Filed Pursuant to Rule 424(b)(2)
Registration Statement No. 333-264682
PROSPECTUS SUPPLEMENT
(To Prospectus dated May 4, 2022)
BLACKROCK SCIENCE AND TECHNOLOGY TRUST
Up to 18,000,000 Common Shares of Beneficial Interest
The BlackRock Science and Technology
Trust (the Trust, we, us or our) is offering for sale 18,000,000 of our common shares of beneficial interest (common shares). Our common shares are listed on the New York Stock Exchange
(NYSE) under the symbol BST. As of the close of business on May 9, 2022, the last reported net asset value per share of our common shares was $37.18 and the last reported sales price per share of our common shares on the NYSE
was $35.66.
The Trust is a diversified, closed-end management investment company registered under
the Investment Company Act of 1940, as amended (the Investment Company Act). The Trusts investment objectives are to provide income and total return through a combination of current income, current gains and long-term capital
appreciation. The Trusts investment adviser is BlackRock Advisors, LLC (the Advisor).
The Trust has entered into a
distribution agreement dated May 10, 2022 (the Distribution Agreement) with BlackRock Investments, LLC (the Distributor), an affiliate of the Advisor, to provide for distribution of the Trusts common shares. The
Distributor has entered into a sub-placement agent agreement dated May 10, 2022 (the Sub-Placement Agent Agreement) with UBS Securities LLC (the Sub-Placement Agent) with respect to the Trust relating to the common shares offered by this Prospectus Supplement and the accompanying Prospectus. In accordance with the terms of the Sub-Placement Agent Agreement, the Trust may offer and sell its common shares from time to time through the Sub-Placement Agent as
sub-placement agent for the offer and sale of its common shares. Under the Investment Company Act, the Trust may not sell any common shares at a price below the current net asset value of such common shares,
exclusive of any distributing commission or discount.
Sales of our common shares, if any, under this Prospectus Supplement and the
accompanying Prospectus may be made in negotiated transactions or transactions that are deemed to be at the market as defined in Rule 415 under the Securities Act of 1933, as amended (the Securities Act), including sales made
directly on the NYSE or sales made to or through a market maker other than on an exchange.
The Trust will compensate the Distributor with
respect to sales of common shares at a commission rate of 1.00% of the gross proceeds of the sale of the Trusts common shares. Out of this commission, the Distributor will compensate the Sub-Placement
Agent at a rate of up to 0.80% of the gross sales proceeds of the sale of the Trusts common shares sold by the Sub-Placement Agent. In connection with the sale of the common shares on the Trusts
behalf, the Distributor may be deemed to be an underwriter within the meaning of the Securities Act and the compensation of the Distributor may be deemed to be underwriting commissions or discounts.
Investing in the Trusts common shares involves certain risks, including risks of leverage, which are described in the
Risks section beginning on page 30 of the accompanying Prospectus and the Leverage section beginning on page 26 of the accompanying Prospectus.
NEITHER THE SEC NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS
SUPPLEMENT IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
May 10, 2022
This Prospectus Supplement, together with the accompanying Prospectus, sets forth concisely the
information about the Trust that a prospective investor should know before investing. You should read this Prospectus Supplement and the accompanying Prospectus, which contain important information, before deciding whether to invest in the common
shares. You should retain the accompanying Prospectus and this Prospectus Supplement for future reference. A Statement of Additional Information (SAI), dated May 4, 2022, containing additional information about the Trust, has been
filed with the Securities and Exchange Commission (SEC) and, as amended from time to time, is incorporated by reference in its entirety into this Prospectus Supplement and the accompanying Prospectus. This Prospectus Supplement, the
accompanying Prospectus and the SAI are part of a shelf registration statement filed with the SEC. This Prospectus Supplement describes the specific details regarding this offering, including the method of distribution. If information in
this Prospectus Supplement is inconsistent with the accompanying Prospectus or the SAI, you should rely on this Prospectus Supplement. You may call (800) 882-0052, visit the Trusts website
(http://www.blackrock.com) or write to the Trust to obtain, free of charge, copies of the SAI and the Trusts semi-annual and annual reports, as well as to obtain other information about the Trust or to make shareholder inquiries. The SAI, as
well as the Trusts semi-annual and annual reports, are also available for free on the SECs website (http://www.sec.gov). You may also e-mail requests for these documents to publicinfo@sec.gov.
Information contained in, or that can be accessed through, the Trusts website is not part of this Prospectus Supplement or the accompanying Prospectus.
You should not construe the contents of this Prospectus Supplement and the accompanying Prospectus as legal, tax or financial advice. You
should consult with your own professional advisors as to the legal, tax, financial or other matters relevant to the suitability of an investment in the Trust.
The Trusts common shares do not represent a deposit or an obligation of, and are not guaranteed or endorsed by, any bank or other
insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency.
You should rely only on the information contained or incorporated by reference in this Prospectus Supplement and the accompanying
Prospectus. Neither the Trust nor the underwriters have authorized anyone to provide you with different information. The Trust is not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should
not assume that the information contained in this Prospectus Supplement and the accompanying Prospectus is accurate as of any date other than the date of this Prospectus Supplement and the accompanying Prospectus, respectively. Our business,
financial condition, results of operations and prospects may have changed since those dates. In this Prospectus Supplement and in the accompanying Prospectus, unless otherwise indicated, Trust, us, our and
we refer to BlackRock Science and Technology Trust, a Delaware statutory trust.
S-2
TABLE OF CONTENTS
Prospectus Supplement
S-3
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus Supplement, the accompanying Prospectus and the SAI contain forward-looking statements. Forward-looking statements
can be identified by the words may, will, intend, expect, estimate, continue, plan, anticipate, and similar terms and the negative of such terms. Such
forward-looking statements may be contained in this Prospectus Supplement as well as in the accompanying Prospectus. By their nature, all forward-looking statements involve risks and uncertainties, and actual results could differ materially from
those contemplated by the forward-looking statements. Several factors that could materially affect our actual results are the performance of the portfolio of securities we hold, the price at which our shares will trade in the public markets and
other factors discussed in our periodic filings with the SEC.
Although we believe that the expectations expressed in our forward-looking
statements are reasonable, actual results could differ materially from those projected or assumed in our forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to
change and are subject to inherent risks and uncertainties, such as those disclosed in the Risks section of the accompanying Prospectus. All forward-looking statements contained or incorporated by reference in this Prospectus Supplement
or the accompanying Prospectus are made as of the date of this Prospectus Supplement or the accompanying Prospectus, as the case may be. Except for our ongoing obligations under the federal securities laws, we do not intend, and we undertake no
obligation, to update any forward-looking statement. The forward-looking statements contained in this Prospectus Supplement, the accompanying Prospectus and the SAI are excluded from the safe harbor protection provided by Section 27A of the
Securities Act.
Currently known risk factors that could cause actual results to differ materially from our expectations include, but are
not limited to, the factors described in the Risks section of the accompanying Prospectus. We urge you to review carefully those sections for a more detailed discussion of the risks of an investment in our common shares.
S-4
PROSPECTUS SUPPLEMENT SUMMARY
The following summary is qualified in its entirety by reference to the more detailed information included elsewhere in this Prospectus
Supplement and in the accompanying Prospectus and in the SAI.
|
|
|
The Trust |
|
The Trust is a diversified, closed-end management investment company. The
Trusts investment objectives are to provide income and total return through a combination of current income, current gains and long-term capital appreciation. The Trust is not intended as, and you should not construe it to be, a complete
investment program. There can be no assurance that the Trusts investment objectives will be achieved or that the Trusts investment program will be successful. The Trusts common shares are listed for trading on the NYSE under the
symbol BST. |
|
|
Investment Advisor |
|
BlackRock Advisors, LLC (previously defined as the Advisor) is the Trusts investment adviser. The Advisor
receives an annual fee, payable monthly, in an amount equal to 1.00% of the average daily value of the Trusts Managed Assets (as defined below). The Advisor contractually agreed to waive receipt of a portion of the management fee in the amount
of 0.20% of the Trusts average daily Managed Assets for the first five years of the Trusts operations (2014 through 2018), 0.15% in year six (2019), 0.10% in year seven (2020) and 0.05% in year eight (2021). The period from the
Trusts inception to December 31, 2014 was considered year one for the waiver. Beginning in year nine (2022), there will be no waiver. |
|
|
The Offering |
|
The Trust has entered into the Distribution Agreement with the Distributor to provide for distribution of the Trusts
common shares. The Distributor has entered into the Sub-Placement Agent Agreement with the Sub-Placement Agent with respect to the Trust relating to the common shares
offered by this Prospectus Supplement and the accompanying Prospectus. In accordance with the terms of the Sub-Placement Agent Agreement, the Trust may offer and sell its common shares from time to time
through the Sub-Placement Agent as sub-placement agent for the offer and sale of its common shares. The Trust will compensate the Distributor with respect to sales of
common shares at a commission rate of 1.00% of the gross proceeds of the sale of the Trusts common shares. Out of this commission, the Distributor will compensate the Sub-Placement Agent at a rate of up
to 0.80% of the |
S-5
|
|
|
|
|
gross sales proceeds of the sale of the Trusts common shares sold by the
Sub-Placement Agent.
The provisions of the Investment Company Act generally require that the public offering price of common shares (less any underwriting
commissions and discounts) must equal or exceed the net asset value per share of a companys common shares (calculated within 48 hours of pricing).
Sales of our common shares, if any, under this Prospectus Supplement and the accompanying Prospectus may be made in negotiated transactions or
transactions that are deemed to be at the market as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange. |
|
|
Use of Proceeds |
|
We currently anticipate that we will be able to invest all of the net proceeds of any sales of common shares pursuant to this
Prospectus Supplement in accordance with our investment objective and policies as described in the accompanying Prospectus under The Trusts Investments within approximately three months of the receipt of such proceeds. Pending such
investment, it is anticipated that the proceeds will be invested in short-term investment grade securities or in high quality, short-term money market instruments.
Depending on market conditions and operations, a portion
of the cash held by the Trust, including any proceeds raised from the offering, may be used to pay distributions in accordance with the Trusts distribution policy and may be a return of capital. |
S-6
SUMMARY OF TRUST EXPENSES
The following table and example are intended to assist you in understanding the various costs and expenses directly or indirectly associated
with investing in our common shares.
|
|
|
|
|
Shareholder Transaction Expenses |
|
|
|
|
Sales load paid by you (as a percentage of offering price) |
|
|
1.00 |
%(1) |
Offering expenses borne by the Trust (as a percentage of offering price) |
|
|
0.02 |
%(2) |
Dividend reinvestment plan fees(3) |
|
|
$0.02 per share for open-market purchases of common shares |
|
Dividend reinvestment plan sale transaction
fee(3) |
|
|
$2.50 |
|
Estimated Annual Expenses (as a percentage of net assets attributable to common
shares) |
|
|
|
|
Management Fees(4)(5) |
|
|
1.00 |
% |
Other Expenses |
|
|
0.05 |
% |
Total Annual Trust Operating Expenses |
|
|
1.05 |
% |
Fee Waiver and/or Expense
Reimbursements(4)(5) |
|
|
|
|
|
|
|
|
|
Total Annual Trust Operating Expenses After Fee Waivers and/or Expense Reimbursements(4)(5) |
|
|
1.05 |
% |
|
|
|
|
|
(1) |
Represents the estimated commission with respect to the Trusts common shares being sold in this
offering. There is no guarantee that there will be any sales of the Trusts common shares pursuant to this Prospectus Supplement and the accompanying Prospectus. Actual sales of the Trusts common shares under this Prospectus Supplement
and the accompanying Prospectus, if any, may be less than as set forth under Capitalization below. In addition, the price per share of any such sale may be greater than or less than the price set forth under Capitalization
below, depending on market price of the Trusts common shares at the time of any such sale. |
(2) |
Based on a sales price per share of $39.97, which represents the last reported sales price per share of the
Trusts common shares on the NYSE on May 4, 2022. Assumes all of the common shares being offered by this Prospectus Supplement and the accompanying Prospectus are sold. Represents the initial offering costs incurred by the Trust in
connection with this offering, which are estimated to be $206,786. Offering costs generally include, but are not limited to, the preparation, review and filing with the SEC of the Trusts registration statement, the preparation, review and
filing of any associated marketing or similar materials, costs associated with the printing, mailing or other distribution of the Prospectus Supplement and the accompanying Prospectus and/or marketing materials, associated filing fees, NYSE listing
fees, and legal and auditing fees associated with the offering. |
(3) |
Computershare Trust Company, N.A.s (the Reinvestment Plan Agent) fees for the handling of
the reinvestment of dividends will be paid by the Trust. However, you will pay a $0.02 per share fee incurred in connection with open-market purchases, which will be deducted from the value of the dividend. You will also be charged a $2.50 sales fee
and pay a $0.15 per share fee if you direct the Reinvestment Plan Agent to sell your common shares held in a dividend reinvestment account. Per share fees include any applicable brokerage commissions the Reinvestment Plan Agent is required to pay.
|
(4) |
The Advisor contractually agreed to waive receipt of a portion of the management fee in the amount of 0.05%
of the Trusts average daily Managed Assets in 2021. Beginning in year nine (2022), there will be no waiver. Managed Assets means the total assets of the Trust (including any assets attributable to money borrowed for investment
purposes) minus the sum of the Trusts accrued liabilities (other than money borrowed for investment purposes). |
(5) |
The Trust and the Advisor have entered into a fee waiver agreement (the Fee Waiver Agreement),
pursuant to which the Advisor has contractually agreed to waive the management fee with respect to any portion of the Trusts assets attributable to investments in any equity and fixed-income mutual funds and exchange-traded funds managed by
the Advisor or its affiliates that have a contractual management fee, through June 30, 2023. In addition, pursuant to the Fee Waiver Agreement, the Advisor has contractually agreed to waive its management fees by the amount of investment
advisory fees the Trust pays to the Advisor indirectly through its investment in money market funds managed by the Advisor or its affiliates, through June 30, 2023. The Fee Waiver Agreement may be terminated at any time, without the payment of
any penalty, only by the Trust (upon the vote of a majority of the Trustees who are not interested persons (as defined in the Investment Company Act) of the Trust or a majority of the outstanding voting securities of the Trust), upon 90
days written notice by the Trust to the Advisor. |
S-7
Example
The following example illustrates the expenses (including the sales load of $10.00 and offering costs of $0.16) that you would pay on a $1,000
investment in common shares, assuming (i) total net annual expenses of 1.05% of net assets attributable to common shares in 2021, and (ii) a 5% annual return:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1 Year |
|
|
3 Years |
|
|
5 Years |
|
|
10 Years |
|
Total expenses incurred |
|
$ |
21 |
|
|
$ |
43 |
|
|
$ |
68 |
|
|
$ |
137 |
|
The example should not be considered a representation of future expenses. The example assumes that the
estimated Other expenses set forth in the Estimated Annual Expenses table are accurate and that all dividends and distributions are reinvested at net asset value. Actual expenses may be greater or less than those assumed. Moreover, the
Trusts actual rate of return may be greater or less than the hypothetical 5% return shown in the example.
USE OF PROCEEDS
Sales of our common shares, if any, under this Prospectus Supplement and the accompanying Prospectus may be made
in negotiated transactions or transactions that are deemed to be at the market as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or sales made to or through a market maker other than on an
exchange. There is no guarantee that there will be any sales of our common shares pursuant to this Prospectus Supplement and the accompanying Prospectus. Actual sales, if any, of our common shares under this Prospectus Supplement and the
accompanying Prospectus may be less than as set forth below in this paragraph. In addition, the price per share of any such sale may be greater or less than the price set forth in this paragraph, depending on the market price of our common shares at
the time of any such sale. As a result, the actual net proceeds we receive may be more or less than the amount of net proceeds estimated in this Prospectus Supplement. Assuming the sale of all of the common shares offered under this Prospectus
Supplement and the accompanying Prospectus, at the last reported sale price of $39.97 per share for our common shares on the NYSE as of May 4, 2022, we estimate that the net proceeds of this offering will be approximately $712,058,614 after
deducting the estimated sales load and the estimated initial offering expenses payable by the Trust, if any.
The net proceeds from the
issuance of common shares hereunder will be invested in accordance with the Trusts investment objective and policies as set forth in this Prospectus Supplement and the accompanying Prospectus. We currently anticipate that we will be able to
invest all of the net proceeds in accordance with our investment objective and policies within approximately three months of the receipt of such proceeds. Pending such investment, it is anticipated that the proceeds will be invested in short-term
investment grade securities or in high quality, short-term money market instruments. Depending on market conditions and operations, a portion of the cash held by the Trust, including any proceeds raised from the offering, may be used to pay
distributions in accordance with the Trusts distribution policy and may be a return of capital. A return of capital is a return to investors of a portion of their original investment in the Trust. In general terms, a return of capital would
involve a situation in which a Trust distribution (or a portion thereof) represents a return of a portion of a shareholders investment in the Trust, rather than making a distribution that is funded from the Trusts earned income or other
profits. Although return of capital distributions may not be currently taxable, such distributions would decrease the basis of a shareholders shares, and therefore, may increase a shareholders tax liability for capital gains upon a sale
of shares, even if sold at a loss to the shareholders original investments.
S-8
CAPITALIZATION
The Trust may offer and sell up to 18,000,000 common shares, $0.001 par value per share, from time to time through the Sub-Placement Agent as sub-placement agent under this Prospectus Supplement and the accompanying Prospectus. There is no guarantee that there will be
any sales of the Trusts common shares pursuant to this Prospectus Supplement and the accompanying Prospectus. The table below assumes that the Trust will sell 18,000,000 common shares at a price of $39.97 per share (which represents the last
reported sales price per share of the Trusts common shares on the NYSE on May 4, 2022). Actual sales, if any, of the Trusts common shares under this Prospectus Supplement and the accompanying Prospectus may be greater or less
than $39.97 per share, depending on the market price of the Trusts common shares at the time of any such sale. The Trust and the Distributor will determine whether any sales of the Trusts common shares will be authorized on a
particular day; the Trust and the Distributor, however, will not authorize sales of the Trusts common shares if the per share price of the shares is less than the current net asset value per share plus the per share amount of the commission to
be paid to the Distributor (the Minimum Price). The Trust and the Distributor may also not authorize sales of the Trusts common shares on a particular day even if the per share price of the shares is equal to or greater than the
Minimum Price, or may only authorize a fixed number of shares to be sold on any particular day. The Trust and the Distributor will have full discretion regarding whether sales of Trust common shares will be authorized on a particular day and, if so,
in what amounts.
The following table sets forth the Trusts capitalization (1) on a historical basis as of December 31,
2021 (audited); and (2) on a pro forma basis as adjusted to reflect the assumed sale of 18,000,000 common shares at $39.97 per share (the last reported price per share of the Trusts common shares on the NYSE on May 4, 2022), in an
offering under this Prospectus Supplement and the accompanying Prospectus, after deducting the assumed commission of $7,194,600 (representing an estimated commission to the Distributor of 1.00% of the gross proceeds of the sale of Trust common
shares, out of which the Distributor will compensate the Sub-Placement Agent at a rate of up to 0.80% of the gross sales proceeds of the sale of the Trusts common shares sold by the Sub-Placement Agent).
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2021 (audited) |
|
|
As adjusted for Offering (unaudited) |
|
Common shares |
|
|
32,083,371 |
|
|
|
50,083,371 |
|
Paid in Capital |
|
$ |
795,202,915 |
|
|
$ |
1,507,261,529 |
|
Undistributed NII |
|
$ |
|
|
|
$ |
|
|
Accumulated Gain |
|
$ |
28,367,276 |
|
|
$ |
28,367,276 |
|
Net appreciation/depreciation |
|
$ |
857,596,247 |
|
|
$ |
857,596,247 |
|
Net Assets |
|
$ |
1,681,166,438 |
|
|
$ |
2,393,225,052 |
|
NAV |
|
$ |
52.40 |
|
|
$ |
47.78 |
|
PLAN OF DISTRIBUTION
Under the Sub-Placement Agent Agreement, upon instructions from the Distributor, the Sub-Placement Agent will use its reasonable best efforts to sell, as sub-placement agent, common shares under the terms and subject to the conditions set forth in the
Sub-Placement Agent Agreement. The Distributor will instruct the Sub-Placement Agent as to the amount of Trust common shares authorized for sale by the Sub-Placement
Agent on any particular day that is a trading day for the exchange on which the Trusts common shares are listed and primarily trade. The Distributor will also instruct the Sub-Placement Agent not to sell
Trust common shares if the sales cannot be effected at or above a price designated by the Distributor, which price will at least be equal to the Minimum Price and which price, may, in the discretion of the Distributor and the Trust, be above the
Minimum Price. The Distributor and the Trust may, in their discretion, determine not to authorize sales of the Trusts common shares on a particular day even if the per share price of the shares is equal to or greater than the
S-9
Minimum Price. The Trust and the Distributor will have full discretion regarding whether sales of Trust common shares will be authorized on a particular day and, if so, in what amounts. The
Trust, the Distributor or the Sub-Placement Agent may suspend a previously authorized offering of Trust common shares upon proper notice and subject to other conditions.
The Sub-Placement Agent will provide written confirmation to the Distributor following the close of
trading on a day on which Trust common shares are sold under the Sub-Placement Agent Agreement. Each confirmation will include the number of shares sold, the net proceeds to the Trust and the compensation the Sub-Placement Agent is owed in connection with the sales.
The Trust will compensate the Distributor
with respect to sales of common shares at a commission rate of 1.00% of the gross proceeds of the sale of the Trusts common shares. Out of this commission, the Distributor will compensate the
Sub-Placement Agent at a rate of up to 0.80% of the gross sales proceeds of the sale of the Trusts common shares sold by the Sub-Placement Agent. There is no
guarantee that there will be any sales of the Trusts common shares pursuant to this Prospectus Supplement and the accompanying Prospectus. Actual sales, if any, of the Trusts common shares under this Prospectus Supplement and the
accompanying Prospectus may be greater or less than the most recent market price set forth in this Prospectus Supplement, depending on the market price of the Trusts common shares at the time of any such sale; provided, however, that sales
will not be made at less than the Minimum Price.
Settlements of sales of common shares will occur on the second business day following
the date on which any such sales are made, in return for payment of the net proceeds to the Trust.
In connection with the sale of common
shares on behalf of the Trust, the Distributor may be deemed to be an underwriter within the meaning of the Securities Act, and the compensation of the Distributor may be deemed to be underwriting commissions or discounts.
The offering of the Trusts common shares pursuant to the Distribution Agreement will terminate upon the earlier of (i) the sale of
all common shares subject thereto or (ii) termination of the Distribution Agreement. The Trust and the Distributor each have the right to terminate the Distribution Agreement in its discretion upon advance notice to the other party.
The Sub-Placement Agent, its affiliates and their respective employees hold or may hold in
the future, directly or indirectly, investment interests in BlackRock, Inc., the parent company of the Distributor, and funds advised by the Advisor and its affiliates. The interests held by employees of
the Sub-Placement Agent or its affiliates are not attributable to, and no investment discretion is held by, the Sub-Placement Agent or its
affiliates.
The Trust has agreed to indemnify the Distributor and hold the Distributor harmless against certain liabilities, including
certain liabilities under the Securities Act, except for any liability to the Trust or its investors to which the Distributor would otherwise be subject by reason of willful misfeasance, bad faith or gross negligence in the performance of its duties
or by its reckless disregard of its obligations and duties under its agreement with the Trust.
LEGAL
MATTERS
Certain legal matters in connection with the common shares will be passed upon for the Trust by Willkie Farr &
Gallagher LLP, New York, New York, counsel to the Trust. Willkie Farr & Gallagher LLP may rely as to certain matters of Delaware law on the opinion of Morris, Nichols, Arsht & Tunnell LLP, Wilmington, Delaware.
S-10
ADDITIONAL INFORMATION
This Prospectus Supplement and the accompanying Prospectus constitute part of a Registration Statement filed by the Trust with the SEC under
the Securities Act and the Investment Company Act. This Prospectus Supplement and the accompanying Prospectus omit certain of the information contained in the Registration Statement, and reference is hereby made to the Registration Statement and
related exhibits for further information with respect to the Trust and the common shares offered hereby. Any statements contained herein concerning the provisions of any document are not necessarily complete, and, in each instance, reference is made
to the copy of such document filed as an exhibit to the Registration Statement or otherwise filed with the SEC. Each such statement is qualified in its entirety by such reference. The complete Registration Statement may be obtained from the SEC upon
payment of the fee prescribed by its rules and regulations or free of charge through the SECs website (http://www.sec.gov).
S-11
BASE PROSPECTUS
18,000,000 Shares
BlackRock Science and Technology Trust
Common Shares
Rights to
Purchase Common Shares
BlackRock Science and Technology Trust (the Trust, we, us or our) is a
diversified, closed-end management investment company. The Trusts investment objectives are to provide income and total return through a combination of current income, current gains and long-term capital
appreciation.
We may offer, from time to time, in one or more offerings, up to 18,000,000 of our common shares of
beneficial interest, par value $0.001 (common shares). We may also offer subscription rights to purchase our common shares. As of May 3, 2022, there remain 32,083,371 common shares that may be sold pursuant to this
Prospectus. Common shares may be offered at prices and on terms to be set forth in one or more supplements to this Prospectus (each, a Prospectus Supplement). You should read this Prospectus and the applicable Prospectus Supplement
carefully before you invest in our common shares.
Our common shares may be offered directly to one or more purchasers,
including existing shareholders in a rights offering, through agents designated from time to time by us, or to or through underwriters or dealers. The Prospectus Supplement relating to the offering will identify any agents or underwriters involved
in the sale of our common shares, and will set forth any applicable purchase price, fee, commission or discount arrangement between us and our agents or underwriters, or among our underwriters, or the basis upon which such amount may be calculated.
The Prospectus Supplement relating to any offering of rights will set forth the number of common shares issuable upon the exercise of each right (or number of rights) and the other terms of such rights offering. We may not sell any of our common
shares through agents, underwriters or dealers without delivery of a Prospectus Supplement describing the method and terms of the particular offering of our common shares.
Our common shares are listed on the New York Stock Exchange (NYSE) under the symbol BST. The last
reported sale price of our common shares, as reported by the NYSE on May 3, 2022 was $38.78 per common share. The net asset value of our common shares at the close of business on May 3, 2022 was $40.30 per common share. Rights issued by the Trust
may also be listed on a securities exchange.
Investing in the Trusts common shares involves certain risks,
including risks of leverage, which are described in the Risks section beginning on page 30 of this Prospectus.
Shares of closed-end management investment companies frequently trade at a discount
to their net asset value. The Trusts common shares have traded at a discount to net asset value, including during recent periods. If the Trusts common shares trade at a discount to its net asset value, the risk of loss may increase for
purchasers in a public offering.
Neither the Securities and Exchange Commission (SEC) nor any state
securities commission has approved or disapproved these securities or passed upon the adequacy of this Prospectus. Any representation to the contrary is a criminal offense.
This Prospectus, together with any Prospectus Supplement, sets forth concisely the information about the Trust that a
prospective investor should know before investing. You should read this Prospectus and applicable Prospectus Supplement, which contain important information, before deciding whether to invest in the common shares. You should retain the Prospectus
and Prospectus Supplement for future reference. A Statement of
Additional Information (SAI), dated May 4, 2022, containing additional information about the Trust, has been filed with the SEC and, as amended from time to time, is incorporated by
reference in its entirety into this Prospectus. You may call (800) 882-0052, visit the Trusts website (http://www.blackrock.com) or write to the Trust to obtain, free of charge, copies of the SAI and the
Trusts semi-annual and annual reports, as well as to obtain other information about the Trust or to make shareholder inquiries. The SAI, as well as the Trusts semi-annual and annual reports, are also available for free on the SECs
website (http://www.sec.gov). You may also e-mail requests for these documents to publicinfo@sec.gov. Information contained in, or that can be accessed through, the Trusts website is not part of this
Prospectus.
You should not construe the contents of this Prospectus as legal, tax or financial advice. You should consult
with your own professional advisors as to the legal, tax, financial or other matters relevant to the suitability of an investment in the Trust.
The Trusts common shares do not represent a deposit or an obligation of, and are not guaranteed or endorsed by, any
bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other government agency.
Prospectus dated May 4, 2022
TABLE OF CONTENTS
You should rely only on the information contained in, or incorporated by reference into, this Prospectus
and any related Prospectus Supplement in making your investment decisions. The Trust has not authorized any person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on
it. The Trust is not making an offer to sell the common shares in any jurisdiction where the offer or sale is not permitted. You should assume that the information in this Prospectus and any Prospectus Supplement is accurate only as of the dates on
their covers. The Trusts business, financial condition and prospects may have changed since the date of its description in this Prospectus or the date of its description in any Prospectus Supplement.
PROSPECTUS SUMMARY
This is only a summary of certain information relating to BlackRock Science and Technology Trust. This summary may not
contain all of the information that you should consider before investing in our common shares. You should consider the more detailed information contained in the Prospectus and in any related Prospectus Supplement and in the Statement of Additional
Information (SAI) before purchasing common shares.
|
|
|
The Trust |
|
BlackRock Science and Technology Trust is a diversified, closed-end management
investment company. Throughout this Prospectus, we refer to BlackRock Science and Technology Trust simply as the Trust or as we, us or our. See The Trust.
The Trusts common shares are listed for trading on
the New York Stock Exchange (NYSE) under the symbol BST. As of May 3, 2022, the net assets of the Trust were $1,292,903,467, the total assets of the Trust were $1,292,903,466.96 and the Trust had outstanding 32,083,371
common shares. The last reported sale price of the Trusts common shares, as reported by the NYSE on May 3, 2022 was $38.78 per common share. The net asset value (NAV) of the Trusts common shares at the close of business
on May 3, 2022 was $40.30 per common share. See Description of Shares. Rights issued by the Trust may also be listed on a securities exchange. |
|
|
The Offering |
|
We may offer, from time to time, in one or more offerings, up to 18,000,000 of our common shares on terms to be determined
at the time of the offering. We may also offer subscription rights to purchase our common shares. As of May 3, 2022, there remain 32,083,371 common shares that may be sold pursuant to this Prospectus. The common shares may be offered at prices
and on terms to be set forth in one or more Prospectus Supplements. You should read this Prospectus and the applicable Prospectus Supplement carefully before you invest in our common shares. Our common shares may be offered directly to one or more
purchasers, through agents designated from time to time by us, or to or through underwriters or dealers. The offering price per common share will not be less than the NAV per common share at the time we make the offering, exclusive of any
underwriting commissions or discounts, provided that rights offerings that meet certain conditions may be offered at a price below the then current NAV. See Rights Offerings. The Prospectus Supplement relating to the offering will
identify any agents, underwriters or dealers involved in the sale of our common shares, and will set forth any applicable purchase price, fee, commission or discount arrangement between us and our agents or underwriters, or among our underwriters,
or the basis upon which such amount may be calculated. See Plan of Distribution. The Prospectus Supplement relating to any offering of rights will set forth the number of common shares issuable upon the exercise of each right (or number
of rights) and the other terms of such rights offering. We may not sell any of our common shares through agents, underwriters or dealers without delivery of a Prospectus Supplement describing the method and terms of the particular offering of our
common shares. |
1
|
|
|
Use of Proceeds |
|
The net proceeds from the issuance of common shares hereunder will be invested in accordance with our investment objectives
and policies as appropriate investment opportunities are identified, which is expected to be substantially completed in approximately three months from the date on which the proceeds from an offering are received by the Trust; however, the
identification of appropriate investment opportunities pursuant to the Trusts investment style or changes in market conditions could result in the Trusts anticipated investment period extending to as long as six months. See Use of
Proceeds. |
|
|
Investment Objectives |
|
Please refer to the section
of the Trusts most recent annual report on Form N-CSR entitled Investment Objectives, Policies and RisksInvestment Objectives and PoliciesBlackRock Science and Technology Trust
(BST), which is incorporated by reference herein, for a discussion of the Trusts investment objective and policies. |
|
|
Leverage |
|
The Trust currently does not intend to borrow money or issue debt securities or preferred shares. The Trust is, however,
permitted to borrow money or issue debt securities in an amount up to 33 1/3% of its Managed Assets (50% of its net assets), and issue preferred shares in an amount up to 50% of its Managed Assets (100% of its net assets). Managed Assets
means the total assets of the Trust (including any assets attributable to money borrowed for investment purposes) minus the sum of the Trusts accrued liabilities (other than money borrowed for investment purposes). Although it has no present
intention to do so, the Trust reserves the right to borrow money from banks or other financial institutions, or issue debt securities or preferred shares, in the future if it believes that market conditions would be conducive to the successful
implementation of a leveraging strategy through borrowing money or issuing debt securities or preferred shares. See Leverage.
The use of leverage, if employed, is subject to numerous risks. When leverage is employed, the Trusts NAV, the market price of the common
shares and the yield to holders of common shares will be more volatile than if leverage were not used. For example, a rise in short-term interest rates, which currently are near historically low levels, generally will cause the Trusts NAV to
decline more than if the Trust had not used leverage. A reduction in the Trusts NAV may cause a reduction in the market price of the Trusts common shares.
The Trust cannot assure you that the use of leverage will
result in a higher yield on the Trusts common shares. When the Trust uses leverage, the management fee payable to the Advisor will be higher than if the Trust did not use leverage because this fee is calculated on the basis of the Trusts
Managed Assets, which include the proceeds of leverage. Any leveraging strategy the Trust employs may not be successful. |
2
|
|
|
Investment Advisor |
|
BlackRock Advisors, LLC is the Trusts investment adviser. The Advisor receives an annual fee, payable monthly, in an
amount equal to 1.00% of the average daily value of the Trusts Managed Assets. The Advisor contractually agreed to waive receipt of a portion of the management fee in the amount of 0.20% of the Trusts average daily Managed Assets for the
first five years of the Trusts operations (2014 through 2018), 0.15% in year six (2019), 0.10% in year seven (2020) and 0.05% in year eight (2021). The period from the Trusts inception to December 31, 2014 was considered year
one for the waiver. Beginning in year nine (2022), there will be no waiver. See Management of the TrustInvestment Advisor. |
|
|
Distributions |
|
The Trust distributes monthly all or a portion of its net investment income, including current gains, to holders of common
shares. The Trust has, pursuant to an SEC exemptive
order granted to certain of BlackRocks closed-end funds, adopted a plan to support a level distribution of income, capital gains and/or return of capital (the Managed Distribution Plan). The
Managed Distribution Plan has been approved by the Board and is consistent with the Trusts investment objectives and policies. Under the Managed Distribution Plan, the Trust will distribute all available investment income, including current
gains, to its shareholders, consistent with its investment objectives and as required by the Internal Revenue Code of 1986, as amended (the Code). If sufficient investment income, including current gains, is not available on a monthly
basis, the Trust will distribute long-term capital gains and/or return of capital to shareholders in order to maintain a level distribution. A return of capital distribution may involve a return of the shareholders original investment. Though
not currently taxable, such a distribution may lower a shareholders basis in the Trust, thus potentially subjecting the shareholder to future tax consequences in connection with the sale of Trust shares, even if sold at a loss to the
shareholders original investment. Each monthly distribution to shareholders is expected to be at a fixed amount established by the Board, except for extraordinary distributions and potential distribution rate increases or decreases to enable
the Trust to comply with the distribution requirements imposed by the Code. Shareholders should not draw any conclusions about the Trusts investment performance from the amount of these distributions or from the terms of the Managed
Distribution Plan. Various factors will affect the
level of the Trusts income, including the asset mix and the Trusts use of options and hedging. To permit the Trust to maintain a more stable monthly distribution, the Trust may from time to time distribute less than the entire amount of
income earned in a particular period. The undistributed income would be available to supplement future distributions. As a result, the distributions paid by the Trust for any particular monthly period may be more or less than the amount of income
actually earned by the |
3
|
|
|
|
|
Trust during that period. Undistributed income will add to the Trusts NAV (and indirectly benefits the Advisor by
increasing its fee) and, correspondingly, distributions from undistributed income will reduce the Trusts NAV. The Trust intends to distribute any long-term capital gains not distributed under the Managed Distribution Plan annually.
Shareholders will automatically have all dividends and
distributions reinvested in common shares of the Trust in accordance with the Trusts dividend reinvestment plan, unless an election is made to receive cash by contacting the Reinvestment Plan Agent (as defined herein), at (800) 699-1236. See Dividend Reinvestment Plan.
Under normal market conditions, the Advisor seeks to manage the Trust in a manner such that the Trusts distributions are reflective of
the Trusts current and projected earnings levels. The distribution level of the Trust is subject to change based upon a number of factors, including the current and projected level of the Trusts earnings, and may fluctuate over time.
The Trust reserves the right to change its distribution
policy and the basis for establishing the rate of its monthly distributions at any time and may do so without prior notice to common shareholders. See Distributions. |
|
|
Listing |
|
The Trusts common shares are listed on the NYSE under the symbol BST. See Description of
SharesCommon Shares. |
|
|
Custodian and Transfer Agent |
|
State Street Bank and Trust Company serves as the Trusts custodian, and Computershare Trust Company, N.A. serves as
the Trusts transfer agent. |
|
|
Administrator |
|
State Street Bank and Trust Company serves as the Trusts administrator and fund accountant. |
|
|
Market Price of Shares |
|
Common shares of closed-end investment companies frequently trade at prices lower
than their NAV. The Trust cannot assure you that its common shares will trade at a price higher than or equal to NAV. See Use of Proceeds. The Trusts common shares trade in the open market at market prices that are a function of
several factors, including dividend levels (which are in turn affected by expenses), NAV, call protection for portfolio securities, portfolio credit quality, liquidity, dividend stability, relative demand for and supply of the common shares in the
market, general market and economic conditions and other factors. See Leverage, Risks, Description of Shares and Repurchase of Common Shares. The common shares are designed primarily for long-term
investors and you should not purchase common shares of the Trust if you intend to sell them shortly after purchase. |
4
5
SUMMARY OF TRUST EXPENSES
|
|
|
|
|
Shareholder Transaction Expenses |
|
|
|
|
Sales load paid by you (as a percentage of offering price)(1) |
|
|
1.00% |
|
Offering expenses borne by the Trust (as a percentage of offering price)(1) |
|
|
0.02% |
|
Dividend reinvestment plan fees |
|
$ |
0.02 per share for open-market purchases of common shares(2) |
|
|
|
|
|
|
Dividend reinvestment plan sale transaction fee |
|
$ |
2.50(2) |
|
|
|
Annual Expenses (as a percentage of net assets attributable to common
shares) |
|
|
|
|
Management Fees(3) |
|
|
1.00% |
|
Other Expenses |
|
|
0.05% |
|
Total Annual Fund Operating Expenses |
|
|
1.05% |
|
Fee Waivers and/or Expense
Reimbursements(3)(4) |
|
|
|
|
|
|
|
|
|
Total Annual Fund Operating Expenses After Fee Waivers and/or Expense Reimbursements(3)(4) |
|
|
1.05% |
|
|
|
|
|
|
(1) |
If the common shares are sold to or through underwriters, the Prospectus Supplement will set forth any
applicable sales load and the estimated offering expenses. Trust shareholders will pay all offering expenses involved with an offering. |
(2) |
The Reinvestment Plan Agents (as defined below under Dividend Reinvestment Plan) fees for
the handling of the reinvestment of dividends will be paid by the Trust. However, you will pay a $0.02 per share fee incurred in connection with open-market purchases, which will be deducted from the value of the dividend. You will also be charged a
$2.50 sales fee and pay a $0.15 per share fee if you direct the Reinvestment Plan Agent to sell your common shares held in a dividend reinvestment account. Per share fees include any applicable brokerage commissions the Reinvestment Plan Agent is
required to pay. |
(3) |
The Advisor contractually agreed to waive receipt of a portion of the management fee in the amount of 0.05%
of the Trusts average daily Managed Assets in 2021. Beginning in 2022, there will be no waiver. |
(4) |
The Trust and the Advisor have entered into a fee waiver agreement (the Fee Waiver Agreement),
pursuant to which the Advisor has contractually agreed to waive the management fee with respect to any portion of the Trusts assets attributable to investments in any equity and fixed-income mutual funds and exchange-traded funds
(ETFs) managed by the Advisor or its affiliates that have a contractual management fee, through June 30, 2023. In addition, pursuant to the Fee Waiver Agreement, the Advisor has contractually agreed to waive its management fees by
the amount of investment advisory fees the Trust pays to the Advisor indirectly through its investment in money market funds managed by the Advisor or its affiliates, through June 30, 2023. The Fee Waiver Agreement may be terminated at any
time, without the payment of any penalty, only by the Trust (upon the vote of a majority of the Trustees who are not interested persons (as defined in the Investment Company Act) of the Trust (the Independent Trustees) or a
majority of the outstanding voting securities of the Trust), upon 90 days written notice by the Trust to the Advisor. |
The following example illustrates the expenses (including the sales load of $10.00 and offering costs of $0.16) that you would
pay on a $1,000 investment in common shares, assuming (i) total net annual expenses of 1.05% of net assets attributable to common shares, and (ii) a 5% annual return:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One Year |
|
|
Three Years |
|
|
Five Years |
|
|
Ten Years |
|
Total expenses incurred |
|
$ |
21 |
|
|
$ |
43 |
|
|
$ |
68 |
|
|
$ |
137 |
|
The example should not be considered a representation of future expenses. The example
assumes that the estimated Other expenses set forth in the Estimated Annual Expenses table are accurate and that all dividends and distributions are reinvested at NAV. Actual expenses may be greater or less than those assumed. Moreover,
the Trusts actual rate of return may be greater or less than the hypothetical 5% return shown in the example.
6
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand the Trusts financial performance. Information is shown
since the commencement of the Trusts operations on October 30, 2014. Certain information reflects financial results for a single Trust Share. The information for the fiscal years ended December 31, 2021, 2020, 2019, 2018 and 2017 has
been audited by Deloitte & Touche LLP, independent registered public accounting firm for the Trust. The report of Deloitte & Touche LLP is included in the Trusts December 31, 2021 Annual Report, and is incorporated by
reference into the Prospectus and SAI.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2021(a) |
|
|
2020(a) |
|
|
2019 |
|
|
2018 |
|
|
2017 |
|
Net asset value, beginning of year |
|
$ |
51.94 |
|
|
$ |
32.45 |
|
|
$ |
26.21 |
|
|
$ |
27.73 |
|
|
$ |
20.10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment loss(b) |
|
|
(0.43 |
) |
|
|
(0.28 |
) |
|
|
(0.17 |
) |
|
|
(0.13 |
) |
|
|
(0.05 |
) |
Net realized and unrealized gain |
|
|
5.84 |
|
|
|
21.82 |
|
|
|
9.92 |
|
|
|
0.37 |
|
|
|
8.96 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase from investment operations |
|
|
5.41 |
|
|
|
21.54 |
|
|
|
9.75 |
|
|
|
0.24 |
|
|
|
8.91 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions(c) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
From net investment income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(d) |
|
|
(0.05 |
) |
From net realized gain |
|
|
(4.27 |
) |
|
|
(2.05 |
) |
|
|
(3.51 |
) |
|
|
(1.76 |
)(d) |
|
|
(0.22 |
) |
Return of capital |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1.01 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total distributions |
|
|
(4.27 |
) |
|
|
(2.05 |
) |
|
|
(3.51 |
) |
|
|
(1.76 |
) |
|
|
(1.28 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dilutive effect of rights offer (Note 10) |
|
|
(0.68 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net asset value, end of year |
|
$ |
52.40 |
|
|
$ |
51.94 |
|
|
$ |
32.45 |
|
|
$ |
26.21 |
|
|
$ |
27.73 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market price, end of year |
|
$ |
49.97 |
|
|
$ |
53.30 |
|
|
$ |
33.27 |
|
|
$ |
27.48 |
|
|
$ |
26.69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Return(e) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Based on net asset value |
|
|
9.44 |
% |
|
|
68.76 |
%(f) |
|
|
37.82 |
% |
|
|
0.24 |
% |
|
|
45.73 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Based on market price |
|
|
1.70 |
% |
|
|
68.92 |
% |
|
|
34.77 |
% |
|
|
9.18 |
% |
|
|
57.15 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios to Average Net
Assets(g) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses |
|
|
1.05 |
% |
|
|
1.09 |
% |
|
|
1.08 |
% |
|
|
1.09 |
% |
|
|
1.09 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses after fees waived and/or reimbursed |
|
|
1.00 |
% |
|
|
0.99 |
% |
|
|
0.92 |
% |
|
|
0.89 |
% |
|
|
0.89 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment loss |
|
|
(0.78 |
)% |
|
|
(0.73 |
)% |
|
|
(0.52 |
)% |
|
|
(0.43 |
)% |
|
|
(0.19 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Data |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net assets, end of year (000) |
|
$ |
1,681,166 |
|
|
$ |
1,297,344 |
|
|
$ |
742,672 |
|
|
$ |
587,908 |
|
|
$ |
620,300 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Portfolio turnover rate |
|
|
31 |
% |
|
|
20 |
% |
|
|
32 |
% |
|
|
53 |
% |
|
|
41 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
Consolidated Financial Highlights. |
(b) |
Based on average shares outstanding. |
(c) |
Distributions for annual periods determined in accordance with U.S. federal income tax regulations.
|
(d) |
Amount previously presented incorrectly as solely distributions from net investment income has been revised
to reflect the proper classification of distributions between net realized gain and net investment income. |
(e) |
Total returns based on market price, which can be significantly greater or less than the net asset value, may
result in substantially different returns. Where applicable, excludes the effects of any sales charges and assumes the reinvestment of distributions at actual reinvestment prices. |
(f) |
For financial reporting purposes, the market value of a certain investment was adjusted as of the report
date. Accordingly, the net asset value (NAV) per share and total return performance based on NAV presented herein are different than the information previously published as of December 31, 2020. |
(g) |
Excludes fees and expenses incurred indirectly as a result of investments in underlying funds.
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
Period October 30, 20141 to December 31, 2014 |
|
|
|
2016 |
|
|
2015 |
|
Per Share Operating Performance |
|
|
|
|
|
|
|
|
|
|
|
|
Net asset value, beginning of period |
|
$ |
19.70 |
|
|
$ |
19.43 |
|
|
$ |
19.10 |
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income (loss)3 |
|
|
0.00 |
4 |
|
|
0.03 |
|
|
|
(0.01 |
) |
Net realized and unrealized gain (loss) |
|
|
1.60 |
|
|
|
1.44 |
|
|
|
0.48 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase from investment operations |
|
|
1.60 |
|
|
|
1.47 |
|
|
|
0.47 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions:5 |
|
|
|
|
|
|
|
|
|
|
|
|
From net investment income |
|
|
|
|
|
|
(0.03 |
) |
|
|
(0.00 |
)6 |
In excess of net investment income |
|
|
|
|
|
|
(0.01 |
) |
|
|
|
|
From return of capital |
|
|
(1.20 |
) |
|
|
(1.16 |
) |
|
|
(0.10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total distributions |
|
|
(1.20 |
) |
|
|
(1.20 |
) |
|
|
(0.10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital Charges with respect to the issuance of Shares |
|
|
|
|
|
|
|
|
|
|
(0.04 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net asset value, end of period |
|
$ |
20.10 |
|
|
$ |
19.70 |
|
|
$ |
19.43 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market price, end of period |
|
$ |
17.94 |
|
|
$ |
17.31 |
|
|
$ |
17.59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Return7 |
|
|
|
|
|
|
|
|
|
|
|
|
Based on net asset value |
|
|
9.36 |
% |
|
|
8.61 |
% |
|
|
2.31 |
%8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Based on market price |
|
|
11.08 |
% |
|
|
5.36 |
% |
|
|
(11.55 |
)%8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratios to Average Net Assets |
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses |
|
|
1.10 |
% |
|
|
1.12 |
% |
|
|
1.19 |
%9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total expenses after fees waived and paid indirectly |
|
|
0.90 |
% |
|
|
0.92 |
% |
|
|
0.97 |
%9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income (loss) |
|
|
0.02 |
% |
|
|
0.15 |
% |
|
|
(0.24 |
)%9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Data |
|
|
|
|
|
|
|
|
|
|
|
|
Net assets, end of period (000) |
|
$ |
452,443 |
|
|
$ |
443,477 |
|
|
$ |
437,380 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Portfolio turnover rate |
|
|
74 |
% |
|
|
91 |
% |
|
|
7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
1 |
Commencement of investment operations. This information includes the initial investment by BlackRock HoldCo2,
Inc. |
2 |
Net asset value, beginning of period, reflects a deduction of $0.8975 per share sales charge from the initial
offering price of $20.00 per share. |
3 |
Based on average shares outstanding. |
4 |
Amount is less than $0.005 per share. |
5 |
Distributions for annual periods determined in accordance with federal income tax regulations.
|
6 |
Amount is greater than $(0.005) per share. |
7 |
Total returns based on market price, which can be significantly greater or less than the net asset value, may
result in substantially different returns. Where applicable, excludes the effects of any sales charges and assumes the reinvestment of distributions. |
8 |
Aggregate total return. |
8
USE OF PROCEEDS
The net proceeds from the issuance of common shares hereunder will be invested in accordance with the Trusts investment
objectives and policies as stated below. We currently anticipate that we will be able to invest all of the net proceeds in accordance with our investment objectives and policies within approximately three months from the date on which the proceeds
from an offering are received by the Trust. Pending such investment, it is anticipated that the proceeds will be invested in short-term investment grade securities or in high quality, short-term money market instruments.
THE TRUST
The Trust is a diversified, closed-end management investment company registered under
the Investment Company Act. The Trust was formed as a Delaware statutory trust on August 13, 2014, pursuant to a Certificate of Trust, governed by the laws of the State of Delaware, and the Certificate of Trust filed with the Secretary of State
of the State of Delaware. The Trusts principal office is located at 100 Bellevue Parkway, Wilmington, Delaware 19809, and its telephone number is (800) 882-0052.
The Trust commenced operations on October 30, 2014, upon the initiation of an initial public offering of 21,000,000 of
its common shares. The proceeds of such offering were approximately $400,260,000 million after the payment of organizational and offering expenses. Subsequent to the Trusts initial public offering, the Trust issued an additional 1,500,000
of its common shares in connection with the exercise by the underwriters of the over-allotment option. The Trusts common shares are traded on the NYSE under the symbol BST.
DESCRIPTION OF SHARES
Common Shares
The Trust
is a statutory trust formed under the laws of Delaware pursuant to a Certificate of Trust, dated as of August 13, 2014, and an Agreement and Declaration of Trust, dated as of August 13, 2014 and as amended from time to time (the
Agreement and Declaration of Trust). The Trust is authorized to issue an unlimited number of common shares of beneficial interest, par value $0.001 per share. Each common share has one vote and, when issued and paid for in accordance
with the terms of this offering, will be fully paid and, under the Delaware Statutory Trust Act, the purchasers of the common shares will have no obligation to make further payments for the purchase of the common shares or contributions to the Trust
solely by reason of their ownership of the common shares, except that the Trustees shall have the power to cause shareholders to pay certain expenses of the Trust by setting off charges due from shareholders from declared but unpaid dividends or
distributions owed the shareholders and/or by reducing the number of common shares owned by each respective shareholder. If and whenever preferred shares are outstanding, the holders of common shares will not be entitled to receive any distributions
from the Trust unless all accrued dividends on preferred shares have been paid, unless asset coverage (as defined in the Investment Company Act) with respect to preferred shares would be at least 200% after giving effect to the distributions and
unless certain other requirements imposed by any rating agencies rating the preferred shares have been met. See Description of SharesPreferred Shares in the SAI. All common shares are equal as to dividends, assets and voting
privileges and have no conversion, preemptive or other subscription rights. The Trust will send annual and semi-annual reports, including financial statements, to all holders of its shares.
Unlike open-end funds, closed-end funds like
the Trust do not continuously offer shares and do not provide daily redemptions. Rather, if a shareholder determines to buy additional common shares or sell shares already held, the shareholder may do so by trading through a broker on the NYSE or
otherwise. Shares of closed-end investment companies frequently trade on an exchange at prices lower than NAV. Shares of closed-end
9
investment companies like the Trust have during some periods traded at prices higher than NAV and during other periods have traded at prices lower than NAV. Because the market value of the common
shares may be influenced by such factors as dividend levels (which are in turn affected by expenses), call protection on its portfolio securities, dividend stability, portfolio credit quality, the Trusts NAV, relative demand for and supply of
such shares in the market, general market and economic conditions and other factors beyond the control of the Trust, the Trust cannot assure you that common shares will trade at a price equal to or higher than NAV in the future. The common shares
are designed primarily for long-term investors and you should not purchase the common shares if you intend to sell them soon after purchase. See Repurchase of Common Shares below and Repurchase of Common Shares in the SAI.
The Trusts outstanding common shares are, and when issued, the common shares offered by this Prospectus will be,
publicly held and listed and traded on the NYSE under the symbol BST. The Trust determines its NAV on a daily basis. The following table sets forth, for the quarters indicated, the highest and lowest daily closing prices on the NYSE per
common share, and the NAV per common share and the premium to or discount from NAV, on the date of each of the high and low market prices. The table also sets forth the number of common shares traded on the NYSE during the respective quarters.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NYSE Market Price Per Common Share |
|
|
NAV per Common Share on Date of Market Price |
|
|
Premium/ (Discount) on Date of Market Price |
|
|
Trading Volume |
|
During Quarter Ended |
|
High |
|
|
Low |
|
|
High |
|
|
Low |
|
|
High |
|
|
Low |
|
March 31, 2022 |
|
$ |
50.99 |
|
|
$ |
40.14 |
|
|
$ |
52.59 |
|
|
$ |
42.32 |
|
|
|
(3.00 |
)% |
|
|
(5.20 |
)% |
|
|
11,617,438 |
|
December 31, 2021 |
|
$ |
55.87 |
|
|
$ |
47.30 |
|
|
$ |
58.61 |
|
|
$ |
50.49 |
|
|
|
(4.70 |
)% |
|
|
(6.30 |
)% |
|
|
10,212,196 |
|
September 30, 2021 |
|
$ |
59.51 |
|
|
$ |
51.84 |
|
|
$ |
55.80 |
|
|
$ |
54.24 |
|
|
|
6.60 |
% |
|
|
(4.40 |
)% |
|
|
10,053,189 |
|
June 30, 2021 |
|
$ |
60.19 |
|
|
$ |
53.81 |
|
|
$ |
53.77 |
|
|
$ |
49.61 |
|
|
|
11.90 |
% |
|
|
8.50 |
% |
|
|
5,123,462 |
|
March 31, 2021 |
|
$ |
61.14 |
|
|
$ |
50.99 |
|
|
$ |
57.77 |
|
|
$ |
49.26 |
|
|
|
5.80 |
% |
|
|
3.50 |
% |
|
|
6,483,722 |
|
December 31, 2020 |
|
$ |
53.94 |
|
|
$ |
42.02 |
|
|
$ |
52.42 |
|
|
$ |
43.44 |
|
|
|
2.90 |
% |
|
|
(3.30 |
)% |
|
|
5,871,901 |
|
September 30, 2020 |
|
$ |
45.42 |
|
|
$ |
38.30 |
|
|
$ |
44.23 |
|
|
$ |
38.67 |
|
|
|
2.70 |
% |
|
|
(1.00 |
)% |
|
|
6,384,101 |
|
June 30, 2020 |
|
$ |
38.34 |
|
|
$ |
27.50 |
|
|
$ |
38.33 |
|
|
$ |
27.50 |
|
|
|
0.03 |
% |
|
|
0.00 |
% |
|
|
8,237,684 |
|
March 31, 2020 |
|
$ |
35.70 |
|
|
$ |
23.44 |
|
|
$ |
34.07 |
|
|
$ |
25.58 |
|
|
|
4.80 |
% |
|
|
(8.40 |
)% |
|
|
9,910,900 |
|
As of May 3, 2022, the NAV per common share of the Trust was $40.30 and the market price per
common share was $38.78, representing a discount to NAV of 3.77%. Common shares of the Trust have historically traded at both a premium and discount to NAV.
As of May 3, 2022, the Trust has 32,083,371 outstanding common shares.
Preferred Shares
The
Agreement and Declaration of Trust provides that the Board may authorize and issue preferred shares, with rights as determined by the Board, by action of the Board without the approval of the holders of the common shares. Holders of common shares
have no preemptive right to purchase any preferred shares that might be issued. The Trust does not currently intend to issue preferred shares.
Under the Investment Company Act, the Trust is not permitted to issue preferred shares unless immediately after such issuance
the value of the Trusts total assets is at least 200% of the liquidation value of the outstanding preferred shares (i.e., the liquidation value may not exceed 50% of the Trusts total assets). In addition, the Trust is not permitted to
declare any cash dividend or other distribution on its common shares unless, at the time of such declaration, the value of the Trusts total assets is at least 200% of such liquidation value. If the Trust issues preferred shares, it may be
subject to restrictions imposed by the guidelines of one or more rating agencies that may issue ratings for preferred shares issued by the Trust. These guidelines may impose asset coverage or portfolio composition requirements that are more
stringent than those imposed on the Trust by the Investment
10
Company Act. It is not anticipated that these covenants or guidelines would impede the Advisor from managing the Trusts portfolio in accordance with the Trusts investment objectives
and policies. Please see Description of Shares in the SAI for more information.
Authorized Shares
The following table provides the Trusts authorized shares and common shares outstanding as of April 19, 2022.
|
|
|
|
|
|
|
|
|
|
|
|
|
Title of Class |
|
Amount Authorized |
|
|
Amount Held by Trust or for its Account |
|
|
Amount Outstanding Exclusive of Amount held by Trust |
|
Common Shares |
|
|
Unlimited |
|
|
|
0 |
|
|
|
32,083,371 |
|
THE TRUSTS INVESTMENTS
Investment Objectives and Policies
Please refer to the section
of the Trusts most recent annual report on Form N-CSR entitled Investment Objectives, Policies and RisksInvestment Objectives and PoliciesBlackRock Science and Technology Trust
(BST), which is incorporated by reference herein, for a discussion of the Trusts investment objective and policies.
Portfolio Contents
and Techniques
The Trusts portfolio will be composed principally of the following investments. Additional
information with respect to the Trusts investment policies and restrictions and certain of the Trusts portfolio investments is contained in the SAI. There is no guarantee the Trust will buy all of the types of securities or use all of
the investment techniques that are described herein and in the SAI.
Equity Securities. The Trust invests in
equity securities, including common stocks, preferred stocks, convertible securities, warrants, depositary receipts, ETFs and equity interests in REITs and MLPs. Common stock represents an equity ownership interest in a company. The Trust may hold
or have exposure to common stocks of issuers of any size, including small and medium capitalization stocks. Because the Trust will ordinarily have exposure to common stocks, historical trends would indicate that the Trusts portfolio and
investment returns will be subject at times, and over time, to higher levels of volatility and market and issuer-specific risk than if it invested exclusively in debt securities. The Trust intends to also employ a strategy, as described below, of
writing call and put options on common stocks.
Options. An option on a security is a contract that gives
the holder of the option, in return for a premium, the right to buy from (in the case of a call) or sell to (in the case of a put) the writer of the option the security underlying the option at a specified exercise or strike price. The
writer of an option on a security has the obligation upon exercise of the option to deliver the underlying security upon payment of the exercise price or to pay the exercise price upon delivery of the underlying security. Certain options, known as
American style options may be exercised at any time during the term of the option. Other options, known as European style options, may be exercised only on the expiration date of the option. As the writer of an option, the
Trust would effectively add leverage to its portfolio because, in addition to its Managed Assets, the Trust would be subject to investment exposure on the value of the assets underlying the option.
If an option written by the Trust expires unexercised, the Trust realizes on the expiration date a capital gain equal to the
premium received by the Trust at the time the option was written. If an option purchased by the Trust
11
expires unexercised, the Trust realizes a capital loss equal to the premium paid. Prior to the earlier of exercise or expiration, an exchange-traded option may be closed out by an offsetting
purchase or sale of an option of the same series (type, underlying security, exercise price and expiration). There can be no assurance, however, that a closing purchase or sale transaction can be effected when the Trust desires. The Trust may sell
call or put options it has previously purchased, which could result in a net gain or loss depending on whether the amount realized on the sale is more or less than the premium and other transaction costs paid on the call or put option when
purchased. The Trust will realize a capital gain from a closing purchase transaction if the cost of the closing transaction is less than the premium received from writing the option, or, if it is more, the Trust will realize a capital loss. If the
premium received from a closing sale transaction is more than the premium paid to purchase the option, the Trust will realize a capital gain or, if it is less, the Trust will realize a capital loss. Net gains from the Trusts options strategy
will be short-term capital gains which, for U.S. federal income tax purposes, will constitute net investment company taxable income.
Call Options. The Trust intends to follow a call options writing strategy intended to generate current gains
from options premiums and to enhance the Trusts risk-adjusted returns. The strategy involves writing both covered and other call options. A call option written by the Trust on a security is considered a covered call option where the Trust owns
the security underlying the call option. Unlike a written covered call option, other written options will not provide the Trust with any potential appreciation on an underlying security to offset any loss the Trust may experience if the option is
exercised.
As the Trust writes covered call options on its portfolio, it may not be able to benefit from capital
appreciation on the underlying securities, as the Trust will lose its ability from such capital appreciation to the extent that it writes covered call options and the securities on which it writes these options appreciate above the exercise prices
of the options. Therefore, at times, the Advisor may choose to decrease the use of a covered call options writing strategy to the extent that it may negatively impact the Trusts ability to benefit from capital appreciation.
For any written call option where the Trust does not own the underlying security, the Trust may have an absolute and immediate
right to acquire that security upon conversion or exchange of other securities held by the Trust without additional cash consideration (or, if additional cash consideration is required, cash or liquid securities in such amount are segregated on the
Trusts books) or the Trust may hold a call on the same security where the exercise price of the call held is (i) equal to or less than the exercise price of the call written, or (ii) greater than the exercise price of the call
written, provided cash or liquid securities in an amount equal to the difference is segregated on the Trusts books.
The standard contract size for a single exchange-listed option is 100 shares of the common stock. There are four items needed
to identify any option: (1) the underlying security, (2) the expiration month, (3) the strike price and (4) the type (call or put). For example, ten XYZ Co. October 40 call options provide the right to purchase 1,000 shares of
XYZ Co. on or before a specified date in October at $40.00 per share. A call option whose strike price is above the current price of the underlying stock is called out-of-the-money. Most of the options that will be sold by the Trust are expected to be
out-of-the-money, allowing for potential appreciation in addition to the proceeds from the sale of the option. An option whose
strike price is below the current price of the underlying stock is called in-the-money and could be sold by the Trust as a defensive measure to protect
against a possible decline in the underlying stock.
The following is a conceptual example of a covered call transaction,
making the following assumptions: (1) a common stock currently trading at $37.15 per share; (2) a six-month call option is written with a strike price of $40.00 (i.e., 7.7% higher than the current
market price); and (3) the writer receives $2.45 (or 6.6%) of the common stocks value as a premium. This example is not meant to represent the performance of any actual common stock, option contract or the Trust itself and does not
reflect any transaction costs of entering into or closing out the option position. Under this scenario, before giving effect to any change in the price of the stock, the covered call writer receives the premium, representing 6.6% of the common
stocks value, regardless of the
12
stocks performance over the six-month period until option expiration. If the stock remains unchanged, the option will expire and there would be a
6.6% return for the six-month period. See Tax MattersTaxation of the TrustThe Trusts Investments. If the stock were to decline in price by 6.6%, the strategy would
break-even thus offering no gain or loss. If the stock were to climb to a price of $40.00 or above, the option would be exercised and the stock would return 7.7% coupled with the option premium of 6.6% for a total return of 14.3%. Under
this scenario, the investor would not benefit from any appreciation of the stock above $40.00, and thus be limited to a 14.3% total return. The premium from writing the covered call option serves to offset some of the unrealized loss on the stock in
the event that the price of the stock declines, but if the stock were to decline more than 6.6% under this scenario, the investor does not have protection from further declines and the stock could eventually become worthless.
For conventional exchange-listed listed call options, the options expiration date can be up to nine months from the date
the call options are first listed for trading. Longer-term call options can have expiration dates up to three years from the date of listing. It is anticipated that, under certain circumstances when deemed at the Advisors discretion to be in
the best interest of the Trust, options that are written against Trust stock holdings will be repurchased in a closing transaction prior to the options expiration date, generating a gain or loss in the options. If the options were not to be
repurchased, the option holder would exercise their rights and buy the stock from the Trust at the strike price if the stock traded at a higher price than the strike price. In general, when deemed at the Advisors discretion to be in the best
interests of the Trust, the Trust may enter into transactions, including closing transactions, that would allow it to continue to hold its common stocks rather than allowing them to be called away by the option holders.
Put Options. Put options are contracts that give the holder of the option, in return for a premium, the right to
sell to the writer of the option the security underlying the option at a specified exercise price at any time during the term of the option. Put option strategies may produce a higher return than covered call writing, but may involve a higher degree
of risk and potential volatility.
When writing a put option on a security, the Trust will segregate on its books cash or
liquid securities in an amount equal to the option exercise price or the Trust may hold a put option on the same security as the put written where the exercise price of the put held is (i) equal to or greater than the exercise price of the put
written, or (ii) less than the exercise price of the put written, provided an amount equal to the difference in cash or liquid securities is segregated on the Trusts books. Unlike a covered call option, a put option written in this manner
will not provide the Trust with any appreciation to offset any loss the Trust experiences if the put option is exercised.
The following is a conceptual example of a put transaction, making the following assumptions: (1) a common stock
currently trading at $37.15 per share; (2) a six-month put option written with a strike price of $35.00 (i.e., 94.21% of the current market price); and (3) the writer receives $1.10 or 2.96% of the
common stocks value as a premium. This example is not meant to represent the performance of any actual common stock, option contract or the Trust itself and does not reflect any transaction costs of entering into or closing out the option
position. Under this scenario, before giving effect to any change in the price of the stock, the put writer receives the premium, representing 2.96% of the common stocks value, regardless of the stocks performance over the six-month period until the option expires. If the stock remains unchanged, appreciates in value or declines less than 5.79% in value, the option will expire and there would be a 2.96% return for the six-month period. If the stock were to decline by 5.79% or more, the Trust would lose an amount equal to the amount by which the stocks price declined minus the premium paid to the Trust. The stocks
price could lose its entire value, in which case the Trust would lose $33.90 ($35.00 minus $1.10).
Options on
Indices. The Trust may write index call and put options. Because index options includes both options on indices of securities and sectors of securities, all types of index options generally have similar characteristics. Index
options differ from options on individual securities because (i) the exercise of an index option requires cash payments and does not involve the actual purchase or sale of securities, (ii) the holder of an
13
index option has the right to receive cash upon exercise of the option if the level of the index upon which the option is based is greater, in the case of a call, or less, in the case of a put,
than the exercise price of the option and (iii) index options reflect price fluctuations in a group of securities or segments of the securities market rather than price fluctuations in a single security.
As the writer of an index call or put option, the Trust receives cash (the premium) from the purchaser. The purchaser of an
index call option has the right to any appreciation in the value of the index over a fixed price (the exercise price) on or before a certain date in the future (the expiration date). The purchaser of an index put option has the right to any
depreciation in the value of the index below a fixed price (the exercise price) on or before a certain date in the future (the expiration date). The Trust, in effect, agrees to sell the potential appreciation (in the case of a call) or accept the
potential depreciation (in the case of a put) in the value of the relevant index in exchange for the premium. If, at or before expiration, the purchaser exercises the call or put option written by the Trust, the Trust will pay the purchaser the
difference between the cash value of the index and the exercise price of the index option. The premium, the exercise price and the market value of the index determine the gain or loss realized by the Trust as the writer of the index call or put
option.
The Trust may execute a closing purchase transaction with respect to an index option it has sold and write
another option (with either a different exercise price or expiration date or both). The Trusts objective in entering into such a closing transaction will be to optimize net index option premiums. The cost of a closing transaction may reduce
the net index option premiums realized from writing the index option.
When writing an index put option, the Trust will
segregate on its books cash or liquid securities in an amount equal to the exercise price, or the Trust may hold a put on the same basket of securities as the put written where the exercise price of the put held is (i) equal to or more than the
exercise price of the put written, or (ii) less than the exercise price of the put written, provided an amount equal to the difference in cash or liquid securities is segregated on the Trusts books. When writing an index call option, the
Trust will segregate on its books cash or liquid securities in an amount equal to the excess of the value of the applicable basket of securities over the exercise price, or the Trust may hold a call on the same basket of securities as the call
written where the exercise price of the call held is (i) equal to or less than the exercise price of the call written, or (ii) greater than the exercise price of the call written, provided an amount equal to the difference in cash or
liquid securities is segregated on the Trusts books.
Limitation on Options Writing Strategy. The
Trust may write put and call options, the notional amount of which would be approximately 10% to 40% of the Trusts total assets, although this percentage may vary from time to time with market conditions. Under current market conditions, the
Trust anticipates writing put and call options, the notional amount of which would be approximately 33% of the Trusts total assets. The Trust generally writes options that are out of the moneyin other words, the strike price
of a written call option will be greater than the market price of the underlying security on the date that the option is written, or, for a written put option, less than the market price of the underlying security on the date that the option is
written; however, the Trust may also write in the money options for defensive or other purposes.
The number
of put and call options on securities the Trust can write is limited by the total assets the Trust holds. The Trusts exchange-listed option transactions will be subject to limitations established by each of the exchanges, boards of trade or
other trading facilities on which such options are traded and cleared. These limitations govern the maximum number of options in each class which may be written or purchased by a single investor or group of investors acting in concert, regardless of
whether the options are written or purchased on the same or different exchanges, boards of trade or other trading facilities or are held or written in one or more accounts or through one or more brokers. Thus, the number of options which the Trust
may write or purchase may be affected by options written or purchased by other investment advisory clients of the Advisor. An exchange, board of trade or other trading facility may order the liquidation of positions found to be in excess of these
limits, and it may impose certain other sanctions.
14
Preferred Securities. The Trust may invest in preferred securities.
There are two basic types of preferred securities. The first type, sometimes referred to as traditional preferred securities, consists of preferred stock issued by an entity taxable as a corporation. The second type, sometimes referred to as trust
preferred securities, are usually issued by a trust or limited partnership and represent preferred interests in deeply subordinated debt instruments issued by the corporation for whose benefit the trust or partnership was established.
Traditional Preferred Securities. Traditional preferred securities generally pay fixed or adjustable rate
dividends to investors and generally have a preference over common stock in the payment of dividends and the liquidation of a companys assets. This means that a company must pay dividends on preferred stock before paying any
dividends on its common stock. In order to be payable, distributions on such preferred securities must be declared by the issuers board of directors. Income payments on typical preferred securities currently outstanding are cumulative, causing
dividends and distributions to accumulate even if not declared by the board of directors or otherwise made payable. In such a case all accumulated dividends must be paid before any dividend on the common stock can be paid. However, some traditional
preferred stocks are non-cumulative, in which case dividends do not accumulate and need not ever be paid. A portion of the portfolio may include investments in
non-cumulative preferred securities, whereby the issuer does not have an obligation to make up any arrearages to its shareholders. Should an issuer of a non-cumulative
preferred stock held by the Trust determine not to pay dividends on such stock, the amount of dividends the Trust pays may be adversely affected. There is no assurance that dividends or distributions on the preferred securities in which the Trust
invests will be declared or otherwise made payable.
Preferred stockholders usually have no right to vote for corporate
directors or on other matters. Shares of preferred stock have a liquidation value that generally equals the original purchase price at the date of issuance. The market value of preferred securities may be affected by favorable and unfavorable
changes impacting companies in the utilities and financial services sectors, which are prominent issuers of preferred securities, and by actual and anticipated changes in tax laws, such as changes in corporate income tax rates or the Dividends
Received Deduction. Because the claim on an issuers earnings represented by preferred securities may become onerous when interest rates fall below the rate payable on such securities, the issuer may redeem the securities. Thus, in
declining interest rate environments in particular, the Trusts holdings, if any, of higher rate-paying fixed rate preferred securities may be reduced and the Trust may be unable to acquire securities of comparable credit quality paying
comparable rates with the redemption proceeds.
Trust Preferred Securities. Trust preferred securities are
typically issued by corporations, generally in the form of interest-bearing notes with preferred security 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 or the beneficiary of 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 eighteen months or more without triggering an event of
default. Generally, the deferral period is five years or more. 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 have many of the key characteristics of equity due to their subordinated position in an issuers capital structure and because
their quality and value are heavily dependent on the profitability of the issuer rather than on any legal claims to specific assets or cash flows.
Convertible Securities. A convertible security is a bond, debenture, note, preferred stock or other security
that may be converted into or exchanged for a prescribed amount of common stock or other equity security of the
15
same or a different issuer within a particular period of time at a specified price or formula. A convertible security entitles the holder to receive interest paid or accrued on debt or the
dividend paid on preferred stock until the convertible security matures or is redeemed, converted or exchanged. Before conversion, convertible securities have characteristics similar to nonconvertible income securities in that they ordinarily
provide a stable stream of income with generally higher yields than those of common stocks of the same or similar issuers, but lower yields than comparable nonconvertible securities. The value of a convertible security is influenced by changes in
interest rates, with investment value declining as interest rates increase and increasing as interest rates decline. The credit standing of the issuer and other factors also may have an effect on the convertible securitys investment value.
Convertible securities rank senior to common stock in a corporations capital structure but are usually subordinated to comparable nonconvertible securities. Convertible securities may be subject to redemption at the option of the issuer at a
price established in the convertible securitys governing instrument.
A synthetic or
manufactured convertible security may be created by the Trust or by a third party by combining separate securities that possess the two principal characteristics of a traditional convertible security: an income producing component and a
convertible component. The income-producing component is achieved by investing in non-convertible, income-producing securities such as bonds, preferred stocks and money market instruments. The convertible
component is achieved by investing in securities or instruments such as warrants or options to buy common stock at a certain exercise price, or options on a stock index. Unlike a traditional convertible security, which is a single security having a
single market value, a synthetic convertible comprises two or more separate securities, each with its own market value. Because the market value of a synthetic convertible security is the sum of the values of its income-producing
component and its convertible component, the value of a synthetic convertible security may respond differently to market fluctuations than a traditional convertible security. The Trust also may purchase synthetic convertible securities created by
other parties, including convertible structured notes. Convertible structured notes are income-producing debentures linked to equity. Convertible structured notes have the attributes of a convertible security; however, the issuer of the convertible
note (typically an investment bank), rather than the issuer of the underlying common stock into which the note is convertible, assumes credit risk associated with the underlying investment and the Trust in turn assumes credit risk associated with
the issuer of the convertible note.
Warrants. Warrants are instruments issued by corporations enabling the owners
to subscribe to and purchase a specified number of shares of the corporation at a specified price during a specified period of time. Warrants normally have a short life span to expiration. The purchase of warrants involves the risk that the Trust
could lose the purchase value of a warrant if the right to subscribe to additional shares is not exercised prior to the warrants expiration. Also, the purchase of warrants involves the risk that the effective price paid for the warrant added
to the subscription price of the related security may exceed the subscribed securitys market price such as when there is no movement in the level of the underlying security.
Depositary Receipts. The Trust may invest in sponsored and unsponsored ADRs, EDRs, GDRs and other similar global
instruments. ADRs typically are issued by a U.S. bank or trust company and evidence ownership of underlying securities issued by a non-U.S. corporation. EDRs, which are sometimes referred to as Continental
Depositary Receipts, are receipts issued in Europe, typically by non-U.S. banks and trust companies, that evidence ownership of either non-U.S. or domestic underlying
securities. GDRs are depositary receipts structured like global debt issues to facilitate trading on an international basis.
Non-U.S. Securities. The Trust may invest without limit in Non-U.S. Securities. These securities may be U.S. dollar-denominated or non-U.S. dollar-denominated. Some Non-U.S. Securities may be
less liquid and more volatile than securities of comparable U.S. issuers. Similarly, there is less volume and liquidity in most foreign securities markets than in the United States and, at times, greater price volatility than in the United States.
Because evidence of ownership of such securities usually is held outside the United States, the Trust will be subject to additional risks if it invests in Non-U.S. Securities, which include adverse political
and economic developments, seizure or nationalization of foreign deposits and adoption of governmental restrictions which might adversely affect or restrict the payment of principal and interest or dividends on the foreign securities to
16
investors located outside the country of the issuer, whether from currency blockage or otherwise. Non-U.S. Securities may trade on days when the common
shares are not priced or traded.
Emerging Markets Investments. The Trust may invest without limitation in
securities of issuers located in emerging market countries, including securities denominated in currencies of emerging market countries. Emerging market countries generally include every nation in the world except the United States, Canada, Japan,
Australia, New Zealand and most countries located in Western Europe. These issuers may be subject to risks that do not apply to issuers in larger, more developed countries. These risks are more pronounced to the extent the Trust invests
significantly in one country. Less information about emerging market issuers or markets may be available due to less rigorous disclosure and accounting standards or regulatory practices. Emerging markets are smaller, less liquid and more volatile
than U.S. markets. In a changing market, the Advisor may not be able to sell the Trusts portfolio securities in amounts and at prices it considers reasonable. The U.S. dollar may appreciate against
non-U.S. currencies or an emerging market government may impose restrictions on currency conversion or trading. The economies of emerging market countries may grow at a slower rate than expected or may
experience a downturn or recession. Economic, political and social developments may adversely affect non-U.S. securities markets.
Restricted and Illiquid Investments. The Trust may invest without limitation in illiquid or less liquid
investments or investments in which no secondary market is readily available or which are otherwise illiquid, including private placement securities. Liquidity of an investment relates to the ability to dispose easily of the investment and the price
to be obtained upon disposition of the investment, which may be less than would be obtained for a comparable more liquid investment. Illiquid investments are investments which cannot be sold within seven days in the ordinary course of
business at approximately the value used by the Trust in determining its NAV. Illiquid investments may trade at a discount from comparable, more liquid investments. Illiquid investments are subject to legal or contractual restrictions on disposition
or lack an established secondary trading market. Investment of the Trusts assets in illiquid investments may restrict the ability of the Trust to dispose of its investments in a timely fashion and for a fair price as well as its ability to
take advantage of market opportunities.
Private Company Investments. At any given time the Trust
anticipates making investments in carefully selected private company investments that the Trust may need to hold for several years or longer. The Trust may invest in equity securities or debt securities, including debt securities issued with
warrants to purchase equity securities or that are convertible into equity securities, of private companies. The Trust may enter into private company investments identified by the Advisor or may co-invest in
private company investment opportunities owned or identified by other third party investors, such as private equity firms, with which neither the Trust nor the Advisor is affiliated. However, the Trust will not invest in private equity funds or
other privately offered pooled investment funds.
Other Investment Companies. The Trust may invest in
securities of other investment companies (including ETFs and BDCs), subject to applicable regulatory limits, that invest primarily in securities of the types in which the Trust may invest directly. As a shareholder in an investment company, the
Trust will bear its ratable share of that investment companys expenses and will remain subject to payment of the Trusts advisory and other fees and expenses with respect to assets so invested. Holders of common shares will therefore be
subject to duplicative expenses to the extent the Trust invests in other investment companies. The Advisor will take expenses into account when evaluating the investment merits of an investment in an investment company relative to available equity
and/or fixed income securities investments. In addition, the securities of other investment companies may be leveraged and will therefore be subject to the same leverage risks to which the Trust may be subject to the extent it employs a leverage
strategy. The NAV and market value of leveraged shares will be more volatile and the yield to shareholders will tend to fluctuate more than the yield generated by unleveraged shares. Investment companies may have investment policies that differ from
those of the Trust. In addition, to the extent the Trust invests in other investment companies, the Trust will be dependent upon the investment and research abilities of persons other than the Advisor.
17
The Trust may invest in ETFs, which are investment companies that typically aim
to track or replicate a desired index, such as a sector, market or global segment. ETFs are typically passively managed and their shares are traded on a national exchange or The NASDAQ Stock Market, Inc. ETFs do not sell individual shares directly
to investors and only issue their shares in large blocks known as creation units. The investor purchasing a creation unit may sell the individual shares on a secondary market. Therefore, the liquidity of ETFs depends on the adequacy of
the secondary market. There can be no assurance that an ETFs investment objective will be achieved, as ETFs based on an index may not replicate and maintain exactly the composition and relative weightings of securities in the index. ETFs are
subject to the risks of investing in the underlying securities. The Trust, as a holder of the securities of the ETF, will bear its pro rata portion of the ETFs expenses, including advisory fees. These expenses are in addition to the direct
expenses of the Trusts own operations.
REITs. REITs are subject to certain risks which differ from an
investment in common stocks. REITs are financial vehicles that pool investors capital to purchase or finance real estate. REITs may concentrate their investments in specific geographic areas or in specific property types (e.g., hotels,
shopping malls, residential complexes and office buildings). The market value of REIT shares and the ability of REITs to distribute income may be adversely affected by several factors, including rising interest rates, changes in the national, state
and local economic climate and real estate conditions, perceptions of prospective tenants of the safety, convenience and attractiveness of the properties, the ability of the owners to provide adequate management, maintenance and insurance, the cost
of complying with the Americans with Disabilities Act, increased competition from new properties, the impact of present or future environmental legislation and compliance with environmental laws, changes in real estate taxes and other operating
expenses, adverse changes in governmental rules and fiscal policies, adverse changes in zoning laws and other factors beyond the control of the REIT issuers. In addition, distributions received by the Trust from REITs may consist of dividends,
capital gains and/or return of capital. As REITs generally pay a higher rate of dividends (on a pre-tax basis) than operating companies, to the extent application of the Trusts investment strategy
results in the Trust investing in REIT shares, the percentage of the Trusts dividend income received from REIT shares will likely exceed the percentage of the Trusts portfolio which is comprised of REIT shares. There are three general
categories of REITs: equity REITs, mortgage REITs and hybrid REITs. Equity REITs invest primarily in direct fee ownership or leasehold ownership of real property; they derive most of their income from rents. Mortgage REITs invest mostly in mortgages
on real estate, which may secure construction, development or long-term loans, and the main source of their income is mortgage interest payments. Hybrid REITs hold both ownership and mortgage interests in real estate.
MLPs. MLPs are limited partnerships or limited liability companies taxable as partnerships. MLPs may derive
income and gains from the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil, or products thereof), or the marketing of any mineral or natural resources. The Trust may,
however, invest in MLP entities in any sector of the economy. MLPs generally have two classes of owners, the general partner and limited partners. When investing in an MLP, the Trust generally purchases publicly traded common units issued to limited
partners of the MLP. The general partner is typically owned by a major energy company, an investment fund, the direct management of the MLP or is an entity owned by one or more of such parties. The general partner may be structured as a private or
publicly traded corporation or other entity. The general partner typically controls the operations and management of the MLP through an up to 2% equity interest in the MLP plus, in many cases, ownership of common units and subordinated units.
Limited partners own the remainder of the partnership, through ownership of common units, and have a limited role in the partnerships operations and management. The limited partners also receive cash distributions.
Corporate Bonds. Corporate bonds are debt obligations issued by corporations. Corporate bonds may be either
secured or unsecured. Collateral used for secured debt includes real property, machinery, equipment, accounts receivable, stocks, bonds or notes. If a bond is unsecured, it is known as a debenture. Bondholders, as creditors, have a prior legal claim
over common and preferred stockholders as to both income and assets of the corporation for the principal and interest due them and may have a prior claim over other creditors if liens or mortgages are involved. Interest on corporate bonds may be
fixed or floating, or the bonds may be zero coupons.
18
Interest on corporate bonds is typically paid semi-annually and is fully taxable to the bondholder. Corporate bonds contain elements of both interest rate risk and credit risk. The market value
of a corporate bond generally may be expected to rise and fall inversely with interest rates and may also be affected by the credit rating of the corporation, the corporations performance and perceptions of the corporation in the marketplace.
Corporate bonds usually yield more than government or agency bonds due to the presence of credit risk.
High Yield
Securities. Subject to its investment policies, the Trust may invest without limit in securities rated, at the time of investment, below investment grade quality such as those rated Ba or below by Moodys Investors Service, Inc.
(Moodys), BB or below by S&P Global Ratings (S&P) or Fitch Ratings, Inc. (Fitch), or securities comparably rated by other rating agencies or in unrated securities determined by the Advisor to be of
comparable quality. Such securities, sometimes referred to as high yield or junk bonds, are predominantly speculative with respect to the capacity to pay interest and repay principal in accordance with the terms of the
security and generally involve greater price volatility than securities in higher rating categories. Often the protection of interest and principal payments with respect to such securities may be very moderate and issuers of such securities face
major ongoing uncertainties or exposure to adverse business, financial or economic conditions which could lead to inadequate capacity to meet timely interest and principal payments.
Lower grade securities, though high yielding, are characterized by high risk. They may be subject to certain risks with
respect to the issuing entity and to greater market fluctuations than certain lower yielding, higher rated securities. The secondary market for lower grade securities may be less liquid than that of higher rated securities. Adverse conditions could
make it difficult at times for the Trust to sell certain securities or could result in lower prices than those used in calculating the Trusts NAV.
The prices of fixed-income securities generally are inversely related to interest rate changes; however, the price volatility
caused by fluctuating interest rates of securities also is inversely related to the coupons of such securities. Accordingly, below investment grade securities may be relatively less sensitive to interest rate changes than higher quality securities
of comparable maturity because of their higher coupon. The investor receives this higher coupon in return for bearing greater credit risk. The higher credit risk associated with below investment grade securities potentially can have a greater effect
on the value of such securities than may be the case with higher quality issues of comparable maturity.
Lower grade
securities may be particularly susceptible to economic downturns. It is likely that an economic recession could severely disrupt the market for such securities and may have an adverse impact on the value of such securities. In addition, it is likely
that any such economic downturn could adversely affect the ability of the issuers of such securities to repay principal and pay interest thereon and increase the incidence of default for such securities.
The ratings of Moodys, S&P, Fitch and other rating agencies represent their opinions as to the quality of the
obligations which they undertake to rate. Ratings are relative and subjective and, although ratings may be useful in evaluating the safety of interest and principal payments, they do not evaluate the market value risk of such obligations. Although
these ratings may be an initial criterion for selection of portfolio investments, the Advisor also will independently evaluate these securities and the ability of the issuers of such securities to pay interest and principal. To the extent that the
Trust invests in lower grade securities that have not been rated by a rating agency, the Trusts ability to achieve its investment objectives will be more dependent on the Advisors credit analysis than would be the case when the Trust
invests in rated securities.
Distressed and Defaulted Securities. The Trust may invest in the securities of
financially distressed and bankrupt issuers, including debt obligations that are in covenant or payment default. Such investments generally trade significantly below par and are considered speculative. The repayment of defaulted obligations is
subject to significant uncertainties. Defaulted obligations might be repaid only after lengthy workout or bankruptcy proceedings, during which the issuer might not make any interest or other payments. Typically such workout or bankruptcy proceedings
result in only partial recovery of cash payments or an exchange of the defaulted obligation for other debt or equity securities of the issuer or its affiliates, which may in turn be illiquid or speculative.
19
U.S. Government Debt Securities. The Trust may invest in debt
securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities, including U.S. Treasury obligations, which differ in their interest rates, maturities and times of issuance. Such obligations include U.S. Treasury bills
(maturity of one year or less), U.S. Treasury notes (maturity of one to ten years) and U.S. Treasury bonds (generally maturities of greater than ten years), including the principal components or the interest components issued by the U.S. Government
under the separate trading of registered interest and principal securities program (i.e., STRIPS), all of which are backed by the full faith and credit of the United States.
Structured Instruments. The Trust may use structured instruments for investment purposes, for risk management
purposes, such as to reduce the duration and interest rate sensitivity of the Trusts portfolio, for leveraging purposes and, with respect to certain structured instruments, as an alternative or complement to its options writing strategy. While
structured instruments may offer the potential for a favorable rate of return from time to time, they also entail certain risks. Structured instruments may be less liquid than other securities and the price of structured instruments may be more
volatile. In some cases, depending on the terms of the embedded index, a structured instrument may provide that the principal and/or interest payments may be adjusted below zero. Structured instruments also may involve significant credit risk and
risk of default by the counterparty. Structured instruments may also be illiquid. Like other sophisticated strategies, the Trusts use of structured instruments may not work as intended.
Structured Notes. The Trust may invest in structured notes and other related instruments, which are
privately negotiated debt obligations in which the principal and/or interest is determined by reference to the performance of a benchmark asset, market or interest rate (an embedded index), such as selected securities, an index of
securities or specified interest rates, or the differential performance of two assets or markets. Structured instruments may be issued by corporations, including banks, as well as by governmental agencies. Structured instruments frequently are
assembled in the form of medium-term notes, but a variety of forms are available and may be used in particular circumstances. The terms of such structured instruments normally provide that their principal and/or interest payments are to be adjusted
upwards or downwards (but ordinarily not below zero) to reflect changes in the embedded index while the structured instruments are outstanding. As a result, the interest and/or principal payments that may be made on a structured product may vary
widely, depending on a variety of factors, including the volatility of the embedded index and the effect of changes in the embedded index on principal and/or interest payments. The rate of return on structured notes may be determined by applying a
multiplier to the performance or differential performance of the referenced index(es) or other asset(s). Application of a multiplier involves leverage that will serve to magnify the potential for gain and the risk of loss.
Equity-Linked Notes. ELNs are hybrid securities with characteristics of both fixed-income and equity securities. An ELN
is a debt instrument, usually a bond, that pays interest based upon the performance of an underlying equity, which can be a single stock, basket of stocks or an equity index. Instead of paying a predetermined coupon, ELNs link the interest payment
to the performance of a particular equity market index or basket of stocks or commodities. The interest payment is typically based on the percentage increase in an index from a predetermined level, but alternatively may be based on a decrease in the
index. The interest payment may in some cases be leveraged so that, in percentage terms, it exceeds the relative performance of the market. ELNs generally are subject to the risks associated with the securities of equity issuers, default risk and
counterparty risk.
In particular, the Trust may invest in ELNs as an alternative or complement to its options writing
strategy. The features of ELNs described above closely replicate the income and return stream associated with single stock covered call options, and permit the Trust to receive interest income instead of the capital gains treatment that results from
the implementation of its options strategy, which the Trust believes may be advantageous in certain circumstances.
Credit Linked Notes. A credit-linked note (CLN) is a derivative instrument. It is a synthetic obligation
between two or more parties where the payment of principal and/or interest is based on the performance of some
20
obligation (a reference obligation). In addition to the credit risk of the reference obligations and interest rate risk, the buyer/seller of the CLN is subject to counterparty risk.
Event-Linked Securities. The Trust may obtain event-linked exposure by investing in event-linked bonds or
event-linked swaps or by implementing event-linked strategies. Event-linked exposure results in gains or losses that typically are contingent upon, or formulaically related to, defined trigger events. Examples of trigger
events include hurricanes, earthquakes, weather-related phenomena or statistics relating to such events. Some event-linked bonds are commonly referred to as catastrophe bonds. If a trigger event occurs, the Trust may lose a portion of or
its entire principal invested in the bond or the entire notional amount of a swap. Event-linked exposure often provides for an extension of maturity to process and audit loss claims when a trigger event has, or possibly has, occurred. An extension
of maturity may increase volatility. Event-linked exposure may also expose the Trust to certain other risks including credit risk, counterparty risk, adverse regulatory or jurisdictional interpretations and adverse tax consequences. Event-linked
exposures may also be subject to illiquidity risk.
Strategic Transactions and Other Management Techniques.
In addition to the options strategy discussed above, the Trust may use a variety of other investment management techniques and instruments. The Trust may purchase and sell futures contracts, enter into various interest rate transactions such as
swaps, caps, floors or collars, currency transactions such as currency forward contracts, currency futures contracts, currency swaps or options on currency or currency futures and swap contracts (including, but not limited to, credit default swaps)
and may purchase and sell exchange-listed and OTC put and call options on securities and swap contracts, financial indices and futures contracts and use other derivative instruments or management techniques. These Strategic Transactions may be used
for duration management and other risk management purposes, including to attempt to protect against possible changes in the market value of the Trusts portfolio resulting from trends in the securities markets and changes in interest rates or
to protect the Trusts unrealized gains in the value of its portfolio securities, to facilitate the sale of portfolio securities for investment purposes, to establish a position in the securities markets as a temporary substitute for purchasing
particular securities or to enhance income or gain. There is no particular strategy that requires use of one technique rather than another as the decision to use any particular strategy or instrument is a function of market conditions and the
composition of the portfolio. The use of Strategic Transactions to enhance current income may be particularly speculative. The ability of the Trust to use Strategic Transactions successfully will depend on the Advisors ability to predict
pertinent market movements as well as sufficient correlation among the instruments, which cannot be assured. The use of Strategic Transactions may result in losses greater than if they had not been used, may require the Trust to sell or purchase
portfolio securities at inopportune times or for prices other than current market values, may limit the amount of appreciation the Trust can realize on an investment or may cause the Trust to hold a security that it might otherwise sell. Inasmuch as
any obligations of the Trust that arise from the use of Strategic Transactions will be covered by segregated or earmarked liquid assets or offsetting transactions, the Trust and the Advisor believe such obligations do not constitute senior
securities and, accordingly, will not treat such transactions as being subject to its borrowing restrictions. See Leverage. Additionally, segregated or earmarked liquid assets, amounts paid by the Trust as premiums and cash or other
assets held in margin accounts with respect to Strategic Transactions are not otherwise available to the Trust for investment purposes. The SAI contains further information about the characteristics, risks and possible benefits of Strategic
Transactions and the Trusts other policies and limitations (which are not fundamental policies) relating to Strategic Transactions. Certain provisions of the Code may restrict or affect the ability of the Trust to engage in Strategic
Transactions. In addition, the use of certain Strategic Transactions may give rise to taxable income and have certain other consequences.
Foreign Currency Transactions. The Trusts common shares are priced in U.S. dollars and the distributions
paid by the Trust to common shareholders are paid in U.S. dollars. However, a portion of the Trusts assets may be denominated in non-U.S. currencies and the income received by the Trust from such
securities will be paid in non-U.S. currencies. The Trust also may invest in or gain exposure to non-U.S. currencies for investment or hedging purposes. The Trusts
investments in securities that trade in, or receive revenues in, non-U.S. currencies will be subject to currency risk, which is the risk that fluctuations in the exchange rates between the U.S. dollar
21
and foreign currencies may negatively affect an investment. The Trust may (but is not required to) hedge some or all of its exposure to non-U.S. currencies
through the use of derivative strategies, including forward foreign currency exchange contracts, foreign currency futures contracts and options on foreign currencies and foreign currency futures. Suitable hedging transactions may not be available in
all circumstances and there can be no assurance that the Trust will engage in such transactions at any given time or from time to time when they would be beneficial. Although the Trust has the flexibility to engage in such transactions, the Advisor
may determine not to do so or to do so only in unusual circumstances or market conditions. These transactions may not be successful and may eliminate any chance for the Trust to benefit from favorable fluctuations in relevant foreign currencies. The
Trust may also use derivatives contracts for purposes of increasing exposure to a foreign currency or to shift exposure to foreign currency fluctuations from one currency to another.
Interest Rate Transactions. The Trust may enter into interest rate swaps and purchase or sell interest rate caps
and floors. The Trust expects to enter into these transactions primarily to preserve a return or spread on a particular investment or portion of its portfolio, as a duration management technique, to protect against any increase in the price of
securities the Trust anticipates purchasing at a later date and/or to hedge against increases in the Trusts costs associated with its leverage strategy. The Trust will ordinarily use these transactions as a hedge or for duration and risk
management although it is permitted to enter into them to enhance income or gain. Interest rate swaps involve the exchange by the Trust with another party of their respective commitments to pay or receive interest (e.g., an exchange of floating rate
payments for fixed rate payments with respect to a notional amount of principal). The purchase of an interest rate cap entitles the purchaser, to the extent that the level of a specified interest rate exceeds a predetermined interest rate (i.e., the
strike price), to receive payments of interest on a notional principal amount from the party selling such interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent that the level of a specified interest rate
falls below a predetermined interest rate (i.e., the strike price), to receive payments of interest on a notional principal amount from the party selling such interest rate floor.
For example, if the Trust holds a debt instrument with an interest rate that is reset only once each year, it may swap the
right to receive interest at this fixed rate for the right to receive interest at a rate that is reset every week. This would enable the Trust to offset a decline in the value of the debt instrument due to rising interest rates but would also limit
its ability to benefit from falling interest rates. Conversely, if the Trust holds a debt instrument with an interest rate that is reset every week and it would like to lock in what it believes to be a high interest rate for one year, it may swap
the right to receive interest at this variable weekly rate for the right to receive interest at a rate that is fixed for one year. Such a swap would protect the Trust from a reduction in yield due to falling interest rates and may permit the Trust
to enhance its income through the positive differential between one week and one year interest rates, but would preclude it from taking full advantage of rising interest rates.
The Trust may hedge both its assets and liabilities through interest rate swaps, caps and floors. Usually, payments with
respect to interest rate swaps will be made on a net basis (i.e., the two payment streams are netted out) with the Trust receiving or paying, as the case may be, only the net amount of the two payments on the payment dates. The Trust will accrue the
net amount of the excess, if any, of the Trusts obligations over its entitlements with respect to each interest rate swap on a daily basis and will segregate with a custodian or designate on its books and records an amount of cash or liquid
assets having an aggregate NAV at all times at least equal to the accrued excess. If there is a default by the other party to an uncleared interest rate swap transaction, generally the Trust will have contractual remedies pursuant to the agreements
related to the transaction. With respect to interest rate swap transactions cleared through a central clearing counterparty, a clearing organization will be substituted for the counterparty and will guaranty the parties performance under the
swap agreement. However, there can be no assurance that the clearing organization will satisfy its obligation to the Trust or that the Trust would be able to recover the full amount of assets deposited on its behalf with the clearing organization in
the event of the default by the clearing organization or the Trusts clearing broker. Certain U.S. federal income tax requirements may limit the Trusts ability to engage in interest rate swaps. Distributions attributable to transactions
in interest rate swaps generally will be taxable as ordinary income to shareholders.
22
Credit Default Swaps. Subject to its investment policies, the Trust
may enter into credit default swap agreements without limit. The credit default swap agreement may have as reference obligations one or more securities that are not currently held by the Trust. The protection buyer in a credit default
contract may be obligated to pay the protection seller an upfront or a periodic stream of payments over the term of the contract, provided that no credit event on the reference obligation occurs. If a credit event occurs, the seller
generally must pay the buyer the par value (full notional amount) of the swap in exchange for an equal face amount of deliverable obligations of the reference entity described in the swap, or if the swap is cash settled the seller may be
required to deliver the related net cash amount (the difference between the market value of the reference obligation and its par value). The Trust may be either the buyer or seller in the transaction. If the Trust is a buyer and no credit event
occurs, the Trust will generally receive no payments from its counterparty under the swap if the swap is held through its termination date. However, if a credit event occurs, the buyer generally may elect to receive the full notional amount of the
swap in exchange for an equal face amount of deliverable obligations of the reference entity, the value of which may have significantly decreased. As a seller, the Trust generally receives an upfront payment or a fixed rate of income throughout the
term of the swap, which typically is between six months and three years, provided that there is no credit event. If a credit event occurs, generally the seller must pay the buyer the full notional amount of the swap in exchange for an equal face
amount of deliverable obligations of the reference entity, the value of which may have significantly decreased. As the seller, the Trust would effectively add leverage to its portfolio because, in addition to its Managed Assets, the Trust would be
subject to investment exposure on the notional amount of the swap.
Credit default swap agreements involve greater risks
than if the Trust had taken a position in the reference obligation directly (either by purchasing or selling) since, in addition to general market risks, credit default swaps are subject to illiquidity risk, counterparty risk and credit risks. A
buyer generally will also lose its upfront payment or any periodic payments it makes to the seller counterparty and receive no payments from its counterparty should no credit event occur and the swap is held to its termination date. If a credit
event were to occur, the value of any deliverable obligation received by the seller, coupled with the upfront or periodic payments previously received, may be less than the full notional amount it pays to the buyer, resulting in a loss of value to
the seller. A seller of a credit default swap or similar instrument is exposed to many of the same risks of leverage since, if a credit event occurs, the seller generally will be required to pay the buyer the full notional amount of the contract net
of any amounts owed by the buyer related to its delivery of deliverable obligations. The Trusts obligations under a credit default swap agreement will be accrued daily (offset against any amounts owed to the Trust). The Trust will at all times
segregate or designate on its books and records in connection with each such transaction liquid assets or cash with a value at least equal to the Trusts exposure (any accrued but unpaid net amounts owed by the Trust to any counterparty) on a marked-to-market basis (as required by the clearing organization with respect to cleared swaps or as calculated pursuant to requirements of the SEC). If the Trust is a seller
of protection in a credit default swap transaction, it will designate on its books and records in connection with such transaction liquid assets or cash with a value at least equal to the full notional amount of the contract. Such designation will
ensure that the Trust has assets available to satisfy its obligations with respect to the transaction and will avoid any potential leveraging of the Trusts portfolio. Such designation will not limit the Trusts exposure to loss.
In addition, the credit derivatives market is subject to a changing regulatory environment. It is possible that regulatory or
other developments in the credit derivatives market could adversely affect the Trusts ability to successfully use credit derivatives.
Indexed and Inverse Securities. The Trust may invest in securities the potential return of which is based on the
change in a specified interest rate or equity index (an indexed security). For example, the Trust may invest in a security that pays a variable amount of interest or principal based on the current level of the French or Korean stock
markets. The Trust may also invest in securities whose return is inversely related to changes in an interest rate or index (inverse securities). In general, the return on inverse securities will decrease when the underlying index or
interest rate goes up and increase when that index or interest rate goes down.
23
Repurchase Agreements and Purchase and Sale Contracts. The Trust
may invest in repurchase agreements. A repurchase agreement is a contractual agreement whereby the seller of securities agrees to repurchase the same security at a specified price on a future date agreed upon by the parties. The agreed upon
repurchase price determines the yield during the Trusts holding period. Repurchase agreements are considered to be loans collateralized by the underlying security that is the subject of the repurchase contract. Income generated from
transactions in repurchase agreements will be taxable. The risk to the Trust is limited to the ability of the issuer to pay the agreed upon repurchase price on the delivery date; however, although the value of the underlying collateral at the time
the transaction is entered into always equals or exceeds the agreed upon repurchase price, if the value of the collateral declines there is a risk of loss of both principal and interest. In the event of default, the collateral may be sold but the
Trust might incur a loss if the value of the collateral declines, and might incur disposition costs or experience delays in connection with liquidating the collateral. In addition, if bankruptcy proceedings are commenced with respect to the seller
of the security, realization upon the collateral by the Trust may be delayed or limited. The Advisor will monitor the value of the collateral at the time the transaction is entered into and at all times subsequent during the term of the repurchase
agreement in an effort to determine that such value always equals or exceeds the agreed upon repurchase price. In the event the value of the collateral declines below the repurchase price, the Advisor will demand additional collateral from the
issuer to increase the value of the collateral to at least that of the repurchase price, including interest.
A purchase
and sale contract is similar to a repurchase agreement, but differs from a repurchase agreement in that the contract arrangements stipulate that the securities are owned by the Trust. In the event of a default under such a repurchase agreement or a
purchase and sale contract, instead of the contractual fixed rate of return, the rate of return to the Trust will be dependent upon intervening fluctuations of the market value of such security and the accrued interest on the security. In such
event, the Trust would have rights against the seller for breach of contract with respect to any losses arising from market fluctuations following the failure of the seller to perform.
Securities Lending. The Trust may lend portfolio securities to certain borrowers determined to be creditworthy
by the Advisor, including to borrowers affiliated with the Advisor. The borrowers provide collateral that is maintained in an amount at least equal to the current market value of the securities loaned. No securities loan will be made on behalf of
the Trust if, as a result, the aggregate value of all securities loans of the Trust exceeds one-third of the value of the Trusts total assets (including the value of the collateral received). The Trust
may terminate a loan at any time and obtain the return of the securities loaned. The Trust receives the value of any interest or cash or non-cash distributions paid on the loaned securities.
With respect to loans that are collateralized by cash, the borrower may be entitled to receive a fee based on the amount of
cash collateral. The Trust is compensated by the difference between the amount earned on the reinvestment of cash collateral and the fee paid to the borrower. In the case of collateral other than cash, the Trust is compensated by a fee paid by the
borrower equal to a percentage of the market value of the loaned securities. Any cash collateral received by the Trust for such loans, and uninvested cash, may be invested, among other things, in a private investment company managed by an affiliate
of the Advisor or in registered money market funds advised by the Advisor or its affiliates; such investments are subject to investment risk.
The Trust conducts its securities lending pursuant to an exemptive order from the SEC permitting it to lend portfolio
securities to borrowers affiliated with the Trust and to retain an affiliate of the Trust as lending agent. To the extent that the Trust engages in securities lending, BlackRock Investment Management, LLC (BIM), an affiliate of the
Advisor, acts as securities lending agent for the Trust, subject to the overall supervision of the Advisor. BIM administers the lending program in accordance with guidelines approved by the Board. Pursuant to the current securities lending
agreement, BIM may lend securities only when the difference between the borrower rebate rate and the risk free rate exceeds a certain level.
To the extent that the Trust engages in securities lending, the Trust retains a portion of securities lending income and
remits a remaining portion to BIM as compensation for its services as securities lending agent.
24
Securities lending income is equal to the total of income earned from the reinvestment of cash collateral (and excludes collateral investment expenses as defined below), and any fees or other
payments to and from borrowers of securities. As securities lending agent, BIM bears all operational costs directly related to securities lending. The Trust is responsible for expenses in connection with the investment of cash collateral received
for securities on loan in a private investment company managed by an affiliate of the Advisor (the collateral investment expenses); however, BIM has agreed to cap the collateral investment expenses the Trust bears to an annual rate of
0.04% of the daily net assets of such private investment company. In addition, in accordance with the exemptive order, the investment adviser to the private investment company will not charge any advisory fees with respect to shares purchased by the
Trust. Such shares also will not be subject to a sales load, redemption fee, distribution fee or service fee.
Pursuant to
the current securities lending agreement, the Trust retains 82% of securities lending income (which excludes collateral investment expenses).
In addition, commencing the business day following the date that the aggregate securities lending income earned across the
BlackRock Fixed-Income Complex in a calendar year exceeds the breakpoint dollar threshold applicable in the given year, the Trust, pursuant to the current securities lending agreement, will receive for the remainder of that calendar year securities
lending income in an amount equal to 85% of securities lending income (which excludes collateral investment expenses).
Short Sales. The Trust may make short sales of securities. A short sale is a transaction in which the Trust
sells a security it does not own in anticipation that the market price of that security will decline. The Trust may make short sales to hedge positions, for duration and risk management, in order to maintain portfolio flexibility or to enhance
income or gain. When the Trust makes a short sale, it must borrow the security sold short and deliver it to the broker-dealer through which it made the short sale as collateral for its obligation to deliver the security upon conclusion of the sale.
The Trust may have to pay a fee to borrow particular securities and is often obligated to pay over to the securities lender any income, distributions or dividends received on such borrowed securities until it returns the security to the securities
lender. The Trusts obligation to replace the borrowed security will be secured by collateral deposited with the securities lender, usually cash, U.S. Government securities or other liquid assets. The Trust will also be required to segregate or
earmark similar collateral with its custodian to the extent, if any, necessary so that the aggregate collateral value is at all times at least equal to the current market value of the security sold short. Depending on arrangements made with the
securities lender regarding payment over of any income, distributions or dividends received by the Trust on such security, the Trust may not receive any payments (including interest) on its collateral deposited with such securities lender. If the
price of the security sold short increases between the time of the short sale and the time the Trust replaces the borrowed security, the Trust will incur a loss; conversely, if the price declines, the Trust will realize a gain. Any gain will be
decreased, and any loss increased, by the transaction costs described above. Although the Trusts gain is limited to the price at which it sold the security short, its potential loss is theoretically unlimited. Short sales, even if covered, may
represent a form of economic leverage and will create risks.
When-Issued, Delayed Delivery and Forward Commitment
Securities. The Trust may purchase securities on a when-issued basis and may purchase or sell securities on a forward commitment basis (including on a TBA (to be announced) basis) or on a delayed
delivery basis. When such transactions are negotiated, the price, which is generally expressed in yield terms, is fixed at the time the commitment is made, but delivery and payment for the securities take place at a later date. When-issued
securities and forward commitments may be sold prior to the settlement date. If the Trust disposes of the right to acquire a when-issued security prior to its acquisition or disposes of its right to deliver or receive against a forward commitment,
it might incur a gain or loss. At the time the Trust enters into a transaction on a when-issued or forward commitment basis, it will designate on its books and records cash or liquid assets with a value not less than the value of the when-issued or
forward commitment securities. The value of these assets will be monitored daily to ensure that their marked to market value will at all times equal or exceed the corresponding obligations of the Trust. Pursuant to recommendations of the Treasury
Market Practices Group, which is sponsored by the Federal Reserve Board of
25
New York, the Trust or its counterparty generally is required to post collateral when entering into certain forward-settling transactions, including without limitation TBA transactions.
There is always a risk that the securities may not be delivered and that the Trust may incur a loss. Settlements in the
ordinary course are not treated by the Trust as when-issued or forward commitment transactions and accordingly are not subject to the foregoing restrictions.
Counterparty Credit Standards. To the extent that the Trust engages in principal transactions, including, but
not limited to, OTC options, forward currency transactions, swap transactions, repurchase and reverse repurchase agreements and the purchase and sale of bonds and other fixed income securities, it must rely on the creditworthiness of its
counterparties under such transactions. In certain instances, the credit risk of a counterparty is increased by the lack of a central clearing house for certain transactions, including certain swap contracts. In the event of the insolvency of a
counterparty, the Trust may not be able to recover its assets, in full or at all, during the insolvency process. Counterparties to investments may have no obligation to make markets in such investments and may have the ability to apply essentially
discretionary margin and credit requirements. Similarly, the Trust will be subject to the risk of bankruptcy of, or the inability or refusal to perform with respect to such investments by, the counterparties with which it deals. The Advisor will
seek to minimize the Trusts exposure to counterparty risk by entering into such transactions with counterparties the Advisor believes to be creditworthy at the time it enters into the transaction. Certain option transactions and Strategic
Transactions may require the Trust to provide collateral to secure its performance obligations under a contract, which would also entail counterparty credit risk.
LEVERAGE
The Trust currently does not intend to borrow money or issue debt securities or preferred shares. The Trust is, however,
permitted to borrow money or issue debt securities in an amount up to 33 1/3% of its Managed Assets (50% of its net assets), and issue preferred shares in an amount up to 50% of its Managed Assets (100% of its net assets). Managed Assets
means the total assets of the Trust (including any assets attributable to money borrowed for investment purposes) minus the sum of the Trusts accrued liabilities (other than money borrowed for investment purposes). Although it has no present
intention to do so, the Trust reserves the right to borrow money from banks or other financial institutions, or issue debt securities or preferred shares, in the future if it believes that market conditions would be conducive to the successful
implementation of a leveraging strategy through borrowing money or issuing debt securities or preferred shares. Any such leveraging will not be fully achieved until the proceeds resulting from the use of leverage have been invested in accordance
with the Trusts investment objectives and policies.
The use of leverage, if employed, can create risks. When
leverage is employed, the NAV and market price of the common shares and the yield to holders of common shares will be more volatile than if leverage were not used. Changes in the value of the Trusts portfolio, including securities bought with
the proceeds of leverage, will be borne entirely by the holders of common shares. If there is a net decrease or increase in the value of the Trusts investment portfolio, leverage will decrease or increase, as the case may be, the NAV per
common share to a greater extent than if the Trust did not utilize leverage. A reduction in the Trusts NAV may cause a reduction in the market price of its shares. During periods in which the Trust is using leverage, the fee paid to the
Advisor for advisory services will be higher than if the Trust did not use leverage, because the fees paid will be calculated on the basis of the Trusts Managed Assets, which includes the proceeds from leverage. Any leveraging strategy the
Trust employs may not be successful.
Certain types of leverage the Trust may use may result in the Trust being subject to
covenants relating to asset coverage and portfolio composition requirements. The Trust may be subject to certain restrictions on investments imposed by one or more lenders or by guidelines of one or more rating agencies, which may issue ratings for
any short-term debt securities or preferred shares issued by the Trust. The terms of any borrowings or
26
rating agency guidelines may impose asset coverage or portfolio composition requirements that are more stringent than those imposed by the Investment Company Act. The Advisor does not believe
that these covenants or guidelines will impede it from managing the Trusts portfolio in accordance with its investment objectives and policies if the Trust were to utilize leverage.
Under the Investment Company Act, the Trust is not permitted to issue senior securities if, immediately after the issuance of
such senior securities, the Trust would have an asset coverage ratio (as defined in the Investment Company Act) of less than 300% with respect to senior securities representing indebtedness (i.e., for every dollar of indebtedness outstanding, the
Trust is required to have at least three dollars of assets) or less than 200% with respect to senior securities representing preferred stock (i.e., for every dollar of preferred stock outstanding, the Trust is required to have at least two dollars
of assets). The Investment Company Act also provides that the Trust may not declare distributions or purchase its stock (including through tender offers) if, immediately after doing so, it will have an asset coverage ratio of less than 300% or 200%,
as applicable. Under the Investment Company Act, certain short-term borrowings (such as for cash management purposes) are not subject to these limitations if (i) repaid within 60 days, (ii) not extended or renewed and (iii) not in
excess of 5% of the total assets of the Trust.
Credit Facility
The Trust is permitted to leverage its portfolio by entering into one or more credit facilities. If the Trust enters into a
credit facility, the Trust may be required to prepay outstanding amounts or incur a penalty rate of interest upon the occurrence of certain events of default. The Trust would also likely have to indemnify the lenders under the credit facility
against liabilities they may incur in connection therewith. In addition, the Trust expects that any credit facility would contain covenants that, among other things, likely would limit the Trusts ability to pay distributions in certain
circumstances, incur additional debt, change certain of its investment policies and engage in certain transactions, including mergers and consolidations, and require asset coverage ratios in addition to those required by the Investment Company Act.
The Trust may be required to pledge its assets and to maintain a portion of its assets in cash or high-grade securities as a reserve against interest or principal payments and expenses. The Trust expects that any credit facility would have customary
covenant, negative covenant and default provisions. There can be no assurance that the Trust will enter into an agreement for a credit facility, or one on terms and conditions representative of the foregoing, or that additional material terms will
not apply. In addition, if entered into, a credit facility may in the future be replaced or refinanced by one or more credit facilities having substantially different terms or by the issuance of preferred shares.
Reverse Repurchase Agreements
The Trust may enter into reverse repurchase agreements with respect to its portfolio investments subject to the investment
restrictions set forth herein. Reverse repurchase agreements involve the sale of securities held by the Trust with an agreement by the Trust to repurchase the securities at an agreed upon price, date and interest payment. At the time the Trust
enters into a reverse repurchase agreement, it may establish and maintain a segregated account with the custodian containing, or designate on its books and records, cash and/or liquid assets having a value not less than the repurchase price
(including accrued interest). If the Trust establishes and maintains such a segregated account, or earmarks such assets as described, a reverse repurchase agreement will not be considered a senior security under the Investment Company Act and
therefore will not be considered a borrowing by the Trust; however, under certain circumstances in which the Trust does not establish and maintain such a segregated account, or earmark such assets on its books and records, such reverse repurchase
agreement will be considered a borrowing for the purpose of the Trusts limitation on borrowings discussed above. The use by the Trust of reverse repurchase agreements involves many of the same risks of leverage since the proceeds derived from
such reverse repurchase agreements may be invested in additional securities. Reverse repurchase agreements involve the risk that the market value of the securities acquired in connection with the reverse repurchase agreement may decline below the
price of the securities the Trust has sold but is obligated to repurchase. Also, reverse repurchase agreements involve the risk that the market value of the securities retained
27
in lieu of sale by the Trust in connection with the reverse repurchase agreement may decline in price. Effective August 19, 2022, certain asset segregation requirements will be replaced by
the requirements under the newly adopted Rule 18f-4 as described in this prospectus.
If the buyer of securities under a reverse repurchase agreement files for bankruptcy or becomes insolvent, such buyer or its
trustee or receiver may receive an extension of time to determine whether to enforce the Trusts obligation to repurchase the securities and the Trusts use of the proceeds of the reverse repurchase agreement may effectively be restricted
pending such decision. Also, the Trust would bear the risk of loss to the extent that the proceeds of the reverse repurchase agreement are less than the value of the securities subject to such agreement.
The Trust also may effect simultaneous purchase and sale transactions that are known as sale-buybacks. A
sale-buyback is similar to a reverse repurchase agreement, except that in a sale-buyback, the counterparty that purchases the security is entitled to receive any principal or interest payments made on the underlying security pending settlement of
the Trusts repurchase of the underlying security.
Dollar Roll Transactions
The Trust may enter into dollar roll transactions. In a dollar roll transaction, the Trust sells a mortgage related
or other security to a dealer and simultaneously agrees to repurchase a similar security (but not the same security) in the future at a pre-determined price. A dollar roll transaction can be viewed, like a
reverse repurchase agreement, as a collateralized borrowing in which the Trust pledges a mortgage related security to a dealer to obtain cash. However, unlike reverse repurchase agreements, the dealer with which the Trust enters into a dollar roll
transaction is not obligated to return the same securities as those originally sold by the Trust, but rather only securities which are substantially identical, which generally means that the securities repurchased will bear the same
interest rate and a similar maturity as those sold, but the pools of mortgages collateralizing those securities may have different prepayment histories than those sold.
During the period between the sale and repurchase, the Trust will not be entitled to receive interest and principal payments
on the securities sold. Proceeds of the sale will be invested in additional instruments for the Trust and the income from these investments will generate income for the Trust. If such income does not exceed the income, capital appreciation and gain
that would have been realized on the securities sold as part of the dollar roll, the use of this technique will diminish the investment performance of the Trust compared with what the performance would have been without the use of dollar rolls.
At the time the Trust enters into a dollar roll transaction, it may establish and maintain a segregated account with the
custodian containing, or designate on its books and records, cash and/or liquid assets having a value not less than the repurchase price (including accrued interest). If the Trust establishes and maintains such a segregated account, or earmarks such
assets as described, a dollar roll transaction will not be considered a senior security under the Investment Company Act and therefore will not be considered a borrowing by the Trust; however, under certain circumstances in which the Trust does not
establish and maintain such a segregated account, or earmark such assets on its books and records, such dollar roll transaction will be considered a borrowing for the purpose of the Trusts limitation on borrowings discussed above.
Dollar roll transactions involve the risk that the market value of the securities the Trust is required to purchase may
decline below the agreed upon repurchase price of those securities. The Trusts right to purchase or repurchase securities may be restricted. Successful use of mortgage dollar rolls may depend upon the investment managers ability to
correctly predict interest rates and prepayments. There is no assurance that dollar rolls can be successfully employed.
Preferred Shares
The Trust is permitted to leverage its portfolio by issuing preferred shares. Under the Investment Company Act, the Trust is
not permitted to issue preferred shares if, immediately after such issuance, the liquidation value
28
of the Trusts outstanding preferred shares exceeds 50% of its assets (including the proceeds from the issuance) less liabilities other than borrowings (i.e., the value of the Trusts
assets must be at least 200% of the liquidation value of its outstanding preferred shares). In addition, the Trust would not be permitted to declare any cash dividend or other distribution on its common shares unless, at the time of such
declaration, the value of the Trusts assets less liabilities other than borrowings is at least 200% of such liquidation value.
The Trust expects that preferred shares, if issued, will pay adjustable rate dividends based on shorter-term interest rates,
which would be redetermined periodically by a fixed spread or remarketing process, subject to a maximum rate which would increase over time in the event of an extended period of unsuccessful remarketing. The adjustment period for preferred share
dividends could be as short as one day or as long as a year or more. Preferred shares, if issued, could include a liquidity feature that allows holders of preferred shares to have their shares purchased by a liquidity provider in the event that sell
orders have not been matched with purchase orders and successfully settled in a remarketing. The Trust expects that it would pay a fee to the provider of this liquidity feature, which would be borne by common shareholders of the Trust. The terms of
such liquidity feature could require the Trust to redeem preferred shares still owned by the liquidity provider following a certain period of continuous, unsuccessful remarketing, which may adversely impact the Trust.
If preferred shares are issued, the Trust may, to the extent possible, purchase or redeem preferred shares from time to time
to the extent necessary in order to maintain asset coverage of any preferred shares of at least 200%. In addition, as a condition to obtaining ratings on the preferred shares, the terms of any preferred shares issued are expected to include asset
coverage maintenance provisions which will require the redemption of the preferred shares in the event of non-compliance by the Trust and may also prohibit dividends and other distributions on the common
shares in such circumstances. In order to meet redemption requirements, the Trust may have to liquidate portfolio securities. Such liquidations and redemptions would cause the Trust to incur related transaction costs and could result in capital
losses to the Trust. Prohibitions on dividends and other distributions on the common shares could impair the Trusts ability to qualify as a RIC under the Code. If the Trust has preferred shares outstanding, two of the Trustees will be elected
by the holders of preferred shares voting separately as a class. The remaining Trustees will be elected by holders of common shares and preferred shares voting together as a single class. In the event the Trust failed to pay dividends on preferred
shares for two years, holders of preferred shares would be entitled to elect a majority of the Trustees.
If the Trust
issues preferred shares, the Trust expects that it will be subject to certain restrictions imposed by guidelines of one or more rating agencies that may issue ratings for preferred shares issued by the Trust. These guidelines are expected to impose
asset coverage or portfolio composition requirements that are more stringent than those imposed on the Trust by the Investment Company Act. It is not anticipated that these covenants or guidelines would impede the Advisor from managing the
Trusts portfolio in accordance with the Trusts investment objectives and policies.
Derivatives
The Trust may enter into derivative transactions that have economic leverage embedded in them. Derivative transactions that the
Trust may enter into and the risks associated with them are described elsewhere in this Prospectus and are also referred to as Strategic Transactions. The Trust cannot assure you that investments in derivative transactions that have
economic leverage embedded in them will result in a higher return on its common shares.
To the extent the terms of such
transactions obligate the Trust to make payments, the Trust may earmark or segregate cash or liquid assets in an amount at least equal to the current value of the amount then payable by the Trust under the terms of such transactions or otherwise
cover such transactions in accordance with applicable interpretations of the staff of the SEC. If the current value of the amount then payable by the Trust under the terms of such transactions is represented by the notional amounts of such
investments, the Trust would segregate or earmark cash or liquid assets having a market value at least equal to such notional amounts, and if the current
29
value of the amount then payable by the Trust under the terms of such transactions is represented by the market value of the Trusts current obligations, the Trust would segregate or earmark
cash or liquid assets having a market value at least equal to such current obligations. To the extent the terms of such transactions obligate the Trust to deliver particular securities to extinguish the Trusts obligations under such
transactions the Trust may cover its obligations under such transactions by either (i) owning the securities or collateral underlying such transactions or (ii) having an absolute and immediate right to acquire such securities
or collateral without additional cash consideration (or, if additional cash consideration is required, having earmarked or segregated an appropriate amount of cash or liquid assets). Such earmarking, segregation or cover is intended to provide the
Trust with available assets to satisfy its obligations under such transactions. As a result of such earmarking, segregation or cover, the Trusts obligations under such transactions will not be considered senior securities representing
indebtedness for purposes of the Investment Company Act, or considered borrowings subject to the Trusts limitations on borrowings discussed above, but may create leverage for the Trust. To the extent that the Trusts obligations under
such transactions are not so earmarked, segregated or covered, such obligations may be considered senior securities representing indebtedness under the Investment Company Act and therefore subject to the 300% asset coverage requirement.
These earmarking, segregation or cover requirements can result in the Trust maintaining securities positions it would
otherwise liquidate, segregating or earmarking assets at a time when it might be disadvantageous to do so or otherwise restrict portfolio management.
On October 28, 2020, the SEC adopted new regulations governing the use of derivatives by registered investment companies
(Rule 18f-4). The Trust will be required to implement and comply with Rule 18f-4 by August 19, 2022. Once implemented, Rule 18f-4 will impose limits on the amount of derivatives a fund can enter into, eliminate the asset segregation framework currently used by funds to comply with Section 18 of the Investment Company Act, treat
derivatives as senior securities and require funds whose use of derivatives is more than a limited specified exposure amount to establish and maintain a comprehensive derivatives risk management program and appoint a derivatives risk manager.
Temporary Borrowings
The
Trust may also borrow money as a temporary measure for extraordinary or emergency purposes, including the payment of dividends and the settlement of securities transactions which otherwise might require untimely dispositions of Trust securities.
RISKS
The NAV and market price of, and dividends paid on, the common shares will fluctuate with and be affected by, among other
things, the risks of investing in the Trust.
General Risks
Please refer to the section
of the Trusts most recent annual report on Form N-CSR entitled Trust Investment Objectives, Policies and RisksRisk Factors, which is incorporated by reference herein, for a
discussion of the general risks of investing in the Trust.
Other Risks
Dividend Paying Equity Securities Risk
Dividends on common equity securities that the Trust may hold are not fixed but are declared at the discretion of an
issuers board of directors. Companies that have historically paid dividends on their securities are
30
not required to continue to pay dividends on such securities. There is no guarantee that the issuers of the common equity securities in which the Trust invests will declare dividends in the
future or that, if declared, they will remain at current levels or increase over time. Therefore, there is the possibility that such companies could reduce or eliminate the payment of dividends in the future. Dividend producing equity securities, in
particular those whose market price is closely related to their yield, may exhibit greater sensitivity to interest rate changes. See Fixed-Income Securities RisksInterest Rate Risk. The Trusts investments in dividend
producing equity securities may also limit its potential for appreciation during a broad market advance.
The prices of
dividend producing equity securities can be highly volatile. Investors should not assume that the Trusts investments in these securities will necessarily reduce the volatility of the Trusts NAV or provide protection, compared
to other types of equity securities, when markets perform poorly.
New Issues Risk
New Issues are IPOs of U.S. equity securities. There is no assurance that the Trust will have access to profitable
IPOs and therefore investors should not rely on any past gains from IPOs as an indication of future performance of the Trust. The investment performance of the Trust during periods when it is unable to invest significantly or at all in IPOs may be
lower than during periods when the Trust is able to do so. Securities issued in IPOs are subject to many of the same risks as investing in companies with smaller market capitalizations. Securities issued in IPOs have no trading history, and
information about the companies may be available for very limited periods. In addition, some companies in IPOs are involved in relatively new industries or lines of business, which may not be widely understood by investors. Some of these companies
may be undercapitalized or regarded as developmental stage companies, without revenues or operating income, or the near-term prospects of achieving them. Further, the prices of securities sold in IPOs may be highly volatile or may decline shortly
after the IPO. When an IPO is brought to the market, availability may be limited and the Trust may not be able to buy any shares at the offering price, or, if it is able to buy shares, it may not be able to buy as many shares at the offering price
as it would like. The limited number of shares available for trading in some IPOs may make it more difficult for the Trust to buy or sell significant amounts of shares.
Growth Stock Risk
Securities of growth companies may be more volatile since such companies usually invest a high portion of earnings in their
business, and they may lack the dividends of value stocks that can cushion stock prices in a falling market. Stocks of companies the Advisor believes are fast-growing may trade at a higher multiple of current earnings than other stocks. The values
of these stocks may be more sensitive to changes in current or expected earnings than the values of other stocks. Earnings disappointments often lead to sharply falling prices because investors buy growth stocks in anticipation of superior earnings
growth. If the Advisors assessment of the prospects for a companys earnings growth is wrong, or if the Advisors judgment of how other investors will value the companys earnings growth is wrong, then the price of the
companys stock may fall or may not approach the value that the Advisor has placed on it.
Value Stock Risk
The Advisor may be wrong in its assessment of a companys value and the stocks the Trust owns may not reach what the
Advisor believes are their full values. A particular risk of the Trusts value stock investments is that some holdings may not recover and provide the capital growth anticipated or a stock judged to be undervalued may actually be appropriately
priced. Further, because the prices of value-oriented securities tend to correlate more closely with economic cycles than growth-oriented securities, they generally are more sensitive to changing economic conditions, such as changes in interest
rates, corporate earnings, and industrial production. The market may not favor value-oriented stocks and may not favor equities at all. During those periods, the Trusts relative performance may suffer.
31
Preferred Securities Risk
There are special risks associated with investing in preferred securities, including:
Deferral Risk. Preferred securities may include provisions that permit the issuer, at its discretion, to defer
distributions for a stated period without any adverse consequences to the issuer. If the Trust owns a preferred security that is deferring its distributions, the Trust may be required to report income for tax purposes although it has not yet
received such income.
Subordination Risk. Preferred securities are subordinated to bonds and other debt
instruments in a companys capital structure in terms of having priority to corporate income and liquidation payments, and therefore will be subject to greater credit risk than debt instruments.
Limited Voting Rights Risk. Generally, preferred security holders (such as the Trust) have no voting rights with
respect to the issuing company unless preferred dividends have been in arrears for a specified number of periods, at which time the preferred security holders may elect a number of directors to the issuers board. Generally, once all the
arrearages have been paid, the preferred security holders no longer have voting rights. In the case of trust preferred securities, holders generally have no voting rights, except if (i) the issuer fails to pay dividends for a specified period
of time or (ii) a declaration of default occurs and is continuing.
Special Redemption Rights Risk. In certain
varying circumstances, an issuer of preferred securities may redeem the securities prior to a specified date. For instance, for certain types of preferred securities, a redemption may be triggered by certain changes in U.S. federal income tax or
securities laws. As with call provisions, a special redemption by the issuer may negatively impact the return of the security held by the Trust.
Trust Preferred Securities Risk. 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 include but are not limited to trust originated preferred securities
(TOPRS®); monthly income preferred securities (MIPS®); quarterly income bond securities (QUIBS®); quarterly income debt securities (QUIDS®); quarterly income preferred securities (QUIPSSM); corporate
trust securities (CORTS®); public income notes (PINES®); and other trust preferred securities.
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 issuers 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
32
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 U.S. 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
U.S. federal income tax purposes. The trust or special purpose entity in turn would be a holder of the operating companys debt and would have priority with respect to the operating companys earnings and profits over the operating
companys common shareholders, but would typically be subordinated to other classes of the operating companys debt. Typically a preferred share has a rating that is slightly below that of its corresponding operating companys senior
debt securities.
New Types of Securities Risk. From time to time, preferred securities, including trust preferred
securities, have been, and may in the future be, offered having features other than those described herein. The Trust reserves the right to invest in these securities if the Advisor believes that doing so would be consistent with the Trusts
investment objectives and policies. Since the market for these instruments would be new, the Trust may have difficulty disposing of them at a suitable price and time. In addition to limited liquidity, these instruments may present other risks, such
as high price volatility.
Convertible Securities Risk
Convertible securities generally offer lower interest or dividend yields than
non-convertible securities of similar quality. The market values of convertible securities tend to decline as interest rates increase and, conversely, to increase as interest rates decline. However, when the
market price of the common stock underlying a convertible security exceeds the conversion price, the convertible security tends to reflect the market price of the underlying common stock. As the market price of the underlying common stock declines,
the convertible security tends to trade increasingly on a yield basis and thus may not decline in price to the same extent as the underlying common stock. Convertible securities rank senior to common stock in an issuers capital structure and
consequently entail less risk than the issuers common stock.
The Trust may invest in synthetic convertible
securities, which are created through a combination of separate securities that possess the two principal characteristics of a traditional convertible security. A holder of a synthetic convertible security faces the risk of a decline in the price of
the security or the level of the index involved in the convertible component, causing a decline in the value of the security or instrument, such as a call option or warrant, purchased to create the synthetic convertible security. Should the price of
the stock fall below the exercise price and remain there throughout the exercise period, the entire amount paid for the call option or warrant would be lost. Because a synthetic convertible security includes the income-producing component as well,
the holder of a synthetic convertible security also faces the risk that interest rates will rise, causing a decline in the value of the income-producing instrument. Synthetic convertible securities are also subject to the risks associated with
derivatives.
Warrants Risk
If the price of the underlying stock does not rise above the exercise price before the warrant expires, the warrant generally
expires without any value and the Trust loses any amount it paid for the warrant. Thus, investments in warrants may involve substantially more risk than investments in common stock. Warrants may trade in the same markets as their underlying stock;
however, the price of the warrant does not necessarily move with the price of the underlying stock.
33
Fixed-Income Securities Risks
Fixed-income securities in which the Trust may invest are generally subject to the following risks:
Interest Rate Risk. The market value of bonds and other fixed-income securities changes in response to interest rate
changes and other factors. Interest rate risk is the risk that prices of bonds and other fixed-income securities will increase as interest rates fall and decrease as interest rates rise. The Trust may be subject to a greater risk of rising interest
rates due to the current period of historically low interest rates, including the Federal Reserves recent lowering of the target for the federal funds rate to a range of 0%-0.25% as part of its efforts
to ease the economic effects of the coronavirus pandemic. There is a risk that interest rates will rise, which will likely drive down bond prices. The magnitude of these fluctuations in the market price of bonds and other fixed-income securities is
generally greater for those securities with longer maturities. Fluctuations in the market price of the Trusts investments will not affect interest income derived from instruments already owned by the Trust, but will be reflected in the
Trusts NAV. The Trust may lose money if short-term or long-term interest rates rise sharply in a manner not anticipated by the Advisor. To the extent the Trust invests in debt securities that may be prepaid at the option of the obligor (such
as mortgage-related securities), the sensitivity of such securities to changes in interest rates may increase (to the detriment of the Trust) when interest rates rise. Moreover, because rates on certain floating rate debt securities typically reset
only periodically, changes in prevailing interest rates (and particularly sudden and significant changes) can be expected to cause some fluctuations in the NAV of the Trust to the extent that it invests in floating rate debt securities. These basic
principles of bond prices also apply to U.S. Government securities. A security backed by the full faith and credit of the U.S. Government is guaranteed only as to its stated interest rate and face value at maturity, not its current
market price. Just like other fixed-income securities, government-guaranteed securities will fluctuate in value when interest rates change.
During periods in which the Trust may use leverage, such use of leverage will tend to increase the Trusts interest rate
risk. The Trust may utilize certain strategies, including taking positions in futures or interest rate swaps, for the purpose of reducing the interest rate sensitivity of fixed-income securities held by the Trust and decreasing the Trusts
exposure to interest rate risk. The Trust is not required to hedge its exposure to interest rate risk and may choose not to do so. In addition, there is no assurance that any attempts by the Trust to reduce interest rate risk will be successful or
that any hedges that the Trust may establish will perfectly correlate with movements in interest rates.
The Trust may
invest in variable and floating rate debt instruments, which generally are less sensitive to interest rate changes than longer duration fixed rate instruments, but may decline in value in response to rising interest rates if, for example, the rates
at which they pay interest do not rise as much, or as quickly, as market interest rates in general. Conversely, variable and floating rate instruments generally will not increase in value if interest rates decline. The Trust also may invest in
inverse floating rate debt securities, which may decrease in value if interest rates increase, and which also may exhibit greater price volatility than fixed rate debt obligations with similar credit quality. To the extent the Trust holds variable
or floating rate instruments, a decrease (or, in the case of inverse floating rate securities, an increase) in market interest rates will adversely affect the income received from such securities, which may adversely affect the NAV of the
Trusts common shares.
Issuer Risk. The value of fixed-income securities may decline for a number of reasons
which directly relate to the issuer, such as management performance, financial leverage, reduced demand for the issuers goods and services, historical and prospective earnings of the issuer and the value of the assets of the issuer.
Credit Risk. Credit risk is the risk that one or more fixed-income securities in the Trusts portfolio will
decline in price or fail to pay interest or principal when due because the issuer of the security experiences a decline in its financial status. Credit risk is increased when a portfolio security is downgraded or the perceived creditworthiness of
the issuer deteriorates. To the extent the Trust invests in below investment grade securities, it will be exposed to a greater amount of credit risk than a fund that only invests in investment grade securities.
34
See Below Investment Grade Securities Risk. In addition, to the
extent the Trust uses credit derivatives, such use will expose it to additional risk in the event that the bonds underlying the derivatives default. The degree of credit risk depends on the issuers financial condition and on the terms of the
securities.
Prepayment Risk. During periods of declining interest rates, borrowers may exercise their option to
prepay principal earlier than scheduled. For fixed rate securities, such payments often occur during periods of declining interest rates, forcing the Trust to reinvest in lower yielding securities, resulting in a possible decline in the Trusts
income and distributions to shareholders. This is known as prepayment or call risk. Below investment grade securities frequently have call features that allow the issuer to redeem the security at dates prior to its stated maturity at a
specified price (typically greater than par) only if certain prescribed conditions are met (i.e., call protection). For premium bonds (bonds acquired at prices that exceed their par or principal value) purchased by the Trust, prepayment
risk may be enhanced.
Reinvestment Risk. Reinvestment risk is the risk that income from the Trusts portfolio
will decline if the Trust invests the proceeds from matured, traded or called fixed-income securities at market interest rates that are below the Trust portfolios current earnings rate.
Duration and Maturity Risk. The Trust has no set policy regarding portfolio maturity or duration of the fixed-income
securities it may hold. The Advisor may seek to adjust the portfolios duration or maturity based on its assessment of current and projected market conditions and all other factors that the Advisor deems relevant.
Spread Risk. Wider credit spreads and decreasing market values typically represent a deterioration of a debt
securitys credit soundness and a perceived greater likelihood or risk of default by the issuer.
Any decisions as to
the targeted duration or maturity of any particular category of investments or of the Trusts portfolio generally will be made based on all pertinent market factors at any given time. The Trust may incur costs in seeking to adjust the
portfolios average duration or maturity. There can be no assurance that the Advisors assessment of current and projected market conditions will be correct or that any strategy to adjust the portfolios duration or maturity will be
successful at any given time. In general, the longer the duration of any fixed-income securities in the Trusts portfolio, the more exposure the Trust will have to the interest rate risks described above.
Corporate Bonds Risk
The
market value of a corporate bond generally may be expected to rise and fall inversely with interest rates. The market value of intermediate and longer term corporate bonds is generally more sensitive to changes in interest rates than is the market
value of shorter term corporate bonds. The market value of a corporate bond also may be affected by factors directly related to the issuer, such as investors perceptions of the creditworthiness of the issuer, the issuers financial
performance, perceptions of the issuer in the market place, performance of management of the issuer, the issuers capital structure and use of financial leverage and demand for the issuers goods and services. Certain risks associated with
investments in corporate bonds are described elsewhere in this Prospectus in further detail, including under Fixed-Income Securities RisksCredit Risk, Fixed-Income Securities RisksInterest Rate Risk,
Fixed-Income Securities RisksPrepayment Risk, Inflation Risk and Deflation Risk. There is a risk that the issuers of corporate bonds may not be able to meet their obligations on interest or
principal payments at the time called for by an instrument. Corporate bonds of below investment grade quality are often high risk and have speculative characteristics and may be particularly susceptible to adverse issuer-specific developments.
Corporate bonds of below investment grade quality are subject to the risks described herein under Below Investment Grade Securities Risk.
Distressed and Defaulted Securities Risk
Investments in the securities of financially distressed issuers are speculative and involve substantial risks. These securities
may present a substantial risk of default or may be in default at the time of investment. The
35
Trust may incur additional expenses to the extent it is required to seek recovery upon a default in the payment of principal or interest on its portfolio holdings. In any reorganization or
liquidation proceeding relating to a portfolio company, the Trust may lose its entire investment or may be required to accept cash or securities with a value less than its original investment. Among the risks inherent in investments in a troubled
entity is that it frequently may be difficult to obtain information as to the true financial condition of such issuer. The Advisors judgment about the credit quality of the issuer and the relative value and liquidity of its securities may
prove to be wrong. Distressed securities and any securities received in an exchange for such securities may be subject to restrictions on resale.
Yield and Ratings Risk
The yields on debt obligations are dependent on a variety of factors, including general market conditions, conditions in the
particular market for the obligation, the financial condition of the issuer, the size of the offering, the maturity of the obligation and the ratings of the issue. The ratings of Moodys, S&P and Fitch, which are described in Appendix A to
the SAI, represent their respective opinions as to the quality of the obligations they undertake to rate. Ratings, however, are general and are not absolute standards of quality. Consequently, obligations with the same rating, maturity and interest
rate may have different market prices. Subsequent to its purchase by the Trust, a rated security may cease to be rated. The Advisor will consider such an event in determining whether the Trust should continue to hold the security.
Unrated Securities Risk
Because the Trust may purchase securities that are not rated by any rating organization, the Advisor may, after assessing their
credit quality, internally assign ratings to certain of those securities in categories similar to those of rating organizations. Some unrated securities may not have an active trading market or may be difficult to value, which means the Trust might
have difficulty selling them promptly at an acceptable price. To the extent that the Trust invests in unrated securities, the Trusts ability to achieve its investment objectives will be more dependent on the Advisors credit analysis than
would be the case when the Trust invests in rated securities.
U.S. Government Securities Risk
U.S. Government debt securities generally involve lower levels of credit risk than other types of fixed-income securities of
similar maturities, although, as a result, the yields available from U.S. Government debt securities are generally lower than the yields available from such other securities. Like other fixed-income securities, the values of U.S. Government
securities change as interest rates fluctuate.
Insolvency of Issuers of Indebtedness Risk
Various laws enacted for the protection of creditors may apply to indebtedness in which the Trust invests. The information in
this and the following paragraph is applicable with respect to U.S. issuers subject to U.S. federal bankruptcy law. Insolvency considerations may differ with respect to other issuers. If, in a lawsuit brought by an unpaid creditor or representative
of creditors of an issuer of indebtedness, a court were to find that the issuer did not receive fair consideration or reasonably equivalent value for incurring the indebtedness and that, after giving effect to such indebtedness, the issuer
(i) was insolvent, (ii) was engaged in a business for which the remaining assets of such issuer constituted unreasonably small capital or (iii) intended to incur, or believed that it would incur, debts beyond its ability to pay such
debts as they mature, such court could determine to invalidate, in whole or in part, such indebtedness as a fraudulent conveyance, to subordinate such indebtedness to existing or future creditors of such issuer, or to recover amounts previously paid
by such issuer in satisfaction of such indebtedness. The measure of insolvency for purposes of the foregoing will vary. Generally, an issuer would be considered insolvent at a particular time if the sum of its debts was then greater than all of its
property at a fair valuation, or if the present fair saleable value of its assets was then less than the amount that would be required to pay its probable liabilities on its existing debts as they became absolute and matured. There can be no
assurance
36
as to what standard a court would apply in order to determine whether the issuer was insolvent after giving effect to the incurrence of the indebtedness in which the Trust invested or
that, regardless of the method of valuation, a court would not determine that the issuer was insolvent upon giving effect to such incurrence. In addition, in the event of the insolvency of an issuer of indebtedness in which the Trust
invests, payments made on such indebtedness could be subject to avoidance as a preference if made within a certain period of time (which may be as long as one year) before insolvency.
The Trust does not anticipate that it will engage in conduct that would form the basis for a successful cause of action based
upon fraudulent conveyance, preference or subordination. There can be no assurance, however, as to whether any lending institution or other party from which the Trust may acquire such indebtedness engaged in any such conduct (or any other conduct
that would subject such indebtedness and the Trust to insolvency laws) and, if it did, as to whether such creditor claims could be asserted in a U.S. court (or in the courts of any other country) against the Trust.
Indebtedness consisting of obligations of non-U.S. issuers may be subject to various
laws enacted in the countries of their issuance for the protection of creditors. These insolvency considerations will differ depending on the country in which each issuer is located or domiciled and may differ depending on whether the issuer is a non-sovereign or a sovereign entity.
Foreign Currency Risk
Because the Trust may invest in securities denominated or quoted in currencies other than the U.S. dollar, changes in foreign
currency exchange rates may affect the value of securities held by the Trust and the unrealized appreciation or depreciation of investments. Currencies of certain countries may be volatile and therefore may affect the value of securities denominated
in such currencies, which means that the Trusts NAV could decline as a result of changes in the exchange rates between foreign currencies and the U.S. dollar. The Advisor may, but is not required to, elect for the Trust to seek to protect
itself from changes in currency exchange rates through hedging transactions depending on market conditions. In addition, certain countries, particularly emerging market countries, may impose foreign currency exchange controls or other restrictions
on the transferability, repatriation or convertibility of currency.
Repurchase Agreements Risk
Subject to its investment objectives and policies, the Trust may invest in repurchase agreements. Repurchase agreements
typically involve the acquisition by the Trust of fixed-income securities from a selling financial institution such as a bank, savings and loan association or broker-dealer. The agreement provides that the Trust will sell the securities back to the
institution at a fixed time in the future. The Trust does not bear the risk of a decline in the value of the underlying security unless the seller defaults under its repurchase obligation. In the event of the bankruptcy or other default of a seller
of a repurchase agreement, the Trust could experience both delays in liquidating the underlying securities and losses, including possible decline in the value of the underlying security during the period in which the Trust seeks to enforce its
rights thereto; possible lack of access to income on the underlying security during this period; and expenses of enforcing its rights. While repurchase agreements involve certain risks not associated with direct investments in fixed-income
securities, the Trust follows procedures approved by the Board that are designed to minimize such risks. In addition, the value of the collateral underlying the repurchase agreement will be at least equal to the repurchase price, including any
accrued interest earned on the repurchase agreement. In the event of a default or bankruptcy by a selling financial institution, the Trust generally will seek to liquidate such collateral. However, the exercise of the Trusts right to liquidate
such collateral could involve certain costs or delays and, to the extent that proceeds from any sale upon a default of the obligation to repurchase were less than the repurchase price, the Trust could suffer a loss.
When-Issued, Forward Commitment and Delayed Delivery Transactions Risk
The Trust may purchase securities on a when-issued basis (including on a forward commitment or TBA (to be
announced) basis) and may purchase or sell securities for delayed delivery. When-issued and delayed
37
delivery transactions occur when securities are purchased or sold by the Trust with payment and delivery taking place in the future to secure an advantageous yield or price. Securities purchased
on a when-issued or delayed delivery basis may expose the Trust to counterparty risk of default as well as the risk that securities may experience fluctuations in value prior to their actual delivery. The Trust will not accrue income with respect to
a when-issued or delayed delivery security prior to its stated delivery date. Purchasing securities on a when-issued or delayed delivery basis can involve the additional risk that the price or yield available in the market when the delivery takes
place may not be as favorable as that obtained in the transaction itself.
Event Risk
Event risk is the risk that corporate issuers may undergo restructurings, such as mergers, leveraged buyouts, takeovers, or
similar events financed by increased debt. As a result of the added debt, the credit quality and market value of a companys securities may decline significantly.
Defensive Investing Risk
For defensive purposes, the Trust may allocate assets into cash or short-term fixed-income securities without limitation. In
doing so, the Trust may succeed in avoiding losses but may otherwise fail to achieve its investment objectives. Further, the value of short-term fixed-income securities may be affected by changing interest rates and by changes in credit ratings of
the investments. If the Trust holds cash uninvested it will be subject to the credit risk of the depository institution holding the cash.
Structured
Investments Risks
The Trust may invest in structured products, including structured notes, ELNs and other types of
structured products. Holders of structured products bear the risks of the underlying investments, index or reference obligation and are subject to counterparty risk.
The Trust may have the right to receive payments only from the structured product and generally does not have direct rights
against the issuer or the entity that sold the assets to be securitized. While certain structured products enable the investor to acquire interests in a pool of securities without the brokerage and other expenses associated with directly holding the
same securities, investors in structured products generally pay their share of the structured products administrative and other expenses.
Although it is difficult to predict whether the prices of indices and securities underlying structured products will rise or
fall, these prices (and, therefore, the prices of structured products) will be influenced by the same types of political and economic events that affect issuers of securities and capital markets generally. If the issuer of a structured product uses
shorter term financing to purchase longer term securities, the issuer may be forced to sell its securities at below market prices if it experiences difficulty in obtaining such financing, which may adversely affect the value of the structured
products owned by the Trust.
Structured Notes Risk. Investments in structured notes involve risks, including
credit risk and market risk. Where the Trusts investments in structured notes are based upon the movement of one or more factors, including currency exchange rates, interest rates, referenced bonds and stock indices, depending on the factor
used and the use of multipliers or deflators, changes in interest rates and movement of the factor may cause significant price fluctuations. Additionally, changes in the reference instrument or security may cause the interest rate on the structured
note to be reduced to zero and any further changes in the reference instrument may then reduce the principal amount payable on maturity. Structured notes may be less liquid than other types of securities and more volatile than the reference
instrument or security underlying the note.
Equity-Linked Notes Risk. ELNs are hybrid securities with
characteristics of both fixed-income and equity securities. An ELN is a debt instrument, usually a bond, that pays interest based upon the performance of an
38
underlying equity, which can be a single stock, basket of stocks or an equity index. The interest payment on an ELN may in some cases be leveraged so that, in percentage terms, it exceeds the
relative performance of the market. ELNs generally are subject to the risks associated with the securities of equity issuers, default risk and counterparty risk. Additionally, because the Trust may use ELNs as an alternative or complement to its
options strategy, the use of ELNs in this manner would expose the Trust to the risk that such ELNs will not perform as anticipated, and the risk that the use of ELNs will expose the Trust to different or additional default and counterparty risk as
compared to a similar investment executed in an options strategy.
Credit-Linked Notes Risk. A CLN is a derivative
instrument. It is a synthetic obligation between two or more parties where the payment of principal and/or interest is based on the performance of some obligation (a reference obligation). In addition to the credit risk of the reference obligations
and interest rate risk, the buyer/seller of the CLN is subject to counterparty risk.
Event-Linked Securities Risk.
Event-linked securities are a form of derivative issued by insurance companies and insurance-related special purpose vehicles that apply securitization techniques to catastrophic property and casualty damages. Unlike other insurable low-severity, high-probability events, the insurance risk of which can be diversified by writing large numbers of similar policies, the holders of a typical event-linked securities are exposed to the risks from
high-severity, low-probability events such as that posed by major earthquakes or hurricanes. If a catastrophe occurs that triggers the event-linked security, investors in such security may lose
some or all of the capital invested. In the case of an event, the funds are paid to the bond sponsoran insurer, reinsurer or corporationto cover losses. In return, the bond sponsors pay interest to investors for this catastrophe
protection. Event-linked securities can be structured to pay-off on three types of variablesinsurance-industry catastrophe loss indices, insured-specific catastrophe losses and parametric indices based
on the physical characteristics of catastrophic events. Such variables are difficult to predict or model, and the risk and potential return profiles of event-linked securities may be difficult to assess. Catastrophe-related event-linked securities
have been in use since the 1990s, and the securitization and risk-transfer aspects of such event-linked securities are beginning to be employed in other insurance and risk-related areas. No active trading market may exist for certain event-linked
securities, which may impair the ability of the Trust to realize full value in the event of the need to liquidate such assets.
Strategic Transactions
and Derivatives Risk
The Trust may engage in various Strategic Transactions for duration management and other risk
management purposes, including to attempt to protect against possible changes in the market value of the Trusts portfolio resulting from trends in the securities markets and changes in interest rates or to protect the Trusts unrealized
gains in the value of its portfolio securities, to facilitate the sale of portfolio securities for investment purposes or to establish a position in the securities markets as a temporary substitute for purchasing particular securities or to enhance
income or gain. Derivatives are financial contracts or instruments whose value depends on, or is derived from, the value of an underlying asset, reference rate or index (or relationship between two indices). The Trust also may use derivatives to add
leverage to the portfolio and/or to hedge against increases in the Trusts costs associated with any leverage strategy that it may employ. The use of Strategic Transactions to enhance current income may be particularly speculative.
Strategic Transactions involve risks. The risks associated with Strategic Transactions include (i) the imperfect
correlation between the value of such instruments and the underlying assets, (ii) the possible default of the counterparty to the transaction, (iii) illiquidity of the derivative instruments, and (iv) high volatility losses caused by
unanticipated market movements, which are potentially unlimited. Although both OTC and exchange-traded derivatives markets may experience a lack of liquidity, OTC non-standardized derivative transactions are
generally less liquid than exchange-traded instruments. The illiquidity of the derivatives markets may be due to various factors, including congestion, disorderly markets, limitations on deliverable supplies, the participation of speculators,
government regulation and intervention, and technical and operational or system failures. In addition, daily limits on price fluctuations and speculative position limits on exchanges on which the Trust may
39
conduct its transactions in derivative instruments may prevent prompt liquidation of positions, subjecting the Trust to the potential of greater losses. Furthermore, the Trusts ability to
successfully use Strategic Transactions depends on the Advisors ability to predict pertinent securities prices, interest rates, currency exchange rates and other economic factors, which cannot be assured. The use of Strategic Transactions may
result in losses greater than if they had not been used, may require the Trust to sell or purchase portfolio securities at inopportune times or for prices other than current market values, may limit the amount of appreciation the Trust can realize
on an investment or may cause the Trust to hold a security that it might otherwise sell. Additionally, segregated or earmarked liquid assets, amounts paid by the Trust as premiums and cash or other assets held in margin accounts with respect to
Strategic Transactions are not otherwise available to the Trust for investment purposes. Please see the Trusts SAI for a more detailed description of Strategic Transactions and the various derivative instruments the Trust may use and the
various risks associated with them.
Exchange-traded derivatives and OTC derivative transactions submitted for clearing
through a central counterparty are also subject to minimum initial and variation margin requirements set by the relevant clearinghouse, as well as possible margin requirements mandated by the SEC or the CFTC. The CFTC and federal banking regulators
also have imposed margin requirements on non-cleared OTC derivatives, and the SECs non-cleared margin requirements for security-based swaps became effective on
November 1, 2021. Applicable margin requirements may increase the overall costs for the Trust.
Many OTC derivatives
are valued on the basis of dealers pricing of these instruments. However, the price at which dealers value a particular derivative and the price that the same dealers would actually be willing to pay for such derivative should the Trust wish
or be forced to sell such position may be materially different. Such differences can result in an overstatement of the Trusts NAV and may materially adversely affect the Trust in situations in which the Trust is required to sell derivative
instruments.
While hedging can reduce or eliminate losses, it can also reduce or eliminate gains. Hedges are sometimes
subject to imperfect matching between the derivative and the underlying security, and there can be no assurance that the Trusts hedging transactions will be effective.
Derivatives may give rise to a form of leverage and may expose the Trust to greater risk and increase its costs. Recent
legislation calls for new regulation of the derivatives markets. The extent and impact of the regulation is not yet known and may not be known for some time. New regulation may make derivatives more costly, may limit the availability of derivatives,
or may otherwise adversely affect the value or performance of derivatives.
On October 28, 2020, the SEC adopted
new regulations governing the use of derivatives by registered investment companies (Rule 18f-4). The Trust will be required to implement and comply with Rule
18f-4 by August 19, 2022. Once implemented, Rule 18f-4 will impose limits on the amount of derivatives a fund can enter into, eliminate the asset segregation
framework currently used by funds to comply with Section 18 of the Investment Company Act, treat derivatives as senior securities and require funds whose use of derivatives is more than a limited specified exposure amount to establish and
maintain a comprehensive derivatives risk management program and appoint a derivatives risk manager.
Counterparty Risk
The Trust will be subject to credit risk with respect to the counterparties to the derivative contracts purchased by the Trust.
Because derivative transactions in which the Trust may engage may involve instruments that are not traded on an exchange or cleared through a central counterparty but are instead traded between counterparties based on contractual relationships, the
Trust is subject to the risk that a counterparty will not perform its obligations under the related contracts. If a counterparty becomes bankrupt or otherwise fails to perform its obligations due to financial difficulties, the Trust may experience
significant delays in obtaining any recovery in bankruptcy or other reorganization proceedings. The Trust may obtain only a limited recovery, or
40
may obtain no recovery, in such circumstances. Although the Trust intends to enter into transactions only with counterparties that the Advisor believes to be creditworthy, there can be no
assurance that, as a result, a counterparty will not default and that the Trust will not sustain a loss on a transaction. In the event of the counterpartys bankruptcy or insolvency, the Trusts collateral may be subject to the conflicting
claims of the counterpartys creditors, and the Trust may be exposed to the risk of a court treating the Trust as a general unsecured creditor of the counterparty, rather than as the owner of the collateral.
The counterparty risk for cleared derivatives is generally lower than for uncleared OTC derivative transactions since
generally a clearing organization becomes substituted for each counterparty to a cleared derivative contract and, in effect, guarantees the parties performance under the contract as each party to a trade looks only to the clearing organization
for performance of financial obligations under the derivative contract. However, there can be no assurance that a clearing organization, or its members, will satisfy its obligations to the Trust, or that the Trust would be able to recover the full
amount of assets deposited on its behalf with the clearing organization in the event of the default by the clearing organization or the Trusts clearing broker. In addition, cleared derivative transactions benefit from daily marking-to-market and settlement, and segregation and minimum capital requirements applicable to intermediaries. Uncleared OTC derivative transactions generally do not benefit
from such protections. This exposes the Trust to the risk that a counterparty will not settle a transaction in accordance with its terms and conditions because of a dispute over the terms of the contract (whether or not bona fide) or because of a
credit or liquidity problem, thus causing the Trust to suffer a loss. Such counterparty risk is accentuated for contracts with longer maturities where events may intervene to prevent settlement, or where the Trust has concentrated its
transactions with a single or small group of counterparties.
In addition, the Trust is subject to the risk that issuers
of the instruments in which it invests and trades may default on their obligations under those instruments, and that certain events may occur that have an immediate and significant adverse effect on the value of those instruments. There can be no
assurance that an issuer of an instrument in which the Trust invests will not default, or that an event that has an immediate and significant adverse effect on the value of an instrument will not occur, and that the Trust will not sustain a loss on
a transaction as a result.
Swaps Risk
Swaps are a type of derivative. Swap agreements involve the risk that the party with which the Trust has entered into the swap
will default on its obligation to pay the Trust and the risk that the Trust will not be able to meet its obligations to pay the other party to the agreement. In order to seek to hedge the value of the Trusts portfolio, to hedge against
increases in the Trusts cost associated with interest payments on any outstanding borrowings or to seek to increase the Trusts return, the Trust may enter into swaps, including interest rate swap, total return swap (sometimes referred to
as a contract for difference) and/or credit default swap transactions. In interest rate swap transactions, there is a risk that yields will move in the direction opposite of the direction anticipated by the Trust, which would cause the
Trust to make payments to its counterparty in the transaction that could adversely affect Trust performance. In addition to the risks applicable to swaps generally (including counterparty risk, high volatility, illiquidity risk and credit risk),
credit default swap transactions involve special risks because they are difficult to value, are highly susceptible to liquidity and credit risk, and generally pay a return to the party that has paid the premium only in the event of an actual default
by the issuer of the underlying obligation (as opposed to a credit downgrade or other indication of financial difficulty).
Historically, swap transactions have been individually negotiated non-standardized
transactions entered into in OTC markets and have not been subject to the same type of government regulation as exchange-traded instruments. However, since the global financial crisis, the OTC derivatives markets have become subject to comprehensive
statutes and regulations. In particular, in the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act), signed into law by President Obama on July 21, 2010, requires that certain
derivatives with U.S. persons must be executed on a regulated market and a substantial
41
portion of OTC derivatives must be submitted for clearing to regulated clearinghouses. As a result, swap transactions entered into by the Trust may become subject to various requirements
applicable to swaps under the Dodd-Frank Act, including clearing, exchange-execution, reporting and recordkeeping requirements, which may make it more difficult and costly for the Trust to enter into swap transactions and may also render certain
strategies in which the Trust might otherwise engage impossible or so costly that they will no longer be economical to implement. Furthermore, the number of counterparties that may be willing to enter into swap transactions with the Trust may also
be limited if the swap transactions with the Trust are subject to the swap regulation under the Dodd-Frank Act.
Credit
default and total return swap agreements may effectively add leverage to the Trusts portfolio because, in addition to its Managed Assets, the Trust would be subject to investment exposure on the notional amount of the swap. Total return swap
agreements are subject to the risk that a counterparty will default on its payment obligations to the Trust thereunder. The Trust is not required to enter into swap transactions for hedging purposes or to enhance income or gain and may choose not to
do so. In addition, the swaps market is subject to a changing regulatory environment. It is possible that regulatory or other developments in the swaps market could adversely affect the Trusts ability to successfully use swaps.
Inflation Risk
Inflation
risk is the risk that the value of assets or income from investment will be worth less in the future, as inflation decreases the value of money. As inflation increases, the real value of the common shares and distributions on those shares can
decline. In addition, during any periods of rising inflation, interest rates on any borrowings by the Trust would likely increase, which would tend to further reduce returns to the holders of common shares.
Deflation Risk
Deflation
risk is the risk that prices throughout the economy decline over time, which may have an adverse effect on the market valuation of companies, their assets and their revenues. In addition, deflation may have an adverse effect on the creditworthiness
of issuers and may make issuer default more likely, which may result in a decline in the value of the Trusts portfolio.
Risk Associated with
Recent Market Events
In response to the financial crisis and recent market events , the United States and other
governments and the Federal Reserve and certain foreign central banks have taken steps to support financial markets. Policy and legislative changes by the U.S. government and the Federal Reserve to assist in the ongoing support of financial markets,
both domestically and in other countries, are changing many aspects of financial regulation. The impact of these changes on the markets, and the practical implications for market participants, may not be fully known for some time. In some countries
where economic conditions are recovering, such countries are nevertheless perceived as still fragile. Withdrawal of government support, failure of efforts in response to the crisis, or investor perception that such efforts are not succeeding, could
adversely impact the value and liquidity of certain investments. The severity or duration of adverse economic conditions may also be affected by policy changes made by governments or quasi-governmental organizations, including changes in tax laws
and the imposition of trade barriers. The impact of new financial regulation legislation on the markets and the practical implications for market participants may not be fully known for some time. Changes to the Federal Reserve policy, including
with respect to certain interest rates, may affect the value, volatility and liquidity of dividend and interest paying securities. Regulatory changes are causing some financial services companies to exit long-standing lines of business, resulting in
dislocations for other market participants.
In addition, the current contentious domestic political environment, as well
as political and diplomatic events in the United States and abroad, such as presidential elections in the United States or the U.S.
42
governments inability at times to agree on a long-term budget and deficit reduction plan, has in the past resulted, and may in the future result, in adverse consequences (including a
government shutdown) to the U.S. regulatory landscape, the general market environment and/or investment sentiment, which could negatively impact the Trusts investments and operations. Such adverse consequences may affect investor and/or
consumer confidence and may adversely impact financial markets and the broader economy, potentially to a significant degree. In recent years, some countries, including the United States, have adopted and/or are considering the adoption of more
protectionist trade policies and/or a move away from tight financial industry regulations, including but not limited to, direct capital infusions into companies, new monetary programs and dramatically lower interest rates, that were previously
adopted in response to serious economic disruptions. The exact shape of these policies is still being considered, but the equity and debt markets may react strongly to expectations of change, which could increase volatility, especially if the
markets expectations are not borne out and an unexpected or sudden reversal of these policies, could increase volatility in securities markets, which could adversely affect the Trusts investments or prevent the Trust from executing on
advantageous investment opportunities in a timely manner. A rise in protectionist trade policies, and the possibility of changes to some international trade agreements, could affect the economies of many nations in ways that cannot necessarily be
foreseen at the present time. In addition, geopolitical and other risks, including environmental and public health, may add to instability in world economies and markets generally. Economies and financial markets throughout the world are becoming
increasingly interconnected. As a result, whether or not the Trust invests in securities of issuers located in or with significant exposure to countries experiencing economic, political and/or financial difficulties, the value and liquidity of the
Trusts investments may be negatively affected by such events.
An outbreak of respiratory disease caused by a novel
coronavirus (COVID-19) that was first detected in China in December 2019 developed into a global pandemic. Although vaccines have been developed and approved for use by various governments, the duration of the
pandemic and its effects cannot be predicted with certainty. This pandemic has resulted in closing borders, enhanced health screenings, healthcare service preparation and delivery, quarantines, cancellations, disruptions to supply chains and
customer activity, as well as general concern and uncertainty. Disruptions in markets can adversely impact the Trust and its investments. Further, certain local markets have been or may be subject to closures, and there can be no certainty regarding
whether trading will continue in any local markets in which the Trust may invest, when any resumption of trading will occur or, once such markets resume trading, whether they will face further closures. Any suspension of trading in markets in which
the Trust invests will have an impact on the Trust and its investments and will impact the Trusts ability to purchase or sell securities in such market. The outbreak could also impair the information technology and other operational systems
upon which the Trusts service providers, including the Advisor, rely, and could otherwise disrupt the ability of employees of the Trusts service providers to perform critical tasks relating to the Trust. The impact of this outbreak has
adversely affected the economies of many nations and the entire global economy and may impact individual issuers and capital markets in ways that cannot be foreseen. Public health crises caused by the outbreak may exacerbate other preexisting
political, social and economic risks in certain countries or globally. Other infectious illness outbreaks that may arise in the future could have similar or other unforeseen effects. The duration of this outbreak or others and their effects cannot
be determined with certainty.
EMU and Redenomination Risk
As the European debt crisis progressed, the possibility of one or more Eurozone countries exiting the EMU, or even the collapse
of the Euro as a common currency, arose, creating significant volatility at times in currency and financial markets generally. The effects of the collapse of the Euro, or of the exit of one or more countries from the EMU, on the U.S. and global
economy and securities markets are impossible to predict and any such events could have a significant adverse impact on the value and risk profile of the Trusts portfolio. Any partial or complete dissolution of the EMU could have significant
adverse effects on currency and financial markets, and on the values of the Trusts portfolio investments. If one or more EMU countries were to stop using the Euro as its primary currency, the Trusts investments in such countries may be
redenominated into a different or newly adopted currency. As a result, the value of those investments could decline significantly and unpredictably. In
43
addition, securities or other investments that are redenominated may be subject to foreign currency risk, illiquidity risk and valuation risk to a greater extent than similar investments
currently denominated in Euros. To the extent a currency used for redenomination purposes is not specified in respect of certain EMU-related investments, or should the Euro cease to be used entirely, the
currency in which such investments are denominated may be unclear, making such investments particularly difficult to value or dispose of. The Trust may incur additional expenses to the extent it is required to seek judicial or other clarification of
the denomination or value of such securities.
Market Disruption and Geopolitical Risk
The occurrence of events similar to those in recent years, such as the aftermath of the war in Iraq, instability in
Afghanistan, Pakistan, Egypt, Libya, Syria, Russia, Ukraine and the Middle East, new and ongoing epidemics and pandemics of infectious diseases and other global health events, natural/environmental disasters, terrorist attacks in the United States
and around the world, social and political discord, debt crises (such as the Greek crisis), sovereign debt downgrades, increasingly strained relations between the United States and a number of foreign countries, including traditional allies, such as
certain European countries, and historical adversaries, such as North Korea, Iran, China and Russia, and the international community generally, new and continued political unrest in various countries, such as Venezuela and Spain, the exit or
potential exit of one or more countries from the EU or the EMU, continued changes in the balance of political power among and within the branches of the U.S. government, among others, may result in market volatility, may have long term effects on
the U.S. and worldwide financial markets, and may cause further economic uncertainties in the United States and worldwide.
Russia launched a large-scale invasion of Ukraine on February 24, 2022. The extent and duration of the military action,
resulting sanctions and resulting future market disruptions, including declines in its stock markets and the value of the ruble against the U.S. dollar, in the region are impossible to predict, but could be significant. Any such disruptions caused
by Russian military action or other actions (including cyberattacks and espionage) or resulting actual and threatened responses to such activity, including purchasing and financing restrictions, boycotts or changes in consumer or purchaser
preferences, sanctions, tariffs or cyberattacks on the Russian government, Russian companies or Russian individuals, including politicians, could have a severe adverse effect on Russia and the European region, including significant negative impacts
on the Russian economy, the European economy and the markets for certain securities and commodities, such as oil and natural gas, and may likely have collateral impacts on such sectors globally as well as other sectors. How long such military action
and related events will last cannot be predicted.
China and the United States have each recently imposed tariffs on the
other countrys products. These actions may trigger a significant reduction in international trade, the oversupply of certain manufactured goods, substantial price reductions of goods and possible failure of individual companies and/or large
segments of Chinas export industry, which could have a negative impact on the Trusts performance. U.S. companies that source material and goods from China and those that make large amounts of sales in China would be particularly
vulnerable to an escalation of trade tensions. Uncertainty regarding the outcome of the trade tensions and the potential for a trade war could cause the U.S. dollar to decline against safe haven currencies, such as the Japanese yen and the euro.
Events such as these and their consequences are difficult to predict and it is unclear whether further tariffs may be imposed or other escalating actions may be taken in the future.
On January 31, 2020, the United Kingdom (UK) officially withdrew from the EU (commonly known as
Brexit). The UK and EU reached a preliminary trade agreement, which became effective on January 1, 2021, regarding the terms of their future trading relationship relating principally to the trading of goods; however, negotiations
are ongoing for matters not covered by the agreement, such as the trade of financial services. Due to uncertainty of the current political environment, it is not possible to foresee the form or nature of the future trading relationship between the
UK and the EU. The longer term economic, legal, political and social framework to be put in place between the UK and the EU remains unclear and the ongoing political and economic uncertainty and periods of exacerbated volatility in both the UK and
in wider European markets may continue for
44
some time. In particular, Brexit may lead to a call for similar referendums in other European jurisdictions which may cause increased economic volatility in the European and global markets and
may destabilize some or all of the other EU member countries. This uncertainty may have an adverse effect on the economy generally and on the ability of the Trust and its investments to execute their respective strategies, to receive attractive
returns and/or to exit certain investments at an advantageous time or price. In particular, currency volatility may mean that the returns of the Trust and its investments are adversely affected by market movements and may make it more difficult, or
more expensive, if the Trust elects to execute currency hedges. Potential decline in the value of the British Pound and/or the Euro against other currencies, along with the potential downgrading of the UKs sovereign credit rating, may also
have an impact on the performance of portfolio companies or investments located in the UK or Europe. In light of the above, no definitive assessment can currently be made regarding the impact that Brexit will have on the Trust, its investments or
its organization more generally.
The occurrence of any of these above events could have a significant adverse impact on
the value and risk profile of the Trusts portfolio. The Trust does not know how long the securities markets may be affected by similar events and cannot predict the effects of similar events in the future on the U.S. economy and securities
markets. There can be no assurance that similar events and other market disruptions will not have other material and adverse implications.
Cybersecurity incidents affecting particular companies or industries may adversely affect the economies of particular
countries of the world in which the Trust invests.
Regulation and Government Intervention Risk
In recent years, the U.S. Government and the Federal Reserve, as well as foreign governments throughout the world, have taken
unprecedented actions designed to support certain financial institutions and segments of the financial markets that experienced extreme volatility, such as implementing stimulus packages, providing liquidity in fixed income, commercial paper and
other markets, providing tax breaks, direct capital infusions into companies and dramatically lowering interest rates, among other actions. Such actions may have unintended and adverse consequences, such as causing or contributing to an increased
risk of inflation and an unexpected or sudden reversal of these policies, or the ineffectiveness of such policies, may increase volatility in securities markets or prevent the Trust from executing on advantageous investment opportunities in a timely
manner and negatively impact the Trusts investments. See Inflation Risk. The reduction or withdrawal of Federal Reserve or other U.S. or non-U.S. governmental support could negatively
affect financial markets generally and reduce the value and liquidity of certain securities. Additionally, with the cessation of certain other market support activities, such as those mentioned above, the Trust may face a heightened level of
interest rate risk as a result of a rise or increased volatility in interest rates.
Federal, state, and other
governments, their regulatory agencies or self-regulatory organizations may take actions that affect the regulation of the issuers in which the Trust invests. Legislation or regulation may also change the way in which the Trust is regulated. Such
legislation or regulation could limit or preclude the Trusts ability to achieve its investment objectives.
In the
aftermath of the global financial crisis, there appears to be a renewed popular, political and judicial focus on finance related consumer protection. Financial institution practices are also subject to greater scrutiny and criticism generally. In
the case of transactions between financial institutions and the general public, there may be a greater tendency toward strict interpretation of terms and legal rights in favor of the consuming public, particularly where there is a real or perceived
disparity in risk allocation and/or where consumers are perceived as not having had an opportunity to exercise informed consent to the transaction. In the event of conflicting interests between retail investors holding common shares of a closed-end investment company such as the Trust and a large financial institution, a court may similarly seek to strictly interpret terms and legal rights in favor of retail investors.
45
The Trust may be affected by governmental action in ways that are not
foreseeable, and there is a possibility that such actions could have a significant adverse effect on the Trust and its ability to achieve its investment objectives.
Regulation as a Commodity Pool
The CFTC subjects advisers to registered investment companies to regulation by the CFTC if a fund that is advised by the
investment adviser either (i) invests, directly or indirectly, more than a prescribed level of its liquidation value in CFTC-regulated futures, options and swaps (CFTC Derivatives), or (ii) markets itself as providing
investment exposure to such instruments. To the extent the Trust uses CFTC Derivatives, it intends to do so below such prescribed levels and will not market itself as a commodity pool or a vehicle for trading such instruments.
Accordingly, the Advisor has claimed an exclusion from the definition of the term commodity pool operator under the Commodity Exchange Act (the CEA) pursuant to Rule 4.5 under the CEA. The Advisor is not, therefore, subject
to registration or regulation as a commodity pool operator under the CEA in respect of the Trust.
Failures of Futures Commission Merchants
and Clearing Organizations Risk
The Trust is required to deposit funds to margin open positions in cleared derivative
instruments (both futures and swaps) with a clearing broker registered as a futures commission merchant (FCM). The CEA requires an FCM to segregate all funds received from customers with respect to any orders for the purchase
or sale of U.S. domestic futures contracts and cleared swaps from the FCMs proprietary assets. Similarly, the CEA requires each FCM to hold in a separate secure account all funds received from customers with respect to any orders for the
purchase or sale of foreign futures contracts and segregate any such funds from the funds received with respect to domestic futures contracts. However, all funds and other property received by an FCM from its customers are held by an FCM on a
commingled basis in an omnibus account and amounts in excess of assets posted to the clearing organization may be invested by an FCM in certain instruments permitted under the applicable regulation. There is a risk that assets deposited by the Trust
with any FCM as margin for futures contracts or commodity options may, in certain circumstances, be used to satisfy losses of other clients of the Trusts FCM. In addition, the assets of the Trust posted as margin against both swaps and futures
contracts may not be fully protected in the event of the FCMs bankruptcy.
Legal, Tax and Regulatory Risks
Legal, tax and regulatory changes could occur that may have material adverse effects on the Trust. For example, the regulatory
and tax environment for derivative instruments in which the Trust may participate is evolving, and such changes in the regulation or taxation of derivative instruments may have material adverse effects on the value of derivative instruments held by
the Trust and the ability of the Trust to pursue its investment strategies.
To qualify for the favorable U.S. federal
income tax treatment generally accorded to RICs, the Trust must, among other things, derive in each taxable year at least 90% of its gross income from certain prescribed sources and distribute for each taxable year at least 90% of its
investment company taxable income (generally, ordinary income plus the excess, if any, of net short-term capital gain over net long-term capital loss). If for any taxable year the Trust does not qualify as a RIC, all of its taxable
income for that year (including its net capital gain) would be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions would be taxable as ordinary dividends to the extent of the
Trusts current and accumulated earnings and profits.
The Biden presidential administration has called for
significant changes to U.S. fiscal, tax, trade, healthcare, immigration, foreign, and government regulatory policy. In this regard, there is significant uncertainty with respect to legislation, regulation and government policy at the federal level,
as well as the state and local levels.
46
Recent events have created a climate of heightened uncertainty and introduced new and difficult-to-quantify
macroeconomic and political risks with potentially far-reaching implications. There has been a corresponding meaningful increase in the uncertainty surrounding interest rates, inflation, foreign exchange
rates, trade volumes and fiscal and monetary policy. To the extent the U.S. Congress or the current presidential administration implements changes to U.S. policy, those changes may impact, among other things, the U.S. and global economy,
international trade and relations, unemployment, immigration, corporate taxes, healthcare, the U.S. regulatory environment, inflation and other areas. Although the Trust cannot predict the impact, if any, of these changes to the Trusts
business, they could adversely affect the Trusts business, financial condition, operating results and cash flows. Until the Trust knows what policy changes are made and how those changes impact the Trusts business and the business of the
Trusts competitors over the long term, the Trust will not know if, overall, the Trust will benefit from them or be negatively affected by them.
The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process
and by the IRS and the U.S. Treasury Department. The Trust cannot predict how any changes in the tax laws might affect its investors or the Trust itself. New legislation, U.S. Treasury regulations, administrative interpretations or court decisions,
with or without retroactive application, could significantly and negatively affect the Trusts ability to qualify as a RIC or the U.S. federal income tax consequences to its investors and itself of such qualification, or could have other
adverse consequences. You are urged to consult with your tax advisor with respect to the status of legislative, regulatory or administrative developments and proposals and their potential effect on an investment in the Trusts shares.
Investment Company Act Regulations
The Trust is a registered closed-end management investment company and as such is
subject to regulations under the Investment Company Act. Generally speaking, any contract or provision thereof that is made, or where performance involves a violation of the Investment Company Act or any rule or regulation thereunder is
unenforceable by either party unless a court finds otherwise.
Potential Conflicts of Interest of the Advisor and Others
The investment activities of BlackRock, the ultimate parent company of the Advisor, and its Affiliates in the management of, or
their interest in, their own accounts and other accounts they manage, may present conflicts of interest that could disadvantage the Trust and its shareholders. BlackRock and its Affiliates provide investment management services to other funds and
discretionary managed accounts that may follow investment programs similar to that of the Trust. Subject to the requirements of the Investment Company Act, BlackRock and its Affiliates intend to engage in such activities and may receive compensation
from third parties for their services. None of BlackRock or its Affiliates are under any obligation to share any investment opportunity, idea or strategy with the Trust. As a result, BlackRock and its Affiliates may compete with the Trust for
appropriate investment opportunities. The results of the Trusts investment activities, therefore, may differ from those of an Affiliate or another account managed by an Affiliate and it is possible that the Trust could sustain losses during
periods in which one or more Affiliates and other accounts achieve profits on their trading for proprietary or other accounts. BlackRock has adopted policies and procedures designed to address potential conflicts of interest. For additional
information about potential conflicts of interest and the way in which BlackRock addresses such conflicts, please see Conflicts of Interest and Management of the TrustPortfolio ManagementPotential Material Conflicts of
Interest in the SAI.
Decision-Making Authority Risk
Investors have no authority to make decisions or to exercise business discretion on behalf of the Trust, except as set forth in
the Trusts governing documents. The authority for all such decisions is generally delegated to the Board, which in turn, has delegated the day-to-day management of
the Trusts investment activities to the Advisor, subject to oversight by the Board.
47
Management Risk
The Trust is subject to management risk because it is an actively managed investment portfolio. The Advisor and the individual
portfolio managers will apply investment techniques and risk analyses in making investment decisions for the Trust, but there can be no guarantee that these will produce the desired results. The Trust may be subject to a relatively high level of
management risk because the Trust may invest in derivative instruments, which may be highly specialized instruments that require investment techniques and risk analyses different from those associated with equities and bonds.
Market and Selection Risk
Market risk is the possibility that the market values of securities owned by the Trust will decline. There is a risk that
equity and/or bond markets will go down in value, including the possibility that such markets will go down sharply and unpredictably.
Stock markets are volatile, and the price of equity securities fluctuates based on changes in a companys financial
condition and overall market and economic conditions. Local, regional or global events such as war, acts of terrorism, the spread of infectious illness or other public health issue, recessions, or other events could have a significant impact on the
Trust and its investments. An adverse event, such as an unfavorable earnings report, may depress the value of a particular common stock held by the Trust. Also, the price of common stocks is sensitive to general movements in the stock market and a
drop in the stock market may depress the price of common stocks to which the Trust has exposure. Common stock prices fluctuate for several reasons, including changes in investors perceptions of the financial condition of an issuer or the
general condition of the relevant stock market, or when political or economic events affecting the issuers occur.
The
prices of fixed-income securities tend to fall as interest rates rise, and such declines tend to be greater among fixed-income securities with longer maturities. Market risk is often greater among certain types of fixed-income securities, such as
zero coupon bonds that do not make regular interest payments but are instead bought at a discount to their face values and paid in full upon maturity. As interest rates change, these securities often fluctuate more in price than securities that make
regular interest payments and therefore subject the Trust to greater market risk than a fund that does not own these types of securities.
When-issued and delayed delivery transactions are subject to changes in market conditions from the time of the commitment
until settlement, which may adversely affect the prices or yields of the securities being purchased. The greater the Trusts outstanding commitments for these securities, the greater the Trusts exposure to market price fluctuations.
Selection risk is the risk that the securities that the Trusts management selects will underperform the equity and/or
bond market, the market relevant indices or other funds with similar investment objectives and investment strategies.
Reliance on the Advisor Risk
The Trust is dependent upon services and resources provided by the Advisor, and therefore the Advisors parent,
BlackRock. The Advisor is not required to devote its full time to the business of the Trust and there is no guarantee or requirement that any investment professional or other employee of the Advisor will allocate a substantial portion of his or her
time to the Trust. The loss of one or more individuals involved with the Advisor could have a material adverse effect on the performance or the continued operation of the Trust. For additional information on the Advisor and BlackRock, see
Management of the TrustInvestment Advisor.
Reliance on Service Providers Risk
The Trust must rely upon the performance of service providers to perform certain functions, which may include functions that
are integral to the Trusts operations and financial performance. Failure by any service
48
provider to carry out its obligations to the Trust in accordance with the terms of its appointment, to exercise due care and skill or to perform its obligations to the Trust at all as a result of
insolvency, bankruptcy or other causes could have a material adverse effect on the Trusts performance and returns to shareholders. The termination of the Trusts relationship with any service provider, or any delay in appointing a
replacement for such service provider, could materially disrupt the business of the Trust and could have a material adverse effect on the Trusts performance and returns to shareholders.
Information Technology Systems Risk
The Trust is dependent on the Advisor for certain management services as well as back-office functions. The Advisor depends on
information technology systems in order to assess investment opportunities, strategies and markets and to monitor and control risks for the Trust. It is possible that a failure of some kind which causes disruptions to these information technology
systems could materially limit the Advisors ability to adequately assess and adjust investments, formulate strategies and provide adequate risk control. Any such information technology-related difficulty could harm the performance of the
Trust. Further, failure of the back-office functions of the Advisor to process trades in a timely fashion could prejudice the investment performance of the Trust.
Cyber Security Risk
With
the increased use of technologies such as the Internet to conduct business, the Trust is susceptible to operational, information security and related risks. In general, cyber incidents can result from deliberate attacks or unintentional events.
Cyber-attacks include, but are not limited to, gaining unauthorized access to digital systems (e.g., through hacking or malicious software coding) for purposes of misappropriating assets or sensitive information, corrupting data, or
causing operational disruption. Cyber-attacks may also be carried out in a manner that does not require gaining unauthorized access, such as causing denial-of-service
attacks on websites (i.e., efforts to make network services unavailable to intended users). Cyber security failures by or breaches of the Advisor and other service providers (including, but not limited to, fund accountants, custodians, transfer
agents and administrators), and the issuers of securities in which the Trust invests, have the ability to cause disruptions and impact business operations, potentially resulting in financial losses, interference with the Trusts ability to
calculate its NAV, impediments to trading, the inability of shareholders to transact business, violations of applicable privacy and other laws, regulatory fines, penalties, reputational damage, reimbursement or other compensation costs, or
additional compliance costs. In addition, substantial costs may be incurred in order to prevent any cyber incidents in the future. While the Trust has established business continuity plans in the event of, and risk management systems to prevent,
such cyber-attacks, there are inherent limitations in such plans and systems including the possibility that certain risks have not been identified. Furthermore, the Trust cannot control the cyber security plans and systems put in place by service
providers to the Trust and issuers in which the Trust invests. As a result, the Trust or its shareholders could be negatively impacted.
Misconduct of
Employees and of Service Providers Risk
Misconduct or misrepresentations by employees of the Advisor or the
Trusts service providers could cause significant losses to the Trust. Employee misconduct may include binding the Trust to transactions that exceed authorized limits or present unacceptable risks and unauthorized trading activities, concealing
unsuccessful trading activities (which, in any case, may result in unknown and unmanaged risks or losses) or making misrepresentations regarding any of the foregoing. Losses could also result from actions by the Trusts service providers,
including, without limitation, failing to recognize trades and misappropriating assets. In addition, employees and service providers may improperly use or disclose confidential information, which could result in litigation or serious financial harm,
including limiting the Trusts business prospects or future marketing activities. Despite the Advisors due diligence efforts, misconduct and intentional misrepresentations may be undetected or not fully comprehended, thereby potentially
undermining the Advisors due diligence efforts. As a result, no assurances can be given that the due diligence performed by the Advisor will identify or prevent any such misconduct.
49
Special Risks for Holders of Rights
There is a risk that performance of the Trust may result in the common shares purchasable upon exercise of the rights being
less attractive to investors at the conclusion of the subscription period. This may reduce or eliminate the value of the rights. Investors who receive rights may find that there is no market to sell rights they do not wish to exercise. If investors
exercise only a portion of the rights, common shares may trade at less favorable prices than larger offerings for similar securities.
Portfolio
Turnover Risk
The Trusts annual portfolio turnover rate may vary greatly from year to year, as well as within a
given year. Portfolio turnover rate is not considered a limiting factor in the execution of investment decisions for the Trust. A higher portfolio turnover rate results in correspondingly greater brokerage commissions and other transactional
expenses that are borne by the Trust. High portfolio turnover may result in an increased realization of net short-term capital gains by the Trust which, when distributed to common shareholders, will be taxable as ordinary income. Additionally, in a
declining market, portfolio turnover may create realized capital losses.
Anti-Takeover Provisions Risk
The Trusts Agreement and Declaration of Trust and Bylaws include provisions that could limit the ability of other
entities or persons to acquire control of the Trust or convert the Trust to open-end status or to change the composition of the Board. Such provisions could limit the ability of shareholders to sell their
shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control of the Trust. See Certain Provisions in the Agreement and Declaration of Trust and Bylaws.
HOW THE TRUST MANAGES RISK
Investment Limitations
The Trust has adopted certain investment limitations designed to limit investment risk. Some of these limitations are
fundamental and thus may not be changed without the approval of the holders of a majority of the outstanding common shares. See Investment Objectives and PoliciesInvestment Restrictions in the SAI.
The restrictions and other limitations set forth throughout this Prospectus and in the SAI apply only at the time of purchase
of securities and will not be considered violated unless an excess or deficiency occurs or exists immediately after and as a result of the acquisition of securities.
Management of Investment Portfolio and Capital Structure to Limit Leverage Risk
The Trust may take certain actions if short-term interest rates increase or market conditions otherwise change (or the Trust
anticipates such an increase or change) and any leverage the Trust may have outstanding begins (or is expected) to adversely affect common shareholders. In order to attempt to offset such a negative impact of any outstanding leverage on common
shareholders, the Trust may shorten the average maturity of its investment portfolio (by investing in short-term securities) or may reduce any indebtedness that it may have incurred. As explained above under RisksLeverage Risk, the
success of any such attempt to limit leverage risk depends on the Advisors ability to accurately predict interest rate or other market changes. Because of the difficulty of making such predictions, the Trust may never attempt to manage its
capital structure in the manner described in this paragraph.
If market conditions suggest that employing leverage, or
employing additional leverage if the Trust already has outstanding leverage, would be beneficial, the Trust may enter into one or more credit facilities, increase any existing credit facilities, sell preferred shares or engage in additional leverage
transactions, subject to the restrictions of the Investment Company Act.
50
Strategic Transactions
The Trust may use certain Strategic Transactions designed to limit the risk of price fluctuations of securities and to preserve
capital. These Strategic Transactions include using swaps, financial futures contracts, options on financial futures or options based on either an index of long-term securities, or on securities whose prices, in the opinion of the Advisor, correlate
with the prices of the Trusts investments. There can be no assurance that Strategic Transactions will be used or used effectively to limit risk, and Strategic Transactions may be subject to their own risks.
MANAGEMENT OF THE TRUST
Trustees and Officers
The Board is responsible for the overall management of the Trust, including supervision of the duties performed by the Advisor.
There are eleven Trustees. A majority of the Trustees are Independent Trustees of the Trust. The name and business address of the Trustees and officers of the Trust and their principal occupations and other affiliations during the past five years
are set forth under Management of the Trust in the SAI.
Investment Advisor
The Advisor is responsible for the management of the Trusts portfolio and provides the necessary personnel, facilities,
equipment and certain other services necessary to the operation of the Trust. The Advisor, located at 100 Bellevue Parkway, Wilmington, Delaware 19809, is a wholly-owned subsidiary of BlackRock.
BlackRock is one of the worlds largest publicly-traded investment management firms. As of December 31, 2021,
BlackRocks assets under management were approximately $10.010 trillion. BlackRock has over 30 years of experience managing closed-end products and, as of December 31, 2021, advised a registered closed-end family of 54 active exchange-traded funds with approximately $61.9 billion in managed assets.
BlackRock is independent in ownership and governance, with no single majority shareholder and a majority of independent
directors.
Investment Philosophy
The Advisor believes that the knowledge and experience of its Science and Technology Team enable it to evaluate the macro
environment and assess its impact on the various sub-sectors within the science and technology sector. Within this framework, the Advisor identifies stocks it believes to have attractive characteristics,
evaluates the use of options and provides ongoing portfolio risk management.
The
top-down or macro component of the investment process is designed to assess the various interrelated macro variables affecting the science and technology sector as a whole. Risk/reward analysis is a key
component of the Advisors macro view. The Advisor evaluates science and technology sub-sectors (e.g., internet software and services, systems software, semiconductors, data processing and outsourced
services, communications equipment, etc.). Selection of sub-sectors within the science and technology sector is a direct result of the Advisors sub-sector
analysis. Once the evaluation of the various sub-sectors in the science and technology sector is complete, the Advisor determines what it believes to be optimal portfolio positioning.
Bottom-up security selection is focused on identifying companies the Advisor believes
to have the most attractive characteristics within each applicable sub-sector of the science and technology sector. The Advisor seeks to identify companies that it believes to have strong product potential,
solid earnings growth and/or earnings power which are under appreciated by investors, a quality management team and compelling relative and absolute valuation. The Advisor believes that the knowledge and experience of its Science and Technology Team
enables it to identify attractive science and technology company securities.
51
The Advisor intends to utilize options strategies that consist of writing
(selling) covered call options on a portion of the common stocks held by the Trust, as well as other options strategies such as writing other call and put options or using options to manage risk. The portfolio management team will work together
closely to determine which options strategies to pursue to seek to generate current gains from options and premiums and to enhance the Trusts risk-adjusted returns.
Portfolio Managers
The
members of the portfolio management team who are primarily responsible for the day-to-day management of the Trusts portfolio are as follows:
Tony Kim, Managing Director and portfolio manager, is a member of BlackRocks Fundamental Active Equity division
of BlackRocks Active Equities Group. He is lead portfolio manager for the information technology sector, product manager for Global Science & Technology equity portfolios, and a member of the teams Investment Strategy Group.
Prior to joining BlackRock in 2013, Mr. Kim was a Senior Research Analyst for Artisan Partners based in San Francisco covering the global technology sector on their International Growth Team, which he joined in 2006. Before assuming this role,
Mr. Kim worked as a Research Analyst at Credit Suisse Asset Management where he worked primarily on their U.S. large funds and was a portfolio manager of their Global Internet and Software sector fund from 2005 to
mid-2006. Mr. Kim has also worked with E-Vue, a spin-off of Sarnoff Labs, and at Neuberger Berman covering technology and
telecom sectors. Mr. Kim began his investment career on the sell-side covering IT at SG Warburg in 1994, where he then moved to Merrill Lynch to execute M&A transactions for technology companies.
Kyle G. McClements, CFA, Managing Director, is Head of the Equity Derivatives team within BlackRocks Fundamental
Equity division. He is a portfolio manager for equity derivatives overlay and hedging assignments, including BlackRocks closed-end funds. Mr. McClements service with the firm dates back to
2004, including his years with State Street Research & Management (SSRM), which merged with BlackRock in 2005. At SSRM, Mr. McClements was a Vice President and senior derivatives strategist responsible for equity derivative strategy
and trading in the Quantitative Equity Group at State Street Research. Prior to joining State Street Research in 2004, Mr. McClements was a senior trader/analyst at Deutsche Asset Management, responsible for derivatives, equity program,
technology and energy sector, and foreign exchange trading. Mr. McClements began his career in 1994 as a derivatives analyst with Donaldson Lufkin & Jenrette responsible for pricing and performance analytics for the derivatives trading
desk.
Christopher M. Accettella, Director, is a member of the Equity Derivatives team within BlackRocks
Fundamental Active Equity division. He is a portfolio manager for equity derivatives overlay and hedging assignments, including BlackRocks equity closed-end funds. Prior to joining BlackRock in 2005,
Mr. Accettella was an institutional sales trader with American Technology Research. From 2001 to 2003, he was with Deutsche Asset Management where he was responsible for derivatives and program trading. Prior to that, he was a senior associate
in the Pacific Basin Equity Group at Scudder Investments Singapore Limited. Mr. Accettella began his investment career in 1997 as a portfolio analyst in the European Equity group of Scudder Kemper Investments, Inc.
Reid Menge, Director, is a member of the Fundamental Active Equity division of BlackRocks Active Equity Group. He
is responsible for coverage of the technology sector. Prior to joining BlackRock in 2014, Mr. Menge was an associate director of equity research at UBS covering global technology. From 2006 to 2009, he was an investment research analyst at
Citigroup responsible for global software. From 2003 to 2006, Mr. Menge was a member of the Prudential Equity Group where he was responsible for enterprise software coverage. Mr. Menge began his investment career in 2001 at Credit Suisse
First Boston as an analyst for fixed income sales. Mr. Menge earned a BA degree in history from Cornell University in 2001.
52
The SAI provides additional information about other accounts managed by the
portfolio management team, the compensation of each portfolio manager and the ownership of the Trusts securities by each portfolio manager.
Investment Management Agreement
Pursuant to an investment management agreement between the Advisor and the Trust (the Investment Management
Agreement), the Trust has agreed to pay the Advisor a monthly management fee at an annual rate equal to 1.00% of the average daily value of the Trusts Managed Assets. The Advisor contractually agreed to waive receipt of a portion of the
management fee in the amount of 0.20% of the Trusts average daily Managed Assets for the first five years of the Trusts operations (2014 through 2018), 0.15% in year six (2019), 0.10% in year seven (2020) and 0.05% in year eight
(2021). The period from the Trusts inception to December 31, 2014 was considered year one for the waiver. Beginning in year nine (2022), there will be no waiver.
Managed Assets means the total assets of the Trust, (including any assets attributable to money borrowed for
investment purposes) minus the sum of the Trusts accrued liabilities (other than money borrowed for investment purposes). This means that during periods in which the Trust is using leverage, the fee paid to the Advisor will be higher than if
the Trust did not use leverage because the fee is calculated as a percentage of the Trusts Managed Assets, which include those assets purchased with leverage.
A discussion regarding the basis for the approval of the Investment Management Agreement by the Board is available in the
Trusts Semi-Annual Report to shareholders for the period ended June 30, 2021.
Except as otherwise described in
this Prospectus, the Trust pays, in addition to the fees paid to the Advisor, all other costs and expenses of its operations, including compensation of its Trustees (other than those affiliated with the Advisor), custodian, leveraging expenses,
transfer and dividend disbursing agent expenses, legal fees, rating agency fees, listing fees and expenses, expenses of independent auditors, expenses of repurchasing shares, expenses of preparing, printing and distributing shareholder reports,
notices, proxy statements and reports to governmental agencies and taxes, if any.
The Trust and the Advisor have entered
into the Fee Waiver Agreement, pursuant to which the Advisor has contractually agreed to waive the management fee with respect to any portion of the Trusts assets attributable to investments in any equity and fixed-income mutual funds and ETFs
managed by the Advisor or its affiliates that have a contractual management fee, through June 30, 2023. In addition, pursuant to the Fee Waiver Agreement, the Advisor has contractually agreed to waive its management fees by the amount of
investment advisory fees the Trust pays to the Advisor indirectly through its investment in money market funds advised by the Advisor or its affiliates, through June 30, 2023. The Fee Waiver Agreement may be continued from year to year
thereafter, provided that such continuance is specifically approved by the Advisor and the Trust (including by a majority of the Trusts Independent Trustees). Neither the Advisor nor the Trust is obligated to extend the Fee Waiver Agreement.
The Fee Waiver Agreement may be terminated at any time, without the payment of any penalty, only by the Trust (upon the vote of a majority of the Independent Trustees or a majority of the outstanding voting securities of the Trust), upon 90
days written notice by the Trust to the Advisor.
Administration and Accounting Services
State Street Bank and Trust Company provides certain administration and accounting services to the Trust pursuant to an
Administration and Fund Accounting Services Agreement (the Administration Agreement). Pursuant to the Administration Agreement, State Street Bank and Trust Company provides the Trust with, among other things, customary fund accounting
services, including computing the Trusts NAV and maintaining books, records and other documents relating to the Trusts financial and portfolio transactions, and customary fund administration services, including assisting the Trust with
regulatory filings, tax compliance and other oversight activities. For these and other services it provides to the Trust, State Street Bank and Trust Company is paid a
53
monthly fee from the Trust at an annual rate ranging from 0.0075% to 0.015% of the Trusts Managed Assets, along with an annual fixed fee ranging from $0 to $10,000 for the services it
provides to the Trust.
Custodian and Transfer Agent
The custodian of the assets of the Trust is State Street Bank and Trust Company, whose principal business address is One
Lincoln Street, Boston, Massachusetts 02111. The custodian is responsible for, among other things, receipt of and disbursement of funds from the Trusts accounts, establishment of segregated accounts as necessary, and transfer, exchange and
delivery of Trust portfolio securities.
Computershare Trust Company, N.A., whose principal business address is 150 Royall
Street, Canton, Massachusetts 02021, serves as the Trusts transfer agent with respect to the common shares.
Independent Registered Public
Accounting Firm
Deloitte & Touche LLP, whose principal business address is 200 Berkeley Street, Boston, MA
02116, is the independent registered public accounting firm of the Trust and is expected to render an opinion annually on the financial statements of the Trust.
NET ASSET VALUE
The NAV of the Trusts common shares will be computed based upon the value of the Trusts portfolio securities and
other assets. NAV per common share will be determined as of the close of the regular trading session on the NYSE on each business day on which the NYSE is open for trading. The Trust calculates NAV per common share by subtracting the Trusts
liabilities (including accrued expenses, dividends payable and any borrowings of the Trust), and the liquidation value of any outstanding preferred shares of the Trust from the Trusts total assets (the value of the securities the Trust holds
plus cash or other assets, including interest accrued but not yet received) and dividing the result by the total number of common shares of the Trust outstanding.
Valuation of securities held by the Trust is as follows:
Equity Investments. Equity securities traded on a recognized securities exchange (e.g., NYSE), on separate trading
boards of a securities exchange or through a market system that provides contemporaneous transaction pricing information (each, an Exchange) are valued using information obtained via independent pricing services generally at the Exchange
closing price or if an Exchange closing price is not available, the last traded price on that Exchange prior to the time as of which the assets or liabilities are valued. However, under certain circumstances, other means of determining current
market value may be used. If an equity security is traded on more than one Exchange, the current market value of the security where it is primarily traded generally will be used. In the event that there are no sales involving an equity security held
by the Trust on a day on which the Trust values such security, the last bid (long positions) or ask (short positions) price, if available, will be used as the value of such security. If the Trust holds both long and short positions in the same
security, the last bid price will be applied to securities held long and the last ask price will be applied to securities sold short. If no bid or ask price is available on a day on which the Trust values such security, the prior days price
will be used, unless the Advisors determine that such prior days price no longer reflects the fair value of the security, in which case such asset would be treated as a Fair Value Asset (as defined below).
Fixed-Income Investments. Fixed-income securities for which market quotations are readily available are generally
valued using such securities current market value. The Trust values fixed-income portfolio securities using the last available bid prices or current market quotations provided by dealers or prices (including evaluated prices) supplied by
the Trusts approved independent third-party pricing services, each in accordance with the policies and procedures approved by the Trusts Board (the Valuation Procedures). The pricing services may
54
use matrix pricing or valuation models that utilize certain inputs and assumptions to derive values, including transaction data (e.g., recent representative bids and offers), credit quality
information, perceived market movements, news, and other relevant information and by other methods, which may include consideration of: yields or prices of securities of comparable quality, coupon, maturity and type; indications as to values from
dealers; general market conditions; and/or other factors and assumptions. Pricing services generally value fixed-income securities assuming orderly transactions of an institutional round lot size, but the Trust may hold or transact in such
securities in smaller, odd lot sizes. Odd lots often trade at lower prices than institutional round lots. The amortized cost method of valuation may be used with respect to debt obligations with 60 days or less remaining to maturity unless
such method does not represent fair value. Certain fixed-income investments including asset-backed and mortgage related securities may be valued based on valuation models that consider the estimated cash flows of each tranche of the issuer,
establish a benchmark yield and develop an estimated tranche specific spread to the benchmark yield based on the unique attributes of the tranche.
Options, Futures, Swaps and Other Derivatives. Exchange-traded equity options for which market quotations are readily
available are valued at the mean of the last bid and ask prices as quoted on the Exchange or the board of trade on which such options are traded. In the event that there is no mean price available for an exchange traded equity option held by the
Trust on a day on which the Trust values such option, the last bid (long positions) or ask (short positions) price, if available, will be used as the value of such option. If no bid or ask price is available on a day on which the Trust values such
option, the prior days price will be used, unless the Advisors determine that such prior days price no longer reflects the fair value of the option in which case such option will be treated as a fair value asset. OTC derivatives may be
valued using a mathematical model which may incorporate a number of market data factors. Financial futures contracts and options thereon, which are traded on exchanges, are valued at their last sale price or settle price as of the close of such
exchanges. Swap agreements and other derivatives are generally valued daily based upon quotations from market makers or by a pricing service in accordance with the Valuation Procedures.
Underlying Funds. Shares of underlying open-end funds are valued at NAV. Shares
of underlying exchange-traded closed-end funds or other ETFs will be valued at their most recent closing price.
General Valuation Information. In determining the market value of portfolio investments, the Trust may employ
independent third party pricing services, which may use, without limitation, a matrix or formula method that takes into consideration market indexes, matrices, yield curves and other specific adjustments. This may result in the assets being valued
at a price different from the price that would have been determined had the matrix or formula method not been used. All cash, receivables and current payables are carried on the Trusts books at their face value. The price the Trust could
receive upon the sale of any particular portfolio investment may differ from the Trusts valuation of the investment, particularly for assets that trade in thin or volatile markets or that are valued using a fair valuation methodology or a
price provided by an independent pricing service. As a result, the price received upon the sale of an investment may be less than the value ascribed by the Trust, and the Trust could realize a greater than expected loss or lesser than expected
gain upon the sale of the investment. The Trusts ability to value its investment may also be impacted by technological issues and/or errors by pricing services or other third party service providers.
All cash, receivables and current payables are carried on the Trusts books at their fair value.
Prices obtained from independent third party pricing services, broker-dealers or market makers to value the Trusts
securities and other assets and liabilities are based on information available at the time the Trust values its assets and liabilities. In the event that a pricing service quotation is revised or updated subsequent to the day on which the Trust
valued such security, the revised pricing service quotation generally will be applied prospectively. Such determination will be made considering pertinent facts and circumstances surrounding the revision.
In the event that application of the methods of valuation discussed above result in a price for a security which is deemed not
to be representative of the fair market value of such security, the security will be valued by,
55
under the direction of or in accordance with a method specified by the Board as reflecting fair value. All other assets and liabilities (including securities for which market quotations are not
readily available) held by the Trust (including restricted securities) are valued at fair value as determined in good faith by the Board or BlackRocks Valuation Committee (the Valuation Committee) (its delegate) pursuant to the
Valuation Procedures. Any assets and liabilities which are denominated in a foreign currency are translated into U.S. dollars at the prevailing market rates.
Certain of the securities acquired by the Trust may be traded on foreign exchanges or OTC markets on days on which the
Trusts NAV is not calculated and common shares are not traded. In such cases, the NAV of the Trusts common shares may be significantly affected on days when investors can neither purchase nor sell shares of the Trust.
Fair Value. When market quotations are not readily available or are believed by the Advisors to be unreliable, the
Trusts investments are valued at fair value (Fair Value Assets). Fair Value Assets are valued by the Advisors in accordance with the Valuation Procedures. The Advisors may reasonably conclude that a market quotation is not readily
available or is unreliable if, among other things, a security or other asset or liability does not have a price source due to its complete lack of trading, if the Advisors believe a market quotation from a broker-dealer or other source is unreliable
(e.g., where it varies significantly from a recent trade, or no longer reflects the fair value of the security or other asset or liability subsequent to the most recent market quotation), where the security or other asset or liability is only thinly
traded or due to the occurrence of a significant event subsequent to the most recent market quotation. For this purpose, a significant event is deemed to occur if the Advisors determine, in their reasonable business judgment, that an
event has occurred after the close of trading for an asset or liability but prior to or at the time of pricing the Trusts assets or liabilities, that is likely to cause a material change to the last exchange closing price or closing market
price of one or more assets or liabilities held by the Trust. On any day the NYSE is open and a foreign market or the primary exchange on which a foreign asset or liability is traded is closed, such asset or liability will be valued using the prior
days price, provided that the Advisors are not aware of any significant event or other information that would cause such price to no longer reflect the fair value of the asset or liability, in which case such asset or liability would be
treated as a Fair Value Asset. For certain foreign assets, a third-party vendor supplies evaluated, systematic fair value pricing based upon the movement of a proprietary multi-factor model after the relevant foreign markets have closed. This
systematic fair value pricing methodology is designed to correlate the prices of foreign assets following the close of the local markets to the price that might have prevailed as of the Trusts pricing time.
The Advisors, with input from portfolio management, will submit their recommendations regarding the valuation and/or valuation
methodologies for Fair Value Assets to the Valuation Committee. The Valuation Committee may accept, modify or reject any recommendations. In addition, the Trusts accounting agent periodically endeavors to confirm the prices it receives from
all third party pricing services, index providers and broker-dealers, and, with the assistance of the Advisors, to regularly evaluate the values assigned to the securities and other assets and liabilities of the Trust. The pricing of all Fair Value
Assets is subsequently reported to the Board or a Committee thereof.
When determining the price for a Fair Value Asset,
the Valuation Committee shall seek to determine the price that the Trust might reasonably expect to receive from the current sale of that asset or liability in an arms-length transaction on the date on
which the asset or liability is being valued, and does not seek to determine the price the Trust might reasonably expect to receive for selling an asset or liability at a later time or if it holds the asset or liability to maturity. Fair value
determinations will be based upon all available factors that the BlackRock Valuation Committee deems relevant at the time of the determination, and may be based on analytical values determined by the Advisors using proprietary or third party
valuation models.
Fair value represents a good faith approximation of the value of an asset or liability. When
determining the fair value of an investment, one or more fair value methodologies may be used (depending on certain factors, including the asset type). For example, the investment may be initially priced based on the original cost of the
56
investment or, alternatively, using proprietary or third-party models that may rely upon one or more unobservable inputs. Prices of actual, executed or historical transactions in the relevant
investment (or comparable instruments) or, where appropriate, an appraisal by a third-party experienced in the valuation of similar instruments, may also be used as a basis for establishing the fair value of an investment.
The fair value of one or more assets or liabilities may not, in retrospect, be the price at which those assets or liabilities
could have been sold during the period in which the particular fair values were used in determining the Trusts NAV. As a result, the Trusts sale or repurchase of its shares at NAV, at a time when a holding or holdings are valued at fair
value, may have the effect of diluting or increasing the economic interest of existing shareholders.
The Trusts
annual audited financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP), follow the requirements for valuation set forth in Financial Accounting
Standards Board Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures (ASC 820), which defines and establishes a framework for measuring fair value under US GAAP and expands financial
statement disclosure requirements relating to fair value measurements.
Generally, ASC 820 and other accounting rules
applicable to investment companies and various assets in which they invest are evolving. Such changes may adversely affect the Trust. For example, the evolution of rules governing the determination of the fair market value of assets or liabilities
to the extent such rules become more stringent would tend to increase the cost and/or reduce the availability of third-party determinations of fair market value. This may in turn increase the costs associated with selling assets or affect their
liquidity due to the Trusts inability to obtain a third-party determination of fair market value. The SEC recently adopted new Rule 2a-5 under the Investment Company Act, which will establish an updated
regulatory framework for registered investment company valuation practices and may impact the Trusts valuation policies. The Trust will not be required to comply with the new rule until September 8, 2022.
DISTRIBUTIONS
The Trust intends to make regular monthly cash distributions of all or a portion of its net investment income, including
current gains, to common shareholders. The Trust will pay common shareholders at least annually all or substantially all of its investment company taxable income. The Investment Company Act generally limits the Trust to one capital gain distribution
per year, subject to certain exceptions, including as discussed below in connection with the Managed Distribution Plan.
The Trust has, pursuant to an SEC exemptive order granted to certain of BlackRocks
closed-end funds, adopted a plan to support a level distribution of income, capital gains and/or return of capital. The Managed Distribution Plan has been approved by the Board and is consistent with the
Trusts investment objectives and policies. Under the Managed Distribution Plan, the Trust will distribute all available investment income, including current gains, to its shareholders, consistent with its investment objectives and as required
by the Code. If sufficient investment income, including current gains, is not available on a monthly basis, the Trust will distribute long-term capital gains and/or return of capital to shareholders in order to maintain a level distribution. A
return of capital distribution may involve a return of the shareholders original investment. Though not currently taxable, such a distribution may lower a shareholders basis in the Trust, thus potentially subjecting the shareholder to
future tax consequences in connection with the sale of Trust shares, even if sold at a loss to the shareholders original investment. Each monthly distribution to shareholders is expected to be at a fixed amount established by the Board, except
for extraordinary distributions and potential distribution rate increases or decreases to enable the Trust to comply with the distribution requirements imposed by the Code. Shareholders should not draw any conclusions about the Trusts
investment performance from the amount of these distributions or from the terms of the Managed Distribution Plan. The Trusts total return performance on NAV
57
will be presented in its financial highlights table, which will be available in the Trusts shareholder reports, every six-months. The Board may
amend, suspend or terminate the Managed Distribution Plan without prior notice if it deems such actions to be in the best interests of the Trust or its shareholders. The suspension or termination of the Managed Distribution Plan could have the
effect of creating a trading discount (if the Trusts stock is trading at or above NAV) or widening an existing trading discount. The Trust is subject to risks that could have an adverse impact on its ability to maintain level distributions.
Examples of potential risks include, but are not limited to, economic downturns impacting the markets, decreased market volatility, companies suspending or decreasing corporate dividend distributions and changes in the Code. Please see
Risks for a more complete description of the Trusts risks.
The tax treatment and characterization of
the Trusts distributions may vary significantly from time to time because of the varied nature of the Trusts investments. The ultimate tax characterization of the Trusts distributions made in a fiscal year cannot finally be
determined until after the end of that fiscal year. As a result, there is a possibility that the Trust may make total distributions during a fiscal year in an amount that exceeds the Trusts earnings and profits for U.S. federal income tax
purposes. In such situations, the amount by which the Trusts total distributions exceed earnings and profits would generally be treated as a return of capital reducing the amount of a shareholders tax basis in such shareholders
shares, with any amounts exceeding such basis treated as gain from the sale of shares.
Various factors will affect the
level of the Trusts income, including the asset mix and the Trusts use of hedging. To permit the Trust to maintain a more stable monthly distribution, the Trust may from time to time distribute less than the entire amount of income
earned in a particular period. The undistributed income would be available to supplement future distributions. As a result, the distributions paid by the Trust for any particular monthly period may be more or less than the amount of income actually
earned by the Trust during that period. Undistributed income will add to the Trusts NAV and, correspondingly, distributions from undistributed income will deduct from the Trusts NAV. The Trust intends to distribute any long-term capital
gains not distributed under the Managed Distribution Plan annually.
Under normal market conditions, the Advisor seeks to
manage the Trust in a manner such that the Trusts distributions are reflective of the Trusts current and projected earnings levels. The distribution level of the Trust is subject to change based upon a number of factors, including the
current and projected level of the Trusts earnings, and may fluctuate over time.
The Trust reserves the right to
change its distribution policy and the basis for establishing the rate of its monthly distributions at any time and may do so without prior notice to common shareholders.
Shareholders will automatically have all dividends and distributions reinvested in common shares of the Trust issued by the
Trust or purchased in the open market in accordance with the Trusts dividend reinvestment plan unless an election is made to receive cash. See Dividend Reinvestment Plan.
DIVIDEND REINVESTMENT PLAN
Please refer to the section
of the Trusts most recent annual report on Form N-CSR entitled Automatic Dividend Reinvestment Plan, which is incorporated by reference herein, for a discussion of the Trusts
dividend reinvestment plan.
RIGHTS OFFERINGS
The Trust may in the future, and at its discretion, choose to make offerings of rights to its shareholders to purchase common
shares. Rights may be issued independently or together with any other offered security and
58
may or may not be transferable by the person purchasing or receiving the rights. In connection with a rights offering to shareholders, we would distribute certificates or other documentation
(i.e., rights cards distributed in lieu of certificates) evidencing the rights and a Prospectus Supplement to our shareholders as of the record date that we set for determining the shareholders eligible to receive rights in such rights offering. Any
such future rights offering will be made in accordance with the Investment Company Act. Under the laws of Delaware, the Board is authorized to approve rights offerings without obtaining shareholder approval.
The staff of the SEC has interpreted the Investment Company Act as not requiring shareholder approval of a transferable rights
offering to purchase common shares at a price below the then current NAV so long as certain conditions are met, including: (i) a good faith determination by a funds board that such offering would result in a net benefit to existing
shareholders; (ii) the offering fully protects shareholders preemptive rights and does not discriminate among shareholders (except for the possible effect of not offering fractional rights); (iii) management uses its best efforts to
ensure an adequate trading market in the rights for use by shareholders who do not exercise such rights; and (iv) the ratio of a transferable rights offering does not exceed one new share for each three rights held.
The applicable Prospectus Supplement would describe the following terms of the rights in respect of which this Prospectus is
being delivered:
|
|
|
the period of time the offering would remain open; |
|
|
|
the underwriter or distributor, if any, of the rights and any associated underwriting fees or discounts
applicable to purchases of the rights; |
|
|
|
the title of such rights; |
|
|
|
the exercise price for such rights (or method of calculation thereof); |
|
|
|
the number of such rights issued in respect of each share; |
|
|
|
the number of rights required to purchase a single share; |
|
|
|
the extent to which such rights are transferable and the market on which they may be traded if they are
transferable; |
|
|
|
if applicable, a discussion of the material U.S. federal income tax considerations applicable to the issuance
or exercise of such rights; |
|
|
|
the date on which the right to exercise such rights will commence, and the date on which such right will
expire (subject to any extension); |
|
|
|
the extent to which such rights include an over-subscription privilege with respect to unsubscribed securities
and the terms of such over-subscription privilege; and |
|
|
|
termination rights we may have in connection with such rights offering. |
A certain number of rights would entitle the holder of the right(s) to purchase for cash such number of common shares at such
exercise price as in each case is set forth in, or be determinable as set forth in, the Prospectus Supplement relating to the rights offered thereby. Rights would be exercisable at any time up to the close of business on the expiration date for such
rights set forth in the Prospectus Supplement. After the close of business on the expiration date, all unexercised rights would become void. Upon expiration of the rights offering and the receipt of payment and the rights certificate or other
appropriate documentation properly executed and completed and duly executed at the corporate trust office of the rights agent, or any other office indicated in the Prospectus Supplement, the common shares purchased as a result of such exercise will
be issued as soon as practicable. To the extent permissible under applicable law, we may determine to offer any unsubscribed offered securities directly to persons other than shareholders, to or through agents, underwriters or dealers or through a
combination of such methods, as set forth in the applicable Prospectus Supplement.
59
TAX MATTERS
The following discussion is a brief summary of certain U.S. federal income tax considerations affecting the Trust and the
purchase, ownership and disposition of the Trusts common shares. A more detailed discussion of the tax rules applicable to the Trust and its common shareholders can be found in the SAI that is incorporated by reference into this Prospectus.
Except as otherwise noted, this discussion assumes you are a taxable U.S. holder (as defined below) and that you hold your common shares as capital assets for U.S. federal income tax purposes (generally, assets held for investment). This discussion
is based upon current provisions of the Code, the regulations promulgated thereunder and judicial and administrative authorities, all of which are subject to change or differing interpretations by the courts or the IRS, possibly with retroactive
effect. No attempt is made to present a detailed explanation of all U.S. federal tax concerns affecting the Trust and its common shareholders. The discussion set forth herein does not constitute tax advice and potential investors are urged to
consult their own tax advisers to determine the specific U.S. federal, state, local and foreign tax consequences to them of investing in the Trust.
In addition, no attempt is made to address tax considerations applicable to an investor with a special tax status, such as a
financial institution, REIT, insurance company, regulated investment company, individual retirement account, other tax-exempt organization, dealer in securities or currencies, person holding shares of the
Trust as part of a hedging, integrated, conversion or straddle transaction, trader in securities that has elected the mark-to-market method of accounting for its
securities, U.S. holder (as defined below) whose functional currency is not the U.S. dollar, investor with applicable financial statements within the meaning of Section 451(b) of the Code, or
non-U.S. investor. Furthermore, this discussion does not reflect possible application of the alternative minimum tax.
A U.S. holder is a beneficial owner that is for U.S. federal income tax purposes:
|
|
|
a citizen or individual resident of the United States (including certain former citizens and former long-term
residents); |
|
|
|
a corporation or other entity treated as a corporation for U.S. federal income tax purposes, created or
organized in or under the laws of the United States or any state thereof or the District of Columbia; |
|
|
|
an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or
|
|
|
|
a trust with respect to which a court within the United States is able to exercise primary supervision over
its administration and one or more U.S. persons have the authority to control all of its substantial decisions or the trust has made a valid election in effect under applicable Treasury regulations to be treated as a U.S. person.
|
Taxation of the Trust
The Trust has elected to be treated as a RIC under Subchapter M of the Code. In order to qualify as a RIC, the Trust must,
among other things, satisfy certain requirements relating to the sources of its income, diversification of its assets, and distribution of its income to its shareholders. First, the Trust must derive at least 90% of its annual gross income from
dividends, interest, payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies, or other income (including but not limited to gains from options, futures and forward contracts)
derived with respect to its business of investing in such stock, securities or currencies, or net income derived from interests in qualified publicly traded partnerships (as defined in the Code) (the 90% gross income test).
Second, the Trust must diversify its holdings so that, at the close of each quarter of its taxable year, (i) at least 50% of the value of its total assets consists of cash, cash items, U.S. Government securities, securities of other RICs and
other securities, with such other securities limited in respect of any one issuer to an amount not greater in value than 5% of the value of the Trusts total assets and to not more than 10% of the outstanding voting securities of such issuer,
and (ii) not more than 25% of the market value of the Trusts total assets is invested in the securities (other than U.S. Government securities and
60
securities of other RICs) of any one issuer, any two or more issuers controlled by the Trust and engaged in the same, similar or related trades or businesses, or any one or more qualified
publicly traded partnerships.
As long as the Trust qualifies as a RIC, the Trust will generally not be subject to
corporate-level U.S. federal income tax on income and gains that it distributes each taxable year to its shareholders, provided that in such taxable year it distributes at least 90% of the sum of (i) its net
tax-exempt interest income, if any, and (ii) its investment company taxable income (which includes, among other items, dividends, taxable interest, taxable original issue discount and market
discount income, income from securities lending, net short-term capital gain in excess of net long-term capital loss, and any other taxable income other than net capital gain (as defined below) and is reduced by deductible expenses)
determined without regard to the deduction for dividends paid. The Trust may retain for investment its net capital gain (which consists of the excess of its net long-term capital gain over its net short-term capital loss). However, if the Trust
retains any net capital gain or any investment company taxable income, it will be subject to tax at regular corporate rates on the amount retained.
The Code imposes a 4% nondeductible excise tax on the Trust to the extent the Trust does not distribute by the end of any
calendar year at least the sum of (i) 98% of its ordinary income (not taking into account any capital gain or loss) for the calendar year and (ii) 98.2% of its capital gain in excess of its capital loss (adjusted for certain ordinary losses) for a one-year period generally ending on October 31 of the calendar year (unless an election is made to use the Trusts fiscal year). In addition, the minimum amounts that must be distributed in any year to
avoid the excise tax will be increased or decreased to reflect the total amount of any under-distribution or over-distribution, as the case may be, from the previous year. For purposes of the excise tax, the Trust will be deemed to have distributed
any income on which it paid U.S. federal income tax. While the Trust intends to distribute any income and capital gain in the manner necessary to minimize imposition of the 4% nondeductible excise tax, there can be no assurance that sufficient
amounts of the Trusts taxable income and capital gain will be distributed to entirely avoid the imposition of the excise tax. In that event, the Trust will be liable for the excise tax only on the amount by which it does not meet the foregoing
distribution requirement.
If in any taxable year the Trust should fail to qualify under Subchapter M of the Code for tax
treatment as a RIC, the Trust would incur a regular corporate U.S. federal income tax upon all of its taxable income for that year, and all distributions to its shareholders (including distributions of net capital gain) would be taxable to
shareholders as ordinary dividend income for U.S. federal income tax purposes to the extent of the Trusts earnings and profits. Provided that certain holding period and other requirements were met, such dividends would be eligible (i) to
be treated as qualified dividend income in the case of shareholders taxed as individuals and (ii) for the dividends received deduction in the case of corporate shareholders. In addition, to qualify again to be taxed as a RIC in a subsequent
year, the Trust would be required to distribute to shareholders its earnings and profits attributable to non-RIC years. In addition, if the Trust failed to qualify as a RIC for a period greater than two
taxable years, then, in order to qualify as a RIC in a subsequent year, the Trust would be required to elect to recognize and pay tax on any net built-in gain (the excess of aggregate gain, including items of
income, over aggregate loss that would have been realized if the Trust had been liquidated) or, alternatively, be subject to taxation on such built-in gain recognized for a period of five years.
The remainder of this discussion assumes that the Trust qualifies for taxation as a RIC.
The Trusts Investments. The Trust has formed a wholly-owned Delaware subsidiary (the Blocker
Subsidiary) to hold interests in certain of its portfolio companies to permit the Trust to continue to meet the qualifications for taxation as a RIC. The Blocker Subsidiary will qualify for the exclusion from the definition of the term
investment company pursuant to Section 3(c)(7) of the Investment Company Act or will otherwise not be required to register as an investment company under the Investment Company Act. Entities such as the Blocker Subsidiary are typically
organized as corporations or as limited liability companies or partnerships that elect to be taxed as corporations for U.S. federal income tax purposes and hold certain investments in pass-through tax entities (such as partnership interests or
limited liability company interests) the gross revenue from which would be bad income for purposes of RIC qualification. The Trust may not invest more than 25% of its
61
total assets in the shares of the Blocker Subsidiary. The Blocker Subsidiary will be subject to U.S. federal corporate income tax. The Blocker Subsidiarys distributions of its after-tax earnings to the Trust will be good income for RIC qualification purposes, and will be treated as qualified dividend income
(for non-corporate shareholders) and as eligible for the dividends received deduction (for corporate shareholders), or as returns of capital.
Certain of the Trusts investment practices are subject to special and complex U.S. federal income tax provisions
(including mark-to-market, constructive sale, straddle, wash sale, short sale and other rules) that may, among other things, (i) disallow, suspend or otherwise
limit the allowance of certain losses or deductions, (ii) convert lower taxed long-term capital gains or qualified dividend income into higher taxed short-term capital gains or ordinary income, (iii) convert ordinary loss or a deduction
into capital loss (the deductibility of which is more limited), (iv) cause the Trust to recognize income or gain without a corresponding receipt of cash, (v) adversely affect the time as to when a purchase or sale of stock or securities is
deemed to occur, (vi) adversely alter the characterization of certain complex financial transactions and (vii) produce income that will not be qualified income for purposes of the 90% annual gross income requirement described
above. These U.S. federal income tax provisions could therefore affect the amount, timing and character of distributions to common shareholders. The Trust intends to monitor its transactions and may make certain tax elections and may be required to
dispose of securities to mitigate the effect of these provisions and prevent disqualification of the Trust as a RIC. Additionally, the Trust may be required to limit its activities in derivative instruments in order to enable it to maintain its RIC
status.
The Trust may invest a portion of its net assets in below investment grade securities. Investments in these types
of securities may present special tax issues for the Trust. U.S. federal income tax rules are not entirely clear about issues such as when the Trust may cease to accrue interest, original issue discount or market discount, when and to what extent
deductions may be taken for bad debts or worthless securities, how payments received on obligations in default should be allocated between principal and income and whether modifications or exchanges of debt obligations in a bankruptcy or workout
context are taxable. These and other issues could affect the Trusts ability to distribute sufficient income to preserve its status as a RIC or to avoid the imposition of U.S. federal income or excise tax.
Certain debt securities acquired by the Trust may be treated as debt securities that were originally issued at a discount.
Generally, the amount of the original issue discount is treated as interest income and is included in taxable income (and required to be distributed by the Trust in order to qualify as a RIC and avoid U.S. federal income tax or the 4% excise tax on
undistributed income) over the term of the security, even though payment of that amount is not received until a later time, usually when the debt security matures.
If the Trust purchases a debt security on a secondary market at a price lower than its adjusted issue price, the excess of the
adjusted issue price over the purchase price is market discount. Unless the Trust makes an election to accrue market discount on a current basis, generally, any gain realized on the disposition of, and any partial payment of principal
on, a debt security having market discount is treated as ordinary income to the extent the gain, or principal payment, does not exceed the accrued market discount on the debt security. Market discount generally accrues in equal daily
installments. If the Trust ultimately collects less on the debt instrument than its purchase price plus the market discount previously included in income, the Trust may not be able to benefit from any offsetting loss deductions.
The Trust may invest in preferred securities or other securities the U.S. federal income tax treatment of which may not be
clear or may be subject to recharacterization by the IRS. To the extent the tax treatment of such securities or the income from such securities differs from the tax treatment expected by the Trust, it could affect the timing or character of income
recognized by the Trust, potentially requiring the Trust to purchase or sell securities, or otherwise change its portfolio, in order to comply with the tax rules applicable to RICs under the Code.
62
Gain or loss on the sale of securities by the Trust will generally be long-term
capital gain or loss if the securities have been held by the Trust for more than one year. Gain or loss on the sale of securities held for one year or less will be short-term capital gain or loss.
Because the Trust may invest in foreign securities, its income from such securities may be subject to non-U.S. taxes. If more than 50% of the Trusts total assets at the close of its taxable year consists of stock or securities of foreign corporations, the Trust may elect for U.S. federal income tax purposes to
treat foreign income taxes paid by it as paid by its shareholders. The Trust may qualify for and make this election in some, but not necessarily all, of its taxable years. If the Trust were to make such an election, shareholders would be required to
take into account an amount equal to their pro rata portions of such foreign taxes in computing their taxable income and then treat an amount equal to those foreign taxes as a U.S. federal income tax deduction or as a foreign tax credit against
their U.S. federal income tax liability. A taxpayers ability to use a foreign tax deduction or credit is subject to limitations under the Code. Shortly after any year for which it makes such an election, the Trust will report to its
shareholder the amount per share of such foreign income tax that must be included in each shareholders gross income and the amount that may be available for the deduction or credit.
Foreign currency gain or loss on foreign currency exchange contracts, non-U.S.
dollar-denominated securities contracts, and non-U.S. dollar-denominated futures contracts, options and forward contracts that are not section 1256 contracts (as defined below) generally will be treated as
ordinary income and loss.
Income from options on individual securities written by the Trust will not be recognized by the
Trust for tax purposes until an option is exercised, lapses or is subject to a closing transaction (as defined by applicable regulations) pursuant to which the Trusts obligations with respect to the option are otherwise terminated.
If the option lapses without exercise, the premiums received by the Trust from the writing of such options will generally be characterized as short-term capital gain. If the Trust enters into a closing transaction, the difference between the
premiums received and the amount paid by the Trust to close out its position will generally be treated as short-term capital gain or loss. If an option written by the Trust is exercised, thereby requiring the Trust to sell the underlying security,
the premium will increase the amount realized upon the sale of the security, and the character of any gain on such sale of the underlying security as short-term or long-term capital gain will depend on the holding period of the Trust in the
underlying security. Because the Trust will not have control over the exercise of the options it writes, such exercises or other required sales of the underlying securities may cause the Trust to realize gains or losses at inopportune times.
Index options that qualify as section 1256 contracts will generally be treated as
marked-to-market for U.S. federal income tax purposes. As a result, the Trust will generally recognize gain or loss on the last day of each taxable year
equal to the difference between the value of the option on that date and the adjusted basis of the option. The adjusted basis of the option will consequently be increased by such gain or decreased by such loss. Any gain or loss with respect to
options on indices and sectors that qualify as section 1256 contracts will be treated as short-term capital gain or loss to the extent of 40% of such gain or loss and long-term capital gain or loss to the extent of 60% of such gain or
loss. Because the mark-to-market rules may cause the Trust to recognize gain in advance of the receipt of cash, the Trust may be required to dispose of investments in
order to meet its distribution requirements. Mark-to-market losses may be suspended or otherwise limited if such losses are part of a straddle or similar
transaction.
Taxation of Common Shareholders
The Trust will either distribute or retain for reinvestment all or part of its net capital gain. If any such gain is retained,
the Trust will be subject to a corporate income tax on such retained amount. In that event, the Trust expects to report the retained amount as undistributed capital gain in a notice to its common shareholders, each of whom, if subject to U.S.
federal income tax on long-term capital gains, (i) will be required to include in income for U.S. federal income tax purposes as long-term capital gain its share of such undistributed amounts, (ii) will be entitled to credit its
proportionate share of the tax paid by the Trust against its U.S. federal income tax liability
63
and to claim refunds to the extent that the credit exceeds such liability and (iii) will increase its basis in its common shares by the amount of undistributed capital gains included in the
shareholders income less the tax deemed paid by the shareholder under clause (ii).
Distributions paid to you by the
Trust from its net capital gain, if any, that the Trust properly reports as capital gain dividends (capital gain dividends) are taxable as long-term capital gains, regardless of how long you have held your common shares. All other
dividends paid to you by the Trust (including dividends from net short-term capital gains or tax-exempt interest, if any) from its current or accumulated earnings and profits (ordinary income
dividends) are generally subject to tax as ordinary income. Provided that certain holding period and other requirements are met, ordinary income dividends (if properly reported by the Trust) may qualify (i) for the dividends received
deduction in the case of corporate shareholders to the extent that the Trusts income consists of dividend income from U.S. corporations, (ii) in the case of individual shareholders, as qualified dividend income eligible to be
taxed at long-term capital gains rates to the extent that the Trust receives qualified dividend income and (iii) in the case of individual shareholders, as section 199A dividends eligible for a 20% qualified business
income deduction in tax years beginning after December 31, 2017 and before January 1, 2026 to the extent the Trust receives ordinary REIT dividends, reduced by allocable Trust expenses. Qualified dividend income is, in general,
dividend income from taxable domestic corporations and certain qualified foreign corporations (e.g., generally, foreign corporations incorporated in a possession of the United States or in certain countries with a qualifying comprehensive tax treaty
with the United States, or whose stock with respect to which such dividend is paid is readily tradable on an established securities market in the United States). There can be no assurance as to what portion, if any, of the Trusts distributions
will constitute qualified dividend income or be eligible for the dividends received deduction or qualified business income deduction.
Any distributions you receive that are in excess of the Trusts current and accumulated earnings and profits will be
treated as a return of capital to the extent of your adjusted tax basis in your common shares, and thereafter as capital gain from the sale of common shares. The amount of any Trust distribution that is treated as a return of capital will reduce
your adjusted tax basis in your common shares, thereby increasing your potential gain or reducing your potential loss on any subsequent sale or other disposition of your common shares.
Common shareholders may be entitled to offset their capital gain dividends with capital losses. The Code contains a number of
statutory provisions affecting when capital losses may be offset against capital gain, and limiting the use of losses from certain investments and activities. Accordingly, common shareholders that have capital losses are urged to consult their tax
advisers.
Dividends and other taxable distributions are taxable to you even though they are reinvested in additional
common shares of the Trust. Dividends and other distributions paid by the Trust are generally treated under the Code as received by you at the time the dividend or distribution is made. If, however, the Trust pays you a dividend in January that was
declared in the previous October, November or December to common shareholders of record on a specified date in one of such months, then such dividend will be treated for U.S. federal income tax purposes as being paid by the Trust and received by you
on December 31 of the year in which the dividend was declared. In addition, certain other distributions made after the close of the Trusts taxable year may be spilled back and treated as paid by the Trust (except for purposes
of the 4% nondeductible excise tax) during such taxable year. In such case, you will be treated as having received such dividends in the taxable year in which the distributions were actually made.
The price of common shares purchased at any time may reflect the amount of a forthcoming distribution. Those purchasing common
shares just prior to the record date of a distribution will receive a distribution which will be taxable to them even though it represents, economically, a return of invested capital.
The Trust will send you information after the end of each year setting forth the amount and tax status of any distributions
paid to you by the Trust.
64
The sale or other disposition of common shares will generally result in capital
gain or loss to you and will be long-term capital gain or loss if you have held such common shares for more than one year at the time of sale. Any loss upon the sale or other disposition of common shares held for six months or less will be treated
as long-term capital loss to the extent of any capital gain dividends received (including amounts credited as an undistributed capital gain dividend) by you with respect to such common shares. Any loss you recognize on a sale or other disposition of
common shares will be disallowed if you acquire other common shares (whether through the automatic reinvestment of dividends or otherwise) within a 61-day period beginning 30 days before and ending 30 days
after your sale or exchange of the common shares. In such case, your tax basis in the common shares acquired will be adjusted to reflect the disallowed loss.
If the Trust liquidates, shareholders generally will realize capital gain or loss upon such liquidation in an amount equal to
the difference between the amount of cash or other property received by the shareholder (including any property deemed received by reason of its being placed in a liquidating trust) and the shareholders adjusted tax basis in its common shares.
Any such gain or loss will be long-term if the shareholder is treated as having a holding period in the Trust shares of greater than one year, and otherwise will be short-term.
Current U.S. federal income tax law taxes both long-term and short-term capital gain of corporations at the rates applicable
to ordinary income. For non-corporate taxpayers, short-term capital gain is currently taxed at rates applicable to ordinary income while long-term capital gain generally is taxed at a reduced maximum rate. The
deductibility of capital losses is subject to limitations under the Code.
Certain U.S. holders who are individuals,
estates or trusts and whose income exceeds certain thresholds will be required to pay a 3.8% Medicare tax on all or a portion of their net investment income, which includes dividends received from the Trust and capital gains from the
sale or other disposition of the Trusts common shares.
A common shareholder that is a nonresident alien individual
or a foreign corporation (a foreign investor) generally will be subject to U.S. federal withholding tax at the rate of 30% (or possibly a lower rate provided by an applicable tax treaty) on ordinary income dividends (except as discussed
below). In general, U.S. federal withholding tax and U.S. federal income tax will not apply to any gain or income realized by a foreign investor in respect of any distribution of net capital gain (including amounts credited as an undistributed
capital gain dividend) or upon the sale or other disposition of common shares of the Trust. Different tax consequences may result if the foreign investor is engaged in a trade or business in the United States or, in the case of an individual, is
present in the United States for 183 days or more during a taxable year and certain other conditions are met. Foreign investors should consult their tax advisers regarding the tax consequences of investing in the Trusts common shares.
Ordinary income dividends properly reported by a RIC are generally exempt from U.S. federal withholding tax where they
(i) are paid in respect of the RICs qualified net interest income (generally, its U.S.-source interest income, other than certain contingent interest and interest from obligations of a corporation or partnership in which the
RIC is at least a 10% shareholder, reduced by expenses that are allocable to such income) or (ii) are paid in respect of the RICs qualified short-term capital gains (generally, the excess of the RICs net short-term
capital gain over its long-term capital loss for such taxable year). Depending on its circumstances, the Trust may report all, some or none of its potentially eligible dividends as such qualified net interest income or as qualified short-term
capital gains, and/or treat such dividends, in whole or in part, as ineligible for this exemption from withholding. In order to qualify for this exemption from withholding, a foreign investor needs to comply with applicable certification
requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form W-8BEN,
W-8BEN-E or substitute Form). In the case of common shares held through an intermediary, the intermediary may have withheld even if the Trust reported the payment as
qualified net interest income or qualified short-term capital gain. Foreign investors should contact their intermediaries with respect to the application of these rules to their accounts. There can be no assurance as to what portion of the
Trusts distributions would qualify for favorable treatment as qualified net interest income or qualified short-term capital gains.
65
In addition, withholding at a rate of 30% will apply to dividends paid in respect
of common shares of the Trust held by or through certain foreign financial institutions (including investment funds), unless such institution enters into an agreement with the Treasury to report, on an annual basis, information with respect to
shares in, and accounts maintained by, the institution to the extent such shares or accounts are held by certain U.S. persons and by certain non-U.S. entities that are wholly or partially owned by U.S. persons
and to withhold on certain payments. Accordingly, the entity through which common shares of the Trust are held will affect the determination of whether such withholding is required. Similarly, dividends paid in respect of common shares of the Trust
held by an investor that is a non-financial foreign entity that does not qualify under certain exemptions will be subject to withholding at a rate of 30%, unless such entity either (i) certifies that such
entity does not have any substantial United States owners or (ii) provides certain information regarding the entitys substantial United States owners, which the Trust or applicable withholding agent will in turn
provide to the Secretary of the Treasury. An intergovernmental agreement between the United States and an applicable foreign country, or future Treasury regulations or other guidance, may modify these requirements. The Trust will not pay any
additional amounts to common shareholders in respect of any amounts withheld. Foreign investors are encouraged to consult with their tax advisers regarding the possible implications of these rules on their investment in the Trusts common
shares.
U.S. federal backup withholding tax may be required on dividends, distributions and sale proceeds payable to
certain non-exempt common shareholders who fail to supply their correct taxpayer identification number (in the case of individuals, generally, their social security number) or to make required certifications,
or who are otherwise subject to backup withholding. Backup withholding is not an additional tax and any amount withheld may be refunded or credited against your U.S. federal income tax liability, if any, provided that you timely furnish the required
information to the IRS.
Ordinary income dividends, capital gain dividends, and gain from the sale or other disposition of
common shares of the Trust also may be subject to state, local, and/or foreign taxes. Common shareholders are urged to consult their own tax advisers regarding specific questions about U.S. federal, state, local or foreign tax consequences to them
of investing in the Trust.
The foregoing is a general and abbreviated summary of certain provisions of the Code and
the Treasury regulations currently in effect as they directly govern the taxation of the Trust and its common shareholders. These provisions are subject to change by legislative or administrative action, and any such change may be retroactive. A
more detailed discussion of the tax rules applicable to the Trust and its common shareholders can be found in the SAI that is incorporated by reference into this Prospectus. Common shareholders are urged to consult their tax advisers regarding
specific questions as to U.S. federal, state, local and foreign income or other taxes.
Please refer to the SAI for
more detailed information. You are urged to consult your tax adviser.
TAXATION OF HOLDERS OF RIGHTS
The value of a right will not be includible in the income of a common shareholder at the time the right is issued.
The basis of a right issued to a common shareholder will be zero, and the basis of the share with respect to which the
subscription right was issued (the old share) will remain unchanged, unless either (a) the fair market value of the right on the date of distribution is at least 15% of the fair market value of the old share, or (b) such shareholder
affirmatively elects (in the manner set out in Treasury regulations under the Code) to allocate to the subscription right a portion of the basis of the old share. If either (a) or (b) applies, then except as described below such
shareholder must allocate basis between the old share and the right in proportion to their fair market values on the date of distribution.
66
The basis of a right purchased in the market will generally be its purchase
price.
The holding period of a right issued to a common shareholder will include the holding period of the old share. No
gain or loss will be recognized by a common shareholder upon the exercise of a right.
No loss will be recognized by a
common shareholder if a right distributed to such common shareholder expires unexercised because the basis of the old share may be allocated to a right only if the right is exercised. If a right that has been purchased in the market expires
unexercised, there will be a recognized loss equal to the basis of the right.
Any gain or loss on the sale of a right
will be a capital gain or loss if the right is held as a capital asset (which in the case of rights issued to common shareholders will depend on whether the old share of common stock is held as a capital asset), and will be a long-term capital gain
or loss if the holding period is deemed to exceed one year.
CERTAIN
PROVISIONS IN THE AGREEMENT AND DECLARATION OF TRUST AND BYLAWS
The Agreement and Declaration of Trust includes
provisions that could have the effect of limiting the ability of other entities or persons to acquire control of the Trust or to change the composition of the Board. This could have the effect of depriving shareholders of an opportunity to sell
their shares at a premium over prevailing market prices by discouraging a third party from seeking to obtain control over the Trust. Such attempts could have the effect of increasing the expenses of the Trust and disrupting the normal operation of
the Trust. The Board is divided into three classes. At each annual meeting of shareholders or special meeting in lieu thereof the term of only one class of Trustees expires and only the Trustees in that one class stand for re-election. Trustees standing for election at an annual meeting of shareholders or special meeting in lieu thereof are elected to a three-year term. This provision could delay for up to two years the replacement of
a majority of the Board. A Trustee may be removed from office for cause only, and not without cause, and only by the action of a majority of the remaining Trustees followed by a vote of the holders of at least 75% of the shares then entitled to vote
for the election of the respective Trustee.
In addition, the Trusts Agreement and Declaration of Trust requires the
favorable vote or consent of a majority of the Board followed by the favorable vote of the holders of at least 75% of the outstanding shares of each affected class or series outstanding of the Trust, voting separately as a class or series, to
approve, adopt or authorize certain transactions with 5% or greater holders of a class or series of shares and their associates, unless 80% of the Trustees by resolution have approved a memorandum of understanding with such holders with respect to
and substantially consistent with such transaction, in which case approval by a majority of the outstanding voting securities (as defined in the Investment Company Act) of the Trust will be the only vote of the shareholders required.
These voting requirements are in addition to any regulatory relief required from the SEC with respect to such transaction. For purposes of these provisions, a 5% or greater holder of a class or series of shares (a Principal Shareholder)
refers to any corporation, person or other entity, who, whether directly or indirectly and whether alone or together with its affiliates and associates, beneficially owns 5% or more of the outstanding shares of all outstanding classes or series of
shares of beneficial interest of the Trust. The 5% holder transactions subject to these special approval requirements are:
|
|
|
the merger or consolidation of the Trust or any subsidiary of the Trust with or into any Principal
Shareholder; |
|
|
|
the issuance of any securities of the Trust to any Principal Shareholder for cash (other than pursuant to any
automatic dividend reinvestment plan); |
|
|
|
the sale, lease or exchange of all or any substantial part of the assets of the Trust to any Principal
Shareholder, except assets having an aggregate fair market value of less than 2% of the total assets of the Trust, aggregating for the purpose of such computation all assets sold, leased or exchanged in any series of similar transactions within a
twelve-month period; or |
67
|
|
|
the sale, lease or exchange to the Trust or any subsidiary of the Trust, in exchange for securities of the
Trust, of any assets of any Principal Shareholder, except assets having an aggregate fair market value of less than 2% of the total assets of the Trust, aggregating for purposes of such computation all assets sold, leased or exchanged in any series
of similar transactions within a twelve-month period. |
To convert the Trust to an open-end investment company, the Trusts Agreement and Declaration of Trust requires the favorable vote of a majority of the Board followed by the favorable vote of the holders of at least 75% of the
outstanding shares of each affected class or series of shares of the Trust, voting separately as a class or series, unless such conversion has been approved by at least 80% of the Trustees, in which case a majority of the outstanding voting
securities (as defined in the Investment Company Act) of the Trust shall be required. The foregoing vote would satisfy a separate requirement in the Investment Company Act that any conversion of the Trust to an
open-end investment company be approved by the shareholders. If approved in the foregoing manner, we anticipate conversion of the Trust to an open-end investment company
might not occur until 90 days after the shareholders meeting at which such conversion was approved and would also require at least 10 days prior notice to all shareholders. Conversion of the Trust to an
open-end investment company would require the redemption of any outstanding preferred shares, which could eliminate or alter the leveraged capital structure of the Trust with respect to the common shares.
Following any such conversion, it is also possible that certain of the Trusts investment policies and strategies would have to be modified to assure sufficient portfolio liquidity, including in order to comply with Rule 22e-4 under the Investment Company Act. In the event of conversion, the common shares would cease to be listed on the NYSE or other national securities exchanges or market systems. Shareholders of an open-end investment company may require the company to redeem their shares at any time, except in certain circumstances as authorized by or under the Investment Company Act, at their NAV, less such redemption
charge, if any, as might be in effect at the time of a redemption. The Trust expects to pay all such redemption requests in cash, but reserves the right to pay redemption requests in a combination of cash or securities. If such partial payment in
securities were made, investors may incur brokerage costs in converting such securities to cash. If the Trust were converted to an open-end fund, it is likely that new shares would be sold at NAV plus a sales
load. The Board believes, however, that the closed-end structure is desirable in light of the Trusts investment objectives and policies. Therefore, you should assume that it is not likely that the Board
would vote to convert the Trust to an open-end fund.
For the purposes of
calculating a majority of the outstanding voting securities under the Trusts Agreement and Declaration of Trust, each class and series of the Trust shall vote together as a single class, except to the extent required by the
Investment Company Act or the Trusts Agreement and Declaration of Trust with respect to any class or series of shares. If a separate vote is required, the applicable proportion of shares of the class or series, voting as a separate class or
series, also will be required.
The Board has determined that provisions with respect to the Board and the shareholder
voting requirements described above, which voting requirements are greater than the minimum requirements under Delaware law or the Investment Company Act, are in the best interests of shareholders generally. Reference should be made to the Agreement
and Declaration of Trust on file with the SEC for the full text of these provisions.
The Trusts Bylaws generally
require that advance notice be given to the Trust in the event a shareholder desires to nominate a person for election to the Board or to transact any other business at an annual meeting of shareholders. Notice of any such nomination or business
must be delivered to or received at the principal executive offices of the Trust not less than 120 calendar days nor more than 150 calendar days prior to the anniversary date of the prior years annual meeting (subject to certain exceptions).
Any notice by a shareholder must be accompanied by certain information as provided in the Bylaws. Reference should be made to the Bylaws on file with the SEC for the full text of these provisions.
68
CLOSED-END FUND STRUCTURE
The Trust is a diversified, closed-end management investment company (commonly
referred to as a closed-end fund). Closed-end funds differ from open-end funds (which are generally referred to as mutual funds)
in that closed-end funds generally list their shares for trading on a stock exchange and do not redeem their shares at the request of the shareholder. This means that if you wish to sell your shares of a closed-end fund you must trade them on the stock exchange like any other stock at the prevailing market price at that time. In a mutual fund, if the shareholder wishes to sell shares of the fund, the mutual fund
will redeem or buy back the shares at NAV. Also, mutual funds generally offer new shares on a continuous basis to new investors and closed-end funds generally do not. The continuous inflows and outflows of
assets in a mutual fund can make it difficult to manage the funds investments. By comparison, closed-end funds are generally able to stay more fully invested in securities that are consistent with their
investment objectives and also have greater flexibility to make certain types of investments and to use certain investment strategies, such as financial leverage and investments in illiquid securities.
Shares of closed-end funds frequently trade at a discount to their NAV. Because of
this possibility and the recognition that any such discount may not be in the interest of shareholders, the Board might consider from time to time engaging in open-market repurchases, tender offers for shares or other programs intended to reduce the
discount. We cannot guarantee or assure, however, that the Board will decide to engage in any of these actions. Nor is there any guarantee or assurance that such actions, if undertaken, would result in the shares trading at a price equal or close to
the NAV. See Repurchase of Common Shares below and Repurchase of Common Shares in the SAI. The Board might also consider converting the Trust to an open-end mutual fund, which would
also require a vote of the shareholders of the Trust.
REPURCHASE OF COMMON
SHARES
Shares of closed-end investment companies often trade at a discount to
their NAVs and the Trusts common shares may also trade at a discount to their NAV, although it is possible that they may trade at a premium above NAV. The market price of the Trusts common shares will be determined by such factors as
relative demand for and supply of such common shares in the market, the Trusts NAV, general market and economic conditions and other factors beyond the control of the Trust. See Net Asset Value and Description of
SharesCommon Shares. Although the Trusts common shareholders will not have the right to redeem their common shares, the Trust may take action to repurchase common shares in the open market or make tender offers for its common
shares. This may have the effect of reducing any market discount from NAV.
There is no assurance that, if action is
undertaken to repurchase or tender for common shares, such action will result in the common shares trading at a price which approximates their NAV. Although share repurchases and tender offers could have a favorable effect on the market price
of the Trusts common shares, you should be aware that the acquisition of common shares by the Trust will decrease the capital of the Trust and, therefore, may have the effect of increasing the Trusts expense ratio and decreasing the
asset coverage with respect to any borrowings or preferred shares outstanding. Any share repurchases or tender offers will be made in accordance with the requirements of the Exchange Act, the Investment Company Act and the principal stock exchange
on which the common shares are traded. For additional information, see Repurchase of Common Shares in the SAI.
Common Stock Repurchase
Program
On September 24, 2021, the Board approved a renewal of the Trusts open market share repurchase
program through November 30, 2022. Commencing on December 1, 2021, the Trust may purchase through November 30, 2022, up to 5% of its shares outstanding as of the close of business on November 30, 2021, subject to certain
conditions. The amount and timing of any repurchases under the Trusts share repurchase program will be determined either at the discretion of the Trusts management or pursuant to predetermined parameters and instructions subject to
market conditions.
69
There is no assurance that the Trust will repurchase common shares in any
particular amount. The share repurchase program seeks to enhance shareholder value by purchasing the Trusts common shares trading at a discount from their NAV per share. For the year ended December 31, 2021, the Trust did not repurchase
any shares.
PLAN OF DISTRIBUTION
We may sell common shares, including to existing shareholders in a rights offering, through underwriters or dealers, directly
to one or more purchasers (including existing shareholders in a rights offering), through agents, to or through underwriters or dealers, or through a combination of any such methods of sale. The applicable Prospectus Supplement will identify any
underwriter or agent involved in the offer and sale of our common shares, any sales loads, discounts, commissions, fees or other compensation paid to any underwriter, dealer or agent, the offering price, net proceeds and use of proceeds and the
terms of any sale. In the case of a rights offering, the applicable Prospectus Supplement will set forth the number of our common shares issuable upon the exercise of each right and the other terms of such rights offering.
The distribution of our common shares may be effected from time to time in one or more transactions at a fixed price or
prices, which may be changed, at prevailing market prices at the time of sale, at prices related to such prevailing market prices, or at negotiated prices. Sales of our common shares may be made in transactions that are deemed to be at the
market as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange.
We may sell our common shares directly to, and solicit offers from, institutional investors or others who may be deemed to be
underwriters as defined in the Securities Act for any resales of the securities. In this case, no underwriters or agents would be involved. We may use electronic media, including the Internet, to sell offered securities directly.
In connection with the sale of our common shares, underwriters or agents may receive compensation from us in the form of
discounts, concessions or commissions. Underwriters may sell our common shares to or through dealers, and such dealers may receive compensation in the form of discounts, concessions or commissions from the underwriters and/or commissions from the
purchasers for whom they may act as agents. Underwriters, dealers and agents that participate in the distribution of our common shares may be deemed to be underwriters under the Securities Act, and any discounts and commissions they receive from us
and any profit realized by them on the resale of our common shares may be deemed to be underwriting discounts and commissions under the Securities Act. Any such underwriter or agent will be identified and any such compensation received from us will
be described in the applicable Prospectus Supplement. The maximum amount of compensation to be received by any Financial Industry Regulatory Authority member or independent broker-dealer will not exceed eight percent for the sale of any securities
being offered pursuant to Rule 415 under the Securities Act. We will not pay any compensation to any underwriter or agent in the form of warrants, options, consulting or structuring fees or similar arrangements. In connection with any rights
offering to existing shareholders, we may enter into a standby underwriting arrangement with one or more underwriters pursuant to which the underwriter(s) will purchase common shares remaining unsubscribed after the rights offering.
If a Prospectus Supplement so indicates, we may grant the underwriters an option to purchase additional common shares at the
public offering price, less the underwriting discounts and commissions, within 45 days from the date of the Prospectus Supplement, to cover any over-allotments.
Under agreements into which we may enter, underwriters, dealers and agents who participate in the distribution of our common
shares may be entitled to indemnification by us against certain liabilities, including liabilities under the Securities Act. Underwriters, dealers and agents may engage in transactions with us, or perform services for us, in the ordinary course of
business.
70
If so indicated in the applicable Prospectus Supplement, we will ourselves, or
will authorize underwriters or other persons acting as our agents to solicit offers by certain institutions to purchase our common shares from us pursuant to contracts providing for payment and delivery on a future date. Institutions with which such
contacts may be made include commercial and savings banks, insurance companies, pension funds, investment companies, educational and charitable institutions and others, but in all cases such institutions must be approved by us. The obligation of any
purchaser under any such contract will be subject to the condition that the purchase of the common shares shall not at the time of delivery be prohibited under the laws of the jurisdiction to which such purchaser is subject. The underwriters and
such other agents will not have any responsibility in respect of the validity or performance of such contracts. Such contracts will be subject only to those conditions set forth in the Prospectus Supplement, and the Prospectus Supplement will set
forth the commission payable for solicitation of such contracts.
To the extent permitted under the Investment Company Act
and the rules and regulations promulgated thereunder, the underwriters may from time to time act as brokers or dealers and receive fees in connection with the execution of our portfolio transactions after the underwriters have ceased to be
underwriters and, subject to certain restrictions, each may act as a broker while it is an underwriter.
A Prospectus and
accompanying Prospectus Supplement in electronic form may be made available on the websites maintained by underwriters. The underwriters may agree to allocate a number of securities for sale to their online brokerage account holders. Such
allocations of securities for Internet distributions will be made on the same basis as other allocations. In addition, securities may be sold by the underwriters to securities dealers who resell securities to online brokerage account holders.
In order to comply with the securities laws of certain states, if applicable, our common shares offered hereby will be sold in
such jurisdictions only through registered or licensed brokers or dealers.
INCORPORATION BY REFERENCE
This Prospectus is part of a registration statement that we have filed with the SEC. We are allowed to incorporate by
reference the information that we file with the SEC, which means that we can disclose important information to you by referring you to those documents. We incorporate by reference into this Prospectus the documents listed below and any future
filings we make with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act, including any filings on or after the date of this Prospectus from the date of filing (excluding any information furnished, rather than filed), until we have
sold all of the offered securities to which this Prospectus and any accompanying prospectus supplement relates or the offering is otherwise terminated. The information incorporated by reference is an important part of this Prospectus. Any statement
in a document incorporated by reference into this Prospectus will be deemed to be automatically modified or superseded to the extent a statement contained in (1) this Prospectus or (2) any other subsequently filed document that is
incorporated by reference into this Prospectus modifies or supersedes such statement. The documents incorporated by reference herein include:
|
|
|
The Trusts SAI, dated May 4, 2022, filed with this Prospectus; |
|
|
|
our annual
report on Form N-CSR for the fiscal year ended December 31, 2021 filed with the SEC on March 4, 2022; and |
|
|
|
the
description of the Trusts common shares contained in our Registration Statement on Form 8-A (File No. 001-36705) filed with the SEC on
October 22, 2014, including any amendment or report filed for the purpose of updating such description prior to the termination of the offering registered hereby. |
71
The Trust will provide without charge to each person, including any beneficial
owner, to whom this Prospectus is delivered, upon written or oral request, a copy of any and all of the documents that have been or may be incorporated by reference in this Prospectus or the accompanying prospectus supplement. You should direct
requests for documents by calling:
Client Services Desk
(800) 882-0052
The Trust makes available this Prospectus, SAI and the Trusts annual and semi-annual reports, free of charge, at
http://www.blackrock.com. You may also obtain this Prospectus, the SAI, other documents incorporated by reference and other information the Trust files electronically, including reports and proxy statements, on the SEC website
(http://www.sec.gov) or with the payment of a duplication fee, by electronic request at publicinfo@sec.gov. Information contained in, or that can be accessed through, the Trusts website is not incorporated by reference into this
Prospectus and should not be considered to be part of this Prospectus or the accompanying prospectus supplement.
PRIVACY PRINCIPLES OF THE TRUST
The Trust is committed to maintaining the privacy
of shareholders and to safeguarding their non-public personal information. The following information is provided to help you understand what personal information the Trust collects, how we protect that
information, and why in certain cases we may share such information with select other parties.
The Trust does not receive
any non-public personal information relating to its shareholders who purchase shares through their broker-dealers. In the case of shareholders who are record holders of the Trust, the Trust receives personal non-public information on account applications or other forms. With respect to these shareholders, the Trust also has access to specific information regarding their transactions in the Trust.
The Trust does not disclose any non-public personal information about its shareholders
or former shareholders to anyone, except as permitted by law or as is necessary in order to service our shareholders accounts (for example, to a transfer agent).
The Trust restricts access to non-public personal information about its shareholders
to BlackRock employees with a legitimate business need for the information. The Trust maintains physical, electronic and procedural safeguards designed to protect the non-public personal information of our
shareholders.
72
18,000,000 Shares
BLACKROCK SCIENCE AND TECHNOLOGY TRUST
Common Shares
Rights
to Purchase Common Shares
PROSPECTUS
May 4, 2022
BLACKROCK SCIENCE AND
TECHNOLOGY TRUST
18,000,000 Common Shares of Beneficial Interest
PROSPECTUS SUPPLEMENT
May 10, 2022
Until
June 4, 2022 (25 days after the date of this Prospectus Supplement), all dealers that buy, sell or trade the common shares, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the
dealers obligation to deliver a prospectus when acting as underwriters.
BlackRock Science and Technology Trust
STATEMENT OF ADDITIONAL INFORMATION
BlackRock Science and Technology Trust (the Trust) is a diversified,
closed-end management investment company. This Statement of Additional Information (SAI) relating to common shares does not constitute a prospectus, but should be read in conjunction with the
prospectus relating thereto dated May 4, 2022 and any related prospectus supplement. This SAI, which is not a prospectus, does not include all information that a prospective investor should consider before purchasing common shares, and investors
should obtain and read the prospectus and any related prospectus supplement prior to purchasing such shares. A copy of the prospectus and any related prospectus supplement may be obtained without charge by calling (800) 882-0052. You may also obtain a copy of the prospectus on the Securities and Exchange Commissions (the SEC) website (http://www.sec.gov). Capitalized terms used but not defined in this SAI have the
meanings ascribed to them in the prospectus.
References to the Investment Company Act of 1940, as amended (the
Investment Company Act), or other applicable law, will include any rules promulgated thereunder and any guidance, interpretations or modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, including court
interpretations, and exemptive, no-action or other relief or permission from the SEC, SEC staff or other authority.
TABLE OF CONTENTS
This Statement of Additional Information is dated May 4, 2022.
THE TRUST
The Trust is a diversified, closed-end management investment company registered under
the Investment Company Act. The Trust was formed as a Delaware statutory trust on August 13, 2014, pursuant to the Trusts Agreement and Declaration of Trust, which is governed by the laws of the State of Delaware. The Trusts
investment adviser is BlackRock Advisors, LLC (the Advisor).
The common shares of the Trust are listed on the
New York Stock Exchange (NYSE) under the symbol BST. As of May 3, 2022, the Trust has outstanding 32,083,371 common shares.
INVESTMENT OBJECTIVES AND POLICIES
Investment Restrictions
The Trust has adopted restrictions and policies relating to the investment of the Trusts assets and its activities.
Certain of the restrictions are fundamental policies of the Trust and may not be changed without the approval of the holders of a majority of the Trusts outstanding voting securities (which for this purpose and under the Investment Company Act
means the lesser of (i) 67% of the shares represented at a meeting at which more than 50% of the outstanding shares are represented or (ii) more than 50% of the outstanding shares), including class approval by a majority of the Trusts
outstanding preferred shares, if any (which for this purpose and under the Investment Company Act means the lesser of (i) 67% of the preferred shares, as a single class, represented at a meeting at which more than 50% of the Trusts outstanding
preferred shares are represented or (ii) more than 50% of the outstanding preferred shares).
Fundamental Investment
Restrictions. Under these fundamental investment restrictions, the Trust may not:
|
1. |
Concentrate its investments in a particular industry, as that term is used in the Investment Company Act,
except that the Trust will concentrate its investments in companies operating in one or more industries within the technology group of industries. |
|
2. |
Borrow money, except as permitted under the Investment Company Act. |
|
3. |
Issue senior securities to the extent such issuance would violate the Investment Company Act.
|
|
4. |
Purchase or hold real estate, except the Trust may purchase and hold securities or other instruments that
are secured by, or linked to, real estate or interests therein, securities of REITs, mortgage-related securities and securities of issuers engaged in the real estate business, and the Trust may purchase and hold real estate as a result of the
ownership of securities or other instruments. |
|
5. |
Underwrite securities issued by others, except to the extent that the sale of portfolio securities by the
Trust may be deemed to be an underwriting or as otherwise permitted by applicable law. |
|
6. |
Purchase or sell commodities or commodity contracts, except as permitted by the Investment Company Act.
|
|
7. |
Make loans to the extent prohibited by the Investment Company Act. |
Notations Regarding the Trusts Fundamental Investment Restrictions. The following notations are not considered to
be part of the Trusts fundamental investment restrictions and are subject to change without shareholder approval.
With respect to the fundamental policy relating to concentration set forth in (1) above, the Investment Company Act does
not define what constitutes concentration in an industry. The SEC staff has taken the position that investment of 25% or more of a funds total assets in one or more issuers conducting their principal activities in the same industry
or group of industries constitutes concentration. It is possible that interpretations of
S-1
concentration could change in the future. The policy in (1) above will be interpreted to refer to concentration as that term may be interpreted from time to time. The policy also will be
interpreted to permit investment without limit in the following: securities of the U.S. Government and its agencies or instrumentalities; tax exempt securities of state, territory, possession or municipal governments and their authorities, agencies,
instrumentalities or political subdivisions; and repurchase agreements collateralized by any such obligations. Accordingly, issuers of the foregoing securities will not be considered to be members of any industry. There also will be no limit on
investment in issuers domiciled in a single jurisdiction or country. Finance companies will be considered to be in the industries of their parents if their activities are primarily related to financing the activities of the parents. Each foreign
government will be considered to be a member of a separate industry. With respect to the Trusts industry classifications, the Trust currently utilizes any one or more of the industry sub-classifications
used by one or more widely recognized market indexes or rating group indexes, and/or as defined by the Advisor. The policy also will be interpreted to give broad authority to the Trust as to how to classify issuers within or among industries.
With respect to the fundamental policy relating to borrowing money set forth in (2) above, the Investment Company Act,
including the rules and regulations thereunder, generally prohibits the Trust from borrowing money (other than certain temporary borrowings) unless immediately after the borrowing the Trust has satisfied the asset coverage test with respect to
senior securities representing indebtedness prescribed by the Investment Company Act; that is, the value of the Trusts total assets less all liabilities and indebtedness not represented by senior securities (for these purposes, total net
assets) is at least 300% of the senior securities representing indebtedness (effectively limiting the use of leverage through senior securities representing indebtedness to 331?3% of the Trusts total net assets, including assets
attributable to such leverage). Certain trading practices and investments, such as reverse repurchase agreements, may be considered to be borrowings or involve leverage and thus are subject to the Investment Company Act restrictions. In accordance
with SEC staff guidance and interpretations, when the Trust engages in such transactions, the Trust, instead of maintaining asset coverage of at least 300%, may segregate or earmark liquid assets, or enter into an offsetting position, in an amount
at least equal to the Trusts exposure, on a mark-to-market basis, to the transaction (as calculated pursuant to requirements of the SEC). The policy in
(2) above will be interpreted to permit the Trust to engage in trading practices and investments that may be considered to be borrowing or to involve leverage to the extent permitted by the Investment Company Act and to permit the Trust to
segregate or earmark liquid assets or enter into offsetting positions in accordance with the Investment Company Act. Under the Investment Company Act, the Trust may not issue senior securities representing stock unless immediately after such
issuance the value of the Trusts total net assets is at least 200% of the liquidation value of the Trusts outstanding senior securities representing stock, plus the aggregate amount of any senior securities representing indebtedness
(effectively limiting the use of leverage through senior securities to 50% of the Trusts total net assets). In addition, the Trust is not permitted to declare any cash dividend or other distribution on common shares unless, at the time of such
declaration, the asset coverage tests described above are satisfied after giving effect to such dividend or distribution. Short-term credits necessary for the settlement of securities transactions and arrangements with respect to securities lending
will not be considered to be borrowings under the policy. Practices and investments that may involve leverage but are not considered to be borrowings are not subject to the policy.
With respect to the fundamental policy relating to underwriting set forth in (5) above, the Investment Company Act does
not prohibit the Trust from engaging in the underwriting business or from underwriting the securities of other issuers; in fact, in the case of diversified funds, the Investment Company Act permits a fund to have underwriting commitments of up to
25% of its assets under certain circumstances. Those circumstances currently are that the amount of the funds underwriting commitments, when added to the value of the funds investments in issuers where the fund owns more than 10% of the
outstanding voting securities of those issuers, cannot exceed the 25% cap. A fund engaging in transactions involving the acquisition or disposition of portfolio securities may be considered to be an underwriter under the Securities Act. Although it
is not believed that the application of the Securities Act provisions described above would cause the Trust to be engaged in the business of underwriting, the policy in (5) above will be interpreted not to prevent the Trust from engaging in
transactions
S-2
involving the acquisition or disposition of portfolio securities, regardless of whether the Trust may be considered to be an underwriter under the Securities Act or is otherwise engaged in the
underwriting business to the extent permitted by applicable law.
With respect to the fundamental policy relating to
lending set forth in (7) above, the Investment Company Act does not prohibit the Trust from making loans (including lending its securities); however, SEC staff interpretations currently prohibit funds from lending more than one-third of their total assets (including lending its securities), except through the purchase of debt obligations or the use of repurchase agreements. In addition, collateral arrangements with respect to options,
forward currency and futures transactions and other derivative instruments (as applicable), as well as delays in the settlement of securities transactions, will not be considered loans.
The Trust is currently classified as a diversified fund under the Investment Company Act. This means that the Trust may not
purchase securities of an issuer (other than (i) obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities and (ii) securities of other investment companies) if, with respect to 75% of its total assets,
(a) more than 5% of the Trusts total assets would be invested in securities of that issuer or (b) the Trust would hold more than 10% of the outstanding voting securities of that issuer. With respect to the remaining 25% of its total
assets, the Trust can invest more than 5% of its assets in one issuer. Under the Investment Company Act, a fund cannot change its classification from diversified to non-diversified without
shareholder approval.
Non-Fundamental Investment Restrictions. Under its non-fundamental investment restrictions, which may be changed by the Board without shareholder approval, the Trust may not make short sales of securities or maintain a short position, except to the extent permitted
by the Trusts prospectus and SAI, as amended from time to time, and applicable law.
Unless otherwise indicated, all
limitations under the Trusts fundamental or non-fundamental investment restrictions apply only at the time that a transaction is undertaken. Any change in the percentage of the Trusts assets
invested in certain securities or other instruments resulting from market fluctuations or other changes in the Trusts total assets will not require the Trust to dispose of an investment until the Advisor determines that it is practicable to
sell or close out the investment without undue market or tax consequences.
S-3
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Trusts investment objectives, policies and techniques that
are described in the prospectus.
Restricted and Illiquid Investments
The Trust may invest in investments that lack an established secondary trading market or otherwise are considered illiquid.
Liquidity of an investment relates to the ability to dispose easily of the investment and the price to be obtained upon disposition of the investment, which may be less than would be obtained for a comparable more liquid investment. Illiquid
investments may trade at a discount from comparable, more liquid investments. Investment of the Trusts assets in illiquid investments may restrict the ability of the Trust to dispose of its investments in a timely fashion and for a fair price
as well as its ability to take advantage of market opportunities. The risks associated with illiquidity will be particularly acute where a Trusts operations require cash, such as when the Trust pays dividends, and could result in the Trust
borrowing to meet short-term cash requirements or incurring capital losses on the sale of illiquid investments.
The Trust
may invest in securities that are not registered under the Securities Act (restricted securities). Restricted securities may be sold in private placement transactions between issuers and their purchasers and may be neither listed on an
exchange nor traded in other established markets. In many cases, privately placed securities may not be freely transferable under the laws of the applicable jurisdiction or due to contractual restrictions on resale. As a result of the absence of a
public trading market, privately placed securities may be less liquid and more difficult to value than publicly traded securities. To the extent that privately placed securities may be resold in privately negotiated transactions, the prices realized
from the sales, due to illiquidity, could be less than those originally paid by the Trust or less than their fair market value. In addition, issuers whose securities are not publicly traded may not be subject to the disclosure and other investor
protection requirements that may be applicable if their securities were publicly traded. If any privately placed securities held by the Trust are required to be registered under the securities laws of one or more jurisdictions before being resold,
the Trust may be required to bear the expenses of registration. Where registration is required for restricted securities, a considerable time period may elapse between the time the Trust decides to sell the security and the time it is actually
permitted to sell the security under an effective registration statement. If during such period, adverse market conditions were to develop, the Trust might obtain less favorable pricing terms than when it decided to sell the security. Transactions
in restricted securities may entail other transaction costs that are higher than those for transactions in unrestricted securities. Certain of the Trusts investments in private placements may consist of direct investments and may include
investments in smaller, less seasoned issuers, which may involve greater risks. These issuers may have limited product lines, markets or financial resources, or they may be dependent on a limited management group. In making investments in such
securities, the Trust may obtain access to material nonpublic information, which may restrict the Trusts ability to conduct portfolio transactions in such securities.
Rights Offerings and Warrants to Purchase
The Trust may participate in rights offerings and may purchase warrants, which are privileges issued by corporations enabling
the owners to subscribe to and purchase a specified number of shares of the corporation at a specified price during a specified period of time. Subscription rights normally have a short life span to expiration. The purchase of rights or warrants
involves the risk that the Trust could lose the purchase value of a right or warrant if the right to subscribe to additional shares is not exercised prior to the rights and warrants expiration. Also, the purchase of rights and/or
warrants involves the risk that the effective price paid for the right and/or warrant added to the subscription price of the related security may exceed the value of the subscribed securitys market price such as when there is no movement in
the level of the underlying security. Buying a warrant does not make the Trust a shareholder of the underlying stock. The warrant holder has no voting or dividend rights with respect to the underlying stock. A warrant does not carry any right to
assets of the issuer, and for this reason investments in warrants may be more speculative than other equity-based investments.
S-4
Special Purpose Acquisition Companies
The Trust may invest in stock, warrants, rights and other interests issued by special purpose acquisition companies
(SPACs) or similar special purpose entities that pool funds to seek potential acquisition opportunities, including the founders shares and warrants described below. A SPAC is a publicly traded company that raises
investment capital via an initial public offering (IPO) for the purpose of identifying and acquiring one or more operating businesses or assets. In connection with forming a SPAC, the SPACs sponsors acquire
founders shares, generally for nominal consideration, and warrants that will result in the sponsors owning a specified percentage (typically 20%) of the SPACs outstanding common stock upon completion of the IPO. At the time a
SPAC conducts an IPO, it has selected a management team but has not yet identified a specific acquisition opportunity. Unless and until an acquisition is completed, a SPAC generally invests its assets in U.S. government securities, money market
securities and cash. If an acquisition that meets the requirements for the SPAC is not completed within a pre-established period of time, the invested funds are returned to the SPACs public
shareholders, the warrants expire, and the founders shares and such warrants become worthless. Because SPACs and similar entities are in essence blank check companies without operating histories or ongoing business
operations (other than identifying and pursuing acquisitions), the potential for the long term capital appreciation of their securities is particularly dependent on the ability of the SPACs management to identify and complete a profitable
acquisition. There is no guarantee that the SPACs in which the Trust invests will complete an acquisition or that any acquisitions completed by the SPACs in which the Trust invests will be profitable. Some SPACs may pursue acquisitions only within
certain industries or regions, which may ultimately lead to an increase in the volatility of their prices following the acquisition. In addition, some of these securities may be considered illiquid and/or subject to restrictions on resale.
Master Limited Partnerships
Master limited partnerships (MLPs) are typically structured such that common units and general partner interests
have first priority to receive quarterly cash distributions up to an established minimum amount (minimum quarterly distributions or MQD). Common and general partner interests also accrue arrearages in distributions to the
extent the MQD is not paid. Once common and general partner interests have been paid, subordinated units receive distributions of up to the MQD; however, subordinated units do not accrue arrearages. Distributable cash in excess of the MQD paid to
both common and subordinated units is distributed to both common and subordinated units generally on a pro rata basis.
The general partner is also eligible to receive incentive distributions if the general partner operates the business in a
manner that results in distributions paid per common unit surpassing specified target levels. As the general partner increases cash distributions to the limited partners, the general partner receives an increasingly higher percentage of the
incremental cash distributions. A common arrangement provides that the general partner can reach a tier where it receives 50% of every incremental dollar paid to common and subordinated unit holders. These incentive distributions encourage the
general partner to streamline costs, increase capital expenditures and acquire assets in order to increase the partnerships cash flow and raise the quarterly cash distribution in order to reach higher tiers. Such results benefit all security
holders of the MLP.
To qualify as a partnership for U.S. federal income tax purposes, an MLP must receive at least 90% of
its income from qualifying sources such as interest, dividends, real estate rents, gain from the sale or disposition of real property, income and gain from mineral or natural resources activities, income and gain from the transportation or storage
of certain fuels, gain from the sale or disposition of a capital asset held for the production of income described in the foregoing and, in certain circumstances, income and gain from commodities or futures, forwards and options with respect to
commodities. Mineral or natural resources activities include exploration, development, production, mining, refining, marketing and transportation (including pipelines), of oil and gas, minerals, geothermal energy, fertilizer, timber or industrial
source carbon dioxide.
S-5
Currently, most MLPs operate in the energy, natural resources or real estate
sectors. Due to their partnership structure, MLPs generally do not pay income taxes. Thus, unlike investors in corporate securities, direct MLP investors are generally not subject to double taxation (i.e. corporate level tax and tax on
corporate dividends).
Equity securities issued by MLPs currently consist of common units, subordinated units and
preferred units.
MLP Common Units. MLP common units represent a limited partnership interest in the MLP.
Common units are listed and traded on U.S. securities exchanges or OTC, with their value fluctuating predominantly based on prevailing market conditions and the success of the MLP. We may purchase common units in market transactions as well as
directly from the MLP or other parties. Unlike owners of common stock of a corporation, owners of common units have limited voting rights and have no ability annually to elect directors. MLPs generally distribute all available cash flow (cash flow
from operations less maintenance capital expenditures) in the form of quarterly distributions. Common units along with general partner units, have first priority to receive quarterly cash distributions up to the MQD and have arrearage rights. In the
event of liquidation, common units have preference over subordinated units, but not debt or preferred units, to the remaining assets of the MLP.
MLP Subordinated Units. MLP subordinated units are typically not listed on an exchange or publicly traded. The
Trust will typically purchase MLP subordinated units through negotiated transactions directly with affiliates of MLPs and institutional holders of such units or will purchase newly issued subordinated units directly from MLPs. Holders of MLP
subordinated units are entitled to receive minimum quarterly distributions after payments to holders of common units have been satisfied and prior to incentive distributions to the general partner. MLP subordinated units do not provide arrearage
rights. Subordinated units typically have limited voting rights similar to common units. Most MLP subordinated units are convertible into common units after the passage of a specified period of time or upon the achievement by the MLP of specified
financial goals.
MLP Preferred Units. MLP preferred units are typically not listed on an exchange or
publicly traded. The Trust will typically purchase MLP preferred units through negotiated transactions directly with MLPs, affiliates of MLPs and institutional holders of such units. Holders of MLP preferred units can be entitled to a wide range of
voting and other rights, depending on the structure of each separate security.
I-Shares. I-Shares represent an
ownership interest issued by an affiliated party of an MLP. The MLP affiliate uses the proceeds from the sale of I-Shares to purchase limited partnership interests in the MLP in the form of i-units. I-units have similar features as MLP common units in terms of voting rights, liquidation preference and distributions. However, rather than receiving cash, the MLP
affiliate receives additional i-units in an amount equal to the cash distributions received by MLP common units. Similarly, holders of I-Shares will receive additional I-Shares, in the same proportion as the MLP affiliates receipt of i-units, rather than cash distributions. I-Shares themselves have
limited voting rights which are similar to those applicable to MLP common units. The MLP affiliate issuing the I-Shares is structured as a corporation for U.S. federal income tax purposes. I-Shares are traded on the NYSE.
Precious Metal-Related Securities
The Trust may invest in the equity and other securities of companies that explore for, extract, process or deal in precious
metals (e.g., gold, silver and platinum), and in asset-based securities indexed to the value of such metals. Such securities may be purchased when they are believed to be attractively priced in relation to the value of a companys precious
metal-related assets or when the values of precious metals are expected to benefit from inflationary pressure or other economic, political or financial uncertainty or instability.
Based on historical experience, during periods of economic or financial instability the securities of companies involved in
precious metals may be subject to extreme price fluctuations, reflecting the high volatility of precious metal prices during such periods. In addition, the instability of precious metal prices may result in volatile earnings of precious
metal-related companies, which may, in turn, adversely affect the financial condition of such companies.
S-6
The major producers of gold include the Republic of South Africa, Russia, Canada,
the United States, Brazil and Australia. Sales of gold by Russia are largely unpredictable and often relate to political and economic considerations rather than to market forces. Economic, financial, social and political factors within South Africa
may significantly affect South African gold production.
Mortgage Related Securities
MBS. Mortgage-backed securities (MBS) include structured debt obligations collateralized by pools of
commercial (CMBS) or residential (RMBS) mortgages. Pools of mortgage loans and mortgage-backed loans, such as mezzanine loans, are assembled as securities for sale to investors by various governmental, government-related and
private organizations. MBS include complex instruments such as collateralized mortgage obligations (CMOs), stripped MBS, mortgage pass-through securities and interests in real estate mortgage investment conduits (REMICs). The
MBS in which the Trust may invest include those with fixed, floating or variable interest rates, those with interest rates that change based on multiples of changes in a specified reference interest rate or index of interest rates and those with
interest rates that change inversely to changes in interest rates, as well as those that do not bear interest. The Trust may invest in RMBS and CMBS issued by governmental entities and private issuers, including subordinated MBS and residual
interests. The Trust may invest in sub-prime mortgages or MBS that are backed by sub-prime mortgages.
In general, losses on a mortgaged property securing a mortgage loan included in a securitization will be borne first by the
equity holder of the property, then by a cash reserve fund or letter of credit, if any, then by the holder of a mezzanine loan or B-Note, if any, then by the first loss subordinated security holder
(generally, the B-Piece buyer) and then by the holder of a higher rated security. The Trust may invest in any class of security included in a securitization. In the event of default and the
exhaustion of any equity support, reserve fund, letter of credit, mezzanine loans or B-Notes, and any classes of securities junior to those in which the Trust invests, the Trust will not be able to recover all
of its investment in the MBS it purchases. MBS in which the Trust invests may not contain reserve funds, letters of credit, mezzanine loans and/or junior classes of securities. The prices of lower credit quality securities are generally less
sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments.
Mortgage Pass-Through Securities. Mortgage pass-through securities differ from other forms of fixed-income
securities, which normally provide for periodic payment of interest in fixed amounts with principal payments at maturity or specified call dates. Instead, these securities provide a monthly payment which consists of both interest and principal
payments. In effect, these payments are a pass through of the monthly payments made by the individual borrowers on their residential or commercial mortgage loans, net of any fees paid to the issuer or guarantor of such securities.
Additional payments are caused by repayments of principal resulting from the sale of the underlying property, refinancing or foreclosure, net of fees or costs that may be incurred. Some mortgage related securities (such as securities issued by the
Government National Mortgage Association (GNMA)) are described as modified pass-through. These securities entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of certain fees, at
the scheduled payment dates regardless of whether or not the mortgagor actually makes the payment.
RMBS.
RMBS are securities the payments on which depend primarily on the cash flow from residential mortgage loans made to borrowers that are secured on a first priority basis or second priority basis, subject to permitted liens, easements and
other encumbrances by residential real estate (one- to four-family properties), the proceeds of which are used to purchase real estate and purchase or construct dwellings thereon or to refinance indebtedness
previously used for such purposes. Non-agency residential mortgage loans are obligations of the borrowers thereunder only and are not typically insured or guaranteed by any other person or entity. The ability
of a borrower to repay a loan secured by residential property is dependent upon the income or assets of the borrower. A number of factors, including a general economic downturn, acts of God, terrorism, social unrest and civil disturbances, may
impair a borrowers ability to repay its loans.
S-7
Agency RMBS. The principal U.S. Governmental guarantor of mortgage
related securities is GNMA, which is a wholly owned U.S. Government corporation. GNMA is authorized to guarantee, with the full faith and credit of the U.S. Government, the timely payment of principal and interest on securities issued by
institutions approved by GNMA (such as savings and loan institutions, commercial banks and mortgage bankers) and backed by pools of mortgages insured by the Federal Housing Administration (FHA), or guaranteed by the Department of
Veterans Affairs (VA). MBS issued by GNMA include GNMA Mortgage Pass-Through Certificates (also known as Ginnie Maes) which are guaranteed as to the timely payment of principal and interest by GNMA and such guarantees are
backed by the full faith and credit of the United States. GNMA certificates also are supported by the authority of GNMA to borrow funds from the U.S. Treasury to make payments under its guarantee.
Government-related guarantors (i.e., not backed by the full faith and credit of the U.S. Government) include the
Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). FNMA is a government-sponsored corporation the common stock of which is owned entirely by private stockholders. FNMA
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 FNMA (also known as Fannie Maes) are guaranteed as to timely payment of principal and interest by FNMA, but are not backed by the full faith and
credit of the U.S. Government. FHLMC 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 that issues FHLMC Guaranteed Mortgage
Pass-Through Certificates (also known as Freddie Macs or PCs), which are pass-through securities, each representing an undivided interest in a pool of residential mortgages. FHLMC 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.
In 2008,
the Federal Housing Finance Agency (FHFA) placed FNMA and FHLMC into conservatorship. FNMA and FHLMC are continuing to operate as going concerns while in conservatorship and each remains liable for all of its obligations, including its
guaranty obligations, associated with its MBS.
As the conservator, FHFA succeeded to all rights, titles, powers and
privileges of FNMA and FHLMC and of any stockholder, officer or director of FNMA and FHLMC with respect to FNMA and FHLMC and the assets of FNMA and FHLMC. In connection with the conservatorship, the U.S. Treasury entered into a Senior Preferred
Stock Purchase Agreement with each of FNMA and FHLMC pursuant to which the U.S. Treasury would purchase up to an aggregate of $100 billion of each of FNMA and FHLMC to maintain a positive net worth in each enterprise. This agreement contains
various covenants that severely limit each enterprises operations. In exchange for entering into these agreements, the U.S. Treasury received $1 billion of each enterprises senior preferred stock and warrants to purchase 79.9% of
each enterprises common stock. In February 2009, the U.S. Treasury doubled the size of its commitment to each enterprise under the Senior Preferred Stock Program to $200 billion. The U.S. Treasurys obligations under the Senior
Preferred Stock Program are for an indefinite period of time for a maximum amount of $200 billion per enterprise. In December 2009, the U.S. Treasury announced further amendments to the Senior Preferred Stock Purchase Agreements which included
additional financial support to certain governmentally supported entities, including the Federal Home Loan Banks (FHLBs), FNMA and FHLMC. It is difficult, if not impossible, to predict the future political, regulatory or economic changes
that could impact FNMA, FHLMC and the FHLBs, and the values of their related securities or obligations. There is no assurance that the obligations of such entities will be satisfied in full, or that such obligations will not decrease in value or
default.
Under the Federal Housing Finance Regulatory Reform Act of 2008 (the Reform Act), which was included
as part of the Housing and Economic Recovery Act of 2008, FHFA, as conservator or receiver, has the power to repudiate any contract entered into by FNMA or FHLMC prior to FHFAs appointment as conservator or receiver, as applicable, if FHFA
determines, in its sole discretion, that performance of the contract is burdensome and that repudiation of the contract promotes the orderly administration of FNMAs or FHLMCs affairs. The Reform Act requires FHFA to exercise its right to
repudiate any contract within a reasonable period
S-8
of time after its appointment as conservator or receiver. FHFA, in its capacity as conservator, has indicated that it has no intention to repudiate the guaranty obligations of FNMA or FHLMC
because FHFA views repudiation as incompatible with the goals of the conservatorship. However, in the event that FHFA, as conservator or if it is later appointed as receiver for FNMA or FHLMC, were to repudiate any such guaranty obligation, the
conservatorship or receivership estate, as applicable, would be liable for actual direct compensatory damages in accordance with the provisions of the Reform Act. Any such liability could be satisfied only to the extent of FNMAs or
FHLMCs assets available therefor. In the event of repudiation, the payments of interest to holders of FNMA or FHLMC MBS would be reduced if payments on the mortgage loans represented in the mortgage loan groups related to such MBS are not made
by the borrowers or advanced by the servicer. Any actual direct compensatory damages for repudiating these guaranty obligations may not be sufficient to offset any shortfalls experienced by such mortgage-backed security holders. Further, in its
capacity as conservator or receiver, FHFA has the right to transfer or sell any asset or liability of FNMA or FHLMC without any approval, assignment or consent. Although FHFA has stated that it has no present intention to do so, if FHFA, as
conservator or receiver, were to transfer any such guaranty obligation to another party, holders of FNMA or FHLMC MBS would have to rely on that party for satisfaction of the guaranty obligation and would be exposed to the credit risk of that party.
In addition, certain rights provided to holders of MBS issued by FNMA and FHLMC under the operative documents related to such securities may not be enforced against FHFA, or enforcement of such rights may be delayed, during the conservatorship or
any future receivership. The operative documents for FNMA and FHLMC MBS may provide (or with respect to securities issued prior to the date of the appointment of the conservator may have provided) that upon the occurrence of an event of default on
the part of FNMA or FHLMC, in its capacity as guarantor, which includes the appointment of a conservator or receiver, holders of such MBS have the right to replace FNMA or FHLMC as trustee if the requisite percentage of MBS holders consent. The
Reform Act prevents mortgage-backed security holders from enforcing such rights if the event of default arises solely because a conservator or receiver has been appointed.
A 2011 report to Congress from the Treasury Department and the Department of Housing and Urban Development set forth a plan to
reform Americas housing finance market, which would reduce the role of and eventually eliminate FNMA and FHLMC. Notably, the plan did not propose similar significant changes to GNMA, which guarantees payments on mortgage related securities
backed by federally insured or guaranteed loans. The report also identified three proposals for Congress and the administration to consider for the long-term structure of the housing finance markets after the elimination of FNMA and FHLMC, including
implementing: (i) a privatized system of housing finance that limits government insurance to very limited groups of creditworthy low- and moderate-income borrowers; (ii) a privatized system with a
government backstop mechanism that would allow the government to insure a larger share of the housing finance market during a future housing crisis; and (iii) a privatized system where the government would offer reinsurance to holders of
certain highly rated mortgage related securities insured by private insurers and would pay out under the reinsurance arrangements only if the private mortgage insurers were insolvent.
Non-Agency RMBS. Non-agency RMBS
are issued by commercial banks, savings and loan institutions, mortgage bankers, private mortgage insurance companies and other non-governmental issuers. Timely payment of principal and interest on RMBS backed
by pools created by non-governmental issuers often is supported partially by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance. The insurance and guarantees
are issued by government entities, private insurers and the mortgage poolers. There can be no assurance that the private insurers or mortgage poolers can meet their obligations under the policies, so that if the issuers default on their obligations,
the holders of the security could sustain a loss. No insurance or guarantee covers the Trust or the price of the Trusts common shares. RMBS issued by non-governmental issuers generally offer a higher
rate of interest than government agency and government-related securities because there are no direct or indirect government guarantees of payment.
CMBS. CMBS generally are multi-class debt or pass-through certificates secured or backed by mortgage loans on
commercial properties. CMBS generally are structured to provide protection to the senior class investors against potential losses on the underlying mortgage loans. This protection generally is provided by having the
S-9
holders of subordinated classes of securities (Subordinated CMBS) take the first loss if there are defaults on the underlying commercial mortgage loans. Other protection, which may
benefit all of the classes or particular classes, may include issuer guarantees, reserve funds, additional Subordinated CMBS, cross-collateralization and over-collateralization.
The Trust may invest in Subordinated CMBS, which are subordinated in some manner as to the payment of principal and/or
interest to the holders of more senior CMBS arising out of the same pool of mortgages and which are often referred to as B-Pieces. The holders of Subordinated CMBS typically are compensated with a
higher stated yield than are the holders of more senior CMBS. On the other hand, Subordinated CMBS typically subject the holder to greater risk than senior CMBS and tend to be rated in a lower rating category (frequently a substantially lower rating
category) than the senior CMBS issued in respect of the same mortgage pool. Subordinated CMBS generally are likely to be more sensitive to changes in prepayment and interest rates and the market for such securities may be less liquid than is the
case for traditional income securities and senior CMBS.
CMOs. A CMO is a multi-class bond backed by a pool
of mortgage pass-through certificates or mortgage loans. CMOs may be collateralized by (i) GNMA, FNMA or FHLMC pass-through certificates, (ii) unsecuritized mortgage loans insured by the FHA or guaranteed by the VA,
(iii) unsecuritized conventional mortgages, (iv) other MBS or (v) any combination thereof. Each class of a CMO, often referred to as a tranche, is issued at a specific coupon rate and has a stated maturity or final
distribution date. Principal prepayments on collateral underlying a CMO may cause it to be retired substantially earlier than its stated maturity or final distribution date. The principal and interest on the underlying mortgages may be allocated
among the several classes of a series of a CMO in many ways. One or more tranches of a CMO may have coupon rates which reset periodically at a specified increment over an index, such as LIBOR (or sometimes more than one index). These floating rate
CMOs typically are issued with lifetime caps on the coupon rate thereon. The Trust will generally not invest in CMO residuals, which represent the interest in any excess cash flow remaining after making the payments of interest and principal on the
tranches issued by the CMO and the payment of administrative expenses and management fees.
The Trust may invest in
inverse floating rate CMOs. Inverse floating rate CMOs constitute a tranche of a CMO with a coupon rate that moves in the reverse direction relative to an applicable index such as LIBOR. Accordingly, the coupon rate thereon will increase as interest
rates decrease. Inverse floating rate CMOs are typically more volatile than fixed or floating rate tranches of CMOs. Many inverse floating rate CMOs have coupons that move inversely to a multiple of an index. The effect of the coupon varying
inversely to a multiple of an applicable index creates a leverage factor. Inverse floating rate debt instruments (inverse floaters) based on multiples of a stated index are designed to be highly sensitive to changes in interest rates and
can subject the holders thereof to extreme reductions of yield and loss of principal. The market for inverse floating rate CMOs with highly leveraged characteristics at times may be very thin. The Trusts ability to dispose of its positions in
such securities will depend on the degree of liquidity in the markets for such securities. It is impossible to predict the amount of trading interest that may exist in such securities, and therefore the future degree of liquidity.
Sub-Prime Mortgages. Sub-prime
mortgages are mortgages rated below A by Moodys Investors Service, Inc., Standard & Poors Corporation Ratings Group, a division of The McGraw-Hill Companies, Inc. or Fitch Ratings. Historically, sub-prime mortgage loans have been made to borrowers with blemished (or non-existent) credit records, and the borrower is charged a higher interest rate to compensate for the
greater risk of delinquency and the higher costs of loan servicing and collection. Sub-prime mortgages are subject to both state and federal anti-predatory lending statutes that carry potential liability to
secondary market purchasers such as the Trust. Sub-prime mortgages have certain characteristics and associated risks similar to below investment grade securities, including a higher degree of credit risk, and
certain characteristics and associated risks similar to MBS, including prepayment risk.
S-10
Mortgage Related ABS. Asset-backed securities (ABS) are
bonds backed by pools of loans or other receivables. ABS are created from many types of assets, including in some cases mortgage related asset classes, such as home equity loan ABS. Home equity loan ABS are subject to many of the same risks as RMBS,
including interest rate risk and prepayment risk.
Mortgage REITs. A REIT is a corporation, or a business
trust that would otherwise be taxed as a corporation, that meets the definitional requirements applicable to REITs under the Internal Revenue Code of 1986, as amended (the Code). The Code permits a qualifying REIT to deduct dividends
paid, thereby generally eliminating corporate level U.S. federal income tax and effectively making the REIT a pass-through vehicle for U.S. federal income tax purposes. To meet the definitional requirements of the Code, a REIT must, among other
things, invest substantially all of its assets in interests in real estate (including mortgages and other REITs) or cash and government securities, derive most of its income from rents from real property or interest on loans secured by mortgages on
real property, and distribute to shareholders annually substantially all of its otherwise taxable income. Mortgage REITs invest mostly in mortgages on real estate, which may secure construction, development or long-term loans, and the main source of
their income is mortgage interest payments. The value of securities issued by REITs is affected by tax and regulatory requirements and by perceptions of management skill. They also are subject to heavy cash flow dependency and the possibility of
failing to qualify for REIT status under the Code or to maintain exemption from the Investment Company Act.
Mortgage Related Derivative Instruments. The Trust may invest in MBS credit default swaps. MBS credit default
swaps include swaps the reference obligation for which is an MBS or related index, such as the CMBX Index (a tradeable index referencing a basket of CMBS), the TRX Index (a tradeable index referencing total return swaps based on CMBS) or the ABX
Index (a tradeable index referencing a basket of sub-prime MBS). The Trust may engage in other derivative transactions related to MBS, including purchasing and selling exchange-listed and OTC put and call
options, futures and forwards on mortgages and MBS. The Trust may invest in newly developed mortgage related derivatives that may hereafter become available.
Net Interest Margin (NIM) Securities. The Trust may invest in net interest margin (NIM) securities.
These securities are derivative interest-only mortgage securities structured off home equity loan transactions. NIM securities 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 yield to maturity 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.
TBA Commitments. The Trust may enter into to be announced or TBA commitments. TBA
commitments are forward agreements for the purchase or sale of securities, including mortgage-backed securities, for a fixed price, with payment and delivery on an agreed upon future settlement date. The specific securities to be delivered are not
identified at the trade date. However, delivered securities must meet specified terms, including issuer, rate and mortgage terms. See The Trusts InvestmentsPortfolio Contents and TechniquesWhen-Issued, Delayed Delivery and
Forward Commitment Securities in the prospectus.
Other Mortgage Related Securities. Other mortgage
related securities include securities other than those described above that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property. Other mortgage related securities may be equity or
debt securities issued by agencies or instrumentalities of the U.S. Government or by private originators of, or investors in, mortgage loans, including savings and loan associations, homebuilders, mortgage banks, commercial banks, investment banks,
partnerships, trusts and special purpose entities of the foregoing.
S-11
Asset-Backed Securities
ABS are securities backed by home equity loans, installment sale contracts, credit card receivables or other assets. ABS are
pass-through securities, meaning that principal and interest paymentsnet of expensesmade by the borrower on the underlying assets (such as credit card receivables) are passed through to the Trust. The value of ABS, like that
of traditional fixed-income securities, typically increases when interest rates fall and decreases when interest rates rise. However, ABS differ from traditional fixed-income securities because of their potential for prepayment. The price paid by
the Trust for its ABS, the yield the Trust expects to receive from such securities and the average life of the securities are based on a number of factors, including the anticipated rate of prepayment of the underlying assets. In a period of
declining interest rates, borrowers may prepay the underlying assets more quickly than anticipated, thereby reducing the yield to maturity and the average life of the ABS. Moreover, when the Trust reinvests the proceeds of a prepayment in these
circumstances, it will likely receive a rate of interest that is lower than the rate on the security that was prepaid. To the extent that the Trust purchases ABS at a premium, prepayments may result in a loss to the extent of the premium paid. If
the Trust buys such securities at a discount, both scheduled payments and unscheduled prepayments will increase current and total returns and unscheduled prepayments will also accelerate the recognition of income which, when distributed to
shareholders, will be taxable as ordinary income. In a period of rising interest rates, prepayments of the underlying assets may occur at a slower than expected rate, creating maturity extension risk. This particular risk may effectively change a
security that was considered short- or intermediate-term at the time of purchase into a longer term security. Since the value of longer-term securities generally fluctuates more widely in response to changes in interest rates than does the value of
shorter-term securities, maturity extension risk could increase the volatility of the Trust. When interest rates decline, the value of an ABS with prepayment features may not increase as much as that of other fixed-income securities, and, as noted
above, changes in market rates of interest may accelerate or retard prepayments and thus affect maturities.
Collateralized Debt Obligations
The Trust may invest in collateralized debt obligations (CDOs), which include collateralized bond obligations
(CBOs), collateralized loan obligations (CLOs) and other similarly structured securities. CDOs are types of asset-backed securities. A CBO is ordinarily issued by a trust or other special purpose entity (SPE) and
is typically backed by a diversified pool of fixed-income securities (which may include high risk, below investment grade securities) held by such issuer. A CLO is ordinarily issued by a trust or other SPE and is typically collateralized by a pool
of loans, which may include, among others, domestic and non-U.S. senior secured loans, senior unsecured loans, and subordinate corporate loans, including loans that may be rated below investment grade or
equivalent unrated loans, held by such issuer. Investments in a CLO organized outside of the United States may not be deemed to be foreign securities if the CLO is collateralized by a pool of loans, a substantial portion of which are U.S. loans.
Although certain CDOs may benefit from credit enhancement in the form of a senior-subordinate structure, over-collateralization or bond insurance, such enhancement may not always be present, and may fail to protect the Trust against the risk of loss
on default of the collateral. Certain CDO issuers may use derivatives contracts to create synthetic exposure to assets rather than holding such assets directly, which entails the risks of derivative instruments described elsewhere in the
prospectus and this SAI. CDOs may charge management fees and administrative expenses, which are in addition to those of the Trust.
For both CBOs and CLOs, the cash flows from the SPE are split into two or more portions, called tranches, varying in risk and
yield. The riskiest portion is the equity tranche, which bears the first loss from defaults from the bonds or loans in the SPE and serves to protect the other, more senior tranches from default (though such protection is not complete).
Since it is partially protected from defaults, a senior tranche from a CBO or CLO typically has higher ratings and lower yields than its underlying securities, and may be rated investment grade. Despite the protection from the equity tranche, CBO or
CLO tranches can experience substantial losses due to actual defaults, downgrades of the underlying collateral by rating agencies, forced liquidation of the collateral pool due to a failure of coverage tests, increased sensitivity to defaults due to
collateral default and disappearance of protecting tranches, market anticipation of defaults as well as investor aversion to CBO or CLO
S-12
securities as a class. Interest on certain tranches of a CDO may be paid in kind or deferred and capitalized (paid in the form of obligations of the same type rather than cash), which involves
continued exposure to default risk with respect to such payments.
The risks of an investment in a CDO depend largely on
the type of the collateral securities and the class of the CDO in which the Trust invests. Normally, CBOs, CLOs and other CDOs are privately offered and sold, and thus are not registered under the securities laws. However, an active dealer market
may exist for CDOs, allowing a CDO to qualify for Rule 144A transactions. In addition to the normal risks associated with fixed-income securities and ABS generally discussed elsewhere in this SAI, CDOs carry additional risks including, but not
limited to: (i) the possibility that distributions from collateral securities will not be adequate to make interest or other payments; (ii) the risk that the collateral may default or decline in value or be downgraded, if rated by a
nationally recognized statistical rating organization; (iii) the Trust may invest in tranches of CDOs that are subordinate to other tranches; (iv) the structure and complexity of the transaction and the legal documents could lead to
disputes among investors regarding the characterization of proceeds; (v) the investment return achieved by the Trust could be significantly different than those predicted by financial models; (vi) the lack of a readily available secondary
market for CDOs; (vii) the risk of forced fire sale liquidation due to technical defaults such as coverage test failures; and (viii) the CDOs manager may perform poorly.
Stripped Securities
Stripped securities are created when the issuer separates the interest and principal components of an instrument and sells them
as separate securities. In general, one security is entitled to receive the interest payments on the underlying assets (the interest only or IO security) and the other to receive the principal payments (the principal only or
PO security). Some stripped securities may receive a combination of interest and principal payments. The yields to maturity on IOs and POs are sensitive to the expected or anticipated rate of principal payments (including prepayments) on
the related underlying assets, and principal payments may have a material effect on yield to maturity. If the underlying assets experience greater than anticipated prepayments of principal, the Trust may not fully recoup its initial investment in
IOs. Conversely, if the underlying assets experience less than anticipated prepayments of principal, the yield on POs could be adversely affected. Stripped securities may be highly sensitive to changes in interest rates and rates of prepayment.
Zero-Coupon Bonds, Step-Ups and
Payment-In-Kind Securities
Zero-coupon
bonds pay interest only at maturity rather than at intervals during the life of the security. Like zero-coupon bonds, step up bonds pay no interest initially but eventually begin to pay a coupon
rate prior to maturity, which rate may increase at stated intervals during the life of the security. Payment-in-kind securities (PIKs) are debt obligations
that pay interest in the form of other debt obligations, instead of in cash. Each of these instruments is normally issued and traded at a deep discount from face value. Zero-coupon bonds, step-ups
and PIKs allow an issuer to avoid or delay the need to generate cash to meet current interest payments and, as a result, may involve greater credit risk than bonds that pay interest currently or in cash. The Trust would be required to distribute the
income on these instruments as it accrues, even though the Trust will not receive the income on a current basis or in cash. Thus, the Trust may have to sell other investments, including when it may not be advisable to do so, to make income
distributions to its shareholders.
Sovereign Government and Supranational Debt
Investments in sovereign debt involve special risks. Foreign governmental issuers of debt or the governmental authorities that
control the repayment of the debt may be unable or unwilling to repay principal or pay interest when due. In the event of default, there may be limited or no legal recourse in that, generally, remedies for defaults must be pursued in the courts of
the defaulting party. Political conditions, especially a sovereign entitys willingness to meet the terms of its debt obligations, are of considerable significance. The ability of a foreign sovereign issuer, especially an emerging market
country, to make timely payments on its debt obligations will also be strongly influenced by the sovereign issuers balance of payments, including export
S-13
performance, its access to international credit facilities and investments, fluctuations of interest rates and the extent of its foreign reserves. The cost of servicing external debt will also
generally be adversely affected by rising international interest rates, as many external debt obligations bear interest at rates which are adjusted based upon international interest rates. Also, there can be no assurances that the holders of
commercial bank loans to the same sovereign entity may not contest payments to the holders of sovereign debt in the event of default under commercial bank loan agreements. In addition, there is no bankruptcy proceeding with respect to sovereign debt
on which a sovereign has defaulted and the Trust may be unable to collect all or any part of its investment in a particular issue. Foreign investment in certain sovereign debt is restricted or controlled to varying degrees, including requiring
governmental approval for the repatriation of income, capital or proceeds of sales by foreign investors. These restrictions or controls may at times limit or preclude foreign investment in certain sovereign debt and increase the costs and expenses
of the Trust.
Bank Obligations
Bank obligations may include certificates of deposit, bankers acceptances and fixed time deposits. Certificates of
deposit are negotiable certificates issued against funds deposited in a commercial bank for a definite period of time and earning a specified return. Bankers acceptances are negotiable drafts or bills of exchange, normally drawn by an importer
or exporter to pay for specific merchandise, which are accepted by a bank, meaning, in effect, that the bank unconditionally agrees to pay the face value of the instrument on maturity. Fixed time deposits are bank obligations payable at
a stated maturity date and bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand by the investor, but may be subject to early withdrawal penalties, which vary depending upon market conditions and the remaining maturity of
the obligation. There are no contractual restrictions on the right to transfer a beneficial interest in a fixed time deposit to a third party, although there is no market for such deposits. Obligations of foreign banks involve somewhat different
investment risks than those affecting obligations of U.S. banks, including the possibilities that their liquidity could be impaired because of future political and economic developments, that their obligations may be less marketable than comparable
obligations of U.S. banks, that a foreign jurisdiction might impose withholding taxes on interest income payable on those obligations, that foreign deposits may be seized or nationalized, that foreign governmental restrictions such as exchange
controls may be adopted which might adversely affect the payment of principal and interest on those obligations and that the selection of those obligations may be more difficult because there may be less publicly available information concerning
foreign banks or the accounting, auditing and financial reporting standards, practices and requirements applicable to foreign banks may differ from those applicable to U.S. banks. Foreign banks are not generally subject to examination by any U.S.
Government agency or instrumentality.
Cash Equivalents and Short-Term Debt Securities
For temporary defensive purposes or to keep cash on hand fully invested, the Trust may invest up to 100% of its total assets in
cash equivalents and short-term debt securities.
Short-term debt securities include, without limitation, the following:
|
1. |
U.S. Government securities, including bills, notes and bonds differing as to maturity and rates of interest
that are either issued or guaranteed by the U.S. Treasury or by U.S. Government agencies or instrumentalities. U.S. Government securities include securities issued by (a) the FHA, Farmers Home Administration, Export-Import Bank of the United
States, Small Business Administration, and GNMA, whose securities are supported by the full faith and credit of the United States; (b) the FHLBs, Federal Intermediate Credit Banks, and Tennessee Valley Authority, whose securities are supported
by the right of the agency to borrow from the U.S. Treasury; (c) the FNMA, whose securities are supported by the discretionary authority of the U.S. Government to purchase certain obligations of the agency or instrumentality; and (d) the
Student Loan Marketing Association, whose securities are supported only by its credit. While the U.S. Government provides financial support to such U.S. Government-sponsored agencies or instrumentalities, no assurance can be given that it always
will do so since it is |
S-14
|
not so obligated by law. The U.S. Government, its agencies and instrumentalities do not guarantee the market value of their securities. Consequently, the value of such securities may fluctuate.
|
|
2. |
Certificates of deposit issued against funds deposited in a bank or a savings and loan association. Such
certificates are for a definite period of time, earn a specified rate of return, and are normally negotiable. The issuer of a certificate of deposit agrees to pay the amount deposited plus interest to the bearer of the certificate on the date
specified thereon. Certificates of deposit purchased by the Trust may not be fully insured by the Federal Deposit Insurance Corporation. |
|
3. |
Repurchase agreements, which involve purchases of debt securities. |
|
4. |
Commercial paper, which consists of short-term unsecured promissory notes, including variable rate master
demand notes issued by corporations to finance their current operations. Master demand notes are direct lending arrangements between the Trust and a corporation. There is no secondary market for such notes. However, they are redeemable by the Trust
at any time. The Advisor will consider the financial condition of the corporation (e.g., earning power, cash flow and other liquidity ratios) and will continuously monitor the corporations ability to meet all of its financial obligations,
because the Trusts liquidity might be impaired if the corporation were unable to pay principal and interest on demand. |
Strategic Transactions and Other Management Techniques
As described in the prospectus, the Trust may use Strategic Transactions (as defined in the prospectus). This section contains
various additional information about the types of Strategic Transactions in which the Trust may engage.
Swaps and
Swaptions. The Trust may enter into swap agreements, including interest rate and index swap agreements. Swap agreements are two party contracts entered into primarily by institutional investors for periods ranging from a few weeks to more
than one year. In a standard swap transaction, two parties agree to exchange the returns (or differentials in rates of return) earned or realized on particular predetermined investments or instruments. The gross returns to be exchanged
or swapped between the parties are calculated with respect to a notional amount, i.e., the dollar amount invested at a particular interest rate, in a particular foreign currency, or in a basket of securities
representing a particular index. The notional amount of the swap agreement is only a fictive basis on which to calculate the obligations that the parties to a swap agreement have agreed to exchange. The Trusts obligations (or
rights) under a swap agreement will generally be equal only to the net amount to be paid or received under the agreement based on the relative values of the positions held by each party to the agreement (the net amount). The Trusts
obligations under a swap agreement will be accrued daily (offset against any amounts owing to the Trust) and the Trust will segregate with a custodian or earmark on its books and records an amount of cash or liquid assets having an aggregate NAV at
all times at least equal to any accrued but unpaid net amounts owed to a swap counterparty.
Whether the Trusts use
of swap agreements will be successful in furthering its investment objectives will depend on the Advisors ability to correctly predict whether certain types of investments are likely to produce greater returns than other investments. Moreover,
the Trust bears the risk of loss of the amount expected to be received under a swap agreement in the event of the default or bankruptcy of a swap agreement counterparty. Swap agreements also bear the risk that the Trust will not be able to meet its
payment obligations to the counterparty. As noted, however, the Trust will deposit in a segregated account, or earmark on its books and records, liquid assets permitted to be so segregated or earmarked by the SEC in an amount equal to or greater
than the market value of the Trusts liabilities under the swap agreement or the amount it would cost the Trust initially to make an equivalent direct investment plus or minus any amount the Trust is obligated to pay or is to receive under the
swap agreement. Restrictions imposed by the tax rules applicable to RICs may limit the Trusts ability to use swap agreements. It is possible that developments in the swap market, including government regulation, could adversely affect the
Trusts ability to terminate existing swap agreements or to realize amounts to be received under such agreements.
S-15
A swaption is a contract that gives a counterparty the right (but not the
obligation) to enter into a new swap agreement or to shorten, extend, cancel or otherwise modify an existing swap agreement, at some designated future time on specified terms. The Trust may write (sell) and purchase put and call swaptions. Depending
on the terms of the particular option agreement, the Trust will generally incur a greater degree of risk when it writes a swaption than it will incur when it purchases a swaption. When the Trust purchases a swaption, it risks losing only the amount
of the premium it has paid should it decide to let the option expire unexercised. However, when the Trust writes a swaption, upon exercise of the option the Trust will become obligated according to the terms of the underlying agreement.
Total Return Swaps. Total return swap agreements are contracts in which one party agrees to make periodic
payments to another party based on the change in market value of the assets underlying the contract, which may include a specified security, basket of securities or securities indices during the specified period, in return for periodic payments
based on a fixed or variable interest rate or the total return from other underlying assets. Total return swap agreements may be used to obtain exposure to a security or market without owning or taking physical custody of such security or investing
directly in such market. Total return swap agreements may effectively add leverage to the Trusts portfolio because, in addition to its Managed Assets (as defined in the prospectus), the Trust would be subject to investment exposure on the
notional amount of the swap.
Total return swap agreements are subject to the risk that a counterparty will default on its
payment obligations to the Trust thereunder. Swap agreements also bear the risk that the Trust will not be able to meet its obligation to the counterparty. Generally, the Trust will enter into total return swaps on a net basis (i.e., the two
payment streams are netted against one another with the Trust receiving or paying, as the case may be, only the net amount of the two payments). The net amount of the excess, if any, of the Trusts obligations over its entitlements with respect
to each total return swap will be accrued on a daily basis, and an amount of liquid assets having an aggregate NAV at least equal to the accrued excess will be segregated by the Trust or earmarked on its books and records. If the total return swap
transaction is entered into on other than a net basis, the full amount of the Trusts obligations will be accrued on a daily basis, and the full amount of the Trusts obligations will be segregated or earmarked by the Trust in an amount
equal to or greater than the market value of the liabilities under the total return swap agreement or the amount it would have cost the Trust initially to make an equivalent direct investment, plus or minus any amount the Trust is obligated to pay
or is to receive under the total return swap agreement.
Foreign Exchange Transactions. The Trust may engage
in spot and forward foreign exchange transactions and currency swaps, purchase and sell options on currencies and purchase and sell currency futures and related options thereon (collectively, Currency Instruments). Such transactions
could be effected with respect to hedges on foreign dollar denominated securities owned by the Trust, sold by the Trust but not yet delivered, or committed or anticipated to be purchased by the Trust. As an illustration, the Trust may use such
techniques to hedge the stated value in U.S. dollars of an investment in a yen-denominated security. In such circumstances, for example, the Trust may purchase a foreign currency put option enabling it to sell
a specified amount of yen for dollars at a specified price by a future date. To the extent the hedge is successful, a loss in the value of the yen relative to the dollar will tend to be offset by an increase in the value of the put option. To
offset, in whole or in part, the cost of acquiring such a put option, the Trust may also sell a call option which, if exercised, requires it to sell a specified amount of yen for dollars at a specified price by a future date (a technique called a
straddle). By selling such a call option in this illustration, the Trust gives up the opportunity to profit without limit from increases in the relative value of the yen to the dollar. Straddles of the type that may be used
by the Trust are considered to constitute hedging transactions. The Trust may not attempt to hedge any or all of its foreign portfolio positions.
Forward Foreign Currency Contracts. The Trust may enter into forward currency contracts to purchase or sell
foreign currencies for a fixed amount of U.S. dollars or another foreign currency. A forward currency contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days (term) from the
date of the forward currency contract agreed upon by the parties, at a price set at the time the forward currency contract is entered into. Forward currency contracts are traded directly between currency traders
S-16
(usually large commercial banks) and their customers. The Trust may purchase a forward currency contract to lock in the U.S. dollar price of a security denominated in a foreign currency that the
Trust intends to acquire. The Trust may sell a forward currency contract to lock in the U.S. dollar equivalent of the proceeds from the anticipated sale of a security or a dividend or interest payment denominated in a foreign currency. The Trust may
also use forward currency contracts to shift the Trusts exposure to foreign currency exchange rate changes from one currency to another. For example, if the Trust owns securities denominated in a foreign currency and the Advisor believes that
currency will decline relative to another currency, the Trust might enter into a forward currency contract to sell the appropriate amount of the first foreign currency with payment to be made in the second currency. The Trust may also purchase
forward currency contracts to enhance income when the Advisor anticipates that the foreign currency will appreciate in value but securities denominated in that currency do not present attractive investment opportunities. The Trust may also use
forward currency contracts to hedge against a decline in the value of existing investments denominated in a foreign currency. Such a hedge would tend to offset both positive and negative currency fluctuations, but would not offset changes in
security values caused by other factors. The Trust could also hedge the position by entering into a forward currency contract to sell another currency expected to perform similarly to the currency in which the Trusts existing investments are
denominated. This type of transaction could offer advantages in terms of cost, yield or efficiency, but may not hedge currency exposure as effectively as a simple forward currency transaction to sell U.S. dollars. This type of transaction may result
in losses if the currency used to hedge does not perform similarly to the currency in which the hedged securities are denominated. The Trust may also use forward currency contracts in one currency or a basket of currencies to attempt to hedge
against fluctuations in the value of securities denominated in a different currency if the Advisor anticipates that there will be a correlation between the two currencies.
The cost to the Trust of engaging in forward currency contracts varies with factors such as the currency involved, the length
of the contract period and the market conditions then prevailing. Because forward currency contracts are usually entered into on a principal basis, no fees or commissions are involved. When the Trust enters into a forward currency contract, it
relies on the counterparty to make or take delivery of the underlying currency at the maturity of the contract. Failure by the counterparty to do so would result in the loss of some or all of any expected benefit of the transaction. Secondary
markets generally do not exist for forward currency contracts, with the result that closing transactions generally can be made for forward currency contracts only by negotiating directly with the counterparty. Thus, there can be no assurance that
the Trust will in fact be able to close out a forward currency contract at a favorable price prior to maturity. In addition, in the event of insolvency of the counterparty, the Trust might be unable to close out a forward currency contract. In
either event, the Trust would continue to be subject to market risk with respect to the position, and would continue to be required to maintain a position in securities denominated in the foreign currency or to maintain cash or liquid assets in a
segregated account or earmark such cash or liquid assets on its books and records. The precise matching of forward currency contract amounts and the value of the securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the forward currency contract has been established. Thus, the Trust might need to purchase or sell foreign currencies in the spot (cash) market to the extent such foreign currencies are
not covered by forward currency contracts. The projection of short-term currency market movements is extremely difficult and the successful execution of a short-term hedging strategy is highly uncertain.
Use of Options as Strategic Transactions. In addition to the options strategy described in the prospectus as
part of the Trusts investment strategy, the Trust may also use options as Strategic Transactions.
Call Options
as Strategic Transactions. The Trust may purchase call options on any of the types of securities or instruments in which it may invest. A purchased call option gives the Trust the right to buy, and obligates the seller to sell, the underlying
security at the exercise price at any time during the option period. The Trust also may purchase and sell call options on indices. Index options are similar to options on securities except that, rather than taking or making delivery of securities
underlying the option at a specified price upon exercise, an index option gives the holder the right to receive cash upon exercise of the option if the level of the index upon which the option is based is greater than the exercise price of the
option.
S-17
The Trust may write (i.e., sell) covered call options on the securities or
instruments it holds and enter into closing purchase transactions with respect to certain of such options. A covered call option is an option in which the Trust, in return for a premium, gives another party a right to buy specified securities owned
by the Trust at a specified future date and price set at the time of the contract. The principal reason for writing covered call options is the attempt to realize, through the receipt of premiums, a greater return than would be realized on the
securities alone. By writing covered call options, the Trust gives up the opportunity, while the option is in effect, to profit from any price increase in the underlying security above the option exercise price. In addition, the Trusts ability
to sell the underlying security will be limited while the option is in effect unless the Trust enters into a closing purchase transaction. A closing purchase transaction cancels out the Trusts position as the writer of an option by means of an
offsetting purchase of an identical option prior to the expiration of the option it has written. Covered call options also serve as a partial hedge to the extent of the premium received against the price of the underlying security declining.
The Trust may write (i.e., sell) uncovered call options on securities or instruments in which it may invest but that
are not currently held by the Trust. The principal reason for writing uncovered call options is to realize income without committing capital to the ownership of the underlying securities or instruments. When writing uncovered call options, the Trust
must deposit and maintain sufficient margin with the broker-dealer through which it made the uncovered call option as collateral to ensure that the securities can be purchased for delivery if and when the option is exercised. In addition, in
connection with each such transaction the Trust will segregate, or designate on its books and records, liquid assets or cash with a value at least equal to the Trusts exposure (the difference between the unpaid amounts owed by the Trust on
such transaction minus any collateral deposited with the broker-dealer), on a marked-to-market basis (as calculated pursuant to requirements of the SEC). Such
segregation or earmarking will ensure that the Trust has assets available to satisfy its obligations with respect to the transaction and will avoid any potential leveraging of the Trusts portfolio. Such designation will not limit the
Trusts exposure to loss. During periods of declining securities prices or when prices are stable, writing uncovered calls can be a profitable strategy to increase the Trusts income with minimal capital risk. Uncovered calls are riskier
than covered calls because there is no underlying security held by the Trust that can act as a partial hedge. Uncovered calls have speculative characteristics and the potential for loss is unlimited. When an uncovered call is exercised, the Trust
must purchase the underlying security to meet its call obligation. There is also a risk, especially with less liquid preferred and debt securities, that the securities may not be available for purchase. If the purchase price exceeds the exercise
price, the Trust will lose the difference.
Put Options as Strategic Transactions. The Trust may purchase put
options. By buying a put option, the Trust acquires a right to sell such underlying securities or instruments at the exercise price, thus limiting the Trusts risk of loss through a decline in the market value of the securities or instruments
until the put option expires. The amount of any appreciation in the value of the underlying securities or instruments will be partially offset by the amount of the premium paid for the put option and any related transaction costs. Prior to its
expiration, a put option may be sold in a closing sale transaction and profit or loss from the sale will depend on whether the amount received is more or less than the premium paid for the put option plus the related transaction costs. A closing
sale transaction cancels out the Trusts position as the purchaser of an option by means of an offsetting sale of an identical option prior to the expiration of the option it has purchased.
The Trust also may write (i.e., sell) put options on securities or instruments in which it may invest but that the
Trust does not currently have a corresponding short position or has not deposited cash equal to the exercise value of the put option with the broker dealer through which it made the uncovered put option as collateral. The principal reason for
writing such put options is to receive premium income and to acquire such securities or instruments at a net cost below the current market value. The Trust has the obligation to buy the securities or instruments at an agreed upon price if the
securities or instruments decrease below the exercise price. If the securities or instruments price increases during the option period, the option will expire worthless and the Trust will retain the premium and will not have to purchase the
securities or instruments at the exercise price. In connection with such transaction, the Trust will segregate or designate on its books and records liquid assets or cash with a value at least equal to the Trusts exposure, on a marked-to-market basis (as calculated pursuant to
S-18
requirements of the SEC). Such designation will ensure that the Trust has assets available to satisfy its obligations with respect to the transaction and will avoid any potential leveraging of
the Trusts portfolio. Such designation will not limit the Trusts exposure to loss.
The Trust will not sell
puts if, as a result, more than 50% of the Trusts total assets would be required to cover its potential obligations under its hedging and other investment transactions. In selling puts, there is a risk that the Trust may be required to buy the
underlying security at a price higher than the current market price.
Futures Contracts and Options on Futures
Contracts. The Trust may engage in transactions in financial futures contracts (futures contracts) and related options on such futures contracts. A futures contract is an agreement between two parties which obligates the
purchaser of the futures contract to buy and the seller of a futures contract to sell a security for a set price on a future date or, in the case of an index futures contract, to make and accept a cash settlement based upon the difference in value
of the index between the time the contract was entered into and the time of its settlement. A majority of transactions in futures contracts, however, do not result in the actual delivery of the underlying instrument or cash settlement, but are
settled through liquidation (i.e., by entering into an offsetting transaction). Futures contracts have been designed by boards of trade which have been designated contract markets by the CFTC.
The Trust may sell financial futures contracts in anticipation of an increase in the general level of interest rates.
Generally, as interest rates rise, the market values of securities that may be held by the Trust will fall, thus reducing the NAV of the Trust. However, as interest rates rise, the value of the Trusts short position in the futures contract
also will tend to increase, thus offsetting all or a portion of the depreciation in the market value of the Trusts investments which are being hedged. While the Trust will incur commission expenses in selling and closing out futures positions,
these commissions are generally less than the transaction expenses which the Trust would have incurred had the Trust sold portfolio securities in order to reduce its exposure to increases in interest rates. The Trust also may purchase financial
futures contracts in anticipation of a decline in interest rates when it is not fully invested in a particular market in which it intends to make investments to gain market exposure that may in part or entirely offset an increase in the cost of
securities it intends to purchase. It is anticipated that, in a substantial majority of these transactions, the Trust will purchase securities upon termination of the futures contract.
The Trust may purchase and write call and put options on futures contracts. Options on futures contracts are similar to
options on securities except that an option on a futures contract gives the purchaser the right in return for the premium paid to assume a position in a futures contract (a long position if the option is a call and a short position if the option is
a put). Generally, these strategies are utilized under the same market and market sector conditions (i.e., conditions relating to specific types of investments) in which the Trust enters into futures transactions. The Trust may purchase put
options or write call options on futures contracts rather than selling the underlying futures contract in anticipation of a decrease in the market value of securities or an increase in interest rates. Similarly, the Trust may purchase call options,
or write put options on futures contracts, as a substitute for the purchase of such futures to hedge against the increased cost resulting from an increase in the market value or a decline in interest rates of securities which the Trust intends to
purchase.
The Trust may engage in options and futures transactions on exchanges and options in the OTC markets. In
general, exchange-traded contracts are third-party contracts (i.e., performance of the parties obligation is guaranteed by an exchange or clearing corporation) with standardized strike prices and expiration dates. OTC options
transactions are two-party contracts with price and terms negotiated by the buyer and seller. See Additional Information About Options, below.
At the time a futures contract is purchased or sold, the Trust must allocate cash or securities as a deposit payment
(initial margin). It is expected that the initial margin that the Trust will pay may range from approximately 1% to approximately 5% of the value of the securities or commodities underlying the contract. In certain circumstances,
however, such as periods of high volatility, the Trust may be required by an exchange to
S-19
increase the level of its initial margin payment. Additionally, initial margin requirements may be increased generally in the future by regulatory action. An outstanding futures contract is
valued daily and the payment in case of variation margin may be required, a process known as marking to the market. Transactions in listed options and futures are usually settled by entering into an offsetting transaction,
and are subject to the risk that the position may not be able to be closed if no offsetting transaction can be arranged.
When the Trust purchases a futures contract or writes a put option or purchases a call option thereon, an amount of cash or
liquid assets will be segregated or designated on the Trusts books and records so that the amount so designated, plus the amount of variation margin held in the account of its broker, equals the market value of the futures contract, thereby
ensuring that the use of such futures is unleveraged.
Additional Information About Options. In the case of
either put or call options that it has purchased, if the option expires without being sold or exercised, the Trust will experience a loss in the amount of the option premium plus any commissions paid by the Trust. When the Trust sells put and call
options, it receives a premium as the seller of the option. The premium that the Trust receives for selling the option will serve as a partial and limited (to the dollar amount of the premium) hedge, in the amount of the option premium, against
changes in the value of the securities in its portfolio. During the term of the option, however, a covered call seller has, in return for the premium on the option, given up the opportunity for capital appreciation above the exercise price of the
option if the value of the underlying security increases, but has retained the risk of loss should the price of the underlying security decline. Conversely, a put seller retains the risk of loss should the market value of the underlying security
decline below the exercise price of the option, less the premium received on the sale of the option. The Trust may purchase and sell exchange-listed options and OTC Options which are privately negotiated with the counterparty. Listed options are
issued by the OCC, which guarantees the performance of the obligations of the parties to such options.
The Trusts
ability to close out its position as a purchaser or seller of an exchange-listed put or call option is dependent upon the existence of a liquid secondary market on option exchanges. Among the possible reasons for the absence of a liquid secondary
market on an exchange are: (i) insufficient trading interest in certain options; (ii) restrictions on transactions imposed by an exchange; (iii) trading halts, suspensions or other restrictions imposed with respect to particular
classes or series of options or underlying securities; (iv) interruption of the normal operations on an exchange; (v) inadequacy of the facilities of an exchange or OCC to handle current trading volume; or (vi) a decision by one or
more exchanges to discontinue the trading of options (or a particular class or series of options), in which event the secondary market on that exchange (or in that class or series of options) would cease to exist, although outstanding options on
that exchange that had been listed by the OCC as a result of trades on that exchange would generally continue to be exercisable in accordance with their terms. OTC Options are purchased from or sold to dealers, financial institutions or other
counterparties which have entered into direct agreements with the Trust. With OTC Options, such variables as expiration date, exercise price and premium will be agreed upon between the Trust and the counterparty, without the intermediation of a
third party such as the OCC. If the counterparty fails to make or take delivery of the securities underlying an option it has written, or otherwise settle the transaction in accordance with the terms of that option as written, the Trust would lose
the premium paid for the option as well as any anticipated benefit of the transaction. OTC Options and assets used to cover OTC Options written by the Trust are considered by the staff of the SEC to be illiquid. The illiquidity of such options or
assets may prevent a successful sale of such options or assets, result in a delay of sale, or reduce the amount of proceeds that might otherwise be realized.
The hours of trading for options on debt securities may not conform to the hours during which the underlying securities are
traded. To the extent that the option markets close before the markets for the underlying securities, significant price and rate movements can take place in the underlying markets that cannot be reflected in the option markets.
Hybrid Instruments. A hybrid instrument is a type of potentially high-risk derivative that combines a
traditional bond, stock or commodity with an option or forward contract. Generally, the principal amount,
S-20
amount payable upon maturity or redemption, or interest rate of a hybrid is tied (positively or negatively) to the price of some commodity, currency or securities index or another interest rate
or some other economic factor (each a benchmark). The interest rate or (unlike most fixed-income securities) the principal amount payable at maturity of a hybrid security may be increased or decreased, depending on changes in the value
of the benchmark. An example of a hybrid could be a bond issued by an oil company that pays a small base level of interest with additional interest that accrues in correlation to the extent to which oil prices exceed a certain predetermined level.
Such a hybrid instrument would be a combination of a bond and a call option on oil. Hybrids can be used as an efficient means of pursuing a variety of investment goals, including currency hedging, duration management and increased total return.
Hybrids may not bear interest or pay dividends. The value of a hybrid or its interest rate may be a multiple of a benchmark and, as a result, may be leveraged and move (up or down) more steeply and rapidly than the benchmark. These benchmarks may be
sensitive to economic and political events, such as commodity shortages and currency devaluations, which cannot be readily foreseen by the purchaser of a hybrid. Under certain conditions, the redemption value of a hybrid could be zero. Thus, an
investment in a hybrid may entail significant market risks that are not associated with a similar investment in a traditional, U.S. dollar-denominated bond that has a fixed principal amount and pays a fixed rate or floating rate of interest. The
purchase of hybrids also exposes the Trust to the credit risk of the issuer of the hybrids. These risks may cause significant fluctuations in the NAV of the Trusts common shares if the Trust invests in hybrid instruments.
New Products. The financial markets continue to evolve and financial products continue to be developed. The
Trust reserves the right to invest in new financial products as they are developed or become more widely accepted. As with any new financial product, these products will entail risks, including risks to which the Trust currently is not subject.
The principal risks relating to the use of futures contracts and other Strategic Transactions are: (i) less than perfect
correlation between the prices of the instrument and the market value of the securities in the Trusts portfolio; (ii) possible lack of a liquid secondary market for closing out a position in such instruments; (iii) losses resulting
from interest rate or other market movements not anticipated by the Advisor; and (iv) the obligation to meet additional variation margin or other payment requirements, all of which could result in the Trust being in a worse position than if
such transactions had not been used.
Certain provisions of the Code may restrict or affect the ability of the Trust to
engage in Strategic Transactions. See Tax Matters.
Environmental, Social and Governance (ESG) Integration
Although the Trust does not seek to implement a specific ESG, impact or sustainability strategy, Trust management will consider
ESG characteristics as part of the investment process for actively managed funds such as the Trust. These considerations will vary depending on a funds particular investment strategies and may include consideration of third-party research as
well as consideration of proprietary research of the Advisor across the ESG risks and opportunities regarding an issuer. Trust management will consider those ESG characteristics it deems relevant or additive when making investment decisions for the
Trust. The ESG characteristics utilized in the Trusts investment process are anticipated to evolve over time and one or more characteristics may not be relevant with respect to all issuers that are eligible for investment.
ESG characteristics are not the sole considerations when making investment decisions for the Trust. Further, investors can
differ in their views of what constitutes positive or negative ESG characteristics. As a result, the Trust may invest in issuers that do not reflect the beliefs and values with respect to ESG of any particular investor. ESG considerations may affect
the Trusts exposure to certain companies or industries and the Trust may forego certain investment opportunities. While Trust management views ESG considerations as having the potential to contribute to the Trusts long-term performance,
there is no guarantee that such results will be achieved.
S-21
ADDITIONAL RISK FACTORS
Convertible Securities Risk
The value of convertible securities is influenced by both the yield on nonconvertible securities of comparable issuers and by
the value of the underlying common stock. The value of a convertible security viewed without regard to its conversion feature (i.e., strictly on the basis of its yield) is sometimes referred to as its investment value. To the extent
interest rates change, the investment value of the convertible security typically will fluctuate. At the same time, however, the value of the convertible security will be influenced by its conversion value, which is the market value of
the underlying common stock that would be obtained if the convertible security were converted. Conversion value fluctuates directly with the price of the underlying common stock. If the conversion value of a convertible security is substantially
below its investment value, the price of the convertible security is governed principally by its investment value. To the extent the conversion value of a convertible security increases to a point that approximates or exceeds its investment value,
the price of the convertible security will be influenced principally by its conversion value. A convertible security will sell at a premium over the conversion value to the extent investors place value on the right to acquire the underlying common
stock while holding a fixed-income security. The yield and conversion premium of convertible securities issued in Japan and the Euromarket are frequently determined at levels that cause the conversion value to affect their market value more than the
securities investment value.
Holders of convertible securities generally have a claim on the assets of the issuer
prior to the common stockholders but may be subordinated to other debt securities of the same issuer. A convertible security may be subject to redemption at the option of the issuer at a price established in a charter provision, indenture or other
governing instrument pursuant to which the convertible security was issued. If a convertible security held by the Trust is called for redemption, the Trust will be required to redeem the security, convert it into the underlying common stock or sell
it to a third party. Certain convertible debt securities may provide a put option to the holder, which entitles the holder to cause the security to be redeemed by the issuer at a premium over the stated principal amount of the debt security under
certain circumstances.
The Trust may also invest in synthetic convertible securities. Synthetic convertible securities
may include either Cash-Settled Convertibles or Manufactured Convertibles. Cash-Settled Convertibles are instruments that are created by the issuer and have the economic characteristics of traditional convertible securities but may not
actually permit conversion into the underlying equity securities in all circumstances. As an example, a private company may issue a Cash-Settled Convertible that is convertible into common stock only if the company successfully completes a public
offering of its common stock prior to maturity and otherwise pays a cash amount to reflect any equity appreciation. Manufactured Convertibles are created by the Advisor or another party by combining separate securities that possess one
of the two principal characteristics of a convertible security, i.e., fixed-income (fixed-income component) or a right to acquire equity securities (convertibility component). The fixed-income component is achieved by
investing in nonconvertible fixed-income securities, such as nonconvertible bonds, preferred stocks and money market instruments. The convertibility component is achieved by investing in call options, warrants, or other securities with equity
conversion features (equity features) granting the holder the right to purchase a specified quantity of the underlying stocks within a specified period of time at a specified price or, in the case of a stock index option, the right to
receive a cash payment based on the value of the underlying stock index.
A Manufactured Convertible differs from
traditional convertible securities in several respects. Unlike a traditional convertible security, which is a single security that has a unitary market value, a Manufactured Convertible is comprised of two or more separate securities, each with its
own market value. Therefore, the total market value of such a Manufactured Convertible is the sum of the values of its fixed-income component and its convertibility component.
More flexibility is possible in the creation of a Manufactured Convertible than in the purchase of a traditional convertible
security. Because many corporations have not issued convertible securities, the Advisor
S-22
may combine a fixed-income instrument and an equity feature with respect to the stock of the issuer of the fixed-income instrument to create a synthetic convertible security otherwise unavailable
in the market. The Advisor may also combine a fixed-income instrument of an issuer with an equity feature with respect to the stock of a different issuer when the Advisor believes such a Manufactured Convertible would better promote the Trusts
investment objectives than alternative investments. For example, the Advisor may combine an equity feature with respect to an issuers stock with a fixed-income security of a different issuer in the same industry to diversify the Trusts
credit exposure, or with a U.S. Treasury instrument to create a Manufactured Convertible with a higher credit profile than a traditional convertible security issued by that issuer. A Manufactured Convertible also is a more flexible investment in
that its two components may be purchased separately and, upon purchasing the separate securities, combined to create a Manufactured Convertible. For example, the Trust may purchase a warrant for eventual inclusion in a Manufactured
Convertible while postponing the purchase of a suitable bond to pair with the warrant pending development of more favorable market conditions.
The value of a Manufactured Convertible may respond to certain market fluctuations differently from a traditional convertible
security with similar characteristics. For example, in the event the Trust created a Manufactured Convertible by combining a short-term U.S. Treasury instrument and a call option on a stock, the Manufactured Convertible would be expected to
outperform a traditional convertible of similar maturity that is convertible into that stock during periods when Treasury instruments outperform corporate fixed-income securities and underperform during periods when corporate fixed-income securities
outperform Treasury instruments.
Rights Risk
The failure to exercise subscription rights to purchase common stock would result in the dilution of the Trusts interest
in the issuing company. The market for such rights is not well developed, and, accordingly, the Trust may not always realize full value on the sale of rights.
Master Limited Partnership Risk
An investment in MLP units involves some risks that differ from an investment in the common stock of a corporation. As compared
to common stockholders of a corporation, holders of MLP units have more limited control and limited rights to vote on matters affecting the partnership. In addition, there are certain tax risks associated with an investment in MLP units and
conflicts of interest may exist between common unit holders and the general partner, including those arising from incentive distribution payments.
Much of the benefit the Trust derives from its investment in equity securities of MLPs is a result of MLPs generally being
treated as partnerships for U.S. federal income tax purposes. Partnerships do not pay U.S. federal income tax at the partnership level. Rather, each partner of a partnership, in computing its U.S. federal income tax liability, will include its
allocable share of the partnerships income, gains, losses, deductions and expenses. A change in current tax law, or a change in the business of a given MLP, could result in an MLP being treated as a corporation for U.S. federal income tax
purposes, which would result in such MLP being required to pay U.S. federal income tax on its taxable income. The classification of an MLP as a corporation for U.S. federal income tax purposes would have the effect of reducing the amount of cash
available for distribution by the MLP and causing any such distributions received by the Trust to be taxed as dividend income to the extent of the MLPs current or accumulated earnings and profits. Thus, if any of the MLPs owned by the Trust
were treated as corporations for U.S. federal income tax purposes, the after-tax return to the Trust and its shareholders with respect to its investment in such MLPs would be materially reduced, which could
cause a decline in the value of the common stock.
To the extent that the Trust invests in the equity securities of an
MLP, the Trust will be a partner in such MLP. Accordingly, the Trust will be required to include in its taxable income the Trusts allocable share of the income, gains, losses, deductions and expenses recognized by each such MLP, regardless of
whether the MLP
S-23
distributes cash to the Trust. Historically, MLPs have been able to offset a significant portion of their income with tax deductions. The Trust will recognize taxable income with respect to its
allocable share of an MLPs income and gains that is not offset by the MLPs tax deductions, losses and credits, or its net operating loss carryforwards, if any. The portion, if any, of a distribution received by the Trust from an MLP that
is offset by the MLPs tax deductions, losses or credits is essentially treated as a return of capital. However, those distributions will reduce the Trusts adjusted tax basis in the equity securities of the MLP, which will result in an
increase in the amount of gain (or decrease in the amount of loss) that will be recognized by the Trust for tax purposes upon the sale of any such equity securities or upon subsequent distributions in respect of such equity securities. The
percentage of an MLPs income and gains that is offset by tax deductions, losses and credits will fluctuate over time for various reasons. A significant slowdown in acquisition activity or capital spending by MLPs held in the Trusts
portfolio could result in a reduction of accelerated depreciation generated by new acquisitions, which may result in an increased distribution requirement for the Trust.
Because of the Trusts investments in equity securities of MLPs, the Trusts earnings and profits may be calculated
using accounting methods that are different from those used for calculating taxable income. Because of these differences, the Trust may make distributions out of its current or accumulated earnings and profits, which will be treated as dividends, in
years in which the Trusts distributions exceed its taxable income. See Tax Matters.
In addition,
changes in tax laws or regulations, or future interpretations of such laws or regulations, could adversely affect the Trust or the MLP investments in which the Trust invests.
Mortgage Related Securities Risks
Investing in MBS entails various risks. MBS represent an interest in a pool of mortgages. The risks associated with MBS
include: credit risk associated with the performance of the underlying mortgage properties and of the borrowers owning these properties; risks associated with their structure and execution (including the collateral, the process by which principal
and interest payments are allocated and distributed to investors and how credit losses affect issuing vehicles and the return to investors in such MBS); whether the collateral represents a fixed set of specific assets or accounts, whether the
underlying collateral assets are revolving or closed-end, under what terms (including maturity of the MBS) any remaining balance in the accounts may revert to the issuing entity and the extent to which the
entity that is the actual source of the collateral assets is obligated to provide support to the issuing vehicle or to the investors in such MBS; risks associated with the servicer of the underlying mortgages; adverse changes in economic conditions
and circumstances, which are more likely to have an adverse impact on MBS secured by loans on certain types of commercial properties than on those secured by loans on residential properties; prepayment risk, which can lead to significant
fluctuations in the value of the mortgage-backed security; loss of all or part of the premium, if any, paid; and decline in the market value of the security, whether resulting from changes in interest rates, prepayments on the underlying mortgage
collateral or perceptions of the credit risk associated with the underlying mortgage collateral. In addition, the Trusts level of investment in MBS of a particular type or in MBS issued or guaranteed by affiliated obligors, serviced by the
same servicer or backed by underlying collateral located in a specific geographic region, may subject the Trust to additional risk.
When market interest rates decline, more mortgages are refinanced and the securities are paid off earlier than expected.
Prepayments may also occur on a scheduled basis or due to foreclosure. During such periods, the reinvestment of prepayment proceeds by the Trust will generally be at lower rates than the rates that were carried by the obligations that have been
prepaid. When market interest rates increase, the market values of MBS decline. At the same time, however, mortgage refinancings and prepayments slow, lengthening the effective maturities of these securities. As a result, the negative effect of the
rate increase on the market value of MBS is usually more pronounced than it is for other types of fixed-income securities. Moreover, the relationship between borrower prepayments and changes in interest rates may mean some high-yielding mortgage
related and other asset-backed securities have less potential for increases in value if market interest rates were to fall than conventional bonds with comparable maturities.
S-24
In general, losses on a mortgaged property securing a mortgage loan included in a
securitization will be borne first by the equity holder of the property, then by a cash reserve fund or letter of credit, if any, then by the holder of a mezzanine loan or B-Note, if any, then by the
first loss subordinated security holder (generally, the B-Piece buyer) and then by the holder of a higher rated security. The Trust could invest in any class of security included in a
securitization. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit, mezzanine loans or B-Notes, and any classes of securities junior to those in which the Trust
invests, the Trust will not be able to recover all of its investment in the MBS it purchases. MBS in which the Trust invests may not contain reserve funds, letters of credit, mezzanine loans and/or junior classes of securities. The prices of lower
credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments.
MBS generally are classified as either RMBS or CMBS, each of which are subject to certain specific risks as further described
below.
RMBS Risks. RMBS are securities the payments on which depend primarily on the cash flow from
residential mortgage loans made to borrowers that are secured by residential real estate. Non-agency residential mortgage loans are obligations of the borrowers thereunder only and are not typically insured or
guaranteed by any other person or entity. The ability of a borrower to repay a loan secured by residential property is dependent upon the income or assets of the borrower. A number of factors, including a general economic downturn, acts of God,
terrorism, social unrest and civil disturbances, may impair a borrowers ability to repay its loans.
Agency
RMBS Risks. MBS issued by FNMA or FHLMC are guaranteed as to timely payment of principal and interest by FNMA or FHLMC, but are not backed by the full faith and credit of the U.S. Government. In 2008, the FHFA placed FNMA and FHLMC into
conservatorship. FNMA and FHLMC are continuing to operate as going concerns while in conservatorship and each remains liable for all of its obligations, including its guaranty obligations, associated with its MBS. As the conservator, FHFA succeeded
to all rights, titles, powers and privileges of FNMA and FHLMC and of any stockholder, officer or director of FNMA and FHLMC with respect to FNMA and FHLMC and the assets of FNMA and FHLMC. In connection with the conservatorship, the U.S. Treasury
entered into an agreement with each of FNMA and FHLMC that contains various covenants that severely limit each enterprises operations. There is no assurance that the obligations of such entities will be satisfied in full, or that such
obligations will not decrease in value or default.
Under the Reform Act, FHFA, as conservator or receiver, has the power
to repudiate any contract entered into by FNMA or FHLMC prior to FHFAs appointment as conservator or receiver, as applicable, if FHFA determines, in its sole discretion, that performance of the contract is burdensome and that repudiation of
the contract promotes the orderly administration of FNMAs or FHLMCs affairs. In the event that FHFA, as conservator of, or if it is later appointed as receiver for, FNMA or FHLMC, were to repudiate any such guaranty obligation, the
conservatorship or receivership estate, as applicable, would be liable for actual direct compensatory damages in accordance with the provisions of the Reform Act. Any such liability could be satisfied only to the extent of FNMAs or
FHLMCs assets available therefor. In the event of repudiation, the payments of interest to holders of FNMA or FHLMC MBS would be reduced if payments on the mortgage loans represented in the mortgage loan groups related to such MBS are not made
by the borrowers or advanced by the servicer. Any actual direct compensatory damages for repudiating these guaranty obligations may not be sufficient to offset any shortfalls experienced by such mortgage-backed security holders. Further, in its
capacity as conservator or receiver, FHFA has the right to transfer or sell any asset or liability of FNMA or FHLMC without any approval, assignment or consent. If FHFA, as conservator or receiver, were to transfer any such guaranty obligation to
another party, holders of FNMA or FHLMC MBS would have to rely on that party for satisfaction of the guaranty obligation and would be exposed to the credit risk of that party. In addition, certain rights provided to holders of MBS issued by FNMA and
FHLMC under the operative documents related to such securities may not be enforced against FHFA, or enforcement of such rights may be delayed, during the conservatorship or any future receivership. The operative documents for FNMA and FHLMC MBS may
provide (or with respect to securities issued prior to the date of the appointment of the conservator may have provided)
S-25
that upon the occurrence of an event of default on the part of FNMA or FHLMC, in its capacity as guarantor, which includes the appointment of a conservator or receiver, holders of such MBS have
the right to replace FNMA or FHLMC as trustee if the requisite percentage of MBS holders consent. The Reform Act prevents mortgage-backed security holders from enforcing such rights if the event of default arises solely because a conservator or
receiver has been appointed.
A 2011 report to Congress from the Treasury Department and the Department of Housing and
Urban Development set forth a plan to reform Americas housing finance market, which would reduce the role of and eventually eliminate FNMA and FHLMC, and identified proposals for Congress and the administration to consider for the long-term
structure of the housing finance markets after the elimination of FNMA and FHLMC. The impact of such reforms on the markets for MBS is currently unknown. It is difficult, if not impossible, to predict the future political, regulatory or economic
changes that could impact FNMA, FHLMC and the Federal Home Loan Banks, and the values of their related securities or obligations.
Non-Agency RMBS Risks.
Non-agency RMBS are securities issued by non-governmental issuers. Non-agency RMBS have no direct or indirect government
guarantees of payment and are subject to various risks as described herein.
Borrower Credit Risk.
Credit-related risk on RMBS arises from losses due to delinquencies and defaults by the borrowers in payments on the underlying mortgage loans and breaches by originators and servicers of their obligations under the underlying documentation pursuant
to which the RMBS are issued. Non-agency residential mortgage loans are obligations of the borrowers thereunder only and are not typically insured or guaranteed by any other person or entity. The rate of
delinquencies and defaults on residential mortgage loans and the aggregate amount of the resulting losses will be affected by a number of factors, including general economic conditions, particularly those in the area where the related mortgaged
property is located, the level of the borrowers equity in the mortgaged property and the individual financial circumstances of the borrower. If a residential mortgage loan is in default, foreclosure on the related residential property may be a
lengthy and difficult process involving significant legal and other expenses. The net proceeds obtained by the holder on a residential mortgage loan following the foreclosure on the related property may be less than the total amount that remains due
on the loan. The prospect of incurring a loss upon the foreclosure of the related property may lead the holder of the residential mortgage loan to restructure the residential mortgage loan or otherwise delay the foreclosure process.
RMBS Legal Risks. Legal risks associated with RMBS can arise as a result of the procedures followed in
connection with the origination of the mortgage loans or the servicing thereof, which may be subject to various federal and state laws (including, without limitation, predatory lending laws), public policies and principles of equity that regulate
interest rates and other charges, require certain disclosures, require licensing of originators, prohibit discriminatory lending practices, regulate the use of consumer credit information and debt collection practices and may limit the
servicers ability to collect all or part of the principal of or interest on a residential mortgage loan, entitle the borrower to a refund of amounts previously paid by it or subject the servicer to damages and sanctions. Specifically,
provisions of federal predatory lending laws, such as the federal Truth-in-Lending Act (as supplemented by the Home Ownership and Equity Protection Act of 1994) and
Regulation Z, and various recently enacted state predatory lending laws provide that a purchaser or assignee of specified types of residential mortgage loans (including an issuer of RMBS) may be held liable for violations by the originator of such
mortgage loans. Under such assignee liability provisions, a borrower is generally given the right to assert against a purchaser of its mortgage loan any affirmative claims and defenses to payment that such borrower could assert against the
originator of the loan or, where applicable, the home improvement contractor that arranged the loan. Liability under such assignee liability provisions could, therefore, result in a disruption of cash flows allocated to the holders of RMBS where
either the issuer of such RMBS is liable for damages or is unable to enforce payment by the borrower.
In most but not all
cases, the amount recoverable against a purchaser or assignee under such assignee liability provisions is limited to amounts previously paid and still owed by the borrower. Moreover, sellers of
S-26
residential mortgage loans to an issuer of RMBS typically represent that the loans have been originated in accordance with all applicable laws and in the event such representation is breached,
the seller typically must repurchase the offending loan. Notwithstanding these protections, an issuer of RMBS may be exposed to an unquantifiable amount of potential assignee liability because, first, the amount of potential assignee liability under
certain predatory lending laws is unclear and has yet to be litigated, and, second, in the event a predatory lending law does not prohibit class action lawsuits, it is possible that an issuer of RMBS could be liable for damages for more than the
original principal amount of the offending loans held by it. In such circumstances the issuer of RMBS may be forced to seek contribution from other parties, who may no longer exist or have adequate funds available to fund such contribution.
In addition, structural and legal risks of RMBS include the possibility that, in a bankruptcy or similar proceeding involving
the originator or the servicer (often the same entity or affiliates), the assets of the issuer could be treated as never having been truly sold by the originator to the issuer and could be substantively consolidated with those of the originator, or
the transfer of such assets to the issuer could be voided as a fraudulent transfer. Challenges based on such doctrines could result also in cash flow delays and losses on the related issue of RMBS.
Mortgage Loan Market Risk. In the recent past, the residential mortgage market in the United States experienced
difficulties that adversely affected the performance and market value of certain mortgages and mortgage related securities. Delinquencies and losses on residential mortgage loans (especially sub-prime and
second lien mortgage loans) generally increased during this period and declines in or flattening of housing values in many housing markets were generally viewed as exacerbating such delinquencies and losses. Borrowers with adjustable rate mortgages
(ARMs) are more sensitive to changes in interest rates, which affect their monthly mortgage payments, and may be unable to secure replacement mortgages at comparably low interest rates.
At any one time, a portfolio of RMBS may be backed by residential mortgage loans that are highly concentrated in only a few
states or regions. As a result, the performance of such residential mortgage loans may be more susceptible to a downturn in the economy, including in particular industries that are highly represented in such states or regions, natural calamities and
other adverse conditions affecting such areas. The economic downturn experienced in the recent past at the national level, and the more serious economic downturn experienced in the recent past in certain geographic areas of the United States,
including in particular areas of the United States where rates of delinquencies and defaults on residential mortgage loans were particularly high, is generally viewed as having contributed to the higher rates of delinquencies and defaults on the
residential mortgage loans underlying RMBS during this period. There also can be no assurance that areas of the United States that mostly avoided higher rates of delinquencies and defaults on residential mortgage loans during this period would
continue to do so if an economic downturn were to reoccur at the national level.
Another factor that may contribute to,
and may in the future result in, higher delinquency and default rates is the increase in monthly payments on ARMs. Any increase in prevailing market interest rates, which are currently at historical lows, may result in increased payments for
borrowers who have ARMs. Moreover, with respect to hybrid mortgage loans (which are mortgage loans combining fixed and adjustable rate features) after their initial fixed rate period or other adjustable-rate mortgage loans, interest-only
products or products having a lower rate, and with respect to mortgage loans with a negative amortization feature which reach their negative amortization cap, borrowers may experience a substantial increase in their monthly payment even without an
increase in prevailing market interest rates. Increases in payments for borrowers may result in increased rates of delinquencies and defaults on residential mortgage loans underlying the non-agency RMBS.
As a result of rising concerns about increases in delinquencies and defaults on residential mortgage loans (particularly on sub-prime and adjustable-rate mortgage loans) and as a result of increasing concerns about the financial strength of originators and servicers and their ability to perform their obligations with respect to non-agency RMBS, there may be an adverse change in the market sentiments of investors about the market values and volatility and the degree of risk of non-agency RMBS
generally. Some or all of the underlying
S-27
residential mortgage loans in an issue of non-agency RMBS may have balloon payments due on their respective maturity dates. Balloon residential mortgage
loans involve a greater risk to a lender than fully amortizing loans, because the ability of a borrower to pay such amount will normally depend on its ability to obtain refinancing of the related mortgage loan or sell the related mortgaged property
at a price sufficient to permit the borrower to make the balloon payment, which will depend on a number of factors prevailing at the time such refinancing or sale is required, including, without limitation, the strength of the local or national
residential real estate markets, interest rates and general economic conditions and the financial condition of the borrower. If borrowers are unable to make such balloon payments, the related issue of
non-agency RMBS may experience losses.
The Trust may acquire RMBS backed by
collateral pools of mortgage loans that have been originated using underwriting standards that are less restrictive than those used in underwriting prime mortgage loans and Alt-A mortgage
loans. These lower standards include mortgage loans made to borrowers having imperfect or impaired credit histories, mortgage loans where the amount of the loan at origination is 80% or more of the value of the mortgage property, mortgage
loans made to borrowers with low credit scores, mortgage loans made to borrowers who have other debt that represents a large portion of their income and mortgage loans made to borrowers whose income is not required to be disclosed or verified and
are commonly referred to as sub-prime mortgage loans. Sub-prime mortgage loans have in recent periods experienced increased rates of delinquency,
foreclosure, bankruptcy and loss, and they are likely to continue to experience delinquency, foreclosure, bankruptcy and loss rates that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a
more traditional manner. Certain categories of RMBS, such as option ARM RMBS and sub-prime RMBS, have been referred to by the financial media as toxic assets.
Although the United States economy has been slowly improving in recent years, the impact of the novel coronavirus pandemic on
the United States economy could cause the economy to deteriorate again and the incidence of mortgage foreclosures, especially sub-prime mortgages, could begin to increase again, which could adversely affect
the value of any RMBS owned by the Trust.
CMBS Risks. CMBS are, generally, securities backed by obligations
(including certificates of participation in obligations) that are principally secured by mortgages on real property or interests therein having a multifamily or commercial use, such as regional malls, other retail space, office buildings, industrial
or warehouse properties, hotels, nursing homes and senior living centers. The market for CMBS developed more recently and, in terms of total outstanding principal amount of issues, is relatively small compared to the market for single-family RMBS.
CMBS are subject to particular risks, including lack of standardized terms, shorter maturities than residential mortgage
loans and payment of all or substantially all of the principal only at maturity rather than regular amortization of principal. Additional risks may be presented by the type and use of a particular commercial property. Special risks are presented by
hospitals, nursing homes, hospitality properties and certain other property types. Commercial property values and net operating income are subject to volatility, which may result in net operating income becoming insufficient to cover debt service on
the related mortgage loan. The repayment of loans secured by income-producing properties is typically dependent upon the successful operation of the related real estate project rather than upon the liquidation value of the underlying real estate.
Furthermore, the net operating income from and value of any commercial property is subject to various risks, including changes in general or local economic conditions and/or specific industry segments; the solvency of the related tenants; declines
in real estate values; declines in rental or occupancy rates; increases in interest rates, real estate tax rates and other operating expenses; changes in governmental rules, regulations and fiscal policies; acts of God; new and ongoing epidemics and
pandemics of infectious diseases and other global health events; natural/environmental disasters; terrorist threats and attacks and social unrest and civil disturbances. Consequently, adverse changes in economic conditions and circumstances are more
likely to have an adverse impact on MBS secured by loans on commercial properties than on those secured by loans on residential properties. In addition, commercial lending generally is viewed as exposing the lender to a greater risk of loss than one- to four- family residential lending. Commercial lending, for example, typically involves larger loans to single borrowers or
S-28
groups of related borrowers than residential one- to four- family mortgage loans. In addition, the repayment of loans secured by income producing
properties typically is dependent upon the successful operation of the related real estate project and the cash flow generated therefrom.
The exercise of remedies and successful realization of liquidation proceeds relating to CMBS is also highly dependent on the
performance of the servicer or special servicer. In many cases, overall control over the special servicing of related underlying mortgage loans will be held by a directing certificateholder or a controlling class
representative, which is appointed by the holders of the most subordinate class of CMBS in such series. The Trust may not have the right to appoint the directing certificateholder. In connection with the servicing of the specially serviced
mortgage loans, the related special servicer may, at the direction of the directing certificateholder, take actions with respect to the specially serviced mortgage loans that could adversely affect the Trusts interests. There may be a limited
number of special servicers available, particularly those that do not have conflicts of interest.
The Trust may invest in
Subordinated CMBS issued or sponsored by commercial banks, savings and loan institutions, mortgage bankers, private mortgage insurance companies and other non-governmental issuers. Subordinated CMBS have no
governmental guarantee and are subordinated in some manner as to the payment of principal and/or interest to the holders of more senior CMBS arising out of the same pool of mortgages. Subordinated CMBS are often referred to as B-Pieces. The holders of Subordinated CMBS typically are compensated with a higher stated yield than are the holders of more senior CMBS. On the other hand, Subordinated CMBS typically subject the holder
to greater risk than senior CMBS and tend to be rated in a lower rating category (frequently a substantially lower rating category) than the senior CMBS issued in respect of the same mortgage pool. Subordinated CMBS generally are likely to be more
sensitive to changes in prepayment and interest rates and the market for such securities may be less liquid than is the case for traditional income securities and senior CMBS.
CMO Risk. There are certain risks associated specifically with CMOs. CMOs are debt obligations collateralized by
mortgage loans or mortgage pass-through securities. The average life of a CMO is determined using mathematical models that incorporate prepayment assumptions and other factors that involve estimates of future economic and market conditions. Actual
future results may vary from these estimates, particularly during periods of extreme market volatility. Further, under certain market conditions, such as those that occurred during the recent downturn in the mortgage markets, the weighted average
life of certain CMOs may not accurately reflect the price volatility of such securities. For example, in periods of supply and demand imbalances in the market for such securities and/or in periods of sharp interest rate movements, the prices of CMOs
may fluctuate to a greater extent than would be expected from interest rate movements alone. CMOs issued by private entities are not obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities and are not guaranteed by
any government agency, although the securities underlying a CMO may be subject to a guarantee. Therefore, if the collateral securing the CMO, as well as any third party credit support or guarantees, is insufficient to make payments when due, the
holder could sustain a loss.
Inverse floating rate CMOs are typically more volatile than fixed or floating rate tranches
of CMOs. Many inverse floating rate CMOs have coupons that move inversely to a multiple of an index. The effect of the coupon varying inversely to a multiple of an applicable index creates a leverage factor. Inverse floaters based on multiples of a
stated index are designed to be highly sensitive to changes in interest rates and can subject the holders thereof to extreme reductions of yield and loss of principal. The market for inverse floating rate CMOs with highly leveraged characteristics
at times may be very thin. The Trusts ability to dispose of its positions in such securities will depend on the degree of liquidity in the markets for such securities. It is impossible to predict the amount of trading interest that may exist
in such securities, and therefore the future degree of liquidity.
The Trust may also invest in REMICs, which are CMOs
that qualify for special tax treatment under the Code and invest in certain mortgages principally secured by interests in real property and other permitted investments.
S-29
Credit Risk Associated With Originators and Servicers of Mortgage
Loans. A number of originators and servicers of residential and commercial mortgage loans, including some of the largest originators and servicers in the residential and commercial mortgage loan market, have experienced serious financial
difficulties, including some that are now or were subject to federal insolvency proceedings. These difficulties have resulted from many factors, including increased competition among originators for borrowers, decreased originations by such
originators of mortgage loans and increased delinquencies and defaults on such mortgage loans, as well as from increases in claims for repurchases of mortgage loans previously sold by them under agreements that require repurchase in the event of
breaches of representations regarding loan quality and characteristics. Such difficulties may affect the performance of MBS backed by mortgage loans. Furthermore, the inability of the originator to repurchase such mortgage loans in the event of loan
representation breaches or the servicer to repurchase such mortgage loans upon a breach of its servicing obligations also may affect the performance of related MBS. Delinquencies and losses on, and, in some cases, claims for repurchase by the
originator of, mortgage loans originated by some mortgage lenders have recently increased as a result of inadequate underwriting procedures and policies, including inadequate due diligence, failure to comply with predatory and other lending laws
and, particularly in the case of any no documentation or limited documentation mortgage loans that may support non-agency RMBS, inadequate verification of income and employment history.
Delinquencies and losses on, and claims for repurchase of, mortgage loans originated by some mortgage lenders have also resulted from fraudulent activities of borrowers, lenders, appraisers, and other residential mortgage industry participants such
as mortgage brokers, including misstatements of income and employment history, identity theft and overstatements of the appraised value of mortgaged properties. Many of these originators and servicers are very highly leveraged. These difficulties
may also increase the chances that these entities may default on their warehousing or other credit lines or become insolvent or bankrupt and thereby increase the likelihood that repurchase obligations will not be fulfilled and the potential for loss
to holders of non-agency MBS and subordinated security holders.
The servicers of non-agency MBS are often the same entities as, or affiliates of, the originators of these mortgage loans. Accordingly, the financial risks relating to originators of MBS described immediately above also may affect
the servicing of MBS. In the case of such servicers, and other servicers, financial difficulties may have a negative effect on the ability of servicers to pursue collection on mortgage loans that are experiencing increased delinquencies and defaults
and to maximize recoveries on sale of underlying properties following foreclosure. In recent years, a number of lenders specializing in residential mortgages have sought bankruptcy protection, shut down or been refused further financings from their
lenders.
MBS typically provide that the servicer is required to make advances in respect of delinquent mortgage loans.
However, servicers experiencing financial difficulties may not be able to perform these obligations or obligations that they may have to other parties of transactions involving these securities. Like originators, these entities are typically very
highly leveraged. Such difficulties may cause servicers to default under their financing arrangements. In certain cases, such entities may be forced to seek bankruptcy protection. Due to the application of the provisions of bankruptcy law, servicers
who have sought bankruptcy protection may not be required to advance such amounts. Even if a servicer were able to advance amounts in respect of delinquent mortgage loans, its obligation to make such advances may be limited to the extent that it
does not expect to recover such advances due to the deteriorating credit of the delinquent mortgage loans or declining value of the related mortgaged properties. Moreover, servicers may overadvance against a particular mortgage loan or charge too
many costs of resolution or foreclosure of a mortgage loan to a securitization, which could increase the potential losses to holders of MBS. In such transactions, a servicers obligation to make such advances may also be limited to the amount
of its servicing fee. In addition, if an issue of MBS provides for interest on advances made by the servicer, in the event that foreclosure proceeds or payments by borrowers are not sufficient to cover such interest, such interest will be paid to
the servicer from available collections or other mortgage income, thereby reducing distributions made on the MBS and, in the case of senior-subordinated MBS described below, first from distributions that would otherwise be made on the most
subordinated MBS of such issue. Any such financial difficulties may increase the possibility of a servicer termination and the need for a transfer of servicing and any such liabilities or inability to assess such liabilities may increase the
difficulties and costs in affecting such transfer and the potential loss, through the allocation of such increased cost of such transfer, to subordinated security holders.
S-30
There can be no assurance that originators and servicers of mortgage loans will
not continue to experience serious financial difficulties or experience such difficulties in the future, including becoming subject to bankruptcy or insolvency proceedings, or that underwriting procedures and policies and protections against fraud
will be sufficient in the future to prevent such financial difficulties or significant levels of default or delinquency on mortgage loans. Because the recent financial difficulties experienced by such originators and servicers is unprecedented and
unpredictable, the past performance of the residential and commercial mortgage loans originated and serviced by them (and the corresponding performance of the related MBS) is not a reliable indicator of the future performance of such residential
mortgage loans (or the related MBS).
In some cases, servicers of MBS have been the subject of legal proceedings involving
the origination and/or servicing practices of such servicers. Large groups of private litigants and states attorneys general have brought such proceedings. Because of the large volume of mortgage loans originated and serviced by such
servicers, such litigation can cause heightened financial strain on servicers. In other cases, origination and servicing practices may cause or contribute to such strain, because of representation and warranty repurchase liability arising in MBS and
mortgage loan sale transactions. Any such financial strain could cause servicers to service below required standards, causing delinquencies and losses in any related MBS transaction to rise, and in extreme cases could cause the servicer to seek the
protection of any applicable bankruptcy or insolvency law. In any such proceeding, it is unclear whether the fees that the servicer charges in such transactions would be sufficient to permit that servicer or a successor servicer to service the
mortgage loans in such transaction adequately. If such fees had to be increased, it is likely that the most subordinated security holders in such transactions would be effectively required to pay such increased fees. Finally, these entities may be
the subject of future laws designed to protect consumers from defaulting on their mortgage loans. Such laws may have an adverse effect on the cash flows paid under such MBS.
In addition, certain lenders who service and/or issue MBS have recently announced that they are being investigated by or have
received information requests from U.S. federal and/or state authorities, including the SEC. As a result of such investigations and other similar investigations and general concerns about the adequacy or accuracy of disclosure of risks to borrowers
and their understanding of such risks, U.S. financial regulators have recently indicated that they may propose new guidelines for the mortgage industry. Guidelines, if introduced, together with the other factors described herein, may make it more
difficult for borrowers with weaker credit to refinance, which may lead to further increases in delinquencies, extensions in duration and losses in mortgage related assets.
Additional Risks of Mortgage Related Securities. Additional risks associated with investments in MBS include:
Interest Rate Risk. In addition to the interest rate risks described above, certain MBS may be subject to
additional risks as the rate of interest payable on certain MBS may be set or effectively capped at the weighted average net coupon of the underlying mortgage loans themselves, often referred to as an available funds cap. As a result of
this cap, the return to the holder of such MBS is dependent on the relative timing and rate of delinquencies and prepayments of mortgage loans bearing a higher rate of interest. In general, early prepayments will have a greater negative impact on
the yield to the holder of such MBS.
Structural Risk. Because MBS generally are ownership or participation
interests in pools of mortgage loans secured by a pool of properties underlying the mortgage loan pool, the MBS are entitled to payments provided for in the underlying agreement only when and if funds are generated by the underlying mortgage loan
pool. This likelihood of the return of interest and principal may be assessed as a credit matter. However, the holders of MBS do not have the legal status of secured creditors, and cannot accelerate a claim for payment on their securities, or force
a sale of the mortgage loan pool in the event that insufficient funds exist to pay such amounts on any date designated for such payment. The holders of MBS do not typically have any right to remove a servicer solely as a result of a failure of the
mortgage pool to perform as expected.
S-31
Subordination Risk. MBS may be subordinated to one or more other
senior classes of securities of the same series for purposes of, among other things, offsetting losses and other shortfalls with respect to the related underlying mortgage loans. For example, in the case of certain MBS, no distributions of principal
will generally be made with respect to any class until the aggregate principal balances of the corresponding senior classes of securities have been reduced to zero. As a result, MBS may be more sensitive to risk of loss, writedowns, the non-fulfillment of repurchase obligations, overadvancing on a pool of loans and the costs of transferring servicing than senior classes of securities.
Prepayment, Extension and Redemption Risks. MBS may reflect an interest in monthly payments made by the
borrowers who receive the underlying mortgage loans. Although the underlying mortgage loans are for specified periods of time, such as 20 or 30 years, the borrowers can, and historically have paid them off sooner. When a prepayment happens, a
portion of the MBS which represents an interest in the underlying mortgage loan will be prepaid. A borrower is more likely to prepay a mortgage which bears a relatively high rate of interest. This means that in times of declining interest rates, a
portion of the Trusts higher yielding securities are likely to be redeemed and the Trust will probably be unable to replace them with securities having as great a yield. In addition to reductions in the level of market interest rates and the
prepayment provisions of the mortgage loans, repayments on the residential mortgage loans underlying an issue of RMBS may also be affected by a variety of economic, geographic and other factors, including the size difference between the interest
rates on the underlying residential mortgage loans (giving consideration to the cost of refinancing) and prevailing mortgage rates and the availability of refinancing. Prepayments can result in lower yields to shareholders. The increased likelihood
of prepayment when interest rates decline also limits market price appreciation of MBS. This is known as prepayment risk.
Except in the case of certain types of RMBS, the mortgage loans underlying RMBS generally do not contain prepayment penalties
and a reduction in market interest rates will increase the likelihood of prepayments on the related RMBS. In the case of certain home equity loan securities and certain types of RMBS, even though the underlying mortgage loans often contain
prepayment premiums, such prepayment premiums may not be sufficient to discourage borrowers from prepaying their mortgage loans in the event of a reduction in market interest rates, resulting in a reduction in the yield to maturity for holders of
the related RMBS. RMBS typically contain provisions that require repurchase of mortgage loans by the originator or other seller in the event of a breach of a representation or warranty regarding loan quality and characteristics of such loan. Any
repurchase of a mortgage loan as a result of a breach has the same effect on the yield received on the related issue of RMBS as a prepayment of such mortgage loan. Any increase in breaches of representations and the consequent repurchases of
mortgage loans that result from inadequate underwriting procedures and policies and protections against fraud will have the same effect on the yield on the related RMBS as an increase in prepayment rates.
Risk of prepayment may be reduced for commercial real estate property loans containing significant prepayment penalties or
prohibitions on principal payments for a period of time following origination.
MBS also are subject to extension risk.
Extension risk is the possibility that rising interest rates may cause prepayments to occur at a slower than expected rate. This particular risk may effectively change a security which was considered short or intermediate term into a long-term
security. The values of long-term securities generally fluctuate more widely in response to changes in interest rates than short or intermediate-term securities.
In addition, MBS may be subject to redemption at the option of the issuer. If a MBS held by the Trust is called for
redemption, the Trust will be required to permit the issuer to redeem or pay-off the security, which could have an adverse effect on the Trusts ability to achieve its investment objectives.
Spread Widening Risk. The prices of MBS may decline substantially, for reasons that may not be attributable
to any of the other risks described in the prospectus and this SAI. In particular, purchasing assets at what may appear to be undervalued levels is no guarantee that these assets will not be trading at even more undervalued
levels at a time of valuation or at the time of sale. It may not be possible to predict, or to protect against, such spread widening risk.
S-32
Illiquidity Risk. The liquidity of MBS varies by type of security;
at certain times the Trust may encounter difficulty in disposing of such investments. Because MBS have the potential to be less liquid than other securities, the Trust may be more susceptible to illiquidity risk than funds that invest in other
securities. In the past, in stressed markets, certain types of MBS suffered periods of illiquidity when disfavored by the market. Due to increased instability in the credit markets, the market for some MBS has experienced reduced liquidity and
greater volatility with respect to the value of such securities, making it more difficult to value such securities.
Asset-Backed Securities Risk
ABS involve certain risks in addition to those presented by MBS. There is the possibility that recoveries on the
underlying collateral may not, in some cases, be available to support payments on these securities. Relative to MBS, ABS may provide the Trust with a less effective security interest in the underlying collateral and are more dependent on the
borrowers ability to pay. If many borrowers on the underlying loans default, losses could exceed the credit enhancement level and result in losses to investors in an ABS transaction. Finally, ABS have structure risk due to a unique
characteristic known as early amortization, or early payout, risk. Built into the structure of most ABS are triggers for early payout, designed to protect investors from losses. These triggers are unique to each transaction and can include a
significant rise in defaults on the underlying loans, a sharp drop in the credit enhancement level or the bankruptcy of the originator. Once early amortization begins, all incoming loan payments (after expenses are paid) are used to pay investors as
quickly as possible based upon a predetermined priority of payment.
The collateral underlying ABS may constitute assets
related to a wide range of industries and sectors, such as credit card and automobile receivables. Credit card receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws,
many of which give debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. The Credit CARD Act of 2009 imposes new regulations on the ability of credit card issuers to adjust the interest rates and
exercise various other rights with respect to indebtedness extended through credit cards. The Trust and the Advisor cannot predict what effect, if any, such regulations might have on the market for ABS and such regulations may adversely affect the
value of ABS owned by the Trust. Most issuers of automobile receivables permit the servicers to retain possession of the underlying obligations. If the servicer were to sell these obligations to another party, there is a risk that the purchaser
would acquire an interest superior to that of the holders of the related automobile receivables. In addition, because of the large number of vehicles involved in a typical issuance and technical requirements under state laws, the trustee for the
holders of the automobile receivables may not have an effective security interest in all of the obligations backing such receivables. If the economy of the United States deteriorates, defaults on securities backed by credit card, automobile and
other receivables may increase, which may adversely affect the value of any ABS owned by Trust. There is the possibility that recoveries on the underlying collateral may not, in some cases, be available to support payments on these securities. In
the past, certain automobile manufacturers have been granted access to emergency loans from the U.S. Government and have experienced bankruptcy. These events may adversely affect the value of securities backed by receivables from the sale or lease
of automobiles.
Some ABS, particularly home equity loan transactions, are subject to interest rate risk and prepayment
risk. A change in interest rates can affect the pace of payments on the underlying loans, which in turn, affects total return on the securities.
Zero
Coupon Securities Risk
Zero coupon securities are securities that are sold at a discount to par value and do not pay
interest during the life of the security. The discount approximates the total amount of interest the security will accrue and compound over the period until maturity at a rate of interest reflecting the market rate of the security at the time of
issuance. Upon maturity, the holder of a zero coupon security is entitled to receive the par value of the security.
S-33
While interest payments are not made on zero coupon securities, holders of such
securities are deemed to have received income (phantom income) annually, notwithstanding that cash may not be received currently. The effect of owning instruments that do not make current interest payments is that a fixed yield is earned
not only on the original investment but also, in effect, on all discount accretion during the life of the obligations. This implicit reinvestment of earnings at a fixed rate eliminates the risk of being unable to invest distributions at a rate as
high as the implicit yield on the zero coupon security, but at the same time eliminates the holders ability to reinvest at higher rates in the future. For this reason, some of these securities may be subject to substantially greater price
fluctuations during periods of changing market interest rates than are comparable securities that pay interest currently. Longer term zero coupon securities are more exposed to interest rate risk than shorter term zero coupon securities. These
investments benefit the issuer by mitigating its need for cash to meet debt service, but also require a higher rate of return to attract investors who are willing to defer receipt of cash.
The Trust accrues income with respect to these securities for U.S. federal income tax and accounting purposes prior to the
receipt of cash payments. Zero coupon securities may be subject to greater fluctuation in value and less liquidity in the event of adverse market conditions than comparably rated securities that pay cash interest at regular intervals.
Further, to maintain its qualification for pass-through treatment under the U.S. federal income tax laws, the Trust is
required to distribute income to its shareholders and, consequently, may have to dispose of other, more liquid portfolio securities under disadvantageous circumstances or may have to leverage itself by borrowing in order to generate the cash to
satisfy these distributions. The required distributions may result in an increase in the Trusts exposure to zero coupon securities.
In addition to the risks described herein, there are certain other risks related to investing in zero coupon securities.
During a period of severe market conditions, the market for such securities may become even less liquid. In addition, as these securities do not pay cash interest, the Trusts investment exposure to these securities and their risks, including
credit risk, will increase during the time these securities are held in the Trusts portfolio.
Pay-in-Kind Bonds Risk
The Trust may invest in PIK bonds. PIK bonds are bonds
which pay interest through the issuance of additional debt or equity securities. Similar to zero coupon obligations, PIK bonds also carry additional risk as holders of these types of securities realize no cash until the cash payment date unless a
portion of such securities is sold and, if the issuer defaults, the Trust may obtain no return at all on its investment. The market price of PIK bonds is affected by interest rate changes to a greater extent, and therefore tends to be more volatile,
than that of securities which pay interest in cash. Additionally, current U.S. federal income tax law requires the holder of certain PIK bonds to accrue income with respect to these securities prior to the receipt of cash payments. To maintain its
qualification as a RIC and avoid liability for U.S. federal income and excise taxes, the Trust may be required to distribute income accrued with respect to these securities and may have to dispose of portfolio securities under disadvantageous
circumstances in order to generate cash to satisfy these distribution requirements.
Sovereign Government and Supranational Debt Risk
Investments in sovereign debt involve special risks. Foreign governmental issuers of debt or the governmental authorities that
control the repayment of the debt may be unable or unwilling to repay principal or pay interest when due. In the event of default, there may be limited or no legal recourse in that, generally, remedies for defaults must be pursued in the courts of
the defaulting party. Political conditions, especially a sovereign entitys willingness to meet the terms of its debt obligations, are of considerable significance. The ability of a foreign sovereign issuer, especially an emerging market
country, to make timely payments on its debt obligations will also be strongly influenced by the sovereign issuers balance of payments, including export
S-34
performance, its access to international credit facilities and investments, fluctuations of interest rates and the extent of its foreign reserves. The cost of servicing external debt will also
generally be adversely affected by rising international interest rates, as many external debt obligations bear interest at rates which are adjusted based upon international interest rates. Also, there can be no assurance that the holders of
commercial bank loans to the same sovereign entity may not contest payments to the holders of sovereign debt in the event of default under commercial bank loan agreements. In addition, there is no bankruptcy proceeding with respect to sovereign debt
on which a sovereign has defaulted and the Trust may be unable to collect all or any part of its investment in a particular issue. Foreign investment in certain sovereign debt is restricted or controlled to varying degrees, including requiring
governmental approval for the repatriation of income, capital or proceeds of sales by foreign investors. These restrictions or controls may at times limit or preclude foreign investment in certain sovereign debt and increase the costs and expenses
of the Trust.
Risk Factors in Strategic Transactions and Derivatives
The Trusts use of derivative instruments involves risks different from, and possibly greater than, the risks associated
with investing directly in securities and other traditional investments. Derivatives are subject to a number of risks such as credit risk, leverage risk, illiquidity risk, correlation risk and index risk as described below:
|
|
|
Credit Riskthe risk that the counterparty in a derivative transaction will be unable to honor its
financial obligation to the Trust, or the risk that the reference entity in a derivative will not be able to honor its financial obligations. In particular, derivatives traded in OTC markets often are not guaranteed by an exchange or clearing
corporation and often do not require payment of margin, and to the extent that the Trust has unrealized gains in such instruments or has deposited collateral with its counterparties the Trust is at risk that its counterparties will become bankrupt
or otherwise fail to honor their obligations. |
|
|
|
Currency Riskthe risk that changes in the exchange rate between two currencies will adversely
affect the value (in U.S. dollar terms) of an investment. |
|
|
|
Leverage Riskthe risk associated with certain types of investments or trading strategies (such
as, for example, borrowing money to increase the amount of investments) that relatively small market movements may result in large changes in the value of an investment. Certain transactions in derivatives (such as futures transactions or sales of
put options) involve substantial leverage risk and may expose the Trust to potential losses that exceed the amount originally invested by the Trust. When the Trust engages in such a transaction, the Trust will deposit in a segregated account, or
earmark on its books and records, liquid assets with a value at least equal to the Trusts exposure, on a mark-to-market basis, to the transaction (as calculated
pursuant to requirements of the SEC). Such segregation or earmarking will ensure that the Trust has assets available to satisfy its obligations with respect to the transaction, but will not limit the Trusts exposure to loss.
|
|
|
|
Illiquidity Riskthe risk that certain securities may be difficult or impossible to sell at the
time that the Trust would like or at the price that the Trust as seller believes the security is currently worth. There can be no assurance that, at any specific time, either a liquid secondary market will exist for a derivative or the Trust will
otherwise be able to sell such instrument at an acceptable price. It may, therefore, not be possible to close a position in a derivative without incurring substantial losses, if at all. The absence of liquidity may also make it more difficult for
the Trust to ascertain a market value for such instruments. Although both OTC and exchange-traded derivatives markets may experience a lack of liquidity, certain derivatives traded in OTC markets, including swaps and OTC options, involve substantial
illiquidity risk. The illiquidity of the derivatives markets may be due to various factors, including congestion, disorderly markets, limitations on deliverable supplies, the participation of speculators, government regulation and intervention, and
technical and operational or system failures. In addition, the liquidity of a secondary market in an exchange-traded derivative contract may be adversely affected by daily price fluctuation limits established by the exchanges which limit
the |
S-35
|
amount of fluctuation in an exchange-traded contract price during a single trading day. Once the daily limit has been reached in the contract, no trades may be entered into at a price beyond the
limit, thus preventing the liquidation of open positions. Prices have in the past moved beyond the daily limit on a number of consecutive trading days. If it is not possible to close an open derivative position entered into by the Trust, the Trust
would continue to be required to make daily cash payments of variation margin in the event of adverse price movements. In such a situation, if the Trust has insufficient cash, it may have to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. |
|
|
|
Correlation Riskthe risk that changes in the value of a derivative will not match the changes in
the value of the portfolio holdings that are being hedged or of the particular market or security to which the Trust seeks exposure through the use of the derivative. There are a number of factors which may prevent a derivative instrument from
achieving the desired correlation (or inverse correlation) with an underlying asset, rate or index, such as the impact of fees, expenses and transaction costs, the timing of pricing, and disruptions or illiquidity in the markets for such derivative
instrument. |
|
|
|
Index RiskIf the derivative is linked to the performance of an index, it will be subject to the
risks associated with changes in that index. If the index changes, the Trust could receive lower interest payments or experience a reduction in the value of the derivative to below the price that the Trust paid for such derivative.
|
|
|
|
Volatility Riskthe risk that the Trusts use of derivatives may reduce income or gain and/or
increase volatility. Volatility is defined as the characteristic of a security, an index or a market to fluctuate significantly in price over a defined time period. The Trust could suffer losses related to its derivative positions as a result of
unanticipated market movements, which losses are potentially unlimited. |
When a derivative is used as a
hedge against a position that the Trust holds, any loss generated by the derivative generally should be substantially offset by gains on the hedged investment, and vice versa. While hedging can reduce or eliminate losses, it can also reduce or
eliminate gains. Hedges are sometimes subject to imperfect matching between the derivative and the underlying security, and there can be no assurance that the Trusts hedging transactions will be effective. The Trust could also suffer losses
related to its derivative positions as a result of unanticipated market movements, which losses are potentially unlimited. The Advisor may not be able to predict correctly the direction of securities prices, interest rates and other economic
factors, which could cause the Trusts derivatives positions to lose value. In addition, some derivatives are more sensitive to interest rate changes and market price fluctuations than other securities. The possible lack of a liquid secondary
market for derivatives and the resulting inability of the Trust to sell or otherwise close a derivatives position could expose the Trust to losses and could make derivatives more difficult for the Trust to value accurately.
When engaging in a hedging transaction, the Trust may determine not to seek to establish a perfect correlation between the
hedging instruments utilized and the portfolio holdings being hedged. Such an imperfect correlation may prevent the Trust from achieving the intended hedge or expose the Trust to a risk of loss. The Trust may also determine not to hedge against a
particular risk because it does not regard the probability of the risk occurring to be sufficiently high as to justify the cost of the hedge or because it does do not foresee the occurrence of the risk. It may not be possible for the Trust to hedge
against a change or event at attractive prices or at a price sufficient to protect the assets of the Trust from the decline in value of the portfolio positions anticipated as a result of such change. The Trust may also be restricted in its ability
to effectively manage the portion of its assets that are segregated or earmarked to cover its obligations. In addition, it may not be possible to hedge at all against certain risks.
If the Trust invests in a derivative instrument it could lose more than the principal amount invested. Moreover, derivatives
raise certain tax, legal, regulatory and accounting issues that may not be presented by investments in securities, and there is some risk that certain issues could be resolved in a manner that could adversely impact the performance of the Trust.
S-36
The Trust is not required to use derivatives or other portfolio strategies to
seek to increase return or to seek to hedge its portfolio and may choose not to do so. Also, suitable derivative transactions may not be available in all circumstances and there can be no assurance that the Trust will engage in these transactions to
reduce exposure to other risks when that would be beneficial. Although the Advisor seeks to use derivatives to further the Trusts investment objectives, there is no assurance that the use of derivatives will achieve this result.
Options Risk. There are several risks associated with transactions in options on securities and indexes. For example,
there are significant differences between the securities and options markets that could result in an imperfect correlation between these markets, causing a given transaction not to achieve its objectives. In addition, a liquid secondary market for
particular options, whether traded OTC or on a recognized securities exchange (e.g., NYSE), separate trading boards of a securities exchange or through a market system that provides contemporaneous transaction pricing information (an
Exchange) may be absent for reasons which include the following: there may be insufficient trading interest in certain options; restrictions may be imposed by an Exchange on opening transactions or closing transactions or both; trading
halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities; unusual or unforeseen circumstances may interrupt normal operations on an Exchange; the facilities of an
Exchange or the OCC may not at all times be adequate to handle current trading volume; or one or more Exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular
class or series of options), in which event the secondary market on that Exchange (or in that class or series of options) would cease to exist, although outstanding options that had been issued by the OCC as a result of trades on that Exchange would
continue to be exercisable in accordance with their terms.
Futures Transactions and Options Risk. The primary
risks associated with the use of futures contracts and options are (a) the imperfect correlation between the change in market value of the instruments held by the Trust and the price of the futures contract or option; (b) possible lack of
a liquid secondary market for a futures contract and the resulting inability to close a futures contract when desired; (c) losses caused by unanticipated market movements, which are potentially unlimited; (d) the Advisors inability
to predict correctly the direction of securities prices, interest rates, currency exchange rates and other economic factors; and (e) the possibility that the counterparty will default in the performance of its obligations.
Investment in futures contracts involves the risk of imperfect correlation between movements in the price of the futures
contract and the price of the security being hedged. The hedge will not be fully effective when there is imperfect correlation between the movements in the prices of two financial instruments. For example, if the price of the futures contract moves
more or less than the price of the hedged security, the Trust will experience either a loss or gain on the futures contract which is not completely offset by movements in the price of the hedged securities. To compensate for imperfect correlations,
the Trust may purchase or sell futures contracts in a greater dollar amount than the hedged securities if the volatility of the hedged securities is historically greater than the volatility of the futures contracts. Conversely, the Trust may
purchase or sell fewer futures contracts if the volatility of the price of the hedged securities is historically lower than that of the futures contracts.
The particular securities comprising the index underlying a securities index financial futures contract may vary from the
securities held by the Trust. As a result, the Trusts ability to hedge effectively all or a portion of the value of its securities through the use of such financial futures contracts will depend in part on the degree to which price movements
in the index underlying the financial futures contract correlate with the price movements of the securities held by the Trust. The correlation may be affected by disparities in the average maturity, ratings, geographical mix or structure of the
Trusts investments as compared to those comprising the securities index and general economic or political factors. In addition, the correlation between movements in the value of the securities index may be subject to change over time as
additions to and deletions from the securities index alter its structure. The correlation between futures contracts on U.S. Government securities and the securities held by the Trust may be adversely affected by similar factors and the risk of
imperfect correlation between movements in the prices of such futures contracts and the prices of securities held by the Trust may be greater. The trading of futures contracts also is subject to certain market risks, such as inadequate trading
activity, which could at times make it difficult or impossible to liquidate existing positions.
S-37
The Trust may liquidate futures contracts it enters into through offsetting
transactions on the applicable contract market. There can be no assurance, however, that a liquid secondary market will exist for any particular futures contract at any specific time. Thus, it may not be possible to close out a futures position. In
the event of adverse price movements, the Trust would continue to be required to make daily cash payments of variation margin. In such situations, if the Trust has insufficient cash, it may be required to sell portfolio securities to meet daily
variation margin requirements at a time when it may be disadvantageous to do so. The inability to close out futures positions also could have an adverse impact on the Trusts ability to hedge effectively its investments in securities. The
liquidity of a secondary market in a futures contract may be adversely affected by daily price fluctuation limits established by commodity exchanges which limit the amount of fluctuation in a futures contract price during a single
trading day. Once the daily limit has been reached in the contract, no trades may be entered into at a price beyond the limit, thus preventing the liquidation of open futures positions. Prices have in the past moved beyond the daily limit on a
number of consecutive trading days.
The successful use of transactions in futures and related options also depends on the
ability of the Advisor to forecast correctly the direction and extent of interest rate movements within a given time frame. To the extent interest rates remain stable during the period in which a futures contract or option is held by the Trust or
such rates move in a direction opposite to that anticipated, the Trust may realize a loss on the Strategic Transaction which is not fully or partially offset by an increase in the value of portfolio securities. As a result, the Trusts total
return for such period may be less than if it had not engaged in the Strategic Transaction.
Because of low initial margin
deposits made upon the opening of a futures position, futures transactions involve substantial leverage. As a result, relatively small movements in the price of the futures contracts can result in substantial unrealized gains or losses. There is
also the risk of loss by the Trust of margin deposits in the event of bankruptcy of a broker with which the Trust has an open position in a financial futures contract. Because the Trust will engage in the purchase and sale of futures contracts for
hedging purposes or to seek to enhance the Trusts return, any losses incurred in connection therewith may, if the strategy is successful, be offset in whole or in part by increases in the value of securities held by the Trust or decreases in
the price of securities the Trust intends to acquire.
The amount of risk the Trust assumes when it purchases an option on
a futures contract is the premium paid for the option plus related transaction costs. In addition to the correlation risks discussed above, the purchase of an option on a futures contract also entails the risk that changes in the value of the
underlying futures contract will not be fully reflected in the value of the option purchased.
General Risk Factors in
Hedging Foreign Currency. Hedging transactions involving Currency Instruments involve substantial risks, including correlation risk. While the Trusts use of Currency Instruments to effect hedging strategies is intended to reduce the
volatility of the NAV of the Trusts common shares, the NAV of the Trusts common shares will fluctuate. Moreover, although Currency Instruments may be used with the intention of hedging against adverse currency movements, transactions in
Currency Instruments involve the risk that anticipated currency movements will not be accurately predicted and that the Trusts hedging strategies will be ineffective. To the extent that the Trust hedges against anticipated currency movements
that do not occur, the Trust may realize losses and decrease its total return as the result of its hedging transactions. Furthermore, the Trust will only engage in hedging activities from time to time and may not be engaging in hedging activities
when movements in currency exchange rates occur.
It may not be possible for the Trust to hedge against currency exchange
rate movements, even if correctly anticipated, in the event that (i) the currency exchange rate movement is so generally anticipated that the Trust is not able to enter into a hedging transaction at an effective price, or (ii) the currency
exchange rate movement relates to a market with respect to which Currency Instruments are not available and it is not possible to engage in effective foreign currency hedging. The cost to the Trust of engaging in foreign currency transactions varies
with such factors as the currencies involved, the length of the contract period and the market conditions then prevailing. Since transactions in foreign currency exchange usually are conducted on a principal basis, no fees or commissions are
involved.
S-38
Foreign Currency Forwards Risk. Forward foreign currency exchange
contracts do not eliminate fluctuations in the value of Non-U.S. Securities (as defined in the prospectus) but rather allow the Trust to establish a fixed rate of exchange for a future point in time. This
strategy can have the effect of reducing returns and minimizing opportunities for gain.
In connection with its trading in
forward foreign currency contracts, the Trust will contract with a foreign or domestic bank, or foreign or domestic securities dealer, to make or take future delivery of a specified amount of a particular currency. There are no limitations on daily
price moves in such forward contracts, and banks and dealers are not required to continue to make markets in such contracts. There have been periods during which certain banks or dealers have refused to quote prices for such forward contracts or
have quoted prices with an unusually wide spread between the price at which the bank or dealer is prepared to buy and that at which it is prepared to sell. Governmental imposition of credit controls might limit any such forward contract trading.
With respect to its trading of forward contracts, if any, the Trust will be subject to the risk of bank or dealer failure and the inability of, or refusal by, a bank or dealer to perform with respect to such contracts. Any such default would deprive
the Trust of any profit potential or force the Trust to cover its commitments for resale, if any, at the then market price and could result in a loss to the Trust.
The Trust may also engage in proxy hedging transactions to reduce the effect of currency fluctuations on the value of existing
or anticipated holdings of portfolio securities. Proxy hedging is often used when the currency to which the Trust is exposed is difficult to hedge or to hedge against the dollar. Proxy hedging entails entering into a forward contract to sell a
currency whose changes in value are generally considered to be linked to a currency or currencies in which some or all of the Trusts securities are, or are expected to be, denominated, and to buy U.S. dollars. Proxy hedging involves some of
the same risks and considerations as other transactions with similar instruments. Currency transactions can result in losses to the Trust if the currency being hedged fluctuates in value to a degree or in a direction that is not anticipated. In
addition, there is the risk that the perceived linkage between various currencies may not be present or may not be present during the particular time that the Trust is engaging in proxy hedging. The Trust may also cross-hedge currencies by entering
into forward contracts to sell one or more currencies that are expected to decline in value relative to other currencies to which the Trust has or in which the Trust expects to have portfolio exposure. For example, the Trust may hold both Canadian
government bonds and Japanese government bonds, and the Advisor may believe that Canadian dollars will deteriorate against Japanese yen. The Trust would sell Canadian dollars to reduce its exposure to that currency and buy Japanese yen. This
strategy would be a hedge against a decline in the value of Canadian dollars, although it would expose the Trust to declines in the value of the Japanese yen relative to the U.S. dollar.
Some of the forward non-U.S. currency contracts entered into by the Trust may be
classified as non-deliverable forwards (NDFs). NDFs are cash-settled, short-term forward contracts that may be thinly traded or are denominated in
non-convertible foreign currency, where the profit or loss at the time at the settlement date is calculated by taking the difference between the agreed upon exchange rate and the spot rate at the time of
settlement, for an agreed upon notional amount of funds. All NDFs have a fixing date and a settlement date. The fixing date is the date at which the difference between the prevailing market exchange rate and the agreed upon exchange rate is
calculated. The settlement date is the date by which the payment of the difference is due to the party receiving payment. NDFs are commonly quoted for time periods of one month up to two years, and are normally quoted and settled in U.S. dollars.
They are often used to gain exposure to and/or hedge exposure to foreign currencies that are not internationally traded.
Currency Futures Risk. The Trust may also seek to hedge against the decline in the value of a currency or to enhance
returns through use of currency futures or options thereon. Currency futures are similar to forward foreign exchange transactions except that futures are standardized, exchange-traded contracts while forward foreign exchange transactions are traded
in the OTC market. Currency futures involve substantial currency risk, and also involve leverage risk.
Currency
Options Risk. The Trust may also seek to hedge against the decline in the value of a currency or to enhance returns through the use of currency options. Currency options are similar to options on securities. For
S-39
example, in consideration for an option premium the writer of a currency option is obligated to sell (in the case of a call option) or purchase (in the case of a put option) a specified amount of
a specified currency on or before the expiration date for a specified amount of another currency. The Trust may engage in transactions in options on currencies either on exchanges or OTC markets. Currency options involve substantial currency risk,
and may also involve credit, leverage or illiquidity risk.
Currency Swaps Risk. The Trust may enter into currency
swaps. Currency swaps involve the exchange of the rights of the Trust and another party to make or receive payments in specified currencies. The Trust may also hedge portfolio positions through currency swaps, which are transactions in which one
currency is simultaneously bought for a second currency on a spot basis and sold for the second currency on a forward basis. Currency swaps usually involve the delivery of the entire principal value of one designated currency in exchange for the
other designated currency. Because currency swaps usually involve the delivery of the entire principal value of one designated currency in exchange for the other designated currency, the entire principal value of a currency swap is subject to the
risk that the other party to the swap will default on its contractual delivery obligations.
Over-the-Counter Trading Risk. The derivative instruments that may be purchased or sold by the Trust may include instruments not traded on an exchange. The risk of
nonperformance by the counterparty to an instrument may be greater than, and the ease with which the Trust can dispose of or enter into closing transactions with respect to an instrument may be less than, the risk associated with an exchange traded
instrument. In addition, significant disparities may exist between bid and asked prices for derivative instruments that are not traded on an exchange. The absence of liquidity may make it difficult or impossible for the Trust
to sell such instruments promptly at an acceptable price. Derivative instruments not traded on exchanges also are not subject to the same type of government regulation as exchange traded instruments, and many of the protections afforded to
participants in a regulated environment may not be available in connection with the transactions. Because derivatives traded in OTC markets generally are not guaranteed by an exchange or clearing corporation and generally do not require payment of
margin, to the extent that the Trust has unrealized gains in such instruments or has deposited collateral with its counterparties the Trust is at risk that its counterparties will become bankrupt or otherwise fail to honor its obligations.
Dodd-Frank Act Risk. Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the
Dodd-Frank Act) (the Derivatives Title) imposed a substantially new regulatory structure on derivatives markets, with particular emphasis on swaps (which were subject to oversight by the CFTC) and security-based swaps (which
were subject to oversight by the SEC). The regulatory framework covers a broad range of swap market participants, including banks, non-banks, credit unions, insurance companies, broker-dealers and investment
advisers. Prudential regulators were granted authority to regulate margining of swaps and security-based swaps of banks and bank-related entities.
Current regulations for swaps require the mandatory central clearing and mandatory exchange trading of particular types of
interest rate swaps and index credit default swaps (together, Covered Swaps). The Trust is required to clear its Covered Swaps through a clearing broker, which requires, among other things, posting initial margin and variation margin to
the Trusts clearing broker in order to enter into and maintain positions in Covered Swaps. Covered Swaps generally are required to be executed through a swap execution facility (SEF), which can involve additional transaction fees.
Additionally, with respect to uncleared swaps, swap dealers are required to collect variation margin from the Trust and
may be required by applicable regulations to collect initial margin from the Trust. Both initial and variation margin may be comprised of cash and/or securities, subject to applicable regulatory haircuts. Shares of investment companies (other than
certain money market funds) may not be posted as collateral under applicable regulations. As capital and margin requirements for swap dealers and capital and margin requirements for security-based swaps are implemented, such requirements may make
certain types of trades and/or trading
S-40
strategies more costly. There may be market dislocations due to uncertainty during the implementation period of any new regulation and the Advisors cannot know how the derivatives market will
adjust to such new regulations.
In addition, regulations adopted by global prudential regulators that are now in effect
require certain bank-regulated counterparties and certain of their affiliates to include in qualified financial contracts, including many derivatives contracts as well as repurchase agreements and securities lending agreements, terms
that delay or restrict the rights of counterparties to terminate such contracts, foreclose upon collateral, exercise other default rights or restrict transfers of affiliate credit enhancements (such as guarantees) in the event that the
bank-regulated counterparty and/or its affiliates are subject to certain types of resolution or insolvency proceedings.
Legal and Regulatory Risk. At any time after the date hereof, legislation or additional regulations may be enacted that
could negatively affect the assets of the Trust. Changing approaches to regulation may have a negative impact on the securities in which the Trust invests. Legislation or regulation may also change the way in which the Trust itself is regulated.
There can be no assurance that future legislation, regulation or deregulation will not have a material adverse effect on the Trust or will not impair the ability of the Trust to achieve its investment objectives. In addition, as new rules and
regulations resulting from the passage of the Dodd-Frank Act are implemented and new international capital and liquidity requirements are introduced under the Basel III Accords, the market may not react the way the Advisor expects. Whether the Trust
achieves its investment objectives may depend on, among other things, whether the Advisor correctly forecasts market reactions to this and other legislation. In the event the Advisor incorrectly forecasts market reaction, the Trust may not achieve
its investment objectives.
S-41
MANAGEMENT OF THE TRUSTS
Investment Management Agreement
Although the Advisor intends to devote such time and effort to the business of the Trust as is reasonably necessary to perform
its duties to the Trust, the services of the Advisor are not exclusive and the Advisor provides similar services to other investment companies and other clients and may engage in other activities.
The investment management agreement between the Advisor and the Trust (the Investment Management Agreement) also
provides that in the absence of willful misfeasance, bad faith, gross negligence or reckless disregard of its obligations thereunder, the Advisor is not liable to the Trust or any of the Trusts shareholders for any act or omission by the
Advisor in the supervision or management of its respective investment activities or for any loss sustained by the Trust or the Trusts shareholders and provides for indemnification by the Trust of the Advisor, its directors, officers,
employees, agents and control persons for liabilities incurred by them in connection with their services to the Trust, subject to certain limitations and conditions.
The Investment Management Agreement provides for the Trust to pay a monthly management fee at an annual rate equal to 1.00% of
the average daily value of the Trusts Managed Assets. The Advisor contractually agreed to waive receipt of a portion of the management fee in the amount of 0.20% of the Trusts average daily Managed Assets for the first five years of the
Trusts operations (2014 through 2018), 0.15% in year six (2019), 0.10% in year seven (2020) and 0.05% in year eight (2021). The period from the Trusts inception to December 31, 2014 was considered year one for the waiver.
Beginning in year nine (2022), there will be no waiver.
The Trust and the Advisor have entered into a fee waiver
agreement (the Fee Waiver Agreement), pursuant to which the Advisor has contractually agreed to waive the management fee with respect to any portion of the Trusts assets attributable to investments in any equity and fixed-income
mutual funds and ETFs managed by the Advisor or its affiliates that have a contractual fee, through June 30, 2023. In addition, effective December 1, 2019, pursuant to the Fee Waiver Agreement, the Advisor has contractually agreed to waive
its management fees by the amount of investment advisory fees the Trust pays to the Advisor indirectly through its investment in money market funds advised by the Advisor or its affiliates, through June 30, 2023. The Fee Waiver Agreement may be
continued from year to year thereafter, provided that such continuance is specifically approved by the Advisor and the Trust (including by a majority of the Trustees who are not interested persons (as defined in the Investment Company
Act) (the Independent Trustees)). Neither the Advisor nor the Trust is obligated to extend the Fee Waiver Agreement. The Fee Waiver Agreement may be terminated at any time, without the payment of any penalty, only by the Trust (upon the
vote of a majority of the Independent Trustees or a majority of the outstanding voting securities of the Trust), upon 90 days written notice by the Trust to the Advisor. Prior to December 1, 2019, such agreement to waive a portion of the
Trusts management fee in connection with the Trusts investment in affiliated money market funds was voluntary.
The Investment Management Agreement was approved by the sole common shareholder of the Trust as of September 24, 2014.
The Investment Management Agreement will continue in effect from year to year provided that each continuance is specifically approved at least annually by both (1) the vote of a majority of the Board or the vote of a majority of the outstanding
voting securities of the Trust (as such term is defined in the Investment Company Act) and (2) by the vote of a majority of the Trustees who are not parties to the Investment Management Agreement or interested persons (as such term
is defined in the Investment Company Act) of any such party, cast in person at a meeting called for the purpose of voting on such approval. The Investment Management Agreement may be terminated as a whole at any time by the Trust, without the
payment of any penalty, upon the vote of a majority of the Board or a majority of the outstanding voting securities of the Trust or by the Advisor, on 60 days written notice by either party to the other which can be waived by the non-terminating party. The Investment Management Agreement will terminate automatically in the event of its assignment (as such term is defined in the Investment Company Act and the rules thereunder).
S-42
The table below sets forth information about the total management fees paid by the Trust to the
Advisor, and the amounts waived by the Advisor, for the periods indicated:
|
|
|
|
|
|
|
|
|
Fiscal Year Ended December 31, |
|
Paid to the Advisor |
|
|
Waived by the Advisor |
|
2021 |
|
$ |
15,499,688 |
|
|
$ |
(791,441) |
|
2020 |
|
$ |
9,223,005 |
|
|
$ |
(927,479) |
|
2019 |
|
$ |
7,091,952 |
|
|
$ |
(1,067,290) |
|
Administration and Accounting Services Agreement
State Street Bank and Trust Company (State Street) provides certain administration and accounting services to the
Trust pursuant to an Administration and Accounting Services Agreement. The table below shows the amounts paid to State Street for such services for the periods indicated:
|
|
|
|
|
Fiscal Year Ended December 31, |
|
Paid to State Street |
|
2021 |
|
$ |
48,758 |
|
2020 |
|
$ |
50,023 |
|
2019 |
|
$ |
49,250 |
|
Biographical Information Pertaining to the Trustees
The Board consists of eleven individuals (each, a Trustee), nine of whom are Independent Trustees. The registered
investment companies advised by the Advisor or its affiliates (the BlackRock-advised Funds) are organized into one complex of closed-end funds and open-end non-index fixed-income funds (the BlackRock Fixed-Income Complex), one complex of open-end equity, multi-asset, index and money market funds (the BlackRock
Multi-Asset Complex) and one complex of exchange-traded funds (each, a BlackRock Fund Complex). The Trust is included in the BlackRock Fund Complex referred to as the BlackRock Fixed-Income Complex. The Trustees also oversee as
board members the operations of the other open-end and closed-end registered investment companies included in the BlackRock Fixed-Income Complex.
Please refer to the section of the Trusts June 8, 2021 definitive proxy statement on Schedule 14A for the annual
meeting of the Trusts shareholders entitled: Proposal 1 - Board Members/Nominees Biographical
Information, which is incorporated by reference herein, for a discussion of the Trusts Trustees other than Lorenzo A. Flores, their principal occupations and other affiliates during the past five years, the number of portfolios in
the Fixed-Income Complex that they oversee, and other information about them.
Effective July 30, 2021, Lorenzo A.
Flores was appointed to the Board as an Independent Trustee. Certain biographical and other information relating to Lorenzo A. Flores is set forth below, including his year of birth, his principal occupation for at least the last five years, the
length of time served, the total number of BlackRock-advised Funds overseen and any public directorships or trusteeships.
|
|
|
|
|
|
|
|
|
Name and
Year of Birth1,2 |
|
Position(s) Held (Length of Service) |
|
Principal Occupation(s)
During Past Five Years |
|
Number of BlackRock- Advised Registered Investment Companies (RICs) Consisting
of Investment Portfolios (Portfolios) Overseen |
|
Public Company and Other Investment Company Directorships Held During Past Five Years |
Lorenzo A. Flores
1946 |
|
Trustee (Since 2021) |
|
Vice Chairman, Kioxia, Inc. since 2019; Chief Financial Officer, Xilinx, Inc. from 2016 to 2019; Corporate Controller,
Xilinx, Inc. from 2008 to 2016. |
|
73 RICs consisting of 102 Portfolios |
|
None |
S-43
1 |
The address of each Trustee is c/o BlackRock, Inc., 55 East 52nd Street, New York, New York 10055.
|
2 |
Each Independent Trustee holds office until his or her successor is duly elected and qualifies or until his
or her earlier death, resignation, retirement or removal as provided by the Trusts bylaws or charter or statute, or until December 31 of the year in which he or she turns 75. Trustees who are interested persons, as defined in
the Investment Company Act, serve until their successor is duly elected and qualifies or until their earlier death, resignation, retirement or removal as provided by the Trusts bylaws or statute, or until December 31 of the year in which
they turn 72. The Board may determine to extend the terms of Independent Trustees on a case-by-case basis, as appropriate. |
The table below discusses some of the experiences, qualifications and skills of Lorenzo A. Flores that support the conclusion that he should serve on the
Board.
|
|
|
Trustee |
|
Experience, Qualifications and Skills |
|
|
Lorenzo A. Flores |
|
The Board benefits from Lorenzo A. Floress many years of business, leadership and financial experience in his
roles at various public and private companies. In particular, Mr. Floress service as Chief Financial Officer and Corporate Controller of Xilinx, Inc. and Vice Chairman of Kioxia, Inc. and his long experience in the technology industry
allow him to provide insight to into financial, business and technology trends. Mr. Floress knowledge of financial and accounting matters qualifies him to serve as a member of the Audit Committee. Mr. Floress independence from
the Trust and the Advisor enhances his service as a member of the Performance Oversight Committee. |
Board Leadership Structure and Oversight
Please refer to the sections of the Trusts definitive proxy statement on Schedule 14A for the annual meeting of the
Trusts shareholders entitled: Proposal 1 - Board Leadership Structure and Oversight and Appendix
E - Committees of the Board which is incorporated by reference herein, for a discussion of the Boards leadership structure and oversight other than as noted below.
During the Trusts fiscal year ended December 31, 2021, the Boards Audit Committee, Governance and Nominating
Committee, Compliance Committee and Executive Committee met the following number of times:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Audit
Committee
Meetings |
|
Number of Governance Committee Meetings |
|
|
Number of Compliance Committee Meetings |
|
|
Number of Performance Oversight Committee Meetings |
|
|
Number of Executive Committee Meetings |
|
12 |
|
|
7 |
|
|
|
4 |
|
|
|
4 |
|
|
|
0 |
|
Effective July 30, 2021, J. Phillip Holloman was appointed to the Audit Committee of the
Board and Stayce D. Harris was appointed to the Compliance Committee of the Board. Effective August 5, 2021, Lorenzo A. Flores was appointed to the Audit Committee of the Board.
Effective November 18, 2021, Lorenzo A. Flores, Stayce D. Harris and J. Phillip Holloman were each appointed to the
Performance Oversight Committee of the Board.
Effective December 31, 2021, Michael J. Castellano and Richard E.
Cavanagh each retired as a Trustee of the Trust.
Ms. Robards intends to retire as a Trustee of the Trust and, in
that regard, has resigned as a Trustee of the Trust effective as of May 31, 2022.
S-44
Effective January 1, 2022, R. Glenn Hubbard was appointed to serve as a
Chair of the Board and as a member and Chair of the Executive Committee of the Board; W. Carl Kester was appointed to serve as Vice Chair of the Board, as a member and Chair of the Governance and Nominating Committee of the Board and as a member of
the Executive Committee of the Board; Catherine A. Lynch was appointed to serve as Chair of the Audit Committee of the Board; and Karen P. Robards no longer serves as Co-Chair of the Board.
Trustee Share Ownership
Information
relating to each Trustees share ownership in the Trust and in all BlackRock-advised Funds that are currently overseen by the respective Trustee (Supervised Funds) as of December 31, 2021 is set forth in the chart below:
|
|
|
|
|
|
|
|
|
Name of Trustee |
|
Dollar Range of Equity Securities in the Trust* |
|
|
Aggregate Dollar Range of Equity Securities in Supervised Funds* |
|
Independent Trustees |
|
|
|
|
|
|
|
|
Cynthia L. Egan |
|
|
Over $100,000 |
|
|
|
Over $100,000 |
|
Frank J. Fabozzi |
|
|
Over $100,000 |
|
|
|
Over $100,000 |
|
Lorenzo A. Flores |
|
|
None |
|
|
|
Over $100,000 |
|
Stayce D. Harris |
|
|
None |
|
|
|
Over $100,000 |
|
J. Phillip Holloman |
|
|
None |
|
|
|
Over $100,000 |
|
R. Glenn Hubbard |
|
|
Over $100,000 |
|
|
|
Over $100,000 |
|
W. Carl Kester |
|
|
Over $100,000 |
|
|
|
Over $100,000 |
|
Catherine A. Lynch |
|
|
Over $100,000 |
|
|
|
Over $100,000 |
|
Karen P. Robards |
|
|
None |
|
|
|
Over $100,000 |
|
Interested Trustees |
|
|
|
|
|
|
|
|
Robert Fairbairn |
|
|
None |
|
|
|
Over $100,000 |
|
John M. Perlowski |
|
|
None |
|
|
|
Over $100,000 |
|
* |
Includes share equivalents owned under the deferred compensation plan in the Supervised Funds by certain
Independent Trustees who have participated in the deferred compensation plan of the Supervised Funds. |
Compensation of Trustees
Each Trustee who is an Independent Trustee is paid an annual retainer of $370,000 per year for his or her services as
a Board member of the BlackRock-advised Funds, including the Trust, and each Independent Trustee may also receive a $10,000 Board meeting fee for special unscheduled meetings or meetings in excess of six Board meetings held in a calendar year,
together with out-of-pocket expenses in accordance with a Board policy on travel and other business expenses relating to attendance at meetings. In addition, the Chair
of the Board is paid an additional annual retainer of $100,000. The Chairs of the Audit Committee, Performance Oversight Committee, Compliance Committee, and Governance and Nominating Committee are paid an additional annual retainer of $45,000,
$37,500, $45,000 and $37,500, respectively. Each of the members of the Audit Committee and Compliance Committee are paid an additional annual retainer of $30,000 and $25,000, respectively, for his or her service on such committee. Effective
January 1, 2022, the Vice Chair of the Board is paid an additional annual retainer of $60,000, and each of the members of the Governance and Nominating Committee is paid an additional annual retainer of $25,000 for his or her service on such
committee. The Trust will pay a pro rata portion quarterly (based on relative net assets) of the foregoing Trustee fees paid by the funds in the BlackRock Fixed-Income Complex.
The Independent Trustees have agreed that a maximum of 50% of each Independent Trustees total compensation paid by funds
in the BlackRock Fixed-Income Complex may be deferred pursuant to the BlackRock Fixed-Income Complexs deferred compensation plan. Under the deferred compensation plan, deferred amounts earn a return for the Independent Trustees as though
equivalent dollar amounts had been invested in shares of certain funds in the BlackRock Fixed-Income Complex selected by the Independent
S-45
Trustees. This has approximately the same economic effect for the Independent Trustees as if they had invested the deferred amounts in such funds in the BlackRock Fixed-Income Complex. The
deferred compensation plan is not funded and obligations thereunder represent general unsecured claims against the general assets of a fund and are recorded as a liability for accounting purposes.
The following table sets forth the compensation paid to the Trustees by the Trust for the fiscal year ended December 31,
2021, and the aggregate compensation, including deferred compensation amounts, paid to them by all BlackRock-advised Funds for the calendar year ended December 31, 2021. Messrs. Fairbairn and Perlowski serve without compensation from the Trust
because of their affiliation with BlackRock, Inc. (BlackRock) and the Advisor.
|
|
|
|
|
|
|
|
|
|
|
|
|
Name(1) |
|
Compensation from the Trust |
|
|
Estimated Annual Benefits upon Retirement |
|
|
Aggregate Compensation from the BlackRock-Advised Funds(2)(3) |
|
Independent Trustees |
|
|
|
|
|
|
|
|
|
|
|
|
Michael J. Castellano(4) |
|
$ |
8,552 |
|
|
|
None |
|
|
$ |
445,000 |
|
Richard E. Cavanagh(5) |
|
$ |
9,529 |
|
|
|
None |
|
|
$ |
495,000 |
|
Cynthia L. Egan |
|
$ |
8,454 |
|
|
|
None |
|
|
$ |
440,000 |
|
Frank J. Fabozzi |
|
$ |
8,409 |
|
|
|
None |
|
|
$ |
478,750 |
|
Lorenzo A. Flores(6) |
|
$ |
3,571 |
|
|
|
None |
|
|
$ |
167,988 |
|
Stayce D. Harris(7) |
|
$ |
4,080 |
|
|
|
None |
|
|
$ |
216,875 |
|
J. Phillip Holloman(8) |
|
$ |
4,126 |
|
|
|
None |
|
|
$ |
218,981 |
|
R. Glenn Hubbard |
|
$ |
8,316 |
|
|
|
None |
|
|
$ |
432,500 |
|
W. Carl Kester |
|
$ |
7,575 |
|
|
|
None |
|
|
$ |
443,750 |
|
Catherine A. Lynch |
|
$ |
7,673 |
|
|
|
None |
|
|
$ |
441,250 |
|
Karen P. Robards |
|
$ |
9,627 |
|
|
|
None |
|
|
$ |
500,000 |
|
Interested Trustees |
|
|
|
|
|
|
|
|
|
|
|
|
Robert Fairbairn |
|
|
None |
|
|
|
None |
|
|
|
None |
|
John M. Perlowski |
|
|
None |
|
|
|
None |
|
|
|
None |
|
(1) |
For the number of BlackRock-advised Funds from which each Trustee receives compensation, see the
Biographical Information section beginning on page S-43. |
(2) |
For the Independent Trustees, this amount represents the aggregate compensation earned from the funds in the
BlackRock Fixed-Income Complex during the calendar year ended December 31, 2021. Of this amount, Mr. Castellano, Mr. Cavanagh, Dr. Fabozzi, Mr. Flores, Ms. Harris, Mr. Holloman, Dr. Hubbard, Dr. Kester
and Ms. Lynch deferred $133,500, $163,350, $71,812, $50,000, $51,514, $52,567, $216,250, $20,000 and $66,187, respectively, pursuant to the BlackRock Fixed-Income Complexs deferred compensation plan. |
(3) |
Total amount of deferred compensation payable by the BlackRock Fixed-Income Complex to Mr. Castellano,
Mr. Cavanagh, Dr. Fabozzi, Mr. Flores, Ms. Harris, Mr. Holloman, Dr. Hubbard, Dr. Kester and Ms. Lynch is $1,563,029, $2,322,521, $1,263,915, $50,820, $52,360, $53,430, $3,749,161, $1,769,688 and $395,097,
respectively, as of December 31, 2021. Ms. Egan and Ms. Robards did not participate in the deferred compensation plan as of December 31, 2021. |
(4) |
Mr. Castellano retired as a Trustee of the Trust and Chair of the Audit Committee effective
December 31, 2021. |
(5) |
Mr. Cavanagh retired as a Trustee of the Trust and Co-Chair of
the Board effective December 31, 2021. |
(6) |
Mr. Flores was appointed as a Trustee of the Trust effective July 30, 2021, a member of the Audit
Committee effective August 5, 2021 and a member of the Performance Oversight Committee effective November 18, 2021. |
(7) |
Ms. Harris was appointed as a Trustee of the Trust effective June 10, 2021, a member of the
Compliance Committee effective July 30, 2021 and a member of the Performance Oversight Committee effective November 18, 2021. |
(8) |
Mr. Holloman was appointed as a Trustee of the Trust effective June 10, 2021, a member of the
Audit Committee effective July 30, 2021 and a member of the Performance Oversight Committee effective November 18, 2021. |
S-46
Independent Trustee Ownership of Securities
As of December 31, 2021, none of the Independent Trustees of the Trust or their immediate family members owned
beneficially or of record any securities of BlackRock or any affiliate of any BlackRock person controlling, controlled by or under common control with BlackRock nor did any Independent Trustee of the Trust or their immediate family member have any
material interest in any transaction, or series of similar transactions, during the most recently completed two calendar years involving the Trust, BlackRock or any affiliate of any BlackRock person controlling, controlled by or under common control
with the Trust or BlackRock.
As of the date of this SAI, the officers and Trustees of the Trust, as a group, beneficially
owned less than 1% of the outstanding common shares of the Trust.
Information Pertaining to the Officers
Please refer to the section of the Trusts definitive proxy statement on Schedule 14A for the annual meeting of the
Trusts shareholders entitled: Appendix F Information Pertaining to the Executive Officers of the Funds, which
is incorporated by reference herein, for certain biographical and other information relating to the officers of the Trust who are not Trustees.
Indemnification of Trustees and Officers
The governing documents of the Trust generally provide that, to the extent permitted by applicable law, the Trust will
indemnify its Trustees and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with the Trust unless, as to liability to the Trust or its investors, it is finally
adjudicated that they engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in their offices. In addition, the Trust will not indemnify Trustees with respect to any matter as to which Trustees did
not act in good faith in the reasonable belief that his or her action was in the best interest of the Trust or, in the case of any criminal proceeding, as to which Trustees had reasonable cause to believe that the conduct was unlawful.
Indemnification provisions contained in the Trusts governing documents are subject to any limitations imposed by applicable law.
Closed-end funds in the BlackRock Fixed-Income Complex, including the Trust, have also
entered into a separate indemnification agreement with the board members of each board of such funds (the Indemnification Agreement). The Indemnification Agreement (i) extends the indemnification provisions contained in a
funds governing documents to board members who leave that funds board and serve on an advisory board of a different fund in the BlackRock Fixed-Income Complex; (ii) sets in place the terms of the indemnification provisions of a
funds governing documents once a board member retires from a board; and (iii) in the case of board members who left the board of a fund in connection with or prior to the board consolidation that occurred in 2007 as a result of the merger
of BlackRock and Merrill Lynch & Co., Inc.s investment management business, clarifies that such fund continues to indemnify the trustee for claims arising out of his or her past service to that fund.
S-47
Portfolio Management
Portfolio Manager Assets Under Management
The following table sets forth information about funds and accounts other than the Trust for which the portfolio managers are
primarily responsible for the day-to-day portfolio management as of December 31, 2021:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Other Accounts Managed and Assets by Account Type |
|
Number of Other Accounts and Assets for Which Advisory Fee is
Performance-Based |
Name of Portfolio Manager |
|
Other Registered Investment Companies |
|
Other Pooled Investment Vehicles |
|
Other Accounts |
|
Other Registered Investment Companies |
|
Other Pooled Investment Vehicles |
|
Other Accounts |
Tony Kim |
|
3 |
|
5 |
|
2 |
|
0 |
|
1 |
|
0 |
|
|
$11.98 Billion |
|
$21.97 Billion |
|
$182.5 Million |
|
$0 |
|
$1.91 Billion |
|
$0 |
Kyle G. McClements, CFA |
|
12 |
|
7 |
|
0 |
|
0 |
|
0 |
|
0 |
|
|
$17.49 Billion |
|
$1.36 Billion |
|
$0 |
|
$0 |
|
$0 |
|
$0 |
Christopher Accettella |
|
12 |
|
4 |
|
0 |
|
0 |
|
0 |
|
0 |
|
|
$17.83 Billion |
|
$742.2 Million |
|
$0 |
|
$0 |
|
$0 |
|
$0 |
Reid Menge |
|
3 |
|
5 |
|
2 |
|
0 |
|
1 |
|
0 |
|
|
$11.98 Billion |
|
$21.97 Billion |
|
$182.5 Million |
|
$0 |
|
$1.91 Billion |
|
$0 |
Portfolio Manager Compensation Overview
The discussion below describes the portfolio managers compensation as of December 31, 2021.
The Advisors financial arrangements with its portfolio managers, its competitive compensation and its career path
emphasis at all levels reflect the value senior management places on key resources. Compensation may include a variety of components and may vary from year to year based on a number of factors. The principal components of compensation include a base
salary, a performance-based discretionary bonus, participation in various benefits programs and one or more of the incentive compensation programs established by the Advisor.
Base Compensation. Generally, portfolio managers receive base compensation based on their position with the firm.
Discretionary Incentive CompensationMessrs. Kim and Menge
Generally, discretionary incentive compensation for Active Equity portfolio managers is based on a formulaic compensation
program. The Advisors formulaic portfolio manager compensation program is based on team revenue and pre-tax investment performance relative to appropriate competitors or benchmarks over 1-, 3- and 5-year performance periods, as applicable. In most cases, these benchmarks are the same as the benchmark or benchmarks
against which the performance of the funds or other accounts managed by the portfolio managers are measured. The Advisors Chief Investment Officers determine the benchmarks or rankings against which the performance of funds and other
accounts managed by each portfolio management team is compared and the period of time over which performance is evaluated. With respect to the portfolio managers, such benchmarks for the Trust and other accounts are: BST Opt Overwriting
Strategy Composite Index; MSCI All Country World Information Technology- Net Return in USD.
A smaller element of
portfolio manager discretionary compensation may include consideration of: financial results, expense control, profit margins, strategic planning and implementation, quality of client service, market share, corporate reputation, capital allocation,
compliance and risk control, leadership, technology and innovation. These factors are considered collectively by the Advisors management and the relevant Chief Investment Officers.
S-48
Discretionary Incentive CompensationMessrs. Accettella and McClements
Discretionary incentive compensation is a function of several components: the performance of BlackRock, Inc., the performance
of the portfolio managers group within the Advisor, the investment performance, including risk-adjusted returns, of the firms assets or strategies under management or supervision by that portfolio manager, and/or the individuals
performance and contribution to the overall performance of these portfolios and the Advisor. Among other things, the Advisors Chief Investment Officers make a subjective determination with respect to each portfolio managers compensation
based on the performance of the funds, other accounts or strategies managed by each portfolio manager. Performance is generally measured on a pre-tax basis over various time periods including 1-, 3- and 5- year periods, as applicable. The performance of some funds, other accounts or strategies may not be measured against a
specific benchmark.
Distribution of Discretionary Incentive Compensation. Discretionary incentive compensation is
distributed to portfolio managers in a combination of cash, deferred BlackRock, Inc. stock awards, and/or deferred cash awards that notionally track the return of certain Advisor investment products.
Portfolio managers receive their annual discretionary incentive compensation in the form of cash. Portfolio managers whose
total compensation is above a specified threshold also receive deferred BlackRock, Inc. stock awards annually as part of their discretionary incentive compensation. Paying a portion of discretionary incentive compensation in the form of deferred
BlackRock, Inc. stock puts compensation earned by a portfolio manager for a given year at risk based on the Advisors ability to sustain and improve its performance over future periods. In some cases, additional deferred BlackRock,
Inc. stock may be granted to certain key employees as part of a long-term incentive award to aid in retention, align interests with long-term shareholders and motivate performance. Deferred BlackRock, Inc. stock awards are generally granted in the
form of BlackRock, Inc. restricted stock units that vest pursuant to the terms of the applicable plan and, once vested, settle in BlackRock, Inc. common stock. The portfolio managers of the Trust have deferred BlackRock, Inc. stock awards.
For certain portfolio managers, a portion of the discretionary incentive compensation is also distributed in the form of
deferred cash awards that notionally track the returns of select investment products of the Advisor they manage, which provides direct alignment of portfolio manager discretionary incentive compensation with investment product results. Deferred cash
awards vest ratably over a number of years and, once vested, settle in the form of cash. Only portfolio managers who manage specified products and whose total compensation is above a specified threshold are eligible to participate in the deferred
cash award program.
Other Compensation Benefits. In addition to base salary and discretionary incentive
compensation, portfolio managers may be eligible to receive or participate in one or more of the following:
Incentive
Savings PlansBlackRock, Inc. has created a variety of incentive savings plans in which BlackRock, Inc. employees are eligible to participate, including a 401(k) plan, the BlackRock Retirement Savings Plan (RSP), and the BlackRock
Employee Stock Purchase Plan (ESPP). The employer contribution components of the RSP include a company match equal to 50% of the first 8% of eligible pay contributed to the plan capped at $5,000 per year, and a company retirement contribution equal
to 3-5% of eligible compensation up to the Internal Revenue Service limit ($305,000 for 2022). The RSP offers a range of investment options, including registered investment companies and collective
investment funds managed by the firm. BlackRock, Inc. contributions follow the investment direction set by participants for their own contributions or, absent participant investment direction, are invested into a target date fund that corresponds
to, or is closest to, the year in which the participant attains age 65. The ESPP allows for investment in BlackRock, Inc. common stock at a 5% discount on the fair market value of the stock on the purchase date. Annual participation in the
ESPP is limited to the purchase of 1,000 shares of common stock or a dollar value of $25,000 based on its fair market value on the purchase date. All of the eligible portfolio managers are eligible to participate in these plans.
S-49
Securities Ownership of Portfolio Managers
As of December 31, 2021, the end of the Trusts most recently completed fiscal year end, the dollar range of
securities beneficially owned by each portfolio manager in the Trust is shown below:
|
|
|
Portfolio Manager |
|
Dollar Range of Equity Securities Beneficially Owned |
Tony Kim |
|
Over $1,000,000 |
Kyle G. McClements |
|
$50,001 - $100,000 |
Christopher M. Accettella |
|
$10,001 - $50,000 |
Reid Menge |
|
$10,001 - $50,000 |
Potential Material Conflicts of Interest
The Advisor has built a professional working environment, firm-wide compliance culture and compliance procedures and systems
designed to protect against potential incentives that may favor one account over another. The Advisor has adopted policies and procedures that address the allocation of investment opportunities, execution of portfolio transactions, personal trading
by employees and other potential conflicts of interest that are designed to ensure that all client accounts are treated equitably over time. Nevertheless, the Advisor furnishes investment management and advisory services to numerous clients in
addition to the Trust, and the Advisor may, consistent with applicable law, make investment recommendations to other clients or accounts (including accounts which are hedge funds or have performance or higher fees paid to the Advisor, or in which
portfolio managers have a personal interest in the receipt of such fees), which may be the same as or different from those made to the Trust. In addition, BlackRock, Inc., its affiliates and significant shareholders and any officer, director,
shareholder or employee may or may not have an interest in the securities whose purchase and sale the Advisor recommends to the Trust. BlackRock, Inc., or any of its affiliates or significant shareholders, or any officer, director, shareholder,
employee or any member of their families may take different actions than those recommended to the Trust by the Advisor with respect to the same securities. Moreover, the Advisor may refrain from rendering any advice or services concerning securities
of companies of which any of BlackRock, Inc.s (or its affiliates or significant shareholders) officers, directors or employees are directors or officers, or companies as to which BlackRock, Inc. or any of its affiliates or
significant shareholders or the officers, directors and employees of any of them has any substantial economic interest or possesses material non-public information. Certain portfolio managers also may manage
accounts whose investment strategies may at times be opposed to the strategy utilized for a fund. It should also be noted that Messrs. Kim and Menge may be managing hedge fund and/or long only accounts, or may be part of a team managing hedge fund
and/or long only accounts, subject to incentive fees. Messrs. Kim and Menge may therefore be entitled to receive a portion of any incentive fees earned on such accounts.
As a fiduciary, the Advisor owes a duty of loyalty to its clients and must treat each client fairly. When the Advisor
purchases or sells securities for more than one account, the trades must be allocated in a manner consistent with its fiduciary duties. The Advisor attempts to allocate investments in a fair and equitable manner among client accounts, with no
account receiving preferential treatment. To this end, BlackRock, Inc. has adopted policies that are intended to ensure reasonable efficiency in client transactions and provide the Advisor with sufficient flexibility to allocate investments in a
manner that is consistent with the particular investment discipline and client base, as appropriate.
Proxy Voting Policies
The Board has delegated the voting of proxies for the Trusts securities to the Advisor pursuant to the Advisors
proxy voting guidelines. Under these guidelines, the Advisor will vote proxies related to Trust securities in the best interests of the Trust and its shareholders. From time to time, a vote may present a conflict between the interests of the
Trusts shareholders, on the one hand, and those of the Advisor, or any affiliated person of the Trust or the Advisor, on the other. In such event, provided that the Advisors Equity Investment
S-50
Policy Oversight Committee, or a sub-committee thereof (the Oversight Committee), is aware of the real or potential conflict, if the matter to
be voted on represents a material, non-routine matter and if the Oversight Committee does not reasonably believe it is able to follow its general voting guidelines (or if the particular proxy matter is not
addressed in the guidelines) and vote impartially, the Oversight Committee may retain an independent fiduciary to advise the Oversight Committee on how to vote or to cast votes on behalf of the Advisors clients. If the Advisor determines not
to retain an independent fiduciary, or does not desire to follow the advice of such independent fiduciary, the Oversight Committee shall determine how to vote the proxy after consulting with the Advisors Portfolio Management Group and/or the
Advisors Legal and Compliance Department and concluding that the vote cast is in its clients best interest notwithstanding the conflict.
A copy of the Closed-End Fund Proxy Voting Policy is included as Appendix B to this
SAI. Information on how the Trust voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 will be available (i) at www.blackrock.com and (ii) on the
SECs website at http://www.sec.gov.
Codes of Ethics
The Trust and the Advisor have adopted codes of ethics pursuant to Rule 17j-1 under the
Investment Company Act. These codes permit personnel subject to the codes to invest in securities, including securities that may be purchased or held by the Trust. These codes may be obtained by calling the SEC at (202) 551-8090. These codes of ethics are available on the EDGAR Database on the SECs website (http://www.sec.gov), and copies of these codes may be obtained, after paying a duplicating fee, by electronic request at
the following e-mail address: publicinfo@sec.gov.
Other Information
BlackRock, Inc. is independent in ownership and governance, with no single majority stockholder and a majority of independent
directors.
S-51
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to policies established by the Board, the Advisor is primarily responsible for the execution of the Trusts
portfolio transactions and the allocation of brokerage. The Advisor does not execute transactions through any particular broker or dealer, but seeks to obtain the best net results for the Trust, taking into account such factors as price (including
the applicable brokerage commission or dealer spread), size of order, difficulty of execution, operational facilities of the firm and the firms risk and skill in positioning blocks of securities. While the Advisor generally seeks reasonable
trade execution costs, the Trust does not necessarily pay the lowest spread or commission available, and payment of the lowest commission or spread is not necessarily consistent with obtaining the best price and execution in particular transactions.
Subject to applicable legal requirements, the Advisor may select a broker based partly upon brokerage or research services provided to the Advisor and its clients, including the Trust. In return for such services, the Advisor may cause the Trust to
pay a higher commission than other brokers would charge if the Advisor determines in good faith that the commission is reasonable in relation to the services provided.
In selecting brokers or dealers to execute portfolio transactions, the Advisor seeks to obtain the best price and most
favorable execution for the Trust, taking into account a variety of factors including: (i) the size, nature and character of the security or instrument being traded and the markets in which it is purchased or sold; (ii) the desired timing
of the transaction; (iii) the Advisors knowledge of the expected commission rates and spreads currently available; (iv) the activity existing and expected in the market for the particular security or instrument, including any
anticipated execution difficulties; (v) the full range of brokerage services provided; (vi) the brokers or dealers capital; (vii) the quality of research and research services provided; (viii) the reasonableness of
the commission, dealer spread or its equivalent for the specific transaction; and (ix) the Advisors knowledge of any actual or apparent operational problems of a broker or dealer.
Section 28(e) of the Exchange Act (Section 28(e)) permits an investment adviser, under certain
circumstances, to cause an account to pay a broker or dealer a commission for effecting a transaction that exceeds the amount another broker or dealer would have charged for effecting the same transaction in recognition of the value of brokerage and
research services provided by that broker or dealer. This includes commissions paid on riskless principal transactions under certain conditions. Brokerage and research services include: (1) furnishing advice as to the value of securities,
including pricing and appraisal advice, credit analysis, risk measurement analysis, performance and other analysis, as well as the advisability of investing in, purchasing or selling securities, and the availability of securities or purchasers or
sellers of securities; (2) furnishing analyses and reports concerning issuers, industries, securities, economic factors and trends, portfolio strategy, and the performance of accounts; and (3) effecting securities transactions and
performing functions incidental to securities transactions (such as clearance, settlement, and custody). The Advisor believes that access to independent investment research is beneficial to its investment decision-making processes and, therefore, to
the Trust.
The Advisor may participate in client commission arrangements under which the Advisor may execute transactions
through a broker-dealer and request that the broker-dealer allocate a portion of the commissions or commission credits to another firm that provides research to the Advisor. The Advisor believes that research services obtained through soft dollar or
commission sharing arrangements enhance its investment decision-making capabilities, thereby increasing the prospects for higher investment returns. The Advisor will engage only in soft dollar or commission sharing transactions that comply with the
requirements of Section 28(e). The Advisor regularly evaluates the soft dollar products and services utilized, as well as the overall soft dollar and commission sharing arrangements to ensure that trades are executed by firms that are regarded
as best able to execute trades for client accounts, while at the same time providing access to the research and other services the Advisor views as impactful to its trading results.
The Advisor may utilize soft dollars and related services, including research (whether prepared by the broker-dealer or
prepared by a third-party and provided to the Advisor by the broker-dealer) and execution or
S-52
brokerage services within applicable rules and the Advisors policies to the extent that such permitted services do not compromise the Advisors ability to seek to obtain best
execution. In this regard, the portfolio management investment and/or trading teams may consider a variety of factors, including the degree to which the broker-dealer: (a) provides access to company management; (b) provides access to their
analysts; (c) provides meaningful/insightful research notes on companies or other potential investments; (d) facilitates calls on which meaningful or insightful ideas about companies or potential investments are discussed;
(e) facilitates conferences at which meaningful or insightful ideas about companies or potential investments are discussed; or (f) provides research tools such as market data, financial analysis, and other third party related research and
brokerage tools that aid in the investment process.
Research-oriented services for which the Advisor might pay with Trust
commissions may be in written form or through direct contact with individuals and may include information as to particular companies or industries and securities or groups of securities, as well as market, economic, or institutional advice and
statistical information, political developments and technical market information that assists in the valuation of investments. Except as noted immediately below, research services furnished by brokers may be used in servicing some or all client
accounts and not all services may be used in connection with the Trust or account that paid commissions to the broker providing such services. In some cases, research information received from brokers by investment company management personnel, or
personnel principally responsible for the Advisors individually managed portfolios, is not necessarily shared by and between such personnel. Any investment advisory or other fees paid by the Trust to the Advisor are not reduced as a result of
the Advisors receipt of research services. In some cases, the Advisor may receive a service from a broker that has both a research and a non-research use. When this occurs the
Advisor makes a good faith allocation, under all the circumstances, between the research and non-research uses of the service. The percentage of the service that is used for research purposes may be paid for
with client commissions, while the Advisor will use its own funds to pay for the percentage of the service that is used for non-research purposes. In making this good faith allocation, the Advisor faces a
potential conflict of interest, but the Advisor believes that its allocation procedures are reasonably designed to ensure that it appropriately allocates the anticipated use of such services to their research and
non-research uses.
Payments of commissions to brokers who are affiliated persons
of the Trust will be made in accordance with Rule 17e-1 under the Investment Company Act.
From time to time, the Trust may purchase new issues of securities in a fixed price offering. In these situations, the broker
may be a member of the selling group that will, in addition to selling securities, provide the Advisor with research services. The Financial Industry Regulatory Authority, Inc. has adopted rules expressly permitting these types of arrangements under
certain circumstances. Generally, the broker will provide research credits in these situations at a rate that is higher than that available for typical secondary market transactions. These arrangements may not fall within the safe harbor
of Section 28(e).
The Advisor does not consider sales of shares of the investment companies it advises as a factor
in the selection of brokers or dealers to execute portfolio transactions for the Trust; however, whether or not a particular broker or dealer sells shares of the investment companies advised by the Advisor neither qualifies nor disqualifies such
broker or dealer to execute transactions for those investment companies.
The Trust anticipates that its brokerage
transactions involving foreign securities generally will be conducted primarily on the principal stock exchanges of the applicable country. Foreign equity securities may be held by the Trust in the form of depositary receipts, or other securities
convertible into foreign equity securities. Depositary receipts may be listed on stock exchanges, or traded in OTC markets in the United States or Europe, as the case may be. American Depositary Receipts, like other securities traded in the United
States, will be subject to negotiated commission rates.
The Trust may invest in certain securities traded in the OTC
market and intends to deal directly with the dealers who make a market in the particular securities, except in those circumstances in which better prices and
S-53
execution are available elsewhere. Under the Investment Company Act, persons affiliated with the Trust and persons who are affiliated with such affiliated persons are prohibited from dealing with
the Trust as principal in the purchase and sale of securities unless a permissive order allowing such transactions is obtained from the SEC. Since transactions in the OTC market usually involve transactions with the dealers acting as principal for
their own accounts, the Trust will not deal with affiliated persons in connection with such transactions. However, an affiliated person of the Trust may serve as its broker in OTC transactions conducted on an agency basis provided that, among other
things, the fee or commission received by such affiliated broker is reasonable and fair compared to the fee or commission received by non-affiliated brokers in connection with comparable transactions.
OTC issues, including most fixed-income securities such as corporate debt and U.S. Government securities, are normally traded
on a net basis without a stated commission, through dealers acting for their own account and not as brokers. The Trust will primarily engage in transactions with these dealers or deal directly with the issuer unless a better price or
execution could be obtained by using a broker. Prices paid to a dealer with respect to both foreign and domestic securities will generally include a spread, which is the difference between the prices at which the dealer is willing to
purchase and sell the specific security at the time, and includes the dealers normal profit.
Purchases of money
market instruments by the Trust are made from dealers, underwriters and issuers. The Trust does not currently expect to incur any brokerage commission expense on such transactions because money market instruments are generally traded on a
net basis with dealers acting as principal for their own accounts without a stated commission. The price of the security, however, usually includes a profit to the dealer.
Securities purchased in underwritten offerings include a fixed amount of compensation to the underwriter, generally referred
to as the underwriters concession or discount. When securities are purchased or sold directly from or to an issuer, no commissions or discounts are paid.
The Advisor may seek to obtain an undertaking from issuers of commercial paper or dealers selling commercial paper to consider
the repurchase of such securities from the Trust prior to maturity at their original cost plus interest (sometimes adjusted to reflect the actual maturity of the securities), if it believes that the Trusts anticipated need for liquidity makes
such action desirable. Any such repurchase prior to maturity reduces the possibility that the Trust would incur a capital loss in liquidating commercial paper, especially if interest rates have risen since acquisition of such commercial paper.
Investment decisions for the Trust and for other investment accounts managed by the Advisor are made independently of each
other in light of differing conditions. The Advisor allocates investments among client accounts in a fair and equitable manner. A variety of factors will be considered in making such allocations. These factors include: (i) investment objectives
or strategies for particular accounts, including sector, industry, country or region and capitalization weightings, (ii) tax considerations of an account, (iii) risk or investment concentration parameters for an account, (iv) supply
or demand for a security at a given price level, (v) size of available investment, (vi) cash availability and liquidity requirements for accounts, (vii) regulatory restrictions, (viii) minimum investment size of an account,
(ix) relative size of account, and (x) such other factors as may be approved by the Advisors general counsel. Moreover, investments may not be allocated to one client account over another based on any of the following considerations:
(i) to favor one client account at the expense of another, (ii) to generate higher fees paid by one client account over another or to produce greater performance compensation to the Advisor, (iii) to develop or enhance a relationship
with a client or prospective client, (iv) to compensate a client for past services or benefits rendered to the Advisor or to induce future services or benefits to be rendered to the Advisor, or (v) to manage or equalize investment
performance among different client accounts.
Equity securities will generally be allocated among client accounts within
the same investment mandate on a pro rata basis. This pro-rata allocation may result in the Trust receiving less of a particular security than if
S-54
pro-ration had not occurred. All allocations of equity securities will be subject, where relevant, to share minimums established for accounts and
compliance constraints.
Initial public offerings of securities may be over-subscribed and subsequently trade at a premium
in the secondary market. When the Advisor is given an opportunity to invest in such an initial offering or new or hot issue, the supply of securities available for client accounts is often less than the amount of securities
the accounts would otherwise take. In order to allocate these investments fairly and equitably among client accounts over time, each portfolio manager or a member of his or her respective investment team will indicate to the Advisors trading
desk their level of interest in a particular offering with respect to eligible clients accounts for which that team is responsible. Initial public offerings of U.S. equity securities will be identified as eligible for particular client
accounts that are managed by portfolio teams who have indicated interest in the offering based on market capitalization of the issuer of the security and the investment mandate of the client account and in the case of international equity
securities, the country where the offering is taking place and the investment mandate of the client account. Generally, shares received during the initial public offering will be allocated among participating client accounts within each investment
mandate on a pro rata basis. In situations where supply is too limited to be allocated among all accounts for which the investment is eligible, portfolio managers may rotate such investment opportunities among one or more accounts so long as the
rotation system provides for fair access for all client accounts over time. Other allocation methodologies that are considered by the Advisor to be fair and equitable to clients may be used as well.
Because different accounts may have differing investment objectives and policies, the Advisor may buy and sell the same
securities at the same time for different clients based on the particular investment objective, guidelines and strategies of those accounts. For example, the Advisor may decide that it may be entirely appropriate for a growth fund to sell a security
at the same time a value fund is buying that security. To the extent that transactions on behalf of more than one client of the Advisor or its affiliates during the same period may increase the demand for securities being purchased or the supply of
securities being sold, there may be an adverse effect on price. For example, sales of a security by the Advisor on behalf of one or more of its clients may decrease the market price of such security, adversely impacting other of the Advisors
clients that still hold the security. If purchases or sales of securities arise for consideration at or about the same time that would involve the Trust or other clients or funds for which the Advisor or an affiliate act as investment manager,
transactions in such securities will be made, insofar as feasible, for the respective funds and clients in a manner deemed equitable to all.
In certain instances, the Advisor may find it efficient for purposes of seeking to obtain best execution, to aggregate or
bunch certain contemporaneous purchases or sale orders of its advisory accounts. In general, all contemporaneous trades for client accounts under management by the same portfolio manager or investment team will be bunched in a single
order if the trader believes the bunched trade would provide each client with an opportunity to achieve a more favorable execution at a potentially lower execution cost. The costs associated with a bunched order will be shared pro rata among the
clients in the bunched order. Generally, if an order for a particular portfolio manager or management team is filled at several different prices through multiple trades, all accounts participating in the order will receive the average price except
in the case of certain international markets where average pricing is not permitted. While in some cases this practice could have a detrimental effect upon the price or value of the security as far as the Trust is concerned, in other cases it could
be beneficial to the Trust. Transactions effected by the Advisor on behalf of more than one of its clients during the same period may increase the demand for securities being purchased or the supply of securities being sold, causing an adverse
effect on price. The trader will give the bunched order to the broker dealer that the trader has identified as being able to provide the best execution of the order. Orders for purchase or sale of securities will be placed within a reasonable amount
of time of the order receipt and bunched orders will be kept bunched only long enough to execute the order.
The Trust
will not purchase securities during the existence of any underwriting or selling group relating to such securities of which the Advisor or any affiliated person (as defined in the Investment Company Act) thereof
S-55
is a member except pursuant to procedures adopted by the Board in accordance with Rule 10f-3 under the Investment Company Act. In no instance will
portfolio securities be purchased from or sold to the Advisor or any affiliated person of the foregoing entities except as permitted by SEC exemptive order or by applicable law.
While the Trust generally does not expect to engage in trading for short-term gains, it will effect portfolio transactions
without regard to any holding period if, in the Advisors judgment, such transactions are advisable in light of a change in circumstances of a particular company or within a particular industry or in general market, economic or financial
conditions. The portfolio turnover rate is calculated by dividing the lesser of the Trusts annual sales or purchases of portfolio securities (exclusive of purchases or sales of U.S. Government Securities and all other securities whose
maturities at the time of acquisition were one year or less) by the monthly average value of the securities in the portfolio during the year. A high rate of portfolio turnover results in certain tax consequences, such as increased capital gain
dividends and/or ordinary income dividends, and in correspondingly greater transaction costs in the form of dealer spreads and brokerage commissions, which are borne directly by the Trust.
Information about the brokerage commissions paid by the Trust, including commissions paid to affiliates, for the last three
fiscal years, is set forth in the following table:
|
|
|
|
|
|
|
|
|
Fiscal Year Ended December 31, |
|
Aggregate Brokerage Commissions Paid |
|
|
Commissions Paid to Affiliates |
|
2021 |
|
$ |
847,526 |
|
|
$ |
0 |
|
2020 |
|
$ |
604,793 |
|
|
$ |
0 |
|
2019 |
|
$ |
773,426 |
|
|
$ |
0 |
|
For the fiscal year ended December 31, 2021, the brokerage commissions paid to affiliates
by the Trust represented 0% of the aggregate brokerage commissions paid and involved 0% of the dollar amount of transactions involving payment of commissions during the year.
The following table shows the dollar amount of brokerage commissions paid to brokers for providing third-party research
services and the approximate dollar amount of the transactions involved for the fiscal year ended December 31, 2021. The provision of third-party research services was not necessarily a factor in the placement of all brokerage business with
such brokers.
|
|
|
|
|
Amount of Commissions Paid to Brokers for
Providing Research Services |
|
Amount of Brokerage Transactions Involved |
|
|
$192,724.36 |
|
$523,573,514.06 |
|
|
As of December 31, 2021, the Trust held no securities of its regular brokers or
dealers (as defined in Rule 10b-1 under the Investment Company Act) whose shares were purchased during the fiscal year ended December 31, 2021.
S-56
CONFLICTS OF INTEREST
Certain activities of BlackRock, Inc., the Advisor and the other subsidiaries of BlackRock, Inc. (collectively referred to
in this section as BlackRock) and their respective directors, officers or employees, with respect to the Trust and/or other accounts managed by BlackRock, may give rise to actual or perceived conflicts of interest such as those described
below.
BlackRock is one of the worlds largest asset management firms. BlackRock and its subsidiaries and their
respective directors, officers and employees, including the business units or entities and personnel who may be involved in the investment activities and business operations of the Trust, are engaged worldwide in businesses, including managing
equities, fixed-income securities, cash and alternative investments, and other financial services, and have interests other than that of managing the Trust. These are considerations of which investors in the Trust should be aware, and which may
cause conflicts of interest that could disadvantage the Trust and its shareholders. These businesses and interests include potential multiple advisory, transactional, financial and other relationships with, or interests in companies and interests in
securities or other instruments that may be purchased or sold by the Trust.
BlackRock has proprietary interests in, and
may manage or advise with respect to, accounts or funds (including separate accounts and other funds and collective investment vehicles) that have investment objectives similar to those of the Trust and/or that engage in transactions in the same
types of securities, currencies and instruments as the Trust. BlackRock is also a major participant in the global currency, equities, swap and fixed-income markets, in each case, for the accounts of clients and, in some cases, on a proprietary
basis. As such, BlackRock is or may be actively engaged in transactions in the same securities, currencies, and instruments in which the Trust invests. Such activities could affect the prices and availability of the securities, currencies, and
instruments in which the Trust invests, which could have an adverse impact on the Trusts performance. Such transactions, particularly in respect of most proprietary accounts or client accounts, will be executed independently of the
Trusts transactions and thus at prices or rates that may be more or less favorable than those obtained by the Trust.
When BlackRock seeks to purchase or sell the same assets for client accounts, including the Trust, the assets actually
purchased or sold may be allocated among the accounts on a basis determined in its good faith discretion to be equitable. In some cases, this system may adversely affect the size or price of the assets purchased or sold for the Trust. In addition,
transactions in investments by one or more other accounts managed by BlackRock may have the effect of diluting or otherwise disadvantaging the values, prices or investment strategies of the Trust, particularly, but not limited to, with respect to
small capitalization, emerging market or less liquid strategies. This may occur with respect to BlackRock-advised accounts when investment decisions regarding the Trust are based on research or other information that is also used to support
decisions for other accounts. When BlackRock implements a portfolio decision or strategy on behalf of another account ahead of, or contemporaneously with, similar decisions or strategies for the Trust, market impact, liquidity constraints, or other
factors could result in the Trust receiving less favorable trading results and the costs of implementing such decisions or strategies could be increased or the Trust could otherwise be disadvantaged. BlackRock may, in certain cases, elect to
implement internal policies and procedures designed to limit such consequences, which may cause the Trust to be unable to engage in certain activities, including purchasing or disposing of securities, when it might otherwise be desirable for it to
do so. Conflicts may also arise because portfolio decisions regarding the Trust may benefit other accounts managed by BlackRock. For example, the sale of a long position or establishment of a short position by the Trust may impair the price of the
same security sold short by (and therefore benefit) BlackRock or its other accounts or funds, and the purchase of a security or covering of a short position in a security by the Trust may increase the price of the same security held by (and
therefore benefit) BlackRock or its other accounts or funds.
BlackRock, on behalf of other client accounts, on the one
hand, and the Trust, on the other hand, may invest in or extend credit to different parts of the capital structure of a single issuer. BlackRock may pursue rights, provide advice or engage in other activities, or refrain from pursuing rights,
providing advice or engaging in
S-57
other activities, on behalf of other clients with respect to an issuer in which a Fund has invested, and such actions (or refraining from action) may have a material adverse effect on the Trust.
In situations in which clients of BlackRock (including the Trust) hold positions in multiple parts of the capital structure of an issuer, BlackRock may not pursue certain actions or remedies that may be available to the Trust, as a result of legal
and regulatory requirements or otherwise. BlackRock addresses these and other potential conflicts of interest based on the facts and circumstances of particular situations. For example, BlackRock may determine to rely on information barriers
between different business units or portfolio management teams. BlackRock may also determine to rely on the actions of similarly situated holders of loans or securities rather than, or in connection with, taking such actions itself on behalf of the
Trust.
In addition, to the extent permitted by applicable law, the Trust may invest its assets in other funds advised by
BlackRock, including funds that are managed by one or more of the same portfolio managers, which could result in conflicts of interest relating to asset allocation, timing of Trust purchases and redemptions, and increased remuneration and
profitability for BlackRock and/or its personnel, including portfolio managers.
In certain circumstances, BlackRock, on
behalf of the Trust, may seek to buy from or sell securities to another fund or account advised by BlackRock. BlackRock may (but is not required to) effect purchases and sales between BlackRock clients (cross trades), including the
Trust, if BlackRock believes such transactions are appropriate based on each partys investment objectives and guidelines, subject to applicable law and regulation. There may be potential conflicts of interest or regulatory issues relating to
these transactions which could limit BlackRocks decision to engage in these transactions for the Trust. BlackRock may have a potentially conflicting division of loyalties and responsibilities to the parties in such transactions.
BlackRock and its clients may pursue or enforce rights with respect to an issuer in which the Trust has invested, and those
activities may have an adverse effect on the Trust. As a result, prices, availability, liquidity and terms of the Trusts investments may be negatively impacted by the activities of BlackRock or its clients, and transactions for the Trust may
be impaired or effected at prices or terms that may be less favorable than would otherwise have been the case.
The
results of the Trusts investment activities may differ significantly from the results achieved by BlackRock for its proprietary accounts or other accounts (including investment companies or collective investment vehicles) that it manages or
advises. It is possible that one or more accounts managed or advised by BlackRock and such other accounts will achieve investment results that are substantially more or less favorable than the results achieved by the Trust. Moreover, it is possible
that the Trust will sustain losses during periods in which one or more proprietary or other accounts managed or advised by BlackRock achieve significant profits. The opposite result is also possible.
From time to time, the Trust may be restricted from purchasing or selling securities, or from engaging in other investment
activities because of regulatory, legal or contractual requirements applicable to BlackRock or other accounts managed or advised by BlackRock, and/or the internal policies of BlackRock designed to comply with such requirements. As a result, there
may be periods, for example, when BlackRock will not initiate or recommend certain types of transactions in certain securities or instruments with respect to which BlackRock is performing services or when position limits have been reached. For
example, the investment activities of BlackRock for its proprietary accounts and accounts under its management may limit the investment opportunities for the Trust in certain emerging and other markets in which limitations are imposed upon the
amount of investment, in the aggregate or in individual issuers, by affiliated foreign investors.
In connection with its
management of the Trust, BlackRock may have access to certain fundamental analysis and proprietary technical models developed by BlackRock. BlackRock will not be under any obligation, however, to effect transactions on behalf of the Trust in
accordance with such analysis and models. In addition, BlackRock will not have any obligation to make available any information regarding its proprietary activities or strategies, or the activities or strategies used for other accounts managed by
them, for the benefit of the
S-58
management of the Trust and it is not anticipated that BlackRock will have access to such information for the purpose of managing the Trust. The proprietary activities or portfolio strategies of
BlackRock or the activities or strategies used for accounts managed by BlackRock or other client accounts could conflict with the transactions and strategies employed by BlackRock in managing the Trust.
In addition, certain principals and certain employees of the Trusts investment adviser are also principals or employees
of other business units or entities within BlackRock. As a result, these principals and employees may have obligations to such other business units or entities or their clients and such obligations to other business units or entities or their
clients may be a consideration of which investors in the Trust should be aware.
BlackRock may enter into transactions and
invest in securities, instruments and currencies on behalf of the Trust in which clients of BlackRock, or, to the extent permitted by the SEC and applicable law, BlackRock, serves as the counterparty, principal or issuer. In such cases, such
partys interests in the transaction will be adverse to the interests of the Trust, and such party may have no incentive to assure that the Trust obtains the best possible prices or terms in connection with the transactions. In addition, the
purchase, holding and sale of such investments by the Trust may enhance the profitability of BlackRock.
BlackRock may
also create, write or issue derivatives for clients, the underlying securities, currencies or instruments of which may be those in which the Trust invests or which may be based on the performance of the Trust. BlackRock has entered into an
arrangement with Markit Indices Limited, the index provider for underlying fixed-income indexes used by certain iShares ETFs, related to derivative fixed-income products that are based on such iShares ETFs. BlackRock will receive certain payments
for licensing intellectual property belonging to BlackRock and for facilitating provision of data in connection with such derivative products, which may include payments based on the trading volumes of, or revenues generated by, the derivative
products. The Trust and other accounts managed by BlackRock may from time to time transact in such derivative products where permitted by the Trusts investment strategy, which could contribute to the viability of such derivative products by
making them more appealing to funds and accounts managed by third parties, and in turn lead to increased payments to BlackRock. Trading activity in these derivative products could also potentially lead to greater liquidity for such products,
increased purchase activity with respect to these iShares ETFs and increased assets under management for BlackRock.
The
Trust may, subject to applicable law, purchase investments that are the subject of an underwriting or other distribution by BlackRock and may also enter into transactions with other clients of BlackRock where such other clients have interests
adverse to those of the Trust. At times, these activities may cause business units or entities within BlackRock to give advice to clients that may cause these clients to take actions adverse to the interests of the Trust. To the extent such
transactions are permitted, the Trust will deal with BlackRock on an arms-length basis.
To the extent authorized by
applicable law, BlackRock may act as broker, dealer, agent, lender or adviser or in other commercial capacities for the Trust. It is anticipated that the commissions, mark-ups, mark-downs, financial advisory
fees, underwriting and placement fees, sales fees, financing and commitment fees, brokerage fees, other fees, compensation or profits, rates, terms and conditions charged by BlackRock will be in its view commercially reasonable, although BlackRock,
including its sales personnel, will have an interest in obtaining fees and other amounts that are favorable to BlackRock and such sales personnel, which may have an adverse effect on the Trust.
Subject to applicable law, BlackRock (and its personnel and other distributors) will be entitled to retain fees and other
amounts that they receive in connection with their service to the Trust as broker, dealer, agent, lender, adviser or in other commercial capacities. No accounting to the Trust or its shareholders will be required, and no fees or other compensation
payable by the Trust or its shareholders will be reduced by reason of receipt by BlackRock of any such fees or other amounts.
S-59
When BlackRock acts as broker, dealer, agent, adviser or in other commercial
capacities in relation to the Trust or BlackRock may take commercial steps in its own interests, which may have an adverse effect on the Trust. The Trust will be required to establish business relationships with its counterparties based on the
Trusts own credit standing. BlackRock will not have any obligation to allow credit to be used in connection with the Trusts establishment of its business relationships, nor is it expected that the Trusts counterparties will rely on
the credit of BlackRock in evaluating the Trusts creditworthiness.
BlackRock Investment Management, LLC
(BIM), an affiliate of BlackRock, pursuant to SEC exemptive relief, acts as securities lending agent to, and receives a share of securities lending revenues from, the Trust. BlackRock may receive compensation for managing the
reinvestment of the cash collateral from securities lending. There are potential conflicts of interests in managing a securities lending program, including but not limited to: (i) BlackRock as securities lending agent may have an incentive to
increase or decrease the amount of securities on loan or to lend particular securities in order to generate additional risk-adjusted revenue for BlackRock and its affiliates; and (ii) BlackRock as securities lending agent may have an incentive
to allocate loans to clients that would provide more revenue to BlackRock. As described further below, BlackRock seeks to mitigate this conflict by providing its securities lending clients with equal lending opportunities over time in order to
approximate pro rata allocation.
As part of its securities lending program, BlackRock indemnifies certain clients and/or
funds against a shortfall in collateral in the event of borrower default. BlackRock calculates, on a regular basis, its potential dollar exposure to the risk of collateral shortfall upon counterparty default (shortfall risk) under the
securities lending program for both indemnified and non-indemnified clients. On a periodic basis, BlackRock also determines the maximum amount of potential indemnified shortfall risk arising from securities
lending activities (indemnification exposure limit) and the maximum amount of counterparty-specific credit exposure (credit limits) BlackRock is willing to assume as well as the programs operational complexity.
BlackRock oversees the risk model that calculates projected shortfall values using loan-level factors such as loan and collateral type and market value as well as specific borrower counterparty credit characteristics. When necessary, BlackRock may
further adjust other securities lending program attributes by restricting eligible collateral or reducing counterparty credit limits. As a result, the management of the indemnification exposure limit may affect the amount of securities lending
activity BlackRock may conduct at any given point in time and impact indemnified and non-indemnified clients by reducing the volume of lending opportunities for certain loans (including by asset type,
collateral type and/or revenue profile).
BlackRock uses a predetermined systematic process in order to approximate pro
rata allocation over time. In order to allocate a loan to a portfolio: (i) BlackRock as a whole must have sufficient lending capacity pursuant to the various program limits (i.e. indemnification exposure limit and counterparty credit limits);
(ii) the lending portfolio must hold the asset at the time a loan opportunity arrives; and (iii) the lending portfolio must also have enough inventory, either on its own or when aggregated with other portfolios into one single market delivery,
to satisfy the loan request. In doing so, BlackRock seeks to provide equal lending opportunities for all portfolios, independent of whether BlackRock indemnifies the portfolio. Equal opportunities for lending portfolios does not guarantee equal
outcomes. Specifically, short and long-term outcomes for individual clients may vary due to asset mix, asset/liability spreads on different securities, and the overall limits imposed by the firm.
Purchases and sales of securities and other assets for the Trust may be bunched or aggregated with orders for other BlackRock
client accounts, including with accounts that pay different transaction costs solely due to the fact that they have different research payment arrangements. BlackRock, however, is not required to bunch or aggregate orders if portfolio management
decisions for different accounts are made separately, or if they determine that bunching or aggregating is not practicable or required, or in cases involving client direction.
Prevailing trading activity frequently may make impossible the receipt of the same price or execution on the entire volume of
securities purchased or sold. When this occurs, the various prices may be averaged, and the Trust will be charged or credited with the average price. Thus, the effect of the aggregation may operate on some
S-60
occasions to the disadvantage of the Trust. In addition, under certain circumstances, the Trust will not be charged the same commission or commission equivalent rates in connection with a bunched
or aggregated order.
As discussed in the section entitled Portfolio Transactions and Brokerage in this SAI,
BlackRock, unless prohibited by applicable law, may cause the Trust or account to pay a broker or dealer a commission for effecting a transaction that exceeds the amount another broker or dealer would have charged for effecting the same transaction
in recognition of the value of brokerage and research services provided by that broker or dealer.
Subject to applicable
law, BlackRock may select brokers that furnish BlackRock, the Trust, other BlackRock client accounts or personnel, directly or through correspondent relationships, with research or other appropriate services which provide, in BlackRocks view,
appropriate assistance to BlackRock in the investment decision-making process (including with respect to futures, fixed-price offerings and OTC transactions). Such research or other services may include, to the extent permitted by law, research
reports on companies, industries and securities; economic and financial data; financial publications; proxy analysis; trade industry seminars; computer data bases; research-oriented software and other services and products.
Research or other services obtained in this manner may be used in servicing any or all of the Trust and other BlackRock client
accounts, including in connection with BlackRock client accounts other than those that pay commissions to the broker relating to the research or other service arrangements. Such products and services may disproportionately benefit other BlackRock
client accounts relative to the Trust based on the amount of brokerage commissions paid by the Trust and such other BlackRock client accounts. For example, research or other services that are paid for through one clients commissions may not be
used in managing that clients account. In addition, other BlackRock client accounts may receive the benefit, including disproportionate benefits, of economies of scale or price discounts in connection with products and services that may be
provided to the Trust and to such other BlackRock client accounts. To the extent that BlackRock uses soft dollars, it will not have to pay for those products and services itself.
BlackRock, unless prohibited by applicable law, may endeavor to execute trades through brokers who, pursuant to such
arrangements, provide research or other services in order to ensure the continued receipt of research or other services BlackRock believes are useful in its investment decision-making process. BlackRock may from time to time choose not to engage in
the above described arrangements to varying degrees. BlackRock, unless prohibited by applicable law, may also enter into commission sharing arrangements under which BlackRock may execute transactions through a broker-dealer and request that the
broker-dealer allocate a portion of the commissions or commission credits to another firm that provides research to BlackRock. To the extent that BlackRock engages in commission sharing arrangements, many of the same conflicts related to traditional
soft dollars may exist.
BlackRock may utilize certain electronic crossing networks (ECNs) (including, without
limitation, ECNs in which BlackRock has an investment or other interest, to the extent permitted by applicable law) in executing client securities transactions for certain types of securities. These ECNs may charge fees for their services, including
access fees and transaction fees. The transaction fees, which are similar to commissions or markups/markdowns, will generally be charged to clients and, like commissions and markups/markdowns, would generally be included in the cost of the
securities purchased. Access fees may be paid by BlackRock even though incurred in connection with executing transactions on behalf of clients, including the Trust. In certain circumstances, ECNs may offer volume discounts that will reduce the
access fees typically paid by BlackRock. BlackRock will only utilize ECNs consistent with its obligation to seek to obtain best execution in client transactions.
BlackRock owns a minority interest in, and is a member of, Members Exchange (MEMX), a newly created U.S. stock
exchange. Transactions for the Trust may be executed on MEMX if third party brokers select MEMX as the appropriate venue for execution of orders placed by BlackRock traders on behalf of client portfolios.
S-61
BlackRock has adopted policies and procedures designed to prevent conflicts of
interest from influencing proxy voting decisions that it makes on behalf of advisory clients, including the Trust, and to help ensure that such decisions are made in accordance with BlackRocks fiduciary obligations to its clients.
Nevertheless, notwithstanding such proxy voting policies and procedures, actual proxy voting decisions of BlackRock may have the effect of favoring the interests of other clients or businesses of other divisions or units of BlackRock, provided that
BlackRock believes such voting decisions to be in accordance with its fiduciary obligations. For a more detailed discussion of these policies and procedures, see Appendix B.
It is possible that the Trust may invest in securities of, or engage in transactions with, companies in which BlackRock has
significant debt or equity investments or other interests. The Trust may also invest in issuances (such as structured notes) by entities for which BlackRock provides and is compensated for cash management services relating to the proceeds from the
sale of such issuances. In making investment decisions for the Trust, BlackRock is not permitted to obtain or use material non-public information acquired by any unit of BlackRock, in the course of these
activities. In addition, from time to time, the activities of BlackRock may limit the Trusts flexibility in purchases and sales of securities. As indicated below, BlackRock may engage in transactions with companies in which BlackRock-advised
funds or other clients of BlackRock have an investment.
BlackRock may provide valuation assistance to certain clients
with respect to certain securities or other investments and the valuation recommendations made for such clients accounts may differ from the valuations for the same securities or investments assigned by the Trusts pricing vendors,
especially if such valuations are based on broker-dealer quotes or other data sources unavailable to the Trusts pricing vendors. While BlackRock will generally communicate its valuation information or determinations to the Trusts pricing
vendors and/or fund accountants, there may be instances where the Trusts pricing vendors or fund accountants assign a different valuation to a security or other investment than the valuation for such security or investment determined or
recommended by BlackRock.
As disclosed in more detail in Net Asset Value in the prospectus, when market
quotations are not readily available or are believed by BlackRock to be unreliable, the Trusts investments are valued at fair value by BlackRock, in accordance with procedures adopted by the Trusts Board of Trustees. When determining a
fair value price, BlackRock seeks to determine the price that the Trust might reasonably expect to receive from the current sale of that asset or liability in an arms-length transaction. The
price generally may not be determined based on what the Trust might reasonably expect to receive for selling an asset or liability at a later time or if it holds the asset or liability to maturity. While fair value determinations will be based upon
all available factors that BlackRock deems relevant at the time of the determination, and may be based on analytical values determined by BlackRock using proprietary or third party valuation models, fair value represents only a good faith
approximation of the value of an asset or liability. The fair value of one or more assets or liabilities may not, in retrospect, be the price at which those assets or liabilities could have been sold during the period in which the particular fair
values were used in determining the Trusts net asset value. As a result, the Trusts sale or repurchase of its shares at net asset value, at a time when a holding or holdings are valued by BlackRock (pursuant to Board-adopted procedures)
at fair value, may have the effect of diluting or increasing the economic interest of existing shareholders and may affect the amount of revenue received by BlackRock with respect to services for which it receives an asset-based fee.
To the extent permitted by applicable law, the Trust may invest all or some of its short-term cash investments in any money
market fund or similarly-managed private fund advised or managed by BlackRock. In connection with any such investments, the Trust, to the extent permitted by the Investment Company Act, may pay its share of expenses of a money market fund or other
similarly-managed private fund in which it invests, which may result in the Trust bearing some additional expenses.
BlackRock and its directors, officers and employees, may buy and sell securities or other investments for their own accounts
and may have conflicts of interest with respect to investments made on behalf of the Trust. As a result of differing trading and investment strategies or constraints, positions may be taken by directors, officers
S-62
and employees of BlackRock that are the same, different from or made at different times than positions taken for the Trust. To lessen the possibility that the Trust will be adversely affected by
this personal trading, the Trust and the Advisor each have adopted a Code of Ethics in compliance with Section 17(j) of the Investment Company Act that restricts securities trading in the personal accounts of investment professionals and others
who normally come into possession of information regarding the Trusts portfolio transactions. Each Code of Ethics is also available on the EDGAR Database on the SECs Internet site at http://www.sec.gov, and copies may be obtained, after
paying a duplicating fee, by e-mail at publicinfo@sec.gov.
BlackRock will not
purchase securities or other property from, or sell securities or other property to, the Trust, except that the Trust may in accordance with rules or guidance adopted under the Investment Company Act engage in transactions with another
BlackRock-advised fund accounts that are affiliated with the Trust as a result of common officers, directors, or investment advisers or pursuant to exemptive orders granted to the Trust and/or BlackRock by the SEC. These transactions would be
effected in circumstances in which BlackRock determined that it would be appropriate for the Trust to purchase and another client of BlackRock to sell, or the Trust to sell and another client of BlackRock to purchase, the same security or instrument
on the same day. From time to time, the activities of the Trust may be restricted because of regulatory requirements applicable to BlackRock and/or BlackRocks internal policies designed to comply with, limit the applicability of, or otherwise
relate to such requirements. A client not advised by BlackRock would not be subject to some of those considerations. There may be periods when BlackRock may not initiate or recommend certain types of transactions, or may otherwise restrict or limit
its advice in certain securities or instruments issued by or related to companies for which BlackRock is performing advisory or other services or has proprietary positions. For example, when BlackRock is engaged to provide advisory or risk
management services for a company, BlackRock may be prohibited from or limited in purchasing or selling securities of that company on behalf of the Trust, particularly where such services result in BlackRock obtaining material non-public information about the company (e.g., in connection with participation in a creditors committee). Similar situations could arise if personnel of BlackRock serve as directors of companies the
securities of which the Trust wishes to purchase or sell. However, if permitted by applicable law, and where consistent with BlackRocks policies and procedures (including the necessary implementation of appropriate information barriers), the
Trust may purchase securities or instruments that are issued by such companies, are the subject of an advisory or risk management assignment by BlackRock, or where personnel of BlackRock are directors or officers of the issuer.
The investment activities of BlackRock for its proprietary accounts and for client accounts may also limit the investment
strategies and rights of the Trust. For example, in certain circumstances where the Trust invests in securities issued by companies that operate in certain regulated industries, in certain emerging or international markets, or are subject to
corporate or regulatory ownership restrictions, or invest in certain futures and derivative transactions, there may be limits on the aggregate amount invested by BlackRock for its proprietary accounts and for client accounts (including the Trust)
that may not be exceeded without the grant of a license or other regulatory or corporate consent, or, if exceeded, may cause BlackRock, the Trust or other client accounts to suffer disadvantages or business restrictions. If certain aggregate
ownership thresholds are reached or certain transactions undertaken, the ability of BlackRock on behalf of clients (including the Trust) to purchase or dispose of investments, or exercise rights or undertake business transactions, may be restricted
by regulation or otherwise impaired. As a result, BlackRock on behalf of its clients (including the Trust) may limit purchases, sell existing investments, or otherwise restrict, forgo or limit the exercise of rights (including transferring,
outsourcing or limiting voting rights or forgoing the right to receive dividends) when BlackRock, in its sole discretion, deems it appropriate in light of potential regulatory or other restrictions on ownership or other consequences resulting from
reaching investment thresholds.
In those circumstances where ownership thresholds or limitations must be observed,
BlackRock seeks to allocate limited investment opportunities equitably among clients (including the Trust), taking into consideration benchmark weight and investment strategy. When ownership in certain securities nears an applicable threshold,
BlackRock may limit purchases in such securities to the issuers weighting in the applicable benchmark used by BlackRock to manage the Trust. If client (including Trust) holdings of an issuer exceed an applicable threshold
S-63
and BlackRock is unable to obtain relief to enable the continued holding of such investments, it may be necessary to sell down these positions to meet the applicable limitations. In these cases,
benchmark overweight positions will be sold prior to benchmark positions being reduced to meet applicable limitations.
In
addition to the foregoing, other ownership thresholds may trigger reporting requirements to governmental and regulatory authorities, and such reports may entail the disclosure of the identity of a client or BlackRocks intended strategy with
respect to such security or asset.
BlackRock may maintain securities indices. To the extent permitted by applicable laws,
the Trust may seek to license and use such indices as part of their investment strategy. Index based funds that seek to track the performance of securities indices also may use the name of the index or index provider in the fund name. Index
providers, including BlackRock (to the extent permitted by applicable law), may be paid licensing fees for use of their index or index name. BlackRock is not obligated to license its indices to the Trust and the Trust is under no obligation to use
BlackRock indices. The Trust cannot be assured that the terms of any index licensing agreement with BlackRock will be as favorable as those terms offered to other licensees.
BlackRock may enter into contractual arrangements with third-party service providers to the Trust (e.g., custodians,
administrators and index providers) pursuant to which BlackRock receives fee discounts or concessions in recognition of BlackRocks overall relationship with such service providers. To the extent that BlackRock is responsible for paying these
service providers out of its management fee, the benefits of any such fee discounts or concessions may accrue, in whole or in part, to BlackRock.
BlackRock owns or has an ownership interest in certain trading, portfolio management, operations and/or information systems
used by Trust service providers. These systems are, or will be, used by the Trust service provider in connection with the provision of services to accounts managed by BlackRock and funds managed and sponsored by BlackRock, including the Trust, that
engage the service provider (typically the custodian). The Trusts service provider remunerates BlackRock for the use of the systems. The Trusts service providers payments to BlackRock for the use of these systems may enhance the
profitability of BlackRock.
BlackRocks receipt of fees from a service provider in connection with the use of
systems provided by BlackRock may create an incentive for BlackRock to recommend that the Trust enter into or renew an arrangement with the service provider.
In recognition of a BlackRock clients overall relationship with BlackRock, BlackRock may offer special pricing
arrangements for certain services provided by BlackRock. Any such special pricing arrangements will not affect Trust fees and expenses applicable to such clients investment in the Trust.
Present and future activities of BlackRock and its directors, officers and employees, in addition to those described in this
section, may give rise to additional conflicts of interest.
S-64
DESCRIPTION OF SHARES
Common Shares
The Trust
intends to hold annual meetings of shareholders so long as the common shares are listed on a national securities exchange and such meetings are required as a condition to such listing.
Preferred Shares
The
Trust currently does not intend to issue preferred shares. Although the terms of any preferred shares that the Trust might issue in the future, including dividend rate, liquidation preference and redemption provisions, will be determined by the
Board, subject to applicable law and the Agreement and Declaration of Trust, it is likely that any such preferred shares issued would be structured to carry a relatively short-term dividend rate reflecting interest rates on short-term debt
securities, by providing for the periodic redetermination of the dividend rate at relatively short intervals through a fixed spread or remarketing procedure, subject to a maximum rate which would increase over time in the event of an extended period
of unsuccessful remarketing. The Trust also believes that it is likely that the liquidation preference, voting rights and redemption provisions of any such preferred shares would be similar to those stated below.
Liquidation Preference. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the
Trust, the holders of preferred shares will be entitled to receive a preferential liquidating distribution, which would be expected to equal the original purchase price per preferred share plus accrued and unpaid dividends, whether or not declared,
before any distribution of assets is made to holders of common shares. After payment of the full amount of the liquidating distribution to which they are entitled, the holders of preferred shares would not be entitled to any further participation in
any distribution of assets by the Trust.
Voting Rights. The Investment Company Act requires that the holders of
any preferred shares, voting separately as a single class, have the right to elect at least two Trustees at all times. The remaining Trustees will be elected by holders of common shares and preferred shares, voting together as a single class. In
addition, subject to the prior rights, if any, of the holders of any other class of senior securities outstanding, the holders of any preferred shares have the right to elect a majority of the Trustees at any time two years dividends on any
preferred shares are unpaid. The Investment Company Act also requires that, in addition to any approval by shareholders that might otherwise be required, the approval of the holders of a majority of any outstanding preferred shares, voting
separately as a class, would be required to (1) adopt any plan of reorganization that would adversely affect the preferred shares, and (2) take any action requiring a vote of security holders under Section 13(a) of the Investment
Company Act, including, among other things, changes in the Trusts sub-classification as a closed-end investment company or changes in its fundamental investment
restrictions. See Certain Provisions in the Agreement and Declaration of Trust and Bylaws in the prospectus. As a result of these voting rights, the Trusts ability to take any such actions may be impeded to the extent that there
are any preferred shares outstanding. The Board presently intends that, except as otherwise indicated in the prospectus or this SAI and except as otherwise required by applicable law, holders of any preferred shares will have equal voting rights
with holders of common shares (one vote per share, unless otherwise required by the Investment Company Act) and will vote together with holders of common shares as a single class.
The affirmative vote of the holders of a majority of any outstanding preferred shares, voting as a separate class, would be
required to amend, alter or repeal any of the preferences, rights or powers of holders of preferred shares so as to affect materially and adversely such preferences, rights or powers, or to increase or decrease the authorized number of preferred
shares. The class vote of holders of preferred shares described above would in each case be in addition to any other vote required to authorize the action in question.
Redemption, Purchase and Sale of Preferred Shares by the Trust. The terms of any preferred shares are expected to
provide that (1) they are redeemable by the Trust in whole or in part at the original purchase price per
S-65
share plus accrued dividends per share, (2) the Trust may tender for or purchase preferred shares and (3) the Trust may subsequently resell any shares so tendered for or purchased. Any
redemption or purchase of preferred shares by the Trust would reduce the leverage applicable to the common shares, while any resale of shares by the Trust would increase that leverage.
Liquidity Feature. Preferred shares may include a liquidity feature that allows holders of preferred shares to have
their shares purchased by a liquidity provider in the event that sell orders have not been matched with purchase orders and successfully settled in a remarketing. The Trust would pay a fee to the provider of this liquidity feature, which would be
borne by common shareholders of the Trust. The terms of such liquidity feature may require the Trust to redeem preferred shares still owned by the liquidity provider following a certain period of continuous, unsuccessful remarketing, which may
adversely impact the Trust.
The discussion above describes the possible offering of preferred shares by the Trust. If the
Board determines to proceed with such an offering, the terms of the preferred shares may be the same as, or different from, the terms described above, subject to applicable law and the Trusts Agreement and Declaration of Trust. The Board,
without the approval of the holders of common shares, may authorize an offering of preferred shares or may determine not to authorize such an offering, and may fix the terms of the preferred shares to be offered.
Other Shares
The Board
(subject to applicable law and the Trusts Agreement and Declaration of Trust) may authorize an offering, without the approval of the holders of common shares and, depending on their terms, any preferred shares outstanding at that time, of
other classes of shares, or other classes or series of shares, as they determine to be necessary, desirable or appropriate, having such terms, rights, preferences, privileges, limitations and restrictions as the Board sees fit. The Trust currently
does not expect to issue any other classes of shares, or series of shares, except for the common shares.
S-66
REPURCHASE OF COMMON SHARES
The Trust is a closed-end management investment company and as such its shareholders
will not have the right to cause the Trust to redeem their shares. Instead, the Trusts common shares will trade in the open market at a price that will be a function of several factors, including dividend levels (which are in turn affected by
expenses), NAV, call protection for portfolio securities, dividend stability, liquidity, relative demand for and supply of the common shares in the market, general market and economic conditions and other factors. Because shares of a closed-end investment company may frequently trade at prices lower than NAV, the Board may consider action that might be taken to reduce or eliminate any material discount from NAV in respect of common shares, which
may include the repurchase of such shares in the open market or in private transactions, the making of a tender offer for such shares, or the conversion of the Trust to an open-end investment company. The
Board may decide not to take any of these actions. In addition, there can be no assurance that share repurchases or tender offers, if undertaken, will reduce market discount.
Notwithstanding the foregoing, at any time when the Trust has preferred shares outstanding, the Trust may not purchase, redeem
or otherwise acquire any of its common shares unless (1) all accrued preferred share dividends have been paid and (2) at the time of such purchase, redemption or acquisition, the NAV of the Trusts portfolio (determined after
deducting the acquisition price of the common shares) is at least 200% of the liquidation value of any outstanding preferred shares (expected to equal the original purchase price per share plus any accrued and unpaid dividends thereon). Any service
fees incurred in connection with any tender offer made by the Trust will be borne by the Trust and will not reduce the stated consideration to be paid to tendering shareholders.
Subject to its investment restrictions, the Trust may borrow to finance the repurchase of shares or to make a tender offer.
Interest on any borrowings to finance share repurchase transactions or the accumulation of cash by the Trust in anticipation of share repurchases or tender offers will reduce the Trusts net income. Any share repurchase, tender offer or
borrowing that might be approved by the Board would have to comply with the Exchange Act, the Investment Company Act and the rules and regulations thereunder.
Although the decision to take action in response to a discount from NAV will be made by the Board at the time it considers
such issue, it is the Boards present policy, which may be changed by the Board, not to authorize repurchases of common shares or a tender offer for such shares if: (i) such transactions, if consummated, would (a) result in the
delisting of the common shares from the NYSE, or (b) impair the Trusts status as a RIC under the Code, (which would make the Trust a taxable entity, causing the Trusts income to be taxed at the corporate level in addition to the
taxation of shareholders who receive dividends from the Trust) or as a registered closed-end investment company under the Investment Company Act; (ii) the Trust would not be able to liquidate portfolio
securities in an orderly manner and consistent with the Trusts investment objectives and policies in order to repurchase shares; or (iii) there is, in the Boards judgment, any (a) material legal action or proceeding instituted
or threatened challenging such transactions or otherwise materially adversely affecting the Trust, (b) general suspension of or limitation on prices for trading securities on the NYSE, (c) declaration of a banking moratorium by federal or
state authorities or any suspension of payment by United States or New York banks, (d) material limitation affecting the Trust or the issuers of its portfolio securities by federal or state authorities on the extension of credit by lending
institutions or on the exchange of foreign currency, (e) commencement of war, armed hostilities or other international or national calamity directly or indirectly involving the United States, or (f) other event or condition which would
have a material adverse effect (including any adverse tax effect) on the Trust or its shareholders if shares were repurchased. The Board may in the future modify these conditions in light of experience.
The repurchase by the Trust of its shares at prices below NAV will result in an increase in the NAV of those shares that
remain outstanding. However, there can be no assurance that share repurchases or tender offers at or below NAV will result in the Trusts common shares trading at a price equal to their NAV. Nevertheless, the fact
S-67
that the Trusts common shares may be the subject of repurchases or tender offers from time to time, or that the Trust may be converted to an open-end
investment company, may reduce any spread between market price and NAV that might otherwise exist.
In addition, a
purchase by the Trust of its common shares will decrease the Trusts net assets which would likely have the effect of increasing the Trusts expense ratio. Any purchase by the Trust of its common shares at a time when preferred shares are
outstanding will increase the leverage applicable to the outstanding common shares then remaining.
Before deciding
whether to take any action if the common shares trade below NAV, the Board would likely consider all relevant factors, including the extent and duration of the discount, the liquidity of the Trusts portfolio, the impact of any action that
might be taken on the Trust or its shareholders and market considerations. Based on these considerations, even if the Trusts common shares should trade at a discount, the Board may determine that, in the interest of the Trust and its
shareholders, no action should be taken.
S-68
TAX MATTERS
The following is a description of certain U.S. federal income tax consequences to a shareholder of acquiring, holding and
disposing of common shares of the Trust. Except as otherwise noted, this discussion assumes you are a taxable U.S. holder (as defined below). This discussion is based upon current provisions of the Internal Revenue Code of 1986, as amended (the
Code), the regulations promulgated thereunder and judicial and administrative authorities, all of which are subject to change or differing interpretations by the courts or the IRS, possibly with retroactive effect. No attempt is made to
present a detailed explanation of all U.S. federal income tax concerns affecting the Trust and its shareholders, and the discussions set forth here do not constitute tax advice. This discussion assumes that investors hold common shares of the Trust
as capital assets (generally, for investment). The Trust has not sought and will not seek any ruling from the IRS regarding any matters discussed herein. No assurance can be given that the IRS would not assert, or that a court would not sustain, a
position contrary to those set forth below. This summary does not discuss any aspects of foreign, state or local tax. Prospective investors must consult their own tax advisers as to the U.S. federal income tax consequences (including the alternative
minimum tax consequences) of acquiring, holding and disposing of the Trusts common shares, as well as the effects of state, local and non-U.S. tax laws.
In addition, no attempt is made to address tax considerations applicable to an investor with a special tax status, such as a
financial institution, REIT, insurance company, regulated investment company, individual retirement account, other tax-exempt organization, dealer in securities or currencies, person holding shares of the
Trust as part of a hedging, integrated, conversion or straddle transaction, trader in securities that has elected the mark-to-market method of accounting for its
securities, U.S. holder (as defined below) whose functional currency is not the U.S. dollar, investor with applicable financial statements within the meaning of Section 451(b) of the Code, or
non-U.S. investor. Furthermore, this discussion does not reflect possible application of the alternative minimum tax.
A U.S. holder is a beneficial owner that is for U.S. federal income tax purposes:
|
|
|
a citizen or individual resident of the United States (including certain former citizens and former long-term
residents); |
|
|
|
a corporation or other entity treated as a corporation for U.S. federal income tax purposes, created or
organized in or under the laws of the United States or any state thereof or the District of Columbia; |
|
|
|
an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or
|
|
|
|
a trust with respect to which a court within the United States is able to exercise primary supervision over
its administration and one or more U.S. persons have the authority to control all of its substantial decisions or the trust has made a valid election in effect under applicable Treasury regulations to be treated as a U.S. person.
|
Taxation of the Trust
The Trust intends to elect to be treated and to qualify to be taxed as a RIC under Subchapter M of the Code. In order to
qualify as a RIC, the Trust must, among other things, satisfy certain requirements relating to the sources of its income, diversification of its assets, and distribution of its income to its shareholders. First, the Trust must derive at least 90% of
its annual gross income from dividends, interest, payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies, or other income (including but not limited to gains from options,
futures and forward contracts) derived with respect to its business of investing in such stock, securities or currencies, or net income derived from interests in qualified publicly traded partnerships (as defined in the Code) (the
90% gross income test). Second, the Trust must diversify its holdings so that, at the close of each quarter of its taxable year, (i) at least 50% of the value of its total assets consists of cash, cash items, U.S. Government
securities, securities of other RICs and other securities, with such other securities limited in respect of any one issuer to an amount not greater in value than 5% of the
S-69
value of the Trusts total assets and to not more than 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the market value of the Trusts total
assets is invested in the securities (other than U.S. Government securities and securities of other RICs) of any one issuer, any two or more issuers controlled by the Trust and engaged in the same, similar or related trades or businesses, or any one
or more qualified publicly traded partnerships.
As long as the Trust qualifies as a RIC, the Trust will
generally not be subject to corporate-level U.S. federal income tax on income and gains that it distributes each taxable year to its shareholders, provided that in such taxable year it distributes at least 90% of the sum of (i) its net tax-exempt interest income, if any, and (ii) its investment company taxable income (which includes, among other items, dividends, taxable interest, taxable original issue discount and market
discount income, income from securities lending, net short-term capital gain in excess of net long-term capital loss, and any other taxable income other than net capital gain (as defined below) and is reduced by deductible expenses)
determined without regard to the deduction for dividends paid. The Trust may retain for investment its net capital gain (which consists of the excess of its net long-term capital gain over its net short-term capital loss). However, if the Trust
retains any net capital gain or any investment company taxable income, it will be subject to tax at regular corporate rates on the amount retained.
The Code imposes a 4% nondeductible excise tax on the Trust to the extent the Trust does not distribute by the end of any
calendar year at least the sum of (i) 98% of its ordinary income (not taking into account any capital gain or loss) for the calendar year and (ii) 98.2% of its capital gain in excess of its capital loss (adjusted for certain ordinary losses) for a one-year period generally ending on October 31 of the calendar year (unless an election is made to use the Trusts fiscal year). In addition, the minimum amounts that must be distributed in any year to
avoid the excise tax will be increased or decreased to reflect the total amount of any under-distribution or over-distribution, as the case may be, from the previous year. For purposes of the excise tax, the Trust will be deemed to have distributed
any income on which it paid U.S. federal income tax. While the Trust intends to distribute any income and capital gain in the manner necessary to minimize imposition of the 4% nondeductible excise tax, there can be no assurance that sufficient
amounts of the Trusts taxable income and capital gain will be distributed to entirely avoid the imposition of the excise tax. In that event, the Trust will be liable for the excise tax only on the amount by which it does not meet the foregoing
distribution requirement.
If in any taxable year the Trust should fail to qualify under Subchapter M of the Code for tax
treatment as a RIC, the Trust would incur a regular corporate U.S. federal income tax upon all of its taxable income for that year, and all distributions to its shareholders (including distributions of net capital gain) would be taxable to
shareholders as ordinary dividend income for U.S. federal income tax purposes to the extent of the Trusts earnings and profits. Provided that certain holding period and other requirements were met, such dividends would be eligible (i) to
be treated as qualified dividend income in the case of shareholders taxed as individuals and (ii) for the dividends received deduction in the case of corporate shareholders. In addition, to qualify again to be taxed as a RIC in a subsequent
year, the Trust would be required to distribute to shareholders its earnings and profits attributable to non-RIC years. In addition, if the Trust failed to qualify as a RIC for a period greater than two
taxable years, then, in order to qualify as a RIC in a subsequent year, the Trust would be required to elect to recognize and pay tax on any net built-in gain (the excess of aggregate gain, including items of
income, over aggregate loss that would have been realized if the Trust had been liquidated) or, alternatively, be subject to taxation on such built-in gain recognized for a period of five years.
The remainder of this discussion assumes that the Trust qualifies for taxation as a RIC.
The Trusts Investments
The Trust has formed a wholly-owned Delaware subsidiary (the Blocker Subsidiary) to hold interests in certain of
its portfolio companies to permit the Trust to continue to meet the qualifications for taxation as a RIC. The Blocker Subsidiary will qualify for the exclusion from the definition of the term investment company pursuant to Section 3(c)(7) of
the Investment Company Act or will otherwise not be required to register as an
S-70
investment company under the Investment Company Act. Entities such as the Blocker Subsidiary are typically organized as corporations or as limited liability companies or partnerships that elect
to be taxed as corporations for U.S. federal income tax purposes and hold certain investments in pass-through tax entities (such as partnership interests or limited liability company interests) the gross revenue from which would be bad
income for purposes of RIC qualification. The Trust may not invest more than 25% of its total assets in the shares of the Blocker Subsidiary. The Blocker Subsidiary will be subject to U.S. federal corporate income tax. The Blocker
Subsidiarys distributions of its after-tax earnings to the Trust will be good income for RIC qualification purposes, and will be treated as qualified dividend income (for non-corporate shareholders) and as eligible for the dividends received deduction (for corporate shareholders), or as returns of capital.
Certain of the Trusts investment practices are subject to special and complex U.S. federal income tax provisions
(including mark-to-market, constructive sale, straddle, wash sale, short sale and other rules) that may, among other things, (i) disallow, suspend or otherwise
limit the allowance of certain losses or deductions, (ii) convert lower taxed long-term capital gains or qualified dividend income into higher taxed short-term capital gains or ordinary income, (iii) convert ordinary loss or a deduction
into capital loss (the deductibility of which is more limited), (iv) cause the Trust to recognize income or gain without a corresponding receipt of cash, (v) adversely affect the time as to when a purchase or sale of stock or securities is
deemed to occur, (vi) adversely alter the characterization of certain complex financial transactions and (vii) produce income that will not be qualified income for purposes of the 90% annual gross income requirement described
above. These U.S. federal income tax provisions could therefore affect the amount, timing and character of distributions to common shareholders. The Trust intends to monitor its transactions and may make certain tax elections and may be required to
dispose of securities to mitigate the effect of these provisions and prevent disqualification of the Trust as a RIC. Additionally, the Trust may be required to limit its activities in derivative instruments in order to enable it to maintain its RIC
status.
The Trust may invest a portion of its net assets in below investment grade securities, commonly known as
junk securities. Investments in these types of securities may present special tax issues for the Trust. U.S. federal income tax rules are not entirely clear about issues such as when the Trust may cease to accrue interest, original issue
discount or market discount, when and to what extent deductions may be taken for bad debts or worthless securities, how payments received on obligations in default should be allocated between principal and income and whether modifications or
exchanges of debt obligations in a bankruptcy or workout context are taxable. These and other issues could affect the Trusts ability to distribute sufficient income to preserve its status as a RIC or to avoid the imposition of U.S. federal
income or excise tax.
Certain debt securities acquired by the Trust may be treated as debt securities that were
originally issued at a discount. Generally, the amount of the original issue discount is treated as interest income and is included in taxable income (and required to be distributed by the Trust in order to qualify as a RIC and avoid U.S. federal
income tax or the 4% excise tax on undistributed income) over the term of the security, even though payment of that amount is not received until a later time, usually when the debt security matures.
If the Trust purchases a debt security on a secondary market at a price lower than its adjusted issue price, the excess of the
adjusted issue price over the purchase price is market discount. Unless the Trust makes an election to accrue market discount on a current basis, generally, any gain realized on the disposition of, and any partial payment of principal
on, a debt security having market discount is treated as ordinary income to the extent the gain, or principal payment, does not exceed the accrued market discount on the debt security. Market discount generally accrues in equal daily
installments. If the Trust ultimately collects less on the debt instrument than its purchase price plus the market discount previously included in income, the Trust may not be able to benefit from any offsetting loss deductions.
The Trust may invest in preferred securities or other securities the U.S. federal income tax treatment of which may not be
clear or may be subject to recharacterization by the IRS. To the extent the tax treatment of such securities or the income from such securities differs from the tax treatment expected by the Trust, it could
S-71
affect the timing or character of income recognized by the Trust, potentially requiring the Trust to purchase or sell securities, or otherwise change its portfolio, in order to comply with the
tax rules applicable to RICs under the Code.
Gain or loss on the sale of securities by the Trust will generally be
long-term capital gain or loss if the securities have been held by the Trust for more than one year. Gain or loss on the sale of securities held for one year or less will be short-term capital gain or loss.
Because the Trust may invest in foreign securities, its income from such securities may be subject to non-U.S. taxes. If more than 50% of the Trusts total assets at the close of its taxable year consists of stock or securities of foreign corporations, the Trust may elect for U.S. federal income tax purposes to
treat foreign income taxes paid by it as paid by its shareholders. The Trust may qualify for and make this election in some, but not necessarily all, of its taxable years. If the Trust were to make such an election, shareholders would be required to
take into account an amount equal to their pro rata portions of such foreign taxes in computing their taxable income and then treat an amount equal to those foreign taxes as a U.S. federal income tax deduction or as a foreign tax credit against
their U.S. federal income tax liability. A taxpayers ability to use a foreign tax deduction or credit is subject to limitations under the Code. Shortly after any year for which it makes such an election, the Trust will report to its
shareholder the amount per share of such foreign income tax that must be included in each shareholders gross income and the amount that may be available for the deduction or credit.
Foreign currency gain or loss on foreign currency exchange contracts, non-U.S.
dollar-denominated securities contracts, and non-U.S. dollar-denominated futures contracts, options and forward contracts that are not section 1256 contracts (as defined below) generally will be treated as
ordinary income and loss.
Income from options on individual securities written by the Trust will generally not be
recognized by the Trust for tax purposes until an option is exercised, lapses or is subject to a closing transaction (as defined by applicable regulations) pursuant to which the Trusts obligations with respect to the option are
otherwise terminated. If the option lapses without exercise, the premiums received by the Trust from the writing of such options will generally be characterized as short-term capital gain. If the Trust enters into a closing transaction, the
difference between the premiums received and the amount paid by the Trust to close out its position will generally be treated as short-term capital gain or loss. If an option written by the Trust is exercised, thereby requiring the Trust to sell the
underlying security, the premium will increase the amount realized upon the sale of the security, and the character of any gain on such sale of the underlying security as short-term or long-term capital gain will depend on the holding period of the
Trust in the underlying security. Because the Trust will not have control over the exercise of the options it writes, such exercises or other required sales of the underlying securities may cause the Trust to realize gains or losses at inopportune
times.
Options on indices of securities and sectors of securities that qualify as section 1256 contracts will
generally be treated as marked-to-market for U.S. federal income tax purposes. As a result, the Trust will generally recognize gain or loss on the last day
of each taxable year equal to the difference between the value of the option on that date and the adjusted basis of the option. The adjusted basis of the option will consequently be increased by such gain or decreased by such loss. Any gain or loss
with respect to options on indices and sectors that qualify as section 1256 contracts will be treated as short-term capital gain or loss to the extent of 40% of such gain or loss and long-term capital gain or loss to the extent of 60% of
such gain or loss. Because the mark-to-market rules may cause the Trust to recognize gain in advance of the receipt of cash, the Trust may be required to dispose of
investments in order to meet its distribution requirements. Mark-to-market losses may be suspended or otherwise limited if such losses are part of a straddle
or similar transaction.
Taxation of Common Shareholders
The Trust will either distribute or retain for reinvestment all or part of its net capital gain. If any such gain is retained,
the Trust will be subject to a corporate income tax on such retained amount. In that event, the Trust
S-72
expects to report the retained amount as undistributed capital gain in a notice to its common shareholders, each of whom, if subject to U.S. federal income tax on long-term capital gains,
(i) will be required to include in income for U.S. federal income tax purposes as long-term capital gain its share of such undistributed amounts, (ii) will be entitled to credit its proportionate share of the tax paid by the Trust against
its U.S. federal income tax liability and to claim refunds to the extent that the credit exceeds such liability and (iii) will increase its basis in its common shares by the amount of undistributed capital gains included in the
shareholders income less the tax deemed paid by the shareholder under clause (ii).
Distributions paid to you by the
Trust from its net capital gain, if any, that the Trust properly reports as capital gain dividends (capital gain dividends) are taxable as long-term capital gains, regardless of how long you have held your common shares. All other
dividends paid to you by the Trust (including dividends from net short-term capital gains or tax-exempt interest, if any) from its current or accumulated earnings and profits (ordinary income
dividends) are generally subject to tax as ordinary income. Provided that certain holding period and other requirements are met, ordinary income dividends (if properly reported by the Trust) may qualify (i) for the dividends received
deduction in the case of corporate shareholders to the extent that the Trusts income consists of dividend income from U.S. corporations, and (ii) in the case of individual shareholders, as qualified dividend income eligible to
be taxed at long-term capital gains rates to the extent that the Trust receives qualified dividend income. Qualified dividend income is, in general, dividend income from taxable domestic corporations and certain qualified foreign corporations (e.g.,
generally, foreign corporations incorporated in a possession of the United States or in certain countries with a qualifying comprehensive tax treaty with the United States, or whose stock with respect to which such dividend is paid is readily
tradable on an established securities market in the United States). There can be no assurance as to what portion, if any, of the Trusts distributions will constitute qualified dividend income or be eligible for the dividends received
deduction.
Any distributions you receive that are in excess of the Trusts current and accumulated earnings and
profits will be treated as a return of capital to the extent of your adjusted tax basis in your common shares, and thereafter as capital gain from the sale of common shares. The amount of any Trust distribution that is treated as a return of capital
will reduce your adjusted tax basis in your common shares, thereby increasing your potential gain or reducing your potential loss on any subsequent sale or other disposition of your common shares.
Common shareholders may be entitled to offset their capital gain dividends with capital losses. The Code contains a number of
statutory provisions affecting when capital losses may be offset against capital gain, and limiting the use of losses from certain investments and activities. Accordingly, common shareholders that have capital losses are urged to consult their tax
advisers.
Dividends and other taxable distributions are taxable to you even though they are reinvested in additional
common shares of the Trust. Dividends and other distributions paid by the Trust are generally treated under the Code as received by you at the time the dividend or distribution is made. If, however, the Trust pays you a dividend in January that was
declared in the previous October, November or December to common shareholders of record on a specified date in one of such months, then such dividend will be treated for U.S. federal income tax purposes as being paid by the Trust and received by you
on December 31 of the year in which the dividend was declared. In addition, certain other distributions made after the close of the Trusts taxable year may be spilled back and treated as paid by the Trust (except for purposes
of the 4% nondeductible excise tax) during such taxable year. In such case, you will be treated as having received such dividends in the taxable year in which the distributions were actually made.
The price of common shares purchased at any time may reflect the amount of a forthcoming distribution. Those purchasing common
shares just prior to the record date for a distribution will receive a distribution which will be taxable to them even though it represents, economically, a return of invested capital.
The Trust will send you information after the end of each year setting forth the amount and tax status of any distributions
paid to you by the Trust.
S-73
The sale or other disposition of common shares will generally result in capital
gain or loss to you and will be long-term capital gain or loss if you have held such common shares for more than one year at the time of sale. Any loss upon the sale or other disposition of common shares held for six months or less will be treated
as long-term capital loss to the extent of any capital gain dividends received (including amounts credited as an undistributed capital gain dividend) by you with respect to such common shares. Any loss you recognize on a sale or other disposition of
common shares will be disallowed if you acquire other common shares (whether through the automatic reinvestment of dividends or otherwise) within a 61-day period beginning 30 days before and ending 30 days
after your sale or exchange of the common shares. In such case, your tax basis in the common shares acquired will be adjusted to reflect the disallowed loss.
Any sales charges paid upon a purchase of common shares cannot be taken into account for purposes of determining gain or loss
on a sale of the common shares before the 91st day after their purchase to the extent a sales charge is reduced or eliminated in a subsequent acquisition of common shares of the Trust (or of another fund), during the period beginning on the date of
such sale and ending on January 31 of the calendar year following the calendar year in which such sale was made, pursuant to the reinvestment or exchange privilege. Any disregarded amounts will result in an adjustment to the shareholders
tax basis in some or all of any other shares acquired.
If the Trust conducts a tender offer for its shares, a repurchase
by the Trust of a shareholders shares pursuant to such tender offer generally will be treated as a sale or exchange of the shares by a shareholder provided that either (i) the shareholder tenders, and the Trust repurchases, all of such
shareholders shares, thereby reducing the shareholders percentage ownership of the Trust, directly and by attribution under Section 318 of the Code, to 0%, (ii) the shareholder meets numerical safe harbors under the Code with
respect to percentage voting interest and reduction in ownership of the Trust following completion of the tender offer, or (iii) the tender offer otherwise results in a meaningful reduction of the shareholders ownership
percentage interest in the Trust, which determination depends on a particular shareholders facts and circumstances.
If a tendering shareholders proportionate ownership of the Trust (determined after applying the ownership attribution
rules under Section 318 of the Code) is not reduced to the extent required under the tests described above, such shareholder will be deemed to receive a distribution from the Trust under Section 301 of the Code with respect to the shares
held (or deemed held under Section 318 of the Code) by the shareholder after the tender offer (a Section 301 distribution). The amount of this distribution will equal the price paid by the Trust to such shareholder for the
shares sold, and will be taxable as a dividend, i.e., as ordinary income, to the extent of the Trusts current or accumulated earnings and profits allocable to such distribution, with the excess treated as a return of capital reducing the
shareholders tax basis in the shares held after the tender offer, and thereafter as capital gain. Any Trust shares held by a shareholder after a tender offer will be subject to basis adjustments in accordance with the provisions of the Code.
Provided that no tendering shareholder is treated as receiving a Section 301 distribution as a result of selling
shares pursuant to a particular tender offer, shareholders who do not sell shares pursuant to that tender offer will not realize constructive distributions on their shares as a result of other shareholders selling shares in the tender offer. In the
event that any tendering shareholder is deemed to receive a Section 301 distribution, it is possible that shareholders whose proportionate ownership of the Trust increases as a result of that tender offer, including shareholders who do not
tender any shares, will be deemed to receive a constructive distribution under Section 305(c) of the Code in an amount equal to the increase in their percentage ownership of the Trust as a result of the tender offer. Such constructive
distribution will be treated as a dividend to the extent of current or accumulated earnings and profits allocable to it.
Use of the Trusts cash to repurchase shares may adversely affect the Trusts ability to satisfy the distribution
requirements for treatment as a regulated investment company described above. The Trust may also recognize income in connection with the sale of portfolio securities to fund share purchases, in which case the Trust would take any such income into
account in determining whether such distribution requirements have been satisfied.
S-74
If the Trust liquidates, shareholders generally will realize capital gain or loss
upon such liquidation in an amount equal to the difference between the amount of cash or other property received by the shareholder (including any property deemed received by reason of its being placed in a liquidating trust) and the
shareholders adjusted tax basis in its shares. Any such gain or loss will be long-term if the shareholder is treated as having a holding period in Trust shares of greater than one year, and otherwise will be short-term.
The foregoing discussion does not address the tax treatment of shareholders who do not hold their shares as a capital asset.
Such shareholders should consult their own tax advisors on the specific tax consequences to them of participating or not participating in the tender offer or upon liquidation of the Trust.
Current U.S. federal income tax law taxes both long-term and short-term capital gain of corporations at the rates applicable
to ordinary income. For non-corporate taxpayers, short-term capital gain is currently taxed at rates applicable to ordinary income while long-term capital gain generally is taxed at a reduced maximum rate. The
deductibility of capital losses is subject to limitations under the Code.
Certain U.S. holders who are individuals,
estates or trusts and whose income exceeds certain thresholds will be required to pay a 3.8% Medicare tax on all or a portion of their net investment income, which includes dividends received from the Trust and capital gains from the
sale or other disposition of the Trusts common shares.
A common shareholder that is a nonresident alien individual
or a foreign corporation (a foreign investor) generally will be subject to U.S. federal withholding tax at the rate of 30% (or possibly a lower rate provided by an applicable tax treaty) on ordinary income dividends (except as discussed
below). In general, U.S. federal withholding tax and U.S. federal income tax will not apply to any gain or income realized by a foreign investor in respect of any distribution of net capital gain (including amounts credited as an undistributed
capital gain dividend) or upon the sale or other disposition of common shares of the Trust. Different tax consequences may result if the foreign investor is engaged in a trade or business in the United States or, in the case of an individual, is
present in the United States for 183 days or more during a taxable year and certain other conditions are met. Foreign investors should consult their tax advisers regarding the tax consequences of investing in the Trusts common shares.
Ordinary income dividends properly reported by the RIC are generally exempt from U.S. federal withholding tax where they
(i) are paid in respect of the RICs qualified net interest income (generally, its U.S.-source interest income, other than certain contingent interest and interest from obligations of a corporation or partnership in which the
RIC is at least a 10% shareholder, reduced by expenses that are allocable to such income) or (ii) are paid in respect of the RICs qualified short-term capital gains (generally, the excess of the RICs net short-term
capital gain over its long-term capital loss for such taxable year). Depending on its circumstances, the Trust may report all, some or none of its potentially eligible dividends as such qualified net interest income or as qualified short-term
capital gains, and/or treat such dividends, in whole or in part, as ineligible for this exemption from withholding. In order to qualify for this exemption from withholding, a foreign investor needs to comply with applicable certification
requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form W-8BEN,
W-8BEN-E, or substitute Form). In the case of common shares held through an intermediary, the intermediary may have withheld tax even if the Trust reported the payment
as qualified net interest income or qualified short-term capital gain. Foreign investors should contact their intermediaries with respect to the application of these rules to their accounts. There can be no assurance as to what portion of the
Trusts distributions would qualify for favorable treatment as qualified net interest income or qualified short-term capital gains.
In addition withholding at a rate of 30% will apply to dividends paid in respect of common shares of the Trust held by or
through certain foreign financial institutions (including investment funds), unless such institution enters into an agreement with the Treasury to report, on an annual basis, information with respect to shares in, and accounts maintained by, the
institution to the extent such shares or accounts are held by certain
S-75
U.S. persons and by certain non-U.S. entities that are wholly or partially owned by U.S. persons and to withhold on certain payments. Accordingly, the
entity through which common shares of the Trust are held will affect the determination of whether such withholding is required. Similarly, dividends paid in respect of common shares of the Trust held by an investor that is a non-financial foreign entity that does not qualify under certain exemptions will be subject to withholding at a rate of 30%, unless such entity either (i) certifies that such entity does not have any
substantial United States owners or (ii) provides certain information regarding the entitys substantial United States owners, which the applicable withholding agent will in turn provide to the Secretary of the
Treasury. An intergovernmental agreement between the United States and an applicable foreign country, or future Treasury regulations or other guidance, may modify these requirements. The Trust will not pay any additional amounts to common
shareholders in respect of any amounts withheld. Foreign investors are encouraged to consult with their tax advisers regarding the possible implications of these rules on their investment in the Trusts common shares.
U.S. federal backup withholding tax may be required on dividends, distributions and sale proceeds payable to certain non-exempt common shareholders who fail to supply their correct taxpayer identification number (in the case of individuals, generally, their social security number) or to make required certifications, or who are
otherwise subject to backup withholding. Backup withholding is not an additional tax and any amount withheld may be refunded or credited against your U.S. federal income tax liability, if any, provided that you timely furnish the required
information to the IRS.
Ordinary income dividends, capital gain dividends, and gain from the sale or other disposition of
common shares of the Trust also may be subject to state, local, and/or foreign taxes. Common shareholders are urged to consult their own tax advisers regarding specific questions about U.S. federal, state, local or foreign tax consequences to them
of investing in the Trust.
* * *
The foregoing is a general and abbreviated summary of certain provisions of the Code and the Treasury Regulations presently in
effect as they directly govern the taxation of the Trust and its shareholders. For complete provisions, reference should be made to the pertinent Code sections and Treasury Regulations. The Code and the Treasury Regulations are subject to change by
legislative or administrative action, and any such change may be retroactive with respect to Trust transactions. Holders of common shares are advised to consult their own tax advisers for more detailed information concerning the U.S. federal income
taxation of the Trust and the income tax consequences to its holders of common shares.
S-76
CUSTODIAN AND TRANSFER AGENT
The custodian of the assets of the Trust is State Street Bank and Trust Company, whose principal business address is One
Lincoln Street, Boston, Massachusetts 02111. The custodian will be responsible for, among other things, receipt of and disbursement of funds from the Trusts accounts, establishment of segregated accounts as necessary, and transfer, exchange
and delivery of Trust portfolio securities.
Computershare Trust Company, N.A., whose principal business address is 150
Royall Street, Canton, Massachusetts 02021, will serve as the Trusts transfer agent with respect to the common shares.
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP, whose principal business address is
200 Berkeley Street, Boston, MA 02116, is the independent registered public accounting firm of the Trust and is expected to render an opinion annually on the financial statements of the Trust.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
A control person is a person who beneficially owns, either directly or indirectly, more than 25% of the voting securities of a
company. As of April 30, 2022, the Trust did not know of any person or entity who controlled the Trust. As of April 30, 2022, to the knowledge of the Trust, no person owned of record or beneficially 5% or more of the outstanding common
shares of any class of the Trust.
S-77
INCORPORATION BY REFERENCE
This SAI is part of a registration statement that we have filed with the SEC. We are allowed to incorporate by
reference the information that we file with the SEC, which means that we can disclose important information to you by referring you to those documents. We incorporate by reference into this SAI the documents listed below and any future filings
we make with the SEC under Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act, including any filings on or after the date of this SAI from the date of filing (excluding any information furnished, rather than filed), until we have sold all of the
offered securities to which this SAI, the Prospectus and any accompanying prospectus supplement relates or the offering is otherwise terminated. The information incorporated by reference is an important part of this SAI. Any statement in a document
incorporated by reference into this SAI will be deemed to be automatically modified or superseded to the extent a statement contained in (1) this SAI or (2) any other subsequently filed document that is incorporated by reference into this
SAI modifies or supersedes such statement. The documents incorporated by reference herein include:
|
|
|
The Trusts Prospectus, dated May 4, 2022, filed with this SAI; |
|
|
|
our
annual report on Form N-CSR for the fiscal year ended December 31, 2021 filed with the SEC on March 4, 2022; |
|
|
|
the
description of the Trusts common shares contained in our Registration Statement on Form 8-A (File No. 001-36705) filed with the SEC on
October 22, 2014, including any amendment or report filed for the purpose of updating such description prior to the termination of the offering registered hereby. |
The Trust will provide without charge to each person, including any beneficial owner, to whom this SAI is delivered, upon
written or oral request, a copy of any and all of the documents that have been or may be incorporated by reference in this SAI, the Prospectus or the accompanying prospectus supplement. You should direct requests for documents by calling:
Client Services Desk
(800) 882-0052
The Trust makes available the Prospectus, SAI and the Trusts annual and
semi-annual reports, free of charge, at http://www.blackrock.com. You may also obtain this SAI, the Prospectus, other documents incorporated by reference and other information the Trust files electronically, including reports and proxy
statements, on the SEC website (http://www.sec.gov) or with the payment of a duplication fee, by electronic request at publicinfo@sec.gov. Information contained in, or that can be accessed through, the Trusts website is not part of this
SAI, the Prospectus or the accompanying prospectus supplement.
FINANCIAL STATEMENTS
The audited financial statements and financial highlights included in the annual
report to the Trusts shareholders for the fiscal year ended December 31, 2021 (the 2021 Annual Report), together with the report of Deloitte & Touche LLP for the Trusts 2021 Annual Report are
incorporated herein by reference.
S-78
APPENDIX A
DESCRIPTION OF BOND RATINGS
A
Description of Moodys Investors Service, Inc.s (Moodys) Global Rating Scales
Ratings assigned on
Moodys global long-term and short-term rating scales are forward-looking opinions of the relative credit risks of financial obligations issued by non-financial corporates, financial institutions,
structured finance vehicles, project finance vehicles, and public sector entities. Moodys defines credit risk as the risk that an entity may not meet its contractual financial obligations as they come due and any estimated financial loss in
the event of default or impairment. The contractual financial obligations addressed by Moodys ratings are those that call for, without regard to enforceability, the payment of an ascertainable amount, which may vary based upon standard sources
of variation (e.g., floating interest rates), by an ascertainable date. Moodys rating addresses the issuers ability to obtain cash sufficient to service the obligation, and its willingness to pay. Moodys ratings do not address non-standard sources of variation in the amount of the principal obligation (e.g., equity indexed), absent an express statement to the contrary in a press release accompanying an initial rating. Long-term ratings
are assigned to issuers or obligations with an original maturity of one year or more and reflect both on the likelihood of a default or impairment on contractual financial obligations and the expected financial loss suffered in the event of default
or impairment. Short-term ratings are assigned for obligations with an original maturity of thirteen months or less and reflect both on the likelihood of a default or impairment on contractual financial obligations and the expected financial loss
suffered in the event of default or impairment. Moodys issues ratings at the issuer level and instrument level on both the long-term scale and the short-term scale. Typically, ratings are made publicly available although private and
unpublished ratings may also be assigned.
Moodys differentiates structured finance ratings from fundamental ratings (i.e., ratings
on nonfinancial corporate, financial institution, and public sector entities) on the global long-term scale by adding (sf) to all structured finance ratings. The addition of (sf) to structured finance ratings should eliminate any presumption that
such ratings and fundamental ratings at the same letter grade level will behave the same. The (sf) indicator for structured finance security ratings indicates that otherwise similarly rated structured finance and fundamental securities may have
different risk characteristics. Through its current methodologies, however, Moodys aspires to achieve broad expected equivalence in structured finance and fundamental rating performance when measured over a long period of time.
Description of Moodys Global Long-Term Rating Scale
|
|
|
Aaa |
|
Obligations rated Aaa are judged to be of the highest quality, subject to the lowest level of credit risk. |
|
|
Aa |
|
Obligations rated Aa are judged to be of high quality and are subject to very low credit risk. |
|
|
A |
|
Obligations rated A are judged to be upper-medium grade and are subject to low credit risk. |
|
|
Baa |
|
Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics. |
|
|
Ba |
|
Obligations rated Ba are judged to be speculative and are subject to substantial credit risk. |
|
|
B |
|
Obligations rated B are considered speculative and are subject to high credit risk. |
|
|
Caa |
|
Obligations rated Caa are judged to be speculative of poor standing and are subject to very high credit risk. |
|
|
Ca |
|
Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest. |
|
|
C |
|
Obligations rated C are the lowest rated and are typically in default, with little prospect for recovery of principal or interest. |
A-1
Note: Moodys appends numerical modifiers 1, 2, and 3 to each generic rating
classification from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates a ranking in the lower end of that generic rating category. Additionally, a (hyb) indicator is appended to all ratings of hybrid securities issued by banks, insurers, finance companies, and securities firms.
By their terms, hybrid securities allow for the omission of scheduled dividends, interest, or principal payments, which can potentially result
in impairment if such an omission occurs. Hybrid securities may also be subject to contractually allowable write-downs of principal that could result in impairment. Together with the hybrid indicator, the long-term obligation rating assigned to a
hybrid security is an expression of the relative credit risk associated with that security.
Description of Moodys Global Short-Term Rating Scale
|
|
|
P-1 |
|
Ratings of Prime-1 reflect a superior ability to repay short-term obligations. |
|
|
P-2 |
|
Ratings of Prime-2 reflect a strong ability to repay short-term obligations. |
|
|
P-3 |
|
Ratings of Prime-3 reflect an acceptable ability to repay short-term obligations. |
|
|
NP |
|
Issuers (or supporting institutions) rated Not Prime do not fall within any of the Prime rating categories. |
Description of Moodys U.S. Municipal Short-Term Debt and Demand Obligation Ratings
Description of Moodys Short-Term Obligation Ratings
Moodys uses the global short-term Prime rating scale for commercial paper issued by U.S. municipalities and nonprofits. These commercial
paper programs may be backed by external letters of credit or liquidity facilities, or by an issuers self-liquidity.
For other
short-term municipal obligations, Moodys uses one of two other short-term rating scales, the Municipal Investment Grade (MIG) and Variable Municipal Investment Grade (VMIG) scales discussed below.
Moodys uses the MIG scale for U.S. municipal cash flow notes, bond anticipation notes and certain other short-term obligations, which
typically mature in three years or less. Under certain circumstances, Moodys uses the MIG scale for bond anticipation notes with maturities of up to five years.
MIG Scale
|
|
|
MIG 1 |
|
This designation denotes superior credit quality. Excellent protection is afforded by established cash flows, highly reliable liquidity support, or demonstrated broad-based access to the market for refinancing. |
|
|
MIG 2 |
|
This designation denotes strong credit quality. Margins of protection are ample, although not as large as in the preceding group. |
|
|
MIG 3 |
|
This designation denotes acceptable credit quality. Liquidity and cash-flow protection may be narrow, and market access for refinancing is likely to be less well-established. |
|
|
SG |
|
This designation denotes speculative-grade credit quality. Debt instruments in this category may lack sufficient margins of protection. |
Description of Moodys Demand Obligation Ratings
In the case of variable rate demand obligations (VRDOs), a two-component rating is
assigned. The components are a long-term rating and a short-term demand obligation rating. The long-term rating addresses the
A-2
issuers ability to meet scheduled principal and interest payments. The short-term demand obligation rating addresses the ability of the issuer or the liquidity provider to make payments
associated with the purchase-price-upon-demand feature (demand feature) of the VRDO. The short-term demand obligation rating uses the VMIG scale. VMIG ratings with liquidity support use as an input the short-term Counterparty Risk
Assessment of the support provider, or the long-term rating of the underlying obligor in the absence of third party liquidity support. Transitions of VMIG ratings of demand obligations with conditional liquidity support differ from transitions on
the Prime scale to reflect the risk that external liquidity support will terminate if the issuers long-term rating drops below investment grade.
Moodys typically assigns the VMIG short-term demand obligation rating if the frequency of the demand feature is less than every three
years. If the frequency of the demand feature is less than three years but the purchase price is payable only with remarketing proceeds, the short-term demand obligation rating is NR.
VMIG Scale
|
|
|
VMIG 1 |
|
This designation denotes superior credit quality. Excellent protection is afforded by the superior short-term credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of
purchase price upon demand. |
|
|
VMIG 2 |
|
This designation denotes strong credit quality. Good protection is afforded by the strong short-term credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of purchase price
upon demand. |
|
|
VMIG 3 |
|
This designation denotes acceptable credit quality. Adequate protection is afforded by the satisfactory short-term credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of
purchase price upon demand. |
|
|
SG |
|
This designation denotes speculative-grade credit quality. Demand features rated in this category may be supported by a liquidity provider that does not have a sufficiently strong short-term rating or may lack the structural or
legal protections necessary to ensure the timely payment of purchase price upon demand. |
Description of S&P Global Ratings (S&P), a Division of S&P Global Inc., Issue Credit Ratings
An S&P issue credit rating is a forward-looking opinion about the creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations, or a specific financial program (including ratings on medium-term note programs and commercial paper programs). It takes into consideration the creditworthiness of guarantors, insurers, or other
forms of credit enhancement on the obligation and takes into account the currency in which the obligation is denominated. The opinion reflects S&Ps view of the obligors capacity and willingness to meet its financial commitments as
they come due, and this opinion may assess terms, such as collateral security and subordination, which could affect ultimate payment in the event of default.
Issue credit ratings can be either long-term or short-term. Short-term issue credit ratings are generally assigned to those obligations
considered short-term in the relevant market, typically with an original maturity of no more than 365 days. Short-term issue credit ratings are also used to indicate the creditworthiness of an obligor with respect to put features on long-term
obligations. S&P would typically assign a long-term issue credit rating to an obligation with an original maturity of greater than 365 days. However, the ratings S&P assigns to certain instruments may diverge from these guidelines based on
market practices. Medium-term notes are assigned long-term ratings.
Issue credit ratings are based, in varying degrees, on S&Ps
analysis of the following considerations:
|
|
|
The likelihood of paymentthe capacity and willingness of the obligor to meet its financial commitments on
an obligation in accordance with the terms of the obligation; |
|
|
|
The nature and provisions of the financial obligation, and the promise S&P imputes; and
|
A-3
|
|
|
The protection afforded by, and relative position of, the financial obligation in the event of a bankruptcy,
reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors rights. |
An
issue rating is an assessment of default risk but may incorporate an assessment of relative seniority or ultimate recovery in the event of default. Junior obligations are typically rated lower than senior obligations, to reflect lower priority in
bankruptcy, as noted above. (Such differentiation may apply when an entity has both senior and subordinated obligations, secured and unsecured obligations, or operating company and holding company obligations.)
Long-Term Issue Credit Ratings*
|
|
|
AAA |
|
An obligation rated AAA has the highest rating assigned by S&P. The obligors capacity to meet its financial commitments on the obligation is extremely strong. |
|
|
AA |
|
An obligation rated AA differs from the highest-rated obligations only to a small degree. The obligors capacity to meet its financial commitments on the obligation is very strong. |
|
|
A |
|
An obligation rated A is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligors capacity to meet its
financial commitments on the obligation is still strong. |
|
|
BBB |
|
An obligation rated BBB exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to weaken the obligors capacity to meet its financial commitments on
the obligation. |
|
|
BB, B, CCC, CC, and C |
|
Obligations rated BB, B, CCC, CC, and C are regarded as having significant speculative characteristics. BB indicates the least degree of speculation and
C the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposure to adverse conditions. |
|
|
BB |
|
An obligation rated BB is less vulnerable to nonpayment than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions that could lead to
the obligors inadequate capacity to meet its financial commitments on the obligation. |
|
|
B |
|
An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the obligor currently has the capacity to meet its financial commitments on the obligation. Adverse business, financial,
or economic conditions will likely impair the obligors capacity or willingness to meet its financial commitments on the obligation. |
|
|
CCC |
|
An obligation rated CCC is currently vulnerable to nonpayment and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitments on the obligation. In the event
of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitments on the obligation. |
|
|
CC |
|
An obligation rated CC is currently highly vulnerable to nonpayment. The CC rating is used when a default has not yet occurred but S&P expects default to be a virtual certainty, regardless of the
anticipated time to default. |
|
|
C |
|
An obligation rated C is currently highly vulnerable to nonpayment, and the obligation is expected to have lower relative seniority or lower ultimate recovery compared with obligations that are rated
higher. |
A-4
|
|
|
D |
|
An obligation rated D is in default or in breach of an imputed promise. For non-hybrid capital instruments, the D rating category is used when payments on an obligation
are not made on the date due, unless S&P believes that such payments will be made within five business days in the absence of a stated grace period or within the earlier of the stated grace period or 30 calendar days. The D rating
also will be used upon the filing of a bankruptcy petition or the taking of similar action and where default on an obligation is a virtual certainty, for example due to automatic stay provisions. A rating on an obligation is lowered to D
if it is subject to a distressed debt restructuring. |
* Ratings from AA to CCC may be modified by the addition of a plus (+) or minus (-) sign to show
relative standing within the rating categories.
Short-Term Issue Credit Ratings
|
|
|
A-1 |
|
A short-term obligation rated A-1 is rated in the highest category by S&P. The obligors capacity to meet its financial commitments on the obligation is strong. Within
this category, certain obligations are designated with a plus sign (+). This indicates that the obligors capacity to meet its financial commitments on these obligations is extremely strong. |
|
|
A-2 |
|
A short-term obligation rated A-2 is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher rating
categories. However, the obligors capacity to meet its financial commitments on the obligation is satisfactory. |
|
|
A-3 |
|
A short-term obligation rated A-3 exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to weaken an
obligors capacity to meet its financial commitments on the obligation. |
|
|
B |
|
A short-term obligation rated B is regarded as vulnerable and has significant speculative characteristics. The obligor currently has the capacity to meet its financial commitments; however, it faces major ongoing
uncertainties that could lead to the obligors inadequate capacity to meet its financial commitments. |
|
|
C |
|
A short-term obligation rated C is currently vulnerable to nonpayment and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitments on the
obligation. |
|
|
D |
|
A short-term obligation rated D is in default or in breach of an imputed promise. For non-hybrid capital instruments, the D rating category is used when payments on an
obligation are not made on the date due, unless S&P believes that such payments will be made within any stated grace period. However, any stated grace period longer than five business days will be treated as five business days. The D
rating also will be used upon the filing of a bankruptcy petition or the taking of a similar action and where default on an obligation is a virtual certainty, for example due to automatic stay provisions. A rating on an obligation is lowered to
D if it is subject to a distressed debt restructuring. |
Description of S&Ps Municipal Short-Term Note Ratings
An S&P U.S. municipal note rating reflects S&Ps opinion about the liquidity factors and market access risks unique to the notes.
Notes due in three years or less will likely receive a note rating. Notes with an original maturity of more than three years will most likely receive a long-term debt rating. In determining which type of rating, if any, to assign, S&Ps
analysis will review the following considerations:
|
|
|
Amortization schedule the larger the final maturity relative to other maturities, the more likely it will
be treated as a note; and |
|
|
|
Source of payment the more dependent the issue is on the market for its refinancing, the more likely it
will be treated as a note. |
A-5
S&Ps municipal short-term note rating symbols are as follows:
|
|
|
SP-1 |
|
Strong capacity to pay principal and interest. An issue determined to possess a very strong capacity to pay debt service is given a plus (+) designation. |
|
|
SP-2 |
|
Satisfactory capacity to pay principal and interest, with some vulnerability to adverse financial and economic changes over the term of the notes. |
|
|
SP-3 |
|
Speculative capacity to pay principal and interest. |
|
|
D |
|
D is assigned upon failure to pay the note when due, completion of a distressed debt restructuring, or the filing of a bankruptcy petition or the taking of similar action and where default on an obligation is a virtual
certainty, for example due to automatic stay provisions. |
Description of Fitch Ratings (Fitchs) Credit Ratings Scales
Fitch Ratings publishes opinions on a variety of scales. The most common of these are credit ratings, but the agency also publishes ratings,
scores and other relative opinions relating to financial or operational strength. For example, Fitch also provides specialized ratings of servicers of residential and commercial mortgages, asset managers and funds. In each case, users should refer
to the definitions of each individual scale for guidance on the dimensions of risk covered in each assessment.
Fitchs credit
ratings relating to issuers are an opinion on the relative ability of an entity to meet financial commitments, such as interest, preferred dividends, repayment of principal, insurance claims or counterparty obligations. Credit ratings relating to
securities and obligations of an issuer can include a recovery expectation. Credit ratings are used by investors as indications of the likelihood of receiving the money owed to them in accordance with the terms on which they invested. The
agencys credit ratings cover the global spectrum of corporate, sovereign financial, bank, insurance, and public finance entities (including supranational and sub-national entities) and the securities or
other obligations they issue, as well as structured finance securities backed by receivables or other financial assets.
The terms
investment grade and speculative grade have established themselves over time as shorthand to describe the categories AAA to BBB (investment grade) and BB to D (speculative
grade). The terms investment grade and speculative grade are market conventions and do not imply any recommendation or endorsement of a specific security for investment purposes. Investment grade categories indicate relatively low to moderate credit
risk, while ratings in the speculative categories either signal a higher level of credit risk or that a default has already occurred.
For
the convenience of investors, Fitch may also include issues relating to a rated issuer that are not and have not been rated on its web page. Such issues are also denoted as NR.
Credit ratings express risk in relative rank order, which is to say they are ordinal measures of credit risk and are not predictive of a
specific frequency of default or loss. For information about the historical performance of ratings please refer to Fitchs Ratings Transition and Default studies which detail the historical default rates and their meaning. The European
Securities and Markets Authority also maintains a central repository of historical default rates.
Fitchs credit ratings do not
directly address any risk other than credit risk. In particular, ratings do not deal with the risk of a market value loss on a rated security due to changes in interest rates, liquidity and other market considerations. However, in terms of payment
obligation on the rated liability, market risk may be considered to the extent that it influences the ability of an issuer to pay upon a commitment.
Ratings nonetheless do not reflect market risk to the extent that they influence the size or other conditionality of the obligation to pay
upon a commitment (for example, in the case of index-linked bonds).
A-6
In the default components of ratings assigned to individual obligations or instruments, the
agency typically rates to the likelihood of non-payment or default in accordance with the terms of that instruments documentation. In limited cases, Fitch may include additional considerations (i.e. rate
to a higher or lower standard than that implied in the obligations documentation).
The primary credit rating scales can be used to
provide a rating of privately issued obligations or certain note issuance programs or for private ratings. In this case the rating is not published, but only provided to the issuer or its agents in the form of a rating letter.
The primary credit rating scales may also be used to provide ratings for a more narrow scope, including interest strips and return of
principal or in other forms of opinions such as credit opinions or rating assessment services. Credit opinions are either a notch- or category-specific view using the primary rating scale and omit one or more characteristics of a full rating or meet
them to a different standard. Credit opinions will be indicated using a lower case letter symbol combined with either an * (e.g. bbb+*) or (cat) suffix to denote the opinion status. Credit opinions will be point-in-time typically but may be monitored if the analytical group believes information will be sufficiently available. Rating assessment services are a notch-specific view
using the primary rating scale of how an existing or potential rating may be changed by a given set of hypothetical circumstances. While credit opinions and rating assessment services are point-in-time and are not monitored, they may have a directional watch or outlook assigned, which can signify the trajectory of the credit profile.
Description of Fitchs Long-Term Corporate Finance Obligations Rating Scales
Ratings of individual securities or financial obligations of a corporate issuer address relative vulnerability to default on an ordinal scale.
In addition, for financial obligations in corporate finance, a measure of recovery given default on that liability is also included in the rating assessment. This notably applies to covered bonds ratings, which incorporate both an indication of the
probability of default and of the recovery given a default of this debt instrument. On the contrary, Ratings of debtor-in-possession (DIP) obligations
incorporate the expectation of full repayment.
The relationship between the issuer scale and obligation scale assumes a generic
historical average recovery. Individual obligations can be assigned ratings higher, lower, or the same as that entitys issuer rating or issuer default rating (IDR), based on their relative ranking, relative vulnerability to default
or based on explicit Recovery Ratings.
As a result, individual obligations of entities, such as corporations, are assigned ratings
higher, lower, or the same as that entitys issuer rating or IDR, except DIP obligation ratings that are not based off an IDR. At the lower end of the ratings scale, Fitch publishes explicit Recovery Ratings in many cases to complement issuer
and obligation ratings.
Fitch long-term obligations rating scales are as follows:
|
|
|
AAA |
|
Highest Credit Quality. AAA ratings denote the lowest expectation of credit risk. They are assigned only in cases of exceptionally strong capacity for payment of financial commitments. This capacity is highly unlikely to
be adversely affected by foreseeable events. |
|
|
AA |
|
Very High Credit Quality. AA ratings denote expectations of very low credit risk. They indicate very strong capacity for payment of financial commitments. This capacity is not significantly vulnerable to foreseeable
events. |
|
|
A |
|
High Credit Quality. A ratings denote expectations of low credit risk. The capacity for payment of financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to adverse business or
economic conditions than is the case for higher ratings. |
A-7
|
|
|
BBB |
|
Good Credit Quality. BBB ratings indicate that expectations of credit risk are currently low. The capacity for payment of financial commitments is considered adequate, but adverse business or economic conditions are more
likely to impair this capacity. |
|
|
BB |
|
Speculative. BB ratings indicate an elevated vulnerability to credit risk, particularly in the event of adverse changes in business or economic conditions over time; however, business or financial alternatives may be
available to allow financial commitments to be met. |
|
|
B |
|
Highly Speculative. B ratings indicate that material credit risk is present. |
|
|
CCC |
|
Substantial Credit Risk. CCC ratings indicate that substantial credit risk is present. |
|
|
CC |
|
Very High Levels of Credit Risk. CC ratings indicate very high levels of credit risk. |
|
|
C |
|
Exceptionally High Levels of Credit Risk. C indicates exceptionally high levels of credit risk. |
Within rating categories, Fitch may use modifiers. The modifiers + or - may be
appended to a rating to denote relative status within major rating categories.
For example, the rating category AA has three
notch-specific rating levels (AA+; AA; AA; each a rating level). Such suffixes are not added to AAA ratings and ratings below the CCC category. For the short-term rating category of
F1, a + may be appended.
Description of Fitchs Short-Term Ratings Assigned to Issuers and Obligations
A short-term issuer or obligation rating is based in all cases on the short-term vulnerability to default of the rated entity and relates to
the capacity to meet financial obligations in accordance with the documentation governing the relevant obligation. Short-term deposit ratings may be adjusted for loss severity. Short-term ratings are assigned to obligations whose initial maturity is
viewed as short term based on market convention. Typically, this means up to 13 months for corporate, sovereign, and structured obligations and up to 36 months for obligations in U.S. public finance markets.
Fitch short-term ratings are as follows:
|
|
|
F1 |
|
Highest Short-Term Credit Quality. Indicates the strongest intrinsic capacity for timely payment of financial commitments; may have an added + to denote any exceptionally strong credit feature. |
|
|
F2 |
|
Good Short-Term Credit Quality. Good intrinsic capacity for timely payment of financial commitments. |
|
|
F3 |
|
Fair Short-Term Credit Quality. The intrinsic capacity for timely payment of financial commitments is adequate. |
|
|
B |
|
Speculative Short-Term Credit Quality. Minimal capacity for timely payment of financial commitments, plus heightened vulnerability to near term adverse changes in financial and economic conditions. |
|
|
C |
|
High Short-Term Default Risk. Default is a real possibility. |
|
|
RD |
|
Restricted Default. Indicates an entity that has defaulted on one or more of its financial commitments, although it continues to meet other financial obligations. Typically applicable to entity ratings only. |
|
|
D |
|
Default. Indicates a broad-based default event for an entity, or the default of a short-term obligation. |
A-8
APPENDIX B
CLOSED-END FUND PROXY VOTING POLICY
Effective Date: August 1, 2021
Applies to the following types of Funds registered under the 1940 Act:
☐ |
Open-End Mutual Funds (including money market funds)
|
☐ |
Money Market Funds Only |
☐ |
iShares and BlackRock ETFs |
Objective and Scope
Set forth below is the Closed-End Fund Proxy Voting Policy.
Policy / Document Requirements and Statements
The
Boards of Trustees/Directors (the Directors) of the closed-end funds advised by BlackRock Advisors, LLC (BlackRock) (the Funds) have the responsibility for the oversight of
voting proxies relating to portfolio securities of the Funds, and have determined that it is in the best interests of the Funds and their shareholders to delegate that responsibility to BlackRock as part of BlackRocks authority to manage,
acquire and dispose of account assets, all as contemplated by the Funds respective investment management agreements.
BlackRock has adopted
guidelines and procedures (together and as from time to time amended, the BlackRock Proxy Voting Guidelines) governing proxy voting by accounts managed by BlackRock.
BlackRock will cast votes on behalf of each of the Funds on specific proxy issues in respect of securities held by each such Fund in accordance with the
BlackRock Proxy Voting Guidelines; provided, however, that in the case of underlying closed-end funds (including business development companies and other similarly-situated asset pools) held by the Funds that
have, or are proposing to adopt, a classified board structure, BlackRock will typically (a) vote in favor of proposals to adopt classification and against proposals to eliminate classification, and (b) not vote against directors as a
result of their adoption of a classified board structure.
BlackRock will report on an annual basis to the Directors on (1) a summary of all proxy
votes that BlackRock has made on behalf of the Funds in the preceding year together with a representation that all votes were in accordance with the BlackRock Proxy Voting Guidelines (as modified pursuant to the immediately preceding paragraph), and
(2) any changes to the BlackRock Proxy Voting Guidelines that have not previously been reported.
B-1
BlackRock Investment Stewardship
Global Principles
Effective as of January 2022
B-2
Contents
The purpose of this document is to provide an overarching explanation of BlackRocks approach globally to our
responsibilities as a shareholder on behalf of our clients, our expectations of companies, and our commitments to clients in terms of our own governance and transparency.
B-3
Introduction to BlackRock
BlackRocks purpose is to help more and more people experience financial well-being. We manage assets on behalf of institutional and individual
clients, across a full spectrum of investment strategies, asset classes, and regions. Our client base includes pension plans, endowments, foundations, charities, official institutions, insurers, and other financial institutions, as well as
individuals around the world. As part of our fiduciary duty to our clients, we have determined that it is generally in the best long-term interest of our clients to promote sound corporate governance as an informed, engaged shareholder. At
BlackRock, this is the responsibility of the Investment Stewardship team.
Philosophy on investment stewardship
Companies are responsible for ensuring they have appropriate governance structures to serve the interests of shareholders and other key stakeholders. We
believe that there are certain fundamental rights attached to shareholding. Companies and their boards should be accountable to shareholders and structured with appropriate checks and balances to ensure that they operate in shareholders best
interests to create sustainable value. Shareholders should have the right to vote to elect, remove, and nominate directors, approve the appointment of the auditor, and amend the corporate charter or by-laws.
Shareholders should be able to vote on key board decisions that are material to the protection of their investment, including but not limited to, changes to the purpose of the business, dilution levels and
pre-emptive rights, and the distribution of income and capital structure. In order to make informed decisions, we believe that shareholders have the right to sufficient and timely information. In addition,
shareholder voting rights should be proportionate to their economic ownershipthe principle of one share, one vote helps achieve this balance.
Consistent with these shareholder rights, we believe BlackRock has a responsibility to monitor and provide feedback to companies in our role as stewards of
our clients investments. Investment stewardship is how we use our voice as an investor to promote sound corporate governance and business practices to help maximize long-term shareholder value for our clients, the vast majority of whom are
investing for long-term goals such as retirement. BlackRock Investment Stewardship (BIS) does this through engagement with management teams and/or board members on material business issues, including but not limited to environmental,
social, and governance (ESG) matters and, for those clients who have given us authority, through voting proxies in their best long-term economic interests. We also participate in the public dialogue to help shape global norms and
industry standards with the goal of supporting a policy framework consistent with our clients interests as long-term shareholders.
BlackRock
looks to companies to provide timely, accurate, and comprehensive disclosure on all material governance and business matters, including ESG-related issues. This transparency allows shareholders to
appropriately understand and assess how relevant risks and opportunities are being effectively identified and managed. Where company reporting and disclosure is inadequate or we believe the approach taken may be inconsistent with sustainable,
long-term value creation, we will engage with a company and/or vote in a manner that encourages progress.
BlackRock views engagement as an important
activity; engagement provides us with the opportunity to improve our understanding of the business and risks and opportunities that are material to the companies in which our clients invest, including those related to ESG. Engagement also informs
our voting decisions. As long-term investors on behalf of clients, we seek to have regular and continuing dialogue with executives and board directors to advance sound governance and sustainable business practices, as well as to understand the
effectiveness of the companys management and oversight of material issues. Engagement is
B-4
an important mechanism for providing feedback on company practices and disclosures, particularly where we believe they could be enhanced. Similarly, it provides us an opportunity to hear directly
from company boards and management on how they believe their actions are aligned with sustainable, long-term value creation. We primarily engage through direct dialogue, but may use other tools such as written correspondence, to share our
perspectives.
We generally vote in support of management and boards that demonstrate an approach consistent with creating sustainable, long-term value.
If we have concerns about a companys approach, we may choose to explain our expectations to the companys board and management. Following our engagement, we may signal through our voting that we have outstanding concerns, generally by
voting against the re-election of directors we view as having responsibility for an issue. We apply our regional proxy voting guidelines to achieve the outcome we believe is most aligned with our clients
long-term economic interests.
Key themes
We recognize that accepted standards and norms of corporate governance can differ between markets. However, we believe there are certain fundamental
elements of governance practice that are intrinsic globally to a companys ability to create long-term value. This set of global themes are set out in this overarching set of principles (the Principles), which are anchored in
transparency and accountability. At a minimum, we believe companies should observe the accepted corporate governance standards in their domestic market and ask that, if they do not, they explain how their approach better supports sustainable
long-term value creation.
These Principles cover seven key themes:
|
● |
|
Auditors and audit-related issues |
|
● |
|
Capital structure, mergers, asset sales, and other special transactions |
|
● |
|
Compensation and benefits |
|
● |
|
Environmental and social issues |
|
● |
|
General corporate governance matters and shareholder protections |
Our regional and market-specific voting guidelines explain how these Principles inform our voting decisions in relation to specific ballot items for
shareholder meetings.
Boards and directors
Our primary focus is on the performance of the board of directors. The performance of the board is critical to the economic success of the company and the
protection of shareholders interests. As part of their responsibilities, board members owe fiduciary duties to shareholders in overseeing the strategic direction and operation of the company. For this reason, BIS sees engaging with and the
election of directors as one of our most important and impactful responsibilities.
B-5
We support boards whose approach is consistent with creating sustainable, long-term value. This includes the
effective management of strategic, operational, financial, and material ESG factors and the consideration of key stakeholder interests. The board should establish and maintain a framework of robust and effective governance mechanisms to support its
oversight of the companys strategic aims. We look to the board to articulate the effectiveness of these mechanisms in overseeing the management of business risks and opportunities and the fulfillment of the companys purpose. Disclosure
of material issues that affect the companys long-term strategy and value creation, including material ESG factors, is essential for shareholders to be able to appropriately understand and assess how risks are effectively identified, managed
and mitigated.
Where a company has not adequately disclosed and demonstrated it has fulfilled these responsibilities, we will consider voting against
the re-election of directors whom we consider having particular responsibility for the issue. We assess director performance on a
case-by-case basis and in light of each companys circumstances, taking into consideration our assessment of their governance, business practices that support
sustainable, long-term value creation, and performance. In serving the interests of shareholders, the responsibility of the board of directors includes, but is not limited to, the following:
|
● |
|
Establishing an appropriate corporate governance structure |
|
● |
|
Supporting and overseeing management in setting long-term strategic goals and applicable measures of
value-creation and milestones that will demonstrate progress, and taking steps to address anticipated or actual obstacles to success |
|
● |
|
Providing oversight on the identification and management of material, business operational, and
sustainability-related risks |
|
● |
|
Overseeing the financial resilience of the company, the integrity of financial statements, and the robustness
of a companys Enterprise Risk Management1 framework |
|
● |
|
Making decisions on matters that require independent evaluation, which may include mergers, acquisitions and
dispositions, activist situations or other similar cases |
|
● |
|
Establishing appropriate executive compensation structures |
|
● |
|
Addressing business issues, including environmental and social risks and opportunities, when they have the
potential to materially impact the companys long-term value |
There should be clear definitions of the role of the board, the
committees of the board, and senior management. Set out below are ways in which boards and directors can demonstrate a commitment to acting in the best long-term economic interests of all shareholders.
We will seek to engage with the appropriate directors where we have concerns about the performance of the company, board, or individual directors and may
signal outstanding concerns in our voting.
1 |
Enterprise risk management is a process, effected by the entitys board of directors, management, and
other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within the risk appetite, to provide reasonable assurance regarding the achievement of
objectives. (Committee of Sponsoring Organizations of the Treadway Commission (COSO), Enterprise Risk Management Integrated Framework, September 2004, New York, NY). |
B-6
Regular accountability
BlackRock believes that directors should stand for re-election on a regular basis, ideally annually. In our
experience, annual re-elections allow shareholders to reaffirm their support for board members or hold them accountable for their decisions in a timely manner. When board members are not re-elected annually, we believe it is good practice for boards to have a rotation policy to ensure that, through a board cycle, all directors have had their appointment
re-confirmed, with a proportion of directors being put forward for re-election at each annual general meeting.
Effective board composition
Regular director
elections also give boards the opportunity to adjust their composition in an orderly way to reflect the evolution of the companys strategy and the market environment. BlackRock believes it is beneficial for new directors to be brought onto the
board periodically to refresh the groups thinking and in a manner that supports both continuity and appropriate succession planning. We consider the average overall tenure of the board, where we are seeking a balance between the knowledge and
experience of longer-serving members and the fresh perspectives of newer members. We expect companies to keep under regular review the effectiveness of their board (including its size), and assess directors nominated for election or re-election in the context of the composition of the board as a whole. This assessment should consider a number of factors, including the potential need to address gaps in skills, experience, diversity, and
independence.
When nominating new directors to the board, we ask that there is sufficient information on the individual candidates so that shareholders
can assess the suitability of each individual nominee and the overall board composition. These disclosures should give an understanding of how the collective experience and expertise of the board aligns with the companys long-term strategy and
business model.
We are interested in diversity in the board room as a means to promoting diversity of thought and avoiding group think. We
ask boards to disclose how diversity is considered in board composition, including demographic characteristics such as gender, race/ethnicity and age; as well as professional characteristics, such as a directors industry experience, specialist
areas of expertise and geographic location. We assess a boards diversity in the context of a companys domicile, business model and strategy. Self-identified board demographic diversity can usefully be disclosed in aggregate, consistent
with local law. We believe boards should aspire to meaningful diversity of membership, at least consistent with local regulatory requirements and best practices, while recognizing that building a strong, diverse board can take time.
This position is based on our view that diversity of perspective and thought in the board room, in the management team and throughout the company
leads to better long term economic outcomes for companies. Academic research already reveals correlations between specific dimensions of diversity and effects on decision-making processes and outcomes.2 In our experience, greater diversity in the board room contributes to more robust discussions and more innovative and resilient decisions. Over time, greater diversity in the board room can also
promote greater diversity and resilience in the leadership team, and the workforce more broadly. That diversity can enable companies to develop businesses that more closely reflect and resonate with the customers and communities they serve.
2 |
For example, the role of gender diversity on team cohesion and participative communication is explored by:
Post, C., 2015, When is female leadership an advantage? Coordination requirements, team cohesion, and team interaction norms, Journal of Organizational Behavior, 36, 1153-1175. http://dx.doi.org/10.1002/job.2031. |
B-7
We expect there to be a sufficient number of independent directors, free from conflicts of interest or undue
influence from connected parties, to ensure objectivity in the decision-making of the board and its ability to oversee management. Common impediments to independence may include but are not limited to:
|
● |
|
Current or recent employment at the company or a subsidiary |
|
● |
|
Being, or representing, a shareholder with a substantial shareholding in the company |
|
● |
|
Interlocking directorships |
|
● |
|
Having any other interest, business, or other relationship which could, or could reasonably be perceived to,
materially interfere with a directors ability to act in the best interests of the company and its shareholders. |
BlackRock
believes that boards are most effective at overseeing and advising management when there is a senior independent board leader. This director may chair the board, or, where the chair is also the CEO (or is otherwise not independent), be designated as
a lead independent director. The role of this director is to enhance the effectiveness of the independent members of the board through shaping the agenda, ensuring adequate information is provided to the board, and encouraging independent
participation in board deliberations. The lead independent director or another appropriate director should be available to shareholders in those situations where an independent director is best placed to explain and contextualize a companys
approach.
There are matters for which the board has responsibility that may involve a conflict of interest for executives or for affiliated directors.
BlackRock believes that objective oversight of such matters is best achieved when the board forms committees comprised entirely of independent directors. In many markets, these committees of the board specialize in audit, director nominations, and
compensation matters. An ad hoc committee might also be formed to decide on a special transaction, particularly one involving a related party, or to investigate a significant adverse event.
Sufficient capacity
As the role and expectations of
a director are increasingly demanding, directors must be able to commit an appropriate amount of time to board and committee matters. It is important that directors have the capacity to meet all of their responsibilities including when there
are unforeseen events - and therefore, they should not take on an excessive number of roles that would impair their ability to fulfill their duties.
Auditors and audit-related issues
BlackRock recognizes the critical importance of financial statements, which should provide a true and fair picture of a companys financial condition.
Accordingly, the assumptions made by management and reviewed by the auditor in preparing the financial statements should be reasonable and justified.
The accuracy of financial statements, inclusive of financial and non-financial information, is of paramount
importance to BlackRock. Investors increasingly recognize that a broader range of risks and opportunities have the potential to materially impact financial performance. Over time, we expect increased scrutiny of the assumptions underlying financial
reports, particularly those that pertain to the impact of the transition to a low carbon economy on a companys business model and asset mix.
B-8
In this context, audit committees, or equivalent, play a vital role in a companys financial reporting
system by providing independent oversight of the accounts, material financial and non-financial information, internal control frameworks, and in the absence of a dedicated risk committee, Enterprise Risk
Management systems. BlackRock believes that effective audit committee oversight strengthens the quality and reliability of a companys financial statements and provides an important level of reassurance to shareholders.
We hold members of the audit committee or equivalent responsible for overseeing the management of the audit function. Audit committees or equivalent should
have clearly articulated charters that set out their responsibilities and have a rotation plan in place that allows for a periodic refreshment of the committee membership to introduce fresh perspectives to audit oversight.
We take particular note of critical accounting matters, cases involving significant financial restatements, or ad hoc notifications of material financial
weakness. In this respect, audit committees should provide timely disclosure on the remediation of Key and Critical Audit Matters identified either by the external auditor or Internal Audit function.
The integrity of financial statements depends on the auditor being free of any impediments to being an effective check on management. To that end, we
believe it is important that auditors are, and are seen to be, independent. Where an audit firm provides services to the company in addition to the audit, the fees earned should be disclosed and explained. Audit committees should have in place a
procedure for assessing annually the independence of the auditor and the quality of the external audit process.
Comprehensive disclosure provides
investors with a sense of the companys long-term operational risk management practices and, more broadly, the quality of the boards oversight. The audit committee or equivalent, or a dedicated risk committee, should periodically review
the companys risk assessment and risk management policies and the significant risks and exposures identified by management, the internal auditors or the independent accountants, and managements steps to address them. In the absence of
robust disclosures, we may reasonably conclude that companies are not adequately managing risk.
Capital structure,
mergers, asset sales, and other special transactions
The capital structure of a company is critical to shareholders as it impacts the value of
their investment and the priority of their interest in the company relative to that of other equity or debt investors. Pre-emptive rights are a key protection for shareholders against the dilution of their
interests.
Effective voting rights are basic rights of share ownership. We believe strongly in one vote for one share as a guiding principle that
supports effective corporate governance. Shareholders, as the residual claimants, have the strongest interest in protecting company value, and voting power should match economic exposure.
In principle, we disagree with the creation of a share class with equivalent economic exposure and preferential, differentiated voting rights. In our view,
this structure violates the fundamental corporate governance principle of proportionality and results in a concentration of power in the hands of a few shareholders, thus disenfranchising other shareholders and amplifying any potential conflicts of
interest. However, we recognize that in certain markets, at least for a period of time, companies may have a valid argument for listing dual classes of shares with differentiated voting rights. We believe that such companies should review these
share class structures on a regular basis or as company circumstances change. Additionally, they should seek shareholder approval of their capital structure on a periodic basis via a management proposal at the companys shareholder meeting. The
proposal should give unaffiliated
B-9
shareholders the opportunity to affirm the current structure or establish mechanisms to end or phase out controlling structures at the appropriate time, while minimizing costs to shareholders.
In assessing mergers, asset sales, or other special transactions, BlackRocks primary consideration is the long-term economic interests of our
clients as shareholders. Boards proposing a transaction need to clearly explain the economic and strategic rationale behind it. We will review a proposed transaction to determine the degree to which it can enhance long-term shareholder value. We
would prefer that proposed transactions have the unanimous support of the board and have been negotiated at arms length. We may seek reassurance from the board that executives and/or board members financial interests in a given
transaction have not adversely affected their ability to place shareholders interests before their own. Where the transaction involves related parties, we would expect the recommendation to support it to come from the independent directors,
and ideally, the terms also have been assessed through an independent appraisal process. In addition, it is good practice that it be approved by a separate vote of the non-conflicted parties.
BlackRock believes that shareholders have a right to dispose of company shares in the open market without unnecessary restriction. In our view, corporate
mechanisms designed to limit shareholders ability to sell their shares are contrary to basic property rights. Such mechanisms can serve to protect and entrench interests other than those of the shareholders. We believe that shareholders are
broadly capable of making decisions in their own best interests. We expect any so-called shareholder rights plans proposed by a board to be subject to shareholder approval upon introduction and
periodically thereafter.
Compensation and benefits
BlackRock expects a companys board of directors to put in place a compensation structure that incentivizes and rewards executives appropriately. There
should be a clear link between variable pay and operational and financial performance. Performance metrics should be stretching and aligned with a companys strategy and business model. BIS does not have a position on the use of ESG-related criteria, but believes that where companies choose to include them, they should be as rigorous as other financial or operational targets. Long-term incentive plans should vest over timeframes aligned
with the delivery of long-term shareholder value. Compensation committees should guard against contractual arrangements that would entitle executives to material compensation for early termination of their employment. Finally, pension contributions
and other deferred compensation arrangements should be reasonable in light of market practice.
We are not supportive of
one-off or special bonuses unrelated to company or individual performance. Where discretion has been used by the compensation committee or its equivalent, we expect disclosure relating to how and why the
discretion was used, and how the adjusted outcome is aligned with the interests of shareholders. We acknowledge that the use of peer group evaluation by compensation committees can help ensure competitive pay; however, we are concerned when the
rationale for increases in total compensation at a company is solely based on peer benchmarking rather than a rigorous measure of outperformance. We encourage companies to clearly explain how compensation outcomes have rewarded outperformance
against peer firms.
We believe consideration should be given to building claw back provisions into incentive plans such that executives would be
required to forgo rewards when they are not justified by actual performance and/or when compensation was based on faulty financial reporting or deceptive business practices. We also favor recoupment from any senior executive whose behavior caused
material financial harm to shareholders, material reputational risk to the company, or resulted in a criminal investigation, even if such actions did not ultimately result in a material restatement of past results.
B-10
Non-executive directors should be compensated in a manner that is
commensurate with the time and effort expended in fulfilling their professional responsibilities. Additionally, these compensation arrangements should not risk compromising directors independence or aligning their interests too closely with
those of the management, whom they are charged with overseeing.
We use third party research, in addition to our own analysis, to evaluate existing and
proposed compensation structures. We may vote against members of the compensation committee or equivalent board members for poor compensation practices or structures.
Environmental and social issues
We believe that well-managed companies will deal effectively with material environmental and social (E&S) factors relevant to their
businesses. Governance is the core structure by which boards can oversee the creation of sustainable, long-term value. Appropriate risk oversight of E&S considerations stems from this construct.
Robust disclosure is essential for investors to effectively evaluate companies strategy and business practices related to material E&S risks and
opportunities. Given the increased understanding of material sustainability risks and opportunities, and the need for better information to assess them, BlackRock will advocate for continued improvement in companies reporting, where necessary,
and will express any concerns through our voting where a companys actions or disclosures are inadequate.
BlackRock encourages companies to use
the framework developed by the Task Force on Climate-related Financial Disclosures (TCFD) to disclose their approach to ensuring they have a sustainable business model and to supplement that disclosure with industry-specific metrics such as those
identified by the Sustainability Accounting Standards Board (SASB).3 While the TCFD framework was developed to support climate-related risk disclosure, the four pillars of the TCFD
Governance, Strategy, Risk Management, and Metrics and Targets are a useful way for companies to disclose how they identify, assess, manage, and oversee a variety of sustainability-related risks and opportunities. SASBs
industry-specific guidance (as identified in its materiality map) is beneficial in helping companies identify key performance indicators (KPIs) across various dimensions of sustainability that are considered to be financially material and
decision-useful within their industry. We recognize that some companies may report using different standards, which may be required by regulation, or one of a number of private standards. In such cases, we ask that companies highlight the metrics
that are industry- or company-specific.
Companies may also adopt or refer to guidance on sustainable and responsible business conduct issued by
supranational organizations such as the United Nations or the Organization for Economic Cooperation and Development. Further, industry-specific initiatives on managing specific operational risks may be useful. Companies should disclose any global
standards adopted, the industry initiatives in which they participate, any peer group benchmarking undertaken, and any assurance processes to help investors understand their approach to sustainable and responsible business practices.
3 |
The International Financial Reporting Standards (IFRS) Foundation announced in November 2021 the
formation of an International Sustainability Standards Board (ISSB) to develop a comprehensive global baseline of high-quality sustainability disclosure standards to meet investors information needs. The IFRS Foundation plans to
complete consolidation of the Climate Disclosure Standards Board (CDSBan initiative of CDP) and the Value Reporting Foundation (VRFwhich houses the Integrated Reporting Framework and the SASB Standards) by June 2022.
|
B-11
Climate risk
BlackRock believes that climate change has become a defining factor in companies long-term prospects. We ask every company to help its investors
understand how it may be impacted by climate-related risk and opportunities, and how these factors are considered within their strategy in a manner consistent with the companys business model and sector. Specifically, we ask companies to
articulate how their business model is aligned to a scenario in which global warming is limited to well below 2°C, moving towards global net zero emissions by 2050.
In Stewardship, we understand that climate change can be very challenging for many companies, as they seek to drive long-term value by mitigating risks and
capturing opportunities. A growing number of companies, financial institutions, as well as governments, have committed to advancing net zero. There is growing consensus that companies can benefit from the more favorable macro-economic environment
under an orderly, timely and just transition to net zero.4 Many companies are asking what their role should be in contributing to a just transition in ensuring a reliable energy supply and
protecting the most vulnerable from energy price shocks and economic dislocation. They are also seeking more clarity as to the public policy path that will help align greenhouse gas reduction actions with commitments.
In this context, we ask companies to disclose a business plan for how they intend to deliver long-term financial performance through the transition to
global net zero, consistent with their business model and sector. We encourage companies to demonstrate that their plans are resilient under likely decarbonization pathways, and the global aspiration to limit warming to 1.5°C.5 We also encourage companies to disclose how considerations related to having a reliable energy supply and just transition affect their plans.
We look to companies to set short-, medium- and long-term science-based targets, where available for their sector, for greenhouse gas reductions and to
demonstrate how their targets are consistent with the long-term economic interests of their shareholders. Companies have an opportunity to use and contribute to the development of alternative energy sources and
low-carbon transition technologies that will be essential to reaching net zero. We also recognize that some continued investment is required to maintain a reliable, affordable supply of fossil fuels during the
transition. We ask companies to disclose how their capital allocation across alternatives, transition technologies, and fossil fuel production is consistent with their strategy and their emissions reduction targets.
Key stakeholder interests
We believe that, to
advance long-term shareholders interests, companies should consider the interests of their key stakeholders. It is for each company to determine its key stakeholders based on what is material to its business, but they are likely to include
employees, business partners (such as suppliers and distributors), clients and consumers, government, and the communities in which they operate.
4 |
For example, BlackRocks Capital Markets Assumptions anticipate 25 points of cumulative economic gains
over a 20-year period in an orderly transition as compared to the alternative. This better macro environment will support better economic growth, financial stability, job growth, productivity, as well as
ecosystem stability and health outcomes. |
5 |
The global aspiration is reflective of aggregated efforts; companies in developed and emerging markets are not
equally equipped to transition their business and reduce emissions at the same ratethose in developed markets with the largest market capitalization are better positioned to adapt their business models at an accelerated pace. Government policy
and regional targets may be reflective of these realities. |
B-12
Considering the interests of key stakeholders recognizes the collective nature of long-term value creation and
the extent to which each companys prospects for growth are tied to its ability to foster strong sustainable relationships with and support from those stakeholders. Companies should articulate how they address adverse impacts that could arise
from their business practices and affect critical business relationships with their stakeholders. We expect companies to implement, to the extent appropriate, monitoring processes (often referred to as due diligence) to identify and mitigate
potential adverse impacts and grievance mechanisms to remediate any actual adverse material impacts. The maintenance of trust within these relationships can be equated with a companys long-term success.
To ensure transparency and accountability, companies should disclose how they have identified their key stakeholders and considered their interests in
business decision-making, demonstrating the applicable governance, strategy, risk management, and metrics and targets. This approach should be overseen by the board, which is well positioned to ensure that the approach taken is informed by and
aligns with the companys strategy and purpose.
General corporate governance matters and shareholder protections
BlackRock believes that shareholders have a right to material and timely information on the financial performance and viability of the companies in
which they invest. In addition, companies should publish information on the governance structures in place and the rights of shareholders to influence these structures. The reporting and disclosure provided by companies help shareholders assess
whether their economic interests have been protected and the quality of the boards oversight of management. We believe shareholders should have the right to vote on key corporate governance matters, including changes to governance mechanisms,
to submit proposals to the shareholders meeting, and to call special meetings of shareholders.
Corporate Form
We believe it is the responsibility of the board to determine the corporate form that is most appropriate given the companys purpose and business
model.6 Companies proposing to change their corporate form to a public benefit corporation or similar entity should put it to a shareholder vote if not already required to do so under applicable
law. Supporting documentation from companies or shareholder proponents proposing to alter the corporate form should clearly articulate how the interests of shareholders and different stakeholders would be impacted as well as the accountability and
voting mechanisms that would be available to shareholders. As a fiduciary on behalf of clients, we generally support management proposals if our analysis indicates that shareholders interests are adequately protected. Relevant shareholder
proposals are evaluated on a case-by-case basis.
Shareholder proposals
In most markets in which BlackRock invests on behalf of clients, shareholders have the right to submit proposals to be
voted on by shareholders at a companys annual or extraordinary meeting, as long as eligibility and procedural requirements are met. The matters that we see put forward by shareholders address a wide range of topics, including governance
reforms, capital management, and improvements in the management or disclosure of E&S risks.
6 |
Corporate form refers to the legal structure by which a business is organized. |
B-13
BlackRock is subject to certain requirements under antitrust law in the United States that place restrictions
and limitations on how BlackRock can interact with the companies in which we invest on behalf of our clients, including our ability to submit shareholder proposals. As noted above, we can vote on proposals put forth by others.
When assessing shareholder proposals, we evaluate each proposal on its merit, with a singular focus on its implications for long-term value creation. We
consider the business and economic relevance of the issue raised, as well as its materiality and the urgency with which we believe it should be addressed. We take into consideration the legal effect of the proposal, as shareholder proposals may be
advisory or legally binding depending on the jurisdiction. We would not support proposals that we believe would result in over-reaching into the basic business decisions of the issuer.
Where a proposal is focused on a material business risk that we agree needs to be addressed and the intended outcome is consistent with long-term value
creation, we will look to the board and management to demonstrate that the company has met the intent of the request made in the shareholder proposal. Where our analysis and/or engagement indicate an opportunity for improvement in the companys
approach to the issue, we may support shareholder proposals that are reasonable and not unduly constraining on management. Alternatively, or in addition, we may vote against the re-election of one or more
directors if, in our assessment, the board has not responded sufficiently or with an appropriate sense of urgency. We may also support a proposal if management is on track, but we believe that voting in favor might accelerate progress.
BlackRocks oversight of its investment stewardship activities
Oversight
We hold ourselves to a very high standard
in our investment stewardship activities, including proxy voting. To meet this standard, BIS is comprised of BlackRock employees who do not have other responsibilities other than their roles in BIS. BIS is considered an investment function.
BlackRock maintains three regional advisory committees (Stewardship Advisory Committees) for (a) the Americas; (b) Europe, the Middle East
and Africa (EMEA); and (c) Asia-Pacific, generally consisting of senior BlackRock investment professionals and/or senior employees with practical boardroom experience. The regional Stewardship Advisory Committees review and advise
on amendments to BIS proxy voting guidelines covering markets within each respective region (Guidelines). The advisory committees do not determine voting decisions, which are the responsibility of BIS.
In addition to the regional Stewardship Advisory Committees, the Investment Stewardship Global Oversight Committee (Global Committee) is a
risk-focused committee, comprised of senior representatives from various BlackRock investment teams, a senior legal representative, the Global Head of Investment Stewardship (Global Head), and other senior executives with relevant
experience and team oversight. The Global Oversight Committee does not determine voting decisions, which are the responsibility of BIS.
The Global Head
has primary oversight of the activities of BIS, including voting in accordance with the Guidelines, which require the application of professional judgment and consideration of each companys unique circumstances. The Global Committee reviews
and approves amendments to these Principles. The Global Committee also reviews and approves amendments to the regional Guidelines, as proposed by the regional Stewardship Advisory Committees.
B-14
In addition, the Global Committee receives and reviews periodic reports regarding the votes cast by BIS, as
well as updates on material process issues, procedural changes, and other risk oversight considerations. The Global Committee reviews these reports in an oversight capacity as informed by the BIS corporate governance engagement program and the
Guidelines.
BIS carries out engagement with companies, monitors and executes proxy votes, and conducts vote operations (including maintaining records
of votes cast) in a manner consistent with the relevant Guidelines. BIS also conducts research on corporate governance issues and participates in industry discussions to contribute to and keep abreast of important developments in the corporate
governance field. BIS may utilize third parties for certain of the foregoing activities and performs oversight of those third parties. BIS may raise complicated or particularly controversial matters for internal discussion with the relevant
investment teams and governance specialists for discussion and guidance prior to making a voting decision.
Vote
execution
We carefully consider proxies submitted to funds and other fiduciary account(s) (Fund or Funds) for which we have
voting authority. BlackRock votes (or refrains from voting) proxies for each Fund for which we have voting authority based on our evaluation of the best long-term economic interests of our clients as shareholders, in the exercise of our independent
business judgment, and without regard to the relationship of the issuer of the proxy (or any shareholder proponent or dissident shareholder) to the Fund, the Funds affiliates (if any), BlackRock or BlackRocks affiliates, or BlackRock
employees (see Conflicts management policies and procedures, below).
When exercising voting rights, BlackRock will normally vote on
specific proxy issues in accordance with the Guidelines for the relevant market. The Guidelines are reviewed annually and are amended consistent with changes in the local market practice, as developments in corporate governance occur, or as
otherwise deemed advisable by the applicable Stewardship Advisory Committees. BIS analysts may, in the exercise of their professional judgment, conclude that the Guidelines do not cover the specific matter upon which a proxy vote is required or that
an exception to the Guidelines would be in the best long-term economic interests of BlackRocks clients.
In the uncommon circumstance of there
being a vote with respect to fixed income securities or the securities of privately held issuers, the decision generally will be made by a Funds portfolio managers and/or BIS based on their assessment of the particular transactions or other
matters at issue.
In certain markets, proxy voting involves logistical issues which can affect BlackRocks ability to vote such proxies, as well
as the desirability of voting such proxies. These issues include, but are not limited to: (i) untimely notice of shareholder meetings; (ii) restrictions on a foreigners ability to exercise votes; (iii) requirements to vote
proxies in person; (iv) share-blocking(requirements that investors who exercise their voting rights surrender the right to dispose of their holdings for some specified period in proximity to the shareholder meeting); (v) potential
difficulties in translating the proxy; (vi) regulatory constraints; and (vii) requirements to provide local agents with unrestricted powers of attorney to facilitate voting instructions. We are not supportive of impediments to the exercise
of voting rights such as share-blocking or overly burdensome administrative requirements.
As a consequence, BlackRock votes proxies in these situations
on a best-efforts basis. In addition, BIS may determine that it is generally in the best interests of BlackRocks clients not to vote proxies (or not to vote our full allocation) if the costs (including but not limited to
opportunity costs associated with share-blocking constraints) associated with exercising a vote are expected to outweigh the benefit the client would derive by voting on the proposal.
B-15
Portfolio managers have full discretion to vote the shares in the Funds they manage based on their analysis of
the economic impact of a particular ballot item on their investors. Portfolio managers may, from time to time, reach differing views on how best to maximize economic value with respect to a particular investment. Therefore, portfolio managers may,
and sometimes do, vote shares in the Funds under their management differently from BIS or from one another. However, because BlackRocks clients are mostly long-term investors with long-term economic goals, ballots are frequently cast in a
uniform manner.
Conflicts management policies and procedures
BIS maintains policies and procedures that seek to prevent undue influence on BlackRocks proxy voting activity. Such influence might stem from any
relationship between the investee company (or any shareholder proponent or dissident shareholder) and BlackRock, BlackRocks affiliates, a Fund or a Funds affiliates, or BlackRock employees. The following are examples of sources of
perceived or potential conflicts of interest:
|
● |
|
BlackRock clients who may be issuers of securities or proponents of shareholder resolutions
|
|
● |
|
BlackRock business partners or third parties who may be issuers of securities or proponents of shareholder
resolutions |
|
● |
|
BlackRock employees who may sit on the boards of public companies held in Funds managed by BlackRock
|
|
● |
|
Significant BlackRock, Inc. investors who may be issuers of securities held in Funds managed by BlackRock
|
|
● |
|
Securities of BlackRock, Inc. or BlackRock investment funds held in Funds managed by BlackRock
|
|
● |
|
BlackRock, Inc. board members who serve as senior executives or directors of public companies held in Funds
managed by BlackRock |
BlackRock has taken certain steps to mitigate perceived or potential conflicts including, but not limited to,
the following:
|
● |
|
Adopted the Guidelines which are designed to advance our clients interests in the companies in which
BlackRock invests on their behalf. |
|
● |
|
Established a reporting structure that separates BIS from employees with sales, vendor management, or business
partnership roles. In addition, BlackRock seeks to ensure that all engagements with corporate issuers, dissident shareholders or shareholder proponents are managed consistently and without regard to BlackRocks relationship with such parties.
Clients or business partners are not given special treatment or differentiated access to BIS. BIS prioritizes engagements based on factors including, but not limited to, our need for additional information to make a voting decision or our view on
the likelihood that an engagement could lead to positive outcome(s) over time for the economic value of the company. Within the normal course of business, BIS may engage directly with BlackRock clients, business partners and/or third parties, and/or
with employees with sales, vendor management, or business partnership roles, in discussions regarding our approach to stewardship, general corporate governance matters, client reporting needs, and/or to otherwise ensure that proxy-related client
service levels are met. |
B-16
|
● |
|
Determined to engage, in certain instances, an independent fiduciary to vote proxies as a further safeguard to
avoid potential conflicts of interest, to satisfy regulatory compliance requirements, or as may be otherwise required by applicable law. In such circumstances, the independent fiduciary provides BlackRocks proxy voting agent with instructions,
in accordance with the Guidelines, as to how to vote such proxies, and BlackRocks proxy voting agent votes the proxy in accordance with the independent fiduciarys determination. BlackRock uses an independent fiduciary to vote proxies of
BlackRock, Inc. and companies affiliated with BlackRock, Inc. BlackRock may also use an independent fiduciary to vote proxies of: |
|
o |
public companies that include BlackRock employees on their boards of directors, |
|
o |
public companies of which a BlackRock, Inc. board member serves as a senior executive or a member of the
board of directors, |
|
o |
public companies that are the subject of certain transactions involving BlackRock Funds,
|
|
o |
public companies that are joint venture partners with BlackRock, and |
|
o |
public companies when legal or regulatory requirements compel BlackRock to use an independent fiduciary.
|
In selecting an independent fiduciary, we assess several characteristics, including but not limited to: independence, an ability to
analyze proxy issues and vote in the best economic interest of our clients, reputation for reliability and integrity, and operational capacity to accurately deliver the assigned votes in a timely manner. We may engage more than one independent
fiduciary, in part to mitigate potential or perceived conflicts of interest at an independent fiduciary. The Global Committee appoints and reviews the performance of the independent fiduciaries, generally on an annual basis.
Securities lending
When
so authorized, BlackRock acts as a securities lending agent on behalf of Funds. Securities lending is a well-regulated practice that contributes to capital market efficiency. It also enables funds to generate additional returns for a fund, while
allowing fund providers to keep fund expenses lower.
With regard to the relationship between securities lending and proxy voting, BlackRocks
approach is informed by our fiduciary responsibility to act in our clients best interests. In most cases, BlackRock anticipates that the potential long-term value to the Fund of voting shares would be less than the potential revenue the loan
may provide the Fund. However, in certain instances, BlackRock may determine, in its independent business judgment as a fiduciary, that the value of voting outweighs the securities lending revenue loss to clients and would therefore recall shares to
be voted in those instances.
The decision to recall securities on loan as part of BlackRocks securities lending program in order to vote is based
on an evaluation of various factors that include, but are not limited to, assessing potential securities lending revenue alongside the potential long-term value to clients of voting those securities (based on the
B-17
information available at the time of recall consideration).7 BIS works with colleagues in the Securities Lending and Risk and Quantitative
Analysis teams to evaluate the costs and benefits to clients of recalling shares on loan.
Periodically, BlackRock reviews our process for determining
whether to recall securities on loan in order to vote and may modify it as necessary.
Voting guidelines
The issue-specific Guidelines published for each region/country in which we vote are intended to summarize BlackRocks general philosophy and approach
to issues that may commonly arise in the proxy voting context in each market where we invest. The Guidelines are not intended to be exhaustive. BIS applies the Guidelines on a
case-by-case basis, in the context of the individual circumstances of each company and the specific issue under review. As such, the Guidelines do not indicate how BIS
will vote in every instance. Rather, they reflect our view about corporate governance issues generally, and provide insight into how we typically approach issues that commonly arise on corporate ballots.
Reporting and vote transparency
We are committed to transparency in the stewardship work we do on behalf of clients. We inform clients about our engagement and voting policies and
activities through direct communication and through disclosure on our website. Each year we publish an annual report that provides a global overview of our investment stewardship engagement and voting activities. Additionally, we make public our
market-specific voting guidelines for the benefit of clients and companies with whom we engage. We also publish commentaries to share our perspective on market developments and emerging key themes.
At a more granular level, we publish quarterly our vote record for each company that held a shareholder meeting during the period, showing how we voted on
each proposal and explaining any votes against management proposals or on shareholder proposals. For shareholder meetings where a vote might be high profile or of significant interest to clients, we may publish a vote bulletin after the meeting,
disclosing and explaining our vote on key proposals. We also publish a quarterly list of all companies with which we engaged and the key topics addressed in the engagement meeting.
In this way, we help inform our clients about the work we do on their behalf in promoting the governance and business models that support long-term
sustainable value creation.
7 |
Recalling securities on loan can be impacted by the timing of record dates. In the United States, for example,
the record date of a shareholder meeting typically falls before the proxy statements are released. Accordingly, it is not practicable to evaluate a proxy statement, determine that a vote has a material impact on a fund and recall any shares on loan
in advance of the record date for the annual meeting. As a result, managers must weigh independent business judgement as a fiduciary, the benefit to a funds shareholders of recalling loaned shares in advance of an estimated record date without
knowing whether there will be a vote on matters which have a material impact on the fund (thereby forgoing potential securities lending revenue for the funds shareholders) or leaving shares on loan to potentially earn revenue for the fund
(thereby forgoing the opportunity to vote). |
B-18
BlackRock
Investment
Stewardship
Proxy voting guidelines for U.S. securities
Effective as of January 2022
B-19
Contents
B-20
These guidelines should be read in conjunction with the BlackRock Investment Stewardship Global Principles.
Introduction
We
believe BlackRock has a responsibility to monitor and provide feedback to companies, in our role as stewards of our clients investments. BlackRock Investment Stewardship (BIS) does this through engagement with management teams
and/or board members on material business issues, including environmental, social, and governance (ESG) matters and, for those clients who have given us authority, through voting proxies in the best long-term economic interests of their
assets.
The following issue-specific proxy voting guidelines(the Guidelines) are intended to summarize BIS regional philosophy and
approach to engagement and voting on ESG factors, as well as our expectations of directors, for U.S. securities. These Guidelines are not intended to limit the analysis of individual issues at specific companies or provide a guide to how BIS will
engage and/or vote in every instance. They are applied with discretion, taking into consideration the range of issues and facts specific to the company, as well as individual ballot items at annual and special meetings.
Voting guidelines
These guidelines are divided into eight key themes, which group together the issues that frequently appear on the agenda of annual and extraordinary
meetings of shareholders:
● |
|
Auditors and audit-related issues |
● |
|
Mergers, acquisitions, asset sales, and other special transactions |
● |
|
Environmental and social issues |
● |
|
General corporate governance matters |
● |
|
Shareholder protections |
Boards and directors
The effective performance of the board is critical to the economic success of the company and the protection of shareholders interests. As part of
their responsibilities, board members owe fiduciary duties to shareholders in overseeing the strategic direction, operations, and risk management of the company. For this reason, BIS sees engagement with and the election of directors as one of our
most critical responsibilities.
Disclosure of material issues that affect the companys long-term strategy and value creation, including material
ESG factors, is essential for shareholders to appropriately understand and assess how effectively the board is identifying, managing, and mitigating risks.
B-21
Where we conclude that a board has failed to address or disclose one or more material issues within a specified
timeframe, we may hold directors accountable or take other appropriate action in the context of our voting decisions.
Director elections
Where a board has not adequately demonstrated, through actions and company disclosures, how material issues are appropriately identified, managed, and
overseen, we will consider voting against the re-election of those directors responsible for the oversight of such issues, as indicated below.
Independence
We expect a majority of the directors
on the board to be independent. In addition, all members of key committees, including audit, compensation, and nominating/governance committees, should be independent. Our view of independence may vary from listing standards.
Common impediments to independence may include:
● |
|
Employment as a senior executive by the company or a subsidiary within the past five years
|
● |
|
An equity ownership in the company in excess of 20% |
● |
|
Having any other interest, business, or relationship (professional or personal) which could, or could
reasonably be perceived to, materially interfere with the directors ability to act in the best interests of the company |
We may
vote against directors serving on key committees who we do not consider to be independent, including at controlled companies.
Oversight
We expect the board to exercise appropriate oversight of management and the business activities of the company. Where we believe a board has failed to
exercise sufficient oversight, we may vote against the responsible committees and/or individual directors. The following illustrates common circumstances:
● |
|
With regard to material ESG risk factors, or where the company has failed to provide shareholders with adequate
disclosure to conclude appropriate strategic consideration is given to these factors by the board, we may vote against directors of the responsible committee, or the most relevant director |
● |
|
With regard to accounting practices or audit oversight, e.g., where the board has failed to facilitate quality,
independent auditing. If substantial accounting irregularities suggest insufficient oversight, we will consider voting against the current audit committee, and any other members of the board who may be responsible |
● |
|
During a period in which executive compensation appears excessive relative to the performance of the company
and compensation paid by peers, we may vote against the members of the compensation committee |
B-22
● |
|
Where a company has proposed an equity compensation plan that is not aligned with shareholders interests,
we may vote against the members of the compensation committee |
● |
|
Where the board is not comprised of a majority of independent directors (this may not apply in the case of a
controlled company), we may vote against the chair of the nominating/governance committee, or where no chair exists, the nominating/governance committee member with the longest tenure |
● |
|
Where it appears the director has acted (at the company or at other companies) in a manner that compromises
their ability to represent the best long-term economic interests of shareholders, we may vote against that individual |
● |
|
Where a director has a multi-year pattern of poor attendance at combined board and applicable committee
meetings, or a director has poor attendance in a single year with no disclosed rationale, we may vote against that individual. Excluding exigent circumstances, BIS generally considers attendance at less than 75% of the combined board and applicable
committee meetings to be poor attendance |
● |
|
Where a director serves on an excessive number of boards, which may limit their capacity to focus on each
boards needs, we may vote against that individual. The following identifies the maximum number of boards on which a director may serve, before BIS considers them to be over-committed: |
|
|
|
|
|
|
|
|
|
Public Company Executive |
|
# Outside Public Boards8 |
|
Total # of Public Boards |
Director A |
|
✓ |
|
1 |
|
2 |
Director B9 |
|
|
|
3 |
|
4 |
Responsiveness to shareholders
We expect a board to be engaged and responsive to its shareholders, including acknowledging voting outcomes for director elections, compensation,
shareholder proposals, and other ballot items. Where we believe a board has not substantially addressed shareholder concerns, we may vote against the responsible committees and/or individual directors. The following illustrates common circumstances:
● |
|
The independent chair or lead independent director, members of the nominating/governance committee, and/or the
longest tenured director(s), where we observe a lack of board responsiveness to shareholders, evidence of board entrenchment, and/or failure to plan for adequate board member succession |
● |
|
The chair of the nominating/governance committee, or where no chair exists, the nominating/governance committee
member with the longest tenure, where board member(s) at the most recent election of directors have received against votes from more than 25% of shares voted, and the board has not taken appropriate action to respond to shareholder concerns. This
may not apply in cases where BIS did not support the initial against vote |
● |
|
The independent chair or lead independent director and/or members of the nominating/governance committee, where
a board fails to consider shareholder proposals that receive substantial support, and the proposals, in our view, have a material impact on the business, shareholder rights, or the potential for long-term value creation |
8 |
In addition to the company under review. |
9 |
Including fund managers whose full-time employment involves responsibility for the investment and oversight of
fund vehicles, and those who have employment as professional investors and provide oversight for those holdings. |
B-23
Shareholder rights
We expect a board to act with integrity and to uphold governance best practices. Where we believe a board has not acted in the best interests of its
shareholders, we may vote against the appropriate committees and/or individual directors. The following illustrates common circumstances:
● |
|
The independent chair or lead independent director and members of the nominating/governance committee, where a
board implements or renews a poison pill without shareholder approval |
● |
|
The independent chair or lead independent director and members of the nominating/governance committee, where a
board amends the charter/articles/bylaws and where the effect may be to entrench directors or to significantly reduce shareholder rights |
● |
|
Members of the compensation committee where the company has repriced options without shareholder approval
|
If a board maintains a classified structure, it is possible that the director(s) with whom we have a particular concern may not be
subject to election in the year that the concern arises. In such situations, if we have a concern regarding the actions of a committee and the responsible member(s), we will generally register our concern by voting against all available members of
the relevant committee.
Board composition and effectiveness
We encourage boards to periodically refresh their membership to ensure relevant skills and experience within the boardroom. To this end, regular performance
reviews and skills assessments should be conducted by the nominating/governance committee or the lead independent director. When nominating new directors to the board, we ask that there is sufficient information on the individual candidates so that
shareholders can assess the suitability of each individual nominee and the overall board composition. Where boards find that age limits or term limits are the most efficient and objective mechanism for ensuring periodic board refreshment, we
generally defer to the boards determination in setting such limits. BIS will also consider the average board tenure to evaluate processes for board renewal. We may oppose boards that appear to have an insufficient mix of short-, medium-, and
long-tenured directors.
Furthermore, we expect boards to be comprised of a diverse selection of individuals who bring their personal and professional
experiences to bear in order to create a constructive debate of a variety of views and opinions in the boardroom. We are interested in diversity in the board room as a means to promoting diversity of thought and avoiding groupthink. We
ask boards to disclose how diversity is considered in board composition, including demographic factors such as gender, race, ethnicity, and age; as well as professional characteristics, such as a directors industry experience, specialist areas
of expertise, and geographic location. We assess a boards diversity in the context of a companys domicile, business model, and strategy. We believe boards should aspire to 30% diversity of membership and encourage companies to have at
least two directors on their board who identify as female and at least one who identifies as a member of an underrepresented group.10
10 |
Including, but not limited to, individuals who identify as Black or African American, Hispanic or Latinx ,
Asian, Native American or Alaska Native, or Native Hawaiian or Pacific Islander; individuals who identify as LGBTQ+; individuals who identify as underrepresented based on national, Indigenous, religious, or cultural identity; individuals with
disabilities; and veterans. |
B-24
We ask that boards disclose:
● |
|
The aspects of diversity that the company believes are relevant to its business and how the diversity
characteristics of the board, in aggregate, are aligned with a companys long-term strategy and business model |
● |
|
The process by which candidates are identified and selected, including whether professional firms or other
resources outside of incumbent directors networks have been engaged to identify and/or assess candidates, and whether a diverse slate of nominees is considered for all available board nominations |
● |
|
The process by which boards evaluate themselves and any significant outcomes of the evaluation process, without
divulging inappropriate and/or sensitive details |
This position is based on our view that diversity of perspective and thought
in the boardroom, in the management team, and throughout the company leads to better long-term economic outcomes for companies. Academic research already reveals correlations between specific dimensions of diversity and effects on
decision-making processes and outcomes.11 In our experience, greater diversity in the boardroom contributes to more robust discussions and more innovative and resilient decisions. Over time, it
can also promote greater diversity and resilience in the leadership team and workforce more broadly, enabling companies to develop businesses that more closely reflect and resonate with the customers and communities they serve.
To the extent that, based on our assessment of corporate disclosures, a company has not adequately accounted for diversity in its board composition within a
reasonable timeframe, we may vote against members of the nominating/governance committee for an apparent lack of commitment to board effectiveness. We recognize that building high-quality, diverse boards can take time. We will look to the largest
companies (e.g., S&P 500) for continued leadership. Our publicly available commentary provides more information on our approach to board diversity.
Board size
We typically defer to the board in
setting the appropriate size and believe directors are generally in the best position to assess the optimal board size to ensure effectiveness. However, we may oppose boards that appear too small to allow for the necessary range of skills and
experience or too large to function efficiently.
CEO and management succession planning
There should be a robust CEO and senior management succession plan in place at the board level that is reviewed and updated on a regular basis. We expect
succession planning to cover scenarios over both the long-term, consistent with the strategic direction of the company and identified leadership needs over time, as well as the short-term, in the event of an unanticipated executive departure. We
encourage the company to explain its executive succession planning process, including where accountability lies within the boardroom for this task, without prematurely divulging sensitive information commonly associated with this exercise.
11 |
For example, the role of gender diversity on team cohesion and participative communication is explored by Post,
C., 2015, When is female leadership an advantage? Coordination requirements, team cohesion, and team interaction norms, Journal of Organizational Behavior, 36, 1153-1175. |
B-25
Classified board of directors/staggered terms
We believe that directors should be re-elected annually; classification of the board generally limits
shareholders rights to regularly evaluate a boards performance and select directors. While we will typically support proposals requesting board de-classification, we may make exceptions, should the
board articulate an appropriate strategic rationale for a classified board structure. This may include when a company needs consistency and stability during a time of transition, e.g., newly public companies or companies undergoing a strategic
restructuring. A classified board structure may also be justified at non-operating companies, e.g., closed-end funds or business development companies (BDC),12 in certain circumstances. We would, however, expect boards with a classified structure to periodically review the rationale for such structure and consider when annual elections might be more
appropriate.
Without a voting mechanism to immediately address concerns about a specific director, we may choose to vote against the directors up for
election at the time (see Shareholder rights for additional detail).
Contested director elections
The details of contested elections, or proxy contests, are assessed on a
case-by-case basis. We evaluate a number of factors, which may include: the qualifications of the dissident and management candidates; the validity of the concerns
identified by the dissident; the viability of both the dissidents and managements plans; the ownership stake and holding period of the dissident; the likelihood that the dissidents solutions will produce the desired change; and
whether the dissident represents the best option for enhancing long-term shareholder value.
Cumulative voting
We believe that a majority vote standard is in the best long-term interests of shareholders. It ensures director accountability through the requirement to
be elected by more than half of the votes cast. As such, we will generally oppose proposals requesting the adoption of cumulative voting, which may disproportionately aggregate votes on certain issues or director candidates.
Director compensation and equity programs
We
believe that compensation for directors should be structured to attract and retain directors, while also aligning their interests with those of shareholders. We believe director compensation packages that are based on the companys long-term
value creation and include some form of long-term equity compensation are more likely to meet this goal. In addition, we expect directors to build meaningful share ownership over time.
Majority vote requirements
BIS believes that
directors should generally be elected by a majority of the shares voted and will normally support proposals seeking to introduce bylaws requiring a majority vote standard for director elections. Majority vote standards assist in ensuring that
directors who are not broadly supported by shareholders are not elected to serve as their representatives. Some companies with a plurality voting standard have adopted
12 |
A BDC is a special investment vehicle under the Investment Company Act of 1940 that is designed to facilitate
capital formation for small and middle-market companies. |
B-26
a resignation policy for directors who do not receive support from at least a majority of votes cast. Where we believe that the company already has a sufficiently robust majority voting process
in place, we may not support a shareholder proposal seeking an alternative mechanism.
We note that majority voting may not be appropriate in all
circumstances, for example, in the context of a contested election, or for majority-controlled companies.
Risk oversight
Companies should have an established process for identifying, monitoring, and managing business and material ESG risks. Independent directors should have
access to relevant management information and outside advice, as appropriate, to ensure they can properly oversee risk. We encourage companies to provide transparency around risk management, mitigation, and reporting to the board. We are
particularly interested in understanding how risk oversight processes evolve in response to changes in corporate strategy and/or shifts in the business and related risk environment. Comprehensive disclosure provides investors with a sense of the
companys long-term risk management practices and, more broadly, the quality of the boards oversight. In the absence of robust disclosures, we may reasonably conclude that companies are not adequately managing risk.
Separation of chair and CEO
We believe that
independent leadership is important in the boardroom. There are two commonly accepted structures for independent board leadership: 1) an independent chair; or 2) a lead independent director when the roles of chair and CEO are combined.
In the absence of a significant governance concern, we defer to boards to designate the most appropriate leadership structure to ensure adequate balance and
independence.13
In the event that the board chooses a combined chair/CEO model, we generally
support the designation of a lead independent director if they have the power to: 1) provide formal input into board meeting agendas; 2) call meetings of the independent directors; and 3) preside at meetings of independent directors.
Furthermore, while we anticipate that most directors will be elected annually, we believe an element of continuity is important for this role to provide appropriate leadership balance to the chair/CEO.
The following table illustrates examples of responsibilities under each board leadership model:
|
|
|
|
|
|
|
|
|
|
|
|
Combined Chair/CEO Model |
|
Separate Chair Model |
|
|
|
|
|
|
Chair/CEO |
|
Lead Independent Director |
|
Chair |
|
|
|
|
|
|
Authority to call full meetings of the board of directors |
|
Attends full meetings of the board of directors |
|
Authority to call full meetings of the board of directors |
|
|
|
|
Board Meetings |
|
|
|
Authority to call meetings of independent directors |
|
|
|
|
|
|
|
|
|
|
Briefs CEO on issues arising from executive sessions
|
|
|
13 |
To this end, we do not view shareholder proposals asking for the separation of chair and CEO to be a proxy for
other concerns we may have at the company for which a vote against directors would be more appropriate. Rather, support for such a proposal might arise in the case of overarching and sustained governance concerns such as lack of independence or
failure to oversee a material risk over consecutive years. |
B-27
|
|
|
|
|
|
|
|
|
|
|
|
Combined Chair/CEO Model |
|
Separate Chair Model |
|
|
|
|
|
|
Chair/CEO |
|
Lead Independent Director |
|
Chair |
|
|
|
|
Agenda |
|
Primary responsibility for shaping board agendas, consulting with the lead independent director |
|
Collaborates with chair/CEO to set board agenda and board information |
|
Primary responsibility for shaping board agendas, in conjunction with CEO |
|
|
|
|
Board Communications
|
|
Communicates with all directors on key issues and concerns outside of full
board meetings |
|
Facilitates discussion among independent directors on key issues and concerns
outside of full board meetings, including contributing to the oversight of CEO and management succession planning |
|
Facilitates discussion among independent directors on key issues and concerns
outside of full board meetings, including contributing to the oversight of CEO and management succession planning |
Auditors and audit-related issues
BIS recognizes the critical importance of financial statements to provide a complete and accurate portrayal of a companys financial condition.
Consistent with our approach to voting on directors, we seek to hold the audit committee of the board responsible for overseeing the management of the audit function at a company. We may vote against the audit committee members where the board has
failed to facilitate quality, independent auditing. We look to public disclosures for insight into the scope of the audit committee responsibilities, including an overview of audit committee processes, issues on the audit committee agenda, and key
decisions taken by the audit committee. We take particular note of cases involving significant financial restatements or material weakness disclosures, and we expect timely disclosure and remediation of accounting irregularities.
The integrity of financial statements depends on the auditor effectively fulfilling its role. To that end, we favor an independent auditor. In addition, to
the extent that an auditor fails to reasonably identify and address issues that eventually lead to a significant financial restatement, or the audit firm has violated standards of practice, we may also vote against ratification.
From time to time, shareholder proposals may be presented to promote auditor independence or the rotation of audit firms. We may support these proposals when
they are consistent with our views as described above.
Capital structure proposals
Equal voting rights
BIS believes that shareholders
should be entitled to voting rights in proportion to their economic interests. We believe that companies that look to add or that already have dual or multiple class share structures should review these structures on a regular basis, or as company
circumstances change. Companies with multiple share classes should receive shareholder approval of their capital structure on a periodic basis via a management proposal on the companys proxy. The proposal should give unaffiliated shareholders
the opportunity to affirm the current structure or establish mechanisms to end or phase out controlling structures at the appropriate time, while minimizing costs to shareholders.
Blank check preferred stock
We frequently oppose
proposals requesting authorization of a class of preferred stock with unspecified voting, conversion, dividend distribution, and other rights (blank check preferred stock) because they may serve as a
B-28
transfer of authority from shareholders to the board and as a possible entrenchment device. We generally view the boards discretion to establish voting rights on a when-issued basis as a
potential anti-takeover device, as it affords the board the ability to place a block of stock with an investor sympathetic to management, thereby foiling a takeover bid without a shareholder vote.
Nonetheless, we may support the proposal where the company:
● |
|
Appears to have a legitimate financing motive for requesting blank check authority |
● |
|
Has committed publicly that blank check preferred shares will not be used for anti-takeover purposes
|
● |
|
Has a history of using blank check preferred stock for financings |
● |
|
Has blank check preferred stock previously outstanding such that an increase would not necessarily provide
further anti-takeover protection but may provide greater financing flexibility |
Increase in authorized common shares
BIS will evaluate requests to increase authorized shares on a case-by-case
basis, in conjunction with industry-specific norms and potential dilution, as well as a companys history with respect to the use of its common shares.
Increase or issuance of preferred stock
We
generally support proposals to increase or issue preferred stock in cases where the company specifies the voting, dividend, conversion, and other rights of such stock and where the terms of the preferred stock appear reasonable.
Stock splits
We generally support stock splits that
are not likely to negatively affect the ability to trade shares or the economic value of a share. We generally support reverse stock splits that are designed to avoid delisting or to facilitate trading in the stock, where the reverse split will not
have a negative impact on share value (e.g., one class is reduced while others remain at pre-split levels). In the event of a proposal for a reverse split that would not proportionately reduce the
companys authorized stock, we apply the same analysis we would use for a proposal to increase authorized stock.
Mergers, acquisitions, asset sales, and other special transactions
In assessing mergers, acquisitions, asset sales, or other special transactions including business combinations involving Special Purpose Acquisition
Companies(SPACs) BIS primary consideration is the long-term economic interests of our clients as shareholders. We expect boards proposing a transaction to clearly explain the economic and strategic rationale behind it. We
will review a proposed transaction to determine the degree to which it enhances long-term shareholder value. While mergers, acquisitions, asset sales, business combinations, and other special transaction proposals vary widely in scope and substance,
we closely examine certain salient features in our analyses, such as:
● |
|
The degree to which the proposed transaction represents a premium to the companys trading price. We
consider the share price over multiple time periods prior to the date of the merger announcement. We |
B-29
|
may consider comparable transaction analyses provided by the parties financial advisors and our own valuation assessments. For companies facing insolvency or bankruptcy, a premium may not
apply |
● |
|
There should be clear strategic, operational, and/or financial rationale for the combination
|
● |
|
Unanimous board approval and arms-length negotiations are
preferred. We will consider whether the transaction involves a dissenting board or does not appear to be the result of an arms-length bidding process. We may also consider whether executive and/or board
members financial interests appear likely to affect their ability to place shareholders interests before their own |
● |
|
We prefer transaction proposals that include the fairness opinion of a reputable financial advisor assessing
the value of the transaction to shareholders in comparison to recent similar transactions |
Poison pill plans
Where a poison pill is put to a shareholder vote by management, our policy is to examine these plans individually. Although we have historically opposed
most plans, we may support plans that include a reasonable qualifying offer clause. Such clauses typically require shareholder ratification of the pill and stipulate a sunset provision whereby the pill expires unless it is renewed. These
clauses also tend to specify that an all-cash bid for all shares that includes a fairness opinion and evidence of financing does not trigger the pill, but forces either a special meeting at which the offer is
put to a shareholder vote or requires the board to seek the written consent of shareholders, where shareholders could rescind the pill at their discretion. We may also support a pill where it is the only effective method for protecting tax or other
economic benefits that may be associated with limiting the ownership changes of individual shareholders.
We generally vote in favor of shareholder
proposals to rescind poison pills.
Reimbursement of expense for successful shareholder campaigns
We generally do not support shareholder proposals seeking the reimbursement of proxy contest expenses, even in situations where we support the shareholder
campaign. We believe that introducing the possibility of such reimbursement may incentivize disruptive and unnecessary shareholder campaigns.
Executive compensation
BIS expects a companys board of directors to put in place a compensation structure that incentivizes and rewards
executives appropriately and is aligned with shareholder interests, particularly the generation of sustainable long-term value.
We expect the
compensation committee to carefully consider the specific circumstances of the company and the key individuals the board is focused on incentivizing. We encourage companies to ensure that their compensation plans incorporate appropriate and rigorous
performance metrics consistent with corporate strategy and market practice. Performance-based compensation should include metrics that are relevant to the business and stated strategy or risk mitigation efforts. Goals, and the processes used to set
these goals, should be clearly articulated and appropriately rigorous. We use third party research, in addition to our own analysis, to evaluate existing and proposed compensation structures. We hold members of the compensation committee, or
equivalent board members, accountable for poor compensation practices or structures.
BIS believes that there should be a clear link between variable
pay and company performance that drives value creation for our clients as shareholders. We are generally not supportive of one-off or special bonuses
B-30
unrelated to company or individual performance. Where discretion has been used by the compensation committee, we expect disclosure relating to how and why the discretion was used and further, how
the adjusted outcome is aligned with the interests of shareholders.
We acknowledge that the use of peer group evaluation by compensation committees can
help calibrate competitive pay; however, we are concerned when the rationale for increases in total compensation is solely based on peer benchmarking, rather than absolute outperformance.
We support incentive plans that foster the sustainable achievement of results both financial and
non-financial, including ESG consistent with the companys strategic initiatives. The vesting and holding timeframes associated with incentive plans should facilitate a focus on long-term value
creation.
Compensation committees should guard against contractual arrangements that would entitle executives to material compensation for early
termination of their contract. Finally, pension contributions and other deferred compensation arrangements should be reasonable in light of market practices. Our publicly available commentary provides more information on our approach to executive
compensation.
Say on Pay advisory resolutions
In cases where there is a Say on Pay vote, BIS will respond to the proposal as informed by our evaluation of compensation practices at that
particular company and in a manner that appropriately addresses the specific question posed to shareholders. Where we conclude that a company has failed to align pay with performance, we will vote against the management compensation proposal and
relevant compensation committee members.
Frequency of Say on Pay advisory resolutions
BIS will generally support annual advisory votes on executive compensation. We believe shareholders should have the opportunity to express feedback on
annual incentive programs and changes to long-term compensation before multiple cycles are issued.
Clawback proposals
We generally favor recoupment from any senior executive whose compensation was based on faulty financial reporting or deceptive business practices. We also
favor recoupment from any senior executive whose behavior caused material financial harm to shareholders, material reputational risk to the company, or resulted in a criminal proceeding, even if such actions did not ultimately result in a material
restatement of past results. This includes, but is not limited to, settlement agreements arising from such behavior and paid for directly by the company. We typically support shareholder proposals on these matters unless the company already has a
robust clawback policy that sufficiently addresses our concerns.
Employee stock purchase plans
We believe employee stock purchase plans (ESPP) are an important part of a companys overall human capital management strategy and can
provide performance incentives to help align employees interests with those of shareholders. The most common form of ESPP qualifies for favorable tax treatment under Section 423 of the Internal Revenue Code. We will typically support
qualified ESPP proposals.
B-31
Equity compensation plans
BIS supports equity plans that align the economic interests of directors, managers, and other employees with those of shareholders. We believe that boards
should establish policies prohibiting the use of equity awards in a manner that could disrupt the intended alignment with shareholder interests (e.g., the use of stock as collateral for a loan; the use of stock in a margin account; the use of stock
in hedging or derivative transactions). We may support shareholder proposals requesting the establishment of such policies.
Our evaluation of equity
compensation plans is based on a companys executive pay and performance relative to peers and whether the plan plays a significant role in a pay-for-performance
disconnect. We generally oppose plans that contain evergreen provisions, which allow for the unlimited increase of shares reserved without requiring further shareholder approval after a reasonable time period. We also generally oppose
plans that allow for repricing without shareholder approval. We may also oppose plans that provide for the acceleration of vesting of equity awards even in situations where an actual change of control may not occur. We encourage companies to
structure their change of control provisions to require the termination of the covered employee before acceleration or special payments are triggered (commonly referred to as double trigger change of control provisions).
Golden parachutes
We generally view golden
parachutes as encouragement to management to consider transactions that might be beneficial to shareholders. However, a large potential pay-out under a golden parachute arrangement also presents the risk of
motivating a management team to support a sub-optimal sale price for a company.
When determining whether to
support or oppose an advisory vote on a golden parachute plan, BIS may consider several factors, including:
● |
|
Whether we believe that the triggering event is in the best interests of shareholders |
● |
|
Whether management attempted to maximize shareholder value in the triggering event |
● |
|
The percentage of total premium or transaction value that will be transferred to the management team, rather
than shareholders, as a result of the golden parachute payment |
● |
|
Whether excessively large excise tax gross-up payments are part of the pay-out |
● |
|
Whether the pay package that serves as the basis for calculating the golden parachute payment was reasonable in
light of performance and peers |
● |
|
Whether the golden parachute payment will have the effect of rewarding a management team that has failed to
effectively manage the company |
It may be difficult to anticipate the results of a plan until after it has been triggered; as a
result, BIS may vote against a golden parachute proposal even if the golden parachute plan under review was approved by shareholders when it was implemented.
We may support shareholder proposals requesting that implementation of such arrangements require shareholder approval.
B-32
Option exchanges
We believe that there may be legitimate instances where underwater options create an overhang on a companys capital structure and a repricing or
option exchange may be warranted. We will evaluate these instances on a case-by-case basis. BIS may support a request to reprice or exchange underwater options under the
following circumstances:
● |
|
The company has experienced significant stock price decline as a result of macroeconomic trends, not individual
company performance |
● |
|
Directors and executive officers are excluded; the exchange is value neutral or value creative to shareholders;
tax, accounting, and other technical considerations have been fully contemplated |
● |
|
There is clear evidence that absent repricing, the company will suffer serious employee incentive or retention
and recruiting problems |
BIS may also support a request to exchange underwater options in other circumstances, if we determine that
the exchange is in the best interests of shareholders.
Supplemental executive retirement plans
BIS may support shareholder proposals requesting to put extraordinary benefits contained in supplemental executive retirement plans (SERP) to a
shareholder vote unless the companys executive pension plans do not contain excessive benefits beyond what is offered under employee-wide plans.
Environmental and social issues
We believe that well-managed companies deal effectively with material ESG factors relevant to their businesses. Governance is the core means by which boards
can oversee the creation of sustainable long-term value. Appropriate risk oversight of environmental and social (E&S) considerations stems from this construct.
Robust disclosure is essential for investors to effectively gauge the impact of companies business practices and strategic planning related to E&S
risks and opportunities. When a companys reporting is inadequate, investors, including BlackRock, will increasingly conclude that the company is not appropriately managing risk. Given the increased understanding of material sustainability
risks and opportunities, and the need for better information to assess them, BIS will advocate for continued improvement in companies reporting and will express concerns through our voting where disclosures or the business practices underlying
them are inadequate.
BIS encourages companies to disclose their approach to maintaining a sustainable business model. We believe that reporting aligned
with the framework developed by the Task Force on Climate-related Financial Disclosures (TCFD), supported by industry-specific metrics such as those identified by the Sustainability Accounting Standards Board (SASB), can
provide a comprehensive picture of a companys sustainability approach and performance. While the TCFD framework was developed to support climate-related risk disclosure, the four pillars of the TCFD Governance, Strategy, Risk
Management, and Metrics and Targets are a useful way for companies to disclose how they identify, assess, manage, and oversee a variety of sustainability-related risks and opportunities. SASBs industry-specific guidance (as identified
in its materiality map) is beneficial in helping companies identify key performance indicators (KPIs) across various dimensions of sustainability that are considered to be financially material and decision-useful within
B-33
their industry. We recognize that some companies may report using different standards, which may be required by regulation, or one of a number of private standards. In such cases, we ask that
companies highlight the metrics that are industry- or company-specific.
Accordingly, we ask companies to:
● |
|
Disclose the identification, assessment, management, and oversight of sustainability-related risks in
accordance with the four pillars of TCFD |
● |
|
Publish investor-relevant, industry-specific, material metrics and rigorous targets, aligned with SASB or
comparable sustainability reporting standards |
Companies should also disclose any supranational standards adopted, the industry
initiatives in which they participate, any peer group benchmarking undertaken, and any assurance processes to help investors understand their approach to sustainable and responsible business conduct.
Climate risk
BlackRock believes that climate change
has become a defining factor in companies long-term prospects. We ask every company to help its investors understand how it may be impacted by climate-related risk and opportunities, and how these factors are considered within strategy in a
manner consistent with the companys business model and sector. Specifically, we ask companies to articulate how their business model is aligned to a scenario in which global warming is limited to well below 2°C, moving towards global net
zero emissions by 2050.
BIS understands that climate change can be very challenging for many companies, as they seek to drive long-term value by
mitigating risks and capturing opportunities. A growing number of companies, financial institutions, as well as governments, have committed to advancing net zero. There is growing consensus that companies can benefit from the more favorable
macro-economic environment under an orderly, timely, and just transition to net zero.14 Many companies are asking what their role should be in contributing to a just transition in ensuring
a reliable energy supply and protecting the most vulnerable from energy price shocks and economic dislocation. They are also seeking more clarity as to the public policy path that will help align greenhouse gas reduction actions with commitments.
In this context, we ask companies to disclose a business plan for how they intend to deliver long-term financial performance through the transition to
global net zero, consistent with their business model and sector. We encourage companies to demonstrate that their plans are resilient under likely decarbonization pathways, and the global aspiration to limit warming to 1.5°C.15 We also encourage companies to disclose how considerations related to having a reliable energy supply and just transition affect their plans.
We look to companies to set short-, medium-, and long-term science-based targets, where available for their sector, for greenhouse gas reductions and to
demonstrate how their targets are consistent with the long-term
14 |
For example, BlackRocks Capital Markets Assumptions anticipate 25 points of cumulative economic gains
over a 20-year period in an orderly transition as compared to the alternative. This better macro environment will support better economic growth, financial stability, job growth, productivity, as well as
ecosystem stability and health outcomes. |
15 |
The global aspiration is reflective of aggregated efforts; companies in developed and emerging markets are not
equally equipped to transition their business and reduce emissions at the same ratethose in developed markets with the largest market capitalization are better positioned to adapt their business models at an accelerated pace. Government policy
and regional targets may be reflective of these realities. |
B-34
economic interests of their shareholders. Companies have an opportunity to use and contribute to the development of alternative energy sources and
low-carbon transition technologies that will be essential to reaching net zero. We also recognize that some continued investment is required to maintain a reliable, affordable supply of fossil fuels during the
transition. We ask companies to disclose how their capital allocation across alternatives, transition technologies, and fossil fuel production is consistent with their strategy and their emissions reduction targets.
In determining how to vote, we will continue to assess whether a companys disclosures are aligned with the TCFD and provide short-, medium-, and
long-term reduction targets for Scope 1 and 2 emissions. We may signal concerns about a companys plans or disclosures in our voting on director elections, particularly at companies facing material climate risks. We may support shareholder
proposals that ask companies to disclose climate plans aligned with our expectations. Our publicly available commentary provides more information on our approach to climate risk.
Key stakeholder interests
We believe that in order
to deliver long-term value for shareholders, companies should also consider the interests of their key stakeholders. While stakeholder groups may vary across industries, they are likely to include employees; business partners (such as suppliers and
distributors); clients and consumers; government and regulators; and the communities in which a company operates. Companies that build strong relationships with their key stakeholders are more likely to meet their own strategic objectives, while
poor relationships may create adverse impacts that expose a company to legal, regulatory, operational, and reputational risks and jeopardize their social license to operate. We expect companies to effectively oversee and mitigate these risks with
appropriate due diligence processes and board oversight. Our publicly available commentaries provide more information on our approach.
Human capital
management
A companys approach to human capital management (HCM) is a critical factor in fostering an inclusive, diverse, and
engaged workforce, which contributes to business continuity, innovation, and long-term value creation. Consequently, we expect companies to demonstrate a robust approach to HCM and provide shareholders with disclosures to understand how their
approach aligns with their stated strategy and business model.
We believe that clear and consistent disclosures on these matters are critical for
investors to make an informed assessment of a companys HCM practices. We expect companies to disclose the steps they are taking to advance diversity, equity, and inclusion; job categories and workforce demographics; and their responses to the
U.S. Equal Employment Opportunity Commissions EEO-1 Survey. Where we believe a companys disclosures or practices fall short relative to the market or peers, or we are unable to ascertain the board
and managements effectiveness in overseeing related risks and opportunities, we may vote against members of the appropriate committee or support relevant shareholder proposals. Our publicly available commentary provides more information on our
approach to HCM.
Corporate political activities
Companies may engage in certain political activities, within legal and regulatory limits, in order to support public policy matters material to the
companies long-term strategies. These activities can also create risks, including: the potential for allegations of corruption; certain reputational risks; and risks that arise from the complex legal, regulatory, and compliance considerations
associated with corporate political spending and
B-35
lobbying activity. Companies that engage in political activities should develop and maintain robust processes to guide these activities and mitigate risks, including board oversight.
When presented with shareholder proposals requesting increased disclosure on corporate political activities, BIS will evaluate publicly available
information to consider how a companys lobbying and political activities may impact the company. We will also evaluate whether there is general consistency between a companys stated positions on policy matters material to its strategy
and the material positions taken by significant industry groups of which it is a member. We may decide to support a shareholder proposal requesting additional disclosures if we identify a material inconsistency or feel that further transparency may
clarify how the companys political activities support its long-term strategy. Our publicly available commentary provides more information on our approach to corporate political activities.
General corporate governance matters
Adjourn meeting to solicit additional votes
We
generally support such proposals unless the agenda contains items that we judge to be detrimental to shareholders best long-term economic interests.
Bundled proposals
We believe that shareholders
should have the opportunity to review substantial governance changes individually without having to accept bundled proposals. Where several measures are grouped into one proposal, BIS may reject certain positive changes when linked with proposals
that generally contradict or impede the rights and economic interests of shareholders.
Exclusive forum provisions
BIS generally supports proposals to seek exclusive forum for certain shareholder litigation. In cases where a board unilaterally adopts exclusive forum
provisions that we consider unfavorable to the interests of shareholders, we will vote against the independent chair or lead independent director and members of the nominating/governance committee.
Multi-jurisdictional companies
Where a company is
listed on multiple exchanges or incorporated in a country different from its primary listing, we will seek to apply the most relevant market guideline(s) to our analysis of the companys governance structure and specific proposals on the
shareholder meeting agenda. In doing so, we typically consider the governance standards of the companys primary listing, the market standards by which the company governs itself, and the market context of each specific proposal on the agenda.
If the relevant standards are silent on the issue under consideration, we will use our professional judgment as to what voting outcome would best protect the long-term economic interests of investors. We expect companies to disclose the rationale
for their selection of primary listing, country of incorporation, and choice of governance structures, particularly where there is conflict between relevant market governance practices.
B-36
Other business
We oppose voting on matters where we are not given the opportunity to review and understand those measures and carry out an appropriate level of shareholder
oversight.
Reincorporation
Proposals to
reincorporate from one state or country to another are most frequently motivated by considerations of anti-takeover protections, legal advantages, and/or cost savings. We will evaluate, on a case-by-case basis, the economic and strategic rationale behind the companys proposal to reincorporate. In all instances, we will evaluate the changes to shareholder protections under the new
charter/articles/bylaws to assess whether the move increases or decreases shareholder protections.
Where we find that shareholder protections are
diminished, we may support reincorporation if we determine that the overall benefits outweigh the diminished rights.
IPO governance
We expect boards to consider and disclose how the corporate governance structures adopted upon initial public offering (IPO) are in
shareholders best long-term interests. We also expect boards to conduct a regular review of corporate governance and control structures, such that boards might evolve foundational corporate governance structures as company circumstances
change, without undue costs and disruption to shareholders. In our letter on unequal voting structures, we articulate our view that one vote for one share is the preferred structure for publicly-traded companies. We also recognize the
potential benefits of dual class shares to newly public companies as they establish themselves; however, we believe that these structures should have a specific and limited duration. We will generally engage new companies on topics such as
classified boards and supermajority vote provisions to amend bylaws, as we believe that such arrangements may not be in the best interest of shareholders in the long-term.
We will typically apply a one-year grace period for the application of certain director-related guidelines
(including, but not limited to, responsibilities on other public company boards and board composition concerns), during which we expect boards to take steps to bring corporate governance standards in line with our expectations.
Further, if a company qualifies as an emerging growth company (an EGC) under the Jumpstart Our Business Startups Act of 2012 (the JOBS
Act), we will give consideration to the NYSE and NASDAQ governance exemptions granted under the JOBS Act for the duration such a company is categorized as an EGC. We expect an EGC to have a totally independent audit committee by the first
anniversary of its IPO, with our standard approach to voting on auditors and audit-related issues applicable in full for an EGC on the first anniversary of its IPO.
Corporate form
Proposals to change a
corporations form, including those to convert to a public benefit corporation (PBC) structure, should clearly articulate how the interests of shareholders and different stakeholders would be augmented or adversely affected, as well
as the accountability and voting mechanisms that would be available to shareholders. We generally support management proposals if our analysis indicates that shareholders interests are adequately protected. Corporate form shareholder proposals
are evaluated on a case-by-case basis.
B-37
Shareholder protections
Amendment to charter/articles/bylaws
We believe
that shareholders should have the right to vote on key corporate governance matters, including changes to governance mechanisms and amendments to the charter/articles/bylaws. We may vote against certain directors where changes to governing documents
are not put to a shareholder vote within a reasonable period of time, particularly if those changes have the potential to impact shareholder rights (see Director elections). In cases where a boards unilateral adoption of changes to
the charter/articles/bylaws promotes cost and operational efficiency benefits for the company and its shareholders, we may support such action if it does not have a negative effect on shareholder rights or the companys corporate governance
structure.
When voting on a management or shareholder proposal to make changes to the charter/articles/bylaws, we will consider in part the
companys and/or proponents publicly stated rationale for the changes; the companys governance profile and history; relevant jurisdictional laws; and situational or contextual circumstances which may have motivated the proposed
changes, among other factors. We will typically support amendments to the charter/articles/bylaws where the benefits to shareholders outweigh the costs of failing to make such changes.
Proxy access
We believe that long-term shareholders
should have the opportunity, when necessary and under reasonable conditions, to nominate directors on the companys proxy card.
In our view,
securing the right of shareholders to nominate directors without engaging in a control contest can enhance shareholders ability to meaningfully participate in the director election process, encourage board attention to shareholder interests,
and provide shareholders an effective means of directing that attention where it is lacking. Proxy access mechanisms should provide shareholders with a reasonable opportunity to use this right without stipulating overly restrictive or onerous
parameters for use, and also provide assurances that the mechanism will not be subject to abuse by short-term investors, investors without a substantial investment in the company, or investors seeking to take control of the board.
In general, we support market-standardized proxy access proposals, which allow a shareholder (or group of up to 20 shareholders) holding three percent of a
companys outstanding shares for at least three years the right to nominate the greater of up to two directors or 20% of the board. Where a standardized proxy access provision exists, we will generally oppose shareholder proposals requesting
outlier thresholds.
Right to act by written consent
In exceptional circumstances and with sufficiently broad support, shareholders should have the opportunity to raise issues of substantial importance without
having to wait for management to schedule a meeting. We therefore believe that shareholders should have the right to solicit votes by written consent provided that: 1) there are reasonable requirements to initiate the consent solicitation process
(in order to avoid the waste of corporate resources in addressing narrowly supported interests); and 2) shareholders receive a minimum of 50% of outstanding shares to effectuate the action by written consent. We may oppose shareholder proposals
requesting the right to act by written consent in cases where the proposal is structured for the benefit of a dominant shareholder to the exclusion of others, or if the proposal is written to discourage the board from incorporating appropriate
mechanisms to avoid the waste of corporate resources when
B-38
establishing a right to act by written consent. Additionally, we may oppose shareholder proposals requesting the right to act by written consent if the company already provides a shareholder
right to call a special meeting that we believe offers shareholders a reasonable opportunity to raise issues of substantial importance without having to wait for management to schedule a meeting.
Right to call a special meeting
In exceptional
circumstances and with sufficiently broad support, shareholders should have the opportunity to raise issues of substantial importance without having to wait for management to schedule a meeting. Accordingly, shareholders should have the right to
call a special meeting in cases where a reasonably high proportion of shareholders (typically a minimum of 15% but no higher than 25%) are required to agree to such a meeting before it is called. However, we may oppose this right in cases where the
proposal is structured for the benefit of a dominant shareholder, or where a lower threshold may lead to an ineffective use of corporate resources. We generally believe that a right to act via written consent is not a sufficient alternative to the
right to call a special meeting.
Simple majority voting
We generally favor a simple majority voting requirement to pass proposals. Therefore, we will support the reduction or the elimination of supermajority
voting requirements to the extent that we determine shareholders ability to protect their economic interests is improved. Nonetheless, in situations where there is a substantial or dominant shareholder, supermajority voting may be protective
of minority shareholder interests and we may support supermajority voting requirements in those situations.
Virtual meetings
Shareholders should have the opportunity to participate in the annual and special meetings for the companies in which they are invested, as these meetings
facilitate an opportunity for shareholders to provide feedback and hear from the board and management. While these meetings have traditionally been conducted in-person, virtual meetings are an increasingly
viable way for companies to utilize technology to facilitate shareholder accessibility, inclusiveness, and cost efficiencies. We expect shareholders to have a meaningful opportunity to participate in the meeting and interact with the board and
management in these virtual settings; companies should facilitate open dialogue and allow shareholders to voice concerns and provide feedback without undue censorship. Relevant shareholder proposals are assessed on a
case-by-case basis.
B-39
BlackRock Science and Te... (NYSE:BST)
Historical Stock Chart
From Mar 2024 to Apr 2024
BlackRock Science and Te... (NYSE:BST)
Historical Stock Chart
From Apr 2023 to Apr 2024