products,
structures and a changing regulatory framework. These changes are likely to
have a significant impact on the financial services industry and the Fund.
Insurance
companies may be subject to severe price competition, claims activity,
marketing competition and general economic conditions. Particular insurance
lines will also be influenced by specific matters. Property and casualty
insurer profits may be affected by events such as man-made and natural
disasters (including weather catastrophe and terrorism). Life and health
insurer profits may be affected by mortality risks and morbidity rates. Individual
insurance companies may be subject to material risks including inadequate
reserve funds to pay claims and the inability to collect from the insurance
companies which insure insurance companies, so-called reinsurance carriers.
Foreign securities For purposes of the
Fund’s prospectus and SAI, “foreign securities” refers to non-U.S. securities.
There are substantial risks associated with investing in the securities of
governments and companies located in, or having substantial operations in,
foreign countries, which are in addition to the usual risks inherent in
domestic investments. The value of foreign securities (like U.S. securities) is
affected by general economic conditions and individual issuer and industry
earnings prospects. Investments in depositary receipts also involve some or all
of the risks described below.
There
is the possibility of cessation of trading on foreign exchanges, expropriation,
nationalization of assets, confiscatory or punitive taxation, withholding and
other foreign taxes on income or other amounts, foreign exchange controls
(which may include suspension of the ability to transfer currency from a given
country), restrictions on removal of assets, political or social instability,
military action or unrest, or diplomatic developments, including sanctions
imposed by other countries or governmental entities, that could affect
investments in securities of issuers in foreign nations. There is no assurance
that the investment manager will be able to anticipate these potential events.
In addition, the value of securities denominated in foreign currencies and of
dividends and interest paid with respect to such securities will fluctuate
based on the relative strength of the U.S. dollar.
There
may be less publicly available information about foreign issuers comparable to
the reports and ratings published about issuers in the U.S. Foreign issuers
generally are not subject to uniform accounting or financial reporting
standards. Auditing practices and requirements may not be comparable to those
applicable to U.S. issuers. Certain countries’ legal institutions, financial
markets and services are less developed than those in the U.S. or other major
economies. The Fund may have greater difficulty voting proxies, exercising
shareholder rights, securing dividends and obtaining information regarding
corporate actions on a timely basis, pursuing legal remedies, and obtaining
judgments with respect to foreign investments in foreign courts than with respect to domestic issuers in U.S. courts. The costs
associated with foreign investments, including withholding taxes, brokerage
commissions, and custodial costs, are generally higher than with U.S.
investments.
Certain
countries require governmental approval prior to investments by foreign
persons, or limit the amount of investment by foreign persons in a particular
company. Some countries limit the investment of foreign persons to only a
specific class of securities of an issuer that may have less advantageous terms
than securities of the issuer available for purchase by nationals. Although
securities subject to such restrictions may be marketable abroad, they may be
less liquid than foreign securities of the same class that are not subject to
such restrictions. In some countries the repatriation of investment income,
capital and proceeds of sales by foreign investors may require governmental
registration and/or approval. The Fund could be adversely affected by delays in
or a refusal to grant any required governmental registration or approval for
repatriation.
From
time to time, trading in a foreign market may be interrupted. Foreign markets
also have substantially less volume than the U.S. markets and securities of
some foreign issuers are less liquid and more volatile than securities of
comparable U.S. issuers. The Fund, therefore, may encounter difficulty in
obtaining market quotations for purposes of valuing its portfolio and
calculating its net asset value.
In
many foreign countries there is less government supervision and regulation of
stock exchanges, brokers, and listed companies than in the U.S., which may
result in greater potential for fraud or market manipulation. Foreign
over-the-counter markets tend to be less regulated than foreign stock exchange
markets and, in certain countries, may be totally unregulated. Brokerage
commission rates in foreign countries, which generally are fixed rather than
subject to negotiation as in the U.S., are likely to be higher. Foreign
security trading, settlement and custodial practices (including those involving
securities settlement where assets may be released prior to receipt of payment)
are often less developed than those in U.S. markets, may be cumbersome and may
result in increased risk or substantial delays. This could occur in the event
of a failed trade or the insolvency of, or breach of duty by, a foreign
broker-dealer, securities depository, or foreign subcustodian.
To
the extent that the Fund invests a significant portion of its assets in a
specific geographic region or country, the Fund will have more exposure to
economic risks related to such region or country than a fund whose investments
are more geographically diversified. Adverse conditions or changes in policies
in a certain region or country can affect securities of other countries whose
economies appear to be unrelated but are otherwise connected. In the event of
economic or political turmoil, a deterioration of diplomatic relations or a
natural or man-made disaster in a region or country where a substantial portion
of the Fund’s assets are invested, the Fund may have difficulty meeting a large
number of shareholder redemption requests.
The
2016 referendum in which the United Kingdom voted to exit the European Union
(EU) has caused, and may continue to cause, market volatility in various
regional markets due to political, economic and legal uncertainty. In addition,
if one or more countries were to exit the EU or abandon the use of the Euro as
a currency, the value of investments associated with those countries or the
Euro could decline significantly and unpredictably and it would likely cause
additional market disruption globally and introduce new legal and regulatory
uncertainties.
The
holding of foreign securities may be limited by the Fund to avoid investment in
certain Passive Foreign Investment Companies (PFICs) and the imposition of a
PFIC tax on the Fund resulting from such investments.
Developing markets or emerging markets.
Investments in issuers domiciled or with significant operations in developing
market or emerging market countries may be subject to potentially higher risks
than investments in developed countries. These risks include, among others (i)
less social, political and economic stability; (ii) smaller securities markets
with low or nonexistent trading volume, which result in greater illiquidity and
greater price volatility; (iii) certain national policies which may restrict
the Fund’s investment opportunities, including restrictions on investment in
issuers or industries deemed sensitive to national interests; (iv) foreign
taxation, including less transparent and established taxation policies; (v)
less developed regulatory or legal structures governing private or foreign
investment or allowing for judicial redress for injury to private property;
(vi) the absence, until recently in many developing market countries, of a
capital market structure or market-oriented economy; (vii) more widespread
corruption and fraud; (viii) the financial institutions with which the Fund may
trade may not possess the same degree of financial sophistication,
creditworthiness or resources as those in developed markets; and (ix) the
possibility that when favorable economic developments occur in some developing
market countries, such developments may be slowed or reversed by unanticipated
economic, political or social events in such countries.
Due to political, military or regional
conflicts or due to terrorism or war, it is possible that the United States,
other nations or other governmental entities (including supranational entities)
could impose sanctions on a country involved in such conflicts that limit or
restrict foreign investment, the movement of assets or other economic activity
in that country. Such sanctions or other intergovernmental actions could result
in the devaluation of a country’s currency, a downgrade in the credit ratings
of issuers in such country, or a decline in the value and liquidity of
securities of issuers in that country. In addition, an imposition of sanctions
upon certain issuers in a country could result in an immediate freeze of that
issuer’s securities, impairing the ability of the Fund to buy, sell, receive or
deliver those securities. Countermeasures could be taken by the country’s
government, which could involve the seizure of the Fund’s assets. In addition,
such actions could adversely affect a country’s economy, possibly forcing the
economy into a recession.
In
addition, many developing market countries have experienced substantial, and
during some periods, extremely high rates of inflation, for many years.
Inflation and rapid fluctuations in inflation rates have had, and may continue
to have, negative effects on the economies and securities markets of certain
countries. Moreover, the economies of some developing market countries may
differ unfavorably from the U.S. economy in such respects as growth of gross
domestic product, rate of inflation, currency depreciation, debt burden,
capital reinvestment, resource self-sufficiency and balance of payments
position. The economies of some developing market countries may be based on
only a few industries, and may be highly vulnerable to changes in local or
global trade conditions.
Settlement
systems in developing market countries may be less organized than in developed
countries. Supervisory authorities may also be unable to apply standards which
are comparable with those in more developed countries. There may be risks that
settlement may be delayed and that cash or securities belonging to the Fund may
be in jeopardy because of failures of or defects in the settlement systems.
Market practice may require that payment be made prior to receipt of the
security which is being purchased or that delivery of a security must be made
before payment is received. In such cases, default by a broker or bank
(counterparty) through whom the relevant transaction is effected might result
in a loss being suffered by the Fund. The Fund seeks, where possible, to use
counterparties whose financial status reduces this risk. However, there can be
no certainty that the Fund will be successful in eliminating or reducing this
risk, particularly as counterparties operating in developing market countries
frequently lack the substance, capitalization and/or financial resources of
those in developed countries. Uncertainties in the operation of settlement
systems in individual markets may increase the risk of competing claims to
securities held by or to be transferred to the Fund. Legal compensation schemes
may be non-existent, limited or inadequate to meet the Fund’s claims in any of
these events.
Securities
trading in developing markets presents additional credit and financial risks.
The Fund may have limited access to, or there may be a limited number of,
potential counterparties that trade in the securities of developing market
issuers. Governmental regulations may restrict potential counterparties to
certain financial institutions located or operating in the particular
developing market. Potential counterparties may not possess, adopt or implement
creditworthiness standards, financial reporting standards or legal and
contractual protections similar to those in developed markets. Currency and
other hedging techniques may not be available or may be limited.
The
local taxation of income and capital gains accruing to non-residents varies
among developing market countries and may be comparatively high. Developing
market countries typically have less well-defined tax laws and procedures and
such laws may permit retroactive taxation so that the Fund could in the future
become subject to local tax liabilities that had not been anticipated in
conducting its investment activities or valuing its assets.
Many
developing 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. Investments in developing market
countries may involve risks of nationalization, expropriation and confiscatory
taxation. For example, the Communist governments of a number of Eastern
European countries expropriated large amounts of private property in the past,
in many cases without adequate compensation, and there can be no assurance that
similar expropriation will not occur in the future. In the event of
expropriation, the Fund could lose all or a substantial portion of any
investments it has made in the affected countries. Accounting, auditing and
reporting standards in certain countries in which the Fund may invest may not
provide the same degree of investor protection or information to investors as
would generally apply in major securities markets. In addition, it is possible
that purported securities in which the Fund invested may subsequently be found
to be fraudulent and as a consequence the Fund could suffer losses.
Finally, currencies of developing market
countries are subject to significantly greater risks than currencies of
developed countries. Some developing market currencies may not be
internationally traded or may be subject to strict controls by local
governments, resulting in undervalued or overvalued currencies and associated
difficulties with the valuation of assets, including the Fund’s securities,
denominated in that currency. Some developing 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
developing market countries, such as certain Eastern European countries, may be
convertible into U.S. dollars, the conversion rates may be artificial to the
actual market values and may be adverse to the Fund’s shareholders.
Foreign
corporate debt securities. Foreign corporate debt securities, including
Samurai bonds, Yankee bonds, Eurobonds and Global Bonds, may be purchased to
gain exposure to investment opportunities in other countries in a certain
currency. A Samurai bond is a yen-denominated bond issued in Japan by a
non-Japanese company. Eurobonds are foreign bonds issued and traded in
countries other than the country and currency in which the bond was
denominated. Eurobonds generally trade on a number of exchanges and are issued
in bearer form, carry a fixed or floating rate of interest, and typically
amortize principal through a single payment for the entire principal at
maturity with semiannual interest payments. Yankee bonds are bonds denominated
in U.S. dollars issued by foreign banks and corporations, and registered with
the SEC for sale in the U.S. A Global Bond is a certificate representing the
total debt of an issue. Such bonds are created to control the primary market
distribution of an issue in compliance with selling restrictions in certain
jurisdictions or because definitive bond certificates are not available. A
Global Bond is also known as a Global Certificate.
Foreign
currency exchange rates. Changes in foreign currency exchange rates will
affect the U.S. dollar market value of securities denominated in such foreign
currencies and any income received or expenses paid by the Fund in that foreign
currency. This may affect the Fund's share price, income and distributions to
shareholders. Some countries may have fixed or managed currencies that are not
free-floating against the U.S. dollar. It will be more difficult for the
investment manager to value securities denominated in currencies that are fixed
or managed. Certain currencies may not be internationally traded, which could
cause illiquidity with respect to the Fund's investments in that currency and
any securities denominated in that currency. Currency markets generally are not
as regulated as securities markets. The Fund endeavors to buy and sell foreign
currencies on as favorable a basis as practicable. Some price spread in
currency exchanges (to cover service charges) may be incurred, particularly
when the Fund changes investments from one country to another or when proceeds
of the sale of securities in U.S. dollars are used for the purchase of
securities denominated in foreign currencies. Some countries may adopt policies
that would prevent the Fund from transferring cash out of the country or
withhold portions of interest and dividends at the source.
Certain
currencies have experienced a steady devaluation relative to the U.S. dollar.
Any devaluations in the currencies in which the Fund's portfolio securities are
denominated may have a detrimental impact on the Fund. Where the exchange rate
for a currency declines materially after the Fund's income has been accrued and
translated into U.S. dollars, the Fund may need to redeem portfolio securities
to make required distributions. Similarly, if an exchange rate declines between
the time the Fund incurs expenses in U.S. dollars and the time such expenses
are paid, the Fund will have to convert a greater amount of the currency into
U.S. dollars in order to pay the expenses.
Investing
in foreign currencies for purposes of gaining from projected changes in
exchange rates further increases the Fund's exposure to foreign securities
losses.
Foreign governmental and supranational debt securities. Investments
in debt securities of governmental or supranational issuers are subject to all
the risks associated with investments in U.S. and foreign securities and
certain additional risks. Foreign government debt securities, sometimes
known as sovereign debt securities, include debt securities issued, sponsored
or guaranteed by: governments or governmental agencies, instrumentalities, or
political subdivisions located in emerging or developed market countries;
government owned, controlled or sponsored entities located in emerging or
developed market countries; and entities organized and operated for the purpose
of restructuring the investment characteristics of instruments issued by any of
the above issuers. A supranational entity is a bank, commission or company
established or financially supported by the national governments of one or more
countries to promote reconstruction, trade, harmonization of standards or laws,
economic development, and humanitarian, political or environmental initiatives.
Supranational debt obligations include: Brady Bonds (which are debt securities
issued under the framework of the Brady Plan as a means for debtor nations to
restructure their outstanding external indebtedness); participations in loans
between emerging market governments and financial institutions; and debt
securities issued by supranational entities such as the World Bank, Asia
Development Bank, European Investment Bank and the
European Economic Community. Foreign government debt securities are subject to
risks in addition to those relating to debt securities generally. Governmental
issuers of foreign debt securities may be unwilling or unable to pay interest
and repay principal, or otherwise meet obligations, when due and may require
that the conditions for payment be renegotiated. As a sovereign entity, the
issuing government may be immune from lawsuits in the event of its failure or
refusal to pay the obligations when due. The debtor’s willingness or ability to
repay in a timely manner may be affected by, among other factors, its cash flow
situation, the extent of its non-U.S. reserves, the availability of sufficient
non-U.S. exchange on the date a payment is due, the relative size of the debt
service burden to the issuing country’s economy as a whole, the sovereign
debtor’s policy toward principal international lenders, such as the
International 33 Monetary Fund or the World Bank, and the political
considerations or constraints to which the sovereign debtor may be subject.
Governmental debtors also will be dependent on expected disbursements from
foreign governments or multinational agencies and the country’s access to, or
balance of, trade. Some governmental debtors have in the past been able to
reschedule or restructure their debt payments without the approval of debt
holders or declare moratoria on payments, and similar occurrences may happen in
the future. There is no bankruptcy proceeding by which the Fund may collect in
whole or in part on debt subject to default by a government.
High-yield
debt securities High-yield
or lower-rated debt securities (also referred to as "junk bonds") are
securities that have been rated below the top four rating categories (e.g., BB+
or Ba1 and lower) by one or more independent rating organizations such as
Moody's or S&P and are considered below investment grade. These securities
generally have greater risk with respect to the payment of interest and
repayment of principal, or may be in default and are often considered to be
speculative and involve greater risk of loss because they are generally
unsecured and are often subordinated to other debt of the issuer.
Adverse
publicity, investor perceptions, whether or not based on fundamental analysis,
or real or perceived adverse economic and competitive industry conditions may
decrease the values and liquidity of lower-rated debt securities, especially in
a thinly traded market. Analysis of the creditworthiness of issuers of
lower-rated debt securities may be more complex than for issuers of
higher-rated securities. The Fund relies on the investment manager's judgment,
analysis and experience in evaluating the creditworthiness of an issuer of
lower-rated securities. In such evaluations, the investment manager takes into
consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters. There can be no
assurance the investment manager will be successful in evaluating the
creditworthiness of an issuer or the value of high yield debt securities
generally.
The
prices of lower-rated debt securities may be less sensitive to interest rate
changes than higher-rated debt securities, but more sensitive to economic
downturns or individual adverse corporate developments. Market anticipation of
an economic downturn or of rising interest rates, for example, could cause a
decline in lower-rated debt securities prices. This is because an economic
downturn could lessen the ability of a highly leveraged company to make principal
and interest payments on its debt securities. Similarly, the impact of
individual adverse corporate developments, or public perceptions thereof, will
be greater for lower-rated securities because the issuers of such securities
are more likely to enter bankruptcy. If the issuer of lower-rated debt
securities defaults, the Fund may incur substantial expenses to seek recovery
of all or a portion of its investments or to exercise other rights as a
security holder. The Fund may choose, at its expense or in conjunction with
others, to pursue litigation or otherwise to exercise its rights as a security
holder to seek to protect the interests of security holders if it determines
this to be in the best interest of the Fund's shareholders.
Lower-rated
debt securities frequently have call or buy-back features that allow an issuer
to redeem the securities from their holders. Although these securities are
typically not callable for a period of time, usually for three to five years
from the date of issue, the Fund will be exposed to prepayment risk.
The
markets in which lower-rated debt securities are traded are more limited than
those in which higher-rated securities are traded. The existence of limited
markets for particular securities may diminish the Fund's ability to sell the
securities at desirable prices to meet redemption requests or to respond to a
specific economic event, such as deterioration in the creditworthiness of the
issuer. Reduced secondary market liquidity for certain lower-rated debt
securities also may make it more difficult for the Fund to obtain accurate
market quotations for the purposes of valuing the Fund's portfolio. Market
quotations are generally available on many lower-rated securities only from a
limited number of dealers and may not necessarily represent firm bids of such
dealers or prices of actual sales, which may limit the Fund's ability to rely
on such quotations.
Some
lower-rated debt securities are sold without registration under federal
securities laws and, therefore, carry restrictions on resale. While many of
such lower-rated debt securities have been sold with registration rights,
covenants and penalty provisions for delayed registration, if the Fund is
required to sell restricted securities before the securities have been registered,
it may be deemed an underwriter of the securities
under the Securities Act of 1933, as amended (1933 Act), which entails special
responsibilities and liabilities. The Fund also may incur extra costs when
selling restricted securities, although the Fund will generally not incur any
costs when the issuer is responsible for registering the securities.
High-yield,
fixed-income securities acquired during an initial underwriting involve special
credit risks because they are new issues. The investment manager will carefully
review the issuer's credit and other characteristics.
The
credit risk factors described above also apply to high-yield zero coupon,
deferred interest and pay-in-kind securities. These securities have an
additional risk, however, because unlike securities that pay interest
periodically until maturity, zero coupon bonds and similar securities will not
make any interest or principal payments until the cash payment date or maturity
of the security. If the issuer defaults, the Fund may not obtain any return on
its investment.
Illiquid
securities
Generally, an “illiquid security” or “illiquid investment” is any
investment that the Fund reasonably expects cannot be sold or disposed of in
current market conditions in seven calendar days or less without the sale or
disposition significantly changing the market value of the investment. Illiquid
investments generally include investments for which no market exists or which
are legally restricted as to their transfer (such as those issued pursuant to
an exemption from the registration requirements of the federal securities
laws). Restricted securities are generally sold in privately negotiated
transactions, pursuant to an exemption from registration under the Securities
Act of 1933, as amended (1933 Act). If registration of a security previously
acquired in a private transaction is required, the Fund, as the holder of the
security, may be obligated to pay all or part of the registration expense and a
considerable period may elapse between the time it decides to seek registration
and the time it will be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions
were to develop, the Fund might obtain a less favorable price than prevailed when
it decided to seek registration of the security. To the extent it is determined
that there is a liquid institutional or other market for certain restricted
securities, the Fund would consider them to be liquid securities. An example is
a restricted security that may be freely transferred among qualified
institutional buyers pursuant to Rule 144A under the 1933 Act, and for which a
liquid institutional market has developed. Rule 144A securities may be subject,
however, to a greater possibility of becoming illiquid than securities that
have been registered with the SEC.
The
following factors may be taken into account in determining whether a restricted
security is properly considered a liquid security: (i) the frequency of trades
and quotes for the security; (ii) the number of dealers willing to buy or sell
the security and the number of other potential buyers; (iii) any dealer
undertakings to make a market in the security; and (iv) the nature of the
security and of the marketplace trades (e.g., any demand, put or tender
features, the method of soliciting offers, the mechanics and other requirements
for transfer, and the ability to assign or offset the rights and obligations of
the security). The nature of the security and its trading includes the time
needed to sell the security, the method of soliciting offers to purchase or
sell the security, and the mechanics of transferring the security including the
role of parties such as foreign or U.S. custodians, subcustodians, currency
exchange brokers, and depositories.
The
sale of illiquid investments often requires more time and results in higher
brokerage charges or dealer discounts and other selling expenses than the sale
of investments eligible for trading on national securities exchanges or in the
over-the-counter (OTC) markets. Illiquid investments often sell at a price
lower than similar investments that are not subject to restrictions on resale.
The
risk to the Fund in holding illiquid investments is that they may be more
difficult to sell if the Fund wants to dispose of the investment in response to
adverse developments or in order to raise money for redemptions or other
investment opportunities. Illiquid trading conditions may also make it more
difficult for the Fund to realize an investment's fair value.
The
Fund may also be unable to achieve its desired level of exposure to a certain
investment, issuer, or sector due to overall limitations on its ability to
invest in illiquid investments and the difficulty in purchasing such
investments.
If
illiquid investments exceed 15% of the Fund’s net assets after the time of
purchase, the Fund will take steps to reduce its holdings of illiquid
investments to or below 15% of its net assets within a reasonable period of
time, and will notify the Trust’s Board of Trustees and make the required
filings with the SEC in accordance with Rule 22e-4 under the 1940 Act. Because
illiquid investments may not be readily marketable, the portfolio managers
and/or investment personnel may not be able to dispose of them in a timely manner.
As a result, the Fund may be forced to hold illiquid investments while their
price depreciates. Depreciation in the price of illiquid investments may cause
the net asset value of a Fund to decline.
Inflation-indexed securities
Inflation-indexed securities are debt securities, the value of which is
periodically adjusted to reflect a measure of inflation. Two structures are
common for inflation-indexed securities. The U.S. Treasury and some other
issuers use a structure that reflects inflation as it accrues by increasing the
U.S. dollar amount of the principal originally invested. Other issuers pay out
the inflation as it accrues as part of a semiannual coupon. Any amount accrued
on an inflation-indexed security, regardless whether paid out as a coupon or
added to the principal, is generally considered taxable income. Where the
accrued amount is added to the principal and no cash income is received until
maturity, the Fund may be required to sell portfolio securities that it would
otherwise continue to hold in order to obtain sufficient cash to make
distributions to shareholders required for U.S. tax purposes.
An
investor could experience a loss of principal and income on investments in
inflation-indexed securities. In a deflationary environment, the value of the
principal invested in an inflation-indexed security will be adjusted downward,
just as it would be adjusted upward in an inflationary environment. Because the
interest on an inflation-indexed security is calculated with respect to the
amount of principal which is smaller following a deflationary period, interest
payments will also be reduced, just as they would be increased following an
inflationary period.
In
the case of U.S. Treasury inflation-indexed securities, the return of at least
the original U.S. dollar amount of principal invested is guaranteed, so an
investor receives the greater of its original principal or the
inflation-adjusted principal. If the return of principal is not guaranteed, the
investor may receive less than the amount it originally invested in an
inflation-indexed security following a period of deflation. Any guarantee of
principal provided by a party other than the U.S. government will increase the
Fund's exposure to the credit risk of that party.
The
value of inflation-indexed securities is generally expected to change in
response to changes in "real" interest rates. The real interest rate
is the rate of interest that would be paid in the absence of inflation. The
actual rate of interest, referred to as the nominal interest rate, is equal to
the real interest rate plus the rate of inflation. If inflation rises at a
faster rate than nominal interest rates, real interest rates might decline,
leading to an increase in value of inflation-indexed securities. In contrast,
if nominal interest rates increase at a faster rate than inflation, real
interest rates might rise, leading to a decrease in value of inflation-indexed
securities.
While
inflation-indexed securities are designed to provide some protection from
long-term inflationary trends, short-term increases in inflation may lead to a
decline in their value. For example, if interest rates rise due to reasons
other than inflation, investors in these securities may not be protected to the
extent that the increase is not reflected in the security's inflation measure.
The reasons that interest rates may rise without a corresponding increase in
inflation include changes in currency exchange rates and temporary shortages of
credit or liquidity. When interest rates rise without a corresponding increase
in inflation, the Fund's investment in inflation-indexed securities will forego
the additional return that could have been earned on a floating rate debt
security.
The
periodic adjustment of U.S. inflation-protected debt securities is tied to the
Consumer Price Index for Urban Consumers (CPI-U), which is calculated monthly
by the U.S. Bureau of Labor Statistics. The CPI-U is an index of changes in the
cost of living, made up of components such as housing, food, transportation and
energy. Inflation-protected debt securities issued by a foreign government are
generally adjusted to reflect a comparable consumer inflation index, calculated
by that government. There can be no assurance that the CPI-U or any foreign
inflation index will accurately measure the actual rate of inflation in the
prices of goods and services. Moreover, there can be no assurance that the rate
of inflation in a foreign country will be correlated to the rate of inflation
in the United States. To the extent that the Fund invests in inflation-indexed
securities as a hedge against inflation, an imperfect hedge will result if the
cost of living (as represented in the CPI-U) has a different inflation rate
than the Fund's interests in industries and sectors minimally affected by
changes in the cost of living.
Interfund
lending program
Pursuant to an exemptive order granted by the SEC (Lending
Order), the Fund has the ability to lend money to, and borrow money from, other
Franklin Templeton funds for temporary purposes (Interfund Lending Program)
pursuant to a master interfund lending agreement (Interfund Loan). Lending and
borrowing through the Interfund Lending Program provides the borrowing fund
with a lower interest rate than it would have paid if it borrowed money from a
bank, and provides the lending fund with an alternative short-term investment
with a higher rate of return than other available short-term investments. All
Interfund Loans would consist only of uninvested cash reserves that the lending
fund otherwise would invest in short-term repurchase agreements or other
short-term instruments. The Fund may only participate in the Interfund Lending
Program to the extent permitted by its investment goal(s), policies and
restrictions and only subject to meeting the conditions of the Lending Order.
Under the Interfund Lending Program, the Fund
may borrow on an unsecured basis through the Interfund Lending Program if its
outstanding borrowings from all sources immediately after the borrowing total
10% or less of its total assets, provided that if the Fund has a secured loan
outstanding from any other lender, including but not limited to another fund,
the Fund’s Interfund Loan will be secured on at least an equal priority basis
with at least an equivalent percentage of collateral to loan value as any
outstanding loan that requires collateral. If the Fund’s total outstanding
borrowings immediately after an Interfund Loan exceed 10% of its total assets,
the Fund may borrow through the Interfund Lending Program on a secured basis only.
The Fund may not borrow under the Interfund Lending Program or from any other
source if its total outstanding borrowings immediately after such borrowing
would be more than 33 1/3% of its total assets or any lower threshold provided
for by the Fund’s investment restrictions.
If
the Fund has outstanding bank borrowings, any Interfund Loans to the Fund
would: (a) be at an interest rate equal to or lower than that of any
outstanding bank loan, (b) be secured at least on an equal priority basis with
at least an equivalent percentage of collateral to loan value as any
outstanding bank loan that requires collateral, (c) have a maturity no longer
than any outstanding bank loan (and in any event not over seven days), and (d)
provide that, if an event of default by the Fund occurs under any agreement
evidencing an outstanding bank loan to the Fund, that event of default will
automatically (without need for action or notice by the lending Fund)
constitute an immediate event of default under the interfund lending agreement,
entitling the lending fund to call the Interfund Loan (and exercise all rights
with respect to any collateral), and that such call would be made if the
lending bank exercises its right to call its loan under its agreement with the
borrowing fund.
In
addition, no fund may lend to another fund through the Interfund Lending
Program if the loan would cause the lending fund’s aggregate outstanding loans
through the Interfund Lending Program to exceed 15% of its current net assets
at the time of the loan. A fund’s Interfund Loans to any one fund shall not
exceed 5% of the lending fund’s net assets. The duration of Interfund Loans
will be limited to the time required to obtain cash sufficient to repay such
Interfund Loan, either through the sale of portfolio securities or the net
sales of the fund’s shares, but in no event more than seven days, and for
purposes of this condition, loans effected within seven days of each other will
be treated as separate loan transactions. Each Interfund Loan may be called on
one business day’s notice by a lending fund and may be repaid on any day by a
borrowing fund.
The
limitations of the Interfund Lending Program are described below and these and
the other conditions of the Lending Order permitting interfund lending are designed
to minimize the risks associated with interfund lending for both the lending
and borrowing fund. However, no borrowing or lending activity is without risk.
When a fund borrows money from another fund under the Interfund Lending
Program, there is a risk that the Interfund Loan could be called on one
business day’s notice, in which case the borrowing fund may have to utilize a
line of credit, which would likely involve higher rates, seek an Interfund Loan
from another fund, or liquidate portfolio securities if no lending sources are
available to meet its liquidity needs. Interfund Loans are subject to the risk
that the borrowing fund could be unable to repay the loan when due, and a delay
in repayment could result in a lost opportunity by the lending fund or force
the lending fund to borrow or liquidate securities to meet its liquidity needs.
Investment
company securities
The Fund may invest in other investment companies to the extent
permitted by the 1940 Act, SEC rules thereunder and exemptions thereto. With
respect to unaffiliated funds in which the Fund may invest, Section 12(d)(1)(A)
of the 1940 Act requires that, as determined immediately after a purchase is
made, (i) not more than 5% of the value of the Fund’s total assets will be
invested in the securities of any one investment company, (ii) not more than
10% of the value of the Fund’s total assets will be invested 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 the Fund. The Fund
will limit its investments in unaffiliated funds in accordance with the Section
12(d)(1)(A) limitations set forth above, except to the extent that any rules,
regulations or no-action or exemptive relief under the 1940 Act permits the
Fund’s investments to exceed such limits in unaffiliated underlying funds. To
the extent that the Fund invests in another investment company, because other
investment companies pay advisory, administrative and service fees that are borne
indirectly by investors, such as the Fund, there may be duplication of
investment management and other fees. The Fund may also invest its cash
balances in affiliated money market funds to the extent permitted by its
investment policies and rules and exemptions granted under the 1940 Act.
The
Fund will not acquire shares of other affiliated or unaffiliated open-end funds
or unit investment trusts in reliance on paragraph (F) or (G) of Section
12(d)(1) of the 1940 Act.
Closed-end
funds. The
shares of a closed-end fund typically are bought and sold on an exchange. The
risks of investing in a closed-end investment company typically reflect the
risk of the types of securities in which the closed-end fund invests. Closed-end
funds often leverage returns by issuing debt securities, variable rate
preferred securities or reverse-repurchase agreements. The Fund may invest in
debt securities issued by closed-end funds, subject to any quality or other
standards applicable to the Fund's investment in debt
securities. If the Fund invests in shares issued by leveraged closed-end funds,
it will face certain risks associated with leveraged investments.
Investments
in closed-end funds are subject to additional risks. For example, the price of
the closed-end fund's shares quoted on an exchange may not reflect the net
asset value of the securities held by the closed-end fund. The premium or
discount that the share prices represent versus net asset value may change over
time based on a variety of factors, including supply of and demand for the
closed-end fund's shares, that are outside the closed-end fund's control or
unrelated to the value of the underlying portfolio securities. If the Fund
invests in the closed-end fund to gain exposure to the closed-end fund's
investments, the lack of correlation between the performance of the closed-end
fund's investments and the closed-end fund's share price may compromise or
eliminate any such exposure.
Exchange-traded
funds.
The Fund may invest in exchange-traded funds (ETFs). Most ETFs
are regulated as registered investment companies under the 1940 Act. Many ETFs
acquire and hold securities of all of the companies or other issuers, or a
representative sampling of companies or other issuers that are components of a
particular index. Such ETFs are intended to provide investment results that,
before expenses, generally correspond to the price and yield performance of the
corresponding market index, and the value of their shares should, under normal
circumstances, closely track the value of the index’s underlying component
securities. Because an ETF has operating expenses and transaction costs, while
a market index does not, ETFs that track particular indices typically will be
unable to match the performance of the index exactly. ETF shares may be
purchased and sold in the secondary trading market on a securities exchange, in
lots of any size, at any time during the trading day. More recently, actively
managed ETFs have been created that are managed similarly to other investment
companies.
The
shares of an ETF may be assembled in a block (typically 50,000 shares) known as
a creation unit and redeemed in kind for a portfolio of the underlying
securities (based on the ETF’s net asset value) together with a cash payment
generally equal to accumulated dividends as of the date of redemption.
Conversely, a creation unit may be purchased from the ETF by depositing a
specified portfolio of the ETF’s underlying securities, as well as a cash
payment generally equal to accumulated dividends of the securities (net of
expenses) up to the time of deposit.
ETF
shares, as opposed to creation units, are generally purchased and sold in a
secondary market on a securities exchange. ETF shares can be traded in lots of
any size, at any time during the trading day. Although the Fund, like most
other investors in ETFs, intends to purchase and sell ETF shares primarily in
the secondary trading market, the Fund may redeem creation units for the
underlying securities (and any applicable cash), and may assemble a portfolio
of the underlying securities and use it (and any required cash) to purchase
creation units, if the investment manager believes it is in the Fund’s best
interest to do so.
An
investment in an ETF is subject to all of the risks of investing in the
securities held by the ETF and has similar risks as investing in a closed-end
fund. In addition, because of the ability of large market participants to
arbitrage price differences by purchasing or redeeming creation units, the
difference between the market value and the net asset value of ETF shares
should in most cases be small. An ETF may be terminated and need to liquidate
its portfolio securities at a time when the prices for those securities are falling.
Investment
grade debt securities
Investment grade debt securities are securities that are rated at
the time of purchase in the top four ratings categories by one or more
independent rating organizations such as S&P (rated BBB- or better) or Moody’s
(rated Baa3 or higher) or, if unrated, are determined to be of comparable
quality by the Fund’s investment manager. Generally, a higher rating indicates
the rating agency’s opinion that there is less risk of default of obligations
thereunder including timely repayment of principal and payment of interest.
Debt securities in the lowest investment grade category may have speculative
characteristics and more closely resemble high-yield debt securities than
investment-grade debt securities. Lower-rated securities may be subject to all
the risks applicable to high-yield debt securities and changes in economic
conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than is the case with higher grade
debt securities.
A
number of risks associated with rating agencies apply to the purchase or sale
of investment grade debt securities.
Mortgage
securities
Overview
of mortgage-backed securities. Mortgage-backed securities,
represent an ownership interest in a pool of mortgage loans, usually originated
by mortgage bankers, commercial banks, savings and loan associations, savings
banks and credit unions to finance purchases of homes,
commercial buildings or other real estate. The individual mortgage loans are
packaged or "pooled" together for sale to investors. These mortgage
loans may have either fixed or adjustable interest rates. A guarantee or other
form of credit support may be attached to a mortgage-backed security to protect
against default on obligations.
As
the underlying mortgage loans are paid off, investors receive principal and
interest payments, which "pass-through" when received from individual
borrowers, net of any fees owed to the administrator, guarantor or other
service providers. Some mortgage-backed securities make payments of both
principal and interest at a range of specified intervals; others make
semiannual interest payments at a predetermined rate and repay principal at
maturity (like a typical bond).
Mortgage-backed
securities are based on different types of mortgages, including those on
commercial real estate or residential properties. The primary issuers or
guarantors of mortgage-backed securities have historically been the Government
National Mortgage Association (GNMA or Ginnie Mae), the Federal National
Mortgage Association (FNMA or Fannie Mae) and the Federal Home Loan Mortgage
Corporation (FHLMC or Freddie Mac). Other issuers of mortgage-backed securities
include commercial banks and other private lenders. Trading in mortgage-backed
securities guaranteed by a governmental agency, instrumentality or sponsored
enterprise may frequently take place in the to-be-announced (TBA) forward
market. On June 3, 2019, under the FHFA's “Single Security Initiative” intended
to maximize liquidity for both Fannie Mae and Freddie Mac mortgage-backed
securities in the TBA market, Fannie Mae and Freddie Mac started issuing
uniform mortgage-backed securities (“UMBS”) in place of their separate
offerings of TBA-eligible mortgage-backed securities. The issuance of UMBS may
not achieve the intended results and may have unanticipated or adverse effects
on the market for mortgage-backed securities. See “When-issued, delayed
delivery and to-be-announced transactions” below.
Ginnie
Mae is a wholly-owned United States government corporation within the
Department of Housing and Urban Development. Ginnie Mae guarantees the
principal and interest on securities issued by institutions approved by Ginnie
Mae (such as savings and loan institutions, commercial banks and mortgage
bankers). Ginnie Mae also guarantees the principal and interest on securities
backed by pools of mortgages insured by the Federal Housing Administration (the
“FHA”), or guaranteed by the Department of Veterans Affairs (the “VA”). Ginnie
Mae’s guarantees are backed by the full faith and credit of the U.S.
government. Guarantees as to the timely payment of principal and interest do
not extend to the value or yield of mortgage-backed securities nor do they
extend to the value of the Fund’s shares which will fluctuate daily with market
conditions.
Fannie
Mae is a government-sponsored corporation, but its common stock is owned by
private stockholders. Fannie Mae purchases conventional (i.e., not insured or
guaranteed by any government agency) residential mortgages from a list of
approved seller/servicers which include state and federally chartered savings
and loan associations, mutual savings banks, commercial banks and credit unions
and mortgage bankers. Pass-through securities issued by Fannie Mae are
guaranteed as to timely payment of principal and interest by Fannie Mae, but
are not backed by the full faith and credit of the U.S. government.
Freddie
Mac was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. It is a
government-sponsored corporation formerly owned by the twelve Federal Home Loan
Banks but now its common stock is owned entirely by private stockholders.
Freddie Mac issues Participation Certificates (PCs), which are pass-through
securities, each representing an undivided interest in a pool of residential
mortgages. Freddie Mac guarantees the timely payment of interest and ultimate
collection of principal, but PCs are not backed by the full faith and credit of
the U.S. government.
Although
the mortgage-backed securities of Fannie Mae and Freddie Mac are not backed by
the full faith and credit of the U.S. government, the Secretary of the Treasury
has the authority to support Fannie Mae and Freddie Mac by purchasing limited
amounts of their respective obligations. The yields on these mortgage-backed
securities have historically exceeded the yields on other types of U.S.
government securities with comparable maturities due largely to their
prepayment risk. The U.S. government, in the past, provided financial support
to Fannie Mae and Freddie Mac, but the U.S. government has no legal obligation
to do so, and no assurance can be given that the U.S. government will continue
to do so.
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. FHFA selected a
new chief executive officer and chairman of the board of directors for each of
Fannie Mae and Freddie Mac. Also, the U.S. Treasury entered into a Senior
Preferred Stock Purchase Agreement imposing various covenants that severely
limit each enterprise’s operations.
Fannie Mae and Freddie Mac continue to
operate as going concerns while in conservatorship and each remains liable for
all of its obligations, including its guaranty obligations associated with its
mortgage-backed securities. The FHFA has the power to repudiate any contract
entered into by Fannie Mae and Freddie Mac prior to FHFA’s appointment as
conservator or receiver, including the guaranty obligations of Fannie Mae and
Freddie Mac. Accordingly, securities issued by Fannie Mae and Freddie Mac will
involve a risk of non-payment of principal and interest.
Private
mortgage-backed securities. Issuers of private mortgage-backed
securities, such as commercial banks, savings and loan institutions, private
mortgage insurance companies, mortgage bankers and other secondary market
issuers, are not U.S. government agencies and may be both the originators of
the underlying mortgage loans as well as the guarantors of the mortgage-backed
securities, or they may partner with a government entity by issuing mortgage
loans guaranteed or sponsored by the U.S. government or a U.S. government
agency or sponsored enterprise. Pools of mortgage loans created by private
issuers generally offer a higher rate of interest than government and government-related
pools because there are no direct or indirect government or government agency
guarantees of payment. The risk of loss due to default on private
mortgage-backed securities is historically higher because neither the U.S.
government nor an agency or instrumentality have guaranteed them. Timely
payment of interest and principal is, however, generally supported by various
forms of insurance or guarantees, including individual loan, title, pool and
hazard insurance. Government entities, private insurance companies or the
private mortgage poolers issue the insurance and guarantees. The insurance and
guarantees and the creditworthiness of their issuers will be considered when
determining whether a mortgage-backed security meets the Fund's quality standards.
The Fund may buy mortgage-backed securities without insurance or guarantees if,
through an examination of the loan experience and practices of the poolers, the
investment manager determines that the securities meet the Fund's quality
standards. Private mortgage-backed securities whose underlying assets are
neither U.S. government securities nor U.S. government-insured mortgages, to
the extent that real properties securing such assets may be located in the same
geographical region, may also be subject to a greater risk of default than
other comparable securities in the event of adverse economic, political or
business developments that may affect such region and, ultimately, the ability
of property owners to make payments of principal and interest on the underlying
mortgages. Non-government mortgage-backed securities are generally subject to
greater price volatility than those issued, guaranteed or sponsored by
government entities because of the greater risk of default in adverse market
conditions. Where a guarantee is provided by a private guarantor, the Fund is
subject to the credit risk of such guarantor, especially when the guarantor
doubles as the originator.
Mortgage-backed
securities that are issued or guaranteed by the U.S. government, its agencies
or instrumentalities, are not subject to the Fund's industry concentration
restrictions, set forth under "Fundamental Investment Policies," by
virtue of the exclusion from that test available to securities issued or
guaranteed by the U.S. government or any of its agencies or instrumentalities.
In the case of privately issued mortgage-backed securities, the Fund
categorizes the securities by the issuer's industry for purposes of the Fund's
industry concentration restrictions.
Other
mortgage securities.
Mortgage securities may include interests in pools of (i) reperforming
loans, meaning that the mortgage loans are current, including because of loan
modifications, but had been delinquent in the past and (ii) non-performing
loans, meaning that the mortgage loans are not current. Such mortgage
securities present increased risks of default, including non-payment of
principal and interest.
Additional
risks.
In addition to the special risks described below, mortgage
securities are subject to many of the same risks as other types of debt
securities. The market value of mortgage securities, like other debt
securities, will generally vary inversely with changes in market interest
rates, declining when interest rates rise and rising when interest rates decline.
Mortgage securities differ from conventional debt securities in that most
mortgage securities are pass-through securities. This means that they typically
provide investors with periodic payments (typically monthly) consisting of a
pro rata share of both regular interest and principal payments, as well as
unscheduled early prepayments, on the underlying mortgage pool (net of any fees
paid to the issuer or guarantor of such securities and any applicable loan
servicing fees). As a result, the holder of the mortgage securities (i.e., the
Fund) receives scheduled payments of principal and interest and may receive
unscheduled principal payments representing prepayments on the underlying
mortgages. The rate of prepayments on the underlying mortgages generally increases
as interest rates decline, and when the Fund reinvests the payments and any
unscheduled payments of principal it receives, it may receive a rate of
interest that is lower than the rate on the existing mortgage securities. For
this reason, pass-through mortgage securities may have less potential for
capital appreciation as interest rates decline and may be less effective than
other types of U.S. government or other debt securities as a means of
"locking in" long-term interest rates. In general, fixed rate
mortgage securities have greater exposure to this "prepayment risk"
than variable rate securities.
An unexpected rise in interest rates could
extend the average life of a mortgage security because of a lower than expected
level of prepayments or higher than expected amounts of late payments or
defaults. In addition, to the extent mortgage securities are purchased at a
premium, mortgage foreclosures and unscheduled principal prepayments may result
in some loss of the holder's principal investment to the extent of the premium
paid. On the other hand, if mortgage securities are purchased at a discount,
both a scheduled payment of principal and an unscheduled payment of principal
will increase current and total returns and will accelerate the recognition of
income that, when distributed to shareholders, will generally be taxable as
ordinary income. Regulatory, policy or tax changes may also adversely affect
the mortgage securities market as a whole or particular segments of such
market, including if one or more government sponsored entities, such as Fannie
Mae or Freddie Mac, are privatized or their conservatorship is terminated.
Guarantees. The
existence of a guarantee or other form of credit support on a mortgage security
usually increases the price that the Fund pays or receives for the security.
There is always the risk that the guarantor will default on its obligations.
When the guarantor is the U.S. government, there is minimal risk of guarantor
default. However, the risk remains if the credit support or guarantee is
provided by a private party or a U.S. government agency or sponsored
enterprise. Even if the guarantor meets its obligations, there can be no
assurance that the type of guarantee or credit support provided will be
effective at reducing losses or delays to investors, given the nature of the
default. A guarantee only assures timely payment of interest and principal, not
a particular rate of return on the Fund's investment or protection against
prepayment or other risks. The market price and yield of the mortgage security
at any given time are not guaranteed and likely to fluctuate.
Sector
focus.
The Fund's investments in mortgage securities may cause the Fund
to have significant, indirect exposure to a given market sector. If the underlying
mortgages are predominantly from borrowers in a given market sector, the
mortgage securities may respond to market conditions just as a direct
investment in that sector would. As a result, the Fund may experience greater
exposure to that specific market sector than it would if the underlying
mortgages came from a wider variety of borrowers. Greater exposure to a
particular market sector may result in greater volatility of the security's
price and returns to the Fund, as well as greater potential for losses in the
absence or failure of a guarantee to protect against widespread defaults or
late payments by the borrowers on the underlying mortgages.
Similar
risks may result from an investment in mortgage securities if the underlying
real properties are located in the same geographical region or dependent upon
the same industries or sectors. Such mortgage securities will experience
greater risk of default or late payment than other comparable but diversified
securities in the event of adverse economic, political or business developments
because of the widespread affect an adverse event will have on borrowers'
ability to make payments on the underlying mortgages.
Adjustable
rate mortgage securities (ARMS) ARMS, like traditional fixed
rate mortgage-backed securities, represent an ownership interest in a pool of
mortgage loans and are issued, guaranteed or otherwise sponsored by
governmental or by private entities. Unlike traditional mortgage-backed
securities, the mortgage loans underlying ARMS generally carry adjustable
interest rates, and in some cases principal repayment rates, that are reset
periodically. An adjustable interest rate may be passed-through or otherwise
offered on certain ARMS. The interest obtained by owning ARMS (and, as a
result, the value of the ARMS) may vary monthly as a result of resets in
interest rates and/or principal repayment rates of any of the mortgage loans
that are part of the pool of mortgage loans comprising the ARMS. Investing in
ARMS may permit the Fund to participate in increases in prevailing current
interest rates through periodic adjustments in the interest rate payments on
mortgages underlying the pool on which the ARMS are based. ARMS generally have
lower price fluctuations than is the case with more traditional fixed income
debt securities of comparable rating and maturity.
The
interest rates paid on ARMS generally are readjusted at intervals of one year
or less to a rate that is an increment over some predetermined interest rate
index, although some securities may have reset intervals as long as five years.
Some adjustable rate mortgage loans have fixed rates for an initial period,
typically three, five, seven or ten years, and adjust annually thereafter.
There are three main categories of indices: those based on LIBOR, those based
on U.S. Treasury securities and those derived from a calculated measure such as
a cost of funds index (indicating the cost of borrowing) or a moving average of
mortgage rates. Commonly used indices include the one-, three-, and five-year constant-maturity
Treasury 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-, three-,
six-month, or one-year LIBOR; the prime rate of a specific bank; or commercial
paper rates.
In a changing interest rate environment, the
reset feature may act as a buffer to reduce sharp changes in the ARMS' value in
response to normal interest rate fluctuations. However, the time interval
between each interest reset causes the yield on the ARMS to lag behind changes
in the prevailing market interest rate. As interest rates are reset on the
underlying mortgages, the yields of the ARMS gradually re-align themselves to
reflect changes in market rates so that their market values remain relatively
stable compared to fixed-rate mortgage-backed securities.
As
a result, ARMS generally also have less risk of a decline in value during
periods of rising interest rates than traditional long-term, fixed-rate
mortgage-backed securities. However, during such periods, this reset lag may
result in a lower net asset value until the interest rate resets to market
rates. If prepayments of principal are made on the underlying mortgages during
periods of rising interest rates, the Fund generally will be able to reinvest
these amounts in securities with a higher current rate of return. However, the
Fund will not benefit from increases in interest rates to the extent that interest
rates exceed the maximum allowable annual or lifetime reset limits (or cap
rates) for a particular mortgage-backed security. See “Caps and floors.”
Additionally, borrowers with adjustable rate mortgage loans that are pooled
into ARMS generally see an increase in their monthly mortgage payments when
interest rates rise which in turn may increase their rate of late payments and
defaults.
Because
an investor is "locked in" at a given interest rate for the duration
of the interval until the reset date, whereas interest rates continue to
fluctuate, the sensitivity of an ARMS' price to changes in interest rates tends
to increase along with the length of the interval. To the extent the Fund
invests in ARMS that reset infrequently, the Fund will be subject to similar
interest rate risks as when investing in fixed-rate debt securities. For
example, the Fund can expect to receive a lower interest rate than the
prevailing market rates (or index rates) in a rising interest rate environment
because of the lag between daily increases in interest rates and periodic
readjustments.
During
periods of declining interest rates, the interest rates on the underlying
mortgages may reset downward with a similar lag, resulting in lower yields to
the Fund. As a result, the value of ARMS is unlikely to rise during periods of
declining interest rates to the same extent as the value of fixed-rate
securities do.
Caps
and floors.
The underlying mortgages that collateralize ARMS will frequently
have caps and floors that limit the maximum amount by which the interest rate
to the residential borrower may change up or down (a) per reset or adjustment
interval and (b) over the life of the loan. Fluctuations in interest rates
above the applicable caps or floors on the ARMS could cause the ARMS to
"cap out" and to behave more like long-term, fixed-rate debt
securities.
Negative
amortization.
Some mortgage loans restrict periodic adjustments by limiting
changes in the borrower's monthly principal and interest payments rather than
limiting interest rate changes. These payment caps may result in negative
amortization, where payments are less than the amount of principal and interest
owed, with excess amounts added to the outstanding principal balance, which can
extend the average life of the mortgage-backed securities.
Credit
risk transfer securities Another type of mortgage security are those issued by
agencies or instrumentalities of the U.S. Government, such as Fannie Mae and
Freddie Mac, but without any government guaranty, including “credit risk
transfer securities.” Credit risk transfer securities are fixed- or
floating-rate unsecured general obligation mortgage securities issued from time
to time by Freddie Mac, Fannie Mae or other government sponsored entities
(each, a “GSE”). Typically, such securities are issued at par and have stated
final maturities. The credit risk transfer securities are structured so that:
(i) interest is paid directly by the issuing GSE; and (ii) principal is paid by
the issuing GSE in accordance with the principal payments and default
performance of a certain pool of residential mortgage loans acquired by the
GSE. The issuing GSE selects the pool of mortgage loans based on that GSE’s
eligibility criteria. The performance of the credit risk transfer securities
will be directly affected by the selection of the underlying mortgage loans by
the GSE. Credit risk transfer securities are issued in tranches to which are
allocated certain principal repayments and credit losses corresponding to the
seniority of the particular tranche. Each tranche will have credit exposure to
the underlying mortgage loans and the yield to maturity will be directly
related to the amount and timing of certain defined credit events on the
underlying mortgage loans, any prepayments by borrowers and any removals of a
mortgage loan from the pool.
Credit
risk transfer securities are unguaranteed and unsecured debt securities issued
by the GSE and therefore are not directly linked to or backed by the underlying
mortgage loans. Thus, although the payment of principal and interest on such
securities is tied to the performance of the pool of underlying mortgage loans,
the holders of the credit risk transfer securities will have no interest in the
underlying mortgage loans. As a result, in the event that a GSE fails to pay
principal or interest on its credit risk transfer
securities or goes through a bankruptcy, insolvency or similar proceeding,
holders of such credit risk transfer securities have no direct recourse to the
underlying mortgage loans. Such holders will receive recovery on par with other
unsecured note holders (agency debentures) in such a scenario.
The
Fund may also invest in credit risk transfer securities that are issued by
private entities, such as banks or other financial institutions. Credit risk
transfer securities issued by private entities are structured similarly to
those issued by a GSE and are generally subject to the same types of risks,
including credit (risk of non-payment of principal and interest when due),
prepayment, extension, interest rate and market risks.
The
risks associated with an investment in credit risk transfer securities will be
different than the risks associated with an investment in mortgage-backed
securities issued by Fannie Mae and Freddie Mac, or other GSEs or issued by a
private issuer because some or all of the mortgage default or credit risk
associated with the underlying mortgage loans is transferred to investors, such
as the Fund. As a result, investors in these securities could lose some or all
of their investment in these securities if the underlying mortgage loans
default.
Collateralized
mortgage obligations (CMOs), real estate mortgage investment conduits (REMICs)
and multi-class pass-throughs Some mortgage-backed securities
known as collateralized mortgage obligations (CMOs) are divided into multiple
classes. Each of the classes is allocated a different share of the principal
and/or interest payments received from the pool according to a different
payment schedule depending on, among other factors, the seniority of a class
relative to their classes. Other mortgage-backed securities such as real estate
mortgage investment conduits (REMICs) are also divided into multiple classes
with different rights to the interest and/or principal payments received on the
pool of mortgages. A CMO or REMIC may designate the most junior of the
securities it issues as a "residual" which will be entitled to any
amounts remaining after all classes of shareholders (and any fees or expenses)
have been paid in full. Some of the different rights may include different
maturities, interest rates, payment schedules, and allocations of interest
and/or principal payments on the underlying mortgage loans. Multi-class
pass-through securities are equity interests in a trust composed of mortgage
loans or other mortgage-backed securities. Payments of principal and interest
on the underlying collateral provide the funds to pay the debt service on CMOs
or REMICs or to make scheduled distributions on the multi-class pass-through
securities. Unless the context indicates otherwise, the discussion of CMOs
below also applies to REMICs and multi-class pass-through securities.
All
the risks applicable to a traditional mortgage-backed security also apply to
the CMO or REMIC taken as a whole, even though certain classes of the CMO or
REMIC will be protected against a particular risk by subordinated classes. The
risks associated with an investment in a particular CMO or REMIC class vary
substantially depending on the combination of rights associated with that
class. An investment in the most subordinated classes of a CMO or REMIC bears a
disproportionate share of the risks associated with mortgage-backed securities
generally, be it credit risk, prepayment or extension risk, interest rate risk,
income risk, market risk, illiquidity risk or any other risk associated with a
debt or equity instrument with similar features to the relevant class. As a
result, an investment in the most subordinated classes of a CMO or REMIC is
often riskier than an investment in other types of mortgage-backed securities.
CMOs
are generally required to maintain more collateral than REMICs to collateralize
the CMOs being issued. Most REMICs are not subject to the same minimum
collateralization requirements and may be permitted to issue the full value of
their assets as securities, without reserving any amount as collateral. As a
result, an investment in the subordinated classes of a REMIC may be riskier
than an investment in equivalent classes of a CMO.
CMOs
may be issued, guaranteed or sponsored by governmental entities or by private
entities. Consequently, they involve risks similar to those of traditional
mortgage-backed securities that have been issued, guaranteed or sponsored by
such government and/or private entities. For example, the Fund is generally
exposed to a greater risk of loss due to default when investing in CMOs that
have not been issued, guaranteed or sponsored by a government entity.
CMOs
are typically issued in multiple classes. Each class, often referred to as a
"tranche," is issued at a specified coupon rate or adjustable rate
and has a stated maturity or final distribution date. Principal prepayments on
collateral underlying CMOs may cause the CMOs to be retired substantially
earlier than their stated maturities or final distribution dates. Interest is
paid or accrues on most classes of a CMO on a monthly, quarterly or semiannual
basis. The principal and interest on the mortgages underlying CMOs may be
allocated among the several classes in many ways. In a common structure,
payments of principal on the underlying mortgages, including any principal
prepayments, are applied to the classes of a series of a CMO in the order of
their respective stated maturities or final
distribution dates, so that no payment of principal will be made on any class
until all other classes having an earlier stated maturity or final distribution
date have been paid in full.
One
or more classes of a CMO may have interest rates that reset periodically as
ARMS do. These adjustable rate classes are known as "floating-rate
CMOs" and are subject to most risks associated with ARMS. Floating-rate
CMOs may be backed by fixed- or adjustable-rate mortgages. To date, fixed-rate
mortgages have been more commonly used for this purpose. Floating-rate CMOs are
typically issued with lifetime "caps" on the interest rate. These
caps, similar to the caps on ARMS, limit the Fund's potential to gain from
rising interest rates and increasing the sensitivity of the CMO's price to interest
rate changes while rates remain above the cap.
Timely
payment of interest and principal (but not the market value and yield) of some
of these pools is supported by various forms of insurance or guarantees issued
by private issuers, those who pool the mortgage assets and, in some cases, by
U.S. government agencies.
CMOs
involve risks including the uncertainty of the timing of cash flows that
results from the rate of prepayments on the underlying mortgages serving as
collateral, and risks resulting from the structure of the particular CMO
transaction and the priority of the individual tranches. The prices of some
CMOs, depending on their structure and the rate of prepayments, can be
volatile. Some CMOs may be less liquid than other types of mortgage-backed
securities. As a result, it may be difficult or impossible to sell the
securities at an advantageous price or time under certain circumstances. Yields
on privately issued CMOs have been historically higher than the yields on CMOs
issued or guaranteed by U.S. government agencies or instrumentalities. The risk
of loss due to default on privately issued CMOs, however, is historically
higher since the U.S. government has not guaranteed them.
To
the extent any privately issued CMOs in which the Fund invests are considered
by the SEC to be an investment company, the Fund will limit its investments in
such securities in a manner consistent with the provisions of the 1940 Act.
CMO
and REMIC Residuals.
The residual in a CMO or REMIC structure is the interest in any
excess cash flow generated by the mortgage pool that remains after first making
the required payments of principal and interest to the other classes of the CMO
or REMIC and, second, paying the related administrative expenses and any
management fee of the issuer. Each payment of such excess cash flow to a holder
of the related CMO or REMIC residual represents income and/or a return of
capital. The amount of residual cash flow resulting from a CMO or REMIC will
depend on, among other things, the characteristics of the mortgage assets, the
interest rate of each class, prevailing interest rates, the amount of
administrative expenses and the pre-payment experience on the mortgage assets.
In particular, the return on CMO and REMIC residuals is extremely sensitive to
pre-payments on the related underlying mortgage assets. If a class of a CMO or
REMIC bears interest at an adjustable rate, the CMO or REMIC residual will also
be extremely sensitive to changes in the level of the index upon which interest
rate adjustments are based. CMO and REMIC residuals are generally purchased and
sold by institutional investors through several investment banking firms acting
as brokers or dealers and may not have been registered under the 1933 Act. CMO
and REMIC residuals, whether or not registered under the 1933 Act, may be
subject to certain restrictions on transferability, and may be deemed
"illiquid" and subject to the Fund's limitation on investment in
illiquid securities.
Stripped
mortgage-backed securities and net interest margin securities Some
mortgage-backed securities referred to as stripped mortgage-backed securities
are divided into classes which receive different proportions of the principal
and interest payments or, in some cases, only payments of principal or interest
(but not both). Other mortgage-backed securities referred to as net interest
margin (NIM) securities give the investor the right to receive any excess
interest earned on a pool of mortgage loans remaining after all classes and
service providers have been paid in full. Stripped mortgage-backed securities
may be issued by government or private entities. Stripped mortgage-backed
securities issued or guaranteed by agencies or instrumentalities of the U.S.
government are typically more liquid than privately issued stripped
mortgage-backed securities.
Stripped
mortgage-backed securities are usually structured with two classes, each
receiving different proportions of the interest and principal distributions on
a pool of mortgage assets. In most cases, one class receives all of the
interest (interest-only or "IO" class), while the other class
receives all of the principal (principal-only or "PO" class). The
return on an IO class is extremely sensitive not only to changes in prevailing
interest rates but also to the rate of principal payments (including
prepayments) on the underlying mortgage assets. A rapid rate of principal
payments may have a material adverse effect on any IO class held by the Fund.
If the underlying mortgage assets experience greater than anticipated
prepayments of principal, the Fund may fail to recoup its
initial investment fully, even if the securities are rated in the highest
rating categories, AAA or Aaa, by S&P or Moody's, respectively.
NIM
securities represent a right to receive any "excess" interest
computed after paying coupon costs, servicing costs and fees and any credit
losses associated with the underlying pool of home equity loans. Like
traditional stripped mortgage-backed securities, the return on a NIM security
is sensitive not only to changes in prevailing interest rates but also to the
rate of principal payments (including prepayments) on the underlying home
equity loans. NIM securities are highly sensitive to credit losses on the
underlying collateral and the timing in which those losses are taken.
Stripped
mortgage-backed securities and NIM securities tend to exhibit greater market
volatility in response to changes in interest rates than other types of
mortgage-backed securities and are purchased and sold by institutional
investors, such as the Fund, through investment banking firms acting as brokers
or dealers. Some of these securities may be deemed "illiquid" and
therefore subject to the Fund's limitation on investment in illiquid securities
and the risks associated with illiquidity.
Future
developments.
Mortgage loan and home equity loan pools offering pass-through
investments in addition to those described above may be created in the future.
The mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or interest payments
may vary or whose terms to maturity may differ from customary long-term,
fixed-rate mortgages. As new types of mortgage and home equity loan securities
are developed and offered to investors, the Fund may invest in them if they are
consistent with the Fund's goals, policies and quality standards.
Mortgage
Dollar and U.S. Treasury Rolls
Mortgage
dollar rolls.
In a mortgage dollar roll, the Fund sells or buys mortgage-backed
securities for delivery in the current month and simultaneously contracts to
repurchase or sell substantially similar (same type, coupon, and maturity)
securities on a specified future date. During the period between the sale and
repurchase (known as the "roll period"), the Fund forgoes principal
and interest payments that it would otherwise have received on the securities
sold. The Fund is compensated by the difference between the current sales
price, which it receives, and the lower forward price that it will pay for the
future purchase (often referred to as the "drop"), as well as by the
interest earned on the cash proceeds of the initial sale.
For
each roll transaction, the Fund will segregate assets as set forth in
"Segregation of assets" under "Borrowing."
The
Fund is exposed to the credit risk of its counterparty in a mortgage dollar
roll or U.S. Treasury roll transaction. The Fund could suffer a loss if the
counterparty fails to perform the future transaction or otherwise meet its
obligations and the Fund is therefore unable to repurchase at the agreed upon
price the same or substantially similar mortgage-backed securities it initially
sold. The Fund also takes the risk that the mortgage-backed securities that it
repurchases at a later date will have less favorable market characteristics
than the securities originally sold (e.g., greater prepayment risk).
The
Fund intends to enter into mortgage dollar rolls only with high quality
securities dealers and banks as determined by the investment manager under
board approved counterparty review procedures. Although rolls could add
leverage to the Fund's portfolio, the Fund does not consider the purchase
and/or sale of a mortgage dollar roll to be a borrowing for purposes of the
Fund's fundamental restrictions or other limitations on borrowing.
U.S.
Treasury rolls.
In U.S. Treasury rolls, the Fund sells U.S. Treasury securities
and buys back "when-issued" U.S. Treasury securities of slightly
longer maturity for simultaneous settlement on the settlement date of the
"when-issued" U.S. Treasury security. Two potential advantages of
this strategy are (1) the Fund can regularly and incrementally adjust its
weighted average maturity of its portfolio securities (which otherwise would
constantly diminish with the passage of time); and (2) in a normal yield curve
environment (in which shorter maturities yield less than longer maturities), a
gain in yield to maturity can be obtained along with the desired extension.
During
the period before the settlement date, the Fund continues to earn interest on
the securities it is selling. It does not earn interest on the securities that
it is purchasing until after the settlement date. The Fund could suffer an
opportunity loss if the counterparty to the roll failed to perform its obligations
on the settlement date, and if market conditions changed adversely. The Fund
generally enters into U.S. Treasury rolls only with government securities
dealers recognized by the Federal Reserve Board or with member banks of the
Federal Reserve System.
Municipal securities
Municipal securities are issued by U.S. state and local governments and their
agencies, instrumentalities, authorities and political subdivisions, as well as
by the District of Columbia and U.S. territories and possessions. The issuer
pays a fixed, floating or variable rate of interest, and must repay the
principal at maturity. Municipal securities are issued to raise money for a
variety of public or private purposes, including financing state or local
government, specific projects or public facilities.
Municipal
securities generally are classified as general or revenue obligations. General
obligations are secured by the issuer's pledge of its full faith, credit and
taxing power for the payment of principal and interest. Revenue obligations are
debt securities payable only from the revenues derived from a particular
facility or class of facilities, or a specific excise tax or other revenue
source. As a result, an investment in revenue obligations is subject to greater
risk of delay or non-payment if revenue does not accrue as expected or if other
conditions are not met for reasons outside the control of the Fund. Conversely,
if revenue accrues more quickly than anticipated, the Fund may receive payment
before expected and have difficulty re-investing the proceeds on equally
favorable terms.
The
value of the municipal securities may be highly sensitive to events affecting
the fiscal stability of the municipalities, agencies, authorities and other
instrumentalities that issue securities. In particular, economic, legislative,
regulatory or political developments affecting the ability of the issuers to
pay interest or repay principal may significantly affect the value of the
Fund's investments. These developments can include or arise from, for example,
insolvency of an issuer, uncertainties related to the tax status of municipal
securities, tax base erosion, state or federal constitutional limits on tax
increases or other actions, budget deficits and other financial difficulties,
or changes in the credit ratings assigned to municipal issuers. There will be a
limited market for certain municipal securities, and the Fund could face
illiquidity risks.
Pre-refunded
bonds These
are outstanding debt securities that are not immediately callable (redeemable)
by the issuer but have been “pre-refunded” by the issuer. The issuer
“pre-refunds” the bonds by setting aside in advance all or a portion of the
amount to be paid to the bondholders when the bond is called. Generally, an
issuer uses the proceeds from a new bond issue to buy high grade, interest
bearing debt securities, including direct obligations of the U.S. government,
which are then deposited in an irrevocable escrow account held by a trustee
bank to secure all future payments of principal and interest on the
pre-refunded bonds. Due to the substantial “collateral” held in escrow,
prerefunded bonds often receive the same rating as obligations of the United
States Treasury. Because pre-refunded bonds still bear the same interest rate
as when they were originally issued and are of very high credit quality, their
market value may increase. However, as the pre-refunded bond approaches its
call or ultimate maturity date, the bond’s market value will tend to fall to
its call or par price.
Repurchase
agreements
Under a repurchase agreement, the Fund agrees to buy securities
guaranteed as to payment of principal and interest by the U.S. government or
its agencies or instrumentalities from a qualified bank, broker-dealer or other
counterparty and then to sell the securities back to such counterparty on an
agreed upon date (generally less than seven days) at a higher price, which
reflects currently prevailing short-term interest rates. Entering into
repurchase agreements allows the Fund to earn a return on cash in the Fund's
portfolio that would otherwise remain un-invested. The counterparty must
transfer to the Fund's custodian, as collateral, securities with an initial
market value of at least 102% of the dollar amount paid by the Fund to the
counterparty. The investment manager will monitor the value of such collateral
daily to determine that the value of the collateral equals or exceeds the
repurchase price.
Repurchase
agreements may involve risks in the event of default or insolvency of the
counterparty, including possible delays or restrictions upon the Fund's ability
to sell the underlying securities and additional expenses in seeking to enforce
the Fund's rights and recover any losses. The Fund will enter into repurchase
agreements only with parties who meet certain creditworthiness standards, i.e.,
banks or broker-dealers that the investment manager has determined, based on
the information available at the time, present no serious risk of becoming
involved in bankruptcy proceedings within the time frame contemplated by the
repurchase agreement. Although the Fund seeks to limit the credit risk under a
repurchase agreement by carefully selecting counterparties and accepting only
high quality collateral, some credit risk remains. The counterparty could default
which may make it necessary for the Fund to incur expenses to liquidate the
collateral. In addition, the collateral may decline in value before it can be
liquidated by the Fund.
A
repurchase agreement with more than seven days to maturity is considered an
illiquid security and is subject to the Fund's investment restriction on
illiquid securities.
Securities lending To
generate additional income, the Fund may lend certain of its portfolio
securities to qualified banks and broker-dealers (referred to as
"borrowers"). In exchange, the Fund receives cash collateral from a
borrower at least equal to the value of the security loaned by the Fund. Cash
collateral typically consists of any combination of cash, securities issued by
the U.S. government and its agencies and instrumentalities, and irrevocable
letters of credit. The Fund may invest this cash collateral while the loan is
outstanding and generally retains part or all of the interest earned on the
cash collateral. Securities lending allows the Fund to retain ownership of the
securities loaned and, at the same time, earn additional income.
For
each loan, the borrower usually must maintain with the Fund's custodian
collateral with an initial market value at least equal to 102% of the market
value of the domestic securities loaned (or 105% of the market value of foreign
securities loaned), including any accrued interest thereon. Such collateral
will be marked-to-market daily, and if the coverage falls below 100%, the
borrower will be required to deliver additional collateral equal to at least
102% of the market value of the domestic securities loaned (or 105% of the
foreign securities loaned).
The
Fund retains all or a portion of the interest received on investment of the
cash collateral or receives a fee from the borrower. The Fund also continues to
receive any distributions paid on the loaned securities. The Fund seeks to
maintain the ability to obtain the right to vote or consent on proxy proposals
involving material events affecting securities loaned. The Fund may terminate a
loan at any time and obtain the return of the securities loaned within the
normal settlement period for the security involved.
If
the borrower defaults on its obligation to return the securities loaned because
of insolvency or other reasons, the Fund could experience delays and costs in
recovering the securities loaned or in gaining access to the collateral. These
delays and costs could be greater for foreign securities. If the Fund is not
able to recover the securities loaned, the Fund may sell the collateral and
purchase a replacement investment in the market. Additional transaction costs
would result, and the value of the collateral could decrease below the value of
the replacement investment by the time the replacement investment is purchased.
Until the replacement can be purchased, the Fund will not have the desired
level of exposure to the security which the borrower failed to return. Cash
received as collateral through loan transactions may be invested in other
eligible securities, including shares of a money market fund. Investing this
cash subjects the Fund to greater market risk including losses on the
collateral and, should the Fund need to look to the collateral in the event of
the borrower's default, losses on the loan secured by that collateral.
The
Fund will loan its securities only to parties who meet creditworthiness
standards approved by the Fund's board (i.e., banks or broker-dealers that the
investment manager has determined are not apparently at risk of becoming involved
in bankruptcy proceedings within the time frame contemplated by the loan). In
addition, pursuant to the 1940 Act and SEC interpretations thereof, the
aggregate market value of securities that may be loaned by the Fund is limited
to 33 1/3% of the Fund's total assets or such lower limit as set by the Fund or
its board.
Stripped
securities
Stripped securities are debt securities that have been
transformed from a principal amount with periodic interest coupons into a
series of zero coupon bonds, each with a different maturity date corresponding
to one of the payment dates for interest coupon payments or the redemption date
for the principal amount. Stripped securities are subject to all the risks
applicable to zero coupon bonds as well as certain additional risks.
Like
zero coupon bonds, stripped securities do not provide for periodic payments of
interest prior to maturity. Rather they are offered at a discount from their
face amount that will be paid at maturity. This results in the security being subject
to greater fluctuations in response to changing interest rates than
interest-paying securities of similar maturities. Federal income taxes
generally accrue on stripped securities each year although no cash income is
received until maturity, and the Fund may be required to sell portfolio
securities that it would otherwise continue to hold in order to obtain
sufficient cash to make distributions to shareholders required for U.S. tax
purposes.
The
riskiness of an investment in stripped securities depends on the type involved.
Some stripped securities are backed by the full faith and credit of the U.S.
government. Others receive an implied backing by the U.S. government as a
sponsor or partner in the agency or entity issuing the stripped security. A few
are secured with a guarantee from the financial institution or broker or dealer
through which the stripped security is held. Others are supported only by the
collateral, revenue stream or third party guarantee securing the underlying
debt obligation from which zero coupon bonds were stripped. Stripped securities
include: U.S. Treasury STRIPS, Stripped Government Securities, Stripped
Obligations of the Financing Corporation (FICO STRIPS), Stripped Corporate
Securities, and Stripped Eurodollar Obligations.
Stripped government securities are issued by the U.S.
federal, state and local governments and their agencies and instrumentalities,
and by "mixed-ownership government corporations." Stripped government
securities vary widely in the terms, conditions and relative assurances of
payment. The type of debt obligation from which the stripped government
security was taken will indicate many of the risks associated with that
investment. U.S. Treasury STRIPS and FICO Strips are types of stripped
government securities.
U.S.
Treasury STRIPS (Separate Trading of Registered Interest and Principal of
Securities)
are considered U.S. Treasury securities for purposes of the Fund's investment
policies and are backed by the full faith and credit of the U.S. government.
Their risks are similar to those of other U.S. government securities, although
their price may be more volatile. The U.S. Treasury has facilitated transfers
of ownership of zero coupon securities by accounting separately for the
beneficial ownership of particular interest coupon and principal payments on
Treasury securities through the Federal Reserve book-entry record-keeping
system.
FICO
STRIPS
represent interests in securities issued by the Financing Corporation (FICO).
FICO was established to enable recapitalization of the Federal Savings and Loan
Insurance Corporation (FSLIC) in the 1980's. FICO STRIPS are not backed by the
full faith and credit of the U.S. government but are generally treated as U.S.
government agency securities. The market for FICO STRIPS is substantially
smaller and, therefore, less liquid and more volatile than the market for U.S.
Treasury STRIPS. A higher yield is typically offered on FICO STRIPS to
compensate investors for the greater illiquidity and additional risk that the
U.S. government will not meet obligations on the FICO STRIPS if FICO defaults.
Structured
investments
Structured investments are interests in entities organized and
operated solely for the purpose of restructuring the investment characteristics
of a security or securities and then issuing that restructured security.
Restructuring involves the deposit with, or purchase by, an entity (such as a
corporation or trust) of specified instruments and the issuance by that entity
of one or more classes of securities (structured investments) backed by, or
representing interests in, the underlying instruments.
Subordinated
classes typically have higher yields and present greater risks than
unsubordinated classes. The extent of the payments made with respect to
structured investments is dependent on the extent of the cash flow on the
underlying instruments.
Certain
issuers of structured investments may be deemed to be "investment
companies" as defined in the 1940 Act. As a result, the Fund's investment
in these structured investments may be limited by the restrictions contained in
the 1940 Act. The risks associated with investing in a structured investment
are usually tied to the risks associated with investing in the underlying
instruments and securities. The risks will also depend upon the comparative
subordination of the class held by the Fund, relative to the likelihood of a
default on the structured investment. To the extent that the Fund is exposed to
default, the Fund's structured investment may involve risks similar to those of
high-yield debt securities. Structured investments typically are sold in
private placement transactions, and there currently is no active trading market
for structured investments. To the extent such investments are deemed to be
illiquid, they will be subject to the Fund's restrictions on investments in
illiquid securities.
These
entities typically are organized by investment banking firms that receive fees
in connection with establishing each entity and arranging for the placement of
its securities. The Fund will indirectly pay its portion of these fees in
addition to the fees associated with the creation and marketing of the
underlying instruments and securities. If an active investment management
component is combined with the underlying instruments and securities in the
structured investment, there may be ongoing advisory fees which the Fund's
shareholders would indirectly pay.
Temporary
investments
When the investment manager believes market or economic
conditions are unfavorable for investors, the investment manager may invest up
to 100% of the Fund's assets in temporary defensive investments, including
cash, cash equivalents or other high quality short-term investments, such as
short-term debt instruments, including U.S. government securities, high grade
commercial paper, repurchase agreements, negotiable certificates of deposit,
non-negotiable fixed time deposits, bankers acceptances, and other money market
equivalents. To the extent allowed by exemptions from and rules under the 1940
Act and the Fund's other investment policies and restrictions, the investment
manager also may invest the Fund's assets in shares of one or more money market
funds managed by the investment manager or its affiliates. Unfavorable market
or economic conditions may include excessive volatility or a prolonged general
decline in the securities markets, the securities in which the Fund normally
invests, or the economies of the countries where the Fund invests. Temporary
defensive investments can and do experience defaults. The likelihood of default
on a temporary defensive investment may increase in the market or economic
conditions which are likely to trigger the Fund's investment therein. The
investment manager also may invest in these types of
securities or hold cash while looking for suitable investment opportunities or
to maintain liquidity. When the Fund's assets are invested in temporary
investments, the Fund may not be able to achieve its investment goal.
Unrated
debt securities
Not all debt securities or their issuers are rated by rating
agencies, sometimes due to the size of or manner of the securities offering,
the decision by one or more rating agencies not to rate certain securities or
issuers as a matter of policy, or the unwillingness or inability of the issuer
to provide the prerequisite information and fees to the rating agencies. Some
debt securities markets may have a disproportionately large number of unrated
issuers.
In
evaluating unrated securities, the investment manager may consider, among other
things, the issuer's financial resources, its sensitivity to economic
conditions and trends, its operating history, the quality of the issuer's
management and regulatory matters. Although unrated debt securities may be
considered to be of investment grade quality, issuers typically pay a higher
interest rate on unrated than on investment grade rated debt securities. Less
information is typically available to the market on unrated securities and
obligors, which may increase the potential for credit and valuation risk.
U.S.
government securities
U.S. government securities include obligations of, or guaranteed
by, the U.S. federal government, its agencies, instrumentalities or sponsored
enterprises. Some U.S. government securities are supported by the full faith
and credit of the U.S. government. These include U.S. Treasury obligations and
securities issued by the GNMA. A second category of U.S. government securities
are those supported by the right of the agency, instrumentality or sponsored
enterprise to borrow from the U.S. government to meet its obligations. These
include securities issued by Federal Home Loan Banks.
A
third category of U.S. government securities are those supported by only the
credit of the issuing agency, instrumentality or sponsored enterprise. These
include securities issued by the FNMA and FHLMC. In the event of a default, an
investor like the Fund would only have legal recourse to the issuer, not the
U.S. government. Although the U.S. government has provided support for these
securities in the past, there can be no assurance that it will do so in the
future. The U.S. government has also made available additional guarantees for
limited periods to stabilize or restore a market in the wake of an economic,
political or natural crisis. Such guarantees, and the economic opportunities
they present, are likely to be temporary and cannot be relied upon by the Fund.
Any downgrade of the credit rating of the securities issued by the U.S.
government may result in a downgrade of securities issued by its agencies or
instrumentalities, including government-sponsored entities.
Variable
rate securities
Variable rate securities are debt securities that provide for
periodic adjustments in the interest rate paid on the debt security. Floating
rate securities, adjustable rate securities and inverse floating rate
securities (referred to as "inverse floaters") are types of variable
rate securities. An adjustable rate security is a debt security with an
interest rate which is adjusted according to a formula that specifies the
interval at which the rate will be reset and the interest rate index, benchmark
or other mechanism upon which the reset rate is based. A floating rate debt
security has a rate of interest which is usually established as the sum of a base
lending rate (e.g., the London Inter-Bank Offered Rate (LIBOR), the U.S. Prime
Rate, the Prime Rate of a designated U.S. bank or the certificate of deposit
rate) plus a specified margin. The interest rate on prime rate-based loans and
securities floats periodically as the prime rate changes. The interest rate on
LIBOR-based and CD-based loans and securities is reset periodically, typically
at regular intervals ranging between 30 days and one year. Certain floating
rate securities will permit the borrower to select an interest rate reset
period of up to one year.
Some
variable rate securities are structured with put features that permit holders
to demand payment of the unpaid principal balance plus accrued interest from
the issuers or certain financial intermediaries at or about the time the
interest rate is reset. If the Fund purchases a variable rate security with a
put feature and market movements make exercise of the put unattractive, the
Fund will forfeit the entire amount of any premium paid plus related
transaction costs.
Movements
in the relevant index or benchmark on which adjustments are based will affect
the interest paid on these securities and, therefore, the current income earned
by the Fund and the securities' market value. The degree of volatility in the
market value of the variable rate securities held by the Fund will generally
increase along with the length of time between adjustments, the degree of
volatility in the applicable index, benchmark or base lending rate and whether
the index, benchmark or base lending rate to which it resets or floats
approximates short-term or other prevailing interest rates. It will also be a
function of the maximum increase or decrease of the interest rate adjustment on
any one adjustment date, in any one year, and over the life of the security.
These maximum increases and decreases are typically referred to as
"caps" and "floors," respectively.
During periods when short-term interest rates
move within the caps and floors of the security held by the Fund, the interest
rate of such security will reset to prevailing rates within a short period. As
a result, the fluctuation in market value of the variable rate security held by
the Fund is generally expected to be limited.
In
periods of substantial short-term volatility in interest rates, the market
value of such debt securities may fluctuate more substantially if the caps
and/or floors prevent the interest rates from adjusting to the full extent of
the movements in the market rates during any one adjustment period or over the
term of the security. In the event of dramatic increases in interest rates, any
lifetime caps on these securities may prevent the securities from adjusting to
prevailing rates over the term of the security. In either the case of caps or
floors, the market value of the securities may be reduced.
The
income earned by the Fund and distributed to shareholders will generally
increase or decrease along with movements in the relevant index, benchmark or
base lending rate. Thus the Fund's income will be more unpredictable than the
income earned on similar investments with a fixed rate of interest.
Inverse
floaters.
Inverse floaters are variable rate debt securities with floating
or variable interest rates that move in the opposite direction, usually at an
accelerated speed, to short-term interest rates or a related benchmark or
index. The prices of inverse floaters can be highly volatile as a result. When
short-term interests rates rise, an inverse floater usually experiences a
decline in both its price and rate of income. The result is that interest rate
risk and volatility of inverse floaters is magnified, and valuation of inverse
floaters will also be more difficult.
Trust
preferred securities
Trust preferred securities are typically issued by corporations, generally in
the form of interest bearing notes with preferred securities characteristics,
or by an affiliated business trust of a corporation, generally in the form of
beneficial interests in subordinated debentures or similarly structured
securities. The trust preferred securities market consists of both fixed and
adjustable coupon rate securities that are either perpetual in nature or have
stated maturity dates.
Trust
preferred securities are typically junior and fully subordinated liabilities of
an issuer and benefit from a guarantee that is junior and fully subordinated to
the other liabilities of the guarantor. In addition, trust preferred securities
typically permit an issuer to defer the payment of income for five years or
more without triggering an event of default. Because of their subordinated
position in the capital structure of an issuer, the ability to defer payments
for extended periods of time without default consequences to the issuer, and
certain other features (such as restrictions on common dividend payments by the
issuer or ultimate guarantor when full cumulative payments on the trust
preferred securities have not been made), these trust preferred securities are
often treated as close substitutes for traditional preferred securities, both
by issuers and investors.
Trust
preferred securities are typically issued with a final maturity date, although
some are perpetual in nature. In certain instances, a final maturity date may
be extended and/or the final payment of principal may be deferred at the
issuer’s option for a specified time without default. No redemption can
typically take place unless all cumulative payment obligations have been met,
although issuers may be able to engage in open-market repurchases without
regard to whether all payments have been paid.
Many
trust preferred securities are issued by trusts or other special purpose
entities established by operating companies and are not a direct obligation of
an operating company. At the time the trust or special purpose entity sells
such preferred securities to investors, it purchases debt of the operating
company (with terms comparable to those of the trust or special purpose entity
securities), which enables the operating company to deduct for tax purposes the
interest paid on the debt held by the trust or special purpose entity. The
trust or special purpose entity is generally required to be treated as
transparent for federal income tax purposes such that the holders of the trust
preferred securities are treated as owning beneficial interests in the
underlying debt of the operating company. Accordingly, payments on the trust
preferred securities are treated as interest rather than dividends for federal
income tax purposes. The trust or special purpose entity in turn would be a
holder of the operating company’s debt and would have priority with respect to
the operating company’s earnings and profits over the operating company’s
common shareholders, but would typically be subordinated to other classes of
the operating company’s debt. Typically a preferred share has a rating that is
slightly below that of its corresponding operating company’s senior debt
securities.
When-issued,
delayed delivery and to-be-announced transactions
When-issued, delayed delivery and to-be-announced (TBA) transactions are
arrangements under which the parties agree on the sale of securities with
payment for and delivery of the security scheduled for a future time. The
securities may have been authorized but not yet issued, or, in the TBA market
for U.S. Government agency mortgage-backed securities, the parties agree on a
price, volume, and basic characteristics of securities to be
delivered on the settlement date, rather than particular securities. In
addition to buying securities on a when-issued, delayed delivery or TBA basis,
the Fund may also sell these securities on a TBA basis to close out an existing
TBA position before the settlement date, to take advantage of an expected
decline in value of the securities, or for hedging purposes.
Entering
into a when-issued, delayed delivery or TBA transaction may be viewed as a form
of leverage and will result in associated risks for the Fund. To mitigate these
risks, when the Fund enters into this type of transaction, it will segregate
liquid assets as set forth in "Segregation of assets" under
"Borrowing." However, the Fund does not consider the purchase and/or
sale of securities on a when-issued, delayed delivery or TBA basis to be a
borrowing for purposes of the Fund’s fundamental restrictions or other
limitations on borrowing.
Many
when-issued, delayed-delivery or TBA transactions also are subject to the risk
that a counterparty may become bankrupt or otherwise fail to perform its
obligations due to financial difficulties, including making payments or
fulfilling other obligations to the Fund. The Fund may obtain no or only
limited recovery in a bankruptcy or other organizational proceedings, and any
recovery may be significantly delayed. With respect to forward settling TBA
transactions involving U.S. Government agency mortgage backed securities, the
counterparty risk may be mitigated by the exchange of variation margin on a
regular basis between counterparties as the market value of the deliverable
security fluctuates.
The
Fund also relies on the counterparty to complete the transaction. The
counterparty’s failure to do so may cause the Fund to miss a price or yield
considered advantageous to the Fund. Although their price typically reflects
accrued interest, securities purchased on a when-issued or delayed delivery
basis do not generally earn interest until their scheduled delivery date.
Purchases or sales of debt securities on a when-issued or delayed delivery
basis are also subject to the risk that the market value or the yield at
delivery may be more or less than the market price or yield available when the
transaction was entered into, or that the Fund is unable to purchase securities
for delivery at the settlement date with the characteristics agreed upon at the
time of the transaction.
Zero
coupon, deferred interest and pay-in-kind bonds Zero
coupon or deferred interest bonds are debt securities that make no periodic
interest payments until maturity or a specified date when the securities begin
paying current interest (cash payment date). Zero coupon and deferred interest
bonds generally are issued and traded at a discount from their face amount or
par value.
The
original discount on zero coupon or deferred interest bonds approximates the total
amount of interest the bonds will accumulate over the period until maturity or
the first cash payment date and compounds at a rate of interest reflecting the
market rate of the security at the time of issuance. The discount varies
depending on the time remaining until maturity or the cash payment date, as
well as prevailing interest rates, liquidity of the market for the security,
and the perceived credit quality of the issuer. The discount, in the absence of
financial difficulties of the issuer, typically decreases as the final maturity
or cash payment date approaches. The discount typically increases as interest
rates rise, the market becomes less liquid or the creditworthiness of the
issuer deteriorates.
Pay-in-kind
bonds are debt securities that provide for interest payments to be made in a
form other than cash, generally at the option of the issuer. Common forms
include payment of additional bonds of the same issuer or an increase in
principal underlying the pay-in-kind bonds. To the extent that no cash income
will be paid for an extended period of time, pay-in-kind bonds resemble zero
coupon or deferred interest bonds and are subject to similar influences and
risks.
For
accounting and federal tax purposes, holders of bonds issued at a discount,
such as the Fund, are deemed to receive interest income over the life of the
bonds even though the bonds do not pay out cash to their holders before
maturity or the cash payment date. That income is distributable to Fund
shareholders even though no cash is received by the Fund at the time of
accrual, which may require the liquidation of other portfolio securities to
satisfy the Fund's distribution obligations.
Because
investors receive no cash prior to the maturity or cash payment date, an
investment in debt securities issued at a discount generally has a greater
potential for complete loss of principal and/or return than an investment in
debt securities that make periodic interest payments. Such investments are more
vulnerable to the creditworthiness of the issuer and any other parties upon
which performance relies.
The
following is a description of the general risks associated with the
Fund's investing in debt securities:
Credit Debt securities are subject to
the risk of an issuer's (or other party's) failure or inability to meet its
obligations under the security. Multiple parties may have obligations under a
debt security. An issuer or borrower may fail to pay principal and interest
when due. A guarantor, insurer or credit support provider may fail to provide
the agreed upon protection. A counterparty to a transaction may fail to perform
its side of the bargain. An intermediary or agent interposed between the
investor and other parties may fail to perform the terms of its service. Also,
performance under a debt security may be linked to the obligations of other
persons who may fail to meet their obligations. The credit risk associated with
a debt security could increase to the extent that the Fund's ability to benefit
fully from its investment in the security depends on the performance by
multiple parties of their respective contractual or other obligations. The
market value of a debt security is also affected by the market's perception of
the creditworthiness of the issuer.
The
Fund may incur substantial losses on debt securities that are inaccurately
perceived to present a different amount of credit risk than they actually do by
the market, the investment manager or the rating agencies. Credit risk is
generally greater where less information is publicly available, where fewer
covenants safeguard the investors' interests, where collateral may be impaired
or inadequate, where little legal redress or regulatory protection is
available, or where a party's ability to meet obligations is speculative.
Additionally, any inaccuracy in the information used by the Fund to evaluate
credit risk may affect the value of securities held by the Fund.
Obligations
under debt securities held by the Fund may never be satisfied or, if satisfied,
only satisfied in part.
Some
securities are subject to risks as a result of a credit downgrade or default by
a government, or its agencies or, instrumentalities. Credit risk is a greater
concern for high-yield debt securities and debt securities of issuers whose
ability to pay interest and principal may be considered speculative. Debt
securities are typically classified as investment grade-quality (medium to
highest credit quality) or below investment grade-quality (commonly referred to
as high-yield or junk bonds). Many individual debt securities are rated by a
third party source, such as Moody's or S&P to help describe the
creditworthiness of the issuer.
Debt
securities ratings
The investment manager performs its own independent investment
analysis of securities being considered for the Fund's portfolio, which
includes consideration of, among other things, the issuer's financial
resources, its sensitivity to economic conditions and trends, its operating
history, the quality of the issuer's management and regulatory matters. The
investment manager also considers the ratings assigned by various investment
services and independent rating agencies, such as Moody's and S&P, that publish
ratings based upon their assessment of the relative creditworthiness of the
rated debt securities. Generally, a lower rating indicates higher credit risk.
Higher yields are ordinarily available from debt securities in the lower rating
categories. These ratings are described at the end of this SAI under
"Description of Ratings."
Using
credit ratings to evaluate debt securities can involve certain risks. For
example, ratings assigned by the rating agencies are based upon an analysis
completed at the time of the rating of the obligor's ability to pay interest
and repay principal. Rating agencies typically rely to a large extent on
historical data which may not accurately represent present or future
circumstances. Ratings do not purport to reflect the risk of fluctuations in
market value of the debt security and are not absolute standards of quality and
only express the rating agency's current opinion of an obligor's overall
financial capacity to pay its financial obligations. A credit rating is not a
statement of fact or a recommendation to purchase, sell or hold a debt
obligation. Also, credit quality can change suddenly and unexpectedly, and
credit ratings may not reflect the issuer's current financial condition or
events since the security was last rated. Rating agencies may have a financial
interest in generating business, including from the arranger or issuer of the
security that normally pays for that rating, and providing a low rating might
affect the rating agency's prospects for future business. While rating agencies
have policies and procedures to address this potential conflict of interest,
there is a risk that these policies will fail to prevent a conflict of interest
from impacting the rating.
Extension The
market value of some debt securities, particularly mortgage securities and
certain asset-backed securities, may be adversely affected when bond calls or
prepayments on underlying mortgages or other assets are less or slower than
anticipated. This risk is extension risk. Extension risk may result from, for
example, rising interest rates or unexpected developments in the markets for
the underlying assets or mortgages. As a consequence, the security's effective
maturity will be extended, resulting in an increase in interest rate
sensitivity to that of a longer-term instrument. Extension risk generally
increases as interest rates rise. This is because, in a rising interest rate
environment, the rate of prepayment and exercise of call or buy-back rights
generally falls and the rate of default and delayed payment generally rises.
When the maturity of an investment is extended in a rising interest rate
environment, a below-market interest rate is usually locked-in and the value of
the security reduced. This risk is greater for fixed-rate than variable-rate
debt securities.
Income The Fund is subject to income
risk, which is the risk that the Fund's income will decline during periods of
falling interest rates or when the Fund experiences defaults on debt securities
it holds. The Fund's income declines when interest rates fall because, as the
Fund's higher-yielding debt securities mature or are prepaid, the Fund must
re-invest the proceeds in debt securities that have lower, prevailing interest
rates. The amount and rate of distributions that the Fund's shareholders
receive are affected by the income that the Fund receives from its portfolio
holdings. If the income is reduced, distributions by the Fund to shareholders
may be less. Fluctuations in income paid to the Fund are generally greater for
variable rate debt securities. The Fund will be deemed to receive taxable
income on certain securities which pay no cash payments until maturity, such as
zero-coupon securities. The Fund may be required to sell portfolio securities
that it would otherwise continue to hold in order to obtain sufficient cash to
make the distribution to shareholders required for U.S. tax purposes.
Fluctuations
in income paid to the Fund are generally greater for variable rate debt
securities. The Fund will be deemed to receive taxable income on certain
securities which pay no cash payments until maturity, such as zero-coupon
securities. The Fund may be required to sell portfolio securities that it would
otherwise continue to hold in order to obtain sufficient cash to make the distribution
to shareholders required for U.S. tax purposes.
Inflation The
market price of debt securities generally falls as inflation increases because
the purchasing power of the future income and repaid principal is expected to
be worth less when received by the Fund. Debt securities that pay a fixed
rather than variable interest rate are especially vulnerable to inflation risk
because variable-rate debt securities may be able to participate, over the long
term, in rising interest rates which have historically corresponded with
long-term inflationary trends.
Interest
rate
The market value of debt securities generally varies in response
to changes in prevailing interest rates. Interest rate changes can be sudden
and unpredictable. In addition, short-term and long-term rates are not
necessarily correlated to each other as short-term rates tend to be influenced
by government monetary policy while long-term rates are market driven and may
be influenced by macroeconomic events (such as economic expansion or
contraction), inflation expectations, as well as supply and demand. During
periods of declining interest rates, the market value of debt securities
generally increases. Conversely, during periods of rising interest rates, the
market value of debt securities generally declines. This occurs because new
debt securities are likely to be issued with higher interest rates as interest
rates increase, making the old or outstanding debt securities less attractive.
In general, the market prices of long-term debt securities or securities that
make little (or no) interest payments are more sensitive to interest rate
fluctuations than shorter-term debt securities. The longer the Fund's average
weighted portfolio duration, the greater the potential impact a change in interest
rates will have on its share price. Also, certain segments of the fixed income
markets, such as high quality bonds, tend to be more sensitive to interest rate
changes than other segments, such as lower-quality bonds.
Prepayment Debt
securities, especially bonds that are subject to "calls," such as
asset-backed or mortgage-backed securities, are subject to prepayment risk if
their terms allow the payment of principal and other amounts due before their
stated maturity. Amounts invested in a debt security that has been
"called" or "prepaid" will be returned to an investor
holding that security before expected by the investor. In such circumstances,
the investor, such as a fund, may be required to re-invest the proceeds it
receives from the called or prepaid security in a new security which, in
periods of declining interest rates, will typically have a lower interest rate.
Prepayment risk is especially prevalent in periods of declining interest rates
and will result for other reasons, including unexpected developments in the
markets for the underlying assets or mortgages. For example, a decline in
mortgage interest rates typically initiates a period of mortgage refinancings.
When homeowners refinance their mortgages, the investor in the underlying pool
of mortgage-backed securities (such as a fund) receives its principal back
sooner than expected, and must reinvest at lower, prevailing rates.
Securities
subject to prepayment risk are often called during a declining interest rate
environment and generally offer less potential for gains and greater price
volatility than other income-bearing securities of comparable maturity.
Call
risk is similar to prepayment risk and results from the ability of an issuer to
call, or prepay, a debt security early. If interest rates decline enough, the
debt security's issuer can save money by repaying its callable debt securities
and issuing new debt securities at lower interest rates.
The
following is a description of the general risks associated with the
Fund's investments:
Focus The greater the Fund's exposure
to (or focus on) any single type of investment – including investment in a
given industry, sector, country, region, or type of security – the greater the
impact of adverse events or conditions in such industry, sector, country,
region or investment will have on the Fund's performance. To the extent the
Fund has greater exposure to any single type of investment, the Fund's
potential for loss (or gain) will be greater than if its portfolio were invested
more broadly in many types of investments.
The
Fund's exposure to such industries, sectors, regions and other investments may
also arise indirectly through the Fund's investments in debt securities (e.g.,
mortgage or asset-backed securities) that are secured by such investments.
Similar risks associated with focusing on a particular type of investment may
result if real properties and collateral securing the Fund's investments are
located in the same geographical region or subject to the same risks or
concerns.
Inside
information
The investment manager (through its representatives or otherwise)
may receive information that restricts the investment manager's ability to
cause the Fund to buy or sell securities of an issuer for substantial periods of
time when the Fund otherwise could realize profit or avoid loss. This may
adversely affect the Fund's flexibility with respect to buying or selling
securities.
Liquidity
Liquidity risk exists when particular investments are or become difficult to purchase
or sell at the price at which the Fund has valued the security, whether because
of current market conditions, the financial condition of the issuer, or the
specific type of investment. If the market for a particular security becomes
illiquid (for example, due to changes in the issuer's financial condition), the
Fund may be unable to sell such security at an advantageous time or price due
to the difficulty in selling such securities. To the extent that the Fund and
its affiliates hold a significant portion of an issuer's outstanding
securities, the Fund may also be subject to greater liquidity risk than if the
issuer's securities were more widely held. The Fund may also need to sell some
of the Fund's more liquid securities when it otherwise would not do so in order
to meet redemption requests, even if such sale of the liquid holdings would be
disadvantageous from an investment standpoint. Reduced liquidity may also have
an adverse impact on a security's market value and the sale of such securities
often results in higher brokerage charges or dealer discounts and other selling
expenses. Reduced liquidity in the secondary market for certain securities will
also make it more difficult for the Fund to obtain market quotations based on
actual trades for purposes of valuing the Fund's portfolio and thus pricing may
be prone to error when market quotations are volatile, infrequent and/or
subject to large spreads between bid and ask prices. In addition, prices
received by the Fund for securities may be based on institutional “round lot”
sizes, but the Fund may purchase, hold or sell smaller, “odd lot” sizes, which
may be harder to sell. Odd lots may trade at lower prices than round lots,
which may affect the Fund’s ability to accurately value its investments.
The
market for certain equity or debt securities may become illiquid under adverse
market or economic conditions independent of any specific adverse changes in
the conditions of a particular issuer. For example, dealer capacity in certain
fixed income markets appears to have undergone fundamental changes since the
financial crisis of 2008, which may result in low dealer inventories and a
reduction in dealer market-making capacity. An increase in interest rates due
to the tapering of the Federal Reserve Board’s quantitative easing program and
other similar central bank actions, coupled with a reduction in dealer
market-making capacity, may decrease liquidity and increase volatility in the
fixed income markets. Liquidity risk generally increases (meaning that securities
become more illiquid) as the number, or relative need, of investors seeking to
liquidate in a given market increases; for example, when an asset class or
classes fall out of favor and investors sell their holdings in such classes,
either directly or indirectly through investment funds, such as mutual funds
and ETFs.
Management The Fund
is an actively managed ETF. The investment manager's judgments about markets,
interest rates or the attractiveness, relative values or potential appreciation
of particular investment strategies or sectors or securities purchased for the
Fund's portfolio may prove to be incorrect, all of which could cause the Fund
to perform less favorably and may result in a decline in the Fund's NAV and
trading price.
The
investment manager selects investments for the Fund based on its own analysis
and information as well as on external sources of information, such as
information that the investment manager obtains from other sources including
through conferences and discussions with third parties, and data that issuers
of securities provide to the investment manager or file with government
agencies. The investment manager may also use information concerning
institutional positions and buying activity in a security. The investment manager
is not in a position to confirm the completeness, genuineness or accuracy of
any of such information that is provided or filed by an issuer, and in some
cases, complete and accurate information is not readily available. It is also
possible that information on which the investment manager relies could be wrong
or misleading. Additionally, legislative, regulatory, or tax developments may
affect the investment techniques available to the investment manager in
connection with managing the Fund and may also
adversely affect the ability of the Fund to achieve its investment goal.
Management risk is greater when less qualitative information is available to
the investment manager about an investment.
Market The
market value of securities owned by the Fund may go up or down, sometimes
rapidly or unpredictably due to general market conditions which are not
specifically related to a single corporate borrower or security issuer. These
general market conditions include real or perceived adverse economic or regulatory
conditions, changes in the general outlook for corporate earnings, changes in
interest or currency exchange rates or adverse investor sentiment generally.
Market values may also decline due to factors which affect a particular
industry or sector, such as labor shortages or increased production costs and
competitive conditions within an industry, or a particular segment, such as
mortgage or government securities. During a general downturn in the securities
markets, multiple asset classes may decline in value simultaneously. When
markets perform well, there can be no assurance that the Fund's securities will
participate in or otherwise benefit from the advance.
Secondary
listings risk
The Fund’s shares may be listed or traded on U.S. and non-U.S. stock
exchanges other than the U.S. stock exchange where the Fund’s primary listing
is maintained. There can be no assurance that the Fund’s shares will continue
to trade on any such stock exchange or in any market or that the Fund’s shares
will continue to meet the requirements for listing or trading on any exchange
or in any market. The Fund’s shares may be less actively traded in certain
markets than others, and investors are subject to the execution and settlement
risks and market standards of the market where they or their broker direct
their trades for execution. Certain information available to investors who
trade Fund shares on a U.S. stock exchange during regular U.S. market hours may
not be available to investors who trade in other markets, which may result in
secondary market prices in such markets being less efficient.
Portfolio
turnover
Portfolio turnover is a measure of how frequently the Fund's
portfolio securities are bought and sold. High portfolio turnover rates
generally increase transaction costs, which are Fund expenses. Such portfolio
transactions may also result in the realization of taxable capital gains,
including short-term capital gains, which are generally taxable at ordinary
income tax rates for federal income tax purposes for shareholders subject to
income tax and who hold their shares in a taxable account. Higher transaction
costs reduce the Fund's returns.
The
SEC requires annual portfolio turnover to be calculated generally as the lesser
of the Fund's purchases or sales of portfolio securities during a given fiscal
year, divided by the monthly average value of the Fund's portfolio securities
owned during that year (excluding securities with a maturity or expiration date
that, at the time of acquisition, was less than one year). For example, a fund
reporting a 100% portfolio turnover rate would have purchased and sold
securities worth as much as the monthly average value of its portfolio
securities during the year. The portfolio turnover rates for the Fund are
disclosed in the sections entitled "Portfolio Turnover" and
"Financial Highlights" of the Fund's prospectus.
Portfolio
turnover is affected by factors within and outside the control of the Fund and
its investment manager. The investment manager's investment outlook for the type
of securities in which the Fund invests may change as a result of unexpected
developments in domestic or international securities markets, or in economic,
monetary or political relationships. High market volatility may result in the
investment manager using a more active trading strategy than it might have
otherwise pursued. The Fund's investment manager will consider the economic
effects of portfolio turnover but generally will not treat portfolio turnover
as a limiting factor in making investment decisions. Investment decisions
affecting turnover may include changes in investment policies or management
personnel, as well as individual portfolio transactions.
Factors
wholly outside the control of the investment manager that may increase
portfolio turnover include increased merger and acquisition activity, or
increased rates of bankruptcy or default, that may create involuntary
transactions for funds that hold affected securities.
During
periods of rapidly declining interest rates, the rate of prepayments on
portfolio investments may increase rapidly. When this happens,
"sales" of portfolio securities are increased due to the return of
principal to the Fund followed by purchases of new portfolio securities to
replace the "sold" ones.
The
rate of bond calls by issuers of fixed-income debt securities may increase as
interest rates decline. This causes "sales" of called bonds by the
Fund and the subsequent purchase of replacement investments.
In addition, creations or redemptions by
Authorized Participants (as defined below) may require the liquidation or
acquisition of portfolio securities. Changes in particular portfolio holdings
may also be made whenever a security is considered to be no longer the most
appropriate investment for the Fund, or another security appears to have a
relatively better opportunity.
Policies
and Procedures Regarding the Release of Portfolio Holdings On each
business day of the Fund, before commencement of trading in shares on a
national securities exchange, the Fund will disclose on its website the
identities and quantities of the Fund’s portfolio holdings that will form the
basis for the Fund’s calculation of NAV at the end of that business day.
Consistent with current law, the Fund also releases complete portfolio holdings
information each fiscal quarter through regulatory filings with no more than a
60-day lag.
Each
business day, the Fund’s portfolio holdings information will be provided to
Franklin Templeton Distributors, Inc. (Distributors) or other agents for dissemination
through the facilities of the National Securities Clearing Corporation (NSCC)
and/or other fee-based subscription services to NSCC members and/or subscribers
to those other fee-based subscription services, including large institutional
investors (known as “Authorized Participants”) that have been authorized by
Distributors to purchase and redeem large blocks of shares pursuant to legal
requirements, and to entities that publish and/or analyze such information in
connection with the process of purchasing or redeeming Creation Units or
trading shares of the Fund in the secondary market.
Portfolio
holdings information made available in connection with the creation/redemption
process may be provided to other entities that provide services to the Fund in
the ordinary course of business after it has been disseminated to the NSCC.
From time to time, information concerning portfolio holdings other than
portfolio holdings information made available in connection with the
creation/redemption process, as discussed above, may be provided to other
entities that provide services to the Fund in the ordinary course of business,
no earlier than one business day following the date of the information. The
eligible third parties to whom portfolio holdings information may be released
in advance of general release fall into the following categories: data
consolidators (including rating agencies), fund rating/ranking services and
other data providers and service providers to the Fund, including Authorized
Participants and pricing services.
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 the 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 Distributors,
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(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 the
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 Listing Exchange is satisfied by the
fact that the prospectus is available at the Listing Exchange upon request. The
prospectus delivery mechanism provided in Rule 153 is available only with
respect to transactions on an exchange.
Officers and Trustees [TO BE UPDATED IN
485(B) FILING]
The
Trust has a board of trustees. Each trustee will serve until that person
resigns and/or a successor is elected and qualified. The board is responsible
for the overall management of the Trust, including general supervision and
review of the Fund's investment activities. The board, in turn, appoints the
officers of the Trust who are responsible for administering the Trust's
day-to-day operations. While none are expected, the board will act
appropriately to resolve any material conflict that may arise.
The name, year of birth and address of the
officers and board members, as well as their affiliations, positions held with
the Trust, principal occupations during at least the past five years, number of
portfolios overseen in the Franklin Templeton fund complex and other
directorships held during at least the past five years are shown below.
Independent Board Members
|
Name, Year of Birth and Address
|
Position
|
Length of Time Served
|
Number of Portfolios
in Fund Complex
Overseen by
Board Member1
|
Other Directorships Held During at Least the Past 5 Years
|
Rohit
Bhagat (1964)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Lead
Independent Trustee
|
Since
2016
|
40
|
Zentific
Investment Management (hedge fund) (2015-present), Axis Bank (2013-present),
AssetMark Financial Holdings, Inc. (investment solutions) (2018-present) and
CapFloat Financial Services Pvt., Ltd. (non-banking finance company)
(2018-present).
|
Principal Occupation
During at Least the Past 5 Years:
Managing Member, Mukt Capital, LLC (private investment firm) (2014-present);
Advisor, Optimal Asset Management (investment technology and advisory
services company) (2015-present); and formerly, Chairman, Asia
Pacific, BlackRock (2009-2012); Global Chief Operating Officer, Barclays
Global Investors (investment management) (2005-2009); and Senior Partner, The
Boston Consulting Group (management consulting) (1992-2005).
|
Anantha
K. Pradeep (1963)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Trustee
|
Since
2016
|
40
|
None
|
Principal Occupation
During at Least the Past 5 Years:
Chief Executive Officer, Smilable, Inc. (technology company) (2014-present);
Chief Executive Officer, MachineVantage (technology company) (2018-present);
Founder and Managing Partner, Consult Meridian, LLC (consulting company)
(2009-present); and formerly, Founder, BoardVantage (board portal
solutions provider delivering paperless process for boards and leadership)
(2000-2002).
|
Interested Board Member and Officers
|
Name, Year of Birth and Address
|
Position
|
Length of Time Served
|
Number of Portfolios
in Fund Complex
Overseen by
Board Member1
|
Other Directorships Held During at Least the Past 5 Years
|
Jennifer
M. Johnson2 (1964)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Trustee
and Chairperson of the Board
|
Since
2016
|
46
|
None
|
Principal Occupation
During at Least the Past 5 Years:
President and Chief Operating Officer, Franklin Resources, Inc.; officer
and/or director or trustee, as the case may be, of some of the other
subsidiaries of Franklin Resources, Inc. and of four of the investment
companies in Franklin Templeton; and formerly, Chief Operating Officer
and Executive Vice President, Franklin Resources, Inc. (1994-2015); Executive
Vice President of Operations and Technology, Franklin Resources, Inc.
(2005-2010); and Senior Vice President, Franklin Resources, Inc. (2003-2005).
|
Alison
E. Baur (1964)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Vice
President
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal
Occupation During at Least the Past 5 Years:
Deputy General Counsel, Franklin Templeton; and officer of some of the other
subsidiaries of Franklin Resources, Inc. and of 44 of the investment
companies in Franklin Templeton.
|
Aliya
S. Gordon (1973)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Vice
President
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Senior Associate General Counsel, Franklin Templeton; Vice President and
Secretary, Franklin Resources, Inc.; and officer of 44 of the investment
companies in Franklin Templeton.
|
Steven
J. Gray (1955)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Vice
President
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Senior Associate General Counsel, Franklin Templeton; Vice President,
Franklin Templeton Distributors, Inc. and FASA, LLC; and officer of 44 of the
investment companies in Franklin Templeton.
|
Matthew
T. Hinkle (1971)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Chief
Executive Officer - Finance and Administration
|
Since
2017
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Senior Vice President, Franklin Templeton Services, LLC; officer of 44 of the
investment companies in Franklin Templeton; and formerly, Vice
President, Global Tax (2012-April 2017) and Treasurer/Assistant Treasurer,
Franklin Templeton (2009-2017).
|
Robert
Lim (1948)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Vice
President - AML Compliance
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Vice President, Franklin Templeton Companies, LLC; Chief Compliance Officer,
Franklin Templeton Distributors, Inc. and Franklin Templeton Investor
Services, LLC; and officer of 44 of the investment companies in Franklin
Templeton.
|
Kimberly
H. Novotny (1972)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Vice
President
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Senior Associate General Counsel, Franklin Templeton; Vice President and Corporate
Secretary, Fiduciary Trust International of the South; Vice President,
Templeton Investment Counsel, LLC; Assistant Secretary, Franklin Resources,
Inc.; and officer of 44 of the investment companies in Franklin Templeton.
|
Patrick
O'Connor (1967)
One Franklin Parkway
San Mateo, CA 94403-1906
|
President
and Chief Executive Officer – Investment Management
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
President and Chief Investment Officer, Franklin Advisory Services, LLC;
Senior Vice President, Franklin Advisers, Inc.; officer of two of the
investment companies in Franklin Templeton; and formerly, Managing
Director, Head of iShares Product Canada, BlackRock (1998-2014).
|
Vivek
Pai (1970)
300 S.E. 2nd Street
Fort Lauderdale, FL 33301-1923
|
Treasurer, Chief
Financial Officer and Chief Accounting Officer
|
Since
May 2019
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Treasurer, U.S. Fund Administration & Reporting and officer of two of the
investment companies in Franklin Templeton.
|
Robert
C. Rosselot (1960)
300 S.E. 2nd Street
Fort Lauderdale, FL 33301-1923
|
Chief
Compliance Officer
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Director, Global Compliance, Franklin Templeton; Vice President, Franklin
Templeton Companies, LLC; officer of 44 of the investment companies in
Franklin Templeton; and formerly, Senior Associate General Counsel,
Franklin Templeton (2007-2013); and Secretary and Vice President, Templeton
Group of Funds (2004-2013).
|
Navid
J. Tofigh (1972)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Vice
President
and Secretary
|
Since
2015
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Associate General Counsel and officer of 44 of the investment companies in
Franklin Templeton.
|
Craig
S. Tyle (1960)
One Franklin Parkway
San Mateo, CA 94403-1906
|
Vice
President
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
General Counsel and Executive Vice President, Franklin Resources, Inc.; and
officer of some of the other subsidiaries of Franklin Resources, Inc. and of
44 of the investment companies in Franklin Templeton.
|
Lori
A. Weber (1964)
300 S.E. 2nd Street
Fort Lauderdale, FL 33301-1923
|
Vice
President
|
Since
2016
|
Not
Applicable
|
Not
Applicable
|
Principal Occupation
During at Least the Past 5 Years:
Senior Associate General Counsel, Franklin Templeton; Assistant Secretary,
Franklin Resources, Inc.; Vice President and Secretary, Templeton Investment
Counsel, LLC; and officer of 44 of the investment companies in Franklin
Templeton.
|
Note
1: Officer information is current as of the date of this SAI. It is possible
that after this date, information about officers may change.
|
1. We
base the number of portfolios on each separate series of the U.S. registered
investment companies within the Franklin Templeton fund complex. These
portfolios have a common investment manager or affiliated investment managers.
2. Jennifer
M. Johnson is considered to be an interested person of the Fund under the
federal securities laws due to her position as an officer of Resources, which
is the parent company of the Fund's investment manager and distributor.
Effective
July 1, 2018, the Trust's independent board members constitute the sole
independent board members of two investment companies in the Franklin Templeton
complex for which each independent board member currently is paid a $110,000
annual retainer fee, together with a $7,000 per meeting fee ($3,500 per meeting
held via telephone) for attendance at each regularly scheduled board meeting, a
portion of which fees are allocated to the Trust. To the extent held, compensation
may also be paid for attendance at specially held board meetings. The Trust's
lead independent board member is paid an annual supplemental retainer of
$15,000 for services to such investment companies, a portion of which is
allocated to the Trust. Board members who serve on the Audit Committee of the
Trust and such other funds are paid a $3,000 fee per Committee meeting in which
they participate, a portion of which is allocated to the Trust. Rohit Bhagat,
who serves as chairman of the Audit Committee of the Trust and such other
funds, receives a fee of $10,000 per year, a portion of which is allocated to
the Trust. Board members who serve on the Nominating Committee of the Trust and
such other funds are paid a $3,000 fee per Committee meeting in which they participate, a portion of which is allocated to the
Trust. Anantha K. Pradeep, who serves as chairman of the Nominating Committee
of the Trust and such other funds, receives a fee of $10,000 per year, a
portion of which is allocated to the Trust.
Prior
to July 1, 2018, each independent board member was paid a $20,000 annual
retainer fee, together with a $5,000 per meeting fee for attendance at
regularly scheduled board meetings. To the extent held, a $5,000 per meeting
fee ($2,000 per meeting held via telephone) was also paid for attendance at
specially held board meetings. Board members who serve on the Audit Committee
of the Trust received a flat fee of $2,500 per Committee meeting attended in
person and $1,000 per telephonic meeting. The chairman of the Audit Committee
of the Trust received an additional fee of $10,000 per year. Members of the
Committee were not separately compensated for any committee meeting held on the
day of a regularly scheduled board meeting.
The
following table provides the total fees paid to independent board members by
the Trust and by other funds in Franklin Templeton. [TO BE UPDATED IN 485(B)
FILING:]
Name
|
Total Fees
Received
from
the Trust
($)1
|
Total Fees
Received
from Franklin
Templeton
($)2
|
Number
of Boards
in Franklin
Templeton
on which
Each
Serves3
|
Rohit Bhagat
|
129,268
|
[____]
|
2
|
Anantha Pradeep
|
117,063
|
[____]
|
2
|
Susan R. Thompson4
|
5,986
|
[____]
|
N/A
|
1. For
the fiscal year ended March 31, 2019.
2. For
the calendar year ended December 31, 2019.
3. We
base the number of boards on the number of U.S. registered investment companies
in Franklin Templeton. This number does not include the total number of series
or portfolios within each investment company for which the board members are
responsible.
4. Resigned
May 1, 2018.
Independent
board members are reimbursed for expenses incurred in connection with attending
board meetings and such expenses are paid pro rata by each fund in Franklin
Templeton for which they serve as director or trustee. No officer or board member
received any other compensation, including pension or retirement benefits,
directly or indirectly from the Trust or other funds in Franklin Templeton.
Certain officers or board members who are shareholders of Franklin Resources,
Inc. (Resources) may be deemed to receive indirect remuneration by virtue of
their participation, if any, in the fees paid to its subsidiaries.
The
following tables provide the dollar range of equity securities beneficially
owned by the board members of the Trust on December 31, 2019.
Independent Board Members [TO BE UPDATED IN
485(B) FILING:]
Name of
Board Member
|
Dollar
Range of
Equity Securities
in the Fund
|
Aggregate
Dollar Range of
Equity Securities in
All Funds Overseen
by the Board
Member in the
Franklin Templeton
Fund Complex
|
Rohit Bhagat
|
[None]
|
[None]
|
Anantha K. Pradeep
|
[None]
|
[None]
|
Interested Board Member [TO BE UPDATED IN
485(B) FILING:]
Name of
Board Member
|
Dollar
Range of
Equity Securities
in the Fund
|
Aggregate
Dollar Range of
Equity Securities in
All Funds Overseen
by the Board
Member in the
Franklin Templeton
Fund Complex
|
Jennifer M. Johnson
|
[None]
|
[Over
$100,000]
|
Board
committees
The board maintains two standing committees: the Audit Committee
and the Nominating Committee. The Audit Committee is generally responsible for
recommending the selection of the Fund’s independent registered public
accounting firm (auditors), including evaluating their independence and meeting
with such auditors to consider and review matters relating to the Fund’s
financial reports and internal controls. The Audit Committee is comprised of
the following independent trustees of the Fund: Rohit Bhagat (Chair) and
Anantha Pradeep. The Nominating Committee is comprised of the following
independent trustees of the Fund: Rohit Bhagat and Anantha Pradeep (Chair).
The
Nominating Committee is responsible for selecting candidates to serve as board
members and recommending such candidates (a) for selection and nomination as
independent board members by the incumbent independent board member and the
full board; and (b) for selection and nomination as interested board members by
the full board.
When
the board has or expects to have a vacancy, the Nominating Committee receives
and reviews information on individuals qualified to be recommended to the full
board as nominees for election as board members, including any recommendations
by “Qualifying Fund Shareholders” (as defined below). To date, the Nominating
Committee has been able to identify, and expects to continue to be able to
identify, from its own resources an ample number of qualified candidates. The
Nominating Committee, however, will review recommendations from Qualifying Fund
Shareholders to fill vacancies on the board if these recommendations are
submitted in writing and addressed to the Nominating Committee at the Trust's
offices at One Franklin Parkway, San Mateo, CA 94403-1906 and are presented
with appropriate background material concerning the candidate that demonstrates
his or her ability to serve as a board member, including as an independent
board member, of the Trust. A Qualifying Fund Shareholder is a shareholder who
(i) has continuously owned of record, or beneficially through a financial
intermediary, shares of the Fund having a net asset value of not less than two
hundred and fifty thousand dollars ($250,000) during the 24-month period prior
to submitting the recommendation; and (ii) provides a written notice to the
Nominating Committee containing the following information: (a) the name and
address of the Qualifying Fund Shareholder making the recommendation; (b) the
number of shares of the Fund which are owned of record and beneficially by such
Qualifying Fund Shareholder and the length of time that such shares have been
so owned by the Qualifying Fund Shareholder; (c) a description of all
arrangements and understandings between such Qualifying Fund Shareholder and
any other person or persons (naming such person or persons) pursuant to which
the recommendation is being made; (d) the name, age, date of birth, business
address and residence address of the person or persons being recommended; (e)
such other information regarding each person recommended by such Qualifying
Fund Shareholder as would be required to be included in a proxy statement filed
pursuant to the proxy rules of the SEC had the nominee been nominated by the
board; (f) whether the shareholder making the recommendation believes the person
recommended would or would not be an “interested person” of the Trust, as
defined in the 1940 Act; and (g) the written consent of each person recommended
to serve as a board member of the Trust if so nominated and elected/appointed.
The
Nominating Committee may amend these procedures from time to time, including
the procedures relating to the evaluation of nominees and the process for
submitting recommendations to the Nominating Committee.
During
the fiscal year ended March 31, 2019, the Audit Committee met twice; the
Nominating Committee did not meet.
Board
role in risk oversight The board, as a whole, considers risk
management issues as part of its general oversight responsibilities throughout
the year at regular board meetings, through regular reports that have been
developed by management, in consultation with the board and its counsel. These
reports address certain investment, valuation and compliance matters. The board
also may receive special written reports or presentations on a variety of risk
issues, either upon the board’s request or upon the investment manager’s initiative.
In addition, the Audit Committee of the board meets regularly with the
investment manager’s internal audit group to review
reports on their examinations of functions and processes within Franklin
Templeton that affect the Fund.
With
respect to investment risk, the board receives regular written reports
describing and analyzing the investment performance of the Fund. In addition,
the portfolio managers of the Fund meet regularly with the board to discuss
portfolio performance, including investment risk. To the extent that the Fund
changes a particular investment strategy that could have a material impact on
the Fund’s risk profile, the board generally is consulted with respect to such
change. To the extent that the Fund invests in certain complex securities,
including derivatives, the board receives periodic reports containing
information about exposure of the Fund to such instruments. In addition, the
investment manager’s investment risk personnel meet regularly with the board to
discuss a variety of issues, including the impact on the Fund of the investment
in particular securities or instruments, such as derivatives and commodities.
With
respect to valuation, the Fund’s administrator provides regular written reports
to the board that enable the board to monitor the number of fair valued
securities in a particular portfolio, the reasons for the fair valuation and
the methodology used to arrive at the fair value. Such reports also include
information concerning illiquid securities within the Fund’s portfolio. The
board also reviews dispositional analysis information on the sale of securities
that require special valuation considerations such as illiquid or fair valued
securities. In addition, the Fund’s Audit Committee reviews valuation
procedures and results with the Fund’s auditors in connection with such
Committee’s review of the results of the audit of the Fund’s year-end financial
statements.
With
respect to compliance risks, the board receives regular compliance reports
prepared by the investment manager’s compliance group and meets regularly with
the Fund’s Chief Compliance Officer (CCO) to discuss compliance issues,
including compliance risks. In accordance with SEC rules, the independent board
members meet regularly in executive session with the CCO, and the Fund’s CCO
prepares and presents an annual written compliance report to the board. The
Fund’s board adopts compliance policies and procedures for the Fund and
approves such procedures for the Fund’s service providers. The compliance
policies and procedures are specifically designed to detect and prevent
violations of the federal securities laws.
The
investment manager periodically provides an enterprise risk management
presentation to the board to describe the way in which risk is managed on a complex-wide
level. Such presentation covers such areas as investment risk, reputational
risk, personnel risk, and business continuity risk.
Board
structure
Two-thirds of board members consist of independent board members
who are not deemed to be “interested persons” by reason of their relationship
with the Fund’s management or otherwise as provided under the 1940 Act. While
the Chairman of the Board is an interested person, the board is also served by
a lead independent board member. The lead independent board member, together
with independent counsel, reviews proposed agendas for board meetings and
generally acts as a liaison with management with respect to questions and
issues raised by the independent board members. The lead independent board
member also presides at separate meetings of independent board members held in
advance of each scheduled board meeting where various matters, including those
being considered at such board meeting are discussed. It is believed such
structure and activities assure that proper consideration is given at board
meetings to matters deemed important to the Fund and its shareholders.
Trustee
qualifications
Information
on the Fund’s officers and board members appears above including information on
the business activities of board members during the past five years and beyond.
In addition to personal qualities, such as integrity, the role of an effective
Fund board member inherently requires the ability to comprehend, discuss and
critically analyze materials and issues presented in exercising judgments and
reaching informed conclusions relevant to his or her duties and fiduciary
obligations. The board believes that the specific background of each board
member evidences such ability and is appropriate to his or her serving on the
Fund’s board. As indicated, Dr. Pradeep has served as chief executive officer
of consulting and technology companies, Rohit Bhagat has extensive experience
in the asset management and financial services industries, and Jennifer M.
Johnson is a high ranking executive officer of Franklin Templeton.
Fair Valuation and Liquidity
The Fund’s board of trustees has delegated to
the investment manager the task of ensuring that regulatory guidelines
governing the fair valuation for securities are applied to the Fund and that
the required level of liquidity is maintained. The Fund’s administrator has
formed a Valuation Committee (VC) to oversee these obligations. The VC oversees
and administers the policies and procedures governing fair valuation and
liquidity determination of securities. The VC meets monthly to review and
approve fair value and liquidity reports and conduct other business, and meets
whenever necessary to review potential significant market events and take
appropriate steps to adjust valuations in accordance with established policies.
The VC provides regular reports that document its activities to the board of
trustees for its review and approval of pricing determinations at scheduled
meetings.
The
Fund's policies and procedures governing fair valuation and liquidity
determination of securities have been initially reviewed and approved by the
board of trustees and any material amendments will also be reviewed and
approved by the board. The investment manager's compliance staff conducts
periodic reviews of compliance with the policies and provides at least annually
a report to the board of trustees regarding the operation of the policies and
any material changes recommended as a result of such review.
Proxy Voting Policies and Procedures
The
board of trustees of the Fund has delegated the authority to vote proxies
related to the portfolio securities held by the Fund to the Fund's investment
manager, Franklin Advisers, Inc., in accordance with the Proxy Voting Policies
and Procedures (Policies) adopted by the investment manager.
The
investment manager has delegated its administrative duties with respect to the
voting of proxies for securities to the Proxy Group within Franklin Templeton
Companies, LLC (Proxy Group), an affiliate and wholly owned subsidiary of
Franklin Resources, Inc. All proxies received by the Proxy Group will be voted
based upon the investment manager’s instructions and/or policies. The
investment manager votes proxies solely in the best interests of the Fund and
its shareholders.
To
assist it in analyzing proxies of equity securities, the investment manager
subscribes to Institutional Shareholder Services, Inc. (ISS), an unaffiliated
third-party corporate governance research service that provides in-depth
analyses of shareholder meeting agendas, vote recommendations, vote execution
services, ballot reconciliation services, recordkeeping and vote disclosure
services. In addition, the investment manager subscribes to Glass, Lewis &
Co., LLC (Glass Lewis), an unaffiliated third-party analytical research firm,
to receive analyses and vote recommendations on the shareholder meetings of
publicly held U.S. companies, as well as a limited subscription to its
international research. Also, the investment manager has a supplemental
subscription to Egan-Jones Proxy Services (Egan-Jones), an unaffiliated third
party proxy advisory firm, to receive analyses and vote recommendations.
Although analyses provided by ISS, Glass Lewis, Egan-Jones, and/or another
independent third party proxy service provider (each a "Proxy
Service") are thoroughly reviewed and considered in making a final voting
decision, the investment manager does not consider recommendations from a Proxy
Service or any third party to be determinative of the investment manager's
ultimate decision. Rather, the investment manager exercises its independent
judgment in making voting decisions. For most proxy proposals, the investment
manager’s evaluation should result in the same position being taken for all
Funds. In some cases, however, the evaluation may result in a Fund voting
differently, depending upon the nature and objective of the Fund, the
composition of its portfolio and other factors. As a matter of policy, the
officers, directors/trustees and employees of the investment manager and the
Proxy Group will not be influenced by outside sources whose interests conflict
with the interests of the Fund and its shareholders. Efforts are made to
resolve all conflicts in the best interests of the investment manager’s
clients. Material conflicts of interest are identified by the Proxy Group based
upon analyses of client, distributor, broker-dealer and vendor lists,
information periodically gathered from directors and officers, and information
derived from other sources, including public filings. In situations where a
material conflict of interest is identified, the Proxy Group may vote
consistent with the voting recommendation of a Proxy Service; or send the proxy
directly to the Fund's board or a committee of the board with the investment
manager's recommendation regarding the vote for approval.
Where
a material conflict of interest has been identified, but the items on which the
investment manager’s vote recommendations differ from a Proxy Service and
relate specifically to (1) shareholder proposals regarding social or
environmental issues, (2) “Other Business” without describing the matters that
might be considered, or (3) items the investment manager wishes to vote in
opposition to the recommendations of an issuer’s management, the Proxy Group may
defer to the vote recommendations of the investment manager rather than sending
the proxy directly to the Fund's board or a board committee for approval.
To avoid certain potential conflicts of
interest, the investment manager will employ echo voting or pass-through
voting, if possible, in the following instances: (1) when the Fund invests in
an underlying fund in reliance on any one of Sections 12(d) (1) (F), or (G) of
the 1940 Act, the rules thereunder, or pursuant to a SEC exemptive order
thereunder; (2) when the Fund invests uninvested cash in affiliated money
market funds pursuant to the rules under the 1940 Act or any exemptive orders
thereunder (“cash sweep arrangement”); or (3) when required pursuant to the
Fund’s governing documents or applicable law. Echo voting means that the
investment manager will vote the shares in the same proportion as the vote of
all of the other holders of the underlying fund's shares. With respect to
instances when a Franklin Templeton U.S. registered investment company invests
in an underlying fund in reliance on any one of Sections 12(d)(1)(F) or (G) of
the 1940 Act, the rules thereunder, or pursuant to an SEC exemptive order
thereunder, and there are no other unaffiliated shareholders also invested in
the underlying fund, the investment manager will vote in accordance with the
recommendation of such investment company’s board of trustees or directors. In
addition, to avoid certain potential conflicts of interest, and where required
under a fund’s governing documents or applicable law, the investment manager
will employ pass-through voting when a Franklin Templeton U.S. registered
investment company invests in an underlying fund in reliance on Section
12(d)(1)(E) of the 1940 Act, the rules thereunder, or pursuant to an SEC
exemptive order thereunder. In “pass-through voting,” a feeder fund will
solicit voting instructions from its shareholders as to how to vote on the
master fund’s proposals.
The
recommendation of management on any issue is a factor that the investment manager
considers in determining how proxies should be voted. However, the investment
manager does not consider recommendations from management to be determinative
of the investment manager’s ultimate decision. As a matter of practice, the
votes with respect to most issues are cast in accordance with the position of
the company's management. Each issue, however, is considered on its own merits,
and the investment manager will not support the position of the company's
management in any situation where it deems that the ratification of
management’s position would adversely affect the investment merits of owning
that company’s shares.
Engagement
with issuers.
The investment manager believes that engagement with issuers is important to
good corporate governance and to assist in making proxy voting decisions. The
investment manager may engage with issuers to discuss specific ballot items to
be voted on in advance of an annual or special meeting to obtain further
information or clarification on the proposals. The investment manager may also
engage with management on a range of environmental, social or corporate
governance issues throughout the year.
Investment
manager’s proxy voting policies and principles The
investment manager has adopted general proxy voting guidelines, which are
summarized below. These guidelines are not an exhaustive list of all the issues
that may arise and the investment manager cannot anticipate all future
situations. In all cases, each proxy and proposal (including both management
and shareholder proposals) will be considered based on the relevant facts and
circumstances on a case-by-case basis.
Board
of directors.
The investment manager supports an independent, diverse board of
directors, and prefers that key committees such as audit, nominating, and
compensation committees be comprised of independent directors. The investment
manager supports boards with strong risk management oversight. The investment
manager will generally vote against management efforts to classify a board and
will generally support proposals to declassify the board of directors. The
investment manager will consider withholding votes from directors who have
attended less than 75% of meetings without a valid reason. While generally in
favor of separating Chairman and CEO positions, the investment manager will
review this issue as well as proposals to restore or provide for cumulative
voting on a case-by-case basis, taking into consideration factors such as the
company’s corporate governance guidelines or provisions and performance. The
investment manager generally will support non-binding shareholder proposals to
require a majority vote standard for the election of directors; however, if
these proposals are binding, the investment manager will give careful review on
a case-by-case basis of the potential ramifications of such implementation.
In
the event of a contested election, the investment manager will review a number
of factors in making a decision including management’s track record, the
company’s financial performance, qualifications of candidates on both slates,
and the strategic plan of the dissidents and/or shareholder nominees.
Ratification
of auditors of portfolio companies. The investment manager will
closely scrutinize the independence, role and performance of auditors. On a
case-by-case basis, the investment manager will examine proposals relating to
non-audit relationships and non-audit fees. The investment manager will also
consider, on a case-by-case basis, proposals to rotate auditors, and will vote
against the ratification of auditors when there is clear and compelling
evidence of a lack of independence, accounting
irregularities or negligence. The investment manager may also consider whether
the ratification of auditors has been approved by an appropriate audit
committee that meets applicable composition and independence requirements.
Management
and director compensation. A company’s equity-based compensation plan
should be in alignment with the shareholders’ long-term interests. The
investment manager believes that executive compensation should be directly
linked to the performance of the company. The investment manager evaluates
plans on a case-by-case basis by considering several factors to determine
whether the plan is fair and reasonable, including the ISS quantitative model
utilized to assess such plans and/or the Glass Lewis evaluation of the plans.
The investment manager will generally oppose plans that have the potential to
be excessively dilutive, and will almost always oppose plans that are
structured to allow the repricing of underwater options, or plans that have an
automatic share replenishment “evergreen” feature. The investment manager will
generally support employee stock option plans in which the purchase price is at
least 85% of fair market value, and when potential dilution is 10% or less.
Severance
compensation arrangements will be reviewed on a case-by-case basis, although
the investment manager will generally oppose “golden parachutes” that are
considered to be excessive. The investment manager will normally support
proposals that require a percentage of directors’ compensation to be in the
form of common stock, as it aligns their interests with those of shareholders.
The
investment manager will review non-binding say-on-pay proposals on a
case-by-case basis, and will generally vote in favor of such proposals unless
compensation is misaligned with performance and/or shareholders’ interests, the
company has not provided reasonably clear disclosure regarding its compensation
practices, or there are concerns with the company’s remuneration practices.
Anti-takeover
mechanisms and related issues. The investment manager generally
opposes anti-takeover measures since they tend to reduce shareholder rights.
However, as with all proxy issues, the investment manager conducts an
independent review of each anti-takeover proposal. On occasion, the investment
manager may vote with management when the research analyst has concluded that
the proposal is not onerous and would not harm the Fund or its shareholders’
interests. The investment manager generally supports proposals that require
shareholder rights’ plans (often referred to as “poison pills”) to be subject
to a shareholder vote and will closely evaluate such plans on a case-by-case
basis to determine whether or not they warrant support. In addition, the
investment manager will generally vote against any proposal to issue stock that
has unequal or subordinate voting rights. The investment manager generally
opposes any supermajority voting requirements as well as the payment of
“greenmail.” The investment manager generally supports “fair price” provisions
and confidential voting. The investment manager will review a company’s
proposal to reincorporate to a different state or country on a case-by-case
basis taking into consideration financial benefits such as tax treatment as
well as comparing corporate governance provisions and general business laws
that may result from the change in domicile.
Changes
to capital structure.
The investment manager realizes that a company's financing
decisions have a significant impact on its shareholders, particularly when they
involve the issuance of additional shares of common or preferred stock or the
assumption of additional debt. The investment manager will review, on a
case-by-case basis, proposals by companies to increase authorized shares and
the purpose for the increase. The investment manager will generally not vote in
favor of dual-class capital structures to increase the number of authorized
shares where that class of stock would have superior voting rights. The
investment manager will generally vote in favor of the issuance of preferred
stock in cases where the company specifies the voting, dividend, conversion and
other rights of such stock and the terms of the preferred stock issuance are
deemed reasonable. The investment manager will review proposals seeking
preemptive rights on a case-by-case basis.
Mergers
and corporate restructuring. Mergers and acquisitions will be
subject to careful review by the research analyst to determine whether they
would be beneficial to shareholders. The investment manager will analyze
various economic and strategic factors in making the final decision on a merger
or acquisition. Corporate restructuring proposals are also subject to a
thorough examination on a case-by-case basis.
Environmental
and social issues.
The investment manager considers environmental and social issues
alongside traditional financial measures to provide a more comprehensive view
of the value, risk and return potential of an investment. Companies may face
significant financial, legal and reputational risks resulting from poor
environmental and social practices, or negligent oversight of environmental or
social issues. Franklin Templeton’s “Responsible Investment Principles and
Policies” describes the investment manager’s approach
to consideration of environmental, social and governance issues within the
investment manager’s processes and ownership practices.
The
investment manager will review shareholder proposals on a case-by-case basis
and may support those that serve to enhance value or mitigate risk, are drafted
appropriately, and do not disrupt the course of business or require a
disproportionate or inappropriate use of company resources. In the investment
manager’s experience, those companies that are managed well are often effective
in dealing with the relevant environmental and social issues that pertain to
their business. As such, the investment manager will generally give management
discretion with regard to environmental and social issues. However, in cases
where management and the board have not demonstrated adequate efforts to mitigate
material environmental or social risks, have engaged in inappropriate or
illegal conduct, or have failed to adequately address current or emergent risks
that threaten shareholder value, the investment manager may choose to support
well-crafted shareholder proposals that serve to promote or protect shareholder
value. This may include seeking appropriate disclosure regarding material
environmental and social issues.
The
investment manager will consider supporting a shareholder proposal seeking
disclosure and greater board oversight of lobbying and corporate political
contributions if the investment manager believes that there is evidence of
inadequate oversight by the company’s board, if the company’s current
disclosure is significantly deficient, or if the disclosure is notably lacking
in comparison to the company’s peers.
Governance
matters.
The investment manager generally supports the right of
shareholders to call special meetings and act by written consent. However, the
investment manager will review such shareholder proposals on a case-by-case
basis in an effort to ensure that such proposals do not disrupt the course of
business or require a disproportionate or inappropriate use of company
resources.
Proxy
access.
In cases where the investment manager is satisfied with company
performance and the responsiveness of management, it will generally vote
against shareholder proxy access proposals not supported by management. In
other instances, the investment manager will consider such proposals on a
case-by-case basis, taking into account factors such as the size of the
company, ownership thresholds and holding periods, nomination limits (e.g.,
number of candidates that can be nominated), the intentions of the shareholder
proponent, and shareholder base.
Global
corporate governance.
Many of the tenets discussed above are applied to the investment
manager's proxy voting decisions for international investments. However, the
investment manager must be flexible in these worldwide markets. Principles of
good corporate governance may vary by country, given the constraints of a
country’s laws and acceptable practices in the markets. As a result, it is on
occasion difficult to apply a consistent set of governance practices to all
issuers. As experienced money managers, the investment manager's analysts are
skilled in understanding the complexities of the regions in which they
specialize and are trained to analyze proxy issues germane to their regions.
The
investment manager will generally attempt to process every proxy it receives
for all domestic and foreign securities. However, there may be situations in
which the investment manager may be unable to successfully vote a proxy, or may
choose not to vote a proxy, such as where: (i) a proxy ballot was not received
from the custodian bank; (ii) a meeting notice was received too late; (iii)
there are fees imposed upon the exercise of a vote and it is determined that
such fees outweigh the benefit of voting; (iv) there are legal encumbrances to
voting, including blocking restrictions in certain markets that preclude the
ability to dispose of a security if the investment manager votes a proxy or
where the investment manager is prohibited from voting by applicable law,
economic or other sanctions, or other regulatory or market requirements,
including but not limited to, effective Powers of Attorney; (v) additional
documentation or the disclosure of beneficial owner details is required; (vi)
the investment manager held shares on the record date but has sold them prior
to the meeting date; (vii) a proxy voting service is not offered by the
custodian in the market; (viii) due to either system error or human error, the
investment manager’s intended vote is not correctly submitted; (ix) the
investment manager believes it is not in the best interest of the Fund or its
shareholders to vote the proxy for any other reason not enumerated herein; or
(x) a security is subject to a securities lending or similar program that has
transferred legal title to the security to another person.
In
some non-U.S. jurisdictions, even if the investment manager uses reasonable
efforts to vote a proxy on behalf of the Fund, such vote or proxy may be
rejected because of (a) operational or procedural issues experienced by one or
more third parties involved in voting proxies in such jurisdictions; (b)
changes in the process or agenda for the meeting by the issuer for which the
investment manager does not have sufficient notice; or (c) the exercise by the
issuer of its discretion to reject the vote of the investment
manager. In addition, despite the best efforts of the Proxy Group and its
agents, there may be situations where the investment manager's votes are not
received, or properly tabulated, by an issuer or the issuer's agent.
The
investment manager or its affiliates may, on behalf of one or more of the
proprietary registered investment companies advised by the investment manager
or its affiliates, determine to use its best efforts to recall any security on
loan where the investment manager or its affiliates (a) learn of a vote on a
material event that may affect a security on loan and (b) determine that it is
in the best interests of such proprietary registered investment companies to
recall the security for voting purposes.
Procedures
for meetings involving fixed income securities & privately held issuers. From
time to time, certain custodians may process events for fixed income securities
through their proxy voting channels rather than corporate action channels for
administrative convenience. In such cases, the Proxy Group will receive ballots
for such events on the ISS voting platform. The Proxy Group will solicit voting
instructions from the investment manager for each Fund involved. If the Proxy
Group does not receive voting instructions from the investment manager, the
Proxy Group will take no action on the event. The investment manager may be
unable to vote a proxy for a fixed income security, or may choose not to vote a
proxy, for the reasons described above.
In
the rare instance where there is a vote for a privately held issuer, the
decision will generally be made by the relevant portfolio managers or research
analysts.
The
Proxy Group will monitor such meetings involving fixed income securities or
privately held issuers for conflicts of interest in accordance with these
procedures. If a fixed income or privately held issuer is flagged as a
potential conflict of interest, the investment manager may nonetheless vote as
it deems in the best interests of the Fund. The investment manager will report
such decisions on an annual basis to the Fund board as may be required.
Shareholders
may view the complete Policies online at franklintempleton.com. Alternatively,
shareholders may request copies of the Policies free of charge by calling the
Proxy Group collect at (954) 527-7678 or by sending a written request to:
Franklin Templeton Companies, LLC, 300 S.E. 2nd Street, Fort Lauderdale, FL
33301-1923, Attention: Proxy Group. Copies of the Fund’s proxy voting records
are available online at franklintempleton.com and posted on the SEC website at
www.sec.gov. The proxy voting records are updated each year by August 31 to
reflect the most recent 12-month period ended June 30.
Management and Other Services
Investment
manager and services provided The Fund's investment manager is
Franklin Advisers, Inc. The investment manager is a wholly owned subsidiary of
Resources, a publicly owned company engaged in the financial services industry
through its subsidiaries. Charles B. Johnson (former Chairman and Director of
Resources) and Rupert H. Johnson, Jr. are the principal shareholders of
Resources.
The
investment manager provides investment research and portfolio management
services, and selects the securities for the Fund to buy, hold or sell. The investment
manager's extensive research activities include, as appropriate, traveling to
meet with issuers and to review project sites. The investment manager also
selects the brokers who execute the Fund's portfolio transactions. The
investment manager provides periodic reports to the board, which reviews and
supervises the investment manager's investment activities. To protect the Fund,
the investment manager, sub-advisor and their officers, directors and employees
are covered by fidelity insurance.
The
investment manager and its affiliates manage numerous other investment
companies and accounts. The investment manager may give advice and take action
with respect to any of the other funds it manages, or for its own account, that
may differ from action taken by the investment manager on behalf of the Fund.
Similarly, with respect to the Fund, the investment manager is not obligated to
recommend, buy or sell, or to refrain from recommending, buying or selling any
security that the investment manager and access persons, as defined by
applicable federal securities laws, may buy or sell for its or their own
account or for the accounts of any other fund. The investment manager is not
obligated to refrain from investing in securities held by the Fund or other
funds it manages.
The
Fund, its investment manager, sub-advisor and principal underwriter have each
adopted a code of ethics, as required by federal securities laws. Under the
code of ethics, employees who are designated as access persons may engage in
personal securities transactions, including
transactions involving securities that are being considered for the Fund or
that are currently held by the Fund, subject to certain general restrictions
and procedures. The personal securities transactions of access persons of the
Fund, its investment manager, sub-advisor and principal underwriter will be
governed by the code of ethics. The code of ethics is on file with, and
available from, the SEC.
The
Fund's sub-advisor is Franklin Templeton Portfolio Advisors, Inc. (FT Portfolio
Advisors). The sub-advisor has an agreement with the investment manager and
provides the investment manager with investment management advice, research and
assistance. The sub-advisor's activities are subject to the board's review and
control, as well as the investment manager's instruction and supervision.
Management
fees
The Fund pays the investment manager a fee for managing the
Fund's assets. The fee is equal to an annual rate of [___]% of the average
daily net assets of the Fund.
The
fee is calculated daily and paid monthly according to the terms of the
management agreement.
The
investment manager pays the sub-advisor for its services.
Portfolio
managers
[TO BE UPDATED IN 485(B) FILING:] This section reflects
information about the portfolio managers as of [______].
The
following table shows the number of other accounts managed by the portfolio
managers and the total assets in the accounts managed within each category:
Name
|
Number of
Other Registered Investment Companies Managed1
|
Assets of
Other Registered Investment Companies Managed (x $1 million)1
|
Number of
Other Pooled Investment Vehicles Managed2
|
Assets of
Other Pooled Investment Vehicles Managed (x $1 million)2
|
Number of
Other Accounts Managed2
|
Assets of
Other Accounts Managed (x $1 million) 2
|
David Yuen
|
[__]
|
[__]
|
[__]
|
[__]
|
[__]
|
[__]
|
Shawn Lyons
|
[__]
|
[__]
|
[__]
|
[__]
|
[__]
|
[__]
|
Thomas Runkel
|
[__]
|
[__]
|
[__]
|
[__]
|
[__]
|
[__]
|
Kent Burns
|
[__]
|
[__]
|
[__]
|
[__]
|
[__]
|
[__]
|
1. These figures represent registered investment companies other
than the Fund included in this SAI.
2. The
various pooled investment vehicles and accounts listed are managed by a team of
investment professionals. Accordingly, the portfolio managers listed would not
be solely responsible for managing such listed amounts.
Portfolio
managers that provide investment services to the Fund may also provide services
to a variety of other investment products, including other funds, institutional
accounts and private accounts. The advisory fees for some of such other
products and accounts may be different than that charged to the Fund and may
include performance based compensation (as noted in the chart above, if any).
This may result in fees that are higher (or lower) than the advisory fees paid
by the Fund. As a matter of policy, each fund or account is managed solely for
the benefit of the beneficial owners thereof. As discussed below, the
separation of the trading execution function from the portfolio management
function and the application of objectively based trade allocation procedures
help to mitigate potential conflicts of interest that may arise as a result of
the portfolio managers managing accounts with different advisory fees.
Conflicts. The
management of multiple funds, including the Fund, and accounts may also give
rise to potential conflicts of interest if the funds and other accounts have
different objectives, benchmarks, time horizons, and fees as the portfolio
manager must allocate his or her time and investment ideas across multiple
funds and accounts. The investment manager seeks to manage
such competing interests for the time and attention of portfolio managers by
having portfolio managers focus on a particular investment discipline. Most
other accounts managed by a portfolio manager are managed using the same
investment strategies that are used in connection with the management of the
Fund. Accordingly, portfolio holdings, position sizes, and industry and sector
exposures tend to be similar across similar portfolios, which may minimize the
potential for conflicts of interest. As noted above, the separate management of
the trade execution and valuation functions from the portfolio management
process also helps to reduce potential conflicts of interest. However, securities
selected for funds or accounts other than the Fund may outperform the
securities selected for the Fund. Moreover, if a portfolio manager identifies a
limited investment opportunity that may be suitable for more than one fund or
other account, the Fund may not be able to take full advantage of that
opportunity due to an allocation of that opportunity across all eligible funds
and other accounts. The investment manager seeks to manage such potential
conflicts by using procedures intended to provide a fair allocation of buy and
sell opportunities among funds and other accounts.
The
structure of a portfolio manager’s compensation may give rise to potential
conflicts of interest. A portfolio manager’s base pay and bonus tend to
increase with additional and more complex responsibilities that include
increased assets under management. As such, there may be an indirect
relationship between a portfolio manager’s marketing or sales efforts and his
or her bonus.
Finally,
the management of personal accounts by a portfolio manager may give rise to
potential conflicts of interest. While the funds and the investment manager
have adopted a code of ethics which they believe contains provisions designed
to prevent a wide range of prohibited activities by portfolio managers and
others with respect to their personal trading activities, there can be no
assurance that the code of ethics addresses all individual conduct that could
result in conflicts of interest.
The
investment manager and the Fund have adopted certain compliance procedures that
are designed to address these, and other, types of conflicts. However, there is
no guarantee that such procedures will detect each and every situation where a
conflict arises.
Compensation. The
investment manager seeks to maintain a compensation program that is
competitively positioned to attract, retain and motivate top-quality investment
professionals. Portfolio managers receive a base salary, a cash incentive bonus
opportunity, an equity compensation opportunity, and a benefits package.
Portfolio manager compensation is reviewed annually and the level of
compensation is based on individual performance, the salary range for a
portfolio manager’s level of responsibility and Franklin Templeton guidelines.
Portfolio managers are provided no financial incentive to favor one fund or
account over another. Each portfolio manager’s compensation consists of the
following three elements:
Base salary Each portfolio manager is
paid a base salary.
Annual bonus Annual bonuses are
structured to align the interests of the portfolio manager with those of the
Fund's shareholders. Each portfolio manager is eligible to receive an annual
bonus. Bonuses generally are split between cash (50% to 65%) and restricted
shares of Franklin Resources stock (17.5% to 25%) and mutual fund shares (17.5%
to 25%). The deferred equity-based compensation is intended to build a vested
interest of the portfolio manager in the financial performance of both Franklin
Resources and mutual funds advised by the investment manager. The bonus plan is
intended to provide a competitive level of annual bonus compensation that is
tied to the portfolio manager achieving consistently strong investment
performance, which aligns the financial incentives of the portfolio manager and
Fund shareholders. The Chief Investment Officer of the investment manager
and/or other officers of the investment manager, with responsibility for the
Fund, have discretion in the granting of annual bonuses to portfolio managers
in accordance with Franklin Templeton guidelines. The following factors are
generally used in determining bonuses under the plan:
-
Investment
performance. Primary consideration is given to the
historic investment performance over the 1, 3 and 5 preceding years of all
accounts managed by the portfolio manager. The pre-tax performance of each
fund managed is measured relative to a relevant peer group and/or
applicable benchmark as appropriate.
-
Non-investment
performance. The more qualitative contributions of the
portfolio manager to the investment manager's business and the investment
management team, including professional knowledge, productivity,
responsiveness to client needs and communication, are evaluated in
determining the amount of any bonus award.
-
Responsibilities. The
characteristics and complexity of funds managed by the portfolio manager
are factored in the investment manager’s appraisal.
Additional long-term
equity-based compensation Portfolio managers may also be awarded
restricted shares or units of Franklin Resources stock or restricted shares or
units of one or more mutual funds. Awards of such deferred equity-based
compensation typically vest over time, so as to create incentives to retain key
talent.
Benefits Portfolio managers also
participate in benefit plans and programs available generally to all employees
of the investment manager.
Ownership
of Fund shares.
The investment manager has a policy of encouraging portfolio
managers to invest in the funds they manage. Exceptions arise when, for
example, a fund is closed to new investors or when tax considerations or
jurisdictional constraints cause such an investment to be inappropriate for the
portfolio manager. The following is the dollar range of Fund shares
beneficially owned by the portfolio managers (such amounts may change from time
to time):
Portfolio Manager
|
Dollar
Range
of Fund Shares
Beneficially Owned
|
David Yuen
|
None
|
Shawn Lyons
|
None
|
Thomas Runkel
|
None
|
Kent Burns
|
None
|
Administrator
and services provided
Franklin Templeton Services, LLC (FT Services) has an agreement
with the investment manager to provide certain administrative services and
facilities for the Fund. FT Services is an indirect, wholly owned subsidiary of
Resources and is an affiliate of the Fund's investment manager, sub-advisor and
principal underwriter.
The
administrative services FT Services provides include preparing and maintaining
books, records, and tax and financial reports, and monitoring compliance with
regulatory requirements.
Administration
fees
Advisers pays FT Services a monthly fee equal to an annual rate
of [___]% of the Fund’s average daily net assets.
Transfer
agent
State Street Bank and Trust Company (State Street), 1 Heritage
Drive, Mail Stop OHD0100, North Quincy, MA 02171, acts as the Fund’s transfer
agent and dividend-paying agent.
Sub-administrator State
Street has an agreement with FT Services to provide certain sub-administrative
services for the Fund. The administrative services State Street provides include,
but are not limited to, certain fund accounting, financial reporting, tax,
corporate governance and compliance and legal administration services.
Custodian State
Street also acts as custodian of the Fund’s securities and other assets
(Custodian). The Custodian is located at One Lincoln Street, Boston, MA 02111.
As foreign custody manager, the Custodian selects and monitors foreign
sub-custodian banks, selects and evaluates non-compulsory foreign depositories,
and furnishes information relevant to the selection of compulsory depositories.
Independent
Registered Public Accounting Firm [____], [address], is the Fund's
independent registered public accounting firm. The independent registered
public accounting firm audits the financial statements included in the Fund's
Annual Report to shareholders.
Payments
to Financial Intermediaries The investment manager, Franklin Templeton
Distributors, Inc. (Distributors)and/or their affiliates may enter into
contractual arrangements with certain broker-dealers and other financial
intermediaries that the investment manager, Distributors and/or their
affiliates believe may benefit the Fund. Pursuant to such arrangements, the
investment manager, Distributors and/or their affiliates may provide cash
payments or non-cash compensation to intermediaries for certain activities
related to the Fund. Such payments are designed to make registered
representatives and other professionals more
knowledgeable about exchange-traded products, including the Fund, or for other
activities, such as participating in marketing activities and presentations,
educational training programs, conferences, data collection and provision,
technology support, the development of technology platforms and reporting
systems. The investment manager, Distributors and/or their affiliates may also
pay intermediaries for certain printing, publishing and mailing costs
associated with the Fund or materials relating to ETFs in general.
In
addition, the investment manager, Distributors and/or their affiliates may make
payments to intermediaries that make Fund shares available to their clients or
for otherwise promoting the Fund. Payments of this type are sometimes referred
to as revenue-sharing payments. Any payments made pursuant to such arrangements
may vary in any year and may be different for different intermediaries. In
certain cases, the payments described in the preceding sentence may be subject
to certain minimum payment levels. As of June 30, 2019, the intermediaries
receiving such payments include Fidelity Brokerage Services LLC; National
Financial Services LLC; Morgan Stanley Smith Barney LLC; and Pershing LLC. Any
additions, modifications or deletions to this list of financial intermediaries
that have occurred since the date noted above are not included in the list.
Any
payments described above by the investment manager, Distributors and/or their
affiliates will be made from their own assets and not from the assets of the
Fund. Although a portion of the investment manager’s revenue comes directly or
indirectly in part from fees paid by the Fund, payments to financial
intermediaries are not financed by the Fund and therefore do not increase the
price paid by investors for the purchase of shares of, or the cost of owning,
the Fund or reduce the amount received by a shareholder as proceeds from the
redemption of Fund shares. As a result, such payments are not reflected in the
fees and expenses listed in the fees and expenses sections of the Fund’s
prospectus.
The
investment manager periodically assesses the advisability of continuing to make
these payments. Payments to a financial intermediary may be significant to that
intermediary, and amounts that intermediaries pay to your adviser, broker or
other investment professional, if any, may also be significant to such adviser,
broker or investment professional. Because an intermediary may make decisions
about what investment options it will make available or recommend, and what
services to provide in connection with various products, based on payments it receives
or is eligible to receive, such payments create conflicts of interest between
the intermediary and its clients. For example, these financial incentives may
cause the intermediary to recommend the Fund over other investments. The same
conflict of interest exists with respect to your financial adviser, broker or
investment professionals if he or she receives similar payments from his or her
intermediary firm.
Please
contact your salesperson, adviser, broker or other investment professional for
more information regarding any such payments or financial incentives his or her
intermediary firm may receive. Any payments made, or financial incentives
offered, by the investment manager, Distributors and/or their affiliates made
to an intermediary may create the incentive for the intermediary to encourage
customers to buy shares of the Fund.
The
investment manager selects brokers and dealers to execute the Fund's portfolio
transactions in accordance with criteria set forth in the management agreement
and any directions that the board may give.
When
placing a portfolio transaction, the trading department of the investment
manager seeks to obtain "best execution" — the best combination of
high quality transaction execution services, taking into account the services
and products to be provided by the broker or dealer, and low relative
commission rates with the view of maximizing value for the Fund and its other
clients. For most transactions in equity securities, the amount of commissions
paid is negotiated between the investment manager and the broker executing the
transaction. The determination and evaluation of the reasonableness of the
brokerage commissions paid are based to a large degree on the professional
opinions of the persons within the trading department of the investment manager
responsible for placement and review of the transactions. These opinions are
based on the experience of these individuals in the securities industry and
information available to them about the level of commissions being paid by
other institutional investors. The investment manager may also place orders to
buy and sell equity securities on a principal rather than agency basis if the
investment manager believes that trading on a principal basis will provide best
execution. Orders for fixed income securities are ordinarily placed with market
makers on a net basis, without any brokerage commissions. Purchases of
portfolio securities from underwriters will include a commission or concession
paid to the underwriter, and purchases from dealers will include a spread
between the bid and ask price.
The investment manager may cause the Fund to
pay certain brokers commissions that are higher than those another broker may
charge, if the investment manager determines in good faith that the amount paid
is reasonable in relation to the value of the brokerage and research services
it receives. This may be viewed in terms of either the particular transaction
or the investment manager's overall responsibilities to client accounts over
which it exercises investment discretion. The brokerage commissions that are
used to acquire services other than brokerage are known as "soft
dollars." Research provided can be either proprietary (created and
provided by the broker-dealer, including tangible research products as well as
access to analysts and traders) or third party (created by a third party but
provided by the broker-dealer). To the extent permitted by applicable law, the
investment manager may use soft dollars to acquire both proprietary and
third-party research.
The
research services that brokers may provide to the investment manager include,
among others, supplying information about particular companies, markets,
countries, or local, regional, national or transnational economies, statistical
data, quotations and other securities pricing information, and other
information that provides lawful and appropriate assistance to the investment
manager in carrying out its investment advisory responsibilities. These
services may not always directly benefit the Fund. They must, however, be of
value to the investment manager in carrying out its overall responsibilities to
its clients.
Since
most purchases by the Fund are principal transactions at net prices, the Fund
incurs little or no brokerage costs. The Fund deals directly with the selling
or buying principal or market maker without incurring charges for the services
of a broker on its behalf, unless it is determined that a better price or
execution may be obtained by using the services of a broker. Purchases of
portfolio securities from underwriters will include a commission or concession
paid to the underwriter, and purchases from dealers will include a spread
between the bid and ask price. The Fund seeks to obtain prompt execution of
orders at the most favorable net price. Transactions may be directed to dealers
in return for research and statistical information, as well as for special
services provided by the dealers in the execution of orders.
It
is not possible to place an accurate dollar value on the special execution or
on the research services the investment manager receives from dealers effecting
transactions in portfolio securities. The allocation of transactions to obtain
additional research services allows the investment manager to supplement its
own research and analysis activities and to receive the views and information
of individuals and research staffs from many securities firms. The receipt of
these products and services does not reduce the investment manager's research
activities in providing investment advice to the Fund.
As
long as it is lawful and appropriate to do so, the investment manager and its
affiliates may use this research and data in their investment advisory
capacities with other clients.
Because
Franklin Templeton Distributors, Inc. (Distributors) is a member of the
Financial Industry Regulatory Authority (FINRA), it may sometimes receive
certain fees when the Fund tenders portfolio securities pursuant to a
tender-offer solicitation. To recapture brokerage for the benefit of the Fund,
any portfolio securities tendered by the Fund will be tendered through
Distributors if it is legally permissible to do so. In turn, the next
management fee payable to the investment manager will be reduced by the amount
of any fees received by Distributors in cash, less any costs and expenses
incurred in connection with the tender.
If
purchases or sales of securities of the Fund and one or more other investment
companies or clients supervised by the investment manager are considered at or
about the same time, transactions in these securities will be allocated among
the several investment companies and clients in a manner deemed equitable to
all by the investment manager, taking into account the respective sizes of the
accounts and the amount of securities to be purchased or sold. In some cases
this procedure could have a detrimental effect on the price or volume of the
security so far as the Fund is concerned. In other cases it is possible that
the ability to participate in volume transactions may improve execution and
reduce transaction costs to the Fund.
Because
the Fund may, from time to time, invest in broker-dealers, it is possible that
the Fund will own more than 5% of the voting securities of one or more
broker-dealers through whom the Fund places portfolio brokerage transactions.
In such circumstances, the broker-dealer would be considered an affiliated
person of the Fund. To the extent the Fund places brokerage transactions
through such a broker-dealer at a time when the broker-dealer is considered to
be an affiliate of the Fund, the Fund will be required to adhere to certain
rules relating to the payment of commissions to an affiliated broker-dealer.
These rules require the Fund to adhere to procedures adopted by the board to
ensure that the commissions paid to such broker-dealers do not exceed what
would otherwise be the usual and customary brokerage commissions for similar
transactions.
[TO BE UPDATED IN 485(B) FILING:]
The
following discussion is a summary of certain additional tax considerations
generally affecting the Fund and its shareholders, some of which may not be
described in the Fund’s prospectus. No attempt is made to present a complete
detailed explanation of the tax treatment of the Fund or its shareholders. The
discussions here and in the prospectus are not intended as a substitute for
careful tax planning.
The
following discussion is based on the Internal Revenue Code of 1986, as amended
(the “Code”), and applicable regulations in effect on the date of this SAI,
including any amendments to the Code resulting from 2017 legislation commonly
known as the Tax Cuts and Jobs Act. Future legislative, regulatory or
administrative changes, including any provisions of law that sunset and
thereafter no longer apply, or court decisions may significantly change the tax
rules applicable to the Fund and its shareholders. Any of these changes or
court decisions may have a retroactive effect. Where indicated below, IRS
refers to the United States Internal Revenue Service.
This
is for general information only and not tax advice. All investors should
consult their own tax advisors as to the federal, state, local and foreign tax
provisions applicable to them.
Distributions The Fund
intends to declare and pay income dividends monthly from its net investment
income. Capital gains, if any, may be paid at least annually. The Fund may
distribute income dividends and capital gains more frequently, if necessary or
appropriate in the board’s discretion. The amount of any distribution will
vary, and there is no guarantee the Fund will pay either income dividends or
capital gain distributions. Distributions in cash may be reinvested
automatically in additional whole Fund shares only if the broker through whom
you purchased the shares makes such option available. Distributions declared in
December to shareholders of record in such month and paid in January are
taxable as if they were paid in December.
Distributions
of net investment income. The Fund receives income generally in the
form of interest on its investments. The Fund may also recognize ordinary
income from other sources. This income, less expenses incurred in the operation
of the Fund, constitutes the Fund's net investment income from which dividends
may be paid to you. If you are a taxable investor, any income dividends (other
than qualified dividends) the Fund pays are taxable to you at ordinary income
tax rates. Generally, none or only a small portion of the income dividends paid
to you may be qualified dividends eligible to be taxed at reduced rates.
Distributions
of capital gains.
The Fund may realize capital gains and losses on the sale of its
portfolio securities.
Distributions
of short-term capital gains are taxable to you as ordinary income.
Distributions of long-term capital gains are taxable to you as long-term
capital gains, regardless of how long you have owned your shares in the Fund.
Any net capital gains realized by the Fund (in excess of any available capital loss
carryovers) generally are distributed once each year, and may be distributed
more frequently, if necessary, to reduce or eliminate excise or income taxes on
the Fund.
Capital
gain dividends and any net long-term capital gains you realize from the sale of
Fund shares are generally taxable at the reduced long-term capital gains tax
rates. For single individuals with taxable income not in excess of $39,375 in
2019 ($78,750 for married individuals filing jointly), the long-term capital
gains tax rate is 0%. For single individuals and joint filers with taxable
income in excess of these amounts but not more than $434,550 or $488,850,
respectively, the long-term capital gains tax rate is 15%. The rate is 20% for
single individuals with taxable income in excess of $434,550 and married
individuals filing jointly with taxable income in excess of $488,850. The
taxable income thresholds are adjusted annually for inflation. An additional
3.8% Medicare tax may also be imposed as discussed below.
Returns
of capital.
If the Fund's distributions exceed its earnings and profits
(i.e., generally, its taxable income and realized capital gains) for a taxable
year, all or a portion of the distributions made in that taxable year may be
characterized as a return of capital to you. A return of capital distribution
will generally not be taxable, but will reduce the cost basis in your Fund
shares and will result in a higher capital gain or in a lower capital loss when
you sell your shares. Any return of capital in excess of the basis in your Fund
shares, however, will be taxable as a capital gain. In the case of a
non-calendar year fund, earnings and profits are first allocated to
distributions made on or before December 31 of its taxable year and then to
distributions made thereafter. The effect of this provision is to “push”
returns of capital into the next calendar year.
Undistributed capital gains. The Fund
may retain or distribute to shareholders its net capital gain for each taxable
year. The Fund currently intends to distribute net capital gains. If the Fund
elects to retain its net capital gain, the Fund will be taxed thereon (except
to the extent of any available capital loss carryovers) at the applicable
corporate tax rate. If the Fund elects to retain its net capital gain, it is
expected that the Fund also will elect to have shareholders treated as if each
received a distribution of its pro rata share of such gain, with the result
that each shareholder will be required to report its pro rata share of such
gain on its tax return as long-term capital gain, will receive a refundable tax
credit for its pro rata share of tax paid by the Fund on the gain, and will
increase the tax basis for its shares by an amount equal to the deemed
distribution less the tax credit.
Dividend
reinvestment.
Brokers, at their own discretion, may offer a dividend
reinvestment service under which Fund shares are purchased in the secondary
market at current market prices. Investors should consult their broker for
further information regarding any dividend reinvestment service offered by such
broker. Dividends which are reinvested will nevertheless be taxable to the same
extent as if such dividends had not been reinvested.
Investments
in foreign securities
The following paragraphs describe tax considerations that are
applicable to the Fund's investments in foreign securities.
Foreign
income tax.
Investment income received by the Fund from sources within
foreign countries may be subject to foreign income tax withheld at the source
and the amount of tax withheld generally will be treated as an expense of the
Fund. The United States has entered into tax treaties with many foreign
countries, which entitle the Fund to a reduced rate of, or exemption from, tax
on such income. Some countries require the filing of a tax reclaim or other
forms to receive the benefit of the reduced tax rate; whether or when the Fund
will receive the tax reclaim is within the control of the individual country.
Information required on these forms may not be available such as shareholder
information; therefore, the Fund may not receive the reduced treaty rates or
potential reclaims. Other countries have conflicting and changing instructions
and restrictive timing requirements which may cause the Fund not to receive the
reduced treaty rates or potential reclaims. Other countries may subject capital
gains realized by the Fund on sale or disposition of securities of that country
to taxation. These and other factors may make it difficult for the Fund to
determine in advance the effective rate of tax on its investments in certain
countries. Under certain circumstances, the Fund may elect to pass-through
certain eligible foreign income taxes paid by the Fund to shareholders,
although it reserves the right not to do so. If the Fund makes such an election
and obtains a refund of foreign taxes paid by the Fund in a prior year, the
Fund may be eligible to reduce the amount of foreign taxes reported by the Fund
to its shareholders, generally by the amount of the foreign taxes refunded, for
the year in which the refund is received. Certain foreign taxes imposed on the
Fund’s investments, such as a foreign financial transaction tax, may not be
creditable against U.S. income tax liability or eligible for pass through by
the Fund to its shareholders.
Effect
of foreign debt investments on distributions. Most foreign exchange
gains realized on the sale of debt securities are treated as ordinary income by
the Fund. Similarly, foreign exchange losses realized on the sale of debt
securities generally are treated as ordinary losses. These gains when
distributed are taxable to you as ordinary income, and any losses reduce the
Fund's ordinary income otherwise available for distribution to you. This
treatment could increase or decrease the Fund's ordinary income distributions
to you, and may cause some or all of the Fund's previously distributed income
to be classified as a return of capital.
Information
on the amount and tax character of distributions The
broker will inform you of the amount of your income dividends and capital gain
distributions at the time they are paid, and will advise you of their tax
status for federal income tax purposes shortly after the close of each calendar
year. The amount of income dividends reported by the Fund, consisting of
qualified dividend income (which is relevant to U.S. investors) and
interest-related and short-term capital gain dividends (which are relevant to
non-U.S. investors) may exceed the total amount of income dividends paid. Such
characterization will not result in more income being reported by the Fund, but
rather will allow the broker to report dividends in a manner that is more tax
efficient to both U.S. and non-U.S. investors. If you have not owned your Fund
shares for a full year, the Fund may distribute:
-
as an ordinary
income, qualified dividend, or capital gain dividend (a distribution of
net long-term capital gains) if you are a U.S. investor, or
-
as an
interest-related, short-term capital gain, or capital gain dividend if you
are a non-U.S. investor
a
percentage of income that may not be equal to the actual amount of each type of
income earned during the period of your investment in the Fund.
The Fund makes every effort to identify
reclassifications of income to reduce the number of corrected forms mailed to
shareholders. However, the Fund may at times find it necessary to reclassify
income after you receive your tax reporting statement and you may receive a
corrected tax reporting statement to reflect reclassified information. This can
result from rules in the Code that effectively prevent regulated investment
companies such as the Fund from ascertaining with certainty until after the
calendar year end the final amount and character of distributions the Fund has
received on its investments during the prior calendar year. If you receive a
corrected tax reporting statement, use the information on this statement, and
not the information on your original statement, in completing your tax returns.
Avoid
"buying a dividend" At the time you purchase your
Fund shares, the price of the shares may reflect undistributed income,
undistributed capital gains, or net unrealized appreciation in the value of the
portfolio securities held by the Fund. For taxable investors, a subsequent
distribution to you of such amounts, although constituting a return of your
investment, would be taxable. Buying shares in the Fund just before it declares
an income dividend or capital gain distribution is sometimes known as “buying a
dividend.”
Election
to be taxed as a regulated investment company The Fund intends to elect
and continue to qualify as a regulated investment company under Subchapter M of
the Code. As a regulated investment company, the Fund generally pays no federal
income tax on the income and gains it distributes to you. In order to qualify
for treatment as a regulated investment company, the Fund must satisfy the
requirements described below.
Distribution
requirement.
The Fund must distribute an amount equal to the sum of at least
90% of its investment company taxable income and 90% of its net tax-exempt
income, if any, for the tax year (including, for purposes of satisfying this
distribution requirement, certain distributions made by the Fund after the
close of its taxable year that are treated as made during such taxable year).
Income
requirement.
The Fund must derive at least 90% of its gross income from
dividends, interest, certain payments with respect to securities loans, and
gains from the sale or other disposition of stock, securities or foreign
currencies, or other income (including, but not limited to, gains from options,
futures or forward contracts) derived from its business of investing in such
stock, securities or currencies and net income derived from qualified publicly
traded partnerships (QPTPs).
Asset
diversification test.
The Fund must satisfy the following asset diversification test at
the close of each quarter of the Fund’s tax year: (1) at least 50% of the value
of the Fund’s assets must consist of cash and cash items, U.S. government
securities, securities of other regulated investment companies, and securities
of other issuers (as to which the Fund has not invested more than 5% of the
value of the Fund’s total assets in securities of an issuer and as to which the
Fund does not hold more than 10% of the outstanding voting securities of the
issuer); and (2) no more than 25% of the value of the Fund’s total assets may
be invested in the securities of any one issuer (other than U.S. government
securities or securities of other regulated investment companies) or of two or
more issuers which the Fund controls and which are engaged in the same or
similar trades or businesses, or, in the securities of one or more QPTPs.
In
some circumstances, the character and timing of income realized by the Fund for
purposes of the income requirement or the identification of the issuer for
purposes of the asset diversification test is uncertain under current law with
respect to a particular investment, and an adverse determination or future
guidance by the IRS with respect to such type of investment may adversely
affect the Fund’s ability to satisfy these requirements. In other
circumstances, the Fund may be required to sell portfolio holdings in order to
meet the income requirement, distribution requirement, or asset diversification
test, which may have a negative impact on the Fund’s income and performance. In
lieu of potential disqualification, the Fund is permitted to pay a tax for
certain failures to satisfy the asset diversification test or income requirement,
which, in general, are limited to those due to reasonable cause and not willful
neglect.
If
for any taxable year the Fund does not qualify as a regulated investment
company, all of its taxable income (including its net capital gain) would be subject
to tax at the applicable corporate tax rate without any deduction for dividends
paid to shareholders, and the dividends would be taxable to the shareholders as
ordinary income (or possibly as qualified dividend income) to the extent of the
Fund’s current and accumulated earnings and profits. Failure to qualify as a
regulated investment company, subject to savings provisions for certain
qualification failures, which, in general, are limited to those due to
reasonable cause and not willful neglect, would thus have a negative impact on
the Fund’s income and performance. In that case, the Fund would be liable for
federal, and possibly state, corporate taxes on its taxable income and gains,
and distributions to you would be taxed as dividend income
to the extent of the Fund’s earnings and profits. Even if such savings
provisions apply, the Fund may be subject to a monetary sanction of $50,000 or
more. Moreover, the board reserves the right not to maintain the qualification
of the Fund as a regulated investment company if it determines such a course of
action to be beneficial to shareholders.
Capital
loss carryovers
The capital losses of the Fund, if any, do not flow through to
shareholders. Rather, the Fund may use its capital losses, subject to applicable
limitations, to offset its capital gains without being required to pay taxes on
or distribute to shareholders such gains that are offset by the losses. If the
Fund has a "net capital loss" (that is, capital losses in excess of
capital gains), the excess (if any) of the Fund's net short-term capital losses
over its net long-term capital gains is treated as a short-term capital loss
arising on the first day of the Fund's next taxable year, and the excess (if
any) of the Fund's net long-term capital losses over its net short-term capital
gains is treated as a long-term capital loss arising on the first day of the
Fund's next taxable year. Any such net capital losses of the Fund that are not
used to offset capital gains may be carried forward indefinitely, subject to
certain limitations, to reduce any future capital gains realized by the Fund in
succeeding taxable years.
Excise
tax distribution requirements
Required
distributions.
To avoid federal excise taxes, the Code requires the Fund to
distribute to you by December 31 of each year, at a minimum, the following
amounts:
-
98% of its taxable
ordinary income earned during the calendar year;
-
98.2% of its
capital gain net income earned during the 12-month period ending October
31; and
-
100% of any
undistributed amounts of these categories of income or gain from the prior
year.
The
Fund intends to declare and pay these distributions in December (or to pay them
in January, in which case you must treat them as received in December), but can
give no assurances that its distributions will be sufficient to eliminate all
taxes.
Tax
reporting for income and excise tax years. Because the periods for
measuring a regulated investment company’s income are different for income
(determined on a fiscal year basis) and excise tax years (determined as noted
above), special rules are required to calculate the amount of income earned in
each period, and the amount of earnings and profits needed to support that
income. For example, if the Fund uses the excise tax period ending on October
31 as the measuring period for calculating and paying out capital gain net
income and realizes a net capital loss between November 1 and the end of the
Fund’s fiscal year, the Fund may calculate its earnings and profits without
regard to such net capital loss in order to make its required distribution of
capital gain net income for excise tax purposes. The Fund also may elect to
treat part or all of any "qualified late year loss" as if it had been
incurred in the succeeding taxable year in determining the Fund’s taxable
income, net capital gain, net short-term capital gain, and earnings and
profits. The effect of this election is to treat any such “qualified late year
loss” as if it had been incurred in the succeeding taxable year, which may
change the timing, amount, or characterization of Fund distributions.
A
"qualified late year loss” includes (i) any net capital loss incurred
after October 31 of the current taxable year, or, if there is no such loss, any
net long-term capital loss or any net short-term capital loss incurred after
October 31 of the current taxable year (“post-October capital losses”), and
(ii) the sum of (1) the excess, if any, of (a) specified losses incurred after
October 31 of the current taxable year, over (b) specified gains incurred after
October 31 of the current taxable year and (2) the excess, if any, of (a)
ordinary losses incurred after December 31 of the current taxable year, over (b)
the ordinary income incurred after December 31 of the current taxable year. The
terms “specified losses” and “specified gains” mean ordinary losses and gains
from the sale, exchange, or other disposition of property (including the
termination of a position with respect to such property), foreign currency
losses and gains, and losses and gains resulting from holding stock in a
passive foreign investment company (PFIC) for which a mark-to-market election
is in effect. The terms “ordinary losses” and “ordinary income” mean other
ordinary losses and income that are not described in the preceding sentence.
Special rules apply to a fund with a fiscal year ending in November or December
that elects to use its taxable year for determining its capital gain net income
for excise tax purposes. The Fund may only elect to treat any post-October
capital loss, specified gains and specified losses incurred after October 31 as
if it had been incurred in the succeeding year in determining its taxable
income for the current year.
Because
these rules are not entirely clear, the Fund may be required to interpret the
"qualified late-year loss" and other rules relating to these
different year-ends to determine its taxable income and capital gains. The
Fund’s reporting of income and its allocation between
different taxable and excise tax years may be challenged by the IRS, possibly
resulting in adjustments in the income reported by the Fund on its tax returns
and/or on your year-end tax statements.
Medicare
tax
An additional 3.8% Medicare tax is imposed on net investment
income earned by certain individuals, estates and trusts. “Net investment
income,” for these purposes, means investment income, including ordinary
dividends and capital gain distributions received from the Fund and net gains
from the sales of Fund shares, reduced by the deductions properly allocable to
such income. In the case of an individual, the tax will be imposed on the
lesser of (1) the shareholder’s net investment income or (2) the amount by
which the shareholder’s modified adjusted gross income exceeds $250,000 (if the
shareholder is married and filing jointly or a surviving spouse), $125,000 (if
the shareholder is married and filing separately) or $200,000 (in any other
case). Any liability for this additional Medicare tax is reported by you on,
and paid with, your federal income tax return.
Sales
of exchange-listed Fund shares Sales of Fund shares are
generally taxable transactions for federal and state income tax purposes. If
you sell your Fund shares, you are required to report any gain or loss on your
sale. If you owned your shares as a capital asset, any gain or loss that you
realize is a capital gain or loss, and is long-term or short-term, depending on
how long you owned your shares. Under current law, shares held one year or less
are short-term and shares held more than one year are long-term. Capital losses
in any year are deductible only to the extent of capital gains plus, in the
case of a noncorporate taxpayer, $3,000 of ordinary income.
Sales
at a loss within six months of purchase. Any loss incurred on the sale of
Fund shares owned for six months or less is treated as a long-term capital loss
to the extent of any long-term capital gains distributed to you by the Fund on
those shares.
Wash
sales.
All or a portion of any loss that you realize on the sale of your
Fund shares will be disallowed to the extent that you buy other shares in the
Fund (through reinvestment of dividends or otherwise) within 30 days before or
after your sale. Any loss disallowed under these rules will be added to your
tax basis in the new shares.
Reportable
transactions.
Under Treasury regulations, if a shareholder recognizes a loss
with respect to the Fund’s shares of $2 million or more for an individual shareholder
or $10 million or more for a corporate shareholder (or certain greater amounts
over a combination of years), the shareholder must file with the IRS a
disclosure statement on Form 8886. The fact that a loss is reportable under
these regulations does not affect the legal determination of whether the
taxpayer’s treatment of the loss is proper.
Cost
basis reporting
The cost basis of Fund shares acquired by purchase will generally
be based on the amount paid for the shares and then may be subsequently
adjusted for other applicable transactions as required by the Code. The
difference between the selling price and the cost basis of the Fund shares
generally determines the amount of the capital gain or loss realized on the
sale of Fund shares. Contact the broker through whom you purchased your Fund
shares to obtain information with respect to the available cost basis reporting
methods and elections for your account. Capital gains and losses on sales of
Fund shares are generally taxable transactions for federal and state income tax
purposes.
Creations
and redemptions of creation units. An Authorized Participant who
exchanges securities for Creation Units generally will recognize a gain or a
loss. The gain or loss will be equal to the difference between the market value
of the Creation Units at the time and the sum of the exchanger’s aggregate
basis in the securities surrendered plus the amount of cash paid for such
Creation Units. A person who redeems Creation Units will generally recognize a
gain or loss equal to the difference between the exchanger’s basis in the
Creation Units and the sum of the aggregate market value of any securities
received plus the amount of any cash received for such Creation Units. The IRS,
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,” or on the basis that there has been no significant change in economic
position.
Any
capital gain or loss realized upon the creation of Creation Units will
generally be treated as long-term capital gain or loss if the securities
exchanged for such Creation Units have been held for more than one year. Any
capital gain or loss realized upon the redemption of Creation Units will
generally be treated as long-term capital gain or loss if the Shares comprising
the Creation Units have been held for more than one year. Otherwise, such
capital gains or losses will generally be treated as short-term capital gain or
loss. Any loss upon a redemption of Creation Units held for six (6) months or
less will be treated as a long-term capital loss to the extent of any amounts
treated as distributions to the applicable Authorized Participant of long-term
capital gain with respect to the Creation Units (including any amounts credited
to the Authorized Participant as undistributed capital gains).
The Fund has the right to reject an order for
Creation Units if the purchaser (or group of purchasers) would, upon obtaining
the Shares so ordered, own 80% or more of the outstanding shares of the Fund
and if, pursuant to sections 351 and 362 of the Code, the Fund would have a
basis in the deposit securities different from the market value of such
securities on the date of deposit. The Fund also has the right to require information
necessary to determine beneficial Share ownership for purposes of the 80%
determination. If the Fund does issue Creation Units to a purchaser (or group
of purchasers) that would, upon obtaining the Shares so ordered, own 80% or
more of the outstanding Shares of the Fund, the purchaser (or group of
purchasers) may not recognize gain or loss upon the exchange of securities for
Creation Units.
If
the Fund redeems Creation Units in cash, it may recognize more capital gains
than it will if it redeems Creation Units in-kind.
Tax
certification and backup withholding Tax laws require that you
certify your tax information with the broker when you become an investor in the
Fund. For U.S. citizens and resident aliens, this certification is made on IRS
Form W-9. Under these laws, you may be subject to federal backup withholding at
24%, and state backup withholding may also apply, on a portion of your taxable
distributions and sales proceeds unless you:
-
provide your
correct Social Security or taxpayer identification number,
-
certify that this
number is correct,
-
certify that you
are not subject to backup withholding, and
-
certify that you
are a U.S. person (including a U.S. resident alien).
The
broker must also withhold if the IRS instructs it to do so. Backup withholding
is not an additional tax. Any amounts withheld may be credited against the
shareholder’s U.S. federal income tax liability, provided the appropriate
information is furnished to the IRS. Certain payees and payments are exempt
from backup withholding and information reporting.
U.S.
government securities
The income earned on certain U.S. government securities is exempt
from state and local personal income taxes if earned directly by you. States
also grant tax-free status to investment company dividends paid to you from
interest earned on these securities, subject in some states to minimum
investment or reporting requirements that must be met by the Fund. The income
on Fund investments in certain securities, such as repurchase agreements,
commercial paper and federal agency-backed obligations (e.g., Ginnie Mae and
Fannie Mae securities), generally does not qualify for tax-free treatment. The
rules on exclusion of this income are different for corporations.
Qualified
dividends and the corporate dividends-received deduction For
individual shareholders, a portion of the dividends paid by the Fund may be
qualified dividend income eligible for taxation at long-term capital gain tax
rates. For single individuals with taxable income not in excess of $39,375 in
2019 ($78,750 for married individuals filing jointly), the long-term capital
gains tax rate is 0%. For single individuals and joint filers with taxable
income in excess of these amounts but not more than $434,550 or $488,850,
respectively, the long-term capital gains tax rate is 15%. The rate is 20% for
single individuals with taxable income in excess of $434,550 and married
individuals filing jointly with taxable income in excess of $488,850. An
additional 3.8% Medicare tax may also be imposed as discussed above.
“Qualified
dividend income” means dividends paid to the Fund (a) by domestic corporations,
(b) by foreign corporations that are either (i) incorporated in a possession of
the United States, or (ii) are eligible for benefits under certain income tax
treaties with the United States that include an exchange of information
program, or (c) with respect to stock of a foreign corporation that is readily
tradable on an established securities market in the United States. Both the
Fund and the investor must meet certain holding period requirements to qualify
Fund dividends for this treatment. Specifically, the Fund must hold the stock
for at least 61 days during the 121-day period beginning 60 days before the
stock becomes ex-dividend (or in the case of certain preferred stocks, for at
least 91 days during the 181-day period beginning 90 days before the stock
becomes ex-dividend). Similarly, investors must hold their Fund shares for at
least 61 days during the 121-day period beginning 60 days before the Fund
distribution goes ex-dividend. Income derived from investments in derivatives,
fixed-income securities, U.S. REITs, PFICs, and income received “in lieu of”
dividends in a securities lending transaction generally is not eligible for
treatment as qualified dividend income. If the qualifying dividend income received
by the Fund is equal to or greater than 95% of the Fund's gross income
(exclusive of net capital gain) in any taxable year, all of the ordinary income
dividends paid by the Fund will be qualifying dividend income.
While the income received in the form of a
qualified dividend is taxed at the same rates as long-term capital gains, such
income will not be considered a long-term capital gain for other federal income
tax purposes. For example, you will not be allowed to offset your long-term
capital losses against qualified dividend income on your federal income tax
return. Any qualified dividend income that you elect to be taxed at these
reduced rates also cannot be used as investment income in determining your
allowable investment interest expense.
For
corporate shareholders, a portion of the dividends paid by the Fund may qualify
for the corporate dividends-received deduction. This deduction generally is
available to corporations for dividends paid by a fund out of income earned on
its investments in domestic corporations. The availability of the
dividends-received deduction is subject to certain holding period and debt
financing restrictions that apply to both the Fund and the investor.
Specifically, the amount that the Fund may report as eligible for the
dividends-received deduction will be reduced or eliminated if the shares on
which the dividends earned by the Fund were debt-financed or held by the Fund
for less than a minimum period of time, generally 46 days during a 91-day
period beginning 45 days before the stock becomes ex-dividend. Similarly, if
your Fund shares are debt-financed or held by you for less than a 46-day period
then the dividends-received deduction for Fund dividends on your shares may
also be reduced or eliminated. Income derived by the Fund from investments in
derivatives, fixed-income and foreign securities generally is not eligible for
this treatment.
Each
year the Fund will report the portion of the income dividends paid by the Fund
that are eligible for treatment as qualified dividend income, if any, and for
the corporate dividends-received deduction, if any. The amounts reported by the
Fund may vary significantly each year depending on the particular mix of the
Fund’s investments. Because the income of the Fund is primarily derived from
investments earning interest rather than dividend income, it is anticipated
that only a small percentage, if any, of the Fund’s income dividends will be
qualified dividends for individual shareholders or will be eligible for the
dividends-received deduction for corporate shareholders. If the percentage of
qualified dividend income or dividend income eligible for the corporate
dividends-received deduction is quite small, the Fund reserves the right to not
report the small percentage of qualified dividend income for individuals or
income eligible for the corporate dividends-received deduction for
corporations.
Investment
in complex securities
The Fund’s investment in certain complex securities could subject
it to one or more special tax rules (including, but not limited to, the wash
sale rules), which may affect whether gains and losses recognized by the Fund
are treated as ordinary or capital or as short-term or long-term, accelerate
the recognition of income or gains to the Fund, defer losses to the Fund, and
cause adjustments to the holding periods of the Fund’s securities. These rules,
therefore, could affect the amount, timing and/or tax character of the Fund’s
distributions to shareholders. Moreover, because the tax rules applicable to
complex securities, including derivative financial instruments, are in some
cases uncertain under current law, an adverse determination or future guidance
by the IRS with respect to these rules (which determination or guidance could
be retroactive) may affect whether the Fund has made sufficient distributions
and otherwise satisfied the relevant requirements to maintain its qualification
as a regulated investment company and avoid a fund-level tax.
In
general.
Gain or loss recognized by the Fund on the sale or other
disposition of its portfolio investments will generally be capital gain or
loss. Such capital gain and loss may be long-term or short-term depending, in
general, upon the length of time a particular investment position is maintained
and, in some cases, upon the nature of the transaction. Portfolio investments
held for more than one year generally will be eligible for long-term capital
gain or loss treatment.
Derivatives. The Fund
may invest in certain derivative contracts, including some or all of the
following types of investments: options on securities and securities indices;
financial and futures contracts; options on financial or futures contracts and stock
index futures; foreign currency contracts, and forward and futures contracts on
foreign currencies. The tax treatment of certain forward and futures contracts
entered into by the Fund, as well as listed non-equity options written or
purchased by the Fund on U.S. exchanges (including options on futures
contracts, broad-based equity indices and debt securities), may be governed by
section 1256 of the Code (“section 1256 contracts”). Gains or losses on section
1256 contracts generally are considered 60% long-term and 40% short-term
capital gains or losses (“60/40”), although certain foreign currency gains and
losses from such contracts may be treated as ordinary in character. Also, any
section 1256 contracts held by the Fund at the end of each taxable year (and,
for purposes of the 4% excise tax, on certain other dates as prescribed under
the Code) are “marked to market” with the result that unrealized gains or
losses are treated as though they were realized and the resulting gain or loss
is treated as ordinary or 60/40 gain or loss, as applicable, even though the
Fund continues to hold the contracts. The Fund may be required to distribute
this income and gains annually in order to avoid income or excise taxes on the
Fund. Section 1256 contracts do not include any interest rate swap, currency
swap, basis swap, interest rate cap, interest rate floor, commodity swap,
equity swap, equity index swap, credit default swap, or similar agreement.
Constructive sales. The
Fund's entry into certain derivative instruments, including forward contracts
and futures could be treated as the "constructive sale" of an
"appreciated financial position," causing it to realize gain, but not
loss, on the position.
Securities
lending transactions.
The Fund may obtain additional income by lending its securities,
typically to brokers. All amounts that are paid to the Fund in a securities
lending transaction, including substitute dividend or interest payments, are
treated as a “fee” for the temporary use of property. As a result, any substitute
dividend payments received by the Fund are neither qualified dividend income
eligible for taxation at reduced long-term capital gain rates in the case of
individual shareholders nor eligible for the corporate dividends received
deduction in the case of corporate shareholders. Similarly, any foreign tax
withheld on payments made “in lieu of” dividends or interest will not qualify
for the pass-through of foreign taxes to shareholders.
Tax
straddles.
If the Fund invests in certain derivative instruments, if it
actively trades stock or otherwise acquires a position with respect to
substantially similar or related property in connection with certain hedging
transactions, or if it engages in spread, straddle or collar transactions, it
could be deemed to hold offsetting positions in securities. If the Fund’s risk
of loss with respect to specific securities in its portfolio is substantially
diminished by the fact that it holds offsetting securities, the Fund could be
deemed to have entered into a tax "straddle" or to hold a
"successor position" that would require any loss realized by it to be
deferred for tax purposes.
Synthetic
convertible securities. The Fund is permitted to invest in synthetic convertible
securities, which are comprised of two distinct security components, for
example, a nonconvertible fixed income security and warrants or stock or stock
index call options. When combined, these investments achieve the same economic
effect as an investment in a traditional convertible security: a desired income
stream and the right to acquire shares of the underlying equity security. Even
though these securities are economically equivalent to traditional convertible
securities, each security forming part of such an investment is analyzed
separately, and the tax consequences of an investment in the component parts of
these securities could differ from those of an investment in a traditional
convertible security.
Credit-linked
securities.
The Fund may enter into credit-linked securities including debt
securities represented by an interest in or collateralized by one or more
corporate debt obligations, or into credit default swap agreements. The rules
governing the tax aspects of credit-linked securities that provide for
contingent nonperiodic payments of this type are in a developing stage and are
not entirely clear in certain aspects. Accordingly, while the Fund intends to
account for such transactions in a manner that it deems to be appropriate, the
IRS might not accept such treatment, and may require the Fund to modify its
treatment of these investments. Certain requirements that must be met under the
Code in order for the Fund to qualify as a regulated investment company may
limit the extent to which the Fund will be able to engage in credit default
swap agreements.
Structured
investments.
The Fund may invest in instruments that are designed to
restructure the investment characteristics of a security or securities, such as
certain structured notes, swap contracts, or swaptions. By investing in these
securities, the Fund could be subject to tax consequences that differ from
those of an investment in traditional debt or equity securities.
Certain
fixed-income investments. Gain recognized on the disposition of a debt
obligation purchased by the Fund with market discount (generally, at a price
less than its principal amount) will be treated as ordinary income to the
extent of the portion of the market discount that accrued during the period of
time the Fund held the debt obligation, unless the Fund made an election to
accrue market discount into income currently. Fund distributions of accrued
market discount, including any current inclusions, are taxable to shareholders
as ordinary income to the extent of the Fund’s earnings and profits. If the
Fund purchases a debt obligation (such as a zero coupon security or pay-in-kind
security) that was originally issued at a discount, the Fund generally is
required to include in gross income each year the portion of the original issue
discount that accrues during such year. Therefore an investment in such
securities may cause the Fund to recognize income and make distributions to
shareholders before it receives any cash payments on the securities. To
generate cash to satisfy those distribution requirements, the Fund may have to
sell portfolio securities that it otherwise might have continued to hold or to
use cash flows from other sources such as the sale of fund shares.
Investments
in debt obligations that are at risk of or in default. The Fund
may also hold obligations that are at risk of or in default. Tax rules are not
entirely clear about issues such as whether and to what extent the Fund should
recognize market discount on such a debt obligation, when the Fund may cease to
accrue interest, original issue discount or market discount, when and to what
extent the Fund may take deductions for bad debts or worthless securities and
how the Fund should allocate payments received on
obligations in default between principal and income. These and other related
issues will be addressed by the Fund in order to ensure that it distributes
sufficient income to preserve its status as a regulated investment company.
Inflation
indexed securities.
The principal amount of inflation indexed securities purchased by
the Fund will adjust for inflation which may cause the Fund to recognize income
or loss. The inflation adjustment to the principal generally is subject to tax
in the year that the adjustment is made, not at maturity of the security when
the cash from the repayment of principal is received, and is treated as
original issue discount in such year. Any interest payable on the inflation
indexed security is accrued by the Fund. Increases in the indexed principal in
a given year and accrued interest will cause the Fund to distribute income not
yet received. Decreases in the indexed principal in a given year generally (i)
will reduce the amount of interest income otherwise includible in income for
that year in respect of the security, (ii) to the extent not treated as an
offset to current income under (i), will constitute an ordinary loss to the
extent of prior year inclusions of interest, original issue discount and market
discount in respect of the security that exceed ordinary losses in respect of
the security in such prior years, and (iii) to the extent not treated as an
offset to current income under (i) or an ordinary loss under (ii), can be
carried forward as an ordinary loss to reduce interest, original issue discount
and market discount in respect of the security in subsequent taxable years. If
inflation-indexed securities are sold prior to maturity, capital losses or
gains generally are realized in the same manner as traditional debt
instruments. Special rules apply in respect of inflation-indexed securities
issued with more than a prescribed de minimis amount of discount or premium.
Investment
in taxable mortgage pools (excess inclusion income). Under a
Notice issued by the IRS, the Code and Treasury regulations to be issued, a
portion of the Fund’s income from a U.S. REIT that is attributable to the
REIT’s residual interest in a real estate mortgage investment conduit (REMIC)
or equity interests in a “taxable mortgage pool” (referred to in the Code as an
excess inclusion) will be subject to federal income tax in all events. The
excess inclusion income of a regulated investment company, such as the Fund,
will 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 residual interest
or, if applicable, taxable mortgage pool 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), (ii) will
constitute unrelated business taxable income 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 unrelated business income (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, and (iii) in the case of a foreign
stockholder, will not qualify for any reduction in U.S. federal withholding
tax. In addition, if at any time during any taxable year a “disqualified
organization” (which generally includes certain cooperatives, governmental
entities, and tax-exempt organizations not subject to UBTI) is a record holder
of a share in a regulated investment company, then the regulated investment
company will be subject to a tax equal to that portion of its excess inclusion
income for the taxable year that is allocable to the disqualified organization,
multiplied by the applicable corporate tax rate. The Notice imposes certain
reporting requirements upon regulated investment companies that have excess
inclusion income. There can be no assurance that the Fund will not allocate to
shareholders excess inclusion income.
These
rules are potentially applicable to a fund with respect to any income it
receives from the equity interests of certain mortgage pooling vehicles, either
directly or, as is more likely, through an investment in a U.S. REIT. It is not
anticipated that these rules will apply to a fund that does not invest in any
U.S. REITs.
State
income taxes
Some state tax codes adopt the Code through a certain date. As a
result, such conforming states may not have adopted the version of the Code as
amended by enactment of 2017 legislation commonly known as the Tax Cuts and
Jobs Act, the Regulated Investment Company Modernization Act of 2010, or other
federal tax laws enacted after the applicable conformity date. Other states may
have adopted an income or other basis of tax that differs from the Code.
The
tax information furnished to shareholders and the IRS annually with respect to
the amount and character of dividends paid will be prepared on the basis of
current federal income tax law to comply with the information reporting
requirements of the Code, and not necessarily on the basis of the law of any
state in which a shareholder is resident or otherwise subject to tax. Contact
your broker with respect to any state information reporting requirements
applicable to your investment in the Fund.
Accordingly,
the amount and character of income, gain or loss realized by a shareholder with
respect to an investment in Fund shares for state income tax purposes may
differ from that for federal income tax purposes. Franklin Templeton provides
additional tax information on franklintempleton.com to assist shareholders with
the preparation of their federal and state income tax returns. Shareholders are
solely responsible for determining the amount and character of income, gain or
loss to report on their federal, state and local income tax returns each year
as a result of their purchase, holding and sale of Fund shares.
Non-U.S. investors Non-U.S.
investors may be subject to U.S. withholding and estate tax, and are subject to
special U.S. tax certification requirements.
In
general.
The United States imposes a flat 30% withholding tax (or a tax at
a lower treaty rate) on U.S. source dividends. Exemptions from U.S. withholding
tax are provided for capital gains realized on the sales of Fund shares,
capital gain dividends paid by the Fund from net long-term capital gains,
short-term capital gain dividends paid by the Fund from net short-term capital
gains, and interest-related dividends paid by the Fund from its qualified net
interest income from U.S. sources, unless you are a nonresident alien
individual present in the United States for a period or periods aggregating 183
days or more during the calendar year. “Qualified interest income” includes, in
general, the sum of the Fund’s U.S. source: i) bank deposit interest, ii)
short-term original issue discount, iii) portfolio interest, and iv) any
interest-related dividend passed through from another regulated investment
company.
However,
notwithstanding such exemptions from U.S. withholding tax at source, any
taxable distributions and proceeds from the sale of your Fund shares will be
subject to backup withholding at a rate of 24% if you fail to properly certify
that you are not a U.S. person.
It
may not be practical in every case for the Fund to report, and the Fund
reserves the right in these cases to not report, interest-related or short-term
capital gain dividends. Additionally, the Fund’s reporting of interest-related
or short-term capital gain dividends may not, in turn, be passed through to
shareholders by intermediaries who have assumed tax reporting responsibilities
for this income in managed or omnibus accounts due to systems limitations or
operational constraints.
Effectively
connected income.
Taxable ordinary income dividends paid by the Fund to non-U.S.
investors on portfolio investments are generally subject to U.S. withholding
tax at 30% or a lower treaty rate. However, if you hold your Fund shares in
connection with a U.S. trade or business, your income and gains may be
considered effectively connected income and taxed in the U.S. on a net basis at
graduated income tax rates in which case you may be required to file a
nonresident U.S. income tax return.
U.S.
estate tax.
An individual who is a non-U.S. investor will be subject to U.S.
federal estate tax on the value of the Fund shares owned at the time of death,
unless a treaty exemption applies between the country of residence of the
non-U.S. investor and the U.S. Even if a treaty exemption is available, a
decedent’s estate may nevertheless be required to file a U.S. estate tax return
to claim the exemption, as well as to obtain a U.S. federal transfer
certificate. The transfer certificate will identify the property (i.e., Fund
shares) on which a U.S. federal tax lien has been released and is required
before such property of a nonresident alien decedent can be released to his or
her estate. A transfer certificate is not required for property administered by
an executor or administrator appointed, qualified and acting within the United
States. For estates with U.S. situs assets of not more than $60,000 (there is a
statutory estate tax credit for this amount of property), an affidavit from the
executor of the estate or other authorized individual along with additional
evidence requested by the IRS relating to the decedent’s estate evidencing the
U.S. situs assets may be provided in lieu of a federal transfer certificate.
Transfers by gift of shares of the Fund by a non-U.S. investor who is a
nonresident alien individual will not be subject to U.S. federal gift tax. The
tax consequences to a non-U.S. investor entitled to claim the benefits of a
treaty between the country of residence of the non-U.S. investor and the U.S. may
be different from the consequences described above.
Tax
certification and backup withholding as applied to non-U.S. investors. Non-U.S.
investors have special U.S. tax certification requirements to avoid backup
withholding at a rate of 24% and, if applicable, to obtain the benefit of any
income tax treaty between the non-U.S. investor’s country of residence and the
United States. To claim these tax benefits, the non-U.S. investor must provide
a properly completed Form W-8BEN (or other Form W-8, where applicable) to
establish his or her status as a non-U.S. investor, to claim beneficial
ownership over the assets in the account, and to claim, if applicable, a
reduced rate of or exemption from withholding tax under the applicable treaty.
A Form W-8BEN generally remains in effect for a period of three years beginning
on the date that it is signed and ending on the last day of the third
succeeding calendar year. In certain instances, Form W-8BEN may remain valid
indefinitely unless the investor has a change of circumstances that renders the
form incorrect and necessitates a new form and tax certification. Non-U.S.
investors must advise of any change of circumstances that would render the
information given on the form incorrect and must then provide a new W-8BEN to
avoid the prospective application of backup withholding.
Investment in U.S. real property. The
Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) makes non-U.S.
persons subject to U.S. tax on disposition of a U.S. real property interest
(USRPI) as if he or she were a U.S. person. Such gain is sometimes referred to
as FIRPTA gain. The Fund may invest in equity securities of corporations that
invest in USRPI, including U.S. REITs, which may trigger FIRPTA gain to the
Fund’s non-U.S. shareholders.
The
Code provides a look-through rule for distributions of FIRPTA gain when a
regulated investment company is classified as a qualified investment entity. A
regulated investment company will be classified as a qualified investment
entity if, in general, 50% or more of the regulated investment company’s assets
consist of interests in U.S. REITs and other U.S. real property holding
corporations (USRPHC). If a regulated investment company is a qualified
investment entity and the non-U.S. shareholder owns more than 5% of a class of
Fund shares at any time during the one-year period ending on the date of the
FIRPTA distribution, the FIRPTA distribution to the non-U.S. shareholder is
treated as gain from the disposition of a USRPI, causing the distribution to be
subject to U.S. withholding tax at the applicable corporate tax rate (unless
reduced by future regulations), and requiring the non-U.S. shareholder to file
a nonresident U.S. income tax return. In addition, even if the non-U.S.
shareholder does not own more than 5% of a class of Fund shares, but the Fund
is a qualified investment entity, the FIRPTA distribution will be taxable as
ordinary dividends (rather than as a capital gain or short-term capital gain
dividend) subject to withholding at 30% or a lower treaty rate.
Because
the Fund expects to invest less than 50% of its assets at all times, directly
or indirectly, in U.S. real property interests, it expects that neither gain on
the sale or redemption of Fund shares nor Fund dividends and distributions
should be subject to FIRPTA reporting and tax withholding.
Foreign
Account Tax Compliance Act Under the Foreign Account Tax Compliance Act
(FATCA), foreign entities, referred to as foreign financial institutions (FFI)
or non-financial foreign entities (NFFE) that are shareholders in the Fund may
be subject to a 30% withholding tax on income dividends paid by the Fund. The
FATCA withholding tax generally can be avoided: (a) by an FFI, if it reports
certain direct and indirect ownership of foreign financial accounts held by
U.S. persons with the FFI, and (b) by an NFFE, if it: (i) certifies that it has
no substantial U.S. persons as owners, or (ii) if it does have such owners,
reports information relating to them to the withholding agent, which will, in
turn, report that information to the IRS. The U.S. Treasury has negotiated
intergovernmental agreements (IGA) with certain countries and is in various
stages of negotiations with a number of other foreign countries with respect to
one or more alternative approaches to implement FATCA. An entity in one of
those countries may be required to comply with the terms of an IGA and
applicable local law instead of U.S. Treasury regulations.
An
FFI can avoid FATCA withholding if it is deemed compliant or by becoming a
“participating FFI,” which requires the FFI to enter into a U.S. tax compliance
agreement with the IRS under section 1471(b) of the Code (FFI agreement) under
which it agrees to verify, report and disclose certain of its U.S.
accountholders and provided that such entity meets certain other specified
requirements. The FFI will report to the IRS, or, depending on the FFI’s
country of residence, to the government of that country (pursuant to the terms
and conditions of an applicable IGA and applicable law), which will, in turn,
report to the IRS. An FFI that is resident in a country that has entered into
an IGA with the U.S. to implement FATCA will be exempt from FATCA withholding
provided that the FFI shareholder and the applicable foreign government comply
with the terms of such agreement.
An
NFFE that is the beneficial owner of a payment from the Fund can avoid the
FATCA withholding tax generally by certifying that it does not have any
substantial U.S. owners or by providing the name, address and taxpayer
identification number of each substantial U.S. owner. The NFFE will report
information either (i) to the applicable withholding agent, which will, in
turn, report information to the IRS, or (ii) directly to the IRS.
Such
foreign shareholders also may fall into certain exempt, excepted or deemed
compliant categories as established by U.S. Treasury regulations, IGAs, and
other guidance regarding FATCA. An FFI or NFFE that invests in a Fund will need
to provide documentation properly certifying the entity’s status under FATCA in
order to avoid FATCA withholding. The requirements imposed by FATCA are different
from, and in addition to, the U.S. tax certification rules to avoid backup
withholding described above.
Organization, Voting Rights, Principal
Holders and Additional Information Concerning the Trust
The
Fund is a diversified series of the Trust, an open-end management investment
company. The Trust was organized as a Delaware statutory trust on October 9,
2015 and is registered with the SEC.
The Trust has noncumulative voting rights. For
board member elections, this gives holders of more than 50% of the shares
voting the ability to elect all of the members of the board. If this happens,
holders of the remaining shares voting will not be able to elect anyone to the
board.
The
Trust does not intend to hold annual shareholder meetings. The Trust or a series
of the Trust may hold special meetings, however, for matters requiring
shareholder approval.
From
time to time, the number of Fund shares held in the “street name” accounts of
various securities dealers for the benefit of their clients or in centralized
securities depositories may exceed 5% of the total shares outstanding.
Following
the creation of the initial Creation Unit(s) of shares of the Fund and
immediately prior to the commencement of trading in the Fund’s shares, a holder
of shares may be a “control person” of the Fund, as defined in the 1940 Act.
The Fund cannot predict the length of time for which one or more shareholders
may remain a control person of the Fund.
Depository
Trust Company (DTC) acts as securities depository for shares of the Fund.
Shares of the Fund are represented by securities registered in the name of DTC
or its nominee and deposited with, or on behalf of, DTC.
DTC
was created in 1973 to enable electronic movement of securities between its
participants (DTC Participants), and NSCC was established in 1976 to provide a
single settlement system for securities clearing and to serve as central
counterparty for securities trades among DTC Participants. In 1999, DTC and
NSCC were consolidated within the Depository Trust & Clearing Corporation
(DTCC) and became wholly owned subsidiaries of DTCC. The common stock of DTCC
is owned by the DTC Participants, but the New York Stock Exchange and FINRA,
through subsidiaries, hold preferred shares in DTCC that provide them with the
right to elect one member each to the DTCC Board of Directors. Access to the
DTC system is available to entities, such as banks, brokers, dealers and trust
companies, that clear through or maintain a custodial relationship with a DTC
Participant, either directly or indirectly (Indirect Participants).
Beneficial
ownership of shares is limited to DTC Participants, Indirect Participants and
persons holding interests through DTC Participants and Indirect Participants.
Ownership of beneficial interests in shares (owners of such beneficial
interests are referred to herein as “Beneficial Owners”) is shown on, and the
transfer of ownership is effected only through, records maintained by DTC (with
respect to DTC Participants) and on the records of DTC Participants (with
respect to Indirect Participants and Beneficial Owners that are not DTC
Participants). Beneficial Owners will receive from or through the DTC
Participant a written confirmation relating to their purchase of shares. The
laws of some jurisdictions may require that certain purchasers of securities
take physical delivery of such securities in definitive form. Such laws may
impair the ability of certain investors to acquire beneficial interests in
shares.
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 of the Fund held by 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 of the Trust. 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 of the Fund 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 aspect 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 decide to discontinue providing its service with respect
to shares of the Trust 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 to find a replacement for
DTC to perform its functions at a comparable cost.
Creation and Redemption of Creation
Units
General. The
Trust issues and sells shares of the Fund only in Creation Units on a
continuous basis through Distributors or its agent, without a sales load, at a
price based on the Fund’s NAV next determined after receipt, on any Business
Day (as defined below), of an order received by Distributors or its agent in
proper form. On days when the Listing Exchange closes earlier than normal, the
Fund may require orders to be placed earlier in the day. The number of shares
of the Fund that constitutes a Creation Unit is [50,000].
In
its discretion, the investment manager reserves the right to increase or
decrease the number of the Fund’s shares that constitute a Creation Unit. The
board reserves the right to declare a split or a consolidation in the number of
shares outstanding of the Fund, and to make a corresponding change in the
number of shares constituting a Creation Unit, in the event that the per share
price in the secondary market rises (or declines) to an amount that falls
outside the range deemed desirable by the board.
A
“Business Day” with respect to the Fund is any day on which the Listing
Exchange on which the Fund is listed for trading is open for business. As of
the date of this SAI, the Listing Exchange observes the following holidays: New
Year’s Day, Martin Luther King, Jr. Day, Presidents’ Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
To
the extent the Fund engages in in-kind transactions, the Fund intends to comply
with the U.S. federal securities laws in accepting securities for deposit and
satisfying redemptions with redemption securities by, among other means,
assuring that any securities accepted for deposit and any securities used to
satisfy redemption requests will be sold in transactions that would be exempt
from registration under the 1933 Act. Further, an Authorized Participant that
is not a “qualified institutional buyer,” as such term is defined under Rule
144A of the 1933 Act, will not be able to receive securities that are
restricted securities eligible for resale under Rule 144A.
Fund
Deposit.
The consideration for purchase of Creation Units of the Fund may
consist of the Deposit Securities (i.e., the in-kind deposit of a designated
portfolio of securities (including any portion of such securities for which
cash may be substituted)) and the Cash Component computed as described below.
Together, the Deposit Securities and the Cash Component constitute the “Fund
Deposit,” which will be applicable (subject to possible amendment or
correction) to creation requests received in proper form. The Fund Deposit
represents the minimum initial and subsequent investment amount for a Creation
Unit of the Fund. Currently, the Fund is generally offered in Creation Units
solely for cash.
The
“Cash Component” is 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 market value of the Deposit Securities, and serves to compensate for any
differences between the NAV per Creation Unit and the Deposit Amount. Payment
of any stamp duty or other similar fees and expenses payable upon transfer of
beneficial ownership of the Deposit Securities are the sole responsibility of
the Authorized Participant purchasing the Creation Unit. Please see the Cash
purchase method section below and the following discussion summarizing the
in-kind method for further information on purchasing Creation Units of the
Fund.
The
Fund’s current policy is to accept cash in substitution for the Deposit
Securities it might otherwise accept as in-kind consideration for the purchase
of Creation Units. The Fund may, at times, elect to receive Deposit Securities
(i.e., the in-kind deposit of a designated portfolio of securities) and a Cash
Component as consideration for the purchase of Creation Units. If the Fund elects
to accept Deposit Securities, a purchaser’s delivery of the Deposit Securities
together with the Cash Component will constitute the “Fund Deposit,” which will
represent the consideration for a Creation Unit of the Fund.
Advisers
makes available through the NSCC on each Business Day prior to the opening of
business on the Listing Exchange, the list of names and the required number of
shares of each Deposit Security and the amount of the Cash Component (if any)
to be included in the current Fund Deposit (based on information as of the end
of the previous Business Day for the Fund). Such Fund Deposit
is applicable, subject to any adjustments as described below, to purchases of
Creation Units of shares of the Fund until such time as the next-announced Fund
Deposit is made available.
The
identity and number of shares of the Deposit Securities and the amount of the
Cash Component changes pursuant to changes in the composition of the Fund’s
portfolio and as rebalancing adjustments and corporate action events are
reflected from time to time by Advisers with a view to the investment goal of
the Fund. The composition of the Deposit Securities and the amount of the Cash
Component may also change in response to adjustments to the weighting or
composition of the component securities constituting the Fund's portfolio.
The
Trust may require the substitution of an amount of cash (i.e., a “cash-in-lieu”
amount) to replace any Deposit Security of the Fund that is a TBA transaction
or an interest in a mortgage pass-through security. The amount of cash
contributed will be equivalent to the price of the TBA transaction or mortgage
pass-through security interest listed as a Deposit Security. A transaction fee
may be charged on the cash amount contributed in lieu of the TBA transaction or
mortgage pass-through security.
The
Fund reserves the right to permit or require the substitution of a “cash in
lieu” amount to be added to the Cash Component to replace any Deposit Security
that may not be available in sufficient quantity for delivery or that may not
be eligible for transfer through the facilities of DTC (DTC Facilities) or the
clearing process through the Continuous Net Settlement System of the NSCC (NSCC
Clearing Process), a clearing agency that is registered with the SEC (as discussed
below), or that the Authorized Participant is not able to trade due to a
trading restriction. The Fund also reserves the right to permit or require a
“cash in lieu” amount in certain circumstances, including circumstances in
which: (i) the delivery of the Deposit Security by the Authorized Participant
would be restricted under applicable securities or other local laws; (ii) the
delivery of the Deposit Security to the Authorized Participant would result in
the disposition of the Deposit Security by the Authorized Participant becoming
restricted under applicable securities or other local laws; or (iii) in certain
other situations. As noted above, Creation Units of the Fund currently are
generally available only for cash purchases.
Cash
purchase method.
When partial or full cash purchases of Creation Units are
available or specified for the Fund (currently, Creation Units of the Fund are
generally offered solely for cash), they will be effected in essentially the
same manner as in-kind purchases thereof. In the case of a partial or full cash
purchase, the Authorized Participant must pay the cash equivalent of the
Deposit Securities it would otherwise be required to provide through an in-kind
purchase, plus the same Cash Component required to be paid by an in-kind
purchaser.
Creation
Units.
To be eligible to place orders with Distributors and to create a
Creation Unit of the Fund, an entity must be: (i) a “Participating Party,”
i.e., a broker-dealer or other participant in the NSCC Clearing Process, or
(ii) a DTC Participant, and, in either case, must have executed an agreement
with Distributors with respect to creations and redemptions of Creation Units
(Authorized Participant Agreement). A Participating Party or DTC Participant
who has executed an Authorized Participant Agreement is referred to as an
“Authorized Participant.” All shares of the Fund, however created, will be
entered on the records of DTC in the name of Cede & Co. for the account of
a DTC Participant.
Role
of the Authorized Participant. Creation Units may be purchased
only by or through an Authorized Participant that has entered into an
Authorized Participant Agreement with Distributors. Such Authorized Participant
will agree, pursuant to the terms of such Authorized Participant Agreement and
on behalf of itself or any investor on whose behalf it will act, to certain
conditions, including that such Authorized Participant will make available in
advance of each purchase of shares an amount of cash sufficient to pay the Cash
Component, once the net asset value of a Creation Unit is next determined after
receipt of the purchase order in proper form, together with the transaction
fees described below. An Authorized Participant, acting on behalf of an
investor, may require the investor to enter into an agreement with such
Authorized Participant with respect to certain matters, including payment of
the Cash Component. Investors who are not Authorized Participants must make
appropriate arrangements with an Authorized Participant. Investors should be
aware that their particular broker may not be an Authorized Participant or may
not have executed an Authorized Participant Agreement and that orders to
purchase Creation Units may have to be placed by the investor’s broker through
an Authorized Participant. As a result, purchase orders placed through an
Authorized Participant may result in additional charges to such investor. The
Trust does not expect to enter into an Authorized Participant Agreement with
more than a small number of Authorized Participants.
Placement
of creation orders.
An Authorized Participant must submit an irrevocable order to
purchase shares of the Fund, in proper form, generally before 4 p.m., Eastern
time on any Business Day in order to receive that day’s NAV. Orders for Creation
Units must be transmitted by an Authorized Participant
by telephone or other transmission method acceptable to Distributors or its
agent pursuant to procedures set forth in the Authorized Participant Agreement
and Authorized Participant Handbook (as may be amended or supplemented from
time to time), as described below. Economic or market disruptions or changes,
or telephone or other communication failure, may impede the ability to reach
Distributors or its agent or an Authorized Participant. Orders to create shares
of the Fund that are submitted on the Business Day immediately preceding a
holiday or a day (other than a weekend) when the equity markets in the relevant
non-U.S. market are closed may not be accepted. The Fund’s deadline specified
above for the submission of purchase orders is referred to as the Fund’s
“Cutoff Time.” Distributors or its agent, in their discretion, may permit the
submission of such orders and requests by or through an Authorized Participant
at any time (including on days on which the Listing Exchange is not open for
business) via communication through the facilities of Distributors’ or its
agent’s proprietary website maintained for this purpose.
Investors,
other than Authorized Participants, are responsible for making arrangements for
a creation request to be made through an Authorized Participant. Those placing
orders to purchase Creation Units through an Authorized Participant should
allow sufficient time to permit proper submission of the purchase order to
Distributors or its agent by the Cutoff Time on such Business Day.
Upon
receiving an order for a Creation Unit, Distributors or its agent will notify
Advisers and the custodian of such order. The custodian will then provide such
information to any appropriate sub-custodian.
The
Authorized Participant must make available on or before the prescribed
settlement date, by means satisfactory to the Fund, immediately available or
same day funds estimated by the Fund to be sufficient to pay the Cash Component
next determined after acceptance of the purchase order, together with the
applicable purchase transaction fees. Any excess funds will be returned
following settlement of the issue of the Creation Unit. Those placing orders
should ascertain the applicable deadline for cash transfers by contacting the
operations department of the broker or depositary institution effectuating the
transfer of the Cash Component. This deadline is likely to be significantly
earlier than the Cutoff Time of the Fund. Investors should be aware that an Authorized
Participant may require orders for purchases of shares placed with it to be in
the particular form required by the individual Authorized Participant.
The
Authorized Participant is responsible for all transaction-related fees,
expenses and other costs (as described below), as well as any applicable cash
amounts, in connection with any purchase order.
Once
a purchase order has been accepted, it will be processed based on the NAV next
determined after such acceptance in accordance with the Fund’s Cutoff Times as
provided in the Authorized Participant Agreement and Authorized Participant
Handbook (as may be amended or supplemented from time to time) and disclosed in
this SAI.
Acceptance
of orders for Creation Units. Subject to the conditions that (i)
an irrevocable purchase order has been submitted by the Authorized Participant
(either on its own or another investor’s behalf) and (ii) arrangements
satisfactory to the Fund are in place for payment of the Cash Component and any
other cash amounts which may be due, an order will be accepted, subject to the
Fund’s right (and the right of Distributors and Advisers) to reject any order
until acceptance, as set forth below.
Once
an order has been accepted, upon the next determination of the net asset value
of the shares, the Fund will confirm the issuance of a Creation Unit, against
receipt of payment, at such net asset value. Distributors or its agent will
then transmit a confirmation of acceptance to the Authorized Participant that
placed the order.
The
Fund reserves the absolute right to reject or revoke a creation order
transmitted to it by Distributors or its agent if: (i) the order is not in
proper form; (ii) the investor(s), upon obtaining the shares ordered, would own
80% or more of the currently outstanding shares of the Fund; (iii) the Deposit
Securities delivered do not conform to the identity and number of shares
specified, as described above; (iv) acceptance of the Fund Deposit would have
certain adverse tax consequences to the Fund; (v) acceptance of the Fund
Deposit would, in the opinion of the Fund, be unlawful; (vi) acceptance of the
Fund Deposit would, in the discretion of the Fund or Advisers, have an adverse
effect on the Fund or the rights of beneficial owners; or (vii) circumstances
outside the control of the Fund make it impossible to process purchase orders
for all practical purposes. Distributors or its agent shall notify a
prospective purchaser of a Creation Unit and/or the Authorized Participant
acting on behalf of such purchaser of its rejection of such order. The Fund,
the Fund’s custodian, the sub-custodian and Distributors or its agent are under
no duty, however, to give notification of any defects
or irregularities in the delivery of Fund Deposits nor shall any of them incur
any liability for failure to give such notification.
Issuance
of a Creation Unit.
Except as provided herein, a Creation Unit will not be issued
until the transfer of good title to the Fund of the Deposit Securities and the
payment of the Cash Component have been completed. When the sub-custodian has
confirmed to the custodian that the securities included in the Fund Deposit (or
the cash value thereof) have been delivered to the account of the relevant
sub-custodian or sub-custodians, Distributors or its agent and Advisers shall
be notified of such delivery and the Fund will issue and cause the delivery of
the Creation Unit. [Typically, Creation Units are issued on a “T+2 basis”
(i.e., two Business Days after trade date). However, the Fund reserves the
right to settle Creation Unit transactions on a basis other than T+2 if
necessary or appropriate under the circumstances.]
To
the extent contemplated by an Authorized Participant Agreement with
Distributors, the Fund will issue Creation Units to an Authorized Participant,
notwithstanding the fact that the corresponding Fund Deposits have not been
received in part or in whole, in reliance on the undertaking of the Authorized
Participant to deliver the missing Deposit Securities as soon as possible,
which undertaking shall be secured by such Authorized Participant’s delivery
and maintenance of collateral having a value at least equal to 105% and up to
115%, which percentage the Trust may change at any time, in its sole
discretion, of the value of the missing Deposit Securities in accordance with
the Fund’s then-effective procedures. The Trust may use such cash deposit at
any time to buy Deposit Securities for the Fund. The only collateral that is
acceptable to the Fund is cash in U.S. dollars. Such cash collateral must be
delivered no later than 1 p.m., Eastern time on the prescribed settlement date
or such other time as designated by the Fund’s custodian. Information
concerning the Fund’s current procedures for collateralization of missing
Deposit Securities is available from Distributors or its agent. The Authorized
Participant Agreement will permit the Fund to buy the missing Deposit
Securities at any time and will subject the Authorized Participant to liability
for any shortfall between the cost to the Fund of purchasing such securities
and the value of the cash collateral including, without limitation, liability
for related brokerage, borrowings and other charges.
In
certain cases, Authorized Participants may create and redeem Creation Units on
the same trade date and in these instances, the Fund reserves the right to
settle these transactions on a net basis or require a representation from the
Authorized Participants that the creation and redemption transactions are for
separate beneficial owners. All questions as to the number of shares of each
security in the Deposit Securities and the validity, form, eligibility and
acceptance for deposit of any securities to be delivered shall be determined by
the Fund and the Fund’s determination shall be final and binding.
Costs
associated with creation transactions. A standard creation transaction
fee is imposed to offset the transfer and other transaction costs associated
with the issuance of Creation Units. The standard creation transaction fee is
charged to the Authorized Participant on the day such Authorized Participant
creates a Creation Unit, and is the same, regardless of the number of Creation
Units purchased by the Authorized Participant on the applicable Business Day.
The Authorized Participant may also be required to cover certain brokerage,
tax, foreign exchange, execution, market impact and other costs and expenses
related to the execution of trades resulting from such transaction (up to the
maximum amount shown below). Authorized Participants will also bear the costs
of transferring the Deposit Securities to the Fund. Investors who use the
services of a broker or other financial intermediary to acquire Fund shares may
be charged a fee for such services.
The
following table sets forth the Fund’s standard creation transaction fees and
maximum additional charge (as described above):
Standard Creation Transaction Fee
|
Maximum
Additional Charge for Creations1
|
$[__]
|
[__]%
|
1. As
a percentage of the net asset value per Creation Unit.
Redemption
of Creation Units.
Shares of the Fund may be redeemed by Authorized Participants
only in Creation Units at their NAV next determined after receipt of a
redemption request in proper form by Distributors or its agent and only on a
Business Day. The Fund will not redeem shares in amounts less than Creation
Units. There can be no assurance, however, that there will be sufficient
liquidity in the secondary 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 Creation Unit
that could be redeemed by an Authorized Participant. Beneficial owners also may
sell shares in the secondary market. Currently, the Fund generally
redeems Creation Units solely for cash; however, the Fund reserves the right to
distribute securities in-kind as payment for Creation Units being redeemed.
Please see the Cash redemption method section below and the following
discussion summarizing the in-kind method for further information on redeeming
Creation Units of the Fund.
Advisers
makes available through the NSCC, prior to the opening of business on the
Listing Exchange on each Business Day, the designated portfolio of securities
(including any portion of such securities for which cash may be substituted)
that will be applicable (subject to possible amendment or correction) to
redemption requests received in proper form (as defined below) on that day
(Fund Securities), and an amount of cash as described below (Cash Amount) (if
any). Such Fund Securities and the corresponding Cash Amount (each subject to
possible amendment or correction) are applicable in order to effect redemptions
of Creation Units of the Fund until such time as the next announced composition
of the Fund Securities and Cash Amount is made available. Fund Securities
received on redemption may not be identical to Deposit Securities that are
applicable to creations of Creation Units under certain circumstances.
Unless
cash redemptions are available or specified for the Fund, the redemption
proceeds for a Creation Unit generally consist of Fund Securities, plus the
Cash Amount, which is an amount equal to the difference between the net asset
value of the shares being redeemed, as next determined after the receipt of a
redemption request in proper form, and the value of Fund Securities, less a
redemption transaction fee (as described below).
The
Fund may, in its sole discretion, substitute a “cash in lieu” amount to replace
any Fund Security that may not be eligible for transfer through DTC Facilities
or the NSCC Clearing Process or that the Authorized Participant is not able to
trade due to a trading restriction. The Fund also reserves the right to permit
or require a “cash in lieu” amount in certain circumstances, including
circumstances in which: (i) the delivery of a Fund Security to the Authorized
Participant would be restricted under applicable securities or other local
laws; (ii) the delivery of a Fund Security to the Authorized Participant would
result in the disposition of the Fund Security by the Authorized Participant
becoming restricted under applicable securities or other local laws; or (iii)
in certain other situations. The amount of cash paid out in such cases will be
equivalent to the value of the substituted security listed as a Fund Security.
In the event that the Fund Securities have a value greater than the NAV of the
shares, a compensating cash payment equal to the difference is required to be
made by or through an Authorized Participant by the redeeming shareholder.
Currently, the Fund generally redeems Creation Units solely for cash.
Cash
redemption method.
When partial or full cash redemptions of Creation Units are
available or specified for the Fund (currently, Creation Units of the Fund are
generally redeemed solely for cash), they will be effected in essentially the
same manner as in-kind redemptions thereof. In the case of partial or full cash
redemptions, the Authorized Participant receives the cash equivalent of the
Fund Securities it would otherwise receive through an in-kind redemption, plus
the same Cash Amount to be paid to an in-kind redeemer.
Costs
associated with redemption transactions. A standard redemption
transaction fee is imposed to offset transfer and other transaction costs that
may be incurred by the Fund. The standard redemption transaction fee is charged
to the Authorized Participant on the day such Authorized Participant redeems a
Creation Unit, and is the same regardless of the number of Creation Units redeemed
by an Authorized Participant on the applicable Business Day. The Authorized
Participant may also be required to cover certain brokerage, tax, foreign
exchange, execution, market impact and other costs and expenses related to the
execution of trades resulting from such transaction (up to the maximum amount
shown below). Authorized Participants will also bear the costs of transferring
the Fund Securities from the Fund to their account on their order. Investors
who use the services of a broker or other financial intermediary to dispose of
Fund shares may be charged a fee for such services.
The
following table sets forth the Fund’s standard redemption transaction fees and
maximum additional charge (as described above):
Standard Redemption Transaction Fee
|
Maximum
Additional Charge for Redemptions1
|
$[__]
|
2%
|
1. As
a percentage of the net asset value per Creation Unit, inclusive of the
standard redemption transaction fee.
Placement of redemption orders.
Redemption requests for Creation Units of the Fund must be submitted to
Distributors or its agent by or through an Authorized Participant. An
Authorized Participant must submit an irrevocable request to redeem shares of
the Fund, in proper form, generally before 4 p.m., Eastern time on any Business
Day, in order to receive that day’s NAV. On days when the Listing Exchange
closes earlier than normal, the Fund may require orders to redeem Creation
Units to be placed earlier that day. Investors, other than Authorized
Participants, are responsible for making arrangements for a redemption request
to be made through an Authorized Participant.
The
Authorized Participant must transmit the request for redemption in the form
required by the Fund to Distributors or its agent in accordance with procedures
set forth in the Authorized Participant Agreement and Authorized Participant
Handbook (as may be amended or supplemented from time to time). Investors
should be aware that their particular broker may not have executed an
Authorized Participant Agreement and that, therefore, requests to redeem
Creation Units may have to be placed by the investor’s broker through an
Authorized Participant who has executed an Authorized Participant Agreement. At
any time, only a limited number of broker-dealers will have an Authorized
Participant Agreement in effect. Investors making a redemption request should
be aware that such request must be in the form specified by such Authorized
Participant. Investors making a request to redeem Creation Units should allow
sufficient time to permit proper submission of the request by an Authorized
Participant and transfer of the shares to the Fund’s transfer agent; such
investors should allow for the additional time that may be required to effect redemptions
through their banks, brokers or other financial intermediaries if such
intermediaries are not Authorized Participants.
A
redemption request is considered to be in “proper form” if: (i) an Authorized
Participant has transferred or caused to be transferred to the Fund’s transfer
agent the Creation Unit redeemed through the book-entry system of DTC so as to
be effective by the Listing Exchange closing time on any Business Day; (ii) a
request in form satisfactory to the Fund is received by Distributors or its
agent from the Authorized Participant on behalf of itself or another redeeming
investor within the time periods specified above; and (iii) all other
procedures set forth in the Authorized Participant Agreement are properly
followed. If the transfer agent does not receive the investor’s shares through
DTC Facilities by 10 a.m., Eastern time on the prescribed settlement date, the
redemption request may be deemed rejected. Investors should be aware that the
deadline for such transfers of shares through the DTC Facilities may be
significantly earlier than the close of business on the Listing Exchange. Those
making redemption requests should ascertain the deadline applicable to
transfers of shares through the DTC Facilities by contacting the operations department
of the broker or depositary institution effecting the transfer of the shares.
Upon
receiving a redemption request, Distributors or its agent shall notify the Fund
and the Fund’s transfer agent of such redemption request. The tender of an
investor’s shares for redemption and the distribution of the securities and/or
cash included in the redemption payment made in respect of Creation Units
redeemed will be made through DTC and the relevant Authorized Participant to
the Beneficial Owner thereof as recorded on the book-entry system of DTC or the
DTC Participant through which such investor holds, as the case may be, or by
such other means specified by the Authorized Participant submitting the
redemption request.
A
redeeming Beneficial Owner or Authorized Participant acting on behalf of such
Beneficial Owner must maintain appropriate security arrangements with a
qualified broker-dealer, bank or other custody providers in each jurisdiction
in which any of the portfolio securities are customarily traded, to which
account such portfolio securities will be delivered.
[Deliveries
of redemption proceeds by the Fund generally will be made within two Business
Days (i.e., “T+2”). The Fund reserves the right to settle redemption
transactions later than T+2] but by T+7 if necessary or appropriate under the
circumstances and compliant with applicable law. Delayed settlement may occur
due to a number of different reasons, including, without limitation, settlement
cycles for the underlying securities, unscheduled market closings, an effort to
link distribution to dividend record dates and ex-dates and newly announced
holidays. For example, the redemption settlement process may be extended beyond
T+2 because of the occurrence of a holiday in a non-U.S. market or in the U.S.
bond market that is not a holiday observed in the U.S. equity market.
If
neither the redeeming Beneficial Owner nor the Authorized Participant acting on
behalf of such redeeming Beneficial Owner has appropriate arrangements to take
delivery of Fund Securities in the applicable non-U.S. jurisdiction and it is
not possible to make other such arrangements, or if it is not possible to
effect deliveries of Fund Securities in such jurisdiction, the Fund may in its
discretion exercise its option to redeem such shares in cash, and the redeeming
Beneficial Owner will be required to receive its redemption proceeds in cash.
In such case, the investor will receive a cash payment equal to the net asset
value of its shares based on the NAV of the Fund next determined after the
redemption request is received in proper form (minus a redemption transaction
fee and additional charges specified above, to offset the Fund’s brokerage and
other transaction costs associated with the
disposition of Fund Securities). Redemptions of shares for Fund Securities will
be subject to compliance with applicable U.S. federal and state securities laws
and the Fund (whether or not it otherwise permits cash redemptions) reserves
the right to redeem Creation Units for cash to the extent that the Fund cannot
lawfully deliver specific Fund Securities upon redemptions or cannot do so
without first registering the Fund Securities under such laws.
In
the event that cash redemptions are permitted or required by the Trust
(currently, Creation Units of the Fund are generally redeemed solely for cash),
proceeds will be paid to the Authorized Participant redeeming shares as soon as
practicable after the date of redemption (within seven calendar days
thereafter).
To
the extent contemplated by an Authorized Participant Agreement with
Distributors, in the event an 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, at or prior to 10 a.m., Eastern time on the
prescribed settlement date, Distributors or its agent will 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, in U.S. dollars in immediately available funds, having a
value at least equal to 105% and up to 115%, which percentage the Trust may
change at any time, in its sole discretion, of the value of the missing shares.
Such cash collateral must be delivered no later than 10 a.m., Eastern time on
the prescribed settlement date and shall be held by the Fund’s custodian and
marked-to-market daily. The fees of the Fund’s 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
Agreement will permit the Fund to purchase missing Fund shares or acquire the
Deposit Securities and the Cash Amount underlying such shares, and will subject
the Authorized Participant to liability for any shortfall between the cost of
the Fund acquiring such shares, the Deposit Securities or Cash Amount and the
value of the cash collateral including, without limitation, liability for
related brokerage and other charges.
Because
the portfolio securities of the Fund may trade on exchange(s) on days that the
Listing Exchange is closed or are otherwise not Business Days for the Fund,
shareholders may not be able to redeem their shares of the Fund, or purchase or
sell shares of the Fund on the Listing Exchange on days when the NAV of the
Fund could be significantly affected by events in the relevant non-U.S.
markets.
The
right of redemption may be suspended or the date of payment postponed with
respect to the Fund: (i) for any period during which the Listing Exchange is
closed (other than customary weekend and holiday closings); (ii) for any period
during which trading on the Listing Exchange is restricted; (iii) for any
period during which an emergency exists as a result of which disposal of the
shares of the Fund’s portfolio securities or determination of its net asset
value is not reasonably practicable; or (iv) in such other circumstances as is
permitted by the SEC.
Franklin
Templeton Distributors, Inc. (Distributors) acts as the principal underwriter
in the continuous public offering of the Fund's shares. Distributors is located
at One Franklin Parkway, San Mateo, CA 94403-1906.
Shares
are continuously offered for sale by the Fund through Distributors or its agent
only in Creation Units, as described in the prospectus and above in the
“Creation and Redemption of Creation Units” section of this SAI. Fund shares in
amounts less than Creation Units are generally not distributed by Distributors
or its agent. Distributors or its agent will arrange for the delivery of the
prospectus and, upon request, this SAI to persons purchasing Creation Units and
will maintain records of both orders placed with it or its agents and
confirmations of acceptance furnished by it or its agents.
Distributors
may enter into agreements with securities dealers (Soliciting Dealers) who will
solicit purchases of Creation Units of Fund shares. Such Soliciting Dealers may
also be Authorized Participants, DTC participants and/or investor services
organizations.
Distributors
may be entitled to payments from the Fund under the Rule 12b-1 plan, as
discussed below. Except as noted, Distributors received no other compensation
from the Fund for acting as underwriter.
Distribution
and service (12b-1) fees The board has adopted a plan pursuant to
Rule 12b-1 for the Fund. However, no Rule 12b-1 plan fee is currently charged
to the Fund, and there are no plans in place to impose a Rule 12b-1 plan fee.
The plan is designed to benefit the Fund and its
shareholders. The plan is expected to, among other things, increase advertising
of the Fund, encourage purchases of Fund shares and service to its
shareholders, and increase or maintain assets of the Fund so that certain fixed
expenses may be spread over a broader asset base, with a positive impact on per
share expense ratios. In addition, a positive cash flow into the Fund is useful
in managing the Fund because the investment manager has more flexibility in
taking advantage of new investment opportunities and handling shareholder
redemptions.
Under
the plan, the Fund pays Distributors or others for the expenses of activities
that are primarily intended to sell shares of the Fund. These expenses also may
include service fees paid to securities dealers or others who have executed a
servicing agreement with the Fund, Distributors or its affiliates and who
provide service or account maintenance to shareholders (service fees); and the
expenses of printing prospectuses and reports used for sales purposes, of
marketing support and of preparing and distributing sales literature and
advertisements. Together, these expenses, including the service fees, are
"eligible expenses." The 12b-1 fees charged to the Fund are based
only on the fees attributable to that particular Fund and are calculated, as a
percentage of such Fund's net assets, over the 12-month period of February 1
through January 31. Because this 12-month period may not match the Fund’s
fiscal year, the amount, as a percentage of the Fund's net assets, for the
Fund’s fiscal year may vary from the amount stated under the plan, but will
never exceed that amount during the 12-month period of February 1 through
January 31.
In
addition to the payments that Distributors or others are entitled to under the
plan, the plan also provides that to the extent the Fund, the investment
manager or Distributors or other parties on behalf of the Fund, the investment
manager or Distributors make payments that are deemed to be for the financing
of any activity primarily intended to result in the sale of Fund shares within
the context of Rule 12b-1 under the 1940 Act, then such payments shall be
deemed to have been made pursuant to the plan.
To
the extent fees are for distribution or marketing functions, as distinguished
from administrative servicing or agency transactions, certain banks may not
participate in the plan because of applicable federal law prohibiting certain
banks from engaging in the distribution of fund shares. These banks, however,
are allowed to receive fees under the plan for administrative servicing or for
agency transactions.
Distributors
must provide written reports to the board at least quarterly on the amounts and
purpose of any payment made under the plan and any related agreements, and
furnish the board with such other information as the board may reasonably
request to enable it to make an informed determination of whether the plan
should be continued.
The
plan has been approved according to the provisions of Rule 12b-1. The terms and
provisions of the plan also are consistent with Rule 12b-1.
Miscellaneous Information
The
Fund may help you achieve various investment goals such as accumulating money
for retirement, saving for a down payment on a home, college costs and other
long-term goals. The Franklin College Savings Planner may help you in
determining how much money must be invested on a monthly basis to have a
projected amount available in the future to fund a child's college education.
(Projected college cost estimates are based upon current costs published by the
College Board.) The Franklin Retirement Savings Planner leads you through the
steps to start a retirement savings program. Of course, an investment in the
Fund cannot guarantee that these goals will be met.
The
Fund is a member of Franklin Templeton, one of the largest fund organizations
in the U.S., and may be considered in a program for diversification of assets.
Founded in 1947, Franklin is one of the oldest fund organizations and now
services more than [2] million shareholder accounts. In 1992, Franklin, a
leader in managing fixed-income funds and an innovator in creating domestic
equity funds, joined forces with Templeton, a pioneer in international investing.
The Mutual Series team, known for its value-driven approach to domestic equity
investing, became part of the organization four years later. In 2001, the
Fiduciary Trust team, known for providing global investment management to
institutions and high net worth clients worldwide, joined the organization.
Together, Franklin Templeton has, as of [___], over $[___] billion in assets
under management for more than [3] million U.S. based fund shareholder and
other accounts. Franklin Templeton offers [___] U.S. based open-end investment
companies to the public. The Fund may identify itself by its Exchange ticker
symbol or CUSIP number.
Corporate Obligation Ratings
Moody's
INVESTMENT
GRADE
Aaa:
Bonds rated Aaa are judged to be of the highest quality, with minimal credit
risk.
Aa:
Bonds rated Aa are judged to be high quality and are subject to very low credit
risk.
A:
Bonds rated A are considered upper medium-grade obligations and are subject to
low credit risk.
Baa:
Bonds rated Baa are subject to moderate credit risk and are considered
medium-grade obligations. As such they may have certain speculative
characteristics.
BELOW
INVESTMENT GRADE
Ba:
Bonds rated Ba are judged to have speculative elements and are subject to
substantial credit risk.
B:
Bonds rated B are considered speculative and are subject to high credit risk.
Caa:
Bonds rated Caa are judged to be of poor standing and are subject to very high
credit risk.
Ca:
Bonds rated Ca are considered highly speculative and are likely in, or very
near, default, with some prospect of recovery of principal and interest.
C:
Bonds rated C are the lowest rated class of bonds and are typically in default.
They have little prospects 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; modifier 2
indicates a mid-range ranking; and modifier 3 indicates a ranking in the lower
end of that generic rating category.
S&P®
The
issue rating definitions are expressions in terms of default risk. As such,
they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy. (Such differentiation applies when an entity has both senior and
subordinated obligations, secured and unsecured obligations, or operating
company and holding company obligations.) Accordingly, in the case of junior
debt, the rating may not conform exactly with the category definition.
INVESTMENT
GRADE
AAA:
This is the highest rating assigned by S&P to a debt obligation. The
obligor's capacity to meet its financial commitment on the obligation is extremely
strong.
AA:
Obligations rated AA differ from AAA issues only in a small degree. The
obligor's capacity to meet its financial commitment on the obligation is very
strong.
A:
Obligations rated A are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions than obligations in the higher ratings
categories. However, the obligor's capacity to meet its financial commitment on
the obligation is still strong.
BBB: Obligations rated BBB exhibit 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.
BELOW
INVESTMENT GRADE
BB,
B, CCC, CC, C: Obligations rated BB, B, CCC, CC and C are regarded as having
significant speculative characteristics. BB indicates the least degree of
speculation and C the highest degree of speculation. While these obligations
will likely have some quality and protective characteristics, these may be
outweighed by large uncertainties or major exposures 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 commitment on the obligation.
B:
An obligation rated B is more vulnerable to nonpayment than obligations rated
BB, but the obligor currently has the capacity to meet its financial commitment
on the obligation. Adverse business, financial, or economic conditions will
likely impair the obligor's capacity or willingness to meet its financial
commitment on the obligation.
CCC:
An obligation rated CCC is currently vulnerable to nonpayment, and is dependent
upon favorable business, financial, and economic conditions for the obligor to
meet its financial commitment on the obligation. In the event of adverse
business, financial, or economic conditions, the obligor is not likely to have
the capacity to meet its financial commitment on the obligation.
CC:
An obligation rated CC is currently highly vulnerable to nonpayment.
C:
A subordinated debt or preferred stock obligation rated C is currently highly
vulnerable to nonpayment. The C rating may be used to cover a situation where a
bankruptcy petition has been filed or similar action taken, but payments on
this obligation are being continued. The C rating is also assigned to a
preferred stock issue in arrears on dividends or sinking fund payments, but
that is still making payments.
D:
Obligations rated D are in payment default. The D rating category is used when
payments on an obligation are not made on the date due even if the applicable
grace period has not expired, unless S&P believes that such payments will
be made during such grace period. The D rating is also used upon the filing of
a bankruptcy petition or the taking of a similar action if payments on an
obligation are jeopardized.
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.
r:
This symbol is attached to the ratings of instruments with significant
noncredit risks and highlights risks to principal or volatility of expected
returns that are not addressed in the credit rating.
Short-Term
Debt Ratings
Moody's
Moody's
short-term debt ratings are opinions of the ability of issuers to honor
short-term financial obligations. Ratings may be assigned to issuers,
short-term programs and to individual short-term debt instruments. These
obligations generally have an original maturity not exceeding 13 months, unless
explicitly noted. Moody's employs the following designations to indicate the
relative repayment capacity of rated issuers:
P-1
(Prime-1): Issuers (or supporting institutions) so rated have a superior
ability to repay short-term debt obligations.
P-2
(Prime-2): Issuers (or supporting institutions) so rated have a strong ability
to repay short-term debt obligations.
P-3
(Prime-3): Issuers (or supporting institutions) so rated have an acceptable
ability to repay short-term debt obligations.
NP: Issuers (or supporting institutions) rated
Not Prime do not fall within any of the Prime rating categories.
S&P®
S&P's
ratings are a current opinion of the creditworthiness of an obligor with
respect to a specific financial obligation, a specific class of financial
obligations, or a specific financial program. Short-term ratings are generally
assigned to those obligations considered short-term in the relevant market. In
the U.S., for example, that means obligations with an original maturity of no
more than 365 days -- including commercial paper. Short-term ratings are also
used to indicate the creditworthiness of an obligor with respect to put
features on long-term obligations. The result is a dual rating, in which the
short-term rating addresses the put feature, in addition to the usual long-term
rating.
A-1:
This designation indicates that 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:
Issues carrying this designation are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations
carrying the higher designations. However, the obligor's capacity to meet its financial
commitments on the obligation is satisfactory.
A-3:
Issues carrying this designation exhibit 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:
Issues carrying this designation are 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:
Issues carrying this designation are currently vulnerable to nonpayment and are
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation.
D:
Issues carrying this designation are in payment default. The D rating category
is used when payments on an obligation are not made on the due date even if the
applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The D rating also will be used
upon the filing of a bankruptcy petition or the taking of a similar action if
payments on an obligation are jeopardized.
FRANKLIN TEMPLETON ETF TRUST
FILE NOS. 333-208873 & 811-23124
PART C
Other Information
Item 28. Exhibits.
The following exhibits are
incorporated by reference to the previously filed documents indicated below,
except as noted:
(a)
|
Agreement and Declaration
of Trust
|
|
|
(i)
|
|
Amended
and Restated Agreement and Declaration of Trust dated October 19, 2018
Filing:
Post-Effective Amendment No. 42 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: June 14, 2019
|
|
|
|
(b)
|
By-Laws
|
|
|
(i)
|
|
Amended
and Restated By-Laws effective as of October 19, 2018
Filing:
Post-Effective Amendment No. 42 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: June 14, 2019
|
|
|
|
(c)
|
Instruments Defining Rights
of Security Holders
|
|
|
(i)
|
|
Agreement and Declaration of Trust
|
|
|
(a) Article III, Shares
(b) Article V, Shareholders’ Voting Powers and
Meetings
(c) Article VI, Net Asset Value; Distributions;
Redemptions; Transfers
(d) Article VIII, Certain Transactions: Section 4
(e) Article X, Miscellaneous: Section 4
|
|
|
|
(ii)
|
|
By-Laws
|
|
|
(a)
Article II, Meetings of Shareholders
(b)
Article VI, Records and Reports: Section 1, 2 and 3
(c)
Article VII, General Matters: Section 3, 4, 6 and 7
(d)
Article VIII, Amendments: Section 1
|
|
|
|
(iii)
|
|
Part
B, Statement of Additional Information – Item 22
|
|
|
|
(d)
|
Investment Advisory
Contracts
|
|
|
(i)
|
|
Amended
and Restated Investment Management Agreement between Registrant, on behalf of
Franklin LibertyQ International Equity Hedged ETF, and Franklin Advisers,
Inc. dated December 1, 2017
Filing:
Post-Effective Amendment No. 37 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 27, 2018
|
|
|
|
(ii)
|
|
Amended
and Restated Investment Management Agreement between Registrant, on behalf of
Franklin LibertyQ Emerging Markets ETF, and Franklin Advisers, Inc. dated
December 1, 2017
Filing:
Post-Effective Amendment No. 37 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 27, 2018
|
|
|
|
(iii)
|
|
Amended
and Restated Investment Management Agreement between Registrant, on behalf of
Franklin LibertyQ Global Dividend ETF, and Franklin Advisers, Inc. dated
December 1, 2017
Filing:
Post-Effective Amendment No. 37 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 27, 2018
|
|
|
|
(iv)
|
|
Amended
and Restated Investment Management Agreement between Registrant, on behalf of
Franklin LibertyQ Global Equity ETF, and Franklin Advisers, Inc. dated
December 1, 2017
Filing:
Post-Effective Amendment No. 37 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 27, 2018
|
|
|
|
(v)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty U.S.
Low Volatility ETF and Franklin Advisers, Inc. dated April 18, 2016
Filing:
Post-Effective Amendment No. 5 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 15, 2016
|
|
|
|
(vi)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty
Investment Grade Corporate ETF and Franklin Advisers, Inc. dated April 18, 2016
Filing:
Post-Effective Amendment No. 5 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 15, 2016
|
|
|
|
(vii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty
International Opportunities ETF and Franklin Advisers, Inc. dated April 18,
2016
Filing:
Post-Effective Amendment No. 10 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: January 11, 2017
|
|
|
|
(viii)
|
|
Amended
and Restated Investment Management Agreement between Registrant, on behalf of
Franklin LibertyQ U.S. Equity ETF and Franklin Advisers, Inc. dated December
1, 2017
Filing:
Post-Effective Amendment No. 37 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 27, 2018
|
|
|
|
(ix)
|
|
Amended
and Restated Investment Management Agreement between Registrant,
on behalf of Franklin LibertyQ U.S. Mid Cap Equity ETF and Franklin Advisers,
Inc. dated December 1, 2017
Filing:
Post-Effective Amendment No. 37 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 27, 2018
|
|
|
|
(x)
|
|
Amended
and Restated Investment Management Agreement between Registrant, on behalf of
Franklin LibertyQ U.S. Small Cap Equity ETF and Franklin Advisers, Inc. dated
December 1, 2017
Filing:
Post-Effective Amendment No. 37 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 27, 2018
|
|
|
|
(xi)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty Intermediate
Municipal Opportunities ETF and Franklin Advisers, Inc. dated April 1, 2017
Filing:
Post-Effective Amendment No. 23 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: August 30, 2017
|
|
|
|
(xii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty
Municipal Bond ETF and Franklin Advisers, Inc. dated April 1, 2017
Filing:
Post-Effective Amendment No. 23 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: August 30, 2017
|
|
|
|
(xiii)
|
|
Sub-Advisory
Agreement on behalf of Franklin Liberty Investment Grade Corporate ETF
between Franklin Advisers, Inc. and Franklin Templeton Institutional, LLC
dated April 18, 2016
Filing:
Post-Effective Amendment No. 5 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 15, 2016
|
|
|
|
(xiv)
|
|
Sub-Advisory
Agreement on behalf of Franklin Liberty
International
Opportunities ETF between Franklin Advisers, Inc. and Franklin Templeton
Investimentos (Brasil) Ltda. dated January 25, 2017
Filing:
Post-Effective Amendment No. 15 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: April 21, 2017
|
|
|
|
(xv)
|
|
Sub-Advisory
Agreement on behalf of Franklin Liberty
International
Opportunities ETF between Franklin Advisers, Inc. and Franklin Templeton
Investments Corp. dated January 25, 2017
Filing:
Post-Effective Amendment No. 23 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: August 30, 2017
|
|
|
|
(xvi)
|
|
Sub-Advisory
Agreement on behalf of Franklin Liberty
International
Opportunities ETF between Franklin Advisers, Inc. and Franklin Templeton
Investment Management Limited dated January 25, 2017
Filing:
Post-Effective Amendment No. 23 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: August 30, 2017
|
|
|
|
(xvii)
|
|
Sub-Advisory
Agreement on behalf of Franklin Liberty
International
Opportunities ETF between Franklin Advisers, Inc. and Franklin Templeton
Investments (ME) Limited dated January 25, 2017
Filing:
Post-Effective Amendment No. 23 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: August 30, 2017
|
|
|
|
(xviii)
|
|
Sub-Advisory
Agreement on behalf of Franklin Liberty
International
Opportunities ETF between Franklin Advisers, Inc. and Franklin Templeton
Investment Trust Management Co., Ltd. dated January 25, 2017
Filing:
Post-Effective Amendment No. 23 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: August 30, 2017
|
|
|
|
(xix)
|
|
Sub-Advisory
Agreement on behalf of Franklin Liberty
International
Opportunities ETF between Franklin Advisers, Inc. and Templeton Asset
Management Ltd. dated January 25, 2017 with Amended Schedule A dated March 1,
2019
Filing:
Post-Effective Amendment No. 43 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 26, 2019
|
|
|
|
(xx)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Asia ex
Japan ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxi)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Australia
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Russia
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement
on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxiii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Taiwan
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxiv)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Brazil
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxv)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE China ETF
and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxvi)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE India ETF
and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxvii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Japan ETF
and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxviii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Mexico
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxix)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE South
Korea ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxx)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE
Switzerland ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxxi)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE United
Kingdom ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxxii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Canada
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxxiii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Europe
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxxiv)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE France ETF
and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxxv)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Germany
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxxvi)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Hong Kong
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing Date: October 30, 2017
|
|
|
|
(xxxvii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Italy ETF
and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xxxviii)
|
|
Investment Management Agreement between Registrant,
on behalf of Franklin FTSE Europe Hedged ETF and Franklin Advisers, Inc. dated
September 7, 2017
Filing: Post-Effective Amendment No. 25 to
Registration Statement on Form N-1A
File No. 333-208873
Filing Date: October 30, 2017
|
|
|
|
(xxxix)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Japan Hedged
ETF and Franklin Advisers, Inc. dated September 7, 2017
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(xl)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty High
Yield Corporate ETF and Franklin Advisers, Inc. dated May 30, 2018
Filing: Post-Effective Amendment No. 28 to
Registration Statement on Form N-1A
File No. 333-208873
Filing
Date: May 23, 2018
|
|
|
|
(xli)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty
International Aggregate Bond ETF and Franklin Templeton Investment Management
Limited dated May 30, 2018
Filing: Post-Effective Amendment No. 28 to
Registration Statement on Form N-1A
File No. 333-208873
Filing
Date: May 23, 2018
|
|
|
|
(xlii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty Senior
Loan ETF and Franklin Advisers, Inc. dated May 30, 2018
Filing: Post-Effective Amendment No. 28 to
Registration Statement on Form N-1A
File No. 333-208873
Filing
Date: May 23, 2018
|
|
|
|
(xliii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Saudi
Arabia ETF and Franklin Advisers, Inc. dated September 25, 2018
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing Date: September 7, 2018
|
|
|
|
(xliv)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE South
Africa ETF and Franklin Advisers, Inc. dated September 25, 2018
Filing:
Post-Effective Amendment No. 40 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(xlv)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin FTSE Latin
America ETF and Franklin Advisers, Inc. dated September 25, 2018
Filing:
Post-Effective Amendment No. 41 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(xlvi)
|
|
Sub-Advisory
Agreement on behalf of Franklin Liberty International Aggregate Bond ETF
between Franklin Templeton Investment Management Limited and Franklin Advisers,
Inc. dated March 1, 2019
Filing:
Post-Effective Amendment No. 43 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 26, 2019
|
|
|
|
(xlvii)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty U.S.
Core Bond ETF and Franklin Advisers, Inc. effective September 17, 2019
Filing:
Post-Effective Amendment No. 47 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 9, 2019
|
|
|
|
(xlviii)
|
|
Amendment
dated October 1, 2019 to Investment Management Agreement between Registrant,
on behalf of Franklin Liberty U.S. Low Volatility ETF and Franklin Advisers,
Inc.
Filing:
Post-Effective Amendment No. 47 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 9, 2019
|
|
|
|
(xlix)
|
|
Amendment
dated August 1, 2019 to Amended and Restated Investment Management Agreement
between Registrant, on behalf of Franklin LibertyQ Emerging Markets ETF and Franklin
Advisory Services, LLC
Filing:
Post-Effective Amendment No. 47 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 9, 2019
|
|
|
|
(l)
|
|
Amendment
dated August 1, 2019 to Amended and Restated Investment Management Agreement
between Registrant, on behalf of Franklin LibertyQ U.S. Equity ETF and Franklin
Advisory Services, LLC
Filing:
Post-Effective Amendment No. 47 to Registration Statement
on Form N-1A
File
No. 333-208873
Filing
Date: September 9, 2019
|
|
|
|
(li)
|
|
Investment
Management Agreement between Registrant, on behalf of Franklin Liberty Systemic
Prima ETF and Franklin Advisers, Inc. effective December 18, 2019
Filing:
Post-Effective Amendment No. 52 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: December 6, 2019
|
|
|
|
(e)
|
Underwriting Contracts
|
|
|
(i)
|
|
Distribution
Agreement, between the Registrant and Franklin Templeton Distributors, Inc.
dated April 18, 2016 with an Amended Exhibit A dated September 6, 2018
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(ii)
|
|
Form
of Authorized Participant Agreement
Filing:
Pre-Effective Amendment No. 3 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: May 17, 2016
|
|
|
|
(f)
|
Bonus or Profit Sharing Contracts
|
|
|
|
|
Not Applicable
|
|
|
|
(g)
|
Custodian Agreements
|
|
|
(i)
|
|
Master
Custodian Agreement between Registrant and State Street Bank and Trust
Company dated April 18, 2016
Filing:
Pre-Effective Amendment No. 3 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: May 17, 2016
|
|
|
|
(ii)
|
|
Amended
Appendix A dated July 26, 2018 to the Master Custodian Agreement between Registrant
and State Street Bank and Trust Company dated April 18, 2016
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(iii)
|
|
Amendment
to State Street Fund Connect Agreement dated April 16, 2016, as amended September
13, 2018
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(h)
|
Other Material Contracts
|
|
|
(i)
|
|
Sub-Contract
for Fund Administrative Services between Franklin Advisers, Inc. and Franklin
Templeton Services, LLC dated February 1, 2019
Filing:
Post-Effective Amendment No. 43 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 26, 2019
|
|
|
|
(ii)
|
|
Sub-Contract
for Administration and Fund Accounting Services between State Street Bank and
Trust Company and Franklin Templeton Services, LLC dated April 18, 2016 with
an Amended Schedule A dated September 6, 2018
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(iii)
|
|
Amendment
to Sub-Contract for Administration and Fund Accounting Services between State
Street Bank and Trust Company and Franklin Templeton Services, LLC dated
April 18, 2016 and Amended as of December 29, 2017
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(iv)
|
|
Amendment
to Sub-Contract for Administration and Fund Accounting Services between State
Street Bank and Trust Company and Franklin Templeton Services, LLC dated
April 18, 2016 and Amended as of December 29, 2017 with an Amended Annex 1
dated August 21, 2018
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(v)
|
|
Transfer
Agency and Service Agreement between Registrant and State Street Bank and
Trust Company dated April 18, 2016 with an Amended Schedule A dated September
6, 2018
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(vi)
|
|
Index
Sub-License Agreement between Registrant and Franklin Templeton Companies,
LLC dated April 18, 2016
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(vii)
|
|
Index
Sub-License Agreement between Registrant and Franklin Templeton Companies, LLC
dated February 16, 2017
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing Date: September 7, 2018
|
|
|
|
(viii)
|
|
Index
Sub-License Agreement between Registrant and Franklin Templeton Companies, LLC
dated August 29, 2017 with revised Exhibit A as of September 1, 2018
Filing:
Post-Effective Amendment No. 43 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 26, 2019
|
|
|
|
(ix)
|
|
Sub-Contract
for Fund Administrative Services between Franklin Templeton Investment
Management Limited and Franklin Templeton Services, LLC dated February 1, 2019
Filing:
Post-Effective Amendment No. 43 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 26, 2019
|
|
|
|
(x)
|
|
Sub-Contract
for Fund Administrative Services between Franklin Advisory Services, LLC and
Franklin Templeton Services, LLC dated February 1, 2019
Filing:
Post-Effective Amendment No. 43 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 26, 2019
|
|
|
|
(xi)
|
|
Form
of Sub-Contract for Fund Administrative Services between Franklin Advisers,
Inc. and Franklin Templeton Services, LLC dated September 17, 2019 on behalf
of Franklin Liberty Core U.S. Bond ETF
Filing:
Post-Effective Amendment No. 47 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 9, 2019
|
|
|
|
(i)
|
Legal Opinion
|
|
|
(i)
|
|
Opinion
and Consent of Counsel dated May 13, 2016 with respect to Franklin LibertyQ
International Equity Hedged ETF, Franklin LibertyQ Emerging Markets ETF,
Franklin LibertyQ Global Dividend ETF and Franklin LibertyQ Global Equity ETF
Filing:
Pre-Effective Amendment No. 3 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: May 17, 2016
|
|
|
|
(ii)
|
|
Opinion
and Consent of Counsel dated September 14, 2016 with respect to Franklin Liberty U.S. Low Volatility
ETF and Franklin Liberty Investment Grade Corporate ETF
Filing:
Post-Effective Amendment No. 5 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 15, 2016
|
|
|
|
(iii)
|
|
Opinion
and Consent of Counsel dated January 11, 2017 with respect to Franklin Liberty International Opportunities ETF
Filing:
Post-Effective Amendment No. 10 to Registration Statement
on Form N-1A
File
No. 333-208873
Filing
Date: January 11, 2017
|
|
|
|
(iv)
|
|
Opinion
and Consent of Counsel dated April 21, 2017 with respect to Franklin LibertyQ U.S. Equity ETF, Franklin LibertyQ
U.S. Mid Cap Equity ETF and Franklin LibertyQ U.S. Small Cap Equity ETF
Filing:
Post-Effective Amendment No. 15 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: April 21, 2017
|
|
|
|
(v)
|
|
Opinion
and Consent of Counsel dated August 30, 2017 with respect to Franklin Liberty Intermediate Municipal Opportunities
ETF and Franklin Liberty Municipal Bond ETF
Filing:
Post-Effective Amendment No. 23 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: August 30, 2017
|
|
|
|
(vi)
|
|
Opinion
and Consent of Counsel dated October 30, 2017 with respect to FTSE Australia ETF, Franklin FTSE Brazil ETF, Franklin
FTSE Canada ETF, Franklin FTSE China ETF, Franklin FTSE France ETF, Franklin
FTSE Germany ETF, Franklin FTSE Hong Kong ETF, Franklin FTSE India ETF, Franklin
FTSE Italy ETF, Franklin FTSE Japan ETF, Franklin FTSE Mexico ETF, Franklin
FTSE Russia ETF, Franklin FTSE South Korea ETF, Franklin FTSE Switzerland
ETF, Franklin FTSE Taiwan ETF, Franklin FTSE United Kingdom ETF, Franklin
FTSE Asia ex Japan ETF, Franklin FTSE Europe ETF, Franklin FTSE Europe Hedged
ETF, and Franklin FTSE Japan Hedged ETF
Filing:
Post-Effective Amendment No. 25 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: October 30, 2017
|
|
|
|
(vii)
|
|
Opinion
and Consent of Counsel dated May 23, 2018 with
respect to Franklin Liberty High Yield Corporate ETF, Franklin Liberty
International Aggregate Bond ETF and Franklin Liberty Senior Loan ETF
Filing:
Post-Effective Amendment No. 28 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: May 23, 2018
|
|
|
|
(viii)
|
|
Opinion
and Consent of Counsel dated September 7, 2018 with respect to Franklin FTSE
Saudi Arabia ETF
Filing:
Post-Effective Amendment No. 39 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(ix)
|
|
Opinion
and Consent of Counsel dated September 7, 2018 with respect to Franklin FTSE
South Africa ETF
Filing:
Post-Effective Amendment No. 40 to Registration Statement on Form N-1A
File No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(x)
|
|
Opinion
and Consent of Counsel dated September 7, 2018 with respect to Franklin FTSE Latin
America ETF
Filing:
Post-Effective Amendment No. 41 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 7, 2018
|
|
|
|
(xi)
|
|
Opinion
and Consent of Counsel dated September 9, 2019 with respect to Franklin Liberty
U.S. Core Bond ETF
|
|
|
Filing:
Post-Effective Amendment No. 52 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: December 6, 2019
|
|
|
|
(xii)
|
|
Opinion
and Consent of Counsel dated December 6, 2019 with respect to Franklin Liberty
Systematic Style Premia ETF
|
|
|
Filing:
Post-Effective Amendment No. 52 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: December 6, 2019
|
|
|
(j)
|
Other Opinions
|
|
|
|
|
Not Applicable
|
|
|
|
(k)
|
Omitted Financial
Statements
|
|
|
|
|
Not Applicable
|
|
|
|
(l)
|
Initial Capital Agreements
|
|
|
|
|
Not Applicable
|
|
|
|
(m)
|
Rule 12b-1 Plan
|
|
|
(i)
|
|
Distribution
Plan pursuant to Rule 12b-1 dated April 18, 2016 with an Amended Exhibit A dated
September 6, 2019
Filing:
Post-Effective Amendment No. 47 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: September 9, 2019
|
|
|
|
(n)
|
Rule 18f-3 Plan
|
|
|
|
|
Not Applicable
|
|
|
|
(p)
|
Code of Ethics
|
|
|
(i)
|
|
Code
of Ethics dated December 31, 2018
Filing:
Post-Effective Amendment No. 42 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: June 14, 2019
|
|
|
|
(q)
|
Power of Attorney
|
|
|
(i)
|
|
Power
of Attorney dated April 18, 2016
Filing:
Pre-Effective Amendment No. 2 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: April 22, 2016
|
|
|
|
(ii)
|
|
Power
of Attorney dated May 23, 2017 for Matthew T. Hinkle
Filing:
Post-Effective Amendment No. 18 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 3, 2017
|
|
|
|
(iii)
|
|
Power
of Attorney dated July 5, 2019 for Vivek Pai
Filing:
Post-Effective Amendment No. 43 to Registration Statement on Form N-1A
File
No. 333-208873
Filing
Date: July 26, 2019
|
|
|
|
|
Item 29. Persons
Controlled by or Under Common Control with the Registrant
None
Item 30. Indemnification
The Agreement and Declaration
of Trust (the “Declaration”) provides that any person who is or was a Trustee,
officer, employee or other agent, including the underwriter, of such Trust shall
be liable to the Trust and its shareholders only for (1) any act or omission that
constitutes a bad faith violation of the implied contractual covenant of good
faith and fair dealing, or (2) the person’s own willful misfeasance, bad faith,
gross negligence or reckless disregard of the duties involved in the conduct of
such person (such conduct referred to herein as Disqualifying Conduct) and for
nothing else. Except in these instances and to the fullest extent that
limitations of liability of agents are permitted by the Delaware Statutory
Trust Act (the “Delaware Act”), these Agents (as defined in the Declaration)
shall not be responsible or liable for any act or omission of any other Agent
of the Trust or any investment adviser or principal underwriter. Moreover,
except and to the extent provided in these instances, none of these Agents,
when acting in their respective capacity as such, shall be personally liable to
any other person, other than such Trust or its shareholders, for any act,
omission or obligation of the Trust or any trustee thereof.
The Trust shall indemnify,
out of its property, to the fullest extent permitted under applicable law, any
of the persons who was or is a party, or is threatened to be made a party to
any Proceeding (as defined in the Declaration) because the person is or was an
Agent of such Trust. These persons shall be indemnified against any Expenses
(as defined in the Declaration), judgments, fines, settlements and other amounts
actually and reasonably incurred in connection with the Proceeding if the
person acted in good faith or, in the case of a criminal proceeding, had no reasonable
cause to believe that the conduct was unlawful. The termination of any Proceeding
by judgment, order, settlement, conviction or plea of nolo contendere or its equivalent
shall not in itself create a presumption that the person did not act in good faith
or that the person had reasonable cause to believe that the person’s
conduct was unlawful. There shall nonetheless be no indemnification for a
person’s own Disqualifying Conduct.
Insofar as indemnification
for liabilities arising under the Securities Act of 1933, as amended, may be
permitted to Trustees, officers and controlling persons of the Trust pursuant
to the foregoing provisions, or otherwise, the Trust has been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the Trust of expenses incurred or paid by a Trustee, officer
or controlling person of the Trust in the successful defense of any action,
suit or proceeding) is asserted by such Trustee, officer or controlling person
in connection with securities being registered, the Trust may be required, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, to submit to a court or appropriate jurisdiction the question
whether such indemnification is against public policy as expressed in the Act
and will be governed by the final adjudication of such issue.
Item 31. Business and
Other Connections of the Investment Adviser
(a) Franklin Advisers, Inc.
(Advisers)
The officers and directors of
Advisers, Registrant’s investment manager, also serve as officers and/or
directors/trustees for (1) Advisers' corporate parent, Franklin Resources, Inc.
(Resources), and/or (2) other investment companies in Franklin Templeton
Investments. For additional information please see Part B and Schedules A and D
of Form ADV of Advisers (SEC File 801-26292), incorporated herein by reference,
which set forth the officers and directors of Advisers and information as to any
business, profession, vocation or employment of a substantial nature engaged in
by those officers and directors during the past two years.
(b) Franklin Templeton
Institutional, LLC (FT Institutional)
FT Institutional is an
indirect, wholly owned subsidiary of Resources. FT Institutional serves as
sub-adviser to Franklin Liberty Investment Grade Corporate ETF. The officers
of FT Institutional also serve as officers for (1) Resources, and/or (2) other
investment companies in Franklin Templeton Investments. For additional
information please see Part B and Schedules A and D of Form ADV of FT
Institutional (SEC File 801-60684), incorporated herein by reference, which set
forth the officers of FT Institutional and information as to any business,
profession, vocation or employment of a substantial nature engaged in by those officers
and directors during the past two years.
(c) Franklin Templeton Investimentos
(Brasil) Ltda. (FTI Brasil)
FTI Brasil is an indirect,
wholly owned subsidiary of Resources. FTI Brasil serves as sub-adviser to
Franklin Liberty International Opportunities ETF. The officers of FTI Brasil
also serve as officers for (1) Resources, and/or (2) other investment companies
in Franklin Templeton Investments. For additional information please see Part B
and Schedules A and D of Form ADV of FTI Brasil (SEC File 801-71881),
incorporated herein by reference, which set forth the officers of FTI Brasil
and information as to any business, profession,
vocation or employment of a substantial nature engaged in by those officers and
directors during the past two years.
(d) Franklin Templeton
Investments Corp. (FTIC)
FTIC is an indirect, wholly
owned subsidiary of Resources. FTIC serves as sub-adviser to Franklin Liberty
International Opportunities ETF. The officers and/or directors of FTIC also
serve as officers for (1) Resources, and/or (2) other investment companies in
Franklin Templeton Investments. For additional information please see Part B
and Schedules A and D of Form ADV of FTIC (SEC File 801-58185), incorporated
herein by reference, which set forth the officers of FTIC and information as to
any business, profession, vocation or employment of a substantial nature engaged
in by those officers and directors during the past two years.
(e) Franklin Templeton
Investment Management Limited (FTIML)
FTIML is an indirect, wholly
owned subsidiary of Resources. FTIML serves as sub-adviser to Franklin Liberty
International Opportunities ETF. The officers of FTIML also serve as officers
for (1) Resources, and/or (2) other investment companies in Franklin Templeton Investments.
For additional information please see Part B and Schedules A and D of Form ADV
of FTIML (SEC File 801-55170), incorporated herein by reference, which set
forth the officers of FTIML and information as to any business, profession,
vocation or employment of a substantial nature engaged in by those officers and
directors during the past two years.
(f) Franklin Templeton Investments
(ME) Limited (FTIME)
FTIME is an indirect, wholly owned
subsidiary of Resources. FTIME serves as sub-adviser to Franklin Liberty
International Opportunities ETF. The officers of FTIME also serve as officers
for (1) Resources, and/or (2) other investment companies in Franklin Templeton
Investments. For additional information please see Part B and Schedules A and D
of Form ADV of FTIME (SEC File 801-77965), incorporated herein by reference,
which set forth the officers of FTIME and information as to any business,
profession, vocation or employment of a substantial nature engaged in by those
officers and directors during the past two years.
(g) Franklin Templeton
Investment Trust Management Co., Ltd. (FTITMC)
FTITMC is an indirect, wholly
owned subsidiary of Resources. FTITMC serves as sub-adviser to Franklin Liberty
International Opportunities ETF. The officers of FTITMC also serve as officers
for (1) Resources, and/or (2) other investment companies in Franklin Templeton
Investments. For additional information please see Part B and Schedules A and D
of Form ADV of FTITMC (SEC File 801-71877), incorporated herein by reference,
which set forth the officers of FTITMC and information as to any business,
profession, vocation or employment of a substantial nature engaged in by those
officers and directors during the past two years.
(h) Templeton Asset Management
Ltd. (TAML)
TAML is an indirect, wholly
owned subsidiary of Resources. TAML serves as sub-adviser to Franklin Liberty
International Opportunities ETF. The officers of TAML also serve as officers
for (1) Resources, and/or (2) other investment companies in Franklin Templeton
Investments. For additional information please see
Part B and Schedules A and D of Form ADV of TAML (SEC File 801-46997), incorporated
herein by reference, which set forth the officers of TAML and information as to
any business, profession, vocation or employment of a substantial nature
engaged in by those officers and directors during the past two years.
(i)
Franklin Advisory Services, LLC (Advisory Services)
Advisory Services
is an indirect wholly owned subsidiary of Resources. Advisory Services serves as adviser Franklin FTSE Asia
ex Japan ETF, Franklin FTSE Australia ETF, Franklin FTSE Brazil ETF, Franklin
FTSE Canada ETF, Franklin FTSE China ETF, Franklin FTSE Europe ETF, Franklin FTSE
Europe Hedged ETF, Franklin FTSE France ETF, Franklin FTSE Germany ETF, Franklin
FTSE Hong Kong ETF, Franklin FTSE India ETF, Franklin FTSE Italy ETF, Franklin
FTSE Japan ETF, Franklin FTSE Japan Hedged ETF, Franklin FTSE Latin America ETF,
Franklin FTSE Mexico ETF, Franklin FTSE Russia ETF, Franklin FTSE Saudi Arabia ETF,
Franklin FTSE South Africa ETF, Franklin FTSE South Korea ETF, Franklin FTSE
Switzerland ETF, Franklin FTSE Taiwan ETF, Franklin FTSE United Kingdom ETF, Franklin
LibertyQ Emerging Markets ETF, Franklin LibertyQ Global Dividend ETF, Franklin
LibertyQ Global Equity ETF, Franklin LibertyQ International Equity Hedged ETF, Franklin
LibertyQ U.S. Equity ETF, Franklin LibertyQ U.S. Mid Cap Equity ETF and Franklin
LibertyQ U.S. Small Cap Equity ETF. The officers of
Advisory Services also serve as officers for (1) Resources and/or (2) other
investment companies in Franklin Templeton Investments. For additional
information please see Part B and Schedules A and D of Form ADV of Advisory
Services (SEC File 801-51967), incorporated herein by reference, which sets forth
the officers of Advisory Services and information as to any business, profession,
vocation or employment of a substantial nature engaged in by those officers and
directors during the past two years.
Item 32. Principal
Underwriters
(a) Franklin Templeton
Distributors, Inc. (Distributors) also acts as principal underwriter of shares
of:
Franklin Alternative
Strategies Funds
Franklin California Tax-Free Income
Fund
Franklin California Tax-Free
Trust
Franklin Custodian Funds
Franklin ETF Trust
Franklin Federal Tax-Free
Income Fund
Franklin Fund Allocator Series
Franklin Global Trust
Franklin Gold and Precious
Metals Fund
Franklin High Income Trust
Franklin Investors Securities
Trust
Franklin Managed Trust
Franklin Municipal Securities
Trust
Franklin Mutual Series Funds
Franklin New York Tax-Free
Income Fund
Franklin New York Tax-Free
Trust
Franklin Real Estate
Securities Trust
Franklin Strategic Mortgage Portfolio
Franklin Strategic Series
Franklin Tax-Free Trust
Franklin U.S. Government
Money Fund
Franklin
Templeton Variable Insurance Products Trust
Franklin Value Investors
Trust
Institutional Fiduciary Trust
Templeton China World Fund
Templeton Developing Markets
Trust
Templeton Funds
Templeton Global Investment
Trust
Templeton Global Smaller
Companies Fund
Templeton Growth Fund, Inc.
Templeton Income Trust
Templeton Institutional Funds
(b) The information required
with respect to each director and officer of Distributors is incorporated by
reference to Part B of this Form N-1A and Schedule A of Form BD filed by Distributors
with the Securities and Exchange Commission pursuant to the Securities Act of
1934 (SEC File No. 008-05889).
(c) Not Applicable. Registrant's
principal underwriter is an affiliated person of an affiliated person of the
Registrant.
Item 33. Location of
Accounts and Records
The accounts, books or other
documents required to be maintained by Section 31(a) of the Investment Company
Act of 1940 are kept by the Fund at One Franklin Parkway, San Mateo, CA
94403-1906.
Item 34. Management
Services
There are no management-related
service contracts not discussed in Part A or Part B.
Item 35. Undertakings
Not Applicable.
SIGNATURE
Pursuant
to the requirements of the Securities Act of 1933, and the Investment Company
Act of 1940, the Registrant certifies it has duly caused this Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized in the
City of San Mateo and the State of California, on the 13th day of December, 2019.
FRANKLIN
TEMPLETON ETF TRUST
(Registrant)
|
|
By:
|
/s/NAVID J. TOFIGH
|
|
Navid
J. Tofigh
|
Vice
President and Secretary
|
|
Pursuant to the
requirements of the Securities Act of 1933, as amended, this Registration Statement
has been signed below by the following persons in the capacities and on the dates
indicated:
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
Patrick
O’Connor*
|
|
|
|
|
Patrick
O’Connor
|
|
President
and Chief Executive Officer – Investment Management
|
|
December
13, 2019
|
Matthew
T. Hinkle*
|
|
|
|
|
Matthew
T. Hinkle
|
|
Chief
Executive Officer – Finance and Administration
|
|
December
13, 2019
|
|
|
|
|
|
VIVEK
PAI*
|
|
|
|
|
Vivek
Pai
|
|
Chief
Financial Officer, Chief Accounting Officer and Treasurer
|
|
December
13, 2019
|
|
|
|
|
|
Jennifer
M. Johnson*
|
|
|
|
|
Jennifer
M. Johnson
|
|
Trustee
|
|
December
13, 2019
|
|
|
|
|
|
|
|
|
|
|
Rohit
Bhagat*
|
|
|
|
|
Rohit
Bhagat
|
|
Trustee
|
|
December
13, 2019
|
|
|
|
|
|
Anantha
K. Pradeep*
|
|
|
|
|
Anantha
K. Pradeep
|
|
Trustee
|
|
December
13, 2019
|
*
By: /s/NAVID J. TOFIGH
Navid J. Tofigh
Attorney-in-Fact
(Pursuant to Powers of Attorney previously filed)
FRANKLIN TEMPLETON ETF TRUST
REGISTRATION STATEMENT
EXHIBIT INDEX
The following exhibits are attached:
EXHIBIT No.
|
DESCRIPTION
|
|
|
None
|
|
|
|
|
|
|
|
|
|
|
|
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