EXPLANATORY NOTE: This Registration Statement has been filed by Investors Cash
Trust (the "Registrant") pursuant to Section 8(b) of the Investment Company Act
of 1940, as amended. However, shares of beneficial interest of Central Cash
Management Fund, (the "Fund"), a series of the Registrant, are not being
registered under the Securities Act of 1933 (the "1933 Act") since such shares
will be issued by the Registrant solely in private placement transactions which
do not involve any "public offering" within the meaning of Section 4(2) of the
1933 Act. Shares of the Fund may only be purchased by "accredited investors," as
that term is defined in Rule 501(a) of Regulation D under the Securities Act.
This Registration Statement does not constitute an offer to sell, or the
solicitation of an offer to buy, any shares of beneficial interest of the Fund.
PART I: APPENDIX I-J - ADDITIONAL INFORMATION
FUND CLASS CUSIP NUMBER
Central Cash Management Fund Central Cash Management Fund 461473852
Fiscal Year End: 3/31
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I-20
STATEMENT OF ADDITIONAL INFORMATION (SAI) - PART II
PAGE
Part II................................................................................... II-1
Management of the Fund.................................................................. II-1
Board Members.......................................................................... II-3
Fund Organization....................................................................... II-6
Purchase and Redemption of Shares....................................................... II-8
Purchases.............................................................................. II-8
Redemptions............................................................................ II-8
Investments............................................................................. II-10
General Investment Practices and Techniques............................................ II-10
Portfolio Transactions.................................................................. II-10
Portfolio Holdings Information.......................................................... II-12
Net Asset Value......................................................................... II-13
Proxy Voting Guidelines................................................................. II-14
Miscellaneous........................................................................... II-14
Ratings Of Investments.................................................................. II-14
Part II: Appendix II-A - Board Members and Officers..................................... II-21
Part II: Appendix II-B - Portfolio Management Compensation.............................. II-27
Part II: Appendix II-C - Fee Rates of Service Providers................................. II-28
Part II: Appendix II-D - Financial Services Firms' Compensation......................... II-29
Part II: Appendix II-E - Firms With Which Deutsche Asset & Wealth Management Has II-30
Revenue Sharing Arrangements
Part II: Appendix II-F - Class A Sales Charge Schedule.................................. II-31
Part II: Appendix II-G - Investment Practices and Techniques............................ II-32
Part II: Appendix II-H - Taxes.......................................................... II-85
Part II: Appendix II-I - Proxy Voting Policy and Guidelines............................. II-105
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PART II
MANAGEMENT OF THE FUND
INVESTMENT ADVISOR. DIMA, with headquarters at 345 Park Avenue, New York, New
York, is the investment advisor for the fund. Under the oversight of the Board,
DIMA on behalf of the fund makes the investment decisions, buys and sells
securities and conducts research that leads to these purchase and sale
decisions. DIMA manages the fund's daily investment and business affairs
subject to the policies established by the Board. DIMA and its predecessors
have more than 80 years of experience managing mutual funds.
DIMA is an indirect, wholly-owned subsidiary of Deutsche Bank AG, a
multi-national financial services company with limited liability organized
under the laws of the Federal Republic of Germany. As a result, DIMA, which is
part of DeAM, is affiliated with a variety of entities that provide, and/or
engage in commercial banking, insurance, brokerage, investment banking,
financial advisory, broker-dealer activities (including sales and trading),
hedge funds, real estate and private equity investing, in addition to the
provision of investment management services to institutional and individual
investors. DWS Investments is part of the Asset Management division of Deutsche
Bank AG and, within the US, represents the retail asset management activities
of Deutsche Bank AG, Deutsche Bank Trust Company Americas, DIMA and DWS Trust
Company.
DIMA provides investment advisory services to many individuals and
institutions, including insurance companies, corporations, and financial and
banking organizations, as well as providing investment advice to open- and
closed-end registered investment companies.
DeAM is the marketing name in the US for the asset management activities of
Deutsche Bank AG, DIMA, Deutsche Bank Trust Company Americas and DWS Trust
Company. DeAM is a global asset management organization that offers a wide
range of investing expertise and resources, including hundreds of portfolio
managers and analysts and an office network that reaches the world's major
investment centers. This well-resourced global investment platform brings
together a wide variety of experience and investment insight, across
industries, regions, asset classes and investing styles.
In some instances, the investments for a fund may be managed by the same
individuals who manage one or more other mutual funds advised by DIMA that have
similar names, objectives and investment styles. A fund may differ from these
other mutual funds in size, cash flow patterns, distribution arrangements,
expenses and tax matters. Accordingly, the holdings and performance of a fund
may be expected to vary from those of other mutual funds.
Certain investments may be appropriate for a fund and also for other clients
advised by DIMA. Investment decisions for a fund and other clients are made
with a view to achieving their respective investment objectives and after
consideration of such factors as their current holdings, availability of cash
for investment and the size of their investments generally. Frequently, a
particular security may be bought or sold for only one client or in different
amounts and at different times for more than one but less than all clients.
Likewise, a particular security may be bought for one or more clients when one
or more other clients are selling the security. In addition, purchases or sales
of the same security may be made for two or more clients on the same day. In
such event, such transactions will be allocated among the clients in a manner
believed by DIMA to be equitable to each. In some cases, this procedure could
have an adverse effect on the price or amount of the securities purchased or
sold by a fund. Purchase and sale orders for a fund may be combined with those
of other clients of DIMA in the interest of achieving the most favorable net
results to a fund.
DIMA, its parent or its subsidiaries, or affiliates may have deposit, loan and
other commercial banking relationships with the issuers of obligations which
may be purchased on behalf of a fund, including outstanding loans to such
issuers which could be repaid in whole or in part with the proceeds of
securities so purchased. Such affiliates deal, trade and invest for their own
accounts in such obligations and are among the leading dealers of various types
of such obligations. DIMA has informed a fund that, in making its investment
decisions, it does not obtain or use material inside information in its
possession or in the possession of any of its affiliates. In making investment
recommendations for a fund, DIMA will not inquire or take into consideration
whether an issuer of securities proposed for purchase or sale by a fund is a
customer of DIMA, its parent or its subsidiaries or affiliates. Also, in
dealing with its customers, the Advisor, its parent, subsidiaries, and
affiliates will not inquire or take into consideration whether securities of
such customers are held by any fund managed by DIMA or any such affiliate.
II-1
Officers and employees of the Advisor from time to time may have transactions
with various banks, including a fund's custodian bank. It is the Advisor's
opinion that the terms and conditions of those transactions which have occurred
were not influenced by existing or potential custodial or other fund
relationships.
From time to time, DIMA, Deutsche Bank AG or their affiliates may at their sole
discretion invest their own assets in shares of a fund for such purposes it
deems appropriate, including investments designed to assist in the management
of a fund. Any such investment may be hedged by DIMA, Deutsche Bank AG or their
affiliates and, in that event, the return on such investment, net of the effect
of the hedge, would be expected to differ from the return of a fund. DIMA,
Deutsche Bank AG or their affiliates have no obligation to make any investment
in a fund and the amount of any such investment may or may not be significant
in comparison to the level of assets of a fund. In the event that such an
investment is made, except as otherwise required under the 1940 Act, DIMA,
Deutsche Bank AG or their affiliates would be permitted to redeem the
investment at such time that they deem appropriate.
TERMS OF THE INVESTMENT MANAGEMENT AGREEMENT. Pursuant to the Investment
Management Agreement, DIMA provides continuing investment management of the
assets of a fund. In addition to the investment management of the assets of a
fund, the Advisor determines the investments to be made for each fund,
including what portion of its assets remain uninvested in cash or cash
equivalents, and with whom the orders for investments are placed, consistent
with a fund's policies as stated in its prospectus and SAI, or as adopted by a
fund's Board. DIMA will also monitor, to the extent not monitored by a fund's
administrator or other agent, a fund's compliance with its investment and tax
guidelines and other compliance policies.
DIMA provides assistance to a fund's Board in valuing the securities and other
instruments held by a fund, to the extent reasonably required by valuation
policies and procedures that may be adopted by a fund.
Pursuant to the Investment Management Agreement, (unless otherwise provided in
the agreement or as determined by a fund's Board and to the extent permitted by
applicable law), DIMA pays the compensation and expenses of all the Board
members, officers, and executive employees of a fund, including a fund's share
of payroll taxes, who are affiliated persons of DIMA.
The Investment Management Agreement provides that a fund, except as noted
below, is generally responsible for expenses that include, but are not limited
to: fees payable to the Advisor; outside legal, accounting or auditing
expenses, including with respect to expenses related to negotiation,
acquisition or distribution of portfolio investments; maintenance of books and
records that are maintained by a fund, a fund's custodian, or other agents of a
fund; taxes and governmental fees; fees and expenses of a fund's accounting
agent, custodian, sub-custodians, depositories, transfer agents, dividend
reimbursing agents and registrars; payment for portfolio pricing or valuation
services to pricing agents, accountants, bankers and other specialists, if any;
brokerage commissions or other costs of acquiring or disposing of any portfolio
securities or other instruments of a fund; and litigation expenses and other
extraordinary expenses not incurred in the ordinary course of a fund's
business.
The Investment Management Agreement allows DIMA to delegate any of its duties
under the Investment Management Agreement to a sub-advisor, subject to a
majority vote of the Board, including a majority of the Board who are not
interested persons of a fund, and, if required by applicable law, subject to a
majority vote of a fund's shareholders.
The Investment Management Agreement provides that DIMA shall not be liable for
any error of judgment or mistake of law or for any loss suffered by a fund in
connection with matters to which the agreement relates, except a loss resulting
from willful malfeasance, bad faith or gross negligence on the part of DIMA in
the performance of its duties or from reckless disregard by DIMA of its
obligations and duties under the agreement. The Investment Management Agreement
may be terminated at any time, without payment of penalty, by either party or
by vote of a majority of the outstanding voting securities of a fund on 60
days' written notice.
The Investment Management Agreement continues in effect from year to year only
if its continuance is approved annually by the vote of a majority of the Board
Members who are not parties to such agreement or interested persons of any such
party, cast in person at a meeting called for the purpose of voting on such
approval, and either by a vote of the Board or of a majority of the outstanding
voting securities of a fund.
The annual management fee rate for the fund is set forth in PART II - APPENDIX
II-C.
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Under a separate agreement between Deutsche Bank AG and the funds, Deutsche
Bank AG has granted a license to the funds to utilize the trademark "DWS."
AGREEMENT TO INDEMNIFY INDEPENDENT BOARD MEMBERS FOR CERTAIN EXPENSES. In
connection with litigation or regulatory action related to possible improper
market timing or other improper trading activity or possible improper marketing
and sales activity in certain DWS funds (Affected Funds), DIMA has agreed to
indemnify and hold harmless the Affected Funds (Fund Indemnification Agreement)
against any and all loss, damage, liability and expense, arising from market
timing or marketing and sales matters alleged in any enforcement actions
brought by governmental authorities involving or potentially affecting the
Affected Funds or DIMA (Enforcement Actions) or that are the basis for private
actions brought by shareholders of the Affected Funds against the Affected
Funds, their directors and officers, DIMA and/or certain other parties (Private
Litigation), or any proceedings or actions that may be threatened or commenced
in the future by any person (including governmental authorities), arising from
or similar to the matters alleged in the Enforcement Actions or Private
Litigation. In recognition of its undertaking to indemnify the Affected Funds
and in light of the rebuttable presumption generally afforded to independent
directors/trustees of investment companies that they have not engaged in
disabling conduct, DIMA has also agreed, subject to applicable law and
regulation, to indemnify certain (or, with respect to certain Affected Funds,
all) of the Independent Board Members of the Affected Funds, against certain
liabilities the Independent Board Members may incur from the matters alleged in
any Enforcement Actions or Private Litigation or arising from or similar to the
matters alleged in the Enforcement Actions or Private Litigation, and advance
expenses that may be incurred by the Independent Board Members in connection
with any Enforcement Actions or Private Litigation. DIMA is not, however,
required to provide indemnification and advancement of expenses: (1) with
respect to any proceeding or action which the Affected Funds' Board determines
that the Independent Board Members ultimately would not be entitled to
indemnification or (2) for any liability of the Independent Board Members or
their shareholders to which the Independent Board Member would otherwise be
subject by reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of the Independent Board Member's duties as a director or
trustee of the Affected Funds as determined in a final adjudication in such
action or proceeding. The estimated amount of any expenses that may be advanced
to the Independent Board Members or indemnity that may be payable under the
indemnity agreements is currently unknown. These agreements by DIMA will
survive the termination of the Investment Management Agreements between DIMA
and the Affected Funds.
BOARD MEMBERS
BOARD MEMBERS AND OFFICERS' IDENTIFICATION AND BACKGROUND. The identification
and background of the Board Members and Officers of the Registrant are set
forth in PART II - APPENDIX II-A.
BOARD COMMITTEES AND COMPENSATION. Information regarding the Committees of the
Board, as well as compensation paid to the Independent Board Members and to
Board Members who are not officers of the Registrant, for certain specified
periods, is set forth in PART I - APPENDIX I-B AND PART I - APPENDIX I-C.
ADMINISTRATOR, TRANSFER AGENT AND SHAREHOLDER SERVICE AGENT, AND CUSTODIAN
ADMINISTRATOR. DIMA serves as a fund's administrator pursuant to an
Administrative Services Agreement.
For its services under the Administrative Services Agreement, the Administrator
receives a fee at the rate set forth in PART II - APPENDIX II-C. The
Administrator will pay Accounting Agency fees out of the Administrative
Services fee.
Under the Administrative Services Agreement, the Administrator is obligated on
a continuous basis to provide such administrative services as the Board of a
fund reasonably deems necessary for the proper administration of a fund. The
Administrator provides a fund with personnel; arranges for the preparation and
filing of a fund's tax returns; prepares and submits reports and meeting
materials to the Board and the shareholders; prepares and files updates to a
fund's prospectus and statement of additional information as well as other
reports required to be filed by the SEC; maintains a fund's records; provides a
fund with office space, equipment and services; supervises, negotiates the
contracts of and monitors the performance of third parties contractors;
oversees the tabulation of proxies; monitors the valuation of portfolio
securities and monitors compliance with Board-approved valuation procedures;
assists in establishing the accounting and tax policies of a fund; assists in
the resolution of accounting issues that may arise with respect to a fund;
establishes and monitors a fund's operating expense budgets; reviews and
processes a fund's bills; assists in determining the amount of dividends and
distributions available to be paid by a fund, prepares and arranges
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dividend notifications and provides information to agents to effect payments
thereof; provides to the Board periodic and special reports; provides
assistance with investor and public relations matters; and monitors the
registration of shares under applicable federal and state law. The
Administrator also performs certain fund accounting services under the
Administrative Services Agreement.
The Administrative Services Agreement provides that the Administrator will not
be liable under the Administrative Services Agreement except for willful
misfeasance, bad faith or negligence in the performance of its duties or from
the reckless disregard by it of its duties and obligations thereunder. Pursuant
to an agreement between the Administrator and SSB, the Administrator has
delegated certain administrative functions to SSB. The costs and expenses of
such delegation are borne by the Administrator, not by a fund.
Pursuant to the Advisor's procedures, approved by the Board, proof of claim
forms are routinely filed on behalf of a fund by a third party service
provider, with certain limited exceptions. The Board receives periodic reports
regarding the implementation of these procedures.
TRANSFER AGENT AND SHAREHOLDER SERVICE AGENT. State Street and Trust Company
("SSB"), Lafayette Corporate Center, 2 Avenue De Lafayette, Boston, MA 02110 is
the transfer agent, dividend-paying agent and shareholder service agent for the
fund.
CUSTODIAN. Under its custody agreement with a fund, the Custodian (i) maintains
separate accounts in the name of a fund, (ii) holds and transfers portfolio
securities on account of a fund, (iii) accepts receipts and makes disbursements
of money on behalf of a fund, and (iv) collects and receives all income and
other payments and distributions on account of a fund's portfolio securities.
The Custodian has entered into agreements with foreign subcustodians approved
by the Board pursuant to Rule 17f-5 under the 1940 Act.
In some instances, the Custodian may use Deutsche Bank AG or its affiliates, as
subcustodian (DB Subcustodian) in certain countries. To the extent a fund holds
any securities in the countries in which the Custodian uses a DB Subcustodian
as a subcustodian, those securities will be held by DB Subcustodian as part of
a larger omnibus account in the name of the Custodian (Omnibus Account). For
its services, DB Subcustodian receives (1) an annual fee based on a percentage
of the average daily net assets of the Omnibus Account and (2) transaction
charges with respect to transactions that occur within the Omnibus Account. To
the extent that a DB Subcustodian receives any brokerage commissions for any
transactions, such transactions and amount of brokerage commissions paid by the
fund are set forth in PART I - APPENDIX I-H.
The Custodian's fee may be reduced by certain earnings credits in favor of a
fund.
FUND LEGAL COUNSEL. Provides legal services to the funds.
TRUSTEE/DIRECTOR LEGAL COUNSEL. Serves as legal counsel to the Independent
Board Members.
PRINCIPAL UNDERWRITER AND DISTRIBUTION AGREEMENT. Pursuant to a distribution
agreement (Distribution Agreement) with a fund, DIDI, 222 South Riverside
Plaza, Chicago, Illinois 60606, an affiliate of the Advisor, is the distributor
of the fund. The Distribution Agreement remains in effect for a class from year
to year only if its continuance is approved for the class at least annually by
a vote of the Board, including the Board Members who are not parties to the
Distribution Agreement or interested persons of any such party.
REGULATORY MATTERS AND LEGAL PROCEEDINGS. On December 21, 2006, Deutsche Asset
Management (DeAM) settled proceedings with the Securities and Exchange
Commission (SEC) and the New York Attorney General on behalf of Deutsche Asset
Management, Inc. (DAMI) and DIMA, the investment advisors to many of the DWS
Investments funds, regarding allegations of improper trading of fund shares at
DeAM and at the legacy Scudder and Kemper organizations prior to their
acquisition by DeAM in April 2002. These regulators alleged that although the
prospectuses for certain funds in the regulators' view indicated that the funds
did not permit market timing, DAMI and DIMA breached their fiduciary duty to
those funds in that their efforts to limit trading activity in the funds were
not effective at certain times. The regulators also alleged that DAMI and DIMA
breached their fiduciary duty to certain funds by entering into certain market
timing arrangements with investors. These trading arrangements originated in
businesses that existed prior to the currently constituted DeAM organization,
which came together as a result of various mergers of the legacy Scudder,
Kemper and Deutsche fund groups, and all of the arrangements were terminated
prior to the start of the regulatory investigations that began in the summer of
2003. No current DeAM employee approved these trading arrangements. Under the
terms of the settlements, DAMI and DIMA neither admitted nor denied any
wrongdoing.
II-4
The terms of the SEC settlement, which identified improper trading in the
legacy Deutsche and Kemper mutual funds only, provide for payment of
disgorgement in the amount of $17.2 million. The terms of the settlement with
the New York Attorney General provide for payment of disgorgement in the amount
of $102.3 million, which is inclusive of the amount payable under the SEC
settlement, plus a civil penalty in the amount of $20 million. The total amount
payable by DeAM, approximately $122.3 million, will be distributed to
shareholders of the affected funds in accordance with a distribution plan to be
developed by a distribution consultant. The funds' investment advisors do not
believe these amounts will have a material adverse financial impact on them or
materially affect their ability to perform under their investment management
agreements with the DWS funds. The above-described amounts are not material to
Deutsche Bank, and have already been reserved.
Among the terms of the settled orders, DeAM is subject to certain undertakings
regarding the conduct of its business in the future, including formation of a
Code of Ethics Oversight Committee to oversee all matters relating to issues
arising under the advisors' Code of Ethics; establishment of an Internal
Compliance Controls Committee having overall compliance oversight
responsibility of the advisors; engagement of an Independent Compliance
Consultant to conduct a comprehensive review of the advisors' supervisory
compliance and other policies and procedures designed to prevent and detect
breaches of fiduciary duty, breaches of the Code of Ethics and federal
securities law violations by the advisors and their employees; and commencing
in 2008, the advisors shall undergo a compliance review by an independent third
party.
In addition, DeAM is subject to certain further undertakings relating to the
governance of the mutual funds, including that at least 75% of the members of
the Boards of Trustees/Directors overseeing the DWS funds continue to be
independent of DeAM; the Chairmen of the DWS funds' Boards of Trustees continue
to be independent of DeAM; DeAM maintain existing management fee reductions for
certain funds for a period of five years and not increase management fees for
these certain funds during this period; the funds retain a senior officer (or
independent consultants, as applicable) responsible for assisting in the review
of fee arrangements and monitoring compliance by the funds and the investment
advisors with securities laws, fiduciary duties, codes of ethics and other
compliance policies, the expense of which shall be borne by DeAM; and periodic
account statements, fund prospectuses and the mutual funds' web site contain
additional disclosure and/or tools that assist investors in understanding the
fees and costs associated with an investment in the funds and the impact of
fees and expenses on fund returns.
DeAM has also settled proceedings with the Illinois Secretary of State
regarding market timing matters. The terms of the Illinois settlement provide
for investor education contributions totaling approximately $4 million and a
payment in the amount of $2 million to the Securities Audit and Enforcement
Fund.
On September 28, 2006, the SEC and the National Association of Securities
Dealers (NASD) (now known as the Financial Industry Regulatory Authority, or
FINRA) announced final agreements in which Deutsche Investment Management
Americas Inc. (DIMA), Deutsche Asset Management, Inc. (DAMI) and DWS Scudder
Distributors, Inc. (now known as DWS Investments Distributors, Inc. ("DIDI"))
settled administrative proceedings regarding disclosure of brokerage allocation
practices in connection with sales of the DWS funds' (now known as the DWS
Investments Funds) shares during 2001-2003. The agreements with the SEC and
NASD are reflected in orders which state, among other things, that DIMA and
DAMI failed to disclose potential conflicts of interest to the funds' Boards
and to shareholders relating to DIDI's use of certain funds' brokerage
commissions to reduce revenue sharing costs to broker dealer firms with whom it
had arrangements to market and distribute DWS fund shares. These directed
brokerage practices were discontinued in October 2003.
Under the terms of the settlements, in which DIMA, DAMI and DIDI neither
admitted nor denied any of the regulators' findings, DIMA, DAMI and DIDI agreed
to pay disgorgement, prejudgment interest and civil penalties in the total
amount of $19.3 million. The portion of the settlements distributed to the
funds was approximately $17.8 million and was paid to the funds as prescribed
by the settlement orders based upon the amount of brokerage commissions from
each fund used to satisfy revenue sharing agreements with broker dealers who
sold fund shares.
As part of the settlements, DIMA, DAMI and DIDI also agreed to implement
certain measures and undertakings relating to revenue sharing payments
including making additional disclosures in the funds' prospectuses or
Statements of Additional Information, adopting or modifying relevant policies
and procedures and providing regular reporting to the fund Boards.
II-5
Additional information announced by DeAM regarding the terms of the settlements
is available at www.dws investments.com/regulatory_settlements.
The matters alleged in the regulatory settlements described above also serve as
the general basis of a number of private class action lawsuits involving the
DWS funds. These lawsuits name as defendants various persons, including certain
DWS funds, the funds' investment advisors and their affiliates, and certain
individuals, including in some cases fund Trustees/ Directors, officers, and
other parties. Each DWS fund's investment advisor has agreed to indemnify the
applicable DWS funds in connection with these lawsuits, or other lawsuits or
regulatory actions that may be filed making similar allegations.
Based on currently available information, the funds' investment advisors
believe the likelihood that the pending lawsuits will have a material adverse
financial impact on a DWS fund is remote and such actions are not likely to
materially affect their ability to perform under their investment management
agreements with the DWS funds.
CODES OF ETHICS. Each fund, the Advisor, a fund's principal underwriter and, if
applicable, a fund's sub-advisor (and sub-subadvisor) have each adopted codes
of ethics under Rule 17j-1 under the 1940 Act. Board Members, officers of a
Registrant and employees of the Advisor and principal underwriter are permitted
to make personal securities transactions, including transactions in securities
that may be purchased or held by a fund, subject to requirements and
restrictions set forth in the applicable Code of Ethics. The Advisor's Code of
Ethics contains provisions and requirements designed to identify and address
certain conflicts of interest between personal investment activities and the
interests of a fund. Among other things, the Advisor's Code of Ethics prohibits
certain types of transactions absent prior approval, imposes time periods
during which personal transactions may not be made in certain securities, and
requires the submission of duplicate broker confirmations and quarterly
reporting of securities transactions. Additional restrictions apply to
portfolio managers, traders, research analysts and others involved in the
investment advisory process. Exceptions to these and other provisions of the
Advisor's or sub-advisors Codes of Ethics may be granted in particular
circumstances after review by appropriate personnel.
FUND ORGANIZATION
The Board has the authority to divide the shares of the Trust into multiple
funds by establishing and designating two or more series of the Trust. The
Board also has the authority to establish and designate two or more classes of
shares of the Trust, or of any series thereof, with variations in the relative
rights and preferences between the classes as determined by the Board; provided
that all shares of a class shall be identical with each other and with the
shares of each other class of the same series except for such variations
between the classes, including bearing different expenses, as may be authorized
by the Board and not prohibited by the 1940 Act and the rules and regulations
thereunder. All shares issued and outstanding are transferable, have no
pre-emptive or conversion rights (except as may be determined by the Board) and
are redeemable as described in the SAI and in the prospectus. Each share has
equal rights with each other share of the same class of the fund as to voting,
dividends, exchanges, conversion features and liquidation. Shareholders are
entitled to one vote for each full share held and fractional votes for
fractional shares held.
A fund generally is not required to hold meetings of its shareholders. Under
the Declaration of Trust, shareholders only have the power to vote in
connection with the following matters and only to the extent and as provided in
the Declaration of Trust and as required by applicable law: (a) the election,
re-election or removal of one or more Trustees if a meeting of shareholders is
called by or at the direction of the Board for such purpose(s), provided that
the Board shall promptly call a meeting of shareholders for the purpose of
voting upon the question of removal of one or more Trustees as a result of a
request in writing by the holders of not less than ten percent of the
outstanding shares of the Trust; (b) the termination of the Trust or a fund if,
in either case, the Board submits the matter to a vote of shareholders; (c) any
amendment of the Declaration of Trust that (i) would affect the rights of
shareholders to vote under the Declaration of Trust, (ii) requires shareholder
approval under applicable law or (iii) the Board submits to a vote of
shareholders; and (d) such additional matters as may be required by law or as
the Board may determine to be necessary or desirable. Shareholders also vote
upon changes in fundamental policies or restrictions.
The Declaration of Trust provides that shareholder meeting quorum requirements
shall be established in the By-laws. The By-laws of the Trust currently provide
that the presence in person or by proxy of the holders of thirty percent of the
shares entitled to vote at a meeting shall
II-6
constitute a quorum for the transaction of business at meetings of shareholders
of the Trust (or of an individual series or class if required to vote
separately).
On any matter submitted to a vote of shareholders, all shares of the Trust
entitled to vote shall, except as otherwise provided in the By-laws, be voted
in the aggregate as a single class without regard to series or classes of
shares, except (a) when required by applicable law or when the Board has
determined that the matter affects one or more series or classes of shares
materially differently, shares shall be voted by individual series or class;
and (b) when the Board has determined that the matter affects only the
interests of one or more series or classes, only shareholders of such series or
classes shall be entitled to vote thereon.
The Declaration of Trust provides that the Board may, in its discretion,
establish minimum investment amounts for shareholder accounts, impose fees on
accounts that do not exceed a minimum investment amount and involuntarily
redeem shares in any such account in payment of such fees. The Board, in its
sole discretion, also may cause the Trust to redeem all of the shares of the
Trust or one or more series or classes held by any shareholder for any reason,
to the extent permissible by the 1940 Act, including (a) if the shareholder
owns shares having an aggregate net asset value of less than a specified
minimum amount, (b) if a particular shareholder's ownership of shares would
disqualify a series from being a regulated investment company, (c) upon a
shareholder's failure to provide sufficient identification to permit the Trust
to verify the shareholder's identity, (d) upon a shareholder's failure to pay
for shares or meet or maintain the qualifications for ownership of a particular
class or series of shares, (e) if the Board determines (or pursuant to policies
established by the Board it is determined) that share ownership by a particular
shareholder is not in the best interests of remaining shareholders, (f) when a
fund is requested or compelled to do so by governmental authority or applicable
law and (g) upon a shareholder's failure to comply with a request for
information with respect to the direct or indirect ownership of shares or other
securities of the Trust. The Declaration of Trust also authorizes the Board to
terminate a fund or any class without shareholder approval, and the Trust may
suspend the right of shareholders to require the Trust to redeem shares to the
extent permissible under the 1940 Act.
The Declaration of Trust provides that, except as otherwise required by
applicable law, the Board may authorize the Trust or any series or class
thereof to merge, reorganize or consolidate with any corporation, association,
trust or series thereof (including another series or class of the Trust) or
other entity (in each case, the "Surviving Entity") or the Board may sell,
lease or exchange all or substantially all of the Trust property (or all or
substantially all of the Trust property allocated or belonging to a particular
series or class), including its good will, to any Surviving Entity, upon such
terms and conditions and for such consideration as authorized by the Board.
Such transactions may be effected through share-for-share exchanges, transfers
or sales of assets, in-kind redemptions and purchases, exchange offers or any
other method approved by the Board. The Board shall provide notice to affected
shareholders of each such transaction. The authority of the Board with respect
to the merger, reorganization or consolidation of any class of the Trust is in
addition to the authority of the Board to combine two or more classes of a
series into a single class.
Upon the termination of the Trust or any series or class, after paying or
adequately providing for the payment of all liabilities, which may include the
establishment of a liquidating trust or similar vehicle, and upon receipt of
such releases, indemnities and refunding agreements as they deem necessary for
their protection, the Board may distribute the remaining Trust property or
property of the series or class to the shareholders of the Trust or the series
or class involved, ratably according to the number of shares of the Trust or
such series or class held by the several shareholders of the Trust or such
series or class on the date of termination, except to the extent otherwise
required or permitted by the preferences and special or relative rights and
privileges of any classes of shares of a series involved, provided that any
distribution to the shareholders of a particular class of shares shall be made
to such shareholders pro rata in proportion to the number of shares of such
class held by each of them. The composition of any such distribution (e.g.,
cash, securities or other assets) shall be determined by the Trust in its sole
discretion and may be different among shareholders (including differences among
shareholders in the same series or class).
Under Massachusetts law, shareholders of a Massachusetts business trust could,
under certain circumstances, be held personally liable for obligations of a
fund. The Declaration of Trust, however, disclaims shareholder liability for
acts or obligations of the fund and requires that notice of such disclaimer be
given in each agreement, obligation, or instrument entered into or executed by
a fund. Moreover, the Declaration of Trust provides for indemnification out of
fund property for all losses and expenses of any shareholder held personally
liable for the obligations of the fund and the fund may be covered by
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insurance which the Board considers adequate to cover foreseeable tort claims.
Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which a disclaimer is
inoperative and a fund itself is unable to meet its obligations.
PURCHASE AND REDEMPTION OF SHARES
GENERAL INFORMATION. Policies and procedures affecting transactions in the
fund's shares can be changed at any time without notice, subject to applicable
law. Transactions may be contingent upon proper completion of application forms
and other documents by shareholders and their receipt by the fund's agents.
Transaction delays in processing (and changing account features) due to
circumstances within or beyond the control of the fund and its agents may
occur. Shareholders (or their financial service firms) are responsible for all
losses and fees resulting from bad checks, cancelled orders or the failure to
consummate transactions effected pursuant to instructions reasonably believed
to be genuine.
The Board and DIDI each may suspend (in whole or in part) or terminate the
offering of shares of the fund at any time for any reason and may limit the
amount of purchases by, and refuse to sell to, any person. During the period of
such suspension, the Board or DIDI potentially may permit certain persons (for
example, persons who are already shareholders the fund) to continue to purchase
additional shares of the fund and to have dividends reinvested.
Orders will be confirmed at a price based on the net asset value of the fund
next determined after receipt in good order by DIDI of the order accompanied by
payment in the case of a purchase order. Except as described below, orders
received by certain dealers or other financial services firms prior to the
close of the fund's business day will be confirmed at a price based on the net
asset value determined on that day (trade date).
PURCHASES
The fund reserves the right to withdraw all or any part of the offering made by
its prospectus and to reject purchase orders for any reason. Also, from time to
time, the fund may temporarily suspend the offering of its shares to new
investors. During the period of such suspension, persons who are already
shareholders of the fund may be permitted to continue to purchase additional
shares and to have dividends reinvested.
The fund has no minimum initial investment requirement and there are no minimum
subsequent investment requirements.
WIRE TRANSFER OF FEDERAL FUNDS. Orders for shares of the Fund will become
effective when an investor's bank wire order is converted into federal funds
(monies credited to the account of State Street Bank and Trust Company (the
"Custodian") with its registered Federal Reserve Bank). If payment is
transmitted by the Federal Reserve Wire System, the order will become effective
upon receipt. Orders will be executed at 4:00 p.m. on the same day if a bank
wire or check is converted to federal funds or a federal funds' wire is
received by 4:00 p.m. In addition, if investors known to the Fund notify the
Fund by 4:00 p.m. that they intend to wire federal funds to purchase shares of
the Fund on any business day and if monies are received in time to be invested,
orders will be executed at the net asset value per share determined at 4:00
p.m. the same day. Wire transmissions may, however, be subject to delays of
several hours, in which event the effectiveness of the order will be delayed.
Payments by a bank wire other than the Federal Reserve Wire System may take
longer to be converted into federal funds. When payment for shares is by check
drawn on any member of the Federal Reserve System, federal funds normally
become available to the Fund on the business day after the check is deposited.
Orders for shares of the Fund will be executed at the net asset value per share
of such class next determined after an order has become effective.
REDEMPTIONS
GENERAL INFORMATION. Any shareholder may require the fund to redeem his or her
shares. Redemption requests must be unconditional. Additional documentation may
be requested.
The redemption price for shares of the fund will be the net asset value per
share of the fund next determined following receipt by the Transfer Agent of a
properly executed request with any required documents. Payment for shares
redeemed will be made in Federal funds as promptly as practicable but in no
event later than seven calendar days after receipt of a properly executed
request. When the fund is asked to redeem shares for which it may not have yet
received good payment, it may delay transmittal of redemption proceeds until it
has determined that collected funds have been received for the purchase of such
shares, which will be up to 10 days from receipt by the fund of the purchase
amount.
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In addition, the fund reserves the right to suspend or postpone redemptions as
permitted pursuant to Section 22(e) of the 1940 Act. Generally, those
circumstances are when: 1) the NYSE is closed other than customary weekend or
holiday closings; 2) trading on the NYSE is restricted; 3) an emergency exists
which makes the disposal of securities owned by a Series or the fair
determination of the value of a Series' net assets not reasonably practicable;
or 4) the SEC, by order or rule, permits the suspension of the right of
redemption. Redemption payments may also be delayed in the event of a
non-routine closure of the Federal Reserve wire payment system.
The fund and its service providers also reserve the right to waive or modify
the above eligibility requirements and investment minimums from time to time at
their discretion.
REDEMPTION BY WIRE. If the account holder has given or the account holders have
given authorization for wire redemption to an account holder's brokerage or
bank account, shares of the fund can be redeemed and proceeds sent by federal
wire transfer to a single account previously designated by the
accountholder(s). Requests received by the Transfer Agent prior to the
determination of net asset value will result in shares being redeemed that day
at the net asset value per fund share effective on that day and normally the
proceeds will be sent to the designated account the following business day.
Delivery of the proceeds of wire redemptions of $250,000 or more may be delayed
by the fund for up to seven days if the fund or the Transfer Agent deems it
appropriate under then-current market conditions. The fund is not responsible
for the efficiency of the federal wire system or the account holder's financial
services firm or bank. The fund currently does not charge the account holder
for wire transfers. The account holder is responsible for any charges imposed
by the account holder's firm or bank. To change the designated account to
receive wire redemption proceeds, send a written request to the Transfer Agent
with signatures guaranteed as described in the prospectus. During periods when
it is difficult to contact the Transfer Agent by telephone, it may be difficult
to use the redemption by wire privilege, although investors can still redeem by
mail. The fund reserves the right to terminate or modify this privilege at any
time.
REDEMPTIONS IN-KIND. The fund reserves the right to honor any request for
redemption or repurchase by making payment in whole or in part in readily
marketable securities. These securities will be chosen by the fund and valued
as they are for purposes of computing the fund's net asset value. A shareholder
may incur transaction expenses in converting these securities to cash. Please
see the prospectus for any requirements that may be applicable to certain funds
to provide cash up to certain amounts.
DIVIDENDS. Dividends are declared daily and paid monthly. Shareholders will
receive dividends in additional shares unless they elect to receive cash, as
provided in a fund's prospectus. Dividends will be reinvested monthly in shares
of a fund at net asset value on the last business day of the month. The fund
will pay shareholders that redeem their entire accounts all unpaid dividends at
the time of the redemption not later than the next dividend payment date.
The fund calculates its dividends based on its daily net investment income. For
this purpose, the net investment income of a money fund generally consists of
(a) accrued interest income plus or minus amortized discount or premium, (b)
plus or minus all short-term realized gains and losses on investments and (c)
minus accrued expenses allocated to the applicable fund. Expenses of each money
fund are accrued each day. Dividends are reinvested monthly and shareholders
will receive monthly confirmations of dividends and of purchase and redemption
transactions except that confirmations of dividend reinvestment for Individual
Retirement Accounts and other fiduciary accounts for which SSB acts as trustee
will be sent quarterly.
Distributions of the fund's pro rata share of the fund's net realized long-term
capital gains in excess of net realized short-term capital losses, if any, and
any undistributed net realized short-term capital gains in excess of net
realized long-term capital losses are normally declared and paid annually at
the end of the fiscal year in which they were earned to the extent they are not
offset by any capital loss carryforwards.
If the shareholder elects to receive dividends or distributions in cash, checks
will be mailed monthly, within five business days of the reinvestment date, to
the shareholder or any person designated by the shareholder. The fund reinvests
dividend checks (and future dividends) in shares of a fund if checks are
returned as undeliverable. Dividends and other distributions in the aggregate
amount of $10 or less are automatically reinvested in shares of a fund unless
the shareholder requests that such policy not be applied to the shareholder's
account. Shareholders who chose to receive distributions by electronic transfer
are not subject to this minimum.
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Dividends and distributions are treated the same for federal income tax
purposes, whether made in shares or cash.
INVESTMENTS
GENERAL INVESTMENT PRACTICES AND TECHNIQUES
PART II - APPENDIX II-G includes a description of the investment practices and
techniques which a fund may employ in pursuing its investment objective, as
well as the associated risks. Descriptions in this SAI of a particular
investment practice or technique in which a fund may engage are meant to
describe the spectrum of investments that the Advisor (and/or sub-advisor or
sub-subadvisor, if applicable) in its discretion might, but is not required to,
use in managing a fund. The Advisor (and/or sub-advisor or sub-subadvisor, if
applicable) may in its discretion at any time employ such practice, technique
or instrument for one or more funds but not for all funds advised by it.
Furthermore, it is possible that certain types of financial instruments or
investment techniques described herein may not be available, permissible,
economically feasible or effective for their intended purposes in all markets.
Certain practices, techniques or instruments may not be principal activities of
the fund, but, to the extent employed, could from time to time have a material
impact on a fund's performance.
IT IS POSSIBLE THAT CERTAIN INVESTMENT PRACTICES AND TECHNIQUES MAY NOT BE
PERMISSIBLE FOR A FUND BASED ON ITS INVESTMENT RESTRICTIONS, AS DESCRIBED
HEREIN, AND IN A FUND'S PROSPECTUS.
PORTFOLIO TRANSACTIONS
The Advisor is generally responsible for placing orders for the purchase and
sale of portfolio securities, including the allocation of brokerage. With
respect to those funds for which a sub-investment advisor manages a fund's
investments, references in this section to the "Advisor" should be read to mean
the Subadvisor, except as noted below.
The policy of the Advisor in placing orders for the purchase and sale of
securities for a fund is to seek best execution, taking into account such
factors, among others, as price; commission (where applicable); the
broker-dealer's ability to ensure that securities will be delivered on
settlement date; the willingness of the broker-dealer to commit its capital and
purchase a thinly traded security for its own inventory; whether the
broker-dealer specializes in block orders or large program trades; the
broker-dealer's knowledge of the market and the security; the broker-dealer's
ability to maintain confidentiality; the broker-dealer's ability to provide
access to new issues; the broker-dealer's ability to provide support when
placing a difficult trade; the financial condition of the broker-dealer; and
whether the broker-dealer has the infrastructure and operational capabilities
to execute and settle the trade. The Advisor seeks to evaluate the overall
reasonableness of brokerage commissions with commissions charged on comparable
transactions and compares the brokerage commissions (if any) paid by the funds
to reported commissions paid by others. The Advisor routinely reviews
commission rates, execution and settlement services performed and makes
internal and external comparisons.
Commission rates on transactions in equity securities on US securities
exchanges are subject to negotiation. Commission rates on transactions in
equity securities on foreign securities exchanges are generally fixed.
Purchases and sales of fixed-income securities and certain over-the-counter
securities are effected on a net basis, without the payment of brokerage
commissions. Transactions in fixed income and certain over-the-counter
securities are generally placed by the Advisor with the principal market makers
for these securities unless the Advisor reasonably believes more favorable
results are available elsewhere. Transactions with dealers serving as market
makers reflect the spread between the bid and asked prices. Purchases of
underwritten issues will include an underwriting fee paid to the underwriter.
Money market instruments are normally purchased in principal transactions
directly from the issuer or from an underwriter or market maker.
It is likely that the broker-dealers selected based on the considerations
described in this section will include firms that also sell shares of the funds
to their customers. However, the Advisor does not consider sales of shares of
the funds as a factor in the selection of broker-dealers to execute portfolio
transactions for the funds and, accordingly, has implemented policies and
procedures reasonably designed to prevent its traders from considering sales of
shares of the funds as a factor in the selection of broker-dealers to execute
portfolio transactions for the funds.
The Advisor is permitted by Section 28(e) of the Securities Exchange Act of
1934, as amended (1934 Act), when placing portfolio transactions for a fund, to
cause a fund to pay brokerage commissions in excess of that which another
broker-dealer might charge for executing the same transaction in order to
obtain research and brokerage services if the Advisor determines that such
commissions are reasonable in relation to the overall services
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provided. The Advisor may from time to time, in reliance on Section 28(e) of
the 1934 Act, execute portfolio transactions with broker-dealers that provide
research and brokerage services to the Advisor. Consistent with the Advisor's
policy regarding best execution, where more than one broker is believed to be
capable of providing best execution for a particular trade, the Advisor may
take into consideration the receipt of research and brokerage services in
selecting the broker-dealer to execute the trade. Although certain research and
brokerage services from broker-dealers may be useful to a fund and to the
Advisor, it is the opinion of the Advisor that such information only
supplements its own research effort since the information must still be
analyzed, weighed and reviewed by the Advisor's staff. To the extent that
research and brokerage services of value are received by the Advisor, the
Advisor may avoid expenses that it might otherwise incur. Research and
brokerage services received from a broker-dealer may be useful to the Advisor
and its affiliates in providing investment management services to all or some
of its clients, which includes a fund. Services received from broker-dealers
that executed securities transactions for a fund will not necessarily be used
by the Advisor specifically to service that fund.
Research and brokerage services provided by broker-dealers may include, but are
not limited to, information on the economy, industries, groups of securities,
individual companies, statistical information, accounting and tax law
interpretations, political developments, legal developments affecting portfolio
securities, technical market action, pricing and appraisal services, credit
analysis, risk measurement analysis, performance analysis and measurement and
analysis of corporate responsibility issues. Research and brokerage services
are typically received in the form of written or electronic reports, access to
specialized financial publications, telephone contacts and personal meetings
with security analysts, but may also be provided in the form of access to
various computer software and meetings arranged with corporate and industry
representatives.
The Advisor may also select broker-dealers and obtain from them research and
brokerage services that are used in connection with executing trades provided
that such services are consistent with interpretations under Section 28(e) of
the 1934 Act. Typically, these services take the form of computer software
and/or electronic communication services used by the Advisor to facilitate
trading activity with those broker-dealers.
Research and brokerage services may include products obtained from third
parties if the Advisor determines that such product or service constitutes
brokerage and research as defined in Section 28(e) and interpretations
thereunder. Provided a Subadvisor is acting in accordance with any instructions
and directions of the Advisor or the Board, the Subadvisor is authorized to pay
to a broker or dealer who provides third party brokerage and research services
a commission for executing a portfolio transaction for a fund in excess of what
another broker or dealer may charge, if the Subadvisor determines in good faith
that such commission was reasonable in relation to the value of the third party
brokerage and research services provided by such broker or dealer.
The Advisor may use brokerage commissions to obtain certain brokerage products
or services that have a mixed use (i.e., it also serves a function that does
not relate to the investment decision-making process). In those circumstances,
the Advisor will make a good faith judgment to evaluate the various benefits
and uses to which it intends to put the mixed use product or service and will
pay for that portion of the mixed use product or service that it reasonably
believes does not constitute research and brokerage services with its own
resources.
The Advisor will monitor regulatory developments and market practice in the use
of client commissions to obtain research and brokerage services and may adjust
its portfolio transactions policies in response thereto.
Investment decisions for a fund and for other investment accounts managed by
the Advisor are made independently of each other in light of differing
conditions. However, the same investment decision may be made for two or more
of such accounts. In such cases, simultaneous transactions are inevitable. To
the extent permitted by law, the Advisor may aggregate the securities to be
sold or purchased for a fund with those to be sold or purchased for other
accounts in executing transactions. The Advisor has adopted policies and
procedures that are reasonably designed to ensure that when the Advisor
aggregates securities purchased or sold on behalf of accounts, the securities
are allocated among the participating accounts in a manner that the Advisor
believes to be fair and equitable. The Advisor may make allocations among
accounts based upon a number of factors that may include, but not limited to,
investment objectives and guidelines, risk tolerance, availability of other
investment opportunities and available cash for investment. With respect to
limited opportunities or initial public offerings, the Advisor may make
allocations among accounts on a pro-rata basis with consideration given to
suitability. While in some cases this practice could have a detrimental effect
on the price paid or received by, or
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on the size of the position obtained or disposed of for, a fund, in other cases
it is believed that the ability to engage in volume transactions will be
beneficial to a fund.
The Advisor and its affiliates and each fund's management team manage other
mutual funds and separate accounts, some of which use short sales of securities
as a part of its investment strategy. The simultaneous management of long and
short portfolios creates potential conflicts of interest including the risk
that short sale activity could adversely affect the market value of the long
positions (and vice versa), the risk arising from sequential orders in long and
short positions, and the risks associated with receiving opposing orders at the
same time. The Advisor has adopted procedures that it believes are reasonably
designed to mitigate these potential conflicts of interest. Incorporated in the
procedures are specific guidelines developed to ensure fair and equitable
treatment for all clients. The Advisor and the investment team have established
monitoring procedures and a protocol for supervisory reviews, as well as
compliance oversight to ensure that potential conflicts of interest relating to
this type of activity are properly addressed.
Deutsche Bank AG or one of its affiliates (or in the case of a Subadvisor, the
Subadvisor or one of its affiliates) may act as a broker for the funds and
receive brokerage commissions or other transaction-related compensation from
the funds in the purchase and sale of securities, options or futures contracts
when, in the judgment of the Advisor, and in accordance with procedures
approved by the Board, the affiliated broker will be able to obtain a price and
execution at least as favorable as those obtained from other qualified brokers
and if, in the transaction, the affiliated broker charges the funds a rate
consistent with that charged to comparable unaffiliated customers in similar
transactions.
PORTFOLIO TURNOVER. Portfolio turnover rate is defined by the SEC as the ratio
of the lesser of sales or purchases to the monthly average value of such
securities owned during the year, excluding all securities whose remaining
maturities at the time of acquisition were one year or less.
Higher levels of activity by a fund result in higher transaction costs and may
also result in taxes on realized capital gains to be borne by a fund's
shareholders. Purchases and sales are made whenever necessary, in the Advisor's
discretion, to meet a fund's objective.
PORTFOLIO HOLDINGS INFORMATION
In addition to the public disclosure of fund portfolio holdings through
required Securities and Exchange Commission (SEC) quarterly filings (and
monthly filings for money market funds), each fund may make its portfolio
holdings information publicly available on the DWS funds' Web site as described
in a fund's prospectus. Each fund does not disseminate non-public information
about portfolio holdings except in accordance with policies and procedures
adopted by a fund.
Each fund's procedures permit non-public portfolio holdings information to be
shared with Deutsche Asset & Wealth Management and its affiliates, subadvisors,
if any, custodians, independent registered public accounting firms, attorneys,
officers and trustees/directors and each of their respective affiliates and
advisers who require access to this information to fulfill their duties to the
fund and are subject to the duties of confidentiality, including the duty not
to trade on non-public information, imposed by law or contract, or by a fund's
procedures. This non-public information may also be disclosed, subject to the
requirements described below, to certain third parties, such as securities
lending agents, financial printers, proxy voting firms, mutual fund analysts
and rating and tracking agencies, to shareholders in connection with in-kind
redemptions or, in connection with investing in underlying funds, subadvisors
to DWS funds of funds (Authorized Third Parties).
Prior to any disclosure of a fund's non-public portfolio holdings information
to Authorized Third Parties, a person authorized by the Board must make a good
faith determination in light of the facts then known that a fund has a
legitimate business purpose for providing the information, that the disclosure
is in the best interest of a fund, and that the recipient assents or otherwise
has a duty to keep the information confidential and to not trade based on the
information received while the information remains non-public. No compensation
is received by a fund or DeAM for disclosing non-public holdings information.
Periodic reports regarding these procedures will be provided to the Board.
Portfolio holdings information distributed by the trading desks of DeAM or a
subadvisor for the purpose of facilitating efficient trading of such securities
and receipt of relevant research is not subject to the foregoing requirements.
Non-public portfolio holding information does not include portfolio
characteristics (other than holdings or subsets of holdings) about a fund and
information derived therefrom, including, but not limited to, how the fund's
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investments are divided among various sectors, industries, countries, value and
growth stocks, bonds, small, mid and large cap stocks, currencies and cash,
types of bonds, bond maturities, duration, bond coupons and bond credit quality
ratings, alpha, beta, tracking error, default rate, portfolio turnover, and
risk and style characteristics so long as the identity of the fund's holdings
could not be derived from such information.
Registered investment companies that are subadvised by DeAM may be subject to
different portfolio holdings disclosure policies, and neither DeAM nor the
Board exercise control over such policies. In addition, separate account
clients of DeAM have access to their portfolio holdings and are not subject to
a fund's portfolio holdings disclosure policy. The portfolio holdings of some
of the funds subadvised by DeAM and some of the separate accounts managed by
DeAM may substantially overlap with the portfolio holdings of a fund.
DeAM also manages certain unregistered commingled trusts and creates model
portfolios, the portfolio holdings of which may substantially overlap with the
portfolio holdings of a fund. To the extent that investors in these commingled
trusts or recipients of model portfolio holdings information may receive
portfolio holdings information of their trust or of a model portfolio on a
different basis from that on which fund portfolio holdings information is made
public, DeAM has implemented procedures reasonably designed to encourage such
investors and recipients to keep such information confidential, and to prevent
those investors from trading on the basis of non-public holdings information.
There is no assurance that a fund's policies and procedures with respect to the
disclosure of portfolio holdings information will protect the fund from the
potential misuse of portfolio holdings information by those in possession of
that information.
NET ASSET VALUE
The net asset value (NAV) per share of the fund is calculated on each day
(Valuation Day) on which the fund is open for business as of the time described
in the fund's prospectus. The fund is open for business each day the New York
Stock Exchange (Exchange) is open for trading, and the fund may, but is not
required to, accept certain types of purchase and redemption orders (not
including exchanges) on days that the Exchange is not open or beyond an early
Exchange closing time, as described in the fund's prospectus. The Exchange is
scheduled to be closed on the following holidays: New Year's Day, Dr. Martin
Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving and Christmas, and on the preceding Friday or
subsequent Monday when one of these holidays falls on a Saturday or Sunday,
respectively. Net asset value per share is determined separately for each class
of shares by dividing the value of the total assets of the fund attributable to
the shares of that class, less all liabilities attributable to that class, by
the total number of shares of that class outstanding. Although there is no
guarantee, the fund's NAV per share will normally be $1.00.
The fund values its portfolio instruments at amortized cost, which does not
take into account unrealized capital gains or losses. This involves initially
valuing an instrument at its cost and thereafter assuming a constant
amortization to maturity of any discount or premium, regardless of the impact
of fluctuating interest rates on the market value of the instrument. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price the
fund would receive if it sold the instrument.
The Board has established procedures reasonably designed to stabilize the
fund's NAV per share at $1.00. Under the procedures, the Advisor will monitor
and notify the Board of circumstances where the fund's NAV per share calculated
by using market valuations may deviate from the $1.00 per share calculated
using amortized cost. If there were any deviation that the Board believed would
result in a material dilution or unfair result for investors or existing
shareholders, the Board would promptly consider what action, if any, should be
initiated. Such actions could include selling assets prior to maturity to
realize capital gains or losses; shortening the average maturity of the fund's
portfolio; adjusting the level of dividends; redeeming shares in kind; or
valuing assets based on market valuations. For example, if the fund's net asset
value per share (computed using market values) declined, or was expected to
decline, below $1.00 (computed using amortized cost), the fund might
temporarily reduce or suspend dividend payments in an effort to maintain the
net asset value at $1.00 per share. As a result of such reduction or suspension
of dividends or other action by the Board, an investor would receive less
income during a given period than if such a reduction or suspension had not
taken place. Such action could result in investors receiving no dividend for
the period during which they hold their shares and receiving, upon redemption,
a price per share lower than that which they paid. On the other hand, if the
fund's net asset value per share (computed using market values) were to
increase,
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or were anticipated to increase above $1.00 (computed using amortized cost),
the fund might supplement dividends in an effort to maintain the net asset
value at $1.00 per share.
Market valuations are obtained by using actual quotations provided by market
makers, estimates of market value, or values obtained from yield data relating
to classes of money market instruments published by reputable sources at the
mean between the bid and asked prices for the instruments. In accordance with
procedures approved by the Board, in the event market quotations are not
readily available for certain portfolio assets the fair value of such portfolio
assets will be determined in good faith by the fund's Pricing Committee (or, in
some cases, the Board's Valuation Committee) based upon input from the Advisor
or other third parties.
PROXY VOTING GUIDELINES
Each fund has delegated proxy voting responsibilities to the Advisor, subject
to the Board's general oversight. A fund has delegated proxy voting to the
Advisor with the direction that proxies should be voted consistent with the
fund's best economic interests. The Advisor has adopted its own Proxy Voting
Policies and Procedures (Policies), and Proxy Voting Guidelines (Guidelines)
for this purpose. The Policies address, among other things, conflicts of
interest that may arise between the interests of a fund, and the interests of
the Advisor and its affiliates, including a fund's principal underwriter. The
Policies are included in PART II - APPENDIX II-I.
You may obtain information about how a fund voted proxies related to its
portfolio securities during the 12-month period ended June 30 by visiting the
Securities and Exchange Commission's Web site at www.sec.gov or by visiting our
Web site at: www.dws-investments.com (click on "proxy voting" at the bottom of
the page).
MISCELLANEOUS
A fund's prospectuses and this SAI omit certain information contained in the
Registration Statement which a fund has filed with the SEC and reference is
hereby made to the Registration Statement for further information with respect
to a fund and the securities offered hereby. This Registration Statement and
its amendments are available for inspection by the public at the SEC in
Washington, D.C.
RATINGS OF INVESTMENTS
BONDS AND COMMERCIAL PAPER RATINGS
Set forth below are descriptions of ratings which represent opinions as to the
quality of the securities. It should be emphasized, however, that ratings are
relative and subjective and are not absolute standards of quality.
MOODY'S INVESTORS SERVICE, INC.'S LONG-TERM OBLIGATION RATINGS
Moody's long-term ratings are forward-looking opinions of the relative credit
risks of financial obligations with an original maturity of one year or more.
They address the possibility that a financial obligation will not be honored as
promised. Such ratings use Moody's Global Scale and reflect both the likelihood
of default and any financial loss suffered in the event of default.
AAA Obligations rated Aaa are judged to be of the highest quality, 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.
NOTE: Moody's appends numerical modifiers 1, 2, and 3 to each generic rating
classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the modifier
2
II-14
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.
MOODY'S INVESTORS SERVICE, INC.'S SHORT-TERM OBLIGATION RATINGS
Moody's short-term ratings are forward-looking opinions of the ability of
issuers to honor short-term financial obligations. Ratings may be assigned to
issuers, short-term programs or to individual short-term debt instruments. Such
obligations generally have an original maturity not exceeding thirteen months,
unless explicitly noted.
Moody's employs the following designations to indicate the relative repayment
ability of rated issuers:
P-1 Issuers (or supporting institutions) rated Prime-1 have a superior ability
to repay short-term debt obligations.
P-2 Issuers (or supporting institutions) rated Prime-2 have a strong ability to
repay short-term debt obligations.
P-3 Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability to repay short-term obligations.
NP Issuers (or supporting institutions) rated Not Prime do not fall within any
of the Prime rating categories.
MOODY'S INVESTORS SERVICE, INC.'S US MUNICIPAL SHORT-TERM DEBT AND DEMAND
OBLIGATION RATINGS
SHORT-TERM OBLIGATION RATINGS
There are three rating categories for short-term municipal obligations that are
considered investment grade. These ratings are designated as Municipal
Investment Grade (MIG) and are divided into three levels - MIG 1 through MIG 3.
In addition, those short-term obligations that are of speculative quality are
designated SG, or speculative grade. MIG ratings expire at the maturity of the
obligation.
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.
DEMAND OBLIGATION RATINGS
In the case of variable rate demand obligations (VRDOs), a two-component rating
is assigned: a long or short-term debt rating and a demand obligation rating.
The first element represents Moody's evaluation of risk associated with
scheduled principal and interest payments. The second element represents
Moody's evaluation of risk associated with the ability to receive purchase
price upon demand ("demand feature"). The second element uses a rating from a
variation of the MIG scale called the Variable Municipal Investment Grade
(VMIG) scale.
The rating transitions on the VMIG scale differ from those on the Prime scale
to reflect the risk that external liquidity support generally will terminate if
the issuer's long-term ratings drops below investment grade.
VMIG 1 This designation denotes superior credit quality. Excellent protection
is afforded by the superior short-term credit strength of the liquidity
provider and structural and legal protections that ensure the timely payment of
purchase price upon demand.
VMIG 2 This designation denotes strong credit quality. Good protection is
afforded by the strong short-term credit strength of the liquidity provider and
structural and legal protections that ensure the timely payment of purchase
price upon demand.
VMIG 3 This designation denotes acceptable credit quality. Adequate protection
is afforded by the satisfactory short-term credit strength of the liquidity
provider and structural and legal protections that ensure the timely payment of
purchase price upon demand.
II-15
SG This designation denotes speculative-grade credit quality. Demand features
rated in this category may be supported by a liquidity provider that does not
have an investment grade short-term rating or may lack the structural and/or
legal protections necessary to ensure the timely payment of purchase price upon
demand.
STANDARD & POOR'S RATINGS SERVICES LONG-TERM ISSUE CREDIT RATINGS
INVESTMENT GRADE
AAA An obligation rated 'AAA' has the highest rating assigned by Standard &
Poor's. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
AA An obligation rated 'AA' differs from the highest-rated obligations only to
a small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A An obligation rated 'A' is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB An obligation rated 'BBB' exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity of the obligor to meet its financial commitment on the
obligation.
SPECULATIVE GRADE
Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having
significant speculative characteristics. 'BB' indicates the lowest degree of
speculation and 'C' the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
BB An obligation rated 'BB' is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B An obligation rated 'B' is more vulnerable to nonpayment than obligations
rated 'BB', but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC An obligation rated 'CCC' is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC An obligation rated 'CC' is currently highly vulnerable to nonpayment.
C A 'C' rating is assigned to obligations that are currently highly vulnerable
to nonpayment, obligations that have payment arrearages allowed by the terms of
the documents, or obligations of an issuer that is the subject of a bankruptcy
petition or similar action which have not experienced a payment default. Among
others, the 'C' rating may be assigned to subordinated debt, preferred stock or
other obligations on which cash payments have been suspended in accordance with
the instrument's terms or when preferred stock is the subject of a distressed
exchange offer, whereby some or all of the issue is either repurchased for an
amount of cash or replaced by other instruments having a total value that is
less than par.
D An obligation rated 'D' is in payment default. The 'D' rating category is
used when payments on an obligation are not made on the date due, unless
Standard & Poor's believes that such payments will be made within five business
days, irrespective of any grace period. The 'D' rating also will be used upon
the filing of a bankruptcy petition or the taking of similar action if payments
on an obligation are jeopardized. An obligation's rating is lowered to 'D' upon
completion of a distressed exchange offer, whereby some or all of the issue is
either repurchased for an amount of cash or replaced by other instruments
having a total value that is less than par.
NR This indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that Standard & Poor's does not rate
a particular obligation as a matter of policy.
PLUS (+) OR MINUS (-) The ratings from 'AA' to 'CCC' may be modified by the
addition of a plus (+) or minus (-) sign to show relative standing within the
major rating categories.
II-16
STANDARD & POOR'S RATINGS SERVICES SHORT-TERM ISSUE CREDIT RATINGS
A-1 A short-term obligation rated 'A-1' is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2 A short-term obligation rated 'A-2' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to
meet its financial commitment on the obligation is satisfactory.
A-3 A short-term obligation rated 'A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
B A short-term obligation rated 'B' is regarded as vulnerable and has
significant speculative characteristics. The obligor currently has the capacity
to meet its financial commitments; however, it faces major ongoing
uncertainties which could lead to the obligor's 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 commitment on the obligation.
D A short-term obligation rated 'D' is in payment default. The 'D' rating
category is used when payments on an obligation are not made on the date due,
unless Standard & Poor's 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 if
payments on an obligation are jeopardized.
SPUR (STANDARD & POOR'S UNDERLYING RATING) A SPUR rating is a rating of a
stand-alone capacity of an issue to pay debt service on a credit-enhanced debt
issue, without giving effect to the enhancement that applies to it. These
ratings are published only at the request of the debt issuer/ obligor with the
designation SPUR to distinguish them from the credit-enhanced rating that
applies to the debt issue. Standard & Poor's maintains surveillance of an issue
with a published SPUR.
STANDARD & POOR'S RATINGS SERVICES MUNICIPAL SHORT-TERM NOTE RATINGS
DEFINITIONS
A Standard & Poor's U.S. municipal note rating reflects Standard & Poor's
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, Standard & Poor's analysis will review the following considerations:
o Amortization schedule - the larger the final maturity relative to other
maturities, the more likely it will be treated as a note; and
o Source of payment - the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note.
Note rating symbols are as follows:
SP-1 Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus (+)
designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3 Speculative capacity to pay principal and interest.
DUAL RATINGS
Standard & Poor's assigns "dual" ratings to all debt issues that have a put
option or demand feature as part of their structure. The first rating addresses
the likelihood of repayment of principal and interest as due, and the second
rating addresses only the demand feature. The long-term rating symbols are used
for bonds to denote the long-term maturity and the short-term rating symbols
for the put option (for example, 'AAA/A-1+'). With U.S. municipal short-term
demand debt, note rating symbols are used with the short-term issue credit
rating symbols (for example, 'SP-1+/A-1+').
II-17
STANDARD & POOR'S DIVIDEND RANKINGS FOR COMMON STOCKS
Standard & Poor's has provided Earnings and Dividend Rankings, commonly
referred to as Quality Rankings, on common stocks since 1956. Quality Rankings
reflect the long-term growth and stability of a company's earnings and
dividends.
The Quality Rankings System attempts to capture the growth and stability of
earnings and dividends record in a single symbol. In assessing Quality
Rankings, Standard & Poor's recognizes that earnings and dividend performance
is the end result of the interplay of various factors such as products and
industry position, corporate resources and financial policy. Over the long run,
the record of earnings and dividend performance has a considerable bearing on
the relative quality of stocks.
The rankings, however, do not profess to reflect all of the factors, tangible
or intangible, that bear on stock quality.
The rankings are generated by a computerized system and are based on per-share
earnings and dividend records of the most recent 10 years - a period long
enough to measure significant secular growth, capture indications of basic
change in trend as they develop, encompass the full peak-to-peak range of the
business cycle, and include a bull and a bear market. Basic scores are computed
for earnings and dividends, and then adjusted as indicated by a set of
predetermined modifiers for change in the rate of growth, stability within
long-term trends, and cyclicality. Adjusted scores for earnings and dividends
are then combined to yield a final ranking.
The ranking system makes allowance for the fact that corporate size generally
imparts certain advantages from an investment standpoint. Conversely, minimum
size limits (in sales volume) are set for the various rankings. However, the
system provides for making exceptions where the score reflects an outstanding
earnings and dividend record. The following table shows the letter
classifications and brief descriptions of Quality Rankings.
A+ Highest B+ Average C Lowest
A High B Below Average D In Reorganization
A- Above Average B- Lower LIQ Liquidation
|
The ranking system grants some exceptions to the pure quantitative ranking.
Thus, if a company has not paid any dividend over the past 10 years, it is very
unlikely that it will rank higher than A-. In addition, companies may receive a
bonus score based on their sales volume. If a company omits a dividend on
preferred stock, it will receive a rank of no better than C that year. If a
company pays a dividend on the common stock, it is highly unlikely that the
rank will be below B-, even if it has incurred losses. In addition, if a
company files for bankruptcy, the model's rank is automatically changed to D.
FITCH INVESTORS SERVICE, INC. LONG-TERM RATING SCALES
INVESTMENT GRADE
AAA: Highest credit quality. `AAA' ratings denote the lowest expectation of
default 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
default risk. They indicate very strong capacity for payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A: High credit quality. `A' ratings denote expectations of low default risk.
The capacity for payment of financial commitments is considered strong. This
capacity may, nevertheless, be more vulnerable to adverse business or economic
conditions than is the case for higher ratings.
BBB: Good credit quality. `BBB' ratings indicate that expectations of default
risk are currently low. The capacity for payment of financial commitments is
considered adequate but adverse business or economic conditions are more likely
to impair this capacity.
SPECULATIVE GRADE
BB: Speculative. `BB' ratings indicate an elevated vulnerability to default
risk, particularly in the event of adverse changes in business or economic
conditions over time; however, business or financial flexibility exists which
supports the servicing of financial commitments.
B: Highly speculative. `B' ratings indicate that material default risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is vulnerable to
deterioration in the business and economic environment.
CCC: Substantial credit risk. Default is a real possibility.
II-18
CC: Very high levels of credit risk. Default of some kind appears probable.
C: Exceptionally high levels of credit risk. Default is imminent or inevitable,
or the issuer is in standstill. Conditions that are indicative of a `C'
category rating for an issuer include:
a. the issuer has entered into a grace or cure period following non-payment of
a material financial obligation;
b. the issuer has entered into a temporary negotiated waiver or standstill
agreement following a payment default on a material financial obligation; or
c. Fitch Ratings otherwise believes a condition of `RD' or `D' to be imminent
or inevitable, including through the formal announcement of a distressed debt
exchange.
RD: Restricted default. `RD' ratings indicate an issuer that in Fitch Ratings'
opinion has experienced an uncured payment default on a bond, loan or other
material financial obligation but which has not entered into bankruptcy
filings, administration, receivership, liquidation or other formal winding-up
procedure, and which has not otherwise ceased operating. This would include:
a. the selective payment default on a specific class or currency of debt;
b. the uncured expiry of any applicable grace period, cure period or default
forbearance period following a payment default on a bank loan, capital markets
security or other material financial obligation;
c. the extension of multiple waivers or forbearance periods upon a payment
default on one or more material financial obligations, either in series or in
parallel; or
d. execution of a distressed debt exchange on one or more material financial
obligations.
D: Default. `D' ratings indicate an issuer that in Fitch Ratings' opinion has
entered into bankruptcy filings, administration, receivership, liquidation or
other formal winding-up procedure, or which has otherwise ceased business.
Default ratings are not assigned prospectively to entities or their
obligations; within this context, non-payment on an instrument that contains a
deferral feature or grace period will generally not be considered a default
until after the expiration of the deferral or grace period, unless a default is
otherwise driven by bankruptcy or other similar circumstance, or by a
distressed debt exchange.
"Imminent" default typically refers to the occasion where a payment default has
been intimated by the issuer, and is all but inevitable. This may, for example,
be where an issuer has missed a scheduled payment, but (as is typical) has a
grace period during which it may cure the payment default. Another alternative
would be where an issuer has formally announced a distressed debt exchange, but
the date of the exchange still lies several days or weeks in the immediate
future.
In all cases, the assignment of a default rating reflects the agency's opinion
as to the most appropriate rating category consistent with the rest of its
universe of ratings, and may differ from the definition of default under the
terms of an issuer's financial obligations or local commercial practice.
NOTE: The modifiers "+" or "-" may be appended to a rating to denote relative
status within major rating categories. Such suffixes are not added to the `AAA'
Long-Term IDR category, or to Long-Term IDR categories below `B'.
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
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. Applicable to entity ratings only.
II-19
D: Default. Indicates a broad-based default event for an entity, or the default
of a short-term obligation.
FITCH INVESTORS SERVICE, INC. MUNICIPAL SHORT-TERM RATINGS
The highest ratings for state and municipal short-term obligations are "F-1+,"
"F-1," and "F-2."
II-20
PART II: APPENDIX II-A - BOARD MEMBERS AND OFFICERS
IDENTIFICATION AND BACKGROUND
The following table presents certain information regarding the Board Members of
the Trust/Corporation. Each Board Member's year of birth is set forth in
parentheses after his or her name. Unless otherwise noted, (i) each Board
Member has engaged in the principal occupation(s) noted in the table for at
least the most recent five years, although not necessarily in the same
capacity, and (ii) the address of each Board Member that is not an "interested
person" (as defined in the 1940 Act) of the Trust/Corporation or the Advisor
(each, an "Independent Board Member") is c/o Kenneth C. Froewiss, Chairman, DWS
Mutual Funds, P.O. Box 78, Short Hills, NJ 07078. The term of office for each
Board Member is until the election and qualification of a successor, or until
such Board Member sooner dies, resigns, is removed or as otherwise provided in
the governing documents of the Trust/Corporation. Because the fund does not
hold an annual meeting of shareholders, each Board Member will hold office for
an indeterminate period.
INDEPENDENT BOARD MEMBERS
NAME, YEAR OF BIRTH,
POSITION NUMBER OF
WITH THE TRUST/CORPORATION FUNDS IN DWS
AND LENGTH OF TIME BUSINESS EXPERIENCE AND FUND COMPLEX OTHER DIRECTORSHIPS
SERVED/(1)/ DIRECTORSHIPS DURING THE PAST 5 YEARS OVERSEEN HELD BY BOARD MEMBER
Kenneth C. Froewiss (1945) Adjunct Professor of Finance, NYU Stern 102 _
Chairperson since 2013/(9)/, School of Business (September 2009 -
and Board Member since present; Clinical Professor from 1997-
2001 September 2009); Member, Finance
Committee, Association for Asian Studies
(2002-present); Director, Mitsui Sumitomo
Insurance Group (US) (2004-present); prior
thereto, Managing Director, J.P. Morgan
(investment banking firm) (until 1996)
William McClayton (1944) Private equity investor (since October 2009); 102 _
Vice Chairperson since previously: Managing Director, Diamond
2013/(9)/, and Board Member Management & Technology Consultants, Inc.
since 2004 (global consulting firm) (2001-2009);
Directorship: Board of Managers, YMCA of
Metropolitan Chicago; formerly: Senior
Partner, Arthur Andersen LLP (accounting)
(1966-2001); Trustee, Ravinia Festival
John W. Ballantine (1946) Retired; formerly: Executive Vice President 102 Chairman of the Board,
Board Member since 1999 and Chief Risk Management Officer, First Healthways Inc./(2)/ (provider
Chicago NBD Corporation/The First National of disease and care
Bank of Chicago (1996-1998); Executive Vice management services) (2003
President and Head of International Banking to present); Portland General
(1995-1996); former Directorships: Stockwell Electric/(2)/ (utility company)
Capital Investments PLC (private equity); (2003 to present)
First Oak Brook Bancshares, Inc. and Oak
Brook Bank; Prisma Energy International
Henry P. Becton, Jr. (1943) Vice Chair and former President, WGBH 102 Lead Director, Becton
Board Member since 1990 Educational Foundation; Directorships: Public Dickinson and Company/(2)/
Radio International; Public Radio Exchange (medical technology
(PRX); The PBS Foundation; North Bennett company); Lead Director, Belo
Street School (Boston); former Directorships: Corporation/(2)/ (media
Association of Public Television Stations; company)
Boston Museum of Science; American
Public Television; Concord Academy; New
England Aquarium; Mass. Corporation for
Educational Telecommunications; Committee
for Economic Development; Public
Broadcasting Service; Connecticut College
|
II-21
NAME, YEAR OF BIRTH,
POSITION NUMBER OF
WITH THE TRUST/CORPORATION FUNDS IN DWS
AND LENGTH OF TIME BUSINESS EXPERIENCE AND FUND COMPLEX OTHER DIRECTORSHIPS
SERVED/(1)/ DIRECTORSHIPS DURING THE PAST 5 YEARS OVERSEEN HELD BY BOARD MEMBER
Dawn-Marie Driscoll (1946) President, Driscoll Associates (consulting 102 _
Board Member since 1987 firm); Emeritus Executive Fellow, Center for
Business Ethics, Bentley University;
formerly: Partner, Palmer & Dodge (1988-
1990); Vice President of Corporate Affairs
and General Counsel, Filene's (1978-1988);
Directorships: Director of ICI Mutual
Insurance Company (since 2007); Advisory
Board, Center for Business Ethics, Bentley
University; Chairman of the Board of
Trustees, Southwest Florida Community
Foundation (charitable organization); former
Directorships: Sun Capital Advisers Trust
(mutual funds) (2007-2012); Investment
Company Institute (audit, executive,
nominating committees) and Independent
Directors Council (governance, executive
committees)
Keith R. Fox, CFA (1954) Managing General Partner, Exeter Capital 102 _
Board Member since 1996 Partners (a series of private investment
funds) (since 1986); Directorships:
Progressive International Corporation
(kitchen goods importer and distributor); The
Kennel Shop (retailer); former Chairman,
National Association of Small Business
Investment Companies; former
Directorships: BoxTop Media Inc.
(advertising); Sun Capital Advisers Trust
(mutual funds) (2011-2012)
Paul K. Freeman (1950) Consultant, World Bank/Inter-American 102 _
Board Member since 1993, Development Bank; Executive and Governing
and Chairperson (2009 - Jan. Council of the Independent Directors Council
8, 2013) (Chairman of Education Committee);
formerly: Project Leader, International
Institute for Applied Systems Analysis (1998-
2001); Chief Executive Officer, The Eric
Group, Inc. (environmental insurance) (1986-
1998); Directorships: Denver Zoo Foundation
(December 2012-present); former
Directorships: Prisma Energy International
Richard J. Herring (1946) Jacob Safra Professor of International 102 Director, Japan Equity Fund,
Board Member since 1990 Banking and Professor, Finance Department, Inc. (since September 2007),
The Wharton School, University of Thai Capital Fund, Inc. (since
Pennsylvania (since July 1972); Co-Director, 2007), Singapore Fund, Inc.
Wharton Financial Institutions Center (since (since September 2007),
July 2000); Co-Chair, U.S. Shadow Financial Independent Director of
Regulatory Committee; Executive Director, Barclays Bank Delaware
Financial Economists Roundtable; formerly: (since September 2010)
Vice Dean and Director, Wharton
Undergraduate Division (July 1995-June
2000); Director, Lauder Institute of
International Management Studies (July
2000-June 2006)
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II-22
NAME, YEAR OF BIRTH,
POSITION
WITH THE TRUST/CORPORATION
AND LENGTH OF TIME BUSINESS EXPERIENCE AND
SERVED/(1)/ DIRECTORSHIPS DURING THE PAST 5 YEARS
Rebecca W. Rimel (1951) President and Chief Executive Officer, The
Board Member since 1995 Pew Charitable Trusts (charitable
organization) (1994 to present); formerly:
Executive Vice President, The Glenmede
Trust Company (investment trust and wealth
management) (1983-2004); Board Member,
Investor Education (charitable organization)
(2004-2005); Trustee, Executive Committee,
Philadelphia Chamber of Commerce (2001-
2007); Director, Viasys Health Care/(2)/
(January 2007-June 2007); Trustee, Thomas
Jefferson Foundation (charitable organization)
(1994 to 2012)
William N. Searcy, Jr. (1946) Private investor since October 2003;
Board Member since 1993 formerly: Pension & Savings Trust Officer,
Sprint Corporation/(2)/ (telecommunications)
(November 1989-September 2003); Trustee,
Sun Capital Advisers Trust (mutual funds)
(1998-2012)
Jean Gleason Stromberg Retired; formerly: Consultant (1997-2001);
(1943) Board Member since Director, Financial Markets US Government
1997 Accountability Office (1996-1997); Partner,
Fulbright & Jaworski, L.L.P. (law firm) (1978-
1996); Directorships: The William and Flora
Hewlett Foundation; former Directorships:
Service Source, Inc., Mutual Fund Directors
Forum (2002-2004), American Bar
Retirement Association (funding vehicle for
retirement plans) (1987-1990 and 1994-
1996)
Robert H. Wadsworth (1940) President, Robert H. Wadsworth &
Board Member since 1999 Associates, Inc. (consulting firm) (1983 to
present); Director, National Horizon, Inc.
(non-profit organization); Director and
Treasurer, The Phoenix Boys Choir
Association
NAME, YEAR OF BIRTH,
POSITION NUMBER OF
WITH THE TRUST/CORPORATION FUNDS IN DWS
AND LENGTH OF TIME FUND COMPLEX OTHER DIRECTORSHIPS
SERVED/(1)/ OVERSEEN HELD BY BOARD MEMBER
Rebecca W. Rimel (1951) 102 Director, Becton Dickinson
Board Member since 1995 and Company/(2)/ (medical
technology company) (2012
to present); Director,
CardioNet, Inc./(2)/ (healthcare)
(2009-present)
William N. Searcy, Jr. (1946) 102 _
Board Member since 1993
Jean Gleason Stromberg 102 _
(1943) Board Member since
1997
Robert H. Wadsworth (1940) 105 _
Board Member since 1999
|
II-23
INTERESTED BOARD MEMBER AND OFFICER/(4)/
NAME, YEAR OF BIRTH,
POSITION NUMBER OF
WITH THE TRUST/CORPORATION FUNDS IN DWS OTHER DIRECTORSHIPS
AND LENGTH OF TIME BUSINESS EXPERIENCE AND FUND COMPLEX HELD BY BOARD MEMBER
SERVED/(1)(6)/ DIRECTORSHIPS DURING THE PAST 5 YEARS OVERSEEN DURING THE PAST 5 YEARS
Michael J. Woods/(5)/ (1967) Managing Director/(3)/ , Deutsche Asset & 38 _
Board Member since Wealth Management (2009-present); Head
2013/(9)/, and Executive Vice of the Americas Asset Management
President since 2013/(9)/ Business for Deutsche Bank, Member of the
Asset and Wealth Management ("AWM")
Extended Executive Committee, AWM
Global Client Group Executive Committee
and the AWM Active Asset Management
Executive Committee; CEO and US Regional
Head of DWS Investments; formerly: Sr. VP,
Head of the Financial Intermediaries and
Investments Group of Evergreen
Investments (2007-2009), CEO and Vice
Chairman of Board of Directors of XTF Global
Asset Management (2006-2007), Managing
Director - US Head of Sub-Advisory and
Investment Only Business at Citigroup Asset
Management (2000-2006). Mr. Woods is
currently a board member of The Children's
Village, The Big Brothers Big Sisters
Organization, and The Mutual Fund
Education Alliance.
|
OFFICERS/(4)/
NAME, YEAR OF BIRTH, POSITION
WITH THE TRUST/CORPORATION BUSINESS EXPERIENCE AND
AND LENGTH OF TIME SERVED/(6)/ DIRECTORSHIPS DURING THE PAST 5 YEARS
W. Douglas Beck, CFA/(7)/ (1967) Managing Director/(3)/, Deutsche Asset & Wealth Management (2006-present);
President, 2011-present President of DWS family of funds and Head of Product Management, US for DWS
Investments; formerly: Executive Director, Head of Product Management (2002-2006)
and President (2005-2006) of the UBS Funds at UBS Global Asset Management; Co-
Head of Manager Research/Managed Solutions Group, Merrill Lynch (1998-2002)
John Millette/(8)/ (1962) Director/(3)/, Deutsche Asset & Wealth Management
Vice President and Secretary,
1999-present
Paul H. Schubert/(7)/ (1963) Managing Director/(3)/, Deutsche Asset & Wealth Management (since July 2004);
Chief Financial Officer, 2004- formerly: Executive Director, Head of Mutual Fund Services and Treasurer for UBS
present Family of Funds (1998-2004); Vice President and Director of Mutual Fund Finance at
Treasurer, 2005-present UBS Global Asset Management (1994-1998)
Caroline Pearson/(8)/ (1962) Managing Director/(3)/, Deutsche Asset & Wealth Management; formerly: Assistant
Chief Legal Officer, 2010- Secretary for DWS family of funds (1997-2010)
present
Melinda Morrow/(7)/ (1970) Director/(3)/, Deutsche Asset & Wealth Management
Vice President, 2012-present
Hepsen Uzcan/(8)/ (1974) Vice President, Deutsche Asset & Wealth Management
Assistant Secretary, since
2013/(9)/
Paul Antosca/(8) /(1957) Director/(3)/, Deutsche Asset & Wealth Management
Assistant Treasurer, 2007-
present
|
II-24
NAME, YEAR OF BIRTH, POSITION
WITH THE TRUST/CORPORATION BUSINESS EXPERIENCE AND
AND LENGTH OF TIME SERVED/(6)/ DIRECTORSHIPS DURING THE PAST 5 YEARS
Jack Clark /(8)/ (1967) Director/(3)/, Deutsche Asset & Wealth Management
Assistant Treasurer, 2007-
present
Diane Kenneally/(8)/ (1966) Director/(3)/, Deutsche Asset & Wealth Management
Assistant Treasurer, 2007-
present
John Caruso/(7)/ (1965) Managing Director/(3)/, Deutsche Asset & Wealth Management
Anti-Money Laundering
Compliance Officer, 2010-
present
Robert Kloby/(7)/ (1962) Managing Director/(3)/, Deutsche Asset & Wealth Management
Chief Compliance Officer,
2006-present
|
/(1)/ The length of time served represents the year in which the Board Member
joined the board of one or more DWS funds currently overseen by the
Board.
/(2)/ A publicly held company with securities registered pursuant to Section
12 of the Securities Exchange Act of 1934.
/(3)/ Executive title, not a board directorship.
/(4)/ As a result of their respective positions held with the Advisor, these
individuals are considered "interested persons" of the Advisor within
the meaning of the 1940 Act. Interested persons receive no compensation
from the fund.
/(5)/ The mailing address of Mr. Woods is 60 Wall Street, New York, New York
10005. Mr. Woods is an interested Board Member by virtue of his
positions with Deutsche Asset & Wealth Management. As an interested
person, Mr. Woods receives no compensation from the fund. Mr. Woods is
a board member of the following trusts and corporations: Cash Account
Trust, DWS Market Trust, DWS Money Funds, DWS State Tax-Free Income
Series, DWS Target Fund, DWS Value Series, Inc., DWS Variable Series
II, Investors Cash Trust, Tax-Exempt California Money Market Fund, DWS
Global High Income Fund, Inc., DWS High Income Opportunities Fund,
Inc., DWS High Income Trust, DWS Multi-Market Income Trust, DWS
Municipal Income Trust, DWS Strategic Income Trust and DWS Strategic
Municipal Income Trust.
/(6)/ The length of time served represents the year in which the officer was
first elected in such capacity for one or more DWS funds.
/(7)/ Address: 60 Wall Street, New York, New York 10005.
/(8)/ Address: One Beacon Street, Boston, Massachusetts 02108.
/(9)/ Effective as of January 9, 2013.
|
Certain officers hold similar positions for other investment companies for
which DIMA or an affiliate serves as the Advisor.
OFFICER'S ROLE WITH PRINCIPAL UNDERWRITER: DWS INVESTMENTS DISTRIBUTORS, INC.
Paul H. Schubert: Vice President
Caroline Pearson: Secretary
John Caruso: AML Compliance Officer
|
BOARD MEMBER QUALIFICATIONS
The Nominating and Governance Committee is responsible for recommending
proposed nominees for election to the full Board for its approval. In
recommending the election of the current Board Members, the Committee generally
considered the educational, business and professional experience of each Board
Member in determining his or her qualifications to serve as a Board Member,
including the Board Member's record of service as a director or trustee of
public and private organizations. In the case of most Board Members, this
included their many years of previous service as a trustee of certain of the
DWS funds. This previous service has provided these Board Members with a
valuable understanding of the history of the DWS funds and the DIMA
organization and has also served to demonstrate their high level of diligence
and commitment to the interests of fund shareholders and their ability to work
effectively and collegially with other members of the Board. The Committee also
considered, among other factors, the particular attributes described below with
respect to the various individual Board Members:
John W. Ballantine - Mr. Ballantine's experience in banking, financial risk
management and investments acquired in the course of his service as a senior
executive of a major US bank.
II-25
Henry P. Becton, Jr. - Mr. Becton's professional training and experience as an
attorney, his experience as the chief executive officer of a major public media
company and his experience as lead director of two NYSE companies, including
his service at various times as the chair of the audit, compensation and
nominating committees of one or both of such boards.
Dawn-Marie Driscoll - Ms. Dricoll's professional training and experience as an
attorney, her expertise as a consultant, professor and author on the subject of
business ethics, her service as a member of the executive committee of the
Independent Directors Council of the Investment Company Institute and her
experience as a director of an insurance company serving the mutual fund
industry.
Keith R. Fox - Mr. Fox's experience as the chairman and a director of various
private operating companies and investment partnerships and his experience as a
director and audit committee member of several public companies. In addition,
he holds the Chartered Financial Analyst designation.
Paul K. Freeman - Dr. Freeman's professional training and experience as an
attorney and an economist, his experience as the founder and chief executive
officer of an insurance company, his experience as a senior executive and
consultant for various companies focusing on matters relating to risk
management and his service on the Independent Directors Council of the
Investment Company Institute.
Kenneth C. Froewiss - Dr. Froewiss' professional training and experience as an
economist, his experience in finance acquired in various professional positions
with governmental and private banking organizations and his experience as a
professor of finance at a leading business school.
Richard J. Herring - Mr. Herring's experience as a professor of finance at a
leading business school and his service as an advisor to various professional
and governmental organizations.
William McClayton - Mr. McClayton's professional training and experience in
public accounting, including his service as a senior partner of a major public
accounting firm focusing on financial markets companies and his service as a
senior executive of a public management consulting firm.
Rebecca W. Rimel - Ms. Rimel's experience on a broad range of public policy
issues acquired during her service as the executive director of a major
foundation and her experience as a director of several public companies.
William N. Searcy, Jr. - Mr. Searcy's experience as an investment officer for
various major public company retirement plans, which included evaluation of
unaffiliated investment advisers and supervision of various administrative and
accounting functions.
Jean Gleason Stromberg - Ms. Stromberg's professional training and experience
as an attorney specializing in federal securities law, her service in a senior
position with the Securities and Exchange Commission and the US Government
Accountability Office and her experience as a director and audit committee
member of several major non-profit organizations.
Robert H. Wadsworth - Mr. Wadsworth's experience as an owner and chief
executive officer of various businesses serving the mutual fund industry,
including a registered broker-dealer and a registered transfer agent, and his
previous service as a director and/or senior executive officer of several
mutual funds.
Michael J. Woods - Mr. Woods' experience as a senior executive in various parts
of Deutsche Bank's investment management business and his current service as
the chief executive officer of DWS Investments.
II-26
PART II: APPENDIX II-G - INVESTMENT PRACTICES AND TECHNIQUES
ADJUSTABLE RATE SECURITIES. The interest rates paid on the adjustable rate
securities in which a fund invests generally are readjusted at periodic
intervals, usually by reference to a predetermined interest rate index.
Adjustable rate securities include US Government securities and securities of
other issuers. Some adjustable rate securities are backed by pools of mortgage
loans. There are three main categories of interest rate indices: those based on
US Treasury securities, those derived from a calculated measure such as a cost
of funds index and those based on a moving average of mortgage rates. Commonly
used indices include the one-year, three-year and five-year constant maturity
Treasury rates, the three-month Treasury bill rate, the 180-day Treasury bill
rate, rates on longer-term Treasury securities, the 11th District Federal Home
Loan Bank Cost of Funds, the National Median Cost of Funds, the one-month,
three-month, six-month or one-year London Interbank Offered Rate (LIBOR), the
prime rate of a specific bank or commercial paper rates. As with fixed-rates
securities, changes in market interest rates and changes in the issuer's
creditworthiness may affect the value of adjustable rate securities.
Some indices, such as the one-year constant maturity Treasury rate, closely
mirror changes in market interest rate levels. Others, such as the 11th
District Home Loan Bank Cost of Funds index (Cost of Funds Index), tend to lag
behind changes in market rate levels and tend to be somewhat less volatile. To
the extent that the Cost of Funds index may reflect interest changes on a more
delayed basis than other indices, in a period of rising interest rates, any
increase may produce a higher yield later than would be produced by such other
indices, and in a period of declining interest rates, the Cost of Funds index
may remain higher for a longer period of time than other market interest rates,
which may result in a higher level of principal prepayments on adjustable rate
securities which adjust in accordance with the Cost of Funds index than
adjustable rate securities which adjust in accordance with other indices. In
addition, dislocations in the member institutions of the 11th District Federal
Home Loan Bank in recent years have caused and may continue to cause the Cost
of Funds index to change for reasons unrelated to changes in general interest
rate levels. Furthermore, any movement in the Cost of Funds index as compared
to other indices based upon specific interest rates may be affected by changes
in the method used to calculate the Cost of Funds index.
If prepayments of principal are made on the securities during periods of rising
interest rates, a fund generally will be able to reinvest such amounts in
securities with a higher current rate of return. However, a fund will not
benefit from increases in interest rates to the extent that interest rates rise
to the point where they cause the current coupon of adjustable rate securities
held as investments by a fund to exceed the maximum allowable annual or
lifetime reset limits (cap rates) for a particular adjustable rate security.
Also, a fund's net asset value could vary to the extent that current yields on
adjustable rate securities are different than market yields during interim
periods between coupon reset dates.
During periods of declining interest rates, the coupon rates may readjust
downward, resulting in lower yields to a fund. Further, because of this
feature, the value of adjustable rate securities is unlikely to rise during
periods of declining interest rates to the same extent as fixed-rate
instruments. Interest rate declines may result in accelerated prepayment of
adjustable rate securities, and the proceeds from such prepayments must be
reinvested at lower prevailing interest rates.
ADVANCE REFUNDED BONDS. A fund may purchase municipal securities that are
subsequently refunded by the issuance and delivery of a new issue of bonds
prior to the date on which the outstanding issue of bonds can be redeemed or
paid. The proceeds from the new issue of bonds are typically placed in an
escrow fund consisting of US Government obligations that are used to pay the
interest, principal and call premium on the issue being refunded. A fund may
also purchase municipal securities that have been refunded prior to purchase.
ASSET-BACKED SECURITIES. A fund may invest in securities generally referred to
as asset-backed securities. Asset-backed securities are securities that
directly or indirectly represent interests in, or are secured by and payable
from, an underlying pool of assets such as (but not limited to) first lien
mortgages, motor vehicle installment sale contracts, other installment sale
contracts, home equity loans, leases of various types of real and personal
property, and receivables from revolving credit (i.e., credit card) agreements
and trade receivables. Such assets are securitized through the use of trusts
and special purpose corporations. Asset-backed securities may provide periodic
payments that consist of interest and/or principal payments. Consequently, the
life of an asset-backed security varies with the prepayment and loss experience
II-32
of the underlying assets. Payments of principal and interest may be dependent
upon the cash flow generated by the underlying assets backing the securities
and, in certain cases, may be supported by some form of credit enhancement (for
more information, see Credit Enhancement). The degree of credit enhancement
provided for each issue is generally based on historical information respecting
the level of credit risk associated with the underlying assets. Delinquency or
loss in excess of that anticipated or failure of the credit enhancement could
adversely affect the return on an investment in such a security. The value of
the securities also may change because of changes in interest rates or changes
in the market's perception of the creditworthiness of the servicing agent for
the loan pool, the originator of the loans or the financial institution
providing the credit enhancement. Additionally, since the deterioration of
worldwide economic and liquidity conditions that became acute in 2008,
asset-backed securities have been subject to greater liquidity risk.
Asset-backed securities are ultimately dependent upon payment of loans and
receivables by individuals, businesses and other borrowers, and a fund
generally has no recourse against the entity that originated the loans.
Because asset-backed securities may not have the benefit of a security interest
in the underlying assets, asset-backed securities present certain additional
risks that are not present with mortgage-backed securities. For example, 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 such debtors the right to avoid payment of certain amounts owed on the
credit cards, thereby reducing the balance due. Furthermore, most issuers of
automobile receivables permit the servicer 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 a proper security interest
in all of the obligations backing such receivables. Therefore, there is the
possibility that recoveries on repossessed collateral may not, in some cases,
be available to support payments on these securities.
The yield characteristics of the asset-backed securities in which a fund may
invest differ from those of traditional debt securities. Among the major
differences are that interest and principal payments are made more frequently
on asset-backed securities (usually monthly) and that principal may be prepaid
at any time because the underlying assets generally may be prepaid at any time.
As a result, if a fund purchases these securities at a premium, a prepayment
rate that is faster than expected will reduce their yield, while a prepayment
rate that is slower than expected will have the opposite effect of increasing
yield. Conversely, if a fund purchases these securities at a discount, faster
than expected prepayments will increase, while slower than expected prepayments
will reduce, the yield on these securities. Because prepayment of principal
generally occurs during a period of declining interest rates, a fund may
generally have to reinvest the proceeds of such prepayments at lower interest
rates. Therefore, asset-backed securities may have less potential for capital
appreciation in periods of falling interest rates than other income-bearing
securities of comparable maturity.
Other Asset-Backed Securities. The securitization techniques used to develop
mortgage-backed securities are now being applied to a broad range of assets.
Through the use of trusts and special purpose corporations, various types of
assets, including automobile loans, computer leases and credit card
receivables, are being securitized in pass-through structures similar to
mortgage pass-through structures or in a structure similar to the CMO
structure. In general, the collateral supporting these securities is of shorter
maturity than mortgage loans and is less likely to experience substantial
prepayments with interest rate fluctuations.
Several types of asset-backed securities have already been offered to
investors, including Certificates of Automobile Receivables/SM/ (CARS/SM/).
CARS/SM/ represent undivided fractional interests in a trust whose assets
consist of a pool of motor vehicle retail installment sales contracts and
security interests in the vehicles securing the contracts. Payments of
principal and interest on CARS/SM/ are passed through monthly to certificate
holders, and are guaranteed up to certain amounts and for a certain time period
by a letter of credit issued by a financial institution unaffiliated with the
trustee or originator of the trust. An investor's return on CARS/SM/ may be
affected by early prepayment of principal on the underlying vehicle sales
contracts. If the letter of credit is exhausted, the trust may be prevented
from realizing the full amount due on a sales contract because of state law
requirements and restrictions relating to foreclosure sales of vehicles and the
obtaining of deficiency judgments following such sales or because of
depreciation, damage or loss of a vehicle, the application of federal and state
bankruptcy and insolvency laws, or other factors. As a result, certificate
holders may experience delays in payments or losses if the letter of credit is
exhausted.
II-33
A fund may also invest in residual interests in asset-backed securities. In the
case of asset-backed securities issued in a pass-through structure, the cash
flow generated by the underlying assets is applied to make required payments on
the securities and to pay related administrative expenses. The residual in an
asset-backed security pass-through structure represents the interest in any
excess cash flow remaining after making the foregoing payments. The amount of
residual cash flow resulting from a particular issue of asset-backed securities
will depend on, among other things, the characteristics of the underlying
assets, the coupon rates on the securities, prevailing interest rates, the
amount of administrative expenses and the actual prepayment experience on the
underlying assets. Asset-backed security residuals not registered under the
Securities Act may be subject to certain restrictions on transferability. In
addition, there may be no liquid market for such securities.
The availability of asset-backed securities may be affected by legislative or
regulatory developments. It is possible that such developments may require a
fund to dispose of any then-existing holdings of such securities.
ASSET-INDEXED SECURITIES. A fund may purchase asset-indexed securities which
are debt securities usually issued by companies in precious metals related
businesses such as mining, the principal amount, redemption terms, or interest
rates of which are related to the market price of a specified precious metal.
Market prices of asset-indexed securities will relate primarily to changes in
the market prices of the precious metals to which the securities are indexed
rather than to changes in market rates of interest. However, there may not be a
perfect correlation between the price movements of the asset-indexed securities
and the underlying precious metals. Asset-indexed securities typically bear
interest or pay dividends at below market rates (and in certain cases at
nominal rates). The purchase of asset-indexed securities also exposes a fund to
the credit risk of the issuer of the asset-indexed securities.
ASSET SEGREGATION. Certain investment transactions expose a fund to an
obligation to make future payments to third parties. Examples of these types of
transactions, include, but are not limited to, reverse repurchase agreements,
short sales, dollar rolls, when-issued, delayed-delivery or forward commitment
transactions and certain derivatives such as swaps, futures, forwards, and
options. To the extent that a fund engages in such transactions, a fund will
(to the extent required by applicable law) either (1) segregate cash or liquid
assets in the prescribed amount or (2) otherwise "cover" its future obligations
under the transaction, such as by holding an offsetting investment. If a fund
segregates sufficient cash or other liquid assets or otherwise "covers" its
obligations under such transactions, a fund will not consider the transactions
to be borrowings for purposes of its investment restrictions or "senior
securities" under the 1940 Act, and therefore, such transactions will not be
subject to the 300% asset coverage requirement under the 1940 Act otherwise
applicable to borrowings by a fund.
In some cases (e.g., with respect to futures and forwards that are
contractually required to "cash-settle"), a fund will segregate cash or other
liquid assets with respect to the amount of the daily net (marked-to-market)
obligation arising from the transaction, rather than the notional amount of the
underlying contract. By segregating assets in an amount equal to the net
obligation rather than the notional amount, a fund will have the ability to
employ leverage to a greater extent than if it set aside cash or other liquid
assets equal to the notional amount of the contract, which may increase the
risk associated with such transactions.
A fund may utilize methods of segregating assets or otherwise "covering"
transactions that are currently or in the future permitted under the 1940 Act,
the rules and regulations thereunder, or orders issued by the SEC thereunder.
For these purposes, interpretations and guidance provided by the SEC staff may
be taken into account when deemed appropriate by a fund.
Assets used as segregation or "cover" cannot be sold while the position in the
corresponding transaction is open, unless they are replaced with other
appropriate assets. As a result, the commitment of a large portion of a fund's
assets for segregation and "cover" purposes could impede portfolio management
or a fund's ability to meet redemption requests or other current obligations.
Segregating assets or otherwise "covering" for these purposes does not
necessarily limit the percentage of the assets of a fund that may be at risk
with respect to certain derivative transactions.
II-34
AUCTION RATE SECURITIES. Auction rate securities in which certain municipal
funds may invest consist of auction rate municipal securities and auction rate
preferred securities issued by closed-end investment companies that invest
primarily in municipal securities. Provided that the auction mechanism is
successful, auction rate securities normally permit the holder to sell the
securities in an auction at par value at specified intervals. The dividend is
reset by a "Dutch" auction in which bids are made by broker-dealers and other
institutions for a certain amount of securities at a specified minimum yield.
The dividend rate set by the auction is the lowest interest or dividend rate
that covers all securities offered for sale. While this process is designed to
permit auction rate securities to be traded at par value, there is the risk
that an auction will fail due to insufficient demand for the securities. If an
auction fails, the dividend rate of the securities rate adjusts to a maximum
rate, specified in the issuer's offering documents and, in the case of
closed-end funds, relevant charter documents. Security holders that submit sell
orders in a failed auction may not be able to sell any or all of the shares for
which they have submitted sell orders. Security holders may sell their shares
at the next scheduled auction, subject to the same risk that the subsequent
auction will not attract sufficient demand for a successful auction to occur.
Broker-dealers may also try to facilitate secondary trading in the auction rate
securities, although such secondary trading may be limited and may only be
available for shareholders willing to sell at a discount. Since February 2008,
many municipal issuers and closed-end funds have experienced, and continue to
experience, failed auctions of their auction rate securities. Repeated auction
failures have significantly affected the liquidity of auction rate securities,
shareholders of such securities have generally continued to receive dividends
at the above-mentioned maximum rate. There is no assurance that auctions will
resume or that any market will develop for auction rate securities. Valuation
of such securities are highly speculative. Dividends on auction rate preferred
securities issued by a closed-end fund may be reported, generally on Form 1099,
as exempt from federal income tax to the extent they are attributable to
tax-exempt interest income earned by a fund on the securities in its portfolio
and distributed to holders of the preferred securities, provided that the
preferred securities are treated as equity securities for federal income tax
purposes, and the closed-end fund complies with certain requirements under the
Code. A fund's investments in auction rate preferred securities of closed-end
funds are subject to limitations on investments in other US registered
investment companies, which limitations are prescribed by the 1940 Act.
BANK LOANS. Bank loans are typically senior debt obligations of borrowers
(issuers) and, as such, are considered to hold a senior position in the capital
structure of the borrower. These may include loans that hold the most senior
position, that hold an equal ranking with other senior debt, or loans that are,
in the judgment of the Advisor, in the category of senior debt of the borrower.
This capital structure position generally gives the holders of these loans a
priority claim on some or all of the borrower's assets in the event of a
default. In most cases, these loans are either partially or fully
collateralized by the assets of a corporation, partnership, limited liability
company or other business entity, or by cash flow that the Advisor believes at
the time of acquisition is sufficient to service the loan. These loans are
often issued in connection with recapitalizations, acquisitions, leveraged
buy-outs and refinancings. Moody's and S&P may rate bank loans higher than high
yield bonds of the same issuer to reflect their more senior position. A fund
may invest in both fixed- and floating-rate loans.
Bank loans may include restrictive covenants which must be maintained by the
borrower. Such covenants, in addition to the timely payment of interest and
principal, may include mandatory prepayment provisions arising from free cash
flow, restrictions on dividend payments and usually state that a borrower must
maintain specific minimum financial ratios as well as establishing limits on
total debt. A breach of covenant, which is not waived by the agent, is normally
an event of acceleration, i.e., the agent has the right to call the outstanding
bank loan. In addition, loan covenants may include mandatory prepayment
provisions stemming from free cash flow. Free cash flow is cash that is in
excess of capital expenditures plus debt service requirements of principal and
interest. Free cash flow shall be applied to prepay the bank loan in the order
of maturity described in the loan documents.
When a fund has an interest in certain types of bank loans, a fund may have an
obligation to make additional loans upon demand by the borrower. These
commitments may have the effect of requiring a fund to increase its investment
in a borrower at a time when it would not otherwise have done so. A fund
intends to reserve against such contingent obligations by segregating
sufficient assets in high quality short-term liquid investments or borrowing to
cover such obligations.
II-35
Under a bank loan, the borrower generally must pledge as collateral assets
which may include one or more of the following: cash; accounts receivable;
inventory; property, plant and equipment; common and preferred stock in its
subsidiaries; trademarks, copyrights, patent rights; and franchise value. A
fund may also receive guarantees as a form of collateral. In some instances, a
bank loan may be secured only by stock in a borrower or its affiliates. A fund
may also invest in bank loans not secured by any collateral. The market value
of the assets serving as collateral (if any) will, at the time of investment,
in the opinion of the Advisor, equal or exceed the principal amount of the bank
loan. The valuations of these assets may be performed by an independent
appraisal. If the agent becomes aware that the value of the collateral has
declined, the agent may take action as it deems necessary for the protection of
its own interests and the interests of the other lenders, including, for
example, giving the borrower an opportunity to provide additional collateral or
accelerating the loan. There is no assurance, however, that the borrower would
provide additional collateral or that the liquidation of the existing
collateral would satisfy the borrower's obligation in the event of nonpayment
of scheduled interest or principal, or that such collateral could be readily
liquidated.
In a typical interest in a bank loan, the agent administers the loan and has
the right to monitor the collateral. The agent is also required to segregate
the principal and interest payments received from the borrower and to hold
these payments for the benefit of the lenders. A fund normally looks to the
agent to collect and distribute principal of and interest on a bank loan.
Furthermore, a fund looks to the agent to use normal credit remedies, such as
to foreclose on collateral; monitor credit loan covenants; and notify the
lenders of any adverse changes in the borrower's financial condition or
declarations of insolvency. In the event of a default by the borrower, it is
possible, though unlikely, that a fund could receive a portion of the
borrower's collateral. If a fund receives collateral other than cash, such
collateral will be liquidated and the cash received from such liquidation will
be available for investment as part of a fund's portfolio. At times a fund may
also negotiate with the agent regarding the agent's exercise of credit remedies
under a bank loan. The agent is compensated for these services by the borrower
as is set forth in the loan agreement. Such compensation may take the form of a
fee or other amount paid upon the making of the bank loan and/or an ongoing fee
or other amount.
The loan agreement in connection with bank loans sets forth the standard of
care to be exercised by the agents on behalf of the lenders and usually
provides for the termination of the agent's agency status in the event that it
fails to act properly, becomes insolvent, enters FDIC receivership, or if not
FDIC insured, enters into bankruptcy or if the agent resigns. In the event an
agent is unable to perform its obligations as agent, another lender would
generally serve in that capacity.
Loan agreements frequently require the borrower to make full or partial
prepayment of a loan when the borrower engages in asset sales or a securities
issuance. Prepayments on bank loans may also be made by the borrower at its
election. The rate of such prepayments may be affected by, among other things,
general business and economic conditions, as well as the financial status of
the borrower. Prepayment would cause the actual duration of a bank loan to be
shorter than its stated maturity. This should, however, allow a fund to
reinvest in a new loan and recognize as income any unamortized loan fees. This
may result in a new facility fee payable to a fund. Because interest rates paid
on bank loans periodically fluctuate with the market, it is expected that the
prepayment and a subsequent purchase of a new bank loan by a fund will not have
a material adverse impact on the yield of the portfolio. A fund generally holds
bank loans to maturity unless it has become necessary to adjust a fund's
portfolio in accordance with the Advisor's view of current or expected economic
or specific industry or borrower conditions.
A fund may be required to pay and may receive various fees and commissions in
the process of purchasing, selling and holding bank loans. The fee may include
any, or a combination of, the following elements: arrangement fees, non-use
fees, facility fees, letter of credit fees and ticking fees. Arrangement fees
are paid at the commencement of a loan as compensation for the initiation of
the transaction. A non-use fee is paid based upon the amount committed but not
used under the loan. Facility fees are on-going annual fees paid in connection
with a loan. Letter of credit fees are paid if a loan involves a letter of
credit. Ticking fees are negotiated at the time of transaction, and are paid
from the initial commitment indication until loan closing.
If legislation or state or federal regulators impose additional requirements or
restrictions on the ability of financial institutions to make loans that are
considered highly leveraged transactions, the availability of bank loans for
investment by a fund may be adversely affected. In addition, such requirements
or restrictions could reduce or eliminate sources of financing for certain
borrowers. This would increase the risk of default. If legislation or federal
or state regulators
II-36
require financial institutions to dispose of bank loans that are considered
highly leveraged transactions or subject such bank loans to increased
regulatory scrutiny, financial institutions may determine to sell such bank
loans. Such sales by affected financial institutions may not be at desirable
prices, in the opinion of the Advisor. If a fund attempts to sell a bank loan
at a time when a financial institution is engaging in such a sale, the price a
fund could get for the bank loan may be adversely affected.
Affiliates of the Advisor may participate in the primary and secondary market
for bank loans. Because of limitations imposed by applicable law, the presence
of the Advisor's affiliates in the bank loan market may restrict a fund's
ability to acquire some bank loans, or affect the timing or price of such
acquisitions. The Advisor does not believe that this will materially affect a
fund's ability to achieve its investment objective. Also, because the Advisor
may wish to invest in the publicly traded securities of a borrower, it may not
have access to material non-public information regarding the borrower to which
other lenders have access.
Loan Participations and Assignments. A fund's investments in bank loans are
expected in most instances to be in the form of participations in bank loans
(Participations) and assignments of portions of bank loans (Assignments) from
third parties. Large loans to corporations or governments may be shared or
syndicated among several lenders, usually banks. A fund may participate in such
syndicates, or can buy part of a loan, becoming a direct lender. Large loans to
corporations or governments may be shared or syndicated among several lenders,
usually banks. A fund may participate in such syndicates, or can buy part of a
loan, becoming a direct lender.
When a fund buys an Assignment, it is essentially becoming a party to the bank
agreement. The vast majority of all trades are Assignments and would therefore
generally represent the preponderance of bank loans held by a fund. When a fund
is a purchaser of an Assignment, it typically succeeds to all the rights and
obligations under the loan agreement of the assigning lender and becomes a
lender under the loan agreement with the same rights and obligations as the
assigning lender. Because Assignments are arranged through private negotiations
between potential assignees and potential assignors, however, the rights and
obligations acquired by a fund as the purchaser of an Assignment may differ
from, and may be more limited than, those held by the assigning lender.
In certain cases, a fund may buy bank loans on a participation basis, if for
example, a fund did not want to become party to the bank agreement. With
respect to any given bank loan, the rights of a fund when it acquires a
Participation may be more limited than the rights of the original lenders or of
investors who acquire an Assignment. Participations typically will result in a
fund having a contractual relationship only with the lender and not with the
borrower. A fund will have the right to receive payments of principal, interest
and any fees to which it is entitled only from the lender selling the
Participation and only upon receipt by the lender of the payments from the
borrower. In connection with purchasing Participations, a fund generally will
have no right to enforce compliance by the borrower with the terms of the loan
agreement relating to the bank loan, nor any rights of set-off against the
borrower, and a fund may not directly benefit from any collateral supporting
the bank loan in which it has purchased the Participation. As a result, a fund
will assume the credit risk of both the borrower and the lender that is selling
the Participation. In the event of the insolvency of the lender selling a
Participation, a fund may be treated as a general creditor of the lender and
may not benefit from any set-off between the lender and the borrower.
In the case of loan Participations where a bank or other lending institution
serves as financial intermediary between a fund and the borrower, if the
Participation does not shift to a fund the direct debtor-creditor relationship
with the borrower, SEC interpretations require a fund, in some circumstances,
to treat both the lending bank or other lending institution and the borrower as
issuers for purposes of a fund's investment policies. Treating a financial
intermediary as an issuer of indebtedness may restrict a fund's ability to
invest in indebtedness related to a single financial intermediary, or a group
of intermediaries engaged in the same industry, even if the underlying
borrowers represent many different companies and industries.
A fund may pay a fee or forego a portion of interest payments to the lender
selling a Participation or Assignment under the terms of such Participation or
Assignment. In the case of loans administered by a bank or other financial
institution that acts as agent for all holders, if assets held by the agent for
the benefit of a purchaser are determined to be subject to the claims of the
agent's general creditors, the purchaser might incur certain costs and delays
in realizing payment on the loan or loan Participation and could suffer a loss
of principal or interest.
II-37
Participations and Assignments involve credit risk, interest rate risk, and
liquidity risk, as well as the potential liability associated with being a
lender. If a fund purchases a Participation, it may only be able to enforce its
rights through the participating lender, and may assume the credit risk of both
the lender and the borrower. Investments in loans through direct Assignment of
a financial institution's interests with respect to a loan may involve
additional risks. For example, if a loan is foreclosed, a fund could benefit
from becoming part owner of any collateral, however, a fund would bear the
costs and liabilities associated with owning and disposing of the collateral.
A fund may have difficulty disposing of Assignments and Participations. Because
no liquid market for these obligations typically exists, a fund anticipates
that these obligations could be sold only to a limited number of institutional
investors. The lack of a liquid secondary market will have an adverse effect on
a fund's ability to dispose of particular Assignments or Participations when
necessary to meet a fund's liquidity needs or in response to a specific
economic event, such as a deterioration in the creditworthiness of the
borrower. The lack of a liquid secondary market for Assignments and
Participations may also make it more difficult for a fund to assign a value to
those securities for purposes of valuing a fund's portfolio and calculating its
net asset value.
BORROWING. Under the 1940 Act, a fund is required to maintain continuous asset
coverage of 300% with respect to permitted borrowings and to sell (within three
days) sufficient portfolio holdings to restore such coverage if it should
decline to less than 300% due to market fluctuations or otherwise, even if such
liquidation of a fund's holdings may be disadvantageous from an investment
standpoint.
BRADY BONDS. Brady Bonds are securities created through the exchange of
existing commercial bank loans to public and private entities in certain
emerging markets for new bonds in connection with debt restructurings under a
debt restructuring plan introduced by former US Secretary of the Treasury,
Nicholas F. Brady (Brady Plan). Brady Bonds may be collateralized or
uncollateralized and are issued in various currencies (but primarily the
dollar). Dollar-denominated, collateralized Brady Bonds, which may be
fixed-rate bonds or floating-rate bonds, are generally collateralized in full
as to principal by US Treasury zero coupon bonds having the same maturity as
the Brady Bonds. Interest payments on these Brady Bonds generally are
collateralized by cash or securities in an amount that, in the case of fixed
rate bonds, is equal to at least one year of rolling interest payments or, in
the case of floating rate bonds, initially is equal to at least one year's
rolling interest payments based on the applicable interest rate at that time
and is adjusted at regular intervals thereafter. Brady Bonds are often viewed
as having three or four valuation components: the collateralized repayment of
principal at final maturity; the collateralized interest payments; the
uncollateralized interest payments; and any uncollateralized repayment of
principal at maturity (these uncollateralized amounts constitute the residual
risk). In light of the residual risk of Brady Bonds and the history of defaults
of countries issuing Brady Bonds, with respect to commercial bank loans by
public and private entities, investments in Brady Bonds may be viewed as
speculative.
CASH MANAGEMENT VEHICLES. A fund may have cash balances that have not been
invested in portfolio securities (Uninvested Cash). Uninvested Cash may result
from a variety of sources, including dividends or interest received from
portfolio securities, unsettled securities transactions, reserves held for
investment strategy purposes, assets to cover a fund's open futures and other
derivatives positions, scheduled maturity of investments, liquidation of
investment securities to meet anticipated redemptions and dividend payments,
and new cash received from investors. Uninvested Cash may be invested directly
in money market instruments or other short-term debt obligations. A fund may
use Uninvested Cash to purchase shares of affiliated money market funds for
which the Advisor may act as investment advisor now or in the future. Such
affiliated money market funds will operate in accordance with Rule 2a-7 under
the 1940 Act and will seek to maintain a stable net asset value ("NAV") or will
maintain a floating NAV. A fund indirectly bears its proportionate share of the
expenses of each affiliated money market fund in which it invests. The
affiliated money market funds in which a fund may invest are registered under
the 1940 Act or are excluded from the definition of "investment company" under
Section 3(c)(1) or 3(c)(7) of the 1940 Act. Investments in such affiliated
money market funds may exceed the limits of Section 12(d)(1)(A) of the 1940
Act.
COMMERCIAL PAPER. A fund may invest in commercial paper issued by major
corporations under the Securities Act in reliance on the exemption from
registration afforded by Section 3(a)(3) thereof. Such commercial paper may be
issued only to finance current transactions and must mature in nine months or
less. Trading of such commercial paper is conducted primarily by institutional
investors through investment dealers, and individual investor participation in
the commercial paper market is very limited. A fund also may invest in
commercial paper issued in reliance on the
II-38
so-called "private placement" exemption from registration afforded by Section
4(2) of the 1933 Act (Section 4(2) paper). Section 4(2) paper is restricted as
to disposition under the federal securities laws, and generally is sold to
institutional investors such as a fund who agree that they are purchasing the
paper for investment and not with a view to public distribution. Any resale by
the purchaser must be in an exempt transaction. Section 4(2) paper normally is
resold to other institutional investors like a fund through or with the
assistance of the issuer or investment dealers who make a market in Section
4(2) paper, thus providing liquidity.
COMMODITY POOL OPERATOR EXCLUSION. The Advisor currently intends to operate the
fund in compliance with the requirements of Rule 4.5 of the Commodity Futures
Trading Commission (CFTC). As a result, a fund is not deemed to be a "commodity
pool" under the Commodity Exchange Act (CEA) and will be limited in its ability
to use futures and options on futures or commodities or engage in swap
transactions for other than bona fide hedging purposes. Provided a fund
operates within the limits of Rule 4.5 of the CFTC, a fund will be excluded
from registration with and regulation under the CEA and the Advisor will not be
deemed to be a "commodity pool operator" with respect to the operations of a
fund. If a fund were no longer able to claim the exclusion, the fund and the
Advisor would be subject to regulation under the CEA.
COMMODITY POOL OPERATOR REGULATION. The CFTC has made regulatory changes that
require the Advisor to register as a "commodity pool operator." The Advisor is
currently registered with the National Futures Association as a "commodity pool
operator" and a "commodity trading advisor" and the Advisor will act as such
with respect to the operation of a fund as a result of these regulatory
changes. The impact on a fund of these new requirements is uncertain at this
time. CFTC-mandated disclosure, reporting and recordkeeping obligations will
apply with respect to a fund once the CFTC proposal that seeks to "harmonize"
these obligations with overlapping SEC regulations is finalized. The effects of
these regulatory changes could reduce investment returns or limit a fund's
ability to implement its investment strategy. Investors in a fund and their
financial advisers should consider whether a fund's status as a "commodity
pool" impacts their operations or status under the CEA in deciding whether to
invest in a fund.
COMMON STOCK. Common stock is issued by companies to raise cash for business
purposes and represents a proportionate interest in the issuing companies.
Therefore, a fund may participate in the success or failure of any company in
which it holds stock. The market values of common stock can fluctuate
significantly, reflecting the business performance of the issuing company,
investor perception and general economic or financial market movements. Despite
the risk of price volatility, however, common stocks have historically offered
a greater potential for long-term gain on investment, compared to other classes
of financial assets, such as bonds or cash equivalents, although there can be
no assurance that this will be true in the future.
CONVERTIBLE SECURITIES. A fund may invest in convertible securities; that is,
bonds, notes, debentures, preferred stocks and other securities that are
convertible (by the holder or by the issuer) into common stock. Investments in
convertible securities can provide an opportunity for capital appreciation
and/or income through interest and dividend payments by virtue of their
conversion or exchange features.
The convertible securities in which a fund may invest include fixed-income or
zero coupon debt securities, which may be converted or exchanged at a stated or
determinable exchange ratio into underlying shares of common stock. The
exchange ratio for any particular convertible security may be adjusted from
time to time due to stock splits, dividends, spin-offs, other corporate
distributions or scheduled changes in the exchange ratio. A convertible
security may be called for redemption or conversion by the issuer after a
particular date and under certain circumstances (including a specified price)
established upon issue. If a convertible security held by a fund is called for
redemption or conversion, a fund could be required to tender it for redemption,
convert it into the underlying common stock, or sell it to a third party, which
may have an adverse effect on a fund's ability to achieve its investment
objectives. Convertible securities and convertible preferred stocks, until
converted, have general characteristics similar to both debt and equity
securities. Although to a lesser extent than with debt securities generally,
the market values of convertible securities tend to decline as interest rates
increase and, conversely, tend to increase as interest rates decline. In
addition, because of the conversion or exchange feature, the market values of
convertible securities typically change as the market values of the underlying
common stocks change, and, therefore, also tend to follow movements in the
general market for equity securities. A unique feature of convertible
securities is that, as the market price of the underlying common stock
declines, convertible securities tend to trade increasingly on a yield basis,
and so may not experience market
II-39
value declines to the same extent as the underlying common stock. When the
market price of the underlying common stock increases, the prices of the
convertible securities tend to rise as a reflection of the value of the
underlying common stock, although typically not as much as the underlying
common stock. While no securities investments are without risk, investments in
convertible securities generally entail less risk than investments in common
stock of the same issuer.
As debt securities, convertible securities are investments that provide for a
stream of income (or in the case of zero coupon securities, accretion of
income) with generally higher yields than common stocks. Convertible securities
generally offer lower yields than non-convertible securities of similar quality
because of their conversion or exchange features.
Of course, like all debt securities, there can be no assurance of income or
principal payments because the issuers of the convertible securities may
default on their obligations.
Convertible securities are generally subordinated to other similar but
non-convertible securities of the same issuer, although convertible bonds, as
corporate debt obligations, enjoy seniority in right of payment to all equity
securities, and convertible preferred stock is senior to common stock, of the
same issuer. However, because of the subordination feature, convertible bonds
and convertible preferred stock typically have lower ratings than similar
non-convertible securities. Convertible securities may be issued as fixed
income obligations that pay current income or as zero coupon notes and bonds,
including Liquid Yield Option Notes (LYONs).
CREDIT ENHANCEMENT. Mortgage-backed securities and asset-backed securities are
often backed by a pool of assets representing the obligations of a number of
different parties. To lessen the effect of failure by obligors on underlying
assets to make payments, such securities may contain elements of credit
enhancement. Such credit enhancement falls into two categories: (1) liquidity
protection and (2) protection against losses resulting from ultimate default by
an obligor on the underlying assets. Liquidity protection refers to the
provision of advances, generally by the entity administering the pool of
assets, to ensure that the pass-through of payments due on the underlying pool
occurs in a timely fashion. Protection against losses resulting from ultimate
default enhances the likelihood of ultimate payment of the obligations on at
least a portion of the assets in the pool. Such protection may be provided
through guarantees, insurance policies or letters of credit obtained by the
issuer or sponsor from third parties; through various means of structuring the
transaction; or through a combination of such approaches. A fund may pay any
additional fees for such credit enhancement, although the existence of credit
enhancement may increase the price of a security.
The ratings of mortgage-backed securities and asset-backed securities for which
third-party credit enhancement provides liquidity protection or protection
against losses from default are generally dependent upon the continued
creditworthiness of the provider of the credit enhancement. The ratings of such
securities could be subject to reduction in the event of deterioration in the
creditworthiness of the credit enhancement provider even in cases where the
delinquency and loss experience on the underlying pool of assets is better than
expected.
Examples of credit enhancement arising out of the structure of the transaction
include "senior-subordinated securities" (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal
thereof and interest thereon, with the result that defaults on the underlying
assets are borne first by the holders of the subordinated class), creation of
"reserve funds" (where cash or investments, sometimes funded from a portion of
the payments on the underlying assets, are held in reserve against future
losses) and "over-collateralization" (where the scheduled payments on, or the
principal amount of, the underlying assets exceed those required to make
payment of the securities and pay any servicing or other fees). The degree of
credit enhancement provided for each issue is generally based on historical
information with respect to the level of credit risk associated with the
underlying assets. Delinquency or loss in excess of that which is anticipated
could adversely affect the return on an investment in such a security.
Certain of a fund's other investments may be credit-enhanced by a guaranty,
letter of credit, or insurance from a third party. Any bankruptcy,
receivership, default, or change in the credit quality of the third party
providing the credit enhancement may adversely affect the quality and
marketability of the underlying security and could cause losses to a fund and
affect a fund's share price.
II-40
CURRENCY STRATEGIES. In addition to a fund's main investment strategy, certain
funds seek to enhance returns by employing proprietary quantitative,
rules-based methodology currency strategies using derivatives (contracts whose
value are based on, for example, indices, currencies or securities), in
particular forward currency contracts. These currency strategies are long/short
rules-based strategies that offer a core approach to currency investing by
investing across a diversified pool of developed and emerging market
currencies. There are three strategies:
CARRY STRATEGY: Carry trades are widely known in currency markets. In a
carry trade low interest rate currencies are systematically sold and high
interest rate currencies are systematically bought. Such a strategy seeks
to exploit what academics call "forward-rate bias" or the "forward premium
puzzle," that is, circumstances where the forward rate is not an unbiased
estimate of the future spot. Positive returns may occur when an investor's
gain from interest rate differentials between the high yielding and low
yielding jurisdictions exceed any losses from currency rate movements
between the relevant currencies.
MOMENTUM STRATEGY: This strategy is based on the observation that many
exchange rates have followed multi-year trends. A strategy that follows a
multi-year trend may make positive returns over time. The segmentation of
currency market participants, with some acting quickly on news while
others respond more slowly is one reason why, in some circumstances,
trends may emerge and can be protracted.
VALUATION STRATEGY: This strategy is based on the observation that in the
long-term, currencies have tended to move toward their "fair value." The
goal of the valuation strategy is to seek a profit for the fund by
systematically buying "undervalued" currencies and selling "overvalued"
currencies in the medium-term.
The success of the currency strategies depends, in part, on the effectiveness
and implementation of portfolio management's proprietary models. If portfolio
management's analysis proves to be incorrect, losses to the fund may be
significant and may substantially exceed the intended level of market exposure
for the currency strategies.
As part of the currency strategies, a fund will be exposed to the risks of
non-US currency markets. Foreign currency rates may fluctuate significantly
over short periods of time for a number of reasons, including changes in
interest rates and economic or political developments in the US or abroad. As a
result, the fund's exposure to foreign currencies could cause lower returns or
even losses to the fund. Although portfolio management seeks to limit these
risks through the aggregation of various long and short positions, there can be
no assurance that it will be able to do so.
CUSTODIAL RECEIPTS. Custodial receipts are interests in separately traded
interest and principal component parts of US Government securities that are
issued by banks or brokerage firms and are created by depositing US Government
securities into a special account at a custodian bank. The custodian holds the
interest and principal payments for the benefit of the registered owners of the
certificates or receipts. The custodian arranges for the issuance of the
certificates or receipts evidencing ownership and maintains the register.
Custodial receipts include Treasury Receipts (TRs), Treasury Investment Growth
Receipts (TIGRs), and Certificates of Accrual on Treasury Securities (CATS).
TIGRs and CATS are interests in private proprietary accounts while TRs and
STRIPS are interests in accounts sponsored by the US Treasury. Receipts are
sold as zero coupon securities (see Zero Coupon Securities). A fund may acquire
US Government securities and their unmatured interest coupons that have been
separated (stripped) by their holder, typically a custodian bank or investment
brokerage firm. Having separated the interest coupons from the underlying
principal of the US Government securities, the holder will resell the stripped
securities in custodial receipt programs with a number of different names,
including TIGRs and CATS. The stripped coupons are sold separately from the
underlying principal, which is usually sold at a deep discount because the
buyer receives only the right to receive a future fixed payment on the security
and does not receive any rights to periodic interest (cash) payments. The
underlying US Treasury bonds and notes themselves are generally held in
book-entry form at a Federal Reserve Bank. Counsel to the underwriters of these
certificates or other evidences of ownership of US Treasury securities have
stated that, in their opinion, purchasers of the stripped securities most
likely will be deemed the beneficial holders of the underlying US Government
securities for federal tax and securities purposes. In the case of CATS and
TIGRs, the Internal Revenue Service (IRS) has reached a similar conclusion for
the purpose of applying the tax diversification requirements applicable to
regulated investment companies such as a fund. CATS and TIGRs are not
considered US Government securities by the staff of the SEC.
II-41
Further, the IRS conclusion noted above is contained only in a general counsel
memorandum, which is an internal document of no precedential value or binding
effect, and a private letter ruling, which also may not be relied upon by a
fund. A fund is not aware of any binding legislative, judicial or
administrative authority on this issue.
DEPOSITARY RECEIPTS. A fund may invest in sponsored or unsponsored American
Depositary Receipts (ADRs), European Depositary Receipts (EDRs), Global
Depositary Receipts (GDRs), International Depositary Receipts (IDRs) and other
types of Depositary Receipts (which, together with ADRs, EDRs, GDRs and IDRs
are hereinafter referred to as Depositary Receipts). Depositary Receipts
provide indirect investment in securities of foreign issuers. Prices of
unsponsored Depositary Receipts may be more volatile than if they were
sponsored by the issuer of the underlying securities. Depositary Receipts may
not necessarily be denominated in the same currency as the underlying
securities into which they may be converted. In addition, the issuers of
unsponsored Depositary Receipts are not obligated to disclose material
information regarding the underlying securities or their issuer in the United
States and, therefore, there may not be a correlation between such information
and the market value of the Depositary Receipts. ADRs are Depositary Receipts
that are bought and sold in the United States and are typically issued by a US
bank or trust company which evidence ownership of underlying securities by a
foreign corporation. GDRs, IDRs and other types of Depositary Receipts are
typically issued by foreign banks or trust companies, although they may also be
issued by United States banks or trust companies, and evidence ownership of
underlying securities issued by either a foreign or a United States
corporation. Generally, Depositary Receipts in registered form are designed for
use in the United States securities markets and Depositary Receipts in bearer
form are designed for use in securities markets outside the United States.
Depositary Receipts, including those denominated in US dollars will be subject
to foreign currency exchange rate risk. However, by investing in US
dollar-denominated ADRs rather than directly in foreign issuers' stock, a fund
avoids currency risks during the settlement period. In general, there is a
large, liquid market in the United States for most ADRs. However, certain
Depositary Receipts may not be listed on an exchange and therefore may be
illiquid securities.
DERIVATIVES. A fund may use instruments referred to as derivatives
(derivatives). Derivatives are financial instruments the value of which is
derived from another security, a commodity (such as gold or oil), a currency or
an index (a measure of value or rates, such as the S&P 500 Index or the prime
lending rate). Derivatives often allow a fund to increase or decrease the level
of risk to which a fund is exposed more quickly and efficiently than direct
investments in the underlying asset or instruments.
A fund may, to the extent consistent with its investment objective and
policies, purchase and sell (write) exchange-listed and over-the-counter (OTC)
put and call options on securities, equity and fixed-income indices and other
instruments, purchase and sell futures contracts and options thereon, enter
into various transactions such as swaps, caps, floors, and collars, and may
enter into currency forward contracts, currency futures contracts, currency
swaps or options on currencies, or various other currency transactions. In
addition, a fund may invest in structured notes. The types of derivatives
identified above are not intended to be exhaustive and a fund may use types of
derivatives and/or employ derivatives strategies not otherwise described in
this Statement of Additional Information or a fund's prospectuses.
OTC derivatives are purchased from or sold to securities dealers, financial
institutions or other parties (Counterparties) pursuant to an agreement with
the Counterparty. As a result, a significant risk of OTC derivatives is
counterparty risk. The Advisor monitors the creditworthiness of OTC derivative
counterparties and periodically reports to the Board with respect to the
creditworthiness of OTC derivative counterparties.
A fund may use derivatives subject to certain limits imposed by a fund's
investment objective and policies (see Investment Restrictions) and the 1940
Act, or by the requirements for a fund to qualify as a regulated investment
company for tax purposes (see Taxes) (i) to seek to achieve returns, (ii) to
attempt to protect against possible changes in the market value of securities
held in or to be purchased for a fund's portfolio resulting from securities
markets or currency exchange rate fluctuations, (iii) to protect a fund's
unrealized gains in the value of its portfolio securities, (iv) to facilitate
the sale of such securities for investment purposes, (v) to manage the
effective maturity or duration of a fund's portfolio, (vi) to establish a
position in the derivatives markets as a substitute for purchasing or selling
particular securities, (vii) for funds that invest in foreign securities, to
increase exposure to a foreign currency or to shift exposure to foreign
currency fluctuations from one currency to another (not necessarily the US
dollar), or (viii) for any other purposes permitted by law.
II-42
A fund may decide not to employ any of the strategies described below, and no
assurance can be given that any strategy used will succeed. If the Advisor
incorrectly forecasts interest rates, market values or other economic factors
in using a derivatives strategy for a fund, a fund might have been in a better
position if it had not entered into the transaction at all. Also, suitable
derivatives may not be available in all circumstances. The use of these
strategies involves certain special risks, including a possible imperfect
correlation, or even no correlation, between price movements of derivatives and
price movements of related investments. While some strategies involving
derivatives can reduce risk of loss, they can also reduce the opportunity for
gain or even result in losses by offsetting favorable price movements in
related investments or otherwise, due to the possible inability of a fund to
purchase or sell a portfolio security at a time that otherwise would be
favorable or the possible need to sell a portfolio security at a
disadvantageous time because a fund is required to maintain asset coverage or
offsetting positions in connection with transactions in derivatives (refer to
Asset Segregation for more information relating to asset segregation and cover
requirements for derivatives instruments), and the possible inability of a fund
to close out or liquidate its derivatives positions.
General Characteristics of Options. A put option gives the purchaser of the
option, upon payment of a premium, the right to sell, and the writer the
obligation to buy, the underlying security, commodity, index, currency or other
instrument at the exercise price. For instance, a fund's purchase of a put
option on a security might be designed to protect its holdings in the
underlying instrument (or, in some cases, a similar instrument) against a
substantial decline in the market value by giving a fund the right to sell such
instrument at the option exercise price. A call option, upon payment of a
premium, gives the purchaser of the option the right to buy, and the seller the
obligation to sell, the underlying instrument at the exercise price. A fund's
purchase of a call option on a security, commodity, index, currency or other
instrument might be intended to protect a fund against an increase in the price
of the underlying instrument that it intends to purchase in the future by
fixing the price at which it may purchase such instrument. If a fund sells or
"writes" a call option, the premium that it receives may partially offset, to
the extent of the option premium, a decrease in the value of the underlying
securities or instruments in its portfolio or may increase a fund's income. The
sale of put options can also provide income and might be used to protect a fund
against an increase in the price of the underlying instrument or provide, in
the opinion of portfolio management, an acceptable entry point with regard to
the underlying instrument.
A fund may write call options only if they are "covered." A written call option
is covered if a fund owns the security or instrument underlying the call or has
an absolute right to acquire that security or instrument without additional
cash consideration (or if additional cash consideration is required, liquid
assets in the amount of a fund's obligation are segregated according to the
procedures and policies adopted by the Board). For a call option on an index,
the option is covered if a fund segregates liquid assets equal to the contract
value to the extent required by SEC guidelines. A call option is also covered
if a fund holds a call on the same security, index or instrument as the written
call option where the exercise price of the purchased call (long position) 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 that liquid assets
equal to the difference between the exercise prices are segregated to the
extent required by SEC guidelines (see Asset Segregation). Exchange listed
options are issued and cleared by a regulated intermediary such as the Options
Clearing Corporation (OCC). The OCC ensures that the obligations of each option
it clears are fulfilled. The discussion below uses the OCC as an example, but
is also applicable to other financial intermediaries. OCC issued and exchange
listed options generally settle by physical delivery of the underlying security
or currency, or cash delivery for the net amount, if any, by which the option
is "in-the-money" (i.e., where the value of the underlying instrument exceeds,
in the case of a call option, or is less than, in the case of a put option, the
exercise price of the option) at the time the option is exercised. Frequently,
rather than taking or making delivery of the underlying instrument through the
process of exercising the option, listed options are closed by entering into
offsetting purchase or sale transactions that do not result in ownership of the
new option.
As noted above, OTC options are purchased from or sold to Counterparties
through direct bilateral agreement with the Counterparty. In contrast to
exchange listed options, which generally have standardized terms and
performance mechanics, all the terms of an OTC option, including such terms as
method of settlement, term, exercise price, premium, guarantees and security,
are set by negotiation of the parties. Unless the parties provide for it, there
is no central clearing or guaranty function in an OTC option. As a result, if
the Counterparty fails to make or take delivery of the security, currency or
other instrument underlying an OTC option it has entered into with a fund or
fails to make a cash settlement payment due in accordance with the terms of
that option, a fund will lose any premium it paid for the option as well as any
anticipated benefit of the transaction.
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There are a number of risks associated with transactions in options. Options on
particular securities or instruments may be more volatile than a direct
investment in the underlying security or instrument. A decision as to whether,
when and how to use options involves the exercise of skill and judgment, and
even a well-conceived transaction may be unsuccessful to some degree because of
market behavior or unexpected events. Additionally, there are significant
differences between the securities and options markets that could result in an
imperfect correlation between these markets, causing a given options
transaction not to achieve its objective. Disruptions in the markets for the
securities underlying options purchased or sold by a fund could result in
losses on the options. If trading is interrupted in an underlying security, the
trading of options on that security is normally halted as well. As a result, a
fund as purchaser or writer of an option will be unable to close out its
positions until options trading resumes, and it may be faced with losses if
trading in the security reopens at a substantially different price. In
addition, the OCC or other options markets may impose exercise restrictions. If
a prohibition on exercise is imposed at a time when trading in the option has
also been halted, a fund as purchaser or writer of an option will be locked
into its position until one of the two restrictions has been lifted. If a
prohibition on exercise remains in effect until an option owned by a fund has
expired, a fund could lose the entire value of its option.
During the option period, the covered call writer, in return for the premium on
the option, gives up the opportunity to profit from a price increase in the
underlying security or instrument above the sum of the option premium received
and the option's exercise price, but as long as its obligations as a writer
continue, retains the risk of loss, minus the option premium received, should
the price of the underlying security or instrument decline. In writing options,
a fund has no control over the time when it may be required to fulfill its
obligations as the writer of the option. Once a fund receives an exercise
notice for its option, it cannot effect a closing purchase transaction in order
to terminate its obligation under the option and must deliver the underlying
security at the exercise price. Thus, the use of covered call options may
require the fund to sell portfolio securities at inopportune times or for
prices other than current market values, will limit the amount of appreciation
the fund can realize above the exercise price of an option on a security, or
may cause the fund to hold a security that it might otherwise sell.
In writing put options, there is a risk that a fund may be required to buy the
underlying security or instrument at a disadvantageous price if the put option
is exercised against a fund. If a put or call option purchased by a fund is not
sold when it has remaining value, and if the market price of the underlying
security or instrument remains, in the case of a put, equal to or greater than
the exercise price, or in the case of a call, less than or equal to the
exercise price, a fund will lose the premium that it paid for the option. Also,
where a put or call option is purchased as a hedge against price movements in
the underlying security or instrument, the price of the put or call option may
move more or less than the price of the underlying security or instrument.
The value of options may be adversely affected if the market for such options
becomes less liquid or smaller. A fund's ability to close out its position as a
purchaser or seller of an OTC option or exchange listed put or call option is
dependent, in part, upon the liquidity of the option market. There can be no
assurance that a liquid market will exist when a fund seeks to close out an
option position either, in the case of a written call option, by buying the
option, or, in the case of a purchased put option, by selling the option. Among
the possible reasons for the absence of a liquid options 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, including reaching daily price limits; (iv) interruption
of the normal operations of the OCC or an exchange; (v) inadequacy of the
facilities the OCC or an exchange 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 relevant market for
that option on that exchange would cease to exist, although outstanding options
on that exchange would generally continue to be exercisable in accordance with
their terms. A fund's ability to terminate OTC options is more limited than
with exchange-traded options and may involve the risk that broker-dealers
participating in such transactions will not fulfill their obligations. If a
fund were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the
option expired without exercise.
Special risks are presented by internationally traded options. Because of the
differences in trading hours between the US and various foreign countries, and
because different holidays are observed in different countries, foreign options
markets may be open for trading during hours or on days when US markets are
closed. As a result, option premiums may not reflect the current prices of the
underlying interests in the US.
II-44
The hours of trading for options may not conform to the hours during which the
underlying securities are traded. To the extent that the options 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 options markets. Call options are marked-to-market daily and their value
will be affected by changes in the value of and dividend rates of the
underlying securities, an increase in interest rates, changes in the actual or
perceived volatility of the stock market and the underlying securities and the
remaining time to the options' expiration. Additionally, the exercise price of
an option may be adjusted downward before the option's expiration as a result
of the occurrence of certain corporate events affecting the underlying
security, such as extraordinary dividends, stock splits, merger or other
extraordinary distributions or events. A reduction in the exercise price of an
option would reduce a fund's capital appreciation potential on the underlying
security.
The number of call options a fund can write is limited by the number of shares
of underlying securities that the fund holds. Furthermore, a fund's options
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. These limitations govern the maximum number of options in each
class that 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 that a fund 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.
General Characteristics of Futures Contracts and Options on Futures Contracts.
A futures contract is an agreement between two parties to buy or sell a
financial instrument or commodity for a set price on a future date. Futures are
generally bought and sold on the commodities exchanges where they are listed
with payment of initial and variation margin as described below. A futures
contract generally obligates the purchaser to take delivery from the seller of
the specific type of financial instrument or commodity underlying the contract
at a specific future time for a set price. The purchase of a futures contract
enables a fund, during the term of the contract, to lock in the price at which
it may purchase a security, currency or commodity and protect against a rise in
prices pending the purchase of portfolio securities. A futures contract
generally obligates the seller to deliver to the buyer the specific type of
financial instrument underlying the contract at a specific future time for a
set price. The sale of a futures contract enables a fund to lock in a price at
which it may sell a security, currency or commodity and protect against
declines in the value of portfolio securities. 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 and obligates the seller to deliver such
position.
Although most futures contracts call for actual delivery or acceptance of the
underlying financial instrument or commodity, the contracts are usually closed
out before the settlement date without making, or taking, actual delivery.
Futures contracts on financial indices, currency exchange instruments and
certain other instruments provide for the delivery of an amount of cash equal
to a specified dollar amount times the difference between the underlying
instruments value (i.e., the index) at the open or close of the last trading
day of the contract and futures contract price. A futures contract sale is
closed out by effecting a futures contract purchase for the same aggregate
amount of the specific type of underlying financial instrument and the same
delivery date. If the sale price exceeds the offsetting purchase price, the
seller would be paid the difference and would realize a gain. If the offsetting
purchase price exceeds the sale price, the seller would pay the difference and
would realize a loss. Similarly, a futures contract purchase is closed out by
effecting a futures contract sale for the same aggregate amount of the specific
type of underlying financial instrument or commodity and the same delivery
date. If the offsetting sale price exceeds the purchase price, the purchaser
would realize a gain, whereas if the purchase price exceeds the offsetting sale
price, the purchaser would realize a loss. There can be no assurance that a
fund will be able to enter into a closing transaction.
When a purchase or sale of a futures contract is made, a fund is required to
deposit with the financial intermediary as security for its obligations under
the contract an "initial margin" consisting of cash, US Government Securities
or other liquid assets typically ranging from approximately less than 1% to 15%
of the contract amount. The initial margin is set by the exchange on which the
contract is traded and may, from time to time, be modified. In addition,
brokers may establish margin deposit requirements in excess of those required
by the exchange. The margin deposits made are marked to market daily and a fund
may be required to make subsequent deposits of cash, US Government securities
II-45
or other liquid assets, called "variation margin" or "maintenance margin,"
which reflects the price fluctuations of the futures contract. The purchase of
an option on a futures contract involves payment of a premium for the option
without any further obligation on the part of a fund. The sale of an option on
a futures contract involves receipt of a premium for the option and the
obligation to deliver (by physical or cash settlement) the underlying futures
contract. If a fund exercises an option on a futures contract it will be
obligated to post initial margin (and potential subsequent variation margin)
for the resulting futures position just as it would for any position.
There are several risks associated with futures contracts and options on
futures contracts. The prices of financial instruments or commodities subject
to futures contracts (and thereby the futures contract prices) may correlate
imperfectly with the behavior of the cash price of a fund's securities or other
assets (and the currencies in which they are denominated). Also, prices of
futures contracts may not move in tandem with the changes in prevailing
interest rates, market movements and/or currency exchange rates against which a
fund seeks a hedge. Additionally, there is no assurance that a liquid secondary
market will exist for futures contracts and related options in which a fund may
invest. In the event a liquid market does not exist, it may not be possible to
close out a futures position and, in the event of adverse price movements, a
fund would continue to be required to make daily payments of variation margin.
The absence of a liquid market in futures contracts might cause a fund to make
or take delivery of the instruments or commodities underlying futures contracts
at a time when it may be disadvantageous to do so. The inability to close out
positions and futures positions could also have an adverse impact on a fund's
ability to effectively hedge its positions.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the relatively low margin deposits required, and the
extremely high degree of leverage involved in futures pricing. As a result, a
relatively small price movement in a futures contract may result in immediate
and substantial loss (as well as gain) to the investor. Thus, a purchase or
sale of a futures contract may result in losses in excess of the amount
invested in the contract.
Futures contracts and options thereon which are purchased or sold on non-US
commodities exchanges may have greater price volatility than their US
counterparts. Furthermore, non-US commodities exchanges may be less regulated
and under less governmental scrutiny than US exchanges. Brokerage commissions,
clearing costs and other transaction costs may be higher on non-US exchanges.
In the event of the bankruptcy of a broker through which a fund engages in
transactions in futures or options thereon, a fund could experience delays
and/or losses in liquidating open positions purchased or sold through the
broker and/or incur a loss on all or part of its margin deposits with the
broker.
Currency Transactions. A fund may engage in currency transactions for any
purpose consistent with its investment strategy, policies and restrictions,
including, without limitation, for hedging purposes or to seek to enhance
returns. Certain currency transactions may expose a fund to the effects of
leverage. Currency transactions include forward currency contracts, exchange
listed currency futures, exchange listed and OTC options on currencies, and
currency swaps. A forward currency contract involves a privately negotiated
obligation to purchase or sell (with delivery generally required) a specific
currency at a future date, which may be any fixed number of days from the date
of the contract agreed upon by the parties, at a price set at the time of the
contract. Forward contracts are generally traded in an interbank market
directly between currency traders (usually large commercial banks) and their
customers. The parties to a forward contract may agree to offset or terminate
the contract before its maturity, or may hold the contract to maturity and
complete the contemplated currency exchange. A currency swap is an agreement to
exchange cash flows based on the notional difference among two or more
currencies and operates similarly to an interest rate swap, which is described
below.
A fund may engage in currency derivative transactions to seek to enhance
returns by taking a net long or net short position in one or more currencies,
in which case the fund may have currency exposure that is different (in some
cases, significantly different) from the currency exposure of its other
portfolio investments or the currency exposure of its performance index. These
overweight or underweight currency positions may increase the fund's exposure
to the effects of leverage, which may cause the fund to be more volatile. A
fund may realize a loss on a currency derivative in an amount that exceeds the
capital invested in such derivative, regardless of whether the fund entered
into the transaction to enhance returns or for hedging purposes.
II-46
"Transaction hedging" is entering into a currency transaction with respect to
specific assets or liabilities of a fund, which will generally arise in
connection with the purchase or sale of its portfolio securities or the receipt
of income therefrom. Entering into a forward contract for the purchase or sale
of an amount of foreign currency involved in an underlying security transaction
may "lock in" the US dollar price of the security. Forward contracts may also
be used in anticipation of future purchases and sales of securities, even if
specific securities have not yet been selected. "Position hedging" is entering
into a currency transaction with respect to portfolio security positions
denominated or generally quoted in that currency. Position hedging may protect
against a decline in the value of existing investments denominated in the
foreign currency. While such a transaction would generally offset both positive
and negative currency fluctuations, such currency transactions would not offset
changes in security values caused by other factors.
A fund may also "cross-hedge" currencies by entering into transactions to
purchase or sell one or more currencies that are expected to decline in value
relative to other currencies to which a fund has or to which a fund expects to
have portfolio exposure. This type of investment technique will generally
reduce or eliminate exposure to the currency that is sold, and increase the
exposure to the currency that is purchased. As a result, a fund will assume the
risk of fluctuations in the value of the currency purchased at the same time
that it is protected against losses from a decline in the hedged currency.
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, a fund may also engage in "proxy
hedging." Proxy hedging is often used when the currency to which a fund is
exposed is difficult to hedge or to hedge against the dollar. Proxy hedging
entails entering into a commitment or option to sell a currency whose changes
in value are generally considered to be correlated to a currency or currencies
in which some or all of a fund's securities are or are expected to be
denominated. Proxy hedges may result in losses if the currency used to hedge
does not perform similarly to the currency in which the hedged securities are
denominated.
Currency hedging involves some of the same risks and considerations as other
transactions with similar instruments. Currency transactions can result in
losses to a fund if the currency being hedged fluctuates in value to a degree
or in a direction that is not anticipated. Further, there is the risk that the
perceived correlation between various currencies may not be present or may not
be present during the particular time that a fund is engaging in proxy hedging.
Currency transactions are subject to additional special risks that may not
apply to other portfolio transactions. Because currency control is of great
importance to the issuing governments and influences economic planning and
policy, purchases and sales of currency and related instruments can be
negatively affected by government exchange controls, blockages, and
manipulations or exchange restrictions imposed by governments. These can result
in losses to a fund if it is unable to deliver or receive currency or funds in
settlement of obligations and could also cause hedges it has entered into to be
rendered useless, resulting in full currency exposure as well as incurring
transaction costs. Currency exchange rates, bid/ask spreads and liquidity may
fluctuate based on factors that may, or may not be, related to that country's
economy.
Swap Agreements and Options on Swap Agreements. A fund may engage in swap
transactions, including, but not limited to, swap agreements on interest rates,
currencies, indices, credit and event linked swaps, total return and other
swaps and related caps, floors and collars. Swap agreements are two party
contracts 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 a predetermined financial instrument or
instruments, which may be adjusted for an interest factor. The gross return to
be exchanged or "swapped" between the parties is generally calculated with
respect to a "notional amount" which is generally equal to the return on or
increase in value of a particular dollar amount invested at a particular
interest rate in such financial instrument or instruments.
"Interest rate swaps" involve the exchange by a fund 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). A "currency swap" is an agreement to exchange cash flows
on a notional amount of two or more currencies based on the relative value
differential among them. An "index swap" is an agreement to swap cash flows on
a notional amount based on changes in the values of the reference indices. The
purchase of a cap entitles the purchaser to receive payments on a notional
principal amount from the party selling such cap to the extent that a specified
index exceeds a predetermined interest rate or amount. The purchase of a floor
entitles the purchaser to receive payments
II-47
on a notional principal amount from the party selling such floor to the extent
that a specified index falls below a predetermined interest rate or amount. A
collar is a combination of a cap and a floor that preserves a certain return
within a predetermined range of interest rates or values.
A "credit default swap" is a contract between a buyer and a seller of
protection against a pre-defined credit event. The buyer of protection pays the
seller a fixed regular fee provided that no event of default on an underlying
reference obligation has occurred. If an event of default occurs, the seller
must pay the buyer the full notional value, or "par value," of the reference
obligation in exchange for the reference obligation. Credit default swaps are
used as a means of "buying" credit protection, i.e., attempting to mitigate the
risk of default or credit quality deterioration in some portion of a fund's
holdings, or "selling" credit protection, i.e., attempting to gain exposure to
an underlying issuer's credit quality characteristics without directly
investing in that issuer. When a fund is a seller of credit protection, it
effectively adds leverage to its portfolio because, in addition to its net
assets, a fund would be subject to investment exposure on the notional amount
of the swap. A fund will only sell credit protection with respect to securities
in which it would be authorized to invest directly.
If a fund is a buyer of a credit default swap and no event of default occurs, a
fund will lose its investment and recover nothing. However, if a fund is a
buyer and an event of default occurs, a fund will receive the full notional
value of the reference obligation that may have little or no value. As a
seller, a fund receives a fixed rate of income through the term of the contract
(typically between six months and three years), provided that there is no
default event. If an event of default occurs, the seller must pay the buyer the
full notional value of the reference obligation.
Credit default swaps involve greater risks than if a fund had invested in the
reference obligation directly. In addition to the risks applicable to
derivatives generally, credit default swaps 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 issuers of the underlying obligation (as
opposed to a credit downgrade or other indication of financial difficulty).
A fund may use credit default swaps to gain exposure to particular issuers or
particular markets through investments in portfolios of credit default swaps,
such as Dow Jones CDX.NA.HY certificates. By investing in certificates
representing interests in a basket of credit default swaps, a fund is taking
credit risk with respect to an entity or group of entities and providing credit
protection to the swap counterparties.
"Total return" swaps 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 specific 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 of 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
swaps may add leverage to a fund because, in addition to its net assets, a fund
would be subject to investment exposure on the notional amount of the swap.
Swaps typically involve a small investment of cash relative to the magnitude of
risks assumed. As a result, swaps can be highly volatile and may have a
considerable impact on a fund's performance. Depending on how they are used,
swaps may increase or decrease the overall volatility of a fund's investments
and its share price and yield. A fund will usually enter into swaps on a net
basis, i.e., the two payment streams are netted out in a cash settlement on the
payment date or dates specified in the instrument, with a fund receiving or
paying, as the case may be, only the net amount of the two payments.
A fund bears the risk of loss of the amount expected to be received under a
swap in the event of the default or bankruptcy of a Counterparty. In addition,
if the Counterparty's creditworthiness declines, the value of a swap will
likely decline, potentially resulting in losses for a fund. A fund may also
suffer losses if it is unable to terminate outstanding swaps (either by
assignment or other disposition) or reduce its exposure through offsetting
transactions (i.e., by entering into an offsetting swap with the same party or
similarly creditworthy party).
II-48
A fund may also enter into swap options. A swap option is a contract that gives
a counterparty the right (but not the obligation) in return for payment of a
premium, to enter into a new swap agreement or to shorten, extend, cancel or
otherwise modify an existing swap agreement, at some future time on specified
terms. Depending on the terms, a fund will generally incur greater risk when it
writes a swap option than when it purchases a swap option. When a fund
purchases a swap option, it risks losing the amount of the premium it has paid
should it decide to let the option expire.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)
and related regulatory developments have imposed several new requirements on
swap market participants, including registration and new business conduct
requirements on dealers that enter into swaps or non-deliverable forward
currency contracts with certain clients and the imposition of central clearing
for certain swap contracts. Central clearing is currently only required for
limited swap transactions, including some interest rate swaps and credit
default index swaps. Compliance with the central clearing requirements under
the Dodd-Frank Act is expected to occur over time as regulators, such as the
SEC and the CFTC, adopt new regulations requiring central clearing of the
majority of the swap market. In a cleared transaction, a fund will enter into
the transaction with a counterparty, and performance of the transaction will be
effected by a central clearinghouse. A clearing arrangement reduces a fund's
exposure to the credit risk of the counterparty, but subjects the fund to the
credit risk of the clearinghouse and a member of the clearinghouse through
which the fund holds its cleared position. A fund will be required to post
specific levels of margin which may be greater than the margin a fund would
have been required to post in the OTC market. In addition, uncleared OTC swap
transactions will be subject to regulatory collateral requirements that could
adversely affect a fund's ability to enter into swaps in the OTC market. These
regulations (or choice to no longer use a particular derivative instrument that
triggers additional regulations) could cause a fund to change the derivative
investments that it utilizes or to incur additional expenses.
Structured Notes. Structured notes are derivative debt securities, the interest
rate or principal of which is determined by reference to changes in value of a
specific security or securities, reference rate, or index. Indexed securities,
similar to structured notes, are typically, but not always, debt securities
whose value at maturity or coupon rate is determined by reference to other
securities. The performance of a structured note or indexed security is based
upon the performance of the underlying instrument.
The terms of a structured note may provide that, in certain circumstances, no
principal is due on maturity and, therefore, may result in loss of investment.
Structured notes may be indexed positively or negatively to the performance of
the underlying instrument such that the appreciation or deprecation of the
underlying instrument will have a similar effect to the value of the structured
note at maturity at the time of any coupon payment. In addition, changes in the
interest rate and value of the principal at maturity may be fixed at a specific
multiple of the change in value of the underlying instrument, making the value
of the structured note more volatile than the underlying instrument. In
addition, structured notes may be less liquid and more difficult to price
accurately than less complex securities or traditional debt securities.
Participatory Notes. Participatory notes or participation notes are issued by
banks or broker-dealers (often associated with non-US-based brokerage firms)
and are designed to replicate the performance of certain securities or markets.
Typically, purchasers of participatory notes are entitled to a return measured
by the change in value of an identified underlying security or basket of
securities. The price, performance, and liquidity of the participatory note are
all linked directly to the underlying security. The holder of a participatory
note may be entitled to receive any dividends paid in connection with the
underlying security, which may increase the return of a participatory note, but
typically does not receive voting or other rights as it would if it directly
owned the underlying security. A fund's ability to redeem or exercise a
participatory note generally is dependent on the liquidity in the local trading
market for the security underlying the note. Participatory notes are commonly
used when a direct investment in the underlying security is restricted due to
country-specific regulations.
Participatory notes are a type of equity-linked derivative, which are generally
traded over-the-counter and, therefore, will be subject to the same risks as
other over-the-counter derivatives. The performance results of participatory
notes will not replicate exactly the performance of the securities or markets
that the notes seek to replicate due to transaction costs and other expenses.
Investments in participatory notes involve the same risks associated with a
direct investment in the shares of the companies the notes seek to replicate.
Participatory notes constitute general unsecured contractual obligations of the
banks or broker-dealers that issue them. Consequently, a purchaser of a
participatory note is relying
II-49
on the creditworthiness of such banks or broker-dealers and has no rights under
the note against the issuer of the security underlying the note. In addition,
there is no guarantee that a liquid market for a participatory note will exist
or that the issuer of the note will be willing to repurchase the note when a
fund wishes to sell it. Because a participatory note is an obligation of the
issuer of the note, rather than a direct investment in shares of the underlying
security, a fund may suffer losses potentially equal to the full value of the
participatory note if the issuer of the note fails to perform its obligations.
In the case of Indian participatory notes, for example, Indian-based brokerages
buy Indian-based securities and then issue participatory notes to foreign
investors. In certain ways, such notes function similarly to ADRs except that
Indian-based brokerages, not US banks, are depositories for Indian-based
securities on behalf of foreign investors. Unlike ADRs, though, such notes are
subject to credit risk based on the uncertainty of the counterparty's (i.e.,
the Indian-based brokerage's) ability to meet its obligations.
Commodity-Linked Derivatives. A fund may invest in instruments with principal
and/or coupon payments linked to the value of commodities, commodity futures
contracts, or the performance of commodity indices such as "commodity-linked"
or "index-linked" notes. These instruments are sometimes referred to as
"structured notes" because the terms of the instrument may be structured by the
issuer of the note and the purchaser of the note, such as a fund.
The values of commodity-linked notes will rise and fall in response to changes
in the underlying commodity or related index or investment. These notes expose
a fund economically to movements in commodity prices, but a particular note has
many features of a debt obligation. These notes also are subject to credit and
interest rate risks that in general affect the value of debt securities.
Therefore, at the maturity of the note, a fund may receive more or less
principal than it originally invested. A fund might receive interest payments
on the note that are more or less than the stated coupon interest rate
payments.
Commodity-linked notes may involve leverage, meaning that the value of the
instrument will be calculated as a multiple of the upward or downward price
movement of the underlying commodity future or index. The prices of
commodity-linked instruments may move in different directions than investments
in traditional equity and debt securities in periods of rising inflation. Of
course, there can be no guarantee that a fund's commodity-linked investments
would not be correlated with traditional financial assets under any particular
market conditions.
Commodity-linked notes may be issued by US and foreign banks, brokerage firms,
insurance companies and other corporations. These notes, in addition to
fluctuating in response to changes in the underlying commodity assets, will be
subject to credit and interest rate risks that typically affect debt
securities.
Commodity-linked notes may be wholly principal protected, partially principal
protected or offer no principal protection. With a wholly principal protected
instrument, a fund will receive at maturity the greater of the par value of the
note or the increase in value of the underlying index. Partially protected
instruments may suffer some loss of principal up to a specified limit if the
underlying index declines in value during the term of the instrument. For
instruments without principal protection, there is a risk that the instrument
could lose all of its value if the index declines sufficiently. The Advisor's
decision on whether and to what extent to use principal protection depends in
part on the cost of the protection. In addition, the ability of a fund to take
advantage of any protection feature depends on the creditworthiness of the
issuer of the instrument.
Commodity-linked notes are generally hybrid instruments which are excluded from
regulation under the CEA and the rules thereunder. Additionally, from time to
time a fund may invest in other hybrid instruments that do not qualify for
exemption from regulation under the CEA.
In order to qualify for the special tax treatment accorded regulated investment
companies and their shareholders, a fund must, among other things, derive at
least 90% of its income from certain specified sources (qualifying income).
Income from certain commodity-linked derivatives does not constitute qualifying
income to a fund. The tax treatment of commodity-linked notes and certain other
derivative instruments in which a fund might invest is not certain, in
particular with respect to whether income and gains from such instruments
constitutes qualifying income. If the fund treats income from a particular
instrument as qualifying income and the income is later determined not to
constitute
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qualifying income, and, together with any other nonqualifying income, causes
the fund's nonqualifying income to exceed 10% of its gross income in any
taxable year, a fund will fail to qualify as a regulated investment company
unless it is eligible to and does pay a tax at the fund level. Certain funds
(including DWS Enhanced Commodity Strategy Fund, DWS Gold and Precious Metals
Fund, and DWS Global Inflation Fund) have obtained private letter rulings from
the IRS confirming that the income and gain earned through a wholly-owned
Subsidiary that invests in certain types of commodity-linked derivatives
constitute qualifying income under the Code. See "TAXES" in APPENDIX II-H of
this SAI.
Combined Transactions. A fund may enter into multiple transactions, including
multiple options transactions, multiple futures transactions, multiple currency
transactions (including forward currency contracts) and multiple interest rate
transactions and any combination of futures, options, currency and interest
rate transactions (component transactions), instead of a single derivative, as
part of a single or combined strategy when, in the opinion of the Advisor, it
is in the best interests of a fund to do so. A combined transaction will
usually contain elements of risk that are present in each of its component
transactions. Although combined transactions are normally entered into based on
the Advisor's judgment that the combined strategies will reduce risk or
otherwise more effectively achieve the desired portfolio management goal, it is
possible that the combination will instead increase such risks or hinder
achievement of the portfolio management objective.
DIRECT DEBT INSTRUMENTS. Direct debt instruments are interests in amounts owed
by a corporate, governmental or other borrower to lenders (direct loans), to
suppliers of goods or services (trade claims or other receivables) or to other
parties. When a fund participates in a direct loan it will be lending money
directly to an issuer. Direct loans generally do not have an underwriter or
agent bank, but instead, are negotiated between a company's management team and
a lender or group of lenders. Direct loans typically offer better security and
structural terms than other types of high yield securities. Direct debt
obligations are often the most senior obligations in an issuer's capital
structure or are well-collateralized so that overall risk is lessened. Trade
claims are unsecured rights of payment arising from obligations other than
borrowed funds. Trade claims include vendor claims and other receivables that
are adequately documented and available for purchase from high-yield
broker-dealers. Trade claims typically sell at a discount. In addition to the
risks otherwise associated with low-quality obligations, trade claims have
other risks, including the possibility that the amount of the claim may be
disputed by the obligor. Trade claims normally are be considered illiquid and
pricing can be volatile. Direct debt instruments involve a risk of loss in case
of default or insolvency of the borrower. A fund will rely primarily upon the
creditworthiness of the borrower and/or the collateral for payment of interest
and repayment of principal. The value of a fund's investments may be adversely
affected if scheduled interest or principal payments are not made. Because most
direct loans will be secured, there will be a smaller risk of loss with direct
loans than with an investment in unsecured high yield bonds or trade claims.
Investment in the indebtedness of borrowers whose creditworthiness is poor
involves substantially greater risks and may be highly speculative. Borrowers
that are in bankruptcy or restructuring may never pay off their indebtedness or
may pay only a small fraction of the amount owed. Investments in direct debt
instruments also involve interest rate risk and liquidity risk. However,
interest rate risk is lessened by the generally short-term nature of direct
debt instruments and their interest rate structure, which typically floats. To
the extent the direct debt instruments in which a fund invests are considered
illiquid, the lack of a liquid secondary market (1) will have an adverse impact
on the value of such instruments, (2) will have an adverse impact on a fund's
ability to dispose of them when necessary to meet a fund's liquidity needs or
in response to a specific economic event, such as a decline in creditworthiness
of the issuer, and (3) may make it more difficult for a fund to assign a value
to these instruments for purposes of valuing a fund's portfolio and calculating
its net asset value. In order to lessen liquidity risk, a fund anticipates
investing primarily in direct debt instruments that are quoted and traded in
the high yield market. Trade claims may also present a tax risk to a fund.
DOLLAR ROLL TRANSACTIONS. Dollar roll transactions consist of the sale by a
fund to a bank or broker-dealer (counterparty) of mortgage-backed securities
together with a commitment to purchase from the counterparty similar, but not
identical, securities at a future date, at the same price. The counterparty
receives all principal and interest payments, including prepayments, made on
the security while it is the holder. A fund receives a fee from the
counterparty as consideration for entering into the commitment to purchase.
Dollar rolls may be renewed over a period of several months with a different
purchase and repurchase price fixed and a cash settlement made at each renewal
without physical delivery of securities. Moreover, the transaction may be
preceded by a firm commitment agreement pursuant to which a fund agrees to buy
a security on a future date.
II-51
A dollar roll involves costs to a fund. For example, while a fund receives a
fee as consideration for agreeing to repurchase the security, a fund forgoes
the right to receive all principal and interest payments while the counterparty
holds the security. These payments to the counterparty may exceed the fee
received by a fund, in which case the use of this technique will result in a
lower return than would have been realized without the use of dollar rolls.
Further, although a fund can estimate the amount of expected principal
prepayment over the term of the dollar roll, a variation in the actual amount
of prepayment could increase or decrease the cost of the dollar roll. A
"covered roll" is a specific type of dollar roll for which there is an
offsetting cash position or a cash equivalent security position which matures
on or before the forward settlement date of the dollar roll transaction. A fund
may enter into both covered and uncovered rolls.
The entry into dollar rolls involves potential risks of loss that are different
from those related to the securities underlying the transactions. A fund will
be exposed to counterparty risk. For example, if the counterparty becomes
insolvent, a fund's right to purchase from the counterparty might be
restricted. Additionally, the value of such securities may change adversely
before a fund is able to purchase them. Similarly, a fund may be required to
purchase securities in connection with a dollar roll at a higher price than may
otherwise be available on the open market. Since, as noted above, the
counterparty is required to deliver a similar, but not identical security to a
fund, the security that a fund is required to buy under the dollar roll may be
worth less than the identical security. Finally, there can be no assurance that
a fund's use of the cash that it receives from a dollar roll will provide a
return that exceeds transaction costs associated with the dollar roll.
EURODOLLAR OBLIGATIONS. Eurodollar bank obligations are US dollar-denominated
certificates of deposit and time deposits issued outside the US capital markets
by foreign branches of US banks and US branches of foreign banks. Eurodollar
obligations are subject to the same risks that pertain to domestic issues,
notably credit risk, market risk and liquidity risk. Additionally, Eurodollar
obligations are subject to certain sovereign risks. One such risk is the
possibility that a sovereign country might prevent capital, in the form of
dollars, from flowing across its borders. Other risks include: adverse
political and economic developments; the extent and quality of government
regulation of financial markets and institutions; the imposition of foreign
withholding taxes, and the expropriation or nationalization of foreign issues.
FIXED INCOME SECURITIES. Fixed income securities, including corporate debt
obligations, generally expose a fund to the following types of risk: (1)
interest rate risk (the potential for fluctuations in bond prices due to
changing interest rates); (2) income risk (the potential for a decline in a
fund's income due to falling market interest rates); (3) credit risk (the
possibility that a bond issuer will fail to make timely payments of either
interest or principal to a fund); (4) prepayment risk or call risk (the
likelihood that, during periods of falling interest rates, securities with high
stated interest rates will be prepaid, or "called" prior to maturity, requiring
a fund to invest the proceeds at generally lower interest rates); and (5)
extension risk (the likelihood that as interest rates increase, slower than
expected principal payments may extend the average life of fixed income
securities, which will have the effect of locking in a below-market interest
rate, increasing the security's duration and reducing the value of the
security).
In periods of declining interest rates, the yield (income from a fixed income
security held by a fund over a stated period of time) of a fixed income
security may tend to be higher than prevailing market rates, and in periods of
rising interest rates, the yield of a fixed income security may tend to be
lower than prevailing market rates. In addition, when interest rates are
falling, the inflow of net new money to a fund will likely be invested in
portfolio instruments producing lower yields than the balance of a fund's
portfolio, thereby reducing the yield of a fund. In periods of rising interest
rates, the opposite can be true. The net asset value of a fund can generally be
expected to change as general levels of interest rates fluctuate. The value of
fixed income securities in a fund's portfolio generally varies inversely with
changes in interest rates. Prices of fixed income securities with longer
effective maturities are more sensitive to interest rate changes than those
with shorter effective maturities.
Corporate debt obligations generally offer less current yield than securities
of lower quality, but lower-quality securities generally have less liquidity,
greater credit and market risk, and as a result, more price volatility.
FOREIGN CURRENCIES. Because investments in foreign securities usually will
involve currencies of foreign countries, and because a fund may hold foreign
currencies and forward contracts, futures contracts and options on foreign
currencies and foreign currency futures contracts, the value of the assets of a
fund as measured in US dollars may be affected
II-52
favorably or unfavorably by changes in foreign currency exchange rates and
exchange control regulations, and a fund may incur costs and experience
conversion difficulties and uncertainties in connection with conversions
between various currencies. Fluctuations in exchange rates may also affect the
earning power and asset value of the foreign entity issuing the security.
The strength or weakness of the US dollar against these currencies is
responsible for part of a fund's investment performance. If the dollar falls in
value relative to the Japanese yen, for example, the dollar value of a Japanese
stock held in the portfolio will rise even though the price of the stock
remains unchanged. Conversely, if the dollar rises in value relative to the
yen, the dollar value of the Japanese stock will fall. Many foreign currencies
have experienced significant devaluation relative to the dollar.
Although a fund values its assets daily in terms of US dollars, it may not
convert its holdings of foreign currencies into US dollars on a daily basis.
Investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they realize a profit
based on the difference (the spread) between the prices at which they are
buying and selling various currencies. Thus, a dealer may offer to sell a
foreign currency to a fund at one rate, while offering a lesser rate of
exchange should a fund desire to resell that currency to the dealer. A fund
will conduct its foreign currency exchange transactions either on a spot (i.e.,
cash) basis at the spot rate prevailing in the foreign currency exchange
market, or through entering into options or forward or futures contracts to
purchase or sell foreign currencies.
FOREIGN INVESTMENT. Foreign securities are normally denominated and traded in
foreign currencies. As a result, the value of a fund's foreign investments and
the value of its shares may be affected favorably or unfavorably by changes in
currency exchange rates relative to the US dollar. There may be less
information publicly available about a foreign issuer than about a US issuer,
and foreign issuers may not be subject to accounting, auditing and financial
reporting standards and practices comparable to those in the US. The securities
of some foreign issuers are less liquid and at times more volatile than
securities of comparable US issuers. Foreign brokerage commissions and other
fees are also generally higher than in the US. Foreign settlement procedures
and trade regulations may involve certain risks (such as delay in payment or
delivery of securities or in the recovery of a fund's assets held abroad) and
expenses not present in the settlement of investments in US markets. Payment
for securities without delivery may be required in certain foreign markets.
In addition, foreign securities may be subject to the risk of nationalization
or expropriation of assets, imposition of currency exchange controls or
restrictions on the repatriation of foreign currency, confiscatory taxation,
political or financial instability and diplomatic developments which could
affect the value of a fund's investments in certain foreign countries.
Governments of many countries have exercised and continue to exercise
substantial influence over many aspects of the private sector through the
ownership or control of many companies, including some of the largest in these
countries. As a result, government actions in the future could have a
significant effect on economic conditions which may adversely affect prices of
certain portfolio securities. There is also generally less government
supervision and regulation of stock exchanges, brokers, and listed companies
than in the US. Dividends or interest on, or proceeds from the sale of, foreign
securities may be subject to foreign withholding taxes, and special US tax
considerations may apply (see Taxes). Moreover, foreign economies may differ
favorably or unfavorably from the US economy in such respects as growth of
gross national product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payments position.
European financial markets have recently experienced volatility and have been
adversely affected by concerns about economic downturns, credit rating
downgrades, rising government debt level and possible default on or
restructuring of government debt in several European countries. Most countries
in Western Europe are members of the European Union (EU), which faces major
issues involving its membership, structure, procedures and policies. European
countries that are members of the Economic and Monetary Union of the European
Union ((EMU), comprised of the EU members that have adopted the Euro currency)
are subject to restrictions on inflation rates, interest rates, deficits, and
debt levels, as well as fiscal and monetary controls. European countries are
significantly affected by fiscal and monetary controls implemented by the EMU,
and it is possible that the timing and substance of these controls may not
address the needs of all EMU member countries. In addition, the fiscal policies
of a single member state can impact and pose economic risks to the EU as a
whole. Investing in Euro-denominated securities also risks exposure to a
currency that
II-53
may not fully reflect the strengths and weaknesses of the disparate economies
that comprise Europe. There is continued concern over member state-level
support for the Euro, which could lead to certain countries leaving the EMU,
the implementation of currency controls, or potentially the dissolution of the
Euro. The dissolution of the Euro would have significant negative effects on
European financial markets.
Additionally, the manner in which the EU responded to the global recession and
sovereign debt issues raised questions about its ability to react quickly to
rising borrowing costs and a potential default by Greece and other countries on
their sovereign debt and also revealed a lack of cohesion in dealing with the
fiscal problems of member states. Many European countries continue to suffer
from high unemployment rates. Since 2010, several countries, including Greece,
Italy, Spain, Ireland and Portugal, agreed to multi-year bailout loans from the
European Central Bank, International Monetary Fund, and other institutions. To
address budget deficits and public debt concerns, a number of European
countries have imposed strict austerity measures and comprehensive financial
and labor market reforms. In addition, social unrest, including protests
against the newly-imposed austerity measures and domestic terrorism, could
decrease tourism, lower consumer confidence, and otherwise impede financial
recovery in Europe.
Legal remedies available to investors in certain foreign countries may be more
limited than those available with respect to investments in the US or in other
foreign countries. The laws of some foreign countries may limit a fund's
ability to invest in securities of certain issuers organized under the laws of
those foreign countries.
Many foreign countries are heavily dependent upon exports, particularly to
developed countries, and, accordingly, have been and may continue to be
adversely affected by trade barriers, managed adjustments in relative currency
values, and other protectionist measures imposed or negotiated by the US and
other countries with which they trade. These economies also have been and may
continue to be negatively impacted by economic conditions in the US and other
trading partners, which can lower the demand for goods produced in those
countries.
The risks described above, including the risks of nationalization or
expropriation of assets, typically are increased in connection with investments
in "emerging markets." For example, political and economic structures in these
countries may be in their infancy and developing rapidly, and such countries
may lack the social, political and economic stability characteristic of more
developed countries (including amplified risk of war and terrorism). Certain of
these countries have in the past failed to recognize private property rights
and have at times nationalized and expropriated the assets of private
companies. Investments in emerging markets may be considered speculative.
The currencies of certain emerging market countries have experienced
devaluations relative to the US dollar, and future devaluations may adversely
affect the value of assets denominated in such currencies. In addition,
currency hedging techniques may be unavailable in certain emerging market
countries. Many emerging market countries have experienced substantial, and in
some periods extremely high, rates of inflation or deflation for many years,
and future inflation may adversely affect the economies and securities markets
of such countries.
In addition, unanticipated political or social developments may affect the
value of investments in emerging markets and the availability of additional
investments in these markets. Any change in the leadership or politics of
emerging market countries, or the countries that exercise a significant
influence over those countries, may halt the expansion of or reverse the
liberalization of foreign investment policies now occurring and adversely
affect existing investment opportunities. The small size, limited trading
volume and relative inexperience of the securities markets in these countries
may make investments in securities traded in emerging markets illiquid and more
volatile than investments in securities traded in more developed countries. For
example, limited market size may cause prices to be unduly influenced by
traders who control large positions. In addition, a fund may be required to
establish special custodial or other arrangements before making investments in
securities traded in emerging markets. There may be little financial or
accounting information available with respect to issuers of emerging market
securities, and it may be difficult as a result to assess the value of
prospects of an investment in such securities.
The risk also exists that an emergency situation may arise in one or more
emerging markets as a result of which trading of securities may cease or may be
substantially curtailed and prices for a fund's securities in such markets may
not be readily available. A fund may suspend redemption of its shares for any
period during which an emergency exists.
II-54
Certain of the foregoing risks may also apply to some extent to securities of
US issuers that are denominated in foreign currencies or that are traded in
foreign markets, or securities of US issuers having significant foreign
operations.
Supranational Entities. Supranational entities are international organizations
designated or supported by governmental entities to promote economic
reconstruction or development and international banking institutions and
related government agencies. Examples include the International Bank for
Reconstruction and Development (the World Bank), The Asian Development Bank and
the InterAmerican Development Bank. Obligations of supranational entities are
backed by the guarantee of one or more foreign governmental parties which
sponsor the entity.
FUNDING AGREEMENTS. Funding agreements are contracts issued by insurance
companies that provide investors the right to receive a variable rate of
interest and the full return of principal at maturity. Funding agreements also
include a put option that allows a fund to terminate the agreement at a
specified time prior to maturity. Funding agreements generally offer a higher
yield than other variable securities with similar credit ratings. The primary
risk of a funding agreement is the credit quality of the insurance company that
issues it.
GOLD OR PRECIOUS METALS. Gold and other precious metals held by or on behalf of
a fund may be held on either an allocated or an unallocated basis inside or
outside the US. Placing gold or precious metals in an allocated custody account
gives a fund a direct interest in specified gold bars or precious metals,
whereas an unallocated deposit does not and instead gives a fund a right only
to compel the counterparty to deliver a specific amount of gold or precious
metals, as applicable. Consequently, a fund could experience a loss if the
counterparty to an unallocated depository arrangement becomes bankrupt or fails
to deliver the gold or precious metals as requested. An allocated gold or
precious metals custody account also involves the risk that the gold or
precious metals will be stolen or damaged while in transit. Both allocated and
unallocated arrangements require a fund as seller to deliver, either by book
entry or physically, the gold or precious metals sold in advance of the receipt
of payment. These custody risks would apply to a wholly-owned subsidiary of a
fund to the extent the subsidiary holds gold or precious metals.
In addition, in order to qualify for the special tax treatment accorded
regulated investment companies and their shareholders, a fund must, among other
things, derive at least 90% of its income from certain specified sources
(qualifying income). Capital gains from the sale of gold or other precious
metals will not constitute qualifying income. As a result, a fund may not be
able to sell or otherwise dispose of all or a portion of its gold or precious
metal holdings without realizing significant adverse tax consequences,
including paying a tax at the fund level, or the failure to qualify as a
regulated investment company under Subchapter M of the Code. Rather than incur
those tax consequences, a fund may choose to hold some amount of gold or
precious metal that it would otherwise sell.
HIGH YIELD FIXED INCOME SECURITIES - JUNK BONDS. A fund may purchase debt
securities which are rated below investment-grade (junk bonds), that is, rated
Ba and below by Moody's or BB and below by S&P and unrated securities judged to
be of equivalent quality as determined by the Advisor. These securities usually
entail greater risk (including the possibility of default or bankruptcy of the
issuers of such securities), generally involve greater volatility of price and
risk to principal and income, and may be less liquid, than securities in the
higher rating categories. The lower the ratings of such debt securities, the
more their risks render them like equity securities. Securities rated D may be
in default with respect to payment of principal or interest. Investments in
high yield securities are described as "speculative" by ratings agencies.
Securities ranked in the lowest investment grade category may also be
considered speculative by certain ratings agencies. See "Ratings of
Investments" in this SAI for a more complete description of the ratings
assigned by ratings organizations and their respective characteristics.
Issuers of such high yielding securities often are highly leveraged and may not
have available to them more traditional methods of financing. Therefore, the
risk associated with acquiring the securities of such issuers generally is
greater than is the case with higher rated securities. For example, during an
economic downturn or a sustained period of rising interest rates, highly
leveraged issuers of high yield securities may experience financial stress.
During such periods, such issuers may not have sufficient revenues to meet
their interest payment obligations. The issuer's ability to service its debt
obligations may also be adversely affected by specific corporate developments,
or the issuer's inability to meet specific projected business forecasts, or the
unavailability of additional financing. The risk of loss from default by the
issuer is significantly greater for the holders of high yield securities
because such securities are generally unsecured and are often subordinated to
other creditors of the issuer. Prices and yields of high yield securities
II-55
will fluctuate over time and, during periods of economic uncertainty,
volatility of high yield securities may adversely affect a fund's net asset
value. In addition, investments in high yield zero coupon or pay-in-kind bonds,
rather than income-bearing high yield securities, may be more speculative and
may be subject to greater fluctuations in value due to changes in interest
rates.
A fund may have difficulty disposing of certain high yield securities because
they may have a thin trading market. Because not all dealers maintain markets
in all high yield securities, a fund anticipates that such securities could be
sold only to a limited number of dealers or institutional investors. The lack
of a liquid secondary market may have an adverse effect on the market price and
a fund's ability to dispose of particular issues and may also make it more
difficult for a fund to obtain accurate market quotations for purposes of
valuing a fund's assets. Market quotations generally are available on many high
yield issues only from a limited number of dealers and may not necessarily
represent firm bids of such dealers or prices for actual sales. Adverse
publicity and investor perceptions may decrease the values and liquidity of
high yield securities. These securities may also involve special registration
responsibilities, liabilities and costs, and liquidity and valuation
difficulties. Even though such securities do not pay current interest in cash,
a fund nonetheless is required to accrue interest income on these investments
and to distribute the interest income on a current basis. Thus, a fund could be
required at times to liquidate other investments in order to satisfy its
distribution requirements.
Credit quality in the high-yield securities market can change suddenly and
unexpectedly, and even recently issued credit ratings may not fully reflect the
actual risks posed by a particular high-yield security.
Prices for below investment-grade securities may be affected by legislative and
regulatory developments. Also, Congress has from time to time considered
legislation which would restrict or eliminate the corporate tax deduction for
interest payments on these securities and regulate corporate restructurings.
Such legislation may significantly depress the prices of outstanding securities
of this type.
ILLIQUID SECURITIES. Historically, illiquid securities have included securities
subject to contractual or legal restrictions on resale because they have not
been registered under the 1933 Act, securities which are otherwise not readily
marketable and repurchase agreements having a maturity of longer than seven
days. Securities which have not been registered under the 1933 Act are referred
to as private placements or restricted securities and are purchased directly
from the issuer or in the secondary market. Non-publicly traded securities
(including Rule 144A Securities) may involve a high degree of business and
financial risk and may result in substantial losses. These securities may be
less liquid than publicly traded securities, and it may take longer to
liquidate these positions than would be the case for publicly traded
securities. Companies whose securities are not publicly traded may not be
subject to the disclosure and other investor protection requirements applicable
to companies whose securities are publicly traded. Certain securities may be
deemed to be illiquid as a result of the Advisor's receipt from time to time of
material, non-public information about an issuer, which may limit the Advisor's
ability to trade such securities for the account of any of its clients,
including a fund. In some instances, these trading restrictions could continue
in effect for a substantial period of time. Limitations on resale may have an
adverse effect on the marketability of portfolio securities and a mutual fund
might be unable to dispose of restricted or other illiquid securities promptly
or at reasonable prices and might thereby experience difficulty satisfying
redemptions within seven days. An investment in illiquid securities is subject
to the risk that should a fund desire to sell any of these securities when a
ready buyer is not available at a price that is deemed to be representative of
their value, the value of a fund's net assets could be adversely affected.
Mutual funds do not typically hold a significant amount of these restricted or
other illiquid securities because of the potential for delays on resale and
uncertainty in valuation. A mutual fund might also have to register such
restricted securities in order to dispose of them, resulting in additional
expense and delay. A fund selling its securities in a registered offering may
be deemed to be an "underwriter" for purposes of Section 11 of the 1933 Act. In
such event, a fund may be liable to purchasers of the securities under Section
11 if the registration statement prepared by the issuer, or the prospectus
forming a part of it, is materially inaccurate or misleading, although a fund
may have a due diligence defense. Adverse market conditions could impede such a
public offering of securities.
II-56
A large institutional market has developed for certain securities that are not
registered under the 1933 Act, including repurchase agreements, commercial
paper, non-US securities, municipal securities and corporate bonds and notes.
Institutional investors depend on an efficient institutional market in which
the unregistered security can be readily resold or on an issuer's ability to
honor a demand for repayment. The fact that there are contractual or legal
restrictions on resale of such investments to the general public or to certain
institutions may not be indicative of their liquidity.
The SEC has adopted Rule 144A, which allows a broader institutional trading
market for securities otherwise subject to restriction on their resale to the
general public. Rule 144A establishes a "safe harbor" from the registration
requirements of the 1933 Act for resales of certain securities to qualified
institutional buyers.
An investment in Rule 144A Securities will be considered illiquid and therefore
subject to a fund's limit on the purchase of illiquid securities unless a
fund's Board or its delegates determines that the Rule 144A Securities are
liquid. In reaching liquidity decisions, a fund's Board and its delegates may
consider, inter alia, the following factors: (i) the unregistered nature of the
security; (ii) the frequency of trades and quotes for the security; (iii) the
number of dealers wishing to purchase or sell the security and the number of
other potential purchasers; (iv) dealer undertakings to make a market in the
security; and (v) the nature of the security and the nature of the marketplace
trades (e.g., the time needed to dispose of the security, the method of
soliciting offers and the mechanics of the transfer).
Investing in Rule 144A Securities could have the effect of increasing the level
of illiquidity in a fund to the extent that qualified institutional buyers are
unavailable or uninterested in purchasing such securities from a fund. A fund's
Board has adopted guidelines and delegated to the Advisor the daily function of
determining and monitoring the liquidity of Rule 144A Securities, although a
fund's Board will retain ultimate responsibility for any liquidity
determinations.
IMPACT OF LARGE REDEMPTIONS AND PURCHASES OF FUND SHARES. From time to time,
shareholders of a fund (which may include affiliated and/or non-affiliated
registered investment companies that invest in a fund) may make relatively
large redemptions or purchases of fund shares. These transactions may cause a
fund to have to sell securities or invest additional cash, as the case may be.
While it is impossible to predict the overall impact of these transactions over
time, there could be adverse effects on a fund's performance to the extent that
a fund may be required to sell securities or invest cash at times when it would
not otherwise do so. These transactions could also accelerate the realization
of taxable income if sales of securities resulted in capital gains or other
income and could also increase transaction costs, which may impact a fund's
expense ratio and adversely affect a fund's performance.
INDEXED SECURITIES. A fund may invest in indexed securities, the value of which
is linked to currencies, interest rates, commodities, indices or other
financial indicators (reference instruments). Most indexed securities have
maturities of three years or less.
Indexed securities differ from other types of debt securities in which a fund
may invest in several respects. First, the interest rate or, unlike other debt
securities, the principal amount payable at maturity of an indexed security may
vary based on changes in one or more specified reference instruments, such as
an interest rate compared with a fixed interest rate or the currency exchange
rates between two currencies (neither of which need be the currency in which
the instrument is denominated). The reference instrument need not be related to
the terms of the indexed security. For example, the principal amount of a US
dollar denominated indexed security may vary based on the exchange rate of two
foreign currencies. An indexed security may be positively or negatively
indexed; that is, its value may increase or decrease if the value of the
reference instrument increases. Further, the change in the principal amount
payable or the interest rate of an indexed security may be a multiple of the
percentage change (positive or negative) in the value of the underlying
reference instrument(s).
Investment in indexed securities involves certain risks. In addition to the
credit risk of the security's issuer and the normal risks of price changes in
response to changes in interest rates, the principal amount of indexed
securities may decrease as a result of changes in the value of reference
instruments. Further, in the case of certain indexed securities in which the
interest rate is linked to a reference instrument, the interest rate may be
reduced to zero, and any further declines in the value of the security may then
reduce the principal amount payable on maturity. Also, indexed securities may
be more volatile than the reference instruments underlying the indexed
securities. Finally, a fund's investments
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in certain indexed securities may generate taxable income in excess of the
interest paid on the securities to a fund, which may cause a fund to sell
investments to obtain cash to make income distributions (including at a time
when it may not be advantageous to do so).
INDUSTRIAL DEVELOPMENT AND POLLUTION CONTROL BONDS. Industrial Development and
Pollution Control Bonds (which are types of private activity bonds), although
nominally issued by municipal authorities, are generally not secured by the
taxing power of the municipality, but are secured by the revenues of the
authority derived from payments by the industrial user. Consequently, the
credit quality of these securities depends upon the ability of the user of the
facilities financed by the bonds and any guarantor to meet its financial
obligations. Under federal tax legislation, certain types of Industrial
Development Bonds and Pollution Control Bonds may no longer be issued on a
tax-exempt basis, although previously issued bonds of these types and certain
refundings of such bonds are not affected.
INFLATION-INDEXED BONDS. A fund may purchase inflation-indexed securities
issued by the US Treasury, US government agencies and instrumentalities other
than the US Treasury, and entities other than the US Treasury or US government
agencies and instrumentalities.
Inflation-indexed bonds are fixed income securities or other instruments whose
principal value is periodically adjusted according to the rate of inflation.
Two structures are common. The US Treasury and some other issuers use a
structure that accrues inflation on either a current or lagged basis into the
principal value of the bond. Most other issuers pay out the Consumer Price
Index accruals as part of a semi-annual coupon.
Inflation-indexed securities issued by the US Treasury have maturities of
approximately five, ten or twenty years, although it is possible that
securities with other maturities will be issued in the future. The US Treasury
securities pay interest on a semi-annual basis, equal to a fixed percentage of
the inflation-adjusted principal amount. For example, if a fund purchased an
inflation-indexed bond with a par value of $1,000 and a 3% real rate of return
coupon (payable 1.5% semi-annually), and the rate of inflation over the first
six months was 1%, the mid-year par value of the bond would be $1,010 and the
first semi-annual interest payment would be $15.15 ($1,010 times 1.5%). If the
rate of inflation during the second half of the year resulted in the whole
year's inflation equaling 3%, the end of year par value of the bond would be
$1,030 and the second semi-annual interest payment would be $15.45 ($1,030
times 1.5%).
If the periodic adjustment rate measuring inflation falls, the principal value
of inflation-indexed bonds will be adjusted downward, and, consequently, the
interest payable on these securities (calculated with respect to a smaller
principal amount) will be reduced. Repayment of the original bond principal on
maturity (as adjusted for inflation) is guaranteed in the case of US Treasury
inflation-indexed bonds, even during a period of deflation, although the
inflation-adjusted principal received could be less than the inflation-adjusted
principal that had accrued to the bond at the time of purchase. However, the
current market value of the bonds is not guaranteed and will fluctuate. A fund
may also invest in other inflation related bonds that may or may not provide a
similar guarantee. If a guarantee of principal is not provided, the adjusted
principal value of the bond repaid at maturity may be less than the original
principal. In addition, if a fund purchases inflation-indexed bonds offered by
foreign issuers, the rate of inflation measured by the foreign inflation index
may not be correlated to the rate of inflation in the US.
The value of inflation-indexed bonds is expected to change in response to
changes in real interest rates. Real interest rates, in turn, are tied to the
relationship between nominal interest rates and the rate of inflation.
Therefore, if the rate of inflation rises at a faster rate than nominal
interest rates, real interest rates might decline, leading to an increase in
value of inflation-indexed bonds. In contrast, if nominal interest rates
increased at a faster rate than inflation, real interest rates might rise,
leading to a decrease in value of inflation-indexed bonds. There can be no
assurance, however, that the value of inflation-indexed bonds will be directly
correlated to changes in interest rates. In the event of sustained deflation,
it is possible that the amount of semiannual interest payments, the
inflation-adjusted principal of the security and the value of the stripped
components, will decrease. If any of these possibilities are realized, a fund's
net asset value could be negatively affected.
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While these securities are expected to provide protection from long-term
inflationary trends, short-term increases in inflation may lead to a decline in
value. If interest rates rise due to reasons other than inflation (for example,
due to changes in currency exchange rates), investors in these securities may
not be protected to the extent that the increase is not reflected in the bond's
inflation measure.
The periodic adjustment of US inflation-indexed bonds is generally linked to
the Consumer Price Index for Urban Consumers (CPI-U), which is calculated
monthly by the US Bureau of Labor Statistics. The CPI-U is a measurement of
changes in the cost of living, made up of components such as housing, food,
transportation and energy. Inflation-indexed bonds issued by a foreign
government are generally adjusted to reflect a comparable inflation index
calculated by the applicable government. There can be no assurance that the
CPI-U or any foreign inflation index will accurately measure the real rate of
inflation in the prices of goods and services. Moreover, there can be no
assurance that the rate of inflation in a foreign country will be correlated to
the rate of inflation in the US. Finally, income distributions of a fund are
likely to fluctuate more than those of a conventional bond fund.
The taxation of inflation-indexed US Treasury securities is similar to the
taxation of conventional bonds. Both interest payments and the difference
between original principal and the inflation-adjusted principal will be treated
as interest income subject to taxation. Interest payments are taxable when
received or accrued. The inflation adjustment to the principal is subject to
tax in the year the adjustment is made, not at maturity of the security when
the cash from the repayment of principal is received. If an upward adjustment
has been made (which typically should happen), investors in non-tax-deferred
accounts will pay taxes on this amount currently. Decreases in the indexed
principal can be deducted only from current or previous interest payments
reported as income.
Inflation-indexed US Treasury securities therefore have a potential cash flow
mismatch to an investor, because investors must pay taxes on the
inflation-adjusted principal before the repayment of principal is received. It
is possible that, particularly for high income tax bracket investors,
inflation-indexed US Treasury securities would not generate enough income in a
given year to cover the tax liability they could create. This is similar to the
current tax treatment for zero-coupon bonds and other discount securities. If
inflation-indexed US Treasury securities are sold prior to maturity, capital
losses or gains are realized in the same manner as traditional bonds.
Inflation-indexed securities are designed to offer a return linked to
inflation, thereby protecting future purchasing power of the money invested in
them. However, inflation-indexed securities provide this protected return only
if held to maturity. In addition, inflation-indexed securities may not trade at
par value. Real interest rates (the market rate of interest less the
anticipated rate of inflation) change over time as a result of many factors,
such as what investors are demanding as a true value for money. When real rates
do change, inflation-indexed securities prices will be more sensitive to these
changes than conventional bonds, because these securities were sold originally
based upon a real interest rate that is no longer prevailing. Should market
expectations for real interest rates rise, the price of inflation-indexed
securities held by a fund may fall, resulting in a decrease in the share price
of a fund.
INTEREST RATE STRATEGIES. In addition to a fund's main investment strategy,
certain funds seek to enhance returns by employing a rules-based methodology to
identify interest rate trends across developed markets using derivatives
(contracts whose value are based on, for example, indices, currencies or
securities), in particular buying and selling interest rate futures contracts.
The success of the interest rate futures strategies depends, in part, on the
effectiveness and implementation of the Advisor's proprietary models. If the
Advisor's analysis proves to be incorrect, losses to a fund may be significant,
possibly exceeding the amounts invested in the interest rate futures contracts.
The risk of loss is heightened during periods of rapid increases in interest
rates.
INTERFUND BORROWING AND LENDING PROGRAM. The DWS funds have received exemptive
relief from the SEC, which permits the funds to participate in an interfund
lending program. The interfund lending program allows the participating funds
to borrow money from and loan money to each other for temporary or emergency
purposes. The program is subject to a number of conditions designed to ensure
fair and equitable treatment of all participating funds, including the
following: (1) no fund may borrow money through the program unless it receives
a more favorable interest rate than a rate approximating the lowest interest
rate at which bank loans would be available to any of the participating funds
under a loan agreement; and (2) no fund may lend money through the program
unless it receives a more favorable return than that available from an
investment in repurchase agreements and, to the extent applicable, money market
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cash sweep arrangements. In addition, a fund may participate in the program
only if and to the extent that such participation is consistent with a fund's
investment objectives and policies (for instance, money market funds would
normally participate only as lenders and tax exempt funds only as borrowers).
Interfund loans and borrowings have a maximum duration of seven days. Loans may
be called on one day's notice. A fund may have to borrow from a bank at a
higher interest rate if an interfund loan is called or not renewed. Any delay
in repayment to a lending fund could result in a lost investment opportunity or
additional costs. The program is subject to the oversight and periodic review
of the Board.
INVERSE FLOATERS. A fund may invest in inverse floaters. Inverse floaters are
debt instruments with a floating rate of interest that bears an inverse
relationship to changes in short-term market interest rates. Investments in
this type of security involve special risks as compared to investments in, for
example, a fixed rate municipal security. The debt instrument in which a fund
invests may be a tender option bond trust (the trust), which can be established
by a fund, a financial institution or a broker, consisting of underlying
municipal obligations with intermediate to long maturities and a fixed interest
rate. Other investors in the trust usually consist of money market fund
investors receiving weekly floating interest rate payments who have put options
with the financial institutions. A fund may enter into shortfall and
forbearance agreements by which a fund agrees to reimburse the trust, in
certain circumstances, for the difference between the liquidation value of the
fixed rate municipal security held by the trust and the liquidation value of
the floating rate notes. A fund could lose money and its NAV could decline as a
result of investments in inverse floaters if movements in interest rates are
incorrectly anticipated. Moreover, the markets for inverse floaters may be less
developed and may have less liquidity than the markets for more traditional
municipal securities, especially during periods of instability in the credit
markets. An inverse floater may exhibit greater price volatility than a
fixed-rate obligation of similar credit quality. When a fund holds inverse
floating rate securities, an increase in market interest rates will adversely
affect the income received from such securities and the net asset value of a
fund's shares.
INVESTMENT COMPANIES AND OTHER POOLED INVESTMENT VEHICLES. A fund may acquire
securities of other registered investment companies and other pooled investment
vehicles (collectively, investment funds) to the extent that such investments
are consistent with its investment objective, policies, strategies and
restrictions and the limitations of the 1940 Act. Investment funds may include
mutual funds, closed-end funds, exchange-traded funds (ETFs) and hedge funds
(including investment funds managed by the Advisor and its affiliates). A fund
will indirectly bear its proportionate share of any management fees and other
expenses paid by such other investment funds.
Because a fund may acquire securities of investment funds managed by the
Advisor or an affiliate of the Advisor, the Advisor may have a conflict of
interest in selecting investment funds. The Advisor considers such conflicts of
interest as part of its investment process and has established practices
designed to minimize such conflicts. The Advisor, any subadvisor and any
affiliates of the Advisor, as applicable, earn fees at varying rates for
providing services to underlying DWS investment funds. The Advisor and any
subadvisor may, therefore, have a conflict of interest in selecting underlying
DWS investment funds and in determining whether to invest in an unaffiliated
investment fund from which they will not receive any fees. However, the Advisor
and any subadvisor to a fund will select investments that it believes are
appropriate to meet the fund's investment objectives.
ETFs and closed-end funds trade on a securities exchange and their shares may
trade at a premium or discount to their net asset value. A fund will incur
brokerage costs when it buys and sells shares of ETFs and closed-end funds.
ETFs that seek to track the composition and performance of a specific index may
not replicate exactly the performance of their specified index because of
trading costs and operating expenses incurred by the ETF. At times, there may
not be an active trading market for shares of some ETFs and closed-end funds
and trading of ETF and closed-end fund shares may be halted or delisted by the
listing exchange.
To the extent consistent with its investment objective, policies, strategies
and restrictions, a fund may invest in commodity-related ETFs. Certain
commodity-related ETFs may not be registered as investment companies under the
1940 Act and shareholders of such commodity-related ETFs, including the
investing DWS fund, will not have the regulatory protections provided to
investors in registered investment companies. Commodity-related ETFs may invest
in commodities directly (such as purchasing gold) or they may seek to track a
commodities index by investing in commodity-linked derivative instruments.
Commodity-related ETFs are subject to the risks associated with the commodities
or commodity-linked derivative instruments in which they invest. A fund's
ability to invest in commodity-related ETFs may be limited by its intention to
qualify as a regulated investment company under the Internal Revenue Code. In
addition, under recent
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amendments to rules of the Commodity Futures Trading Commission (CFTC), a
fund's investment in commodity-related ETFs may subject the fund and/or the
Advisor to certain registration, disclosure and reporting requirements of the
CFTC. The Advisor will monitor a fund's use of commodity-related ETFs to
determine whether the fund and/or the Advisor will need to comply with CFTC
rules. Because the recent CFTC rules amendments have been challenged in a court
of law, the impact of the changes on the funds remains uncertain.
A fund may seek exposure to alternative asset classes or strategies through
investment in hedge funds. A fund may substitute derivative instruments,
including warrants and swaps, whose values are tied to the value of underlying
hedge funds in lieu of a direct investment in hedge funds. A derivative
instrument whose value is tied to one or more hedge funds or hedge fund indices
will be subject to the market and other risks associated with the underlying
assets held by the hedge fund. Hedge funds are not subject to the provisions of
the 1940 Act or the reporting requirements of the Securities Exchange Act of
1934, as amended, and their advisors may not be subject to the Investment
Advisers Act of 1940, as amended. Investments in hedge funds are illiquid and
may be less transparent than an investment in a registered investment company.
There are no market quotes for securities of hedge funds and hedge funds
generally value their interests no more frequently than monthly or quarterly,
in some cases. An investment in a derivative instrument based on a hedge fund
may be subject to some or all of the structural risks associated with a direct
investment in a hedge fund.
INVESTMENT-GRADE BONDS. A fund may purchase "investment-grade" bonds, which are
those rated Aaa, Aa, A or Baa by Moody's or AAA, AA, A or BBB by S&P or, if
unrated, judged to be of equivalent quality as determined by the Advisor.
Moody's considers bonds it rates Baa to have speculative elements as well as
investment-grade characteristics. To the extent that a fund invests in
higher-grade securities, a fund will not be able to avail itself of
opportunities for higher income which may be available at lower grades.
IPO RISK. Securities issued through an initial public offering (IPO) can
experience an immediate drop in value if the demand for the securities does not
continue to support the offering price. Information about the issuers of IPO
securities is also difficult to acquire since they are new to the market and
may not have lengthy operating histories. A fund may engage in short-term
trading in connection with its IPO investments, which could produce higher
trading costs and adverse tax consequences.
LENDING OF PORTFOLIO SECURITIES. To generate additional income, a fund may lend
a percentage of its investment securities to approved institutional borrowers
who need to borrow securities in order to complete certain transactions, such
as covering short sales, avoiding failures to deliver securities or completing
arbitrage operations, in exchange for collateral in the form of cash or US
government securities. By lending its investment securities, a fund attempts to
increase its net investment income through the receipt of interest on the loan.
Any gain or loss in the market price of the securities loaned that might occur
during the term of the loan would belong to a fund. A fund may lend its
investment securities so long as the terms, structure and the aggregate amount
of such loans are not inconsistent with the 1940 Act or the rules and
regulations or interpretations of the SEC thereunder, which currently require
that (a) the borrower pledge and maintain with a fund collateral consisting of
liquid, unencumbered assets having a value at all times not less than 100% of
the value of the securities loaned, (b) the borrower add to such collateral
whenever the price of the securities loaned rises or the value of non-cash
collateral declines (i.e., the borrower "marks to the market" on a daily
basis), (c) the loan be made subject to termination by a fund at any time, and
(d) a fund receives a reasonable return on the loan (consisting of the return
achieved on investment of the cash collateral, less the rebate owed to
borrowers, plus distributions on the loaned securities and any increase in
their market value).
A fund may pay reasonable fees in connection with loaned securities, pursuant
to written contracts, including fees paid to a fund's custodian and fees paid
to a securities lending agent, including a securities lending agent that is an
affiliate of the Advisor. Voting rights may pass with the loaned securities,
but if an event occurs that the Advisor determines to be a material event
affecting an investment on loan, the loan must be called and the securities
voted. Pursuant to an exemptive order granted by the SEC, cash collateral
received by a fund may be invested in a money market fund managed by the
Advisor (or one of its affiliates).
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A fund is subject to all investment risks associated with the reinvestment of
any cash collateral received, including, but not limited to, interest rate,
credit and liquidity risk associated with such investments. To the extent the
value or return of a fund's investments of the cash collateral declines below
the amount owed to a borrower, a fund may incur losses that exceed the amount
it earned on lending the security. If the borrower defaults on its obligation
to return securities lent because of insolvency or other reasons, a fund could
experience delays and costs in recovering the securities lent or gaining access
to collateral. If a fund is not able to recover securities lent, a fund may
sell the collateral and purchase a replacement investment in the market,
incurring the risk that the value of the replacement security is greater than
the value of the collateral. However, loans will be made only to borrowers
selected by a fund's delegate after a commercially reasonable review of
relevant facts and circumstances, including the creditworthiness of the
borrower.
MASTER LIMITED PARTNERSHIPS (MLPS). Master Limited Partnerships, or MLPs, are
generally organized under state law as limited partnerships or limited
liability companies. An MLP consists of a general partner and limited partners
(or in the case of MLPs organized as limited liability companies, a managing
member and members). The general partner or managing member typically controls
the operations and management of the MLP and has an ownership stake in the MLP.
The limited partners or members, through their ownership of limited partner or
member interests, provide capital to the entity, are intended to have no role
in the operation and management of the entity, and receive cash distributions.
Equity securities issued by MLPs currently consist of common units,
subordinated units and preferred units.
MLP common units are typically listed and traded on U.S. securities exchanges,
including the NYSE and the NASDAQ Stock Market (NASDAQ). A fund may purchase
such common units through open market transactions and underwritten offerings,
but may also acquire common units through direct placements and privately
negotiated transactions. Holders of MLP common units have limited control and
voting rights. Holders of MLP common units are typically entitled to receive a
minimum quarterly distribution (MQD), including arrearage rights, from the
issuer. Generally, an MLP must pay (or set aside for payment) the MQD to
holders of common units before any distributions may be paid to subordinated
unit holders. In addition, incentive distributions are typically not paid to
the general partner or managing member unless the quarterly distributions on
the common units exceed specified threshold levels above the MQD. In the event
of a liquidation, common unit holders are intended to have a preference to the
remaining assets of the issuer over holders of subordinated units. MLPs also
issue different classes of common units that may have different voting,
trading, and distribution rights.
MLP subordinated units, which, like common units, represent limited partner or
member interests, are not typically listed or traded on an exchange. A fund may
purchase outstanding subordinated units through negotiated transactions
directly with holders of such units or newly issued subordinated units directly
from the issuer. Holders of such subordinated units are generally entitled to
receive a distribution only after the MQD and any arrearages from prior
quarters have been paid to holders of common units. Holders of subordinated
units typically have the right to receive distributions before any incentive
distributions are payable to the general partner or managing member.
Subordinated units generally do not provide arrearage rights. Most MLP
subordinated units are convertible into common units after the passage of a
specified period of time or upon the achievement by the issuer of specified
financial goals. MLPs also issue different classes of subordinated units that
may have different voting, trading, and distribution rights.
MLP preferred units are not typically listed or traded on an exchange. A fund
may 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.
Investments in MLPs are generally subject to many of the risks that apply to
partnerships. For example, holders of the units of MLPs may have limited
control and limited voting rights on matters affecting the partnership. There
may be fewer corporate protections afforded investors in an MLP than investors
in a corporation. Conflicts of interest may exist among unit holders,
subordinated unit holders and the general partner of an MLP, including those
arising from incentive distribution payments. MLPs that concentrate in a
particular industry or region are subject to risks associated with such
industry or region. MLPs holding credit-related investments are subject to
interest rate risk and the risk of
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default on payment obligations by debt issuers. Investments held by MLPs may be
illiquid. MLP units may trade infrequently and in limited volume, and they may
be subject to more abrupt or erratic price movements than securities of larger
or more broadly based companies.
MICRO-CAP COMPANIES. Micro-capitalization company stocks have customarily
involved more investment risk than large company stocks. There can be no
assurance that this will continue to be true in the future.
Micro-capitalization companies may have limited product lines, markets or
financial resources; may lack management depth or experience; and may be more
vulnerable to adverse general market or economic developments than large
companies. The prices of micro-capitalization company securities are often more
volatile than prices associated with large company issues, and can display
abrupt or erratic movements at times, due to limited trading volumes and less
publicly available information.
Also, because micro-capitalization companies normally have fewer shares
outstanding and these shares trade less frequently than large companies, it may
be more difficult for a fund to buy and sell significant amounts of such shares
without an unfavorable impact on prevailing market prices.
Some of the companies in which a fund may invest may distribute, sell or
produce products which have recently been brought to market and may be
dependent on key personnel. The securities of micro-capitalization companies
are often traded over-the-counter and may not be traded in the volumes typical
on a national securities exchange. Consequently, in order to sell this type of
holding, a fund may need to discount the securities from recent prices or
dispose of the securities over a long period of time.
MINING AND EXPLORATION RISKS. The business of mining by its nature involves
significant risks and hazards, including environmental hazards, industrial
accidents, labor disputes, discharge of toxic chemicals, fire, drought,
flooding and natural acts. The occurrence of any of these hazards can delay
production, increase production costs and result in liability to the operator
of the mines. A mining operation may become subject to liability for pollution
or other hazards against which it has not insured or cannot insure, including
those in respect of past mining activities for which it was not responsible.
Exploration for gold and other precious metals is speculative in nature,
involves many risks and frequently is unsuccessful. There can be no assurance
that any mineralisation discovered will result in an increase in the proven and
probable reserves of a mining operation. If reserves are developed, it can take
a number of years from the initial phases of drilling and identification of
mineralisation until production is possible, during which time the economic
feasibility of production may change. Substantial expenditures are required to
establish ore reserves properties and to construct mining and processing
facilities. As a result of these uncertainties, no assurance can be given that
the exploration programs undertaken by a particular mining operation will
actually result in any new commercial mining.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent direct or
indirect participations in or obligations collateralized by and payable from
mortgage loans secured by real property, which may include subprime mortgages.
A fund may invest in mortgage-backed securities issued or guaranteed by (i) US
Government agencies or instrumentalities such as the Government National
Mortgage Association (GNMA) (also known as Ginnie Mae), the Federal National
Mortgage Association (FNMA) (also known as Fannie Mae) and the Federal Home
Loan Mortgage Corporation (FHLMC) (also known as Freddie Mac) or (ii) other
issuers, including private companies.
GNMA is a government-owned corporation that is an agency of the US Department
of Housing and Urban Development. It guarantees, with the full faith and credit
of the United States, full and timely payment of all monthly principal and
interest on its mortgage-backed securities. Until recently, FNMA and FHLMC were
government-sponsored corporations owned entirely by private stockholders. Both
issue mortgage-related securities that contain guarantees as to timely payment
of interest and principal but that are not backed by the full faith and credit
of the US government. The value of the companies' securities fell sharply in
2008 due to concerns that the firms did not have sufficient capital to offset
losses. In mid-2008, the US Treasury was authorized to increase the size of
home loans that FNMA and FHLMC could purchase in certain residential areas and,
until 2009, to lend FNMA and FHLMC emergency funds and to purchase the
companies' stock. In September 2008, the US Treasury announced that FNMA and
FHLMC had been placed in conservatorship by the Federal Housing Finance Agency
(FHFA), a newly created independent regulator created under the Federal Housing
Finance Regulatory Reform Act of 2008 (Reform Act). In addition to placing the
companies in
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conservatorship, the US Treasury announced three additional steps that it
intended to take with respect to FNMA and FHLMC. First, the US Treasury has
entered into senior preferred stock purchase agreements ("SPSPAs") under which,
if the FHFA determines that FNMA's or FHLMC's liabilities have exceeded its
assets under generally accepted accounting principles, the US Treasury will
contribute cash capital to the company in an amount equal to the difference
between liabilities and assets. The SPSPAs are designed to provide protection
to the senior and subordinated debt and the mortgage-backed securities issued
by FNMA and FHLMC. Second, the US Treasury established a new secured lending
credit facility that is available to FNMA and FHLMC, which terminated on
December 31, 2009. Third, the US Treasury initiated a temporary program to
purchase FNMA and FHLMC mortgage-backed securities, which terminated on
December 31, 2009. No assurance can be given that the US Treasury initiatives
discussed above with respect to the debt and mortgage-backed securities issued
by FNMA and FHLMC will be successful, or, with respect to initiatives that have
expired, that the US Treasury would undertake similar initiatives in the
future.
FHFA, as conservator or receiver for FNMA and FHLMC, has the power to repudiate
any contract entered into by FNMA or FHLMC prior to FHFA's appointment as
conservator or receiver, as applicable, if FHFA determines, in its sole
discretion, that performance of the contract is burdensome and that repudiation
of the contract promotes the orderly administration of FNMA's or FHLMC's
affairs. The Reform Act requires FHFA to exercise its right to repudiate any
contract within a reasonable period of time after its appointment as
conservator or receiver. FHFA, in its capacity as conservator, has indicated
that it has no intention to repudiate the guaranty obligations of 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 FNMA's or FHLMC's assets available therefor.
In the event of repudiation, the payments of interest to holders of FNMA or
FHLMC mortgage-backed securities would be reduced if payments on the mortgage
loans represented in the mortgage loan groups related to such mortgage-backed
securities are not made by the borrowers or advanced by the servicer. Any
actual direct compensatory damages for repudiating these guaranty obligations
may not be sufficient to offset any shortfalls experienced by such
mortgage-backed security holders. Further, in its capacity as conservator or
receiver, FHFA has the right to transfer or sell any asset or liability of 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 mortgage-backed securities would have to rely on that party for
satisfaction of the guaranty obligation and would be exposed to the credit risk
of that party.
In addition, certain rights provided to holders of mortgage-backed securities
issued by 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 mortgage-backed securities may provide
(or with respect to securities issued prior to the date of the appointment of
the conservator may have provided) that upon the occurrence of an event of
default on the part of FNMA or FHLMC, in its capacity as guarantor, which
includes the appointment of a conservator or receiver, holders of such
mortgage-backed securities have the right to replace FNMA or FHLMC as trustee
if the requisite percentage of mortgage-backed securities holders consent. The
Reform Act prevents mortgage-backed security holders from enforcing such rights
if the event of default arises solely because a conservator or receiver has
been appointed. The Reform Act also provides that no person may exercise any
right or power to terminate, accelerate or declare an event of default under
certain contracts to which FNMA or FHLMC is a party, or obtain possession of or
exercise control over any property of FNMA or FHLMC, or affect any contractual
rights of FNMA or FHLMC, without the approval of FHFA, as conservator or
receiver, for a period of 45 or 90 days following the appointment of FHFA as
conservator or receiver, respectively.
The market value and yield of these mortgage-backed securities can vary due to
market interest rate fluctuations and early prepayments of underlying
mortgages. These securities represent ownership in a pool of federally insured
mortgage loans with a maximum maturity of 30 years. A decline in interest rates
may lead to a faster rate of repayment of the underlying mortgages, and may
expose a fund to a lower rate of return upon reinvestment. To the extent that
such mortgage-backed securities are held by a fund, the prepayment right will
tend to limit to some degree the increase in net asset value of a fund because
the value of the mortgage-backed securities held by a fund may not appreciate
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as rapidly as the price of non-callable debt securities. Mortgage-backed
securities are subject to the risk of prepayment and the risk that the
underlying loans will not be repaid. Because principal may be prepaid at any
time, mortgage-backed securities may involve significantly greater price and
yield volatility than traditional debt securities. At times, a fund may invest
in securities that pay higher than market interest rates by paying a premium
above the securities' par value. Prepayments of these securities may cause
losses on securities purchased at a premium. Unscheduled payments, which are
made at par value, will cause a fund to experience a loss equal to any
unamortized premium.
When interest rates rise, mortgage prepayment rates tend to decline, thus
lengthening the life of a mortgage-related security and increasing the price
volatility of that security, affecting the price volatility of a fund's shares.
The negative effect of interest rate increases on the market-value of mortgage
backed securities is usually more pronounced than it is for other types of
fixed-income securities potentially increasing the volatility of a fund.
Interests in pools of mortgage-backed securities differ from other forms of
debt securities, which normally provide for periodic payment of interest in
fixed amounts with principal payments at maturity or specified call dates.
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 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 which may be incurred. Some mortgage-related securities (such as
securities issued by 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.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional mortgage loans. Such issuers may, in
addition, be the originators and/or servicers of the underlying mortgage loans
as well as the guarantors of the mortgage-related securities. Pools created by
such non-governmental issuers generally offer a higher rate of interest than
government and government-related pools because there are no direct or indirect
government or agency guarantees of payments. However, timely payment of
interest and principal of these pools may be supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance and letters of credit. The insurance and guarantees are issued by
governmental entities, private insurers and the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers thereof will
be considered in determining whether a mortgage-related security meets a fund's
investment quality standards. There can be no assurance that the private
insurers or guarantors can meet their obligations under the insurance policies
or guarantee arrangements. A fund may buy mortgage-related securities without
insurance or guarantees. Although the market for such securities is becoming
increasingly liquid, securities issued by certain private organizations may not
be readily marketable.
Due to prepayments of the underlying mortgage instruments, mortgage-backed
securities do not have a known actual maturity. In the absence of a known
maturity, market participants generally refer to an estimated average life. An
average life estimate is a function of an assumption regarding anticipated
prepayment patterns. The assumption is based upon current interest rates,
current conditions in the relevant housing markets and other factors. The
assumption is necessarily subjective, and thus different market participants
could produce somewhat different average life estimates with regard to the same
security. There can be no assurance that the average estimated life of
portfolio securities will be the actual average life of such securities.
Fannie Mae Certificates. Fannie Mae is a federally chartered corporation
organized and existing under the Federal National Mortgage Association Charter
Act of 1938. The obligations of Fannie Mae are obligations solely of Fannie Mae
and are not backed by the full faith and credit of the US government.
Each Fannie Mae Certificate will represent a pro rata interest in one or more
pools of FHA Loans, VA Loans or conventional mortgage loans (i.e., mortgage
loans that are not insured or guaranteed by any governmental agency) of the
following types: (1) fixed-rate level payment mortgage loans; (2) fixed-rate
growing equity mortgage loans; (3) fixed-rate graduated payment mortgage loans;
(4) variable rate mortgage loans; (5) other adjustable rate mortgage loans; and
(6) fixed-rate and adjustable mortgage loans secured by multifamily projects.
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Freddie Mac Certificates. Freddie Mac is a federally chartered corporation of
the United States created pursuant to the Emergency Home Finance Act of 1970,
as amended (FHLMC Act). The obligations of Freddie Mac are obligations solely
of Freddie Mac and are not backed by the full faith and credit of the US
government.
Freddie Mac Certificates represent a pro rata interest in a group of
conventional mortgage loans (Freddie Mac Certificate group) purchased by
Freddie Mac. The mortgage loans underlying the Freddie Mac Certificates will
consist of fixed-rate or adjustable rate mortgage loans with original terms to
maturity of between ten and thirty years, substantially all of which are
secured by first liens on one- to four-family residential properties or
multifamily projects. Each mortgage loan must meet the applicable standards set
forth in the FHLMC Act. A Freddie Mac Certificate group may include whole
loans, participating interests in whole loans and undivided interests in whole
loans and participations comprising another Freddie Mac Certificate group.
Ginnie Mae Certificates. The National Housing Act of 1934, as amended (Housing
Act), authorizes Ginnie Mae to guarantee the timely payment of the principal of
and interest on certificates that are based on and backed by a pool of mortgage
loans insured by the Federal Housing Administration under the Housing Act, or
Title V of the Housing Act of 1949 (FHA Loans), or guaranteed by the Department
of Veterans Affairs under the Servicemen's Readjustment Act of 1944, as amended
(VA Loans), or by pools of other eligible mortgage loans. The Housing Act
provides that the full faith and credit of the US government is pledged to the
payment of all amounts that may be required to be paid under any Ginnie Mae
guaranty. In order to meet its obligations under such guaranty, Ginnie Mae is
authorized to borrow from the US Treasury with no limitations as to amount.
The Ginnie Mae Certificates in which a fund invests will represent a pro rata
interest in one or more pools of the following types of mortgage loans: (1)
fixed-rate level payment mortgage loans; (2) fixed-rate graduated payment
mortgage loans; (3) fixed-rate growing equity mortgage loans; (4) fixed-rate
mortgage loans secured by manufactured (mobile) homes; (5) mortgage loans on
multifamily residential properties under construction; (6) mortgage loans on
completed multifamily projects; (7) fixed-rate mortgage loans as to which
escrowed funds are used to reduce the borrower's monthly payments during the
early years of the mortgage loans ("buy down" mortgage loans); (8) mortgage
loans that provide for adjustments in payments based on periodic changes in
interest rates or in other payment terms of the mortgage loans; and (9)
mortgage backed serial notes.
Multiple Class Mortgage-Backed Securities. A fund may invest in multiple class
mortgage-backed securities including collateralized mortgage obligations (CMOs)
and real estate mortgage investment conduits (REMIC Certificates). These
securities may be issued by US government agencies and instrumentalities such
as Fannie Mae or Freddie Mac or by trusts formed by private originators of, or
investors in, mortgage loans, including savings and loan associations, mortgage
bankers, commercial banks, insurance companies, investment banks and special
purpose subsidiaries of the foregoing. In general, CMOs are debt obligations of
a legal entity that are collateralized by a pool of mortgage loans or
mortgage-backed securities the payments on which are used to make payments on
the CMOs or multiple class mortgage-backed securities. REMIC Certificates
represent beneficial ownership interests in a REMIC trust, generally consisting
of mortgage loans or Fannie Mae, Freddie Mac or Ginnie Mae guaranteed
mortgage-backed securities. To the extent that a CMO or REMIC Certificate is
collateralized by Ginnie Mae guaranteed mortgage-backed securities, holders of
the CMO or REMIC Certificate receive all interest and principal payments owed
on the mortgage pool, net of certain fees, regardless of whether the mortgagor
actually makes the payments, as a result of the GNMA guaranty, which is backed
by the full faith and credit of the US government. The obligations of Fannie
Mae or Freddie Mac under their respective guaranty of the REMIC Certificates
are obligations solely of Fannie Mae or Freddie Mac, respectively.
Fannie Mae REMIC Certificates are issued and guaranteed as to timely
distribution of principal and interest by Fannie Mae. These certificates are
obligations solely of Fannie Mae and are not backed by the full faith and
credit of the US government. In addition, Fannie Mae will be obligated to
distribute the principal balance of each class of REMIC Certificates in full,
whether or not sufficient funds are otherwise available.
Freddie Mac guarantees the timely payment of interest on Freddie Mac REMIC
Certificates and also guarantees the payment of principal as payments are
required to be made on the underlying mortgage participation certificates
(PCs). These certificates are obligations solely of Freddie Mac and are not
backed by the full faith and credit of the US government. PCs represent
undivided interests in specified level payment residential mortgages or
participations therein purchased
II-66
by Freddie Mac and placed in a PC pool. With respect to principal payments on
PCs, Freddie Mac generally guarantees ultimate collection of all principal of
the related mortgage loans without offset or deduction. Freddie Mac also
guarantees timely payment of principal of certain PCs.
CMOs and REMIC Certificates are issued in multiple classes. Each class of CMOs
or REMIC Certificates, often referred to as a "tranche," is issued at a
specific adjustable or fixed interest rate and must be fully retired no later
than its final distribution date. Principal prepayments on the underlying
mortgage loans or the mortgage-backed securities underlying the CMOs or REMIC
Certificates may cause some or all of the classes of CMOs or REMIC Certificates
to be retired substantially earlier than their final distribution dates.
Generally, interest is paid or accrues on all classes of CMOs or REMIC
Certificates on a monthly basis.
The principal of and interest on the mortgage-backed securities may be
allocated among the several tranches in various ways. In certain structures
(known as sequential pay CMOs or REMIC Certificates), payments of principal,
including any principal prepayments, on the mortgage-backed securities
generally are applied to the classes of CMOs or REMIC Certificates in the order
of their respective final distribution dates. Thus, no payment of principal
will be made on any class of sequential pay CMOs or REMIC Certificates until
all other classes having an earlier final distribution date have been paid in
full. Additional structures of CMOs and REMIC Certificates include, among
others, "parallel pay" CMOs and REMIC Certificates. Parallel pay CMOs or REMIC
Certificates are those which are structured to apply principal payments and
prepayments of the mortgage-backed securities to two or more classes
concurrently on a proportionate or disproportionate basis. These simultaneous
payments are taken into account in calculating the final distribution date of
each class.
A wide variety of REMIC Certificates may be issued in parallel pay or
sequential pay structures. These securities include accrual certificates (Z
Bonds), which only accrue interest at a specified rate until all other
certificates having an earlier final distribution date have been retired and
are converted thereafter to an interest-paying security, and planned
amortization class (PAC) certificates, which are parallel pay REMIC
Certificates that generally require that specified amounts of principal be
applied on each payment date to one or more classes of REMIC Certificates (PAC
Certificates), even though all other principal payments and prepayments of the
mortgage-backed securities are then required to be applied to one or more other
classes of the PAC Certificates. The scheduled principal payments for the PAC
Certificates generally have the highest priority on each payment date after
interest due has been paid to all classes entitled to receive interest
currently. Shortfalls, if any, are added to the amount payable on the next
payment date. The PAC Certificate payment schedule is taken into account in
calculating the final distribution date of each class of PAC. In order to
create PAC tranches, one or more tranches generally must be created that absorb
most of the volatility in the underlying mortgage-backed securities. These
tranches tend to have market prices and yields that are much more volatile than
other PAC classes.
The prices of certain CMOs and REMIC Certificates, depending on their structure
and the rate of prepayments, may be volatile. Some CMOs may also not be as
liquid as other securities. In addition, the value of a CMO or REMIC
Certificate, including those collateralized by mortgage-backed securities
issued or guaranteed by US government agencies or instrumentalities, may be
affected by other factors, such as the availability of information concerning
the pool and its structure, the creditworthiness of the servicing agent for the
pool, the originator of the underlying assets, or the entities providing credit
enhancement. The value of these securities also can depend on the ability of
their servicers to service the underlying collateral and is, therefore, subject
to risks associated with servicers' performance, including mishandling of
documentation. A fund is permitted to invest in other types of mortgage-backed
securities that may be available in the future to the extent consistent with
its investment policies and objective.
Impact of Sub-Prime Mortgage Market. A fund may invest in mortgage-backed,
asset-backed and other fixed-income securities whose value and liquidity may be
adversely affected by the critical downturn in the sub-prime mortgage lending
market in the US. Sub-prime loans, which have higher interest rates, are made
to borrowers with low credit ratings or other factors that increase the risk of
default. Concerns about widespread defaults on sub-prime loans have also
created heightened volatility and turmoil in the general credit markets. As a
result, a fund's investments in certain fixed-income securities may decline in
value, their market value may be more difficult to determine, and a fund may
have more difficulty disposing of them.
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MUNICIPAL LEASES, CERTIFICATES OF PARTICIPATION AND OTHER PARTICIPATION
INTERESTS. A municipal lease is an obligation in the form of a lease or
installment purchase contract that is issued by a state or local government to
acquire equipment and facilities. Income from such obligations is generally
exempt from state and local taxes in the state of issuance (as well as regular
Federal income tax). Municipal leases frequently involve special risks not
normally associated with general obligation or revenue bonds, such as
non-payment and the risk of bankruptcy of the issuer. Leases and installment
purchase or conditional sale contracts (which normally provide for title to the
leased asset to pass eventually to the governmental issuer) have evolved as a
means for governmental issuers to acquire property and equipment without
meeting the constitutional and statutory requirements for the issuance of debt.
The debt issuance limitations are deemed to be inapplicable because of the
inclusion in many leases or contracts of "non-appropriation" clauses that
relieve the governmental issuer of any obligation to make future payments under
the lease or contract unless money is appropriated for such purpose by the
appropriate legislative body on a yearly or other periodic basis. Thus, a
fund's investment in municipal leases will be subject to the special risk that
the governmental issuer may not appropriate funds for lease payments.
In addition, such leases or contracts may be subject to the temporary abatement
of payments in the event the issuer is prevented from maintaining occupancy of
the leased premises or utilizing the leased equipment. Although the obligations
may be secured by the leased equipment or facilities, the disposition of the
property in the event of non-appropriation or foreclosure might prove
difficult, time consuming and costly, and result in an unsatisfactory or
delayed recoupment of a fund's original investment.
Certificates of participation represent undivided interests in municipal
leases, installment purchase contracts or other instruments. The certificates
are typically issued by a trust or other entity that has received an assignment
of the payments to be made by the state or political subdivision under such
leases or installment purchase contracts.
Certain municipal lease obligations and certificates of participation may be
deemed illiquid for the purpose of a fund's limitations on investments in
illiquid securities. Other municipal lease obligations and certificates of
participation acquired by a fund may be determined by the Advisor, pursuant to
guidelines adopted by the Board, to be liquid securities for the purpose of a
fund's limitation on investments in illiquid securities. In determining the
liquidity of municipal lease obligations and certificates of participation, the
Advisor will consider a variety of factors including: (1) dealer undertakings
to make a market in the security; (2) the number of dealers willing to purchase
or sell the obligation and the number of other potential buyers; (3) the
frequency of trades or quotes for the obligation; and (4) the nature of the
security and market for the security (i.e., the time needed to dispose of the
security, the method of soliciting offers, and the mechanics of the transfer.)
In addition, the Advisor will consider factors unique to particular lease
obligations and certificates of participation affecting the marketability
thereof. These include the general creditworthiness of the issuer, the
importance to the issuer of the property covered by the lease and the
likelihood that the marketability of the obligation will be maintained
throughout the time the obligation is held by a fund.
A fund may purchase participations in municipal securities held by a commercial
bank or other financial institution, provided the participation interest is
fully insured. Such participations provide a fund with the right to a pro rata
undivided interest in the underlying municipal securities. In addition, such
participations generally provide a fund with the right to demand payment, on
not more than seven days notice, of all or any part of a fund's participation
interest in the underlying municipal security, plus accrued interest.
Each participation is backed by an irrevocable letter of credit or guarantee of
the selling bank that the Advisor has determined meets the prescribed quality
standards of a fund. Therefore, either the credit of the issuer of the
municipal obligation or the selling bank, or both, will meet the quality
standards of the particular fund. A fund has the right to sell the
participation back to the bank after seven days' notice for the full principal
amount of a fund's interest in the municipal obligation plus accrued interest,
but only (i) as required to provide liquidity to a fund, (ii) to maintain a
high quality investment portfolio or (iii) upon a default under the terms of
the municipal obligation. The selling bank will receive a fee from a fund in
connection with the arrangement.
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Participation interests in municipal securities are subject to the same general
risks as participation interests in bank loans, as described in the Bank Loans
section above. Such risks include credit risk, interest rate risk, and
liquidity risk, as well as the potential liability associated with being a
lender. If a fund purchases a participation, it may only be able to enforce its
rights through the participating lender, and may assume the credit risk of both
the lender and the borrower.
MUNICIPAL SECURITIES. Municipal obligations are issued by or on behalf of
states, territories and possessions of the United States and their political
subdivisions, agencies and instrumentalities and the District of Columbia to
obtain funds for various public purposes. The interest on these obligations is
generally exempt from regular federal income tax in the hands of most
investors. The two principal classifications of municipal obligations are
"notes" and "bonds."
Municipal notes are generally used to provide for short-term capital needs.
Municipal notes include: Tax Anticipation Notes, Revenue Anticipation Notes,
Bond Anticipation Notes, and Construction Loan Notes. Tax Anticipation Notes
are sold to finance working capital needs of municipalities. They are generally
payable from specific tax revenues expected to be received at a future date,
such as income, sales, property, use and business taxes. Revenue Anticipation
Notes are issued in expectation of receipt of other types of revenue, such as
federal revenues available under federal revenue sharing programs. Bond
Anticipation Notes are sold to provide interim financing until long-term bond
financing can be arranged. In most cases, the long-term bonds provide the funds
needed for the repayment of the notes. Construction Loan Notes are sold to
provide construction financing. After the projects are successfully completed
and accepted, many projects receive permanent financing through the Federal
Housing Administration under Fannie Mae (Federal National Mortgage Association)
or Ginnie Mae (Government National Mortgage Association). These notes are
secured by mortgage notes insured by the Federal Housing Authority; however,
the proceeds from the insurance may be less than the economic equivalent of the
payment of principal and interest on the mortgage note if there has been a
default. The obligations of an issuer of municipal notes are generally secured
by the anticipated revenues from taxes, grants or bond financing. An investment
in such instruments, however, presents a risk that the anticipated revenues
will not be received or that such revenues will be insufficient to satisfy the
issuer's payment obligations under the notes or that refinancing will be
otherwise unavailable. There are, of course, a number of other types of notes
issued for different purposes and secured differently from those described
above.
Municipal bonds, which meet longer-term capital needs and generally have
maturities of more than one year when issued, have two principal
classifications: "general obligation" bonds and "revenue" bonds. Issuers of
general obligation bonds include states, counties, cities, towns and regional
districts. The proceeds of these obligations are used to fund a wide range of
public projects including the construction or improvement of schools, highways
and roads, water and sewer systems and a variety of other public purposes. The
basic security behind general obligation bonds is the issuer's pledge of its
full faith, credit, and taxing power for the payment of principal and interest.
The taxes that can be levied for the payment of debt service may be limited or
unlimited as to rate, amount or special assessments.
The principal security for a revenue bond is generally the net revenues derived
from a particular facility or group of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source. Revenue bonds
have been issued to fund a wide variety of capital projects including:
electric, gas, water and sewer systems; highways, bridges and tunnels; port and
airport facilities; colleges and universities; and hospitals. Although the
principal security behind these bonds varies widely, many provide additional
security in the form of a debt service reserve fund whose monies may also be
used to make principal and interest payments on the issuer's obligations.
Housing finance authorities have a wide range of security including partially
or fully-insured, rent-subsidized or collateralized mortgages, and the net
revenues from housing or other public projects. In addition to a debt service
reserve fund, some authorities provide further security in the form of a
state's ability (without obligation) to make up deficiencies in the debt
reserve fund. Lease rental bonds issued by a state or local authority for
capital projects are secured by annual lease rental payments from the state or
locality to the authority sufficient to cover debt service on the authority's
obligations.
Some issues of municipal bonds are payable from United States Treasury bonds
and notes or agency obligations held in escrow by a trustee, frequently a
commercial bank. The interest and principal on these US Government securities
are sufficient to pay all interest and principal requirements of the municipal
securities when due. Some escrowed Treasury securities are used to retire
municipal bonds at their earliest call date, while others are used to retire
municipal bonds at their maturity.
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Securities purchased for a fund may include variable/floating rate instruments,
variable mode instruments, put bonds, and other obligations which have a
specified maturity date but also are payable before maturity after notice by
the holder (demand obligations). Demand obligations are considered for a fund's
purposes to mature at the demand date.
In addition, there are a variety of hybrid and special types of municipal
obligations as well as numerous differences in the security of municipal
obligations both within and between the two principal classifications (i.e.,
notes and bonds) discussed above.
An entire issue of municipal securities may be purchased by one or a small
number of institutional investors such as a fund. Thus, such an issue may not
be said to be publicly offered. Unlike the equity securities of operating
companies or mutual funds which must be registered under the 1933 Act prior to
offer and sale unless an exemption from such registration is available,
municipal securities, whether publicly or privately offered, may nevertheless
be readily marketable. A secondary market exists for municipal securities which
have been publicly offered as well as securities which have not been publicly
offered initially but which may nevertheless be readily marketable. Municipal
securities purchased for a fund are subject to the limitations on holdings of
securities which are not readily marketable based on whether it may be sold in
a reasonable time consistent with the customs of the municipal markets (usually
seven days) at a desirable price (or interest rate). A fund believes that the
quality standards applicable to its investments enhance marketability. In
addition, stand-by commitments, participation interests and demand obligations
also enhance marketability.
Provisions of the federal bankruptcy statutes relating to the adjustment of
debts of political subdivisions and authorities of states of the US provide
that, in certain circumstances, such subdivisions or authorities may be
authorized to initiate bankruptcy proceedings without prior notice to or
consent of creditors, which proceedings could result in material and adverse
modification or alteration of the rights of holders of obligations issued by
such subdivisions or authorities.
Litigation challenging the validity under state constitutions of present
systems of financing public education has been initiated or adjudicated in a
number of states, and legislation has been introduced to effect changes in
public school finances in some states. In other instances there has been
litigation challenging the issuance of pollution control revenue bonds or the
validity of their issuance under state or federal law which litigation could
ultimately affect the validity of those municipal securities or the tax-free
nature of the interest thereon.
In some cases, municipalities may issue bonds relying on proceeds from
litigation settlements. These bonds may be further secured by debt service
reserve funds established at the time the bonds were issued. Bonds that are
supported in whole or in part by expected litigation proceeds are subject to
the risk that part or all of the expected proceeds may not be received. For
example, a damage award could be overturned or reduced by a court, or the terms
of a settlement or damage award may allow for reduced or discontinued payments
if certain conditions are met. As a result, bonds that rely on proceeds from
litigation settlements are subject to an increased risk of nonpayment or
default.
On August 2, 2011, President Obama signed the Budget Control Act of 2011, which
requires the federal government to reduce expenditures by over $2 trillion over
the next ten years. Since the specifics of the federal reductions have yet to
be identified, a detailed assessment of the impact on states cannot be made.
Insured Municipal Securities. A fund may purchase municipal securities that are
insured under policies issued by certain insurance companies. Insured municipal
securities typically receive a higher credit rating which means that the issuer
of the securities pays a lower interest rate. In purchasing such insured
securities, the Advisor gives consideration both to the insurer and to the
credit quality of the underlying issuer. The insurance reduces the credit risk
for a particular municipal security by supplementing the creditworthiness of
the underlying bond and provides additional security for payment of the
principal and interest of a municipal security. Certain of the insurance
companies that provide insurance for municipal securities provide insurance for
other types of securities, including some involving subprime mortgages. The
value of subprime mortgage securities has declined recently and some may
default, increasing a bond insurer's risk of having to make payments to holders
of subprime mortgage securities. Because of this risk, the ratings of some
insurance companies have been, or may be, downgraded and it is possible that an
insurance company may become insolvent. If an insurance company's rating is
downgraded or the company becomes insolvent, the prices of municipal securities
insured by the insurance company may decline.
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Letters of Credit. Municipal obligations, including certificates of
participation, commercial paper and other short-term obligations may be backed
by an irrevocable letter of credit of a bank which assumes the obligation for
payment of principal and interest in the event of default by the issuer.
Pre-Refunded Municipal Securities. Pre-refunded municipal securities are
subject to interest rate risk, market risk and limited liquidity. The principal
of and interest on municipal securities that have been pre-refunded are no
longer paid from the original revenue source for the securities. Instead, after
pre-refunding of the principal of and interest on these securities are
typically paid from an escrow fund consisting of obligations issued or
guaranteed by the US Government. The assets in the escrow fund are derived from
the proceeds of refunding bonds issued by the same issuer as the pre-refunded
municipal securities. Issuers of municipal securities use this advance
refunding technique to obtain more favorable terms with respect to securities
that are not yet subject to call or redemption by the issuer. For example,
advance refunding enables an issuer to refinance debt at lower market interest
rates, restructure debt to improve cash flow or eliminate restrictive covenants
in the indenture or other governing instrument for the pre-refunded municipal
securities. However, except for a change in the revenue source from which
principal and interest payments are made, the pre-refunded municipal securities
remain outstanding on their original terms until they mature or are redeemed by
the issuer. Pre-refunded municipal securities are usually purchased at a price
which represents a premium over their face value.
MUNICIPAL TRUST RECEIPTS. Municipal trust receipts (MTRs) are sometimes called
municipal asset-backed securities, floating rate trust certificates, or
municipal securities trust receipts. MTRs are typically structured by a bank,
broker-dealer or other financial institution by depositing municipal securities
into a trust or partnership, coupled with a conditional right to sell, or put,
the holder's interest in the underlying securities at par plus accrued interest
to a financial institution. MTRs may be issued as fixed or variable rate
instruments. These trusts are organized so that the purchaser of the MTR would
be considered to be investing for federal income tax purposes in the underlying
municipal securities. This structure is intended to allow the federal income
tax exempt status of interest generated by the underlying asset to pass through
to the purchaser. A fund's investments in MTRs are subject to similar risks as
other investments in municipal debt obligations, including interest rate risk,
credit risk, prepayment risk and security selection risk. Additionally,
investments in MTRs raise certain tax issues that may not be presented by
direct investments in municipal bonds. There is some risk that certain legal
issues could be resolved in a manner that could adversely affect the
performance of a fund or shareholder investment returns. The Advisor expects
that it would invest in MTRs for which a legal opinion has been given to the
effect that the income from an MTR is tax-exempt for federal income tax
purposes to the same extent as the underlying bond(s), although it is possible
that the IRS will take a different position and there is a risk that the
interest paid on such MTRs would be deemed taxable.
OBLIGATIONS OF BANKS AND OTHER FINANCIAL INSTITUTIONS. A fund may invest in US
dollar-denominated fixed rate or variable rate obligations of US or foreign
financial institutions, including banks. Obligations of domestic and foreign
financial institutions in which a fund may invest include (but are not limited
to) certificates of deposit, bankers' acceptances, bank time deposits,
commercial paper, and other US dollar-denominated instruments issued or
supported by the credit of US or foreign financial institutions, including
banks, commercial and savings banks, savings and loan associations and other
institutions.
Certificates of deposit are negotiable certificates evidencing the obligations
of a bank to repay funds deposited with it for a specified period of time.
Banker's acceptances are credit instruments evidencing the obligations of a
bank to pay a draft drawn on it by a customer. These instruments reflect the
obligation both of the bank and of the drawer to pay the face amount of the
instrument upon maturity. Time deposits are non-negotiable deposits maintained
in a banking institution for a specified period of time at a stated interest
rate. Time deposits that may be held by a fund will not benefit from insurance
from the Bank Insurance Fund or the Savings Association Insurance Fund
administered by the Federal Deposit Insurance Corporation. Fixed time deposits
may be withdrawn on demand, but may be subject to early withdrawal penalties
that vary with market conditions and the remaining maturity of the obligation.
Obligations of foreign branches of US banks and foreign banks may be general
obligations of the parent bank in addition to the issuing bank or may be
limited by the terms of a specific obligation and by government regulation.
Investments in obligations of foreign banks may entail risks that are different
in some respects from those of investments in obligations of US domestic banks
because of differences in political, regulatory and economic systems and
conditions. These
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risks include the possibility that these obligations may be less marketable
than comparable obligations of United States banks, and the selection of these
obligations may be more difficult because there may be less publicly available
information concerning foreign banks. Other risks include future political and
economic developments, currency blockage, the possible imposition of
withholding taxes on interest payments, possible seizure or nationalization of
foreign deposits, difficulty or inability to pursue legal remedies and obtain
or enforce judgments in foreign courts, possible establishment of exchange
controls or the adoption of other foreign governmental restrictions that might
affect adversely the payment of principal and interest on bank obligations.
Foreign branches of US banks and foreign banks may also be subject to less
stringent reserve requirements and to different accounting, auditing, reporting
and record keeping standards than those applicable to domestic branches of US
banks.
PARTICIPATION INTERESTS. A fund may purchase from financial institutions
participation interests in securities in which a fund may invest. A
participation interest gives a fund an undivided interest in the security in
the proportion that a fund's participation interest bears to the principal
amount of the security. These instruments may have fixed, floating or variable
interest rates. For certain participation interests, a fund will have the right
to demand payment, on not more than seven days' notice, for all or any part of
a fund's participation interests in the security, plus accrued interest. As to
these instruments, a fund generally intends to exercise its right to demand
payment only upon a default under the terms of the security.
PREFERRED STOCK. Preferred stock is an equity security, but possesses certain
attributes of debt securities. Holders of preferred stock normally have the
right to receive dividends at a fixed rate when and as declared by the issuer's
board of directors, but do not otherwise participate in amounts available for
distribution by the issuing corporation. Dividends on preferred stock may be
cumulative, and, in such cases, all cumulative dividends usually must be paid
prior to dividend payments to common stockholders. Preferred stock has a
preference (i.e., ranks higher) in liquidation (and generally dividends) over
common stock, but is subordinated (i.e., ranks lower) in liquidation to fixed
income securities. Because of this preference, preferred stocks generally
entail less risk than common stocks. As a general rule, the market value of
preferred stocks with fixed dividend rates and no conversion rights moves
inversely with interest rates and perceived credit risk, with the price
determined by the dividend rate. Some preferred stocks are convertible into
other securities (e.g., common stock) at a fixed price and ratio or upon the
occurrence of certain events. The market price of convertible preferred stocks
generally reflects an element of conversion value. Because many preferred
stocks lack a fixed maturity date, these securities generally fluctuate
substantially in value when interest rates change; such fluctuations often
exceed those of long-term bonds of the same issuer. Some preferred stocks pay
an adjustable dividend that may be based on an index, formula, auction
procedure or other dividend rate reset mechanism. In the absence of credit
deterioration, adjustable rate preferred stocks tend to have more stable market
values than fixed rate preferred stocks.
All preferred stocks are also subject to the same types of credit risks as
corporate bonds. In addition, because preferred stock is subordinate to debt
securities and other obligations of an issuer, deterioration in the credit
rating of the issuer will cause greater changes in the value of a preferred
stock than in a more senior debt security with similar yield characteristics.
Preferred stocks may be rated by the Standard & Poor's Division of the
McGraw-Hill Companies (S&P) and Moody's Investors Service, Inc. (Moody's)
although there is no minimum rating which a preferred stock must have to be an
eligible investment for a fund.
PRIVATE ACTIVITY BONDS. Certain types of municipal securities, generally
referred to as industrial development bonds (and referred to under current tax
law as private activity bonds), are issued by or on behalf of public
authorities to obtain funds for privately-operated housing facilities, airport,
mass transit or port facilities, sewage disposal, solid waste disposal or
hazardous waste treatment or disposal facilities and certain local facilities
for water supply, gas or electricity. Other types of industrial development
bonds, the proceeds of which are used for the construction, equipment, repair
or improvement of privately operated industrial or commercial facilities, may
constitute municipal securities, although the current federal tax laws place
substantial limitations on the size of such issues. The interest from certain
private activity bonds owned by a fund (including a fund's distributions
attributable to such interest) may be a preference item for purposes of the
alternative minimum tax. The credit quality of such bonds depends upon the
ability of the user of the facilities financed by the bonds and any guarantor
to meet its financial obligations.
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PRIVATIZED ENTERPRISES. A fund may invest in foreign securities which may
include securities issued by enterprises that have undergone or are currently
undergoing privatization. The governments of certain foreign countries have, to
varying degrees, embarked on privatization programs contemplating the sale of
all or part of their interests in state enterprises. A fund's investments in
the securities of privatized enterprises may include privately negotiated
investments in a government or state-owned or controlled company or enterprise
that has not yet conducted an initial equity offering, investments in the
initial offering of equity securities of a state enterprise or former state
enterprise and investments in the securities of a state enterprise following
its initial equity offering.
In certain jurisdictions, the ability of foreign entities, such as a fund, to
participate in privatizations may be limited by local law, or the price or
terms on which a fund may be able to participate may be less advantageous than
for local investors. Moreover, there can be no assurance that governments that
have embarked on privatization programs will continue to divest their ownership
of state enterprises, that proposed privatizations will be successful or that
governments will not re-nationalize enterprises that have been privatized.
In the case of the enterprises in which a fund may invest, large blocks of the
stock of those enterprises may be held by a small group of stockholders, even
after the initial equity offerings by those enterprises. The sale of some
portion or all of those blocks could have an adverse effect on the price of the
stock of any such enterprise.
Prior to making an initial equity offering, most state enterprises or former
state enterprises go through an internal reorganization of management. Such
reorganizations are made in an attempt to better enable these enterprises to
compete in the private sector. However, certain reorganizations could result in
a management team that does not function as well as an enterprise's prior
management and may have a negative effect on such enterprise. In addition, the
privatization of an enterprise by its government may occur over a number of
years, with the government continuing to hold a controlling position in the
enterprise even after the initial equity offering for the enterprise.
Prior to privatization, most of the state enterprises in which a fund may
invest enjoy the protection of and receive preferential treatment from the
respective sovereigns that own or control them. After making an initial equity
offering, these enterprises may no longer have such protection or receive such
preferential treatment and may become subject to market competition from which
they were previously protected. Some of these enterprises may not be able to
operate effectively in a competitive market and may suffer losses or experience
bankruptcy due to such competition.
PUT BONDS. A fund may invest in "put" bonds (including securities with variable
interest rates) that may be sold back to the issuer of the security at face
value at the option of the holder prior to their stated maturity. The option to
"put" the bond back to the issuer before the stated final maturity can cushion
the price decline of the bond in a rising interest rate environment. However,
the premium paid, if any, for an option to put will have the effect of reducing
the yield otherwise payable on the underlying security.
REAL ESTATE INVESTMENT TRUSTS (REITS). A REIT invests primarily in
income-producing real estate or makes loans to persons involved in the real
estate industry. REITs are sometimes informally categorized into equity REITs,
mortgage REITs and hybrid REITs. Equity REITs buy real estate and pay investors
income from the rents received from the real estate owned by the REIT and from
any profits on the sale of its properties. Mortgage REITs lend money to
building developers and other real estate companies and pay investors income
from the interest paid on those loans. Hybrid REITs engage in both owning real
estate and making loans. Investment in REITs may subject a fund to risks
associated with the direct ownership of real estate, such as decreases in real
estate values, delays in completion of construction, overbuilding, increased
competition and other risks related to local or general economic conditions,
increases in operating costs and property taxes, changes in zoning laws,
casualty or condemnation losses, possible environmental liabilities, regulatory
limitations on rent and fluctuations in rental income. Equity REITs generally
experience these risks directly through fee or leasehold interests, whereas
mortgage REITs generally experience these risks indirectly through mortgage
interests, unless the mortgage REIT forecloses on the underlying real estate.
Changes in interest rates may also affect the value of a fund's investment in
REITs. For instance, during periods of declining interest rates, certain
mortgage REITs may hold mortgages that the mortgagors elect to prepay, which
prepayment may diminish the yield on securities issued by those REITs.
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Certain REITs have relatively small market capitalizations, which may tend to
increase the volatility of the market price of their securities. Furthermore,
REITs are dependent upon specialized management skills, have limited
diversification and are, therefore, subject to risks inherent in operating and
financing a limited number of projects. REITs are also subject to heavy cash
flow dependency, defaults by borrowers or lessees and the possibility of
failing to qualify for tax-free pass-through of income under the Code, and to
maintain exemption from the registration requirements of the 1940 Act. By
investing in REITs indirectly through a fund, a shareholder will bear not only
his or her proportionate share of the expenses of a fund, but also, indirectly,
similar expenses of the REITs. In addition, REITs depend generally on their
ability to generate cash flow to make distributions to shareholders.
REPURCHASE AGREEMENTS. A fund may invest in repurchase agreements pursuant to
its investment guidelines. In a repurchase agreement, a fund acquires ownership
of a security (Obligation) and simultaneously commits to resell that security
to the seller, typically a bank or broker/dealer, at a specified time and
price.
A repurchase agreement provides a means for a fund to earn income on funds for
periods as short as overnight. The repurchase price may be higher than the
purchase price, the difference being income to a fund, or the purchase and
repurchase prices may be the same, with interest at a stated rate due to a fund
together with the repurchase price upon repurchase. In either case, the income
to a fund is unrelated to the interest rate on the Obligation itself.
Obligations will be held by the custodian or in the Federal Reserve Book Entry
System.
It is not clear whether a court would consider the Obligation purchased by a
fund subject to a repurchase agreement as being owned by a fund or as being
collateral for a loan by a fund to the seller. In the event of the commencement
of bankruptcy or insolvency proceedings with respect to the seller of the
Obligation before repurchase of the Obligation under a repurchase agreement, a
fund may encounter delay and incur costs before being able to sell the
security. Delays may involve loss of interest or decline in price of the
Obligation. If the court characterizes the transaction as a loan and a fund has
not perfected a security interest in the Obligation, a fund may be required to
return the Obligation to the seller's estate and be treated as an unsecured
creditor of the seller. As an unsecured creditor, a fund would be at risk of
losing some or all of the principal and income involved in the transaction. As
with any unsecured debt obligation purchased for a fund, the Advisor seeks to
reduce the risk of loss through repurchase agreements by analyzing the
creditworthiness of the obligor, in this case the seller of the Obligation.
Apart from the risk of bankruptcy or insolvency proceedings, there is also the
risk that the seller may fail to repurchase the Obligation, in which case a
fund may incur a loss if the proceeds to a fund of the sale to a third party
are less than the repurchase price. However, if the market value (including
interest) of the Obligation subject to the repurchase agreement becomes less
than the repurchase price (including interest), a fund will direct the seller
of the Obligation to deliver additional securities so that the market value
(including interest) of all securities subject to the repurchase agreement will
equal or exceed the repurchase price.
REVERSE REPURCHASE AGREEMENTS. A fund may enter into "reverse repurchase
agreements," which are repurchase agreements in which a fund, as the seller of
the securities, agrees to repurchase such securities at an agreed time and
price. Under a reverse repurchase agreement, a fund continues to receive any
principal and interest payments on the underlying security during the term of
the agreement. A fund segregates assets in an amount at least equal to its
obligation under outstanding reverse repurchase agreements. Such transactions
may increase fluctuations in the market value of fund assets and its yield.
SECURITIES AS A RESULT OF EXCHANGES OR WORKOUTS. Consistent with a fund's
investment objectives, policies and restrictions, a fund may hold various
instruments received in an exchange or workout of a distressed security (i.e.,
a low-rated debt security that is in default or at risk of becoming in
default). Such instruments may include, but are not limited to, equity
securities, warrants, rights, participation interests in sales of assets and
contingent-interest obligations.
SECURITIES WITH PUT RIGHTS. The right of a fund to exercise a put is
unconditional and unqualified. A put is not transferable by a fund, although a
fund may sell the underlying securities to a third party at any time. If
necessary and advisable, a fund may pay for certain puts either separately in
cash or by paying a higher price for portfolio securities that are acquired
subject to such a put (thus reducing the yield to maturity otherwise available
for the same securities).
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The ability of a fund to exercise a put will depend on the ability of a
counterparty to pay for the underlying securities at the time the put is
exercised. In the event that a counterparty should default on its obligation to
repurchase an underlying security, a fund might be unable to recover all or a
portion of any loss sustained from having to sell the security elsewhere.
The acquisition of a put will not affect the valuation by a fund of the
underlying security. The actual put will be valued at zero in determining net
asset value of a fund. Where a fund pays directly or indirectly for a put, its
cost will be reflected in realized gain or loss when the put is exercised or
expires. If the value of the underlying security increases, the potential for
unrealized or realized gain is reduced by the cost of the put.
SHORT SALES. When a fund takes a long position, it purchases a stock outright.
When a fund takes a short position, it sells at the current market price a
stock it does not own but has borrowed in anticipation that the market price of
the stock will decline. To complete, or close out, the short sale transaction,
a fund buys the same stock in the market and returns it to the lender. The
price at such time may be more or less than the price at which the security was
sold by a fund. Until the security is replaced, a fund is required to pay the
lender amounts equal to any dividends or interest, which accrue during the
period of the loan. To borrow the security, a fund may also be required to pay
a premium, which would increase the cost of the security sold. The proceeds of
the short sale will be retained by the broker, to the extent necessary to meet
the margin requirements, until the short position is closed out. A fund makes
money when the market price of the borrowed stock goes down and a fund is able
to replace it for less than it earned by selling it short. Alternatively if the
price of the stock goes up after the short sale and before the short position
is closed, a fund will lose money because it will have to pay more to replace
the borrowed stock than it received when it sold the stock short.
A fund may not always be able to close out a short position at a particular
time or at an acceptable price. A lender may request that the borrowed
securities be returned to it on short notice, and a fund may have to buy the
borrowed securities at an unfavorable price. If this occurs at a time that
other short sellers of the same security also want to close out their
positions, a "short squeeze" can occur. A short squeeze occurs when demand is
greater than supply for the stock sold short. A short squeeze makes it more
likely that a fund will have to cover its short sale at an unfavorable price.
If that happens, a fund will lose some or all of the potential profit from, or
even incur a loss as a result of, the short sale.
Until a fund closes its short position or replaces the borrowed security, a
fund will designate liquid assets it owns (other than the short sales proceeds)
as segregated assets to the books of the broker and/or its custodian in an
amount equal to its obligation to purchase the securities sold short, as
required by the 1940 Act. The amount segregated in this manner will be
increased or decreased each business day equal to the change in market value of
a fund's obligation to purchase the security sold short. If the lending broker
requires a fund to deposit additional collateral (in addition to the short
sales proceeds that the broker holds during the period of the short sale),
which may be as much as 50% of the value of the securities sold short, the
amount of the additional collateral may be deducted in determining the amount
of cash or liquid assets a fund is required to segregate to cover the short
sale obligation pursuant to the 1940 Act. The amount segregated must be
unencumbered by any other obligation or claim than the obligation that is being
covered. A fund believes that short sale obligations that are covered, either
by an offsetting asset or right (acquiring the security sold short or having an
option to purchase the security sold short at exercise price that covers the
obligation), or by a fund's segregated asset procedures (or a combination
thereof), are not senior securities under the 1940 Act and are not subject to a
fund's borrowing restrictions. This requirement to segregate assets limits a
fund's leveraging of its investments and the related risk of losses from
leveraging. A fund also is required to pay the lender of the security any
dividends or interest that accrues on a borrowed security during the period of
the loan. Depending on the arrangements made with the broker or custodian, a
fund may or may not receive any payments (including interest) on collateral it
has deposited with the broker.
Short sales involve the risk that a fund will incur a loss by subsequently
buying a security at a higher price than the price at which a fund previously
sold the security short. Any loss will be increased by the amount of
compensation, interest or dividends, and transaction costs a fund must pay to a
lender of the security. In addition, because a fund's
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loss on a short sale stems from increases in the value of the security sold
short, the extent of such loss, like the price of the security sold short, is
theoretically unlimited. By contrast, a fund's loss on a long position arises
from decreases in the value of the security held by a fund and therefore is
limited by the fact that a security's value cannot drop below zero.
The use of short sales, in effect, leverages a fund's portfolio, which could
increase a fund's exposure to the market, magnify losses and increase the
volatility of returns.
Although a fund's share price may increase if the securities in its long
portfolio increase in value more than the securities underlying its short
positions, a fund's share price may decrease if the securities underlying its
short positions increase in value more than the securities in its long
portfolio.
In addition, a fund's short selling strategies may limit its ability to fully
benefit from increases in the equity markets. Also, there is the risk that the
counterparty to a short sale may fail to honor its contractual terms, causing a
loss to a fund. The SEC and other (including non-U.S.) regulatory authorities
have imposed, and may in the future impose, restrictions on short selling,
either on a temporary or permanent basis, which may include placing limitations
on specific companies and/or industries with respect to which a fund may enter
into short positions. Any such restrictions may hinder a fund in, or prevent it
from, fully implementing its investment strategies, and may negatively affect
performance.
SHORT SALES AGAINST THE BOX. A fund may make short sales of common stocks if,
at all times when a short position is open, a fund owns the stock or owns
preferred stocks or debt securities convertible or exchangeable, without
payment of further consideration, into the shares of common stock sold short.
Short sales of this kind are referred to as short sales "against the box." The
broker/dealer that executes a short sale generally invests cash proceeds of the
sale until they are paid to a fund. Arrangements may be made with the
broker/dealer to obtain a portion of the interest earned by the broker on the
investment of short sale proceeds. A fund will segregate the common stock or
convertible or exchangeable preferred stock or debt securities in a special
account with the custodian. Uncertainty regarding the tax effects of short
sales of appreciated investments may limit the extent to which a fund may enter
into short sales against the box. A fund will incur transaction costs in
connection with short sales against the box.
SHORT-TERM SECURITIES. In order to meet anticipated redemptions, to hold
pending the purchase of additional securities for a fund's portfolio, or, in
some cases, for temporary defensive purposes, a fund may invest a portion (up
to 100%) of its assets in money market and other short-term securities. When a
fund is invested for temporary defensive purposes, it may not achieve or pursue
its investment objective.
Examples of short-term securities include:
o Securities issued or guaranteed by the US government and its agencies and
instrumentalities;
o Commercial paper;
o Certificates of deposit and euro dollar certificates of deposit;
o Bankers' acceptances;
o Short-term notes, bonds, debentures or other debt instruments; and
o Repurchase agreements.
SMALL COMPANIES. The Advisor believes that many small companies often may have
sales and earnings growth rates that exceed those of larger companies, and that
such growth rates may, in turn, be reflected in more rapid share price
appreciation over time. Investing in smaller company stocks, however, involves
greater risk than is customarily associated with investing in larger, more
established companies. For example, smaller companies can have limited product
lines, markets, or financial and managerial resources. Smaller companies may
also be dependent on one or a few key persons, and may be more susceptible to
losses and risks of bankruptcy. Also, the securities of smaller companies may
be
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thinly traded (and therefore have to be sold at a discount from current market
prices or sold in small lots over an extended period of time or their stock
values may fluctuate more sharply than other securities). Transaction costs in
smaller company stocks may be higher than those of larger companies.
SOVEREIGN DEBT. Investments in sovereign debt can involve a high degree of
risk. The governmental entity that controls the repayment of sovereign debt may
not be able or willing to repay the principal and/or interest when due in
accordance with the terms of such debt. A governmental entity's willingness or
ability to repay principal and interest due in a timely manner may be affected
by, among other factors, its cash flow situation, the extent of its foreign
reserves, the availability of sufficient foreign exchange on the date a payment
is due, the relative size of the debt service burden to the economy as a whole,
the governmental entity's policy toward the International Monetary Fund, and
the political constraints to which a governmental entity may be subject.
Governmental entities may also be dependent on expected disbursements from
foreign governments, multilateral agencies and others abroad to reduce
principal and interest arrearages on their debt. The commitment on the part of
these governments, agencies and others to make such disbursements may be
conditioned on a governmental entity's implementation of economic reforms
and/or economic performance and the timely service of such debtor's
obligations. Failure to implement such reforms, achieve such levels of economic
performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds to the
governmental entity, which may further impair such debtor's ability or
willingness to service its debts in a timely manner. Consequently, governmental
entities may default on their sovereign debt. Holders of sovereign debt may be
requested to participate in the rescheduling of such debt and to extend further
loans to governmental entities. There is no reliable bankruptcy proceeding by
which sovereign debt on which governmental entities have defaulted may be
collected in whole or in part.
SPECIAL INFORMATION CONCERNING MASTER-FEEDER FUND STRUCTURE. The following
applies to the extent that the fund employs the master-feeder fund structure.
Unlike other open-end management investment companies (mutual funds) which
directly acquire and manage their own portfolio securities, a fund seeks to
achieve its investment objective by investing substantially all of its assets
in a master portfolio (Portfolio), a separate registered investment company
with the same investment objective as a fund. Therefore, an investor's interest
in the Portfolio's securities is indirect. In addition to selling a beneficial
interest to a fund, the Portfolio may sell beneficial interests to other mutual
funds, investment vehicles or institutional investors. Such investors will
invest in the Portfolio on the same terms and conditions and will pay a
proportionate share of the Portfolio's expenses. However, the other investors
investing in the Portfolio are not required to sell their shares at the same
public offering price as a fund due to variations in sales commissions and
other operating expenses. Therefore, investors in a fund should be aware that
these differences may result in differences in returns experienced by investors
in the different funds that invest in the Portfolio. Such differences in
returns are also present in other mutual fund structures.
Smaller funds investing in the Portfolio may be materially affected by the
actions of larger funds investing in the Portfolio. For example, if a large
fund withdraws from the Portfolio, the remaining funds may experience higher
pro rata operating expenses, thereby producing lower returns (however, this
possibility exists as well for traditionally structured funds which have large
institutional investors). Also, the Portfolio may be required to sell
investments at a price or time not advantageous to the Portfolio in order to
meet such a redemption. Additionally, the Portfolio may become less diverse,
resulting in increased portfolio risk. Also, funds with a greater pro rata
ownership in the Portfolio could have effective voting control of the
operations of the Portfolio. Except as permitted by the SEC, whenever a fund is
requested to vote on matters pertaining to the Portfolio, a fund will hold a
meeting of shareholders of a fund and will cast all of its votes in the same
proportion as the votes of a fund's shareholders.
Certain changes in the Portfolio's investment objectives, policies or
restrictions may require a fund to withdraw its interest in the Portfolio. Any
such withdrawal could result in a distribution "in kind" of portfolio
securities (as opposed to a cash distribution from the Portfolio). If
securities are distributed, a fund could incur brokerage, tax or other charges
in converting the securities to cash. In addition, the distribution in kind may
result in a less diversified portfolio of investments or adversely affect the
liquidity of a fund. Notwithstanding the above, there are other means for
meeting redemption requests, such as borrowing.
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A fund may withdraw its investment from the Portfolio at any time, if the Board
determines that it is in the best interests of the shareholders of a fund to do
so. Upon any such withdrawal, the Board would consider what action might be
taken, including the investment of all the assets of a fund in another pooled
investment entity having the same investment objective as a fund or the
retaining of an investment advisor to manage a fund's assets in accordance with
the investment policies described herein with respect to the Portfolio.
STABLE NET ASSET VALUE (FOR ALL MONEY MARKET FUNDS EXCEPT DWS VARIABLE NAV
MONEY FUND). A fund effects purchases and redemptions at its net asset value
per share. In fulfillment of its responsibilities under Rule 2a-7 of the 1940
Act, the Board has approved policies reasonably designed, taking into account
current market conditions and a fund's investment objective, to stabilize a
fund's net asset value per share, and the Board will periodically review the
Advisor's operations under such policies at regularly scheduled Board meetings.
In addition to imposing limitations on the quality, maturity, diversity and
liquidity of portfolio instruments held by a fund as described in the
prospectus, those policies include a weekly monitoring by the Advisor of
unrealized gains and losses in a fund and, when necessary, in an effort to
avoid a material deviation of a fund's net asset value per share determined by
reference to market valuations from a fund's $1.00 price per share, taking
corrective action, such as adjusting the maturity of a fund, or, if possible,
realizing gains or losses to offset in part unrealized losses or gains. The
result of those policies may be that the yield on shares of a fund will be
lower than would be the case if the policies were not in effect. Such policies
also provide for certain action to be taken with respect to portfolio
securities which experience a downgrade in rating or suffer a default. In
addition, a low interest rate environment may prevent the fund from providing a
positive yield or paying fund expenses out of current income and, at times,
could impair a fund's ability to maintain a stable $1.00 share price. There is
no assurance that a fund's net asset value per share will be maintained at
$1.00.
In June 2013, the SEC proposed money market fund reform intended to address
perceived systemic risks associated with money market funds and to improve
transparency for money market fund investors. The Financial Stability Oversight
Council (FSOC), a board of U.S. regulators established by the Dodd-Frank Act,
had also previously proposed similar recommendations for money market fund
reform. If one or more of the SEC or FSOC proposals for money market fund
reform were to be adopted in the future, such regulatory action may affect the
fund's operations and/or return potential.
STAND-BY COMMITMENTS. A stand-by commitment is a right acquired by a fund, when
it purchases a municipal obligation from a broker, dealer or other financial
institution (seller), to sell up to the same principal amount of such
securities back to the seller, at a fund's option, at a specified price.
Stand-by commitments are also known as "puts." The exercise by a fund of a
stand-by commitment is subject to the ability of the other party to fulfill its
contractual commitment.
Stand-by commitments acquired by a fund may have the following features: (1)
they will be in writing and will be physically held by a fund's custodian; (2)
a fund's right to exercise them will be unconditional and unqualified; (3) they
will be entered into only with sellers which in the Advisor's opinion present a
minimal risk of default; (4) although stand-by commitments will not be
transferable, municipal obligations purchased subject to such commitments may
be sold to a third party at any time, even though the commitment is
outstanding; and (5) their exercise price will be (i) a fund's acquisition cost
(excluding any accrued interest which a fund paid on their acquisition), less
any amortized market premium or plus any amortized original issue discount
during the period a fund owned the securities, plus (ii) all interest accrued
on the securities since the last interest payment date.
A fund expects that stand-by commitments generally will be available without
the payment of any direct or indirect consideration. However, if necessary or
advisable, a fund will pay for stand-by commitments, either separately in cash
or by paying a higher price for portfolio securities which are acquired subject
to the commitments.
It is difficult to evaluate the likelihood of use or the potential benefit of a
stand-by commitment. Therefore, it is expected that the Advisor will determine
that stand-by commitments ordinarily have a "fair value" of zero, regardless of
whether any direct or indirect consideration was paid. However, if the market
price of the security subject to the stand-by commitment is less than the
exercise price of the stand-by commitment, such security will ordinarily be
valued at such exercise price. Where a fund has paid for a stand-by commitment,
its cost will be reflected as unrealized depreciation for the period during
which the commitment is held.
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The IRS has issued a favorable revenue ruling to the effect that, under
specified circumstances, a regulated investment company will be the owner of
tax-exempt municipal obligations acquired subject to a put option. The IRS has
also issued private letter rulings to certain taxpayers (which do not serve as
precedent for other taxpayers) to the effect that tax-exempt interest received
by a regulated investment company with respect to such obligations will be
tax-exempt in the hands of the company and may be distributed to its
shareholders as exempt-interest dividends. The IRS has subsequently announced
that it will not ordinarily issue advance ruling letters as to the identity of
the true owner of property in cases involving the sale of securities or
participation interests therein if the purchaser has the right to cause the
security, or the participation interest therein, to be purchased by either the
seller or a third party. A fund intends to take the position that it owns any
municipal obligations acquired subject to a stand-by commitment and that
tax-exempt interest earned with respect to such municipal obligations will be
tax-exempt in its hands. There is no assurance that the IRS will agree with
such position in any particular case.
SUBSIDIARY COMPANIES. A fund may gain exposure to the commodity markets in part
by investing a portion of a fund's assets in a wholly-owned subsidiary
(Subsidiary). Investments in a Subsidiary are expected to provide exposure to
the commodity markets within the limitations of Subchapter M of the Code and
recent IRS revenue rulings (see Taxes in Appendix II-H of this SAI). The
Subsidiaries are companies organized under the laws of the Cayman Islands, and
each is overseen by its own board of directors.
Among other investments, the Subsidiaries are expected to invest in
commodity-linked derivative instruments, such as swaps and futures. The
Subsidiaries will also invest in fixed income instruments, cash, cash
equivalents and affiliated money market funds. In monitoring compliance with
its investment restrictions, a fund will consider the assets of its Subsidiary
to be assets of the fund. A Subsidiary must, however, comply with the asset
segregation requirements (described elsewhere in this SAI) with respect its
investments in commodity-linked derivatives.
To the extent that a fund invests in its Subsidiary, a fund may be subject to
the risks associated with those derivative instruments and other securities,
which are discussed elsewhere in a fund's prospectuses and this SAI. While the
Subsidiaries may be considered similar to investment companies, they are not
registered under the 1940 Act and are not directly subject to all of the
investor protections of the 1940 Act and other US regulations. Changes in the
laws of the US or the Cayman Islands could result in the inability of a fund or
a Subsidiary to operate as intended or may subject the fund or its advisor to
new or additional regulatory requirements, and could negatively affect a fund
and its shareholders.
In order to qualify for the special tax treatment accorded regulated investment
companies and their shareholders, a fund must, among other things, satisfy
several diversification requirements, including the requirement that not more
than 25% of the value of the fund's total assets may be invested in the
securities (other than those of the US government or other regulated investment
companies) of any one issuer or of two or more issuers which the fund controls
and which are engaged in the same, similar or related trades or businesses.
Therefore, so long as a fund is subject to this limit, the fund may not invest
any more than 25% of the value of its assets in a Subsidiary. Absent this
diversification requirement, a fund would be permitted to invest more than 25%
of the value of its assets in a Subsidiary.
In order to qualify for the special tax treatment accorded regulated investment
companies and their shareholders, a fund must, among other things, derive at
least 90% of its income from certain specified sources (qualifying income).
Income from certain commodity-linked derivatives does not constitute qualifying
income to a fund. The tax treatment of commodity-linked notes and certain other
derivative instruments in which a fund might invest is not certain, in
particular with respect to whether income and gains from such instruments
constitutes qualifying income. If the Fund treats income from a particular
instrument as qualifying income and the income is later determined not to
constitute qualifying income, and, together with any other nonqualifying
income, causes the fund's nonqualifying income to exceed 10% of its gross
income in any taxable year, a fund will fail to qualify as a regulated
investment company unless it is eligible to and does pay a tax at the fund
level. Certain funds (including DWS Enhanced Commodity Strategy Fund, DWS Gold
and Precious Metals Fund, and DWS Global Inflation Fund) have obtained private
letter rulings from the IRS confirming that the income and gain earned through
a wholly-owned Subsidiary that invests in certain types of commodity-linked
derivatives constitute qualifying income under the Code. See Taxes in Appendix
II-H of this SAI.
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TAX-EXEMPT COMMERCIAL PAPER. Issues of tax-exempt commercial paper typically
represent short-term, unsecured, negotiable promissory notes. These obligations
are issued by state and local governments and their agencies to finance working
capital needs of municipalities or to provide interim construction financing
and are paid from general revenues of municipalities or are refinanced with
long-term debt. In most cases, tax-exempt commercial paper is backed by letters
of credit, lending agreements, note repurchase agreements or other credit
facility agreements offered by banks or other institutions.
TAX-EXEMPT CUSTODIAL RECEIPTS. Tax-exempt custodial receipts (Receipts)
evidence ownership in an underlying bond that is deposited with a custodian for
safekeeping. Holders of the Receipts receive all payments of principal and
interest when paid on the bonds. Receipts can be purchased in an offering or
from a counterparty (typically an investment bank). To the extent that any
Receipt is illiquid, it is subject to a fund's limit on illiquid securities.
TAX-EXEMPT PASS-THROUGH SECURITIES. Tax exempt pass-through certificates
represent an interest in a pool or group of fixed-rate long-term debt
obligations issued by or on behalf of primarily not-for-profit institutions,
the interest on which is exempt from federal income taxation, including
alternative minimum taxation. Such fixed-rate long-term debt obligations may be
private activity bonds issued by states, municipalities or public authorities
to provide funds, usually through a loan or lease arrangement, to a non-profit
corporation for the purpose of financing or refinancing the construction or
improvement of a facility to be used by the non-profit corporation.
Distributions on tax exempt pass-through certificates may be adversely affected
by defaults in or prepayment of the underlying debt obligations. Certain tax
exempt pass-through certificates are issued in several classes with different
levels of yields and credit protection. A fund may invest in lower classes of
tax exempt pass-through certificates that have less credit protection. Tax
exempt pass-through certificates have limited liquidity and certain transfer
restrictions may apply. There currently is no trading market for tax exempt
pass-through certificates and there can be no assurance that such a market will
develop.
THIRD PARTY PUTS. A fund may purchase long-term fixed rate bonds that have been
coupled with an option granted by a third party financial institution allowing
a fund at specified intervals to tender (put) the bonds to the institution and
receive the face value thereof (plus accrued interest). These third party puts
are available in several different forms, may be represented by custodial
receipts or trust certificates and may be combined with other features such as
interest rate swaps. A fund receives a short-term rate of interest (which is
periodically reset), and the interest rate differential between that rate and
the fixed rate on the bond is retained by the financial institution. The
financial institution granting the option does not provide credit enhancement,
and in the event that there is a default in the payment of principal or
interest, or downgrading of a bond to below investment grade, or a loss of the
bond's tax-exempt status, the put option will terminate automatically. As a
result, a fund would be subject to the risks associated with holding such a
long-term bond and the weighted average maturity of that fund's portfolio would
be adversely affected.
These bonds coupled with puts may present the same tax issues as are associated
with Stand-By Commitments. As with any Stand-By Commitments acquired by a fund,
a fund intends to take the position that it is the owner of any municipal
obligation acquired subject to a third-party put, and that tax-exempt interest
earned with respect to such municipal obligations will be tax-exempt in its
hands. There is no assurance that the IRS will agree with such position in any
particular case. Additionally, the federal income tax treatment of certain
other aspects of these investments, including the treatment of tender fees and
swap payments, in relation to various regulated investment company tax
provisions is unclear. However, the Advisor seeks to manage a fund's portfolio
in a manner designed to minimize any adverse impact from these investments.
TO BE ANNOUNCED (TBA) PURCHASE COMMITMENTS. Similar to When-Issued or
Delayed-Delivery securities, a TBA purchase commitment is a security that is
purchased or sold for a fixed price with the underlying securities to be
announced at a future date. However, the seller does not specify the particular
securities to be delivered. Instead, a fund agrees to accept any securities
that meets the specified terms. For example, in a TBA mortgage-backed
transaction, a fund and seller would agree upon the issuer, interest rate and
terms of the underlying mortgages, but the seller would not identify the
specific underlying security until it issues the security. TBA purchase
commitments involve a risk of loss if the value of the underlying security to
be purchased declines prior to delivery date. The yield obtained for such
securities may be higher or lower than yields available in the market on
delivery date. Unsettled TBA purchase commitments are valued at the current
market value of the underlying securities.
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TRUST PREFERRED SECURITIES. A fund may invest in Trust Preferred Securities,
which are hybrid instruments issued by a special purpose trust (Special Trust),
the entire equity interest of which is owned by a single issuer. The proceeds
of the issuance to a fund of Trust Preferred Securities are typically used to
purchase a junior subordinated debenture, and distributions from the Special
Trust are funded by the payments of principal and interest on the subordinated
debenture.
If payments on the underlying junior subordinated debentures held by the
Special Trust are deferred by the debenture issuer, the debentures would be
treated as original issue discount (OID) obligations for the remainder of their
term. As a result, holders of Trust Preferred Securities, such as a fund, would
be required to accrue daily for federal income tax purposes their share of the
stated interest and the de minimis OID on the debentures (regardless of whether
a fund receives any cash distributions from the Special Trust), and the value
of Trust Preferred Securities would likely be negatively affected. Interest
payments on the underlying junior subordinated debentures typically may only be
deferred if dividends are suspended on both common and preferred stock of the
issuer. The underlying junior subordinated debentures generally rank slightly
higher in terms of payment priority than both common and preferred securities
of the issuer, but rank below other subordinated debentures and debt
securities. Trust Preferred Securities may be subject to mandatory prepayment
under certain circumstances. The market values of Trust Preferred Securities
may be more volatile than those of conventional debt securities. Trust
Preferred Securities may be issued in reliance on Rule 144A under the 1933 Act,
and, unless and until registered, are restricted securities. There can be no
assurance as to the liquidity of Trust Preferred Securities and the ability of
holders of Trust Preferred Securities, such as a fund, to sell their holdings.
US GOVERNMENT SECURITIES. A fund may invest in obligations issued or guaranteed
as to both principal and interest by the US Government, its agencies,
instrumentalities or sponsored enterprises which include (a) direct obligations
of the US Treasury, and (b) securities issued or guaranteed by US Government
agencies.
Examples of direct obligations of the US Treasury are Treasury bills, notes,
bonds and other debt securities issued by the US Treasury. These instruments
are backed by the "full faith and credit" of the United States. They differ
primarily in interest rates, the length of maturities and the dates of
issuance. Treasury bills have original maturities of one year or less. Treasury
notes have original maturities of one to ten years and Treasury bonds generally
have original maturities of greater than ten years.
Some agency securities are backed by the full faith and credit of the United
States (such as Maritime Administration Title XI Ship Financing Bonds and
Agency for International Development Housing Guarantee Program Bonds) and
others are backed only by the rights of the issuer to borrow from the US
Treasury (such as Federal Home Loan Bank Bonds and Federal National Mortgage
Association Bonds), while still others, such as the securities of the Federal
Farm Credit Bank, are supported only by the credit of the issuer. With respect
to securities supported only by the credit of the issuing agency or by an
additional line of credit with the US Treasury, there is no guarantee that the
US Government will provide support to such agencies and such securities may
involve risk of loss of principal and interest.
US Government securities may include "zero coupon" securities that have been
stripped by the US Government of their unmatured interest coupons and
collateralized obligations issued or guaranteed by a US Government agency or
instrumentality. Because interest on zero coupon securities is not distributed
on a current basis but is, in effect, compounded, zero coupon securities tend
to be subject to greater risk than interest-paying securities of similar
maturities.
Interest rates on US Government securities may be fixed or variable. Interest
rates on variable rate obligations are adjusted at regular intervals, at least
annually, according to a formula reflecting then current specified standard
rates, such as 91-day US Treasury bill rates. These adjustments generally tend
to reduce fluctuations in the market value of the securities.
The government guarantee of the US Government securities in a fund's portfolio
does not guarantee the net asset value of the shares of a fund. There are
market risks inherent in all investments in securities and the value of an
investment in a fund will fluctuate over time. Normally, the value of
investments in US Government securities varies inversely with changes in
interest rates. For example, as interest rates rise the value of investments in
US Government securities will tend to decline, and as interest rates fall the
value of a fund's investments in US Government securities
II-81
will tend to increase. In addition, the potential for appreciation in the event
of a decline in interest rates may be limited or negated by increased principal
prepayments with respect to certain mortgage-backed securities, such as GNMA
Certificates. Prepayments of high interest rate mortgage-backed securities
during times of declining interest rates will tend to lower the return of a
fund and may even result in losses to a fund if some securities were acquired
at a premium. Moreover, during periods of rising interest rates, prepayments of
mortgage-backed securities may decline, resulting in the extension of a fund's
average portfolio maturity. As a result, a fund's portfolio may experience
greater volatility during periods of rising interest rates than under normal
market conditions.
VARIABLE AND FLOATING RATE INSTRUMENTS. Debt instruments purchased by a fund
may be structured to have variable or floating interest rates. The interest
rate on variable and floating rate securities may be reset daily, weekly or on
some other reset period and may have a floor or ceiling on interest rate
changes. The interest rate of variable rate securities ordinarily is determined
by reference to or is a percentage of an objective standard such as a bank's
prime rate, the 90-day US Treasury Bill rate, or the rate of return on
commercial paper or bank certificates of deposit. Generally, the changes in the
interest rate on variable rate securities reduce the fluctuation in the market
value of such securities. Accordingly, as interest rates decrease or increase,
the potential for capital appreciation or depreciation is less than for
fixed-rate obligations. A fund may purchase variable rate securities on which
stated minimum or maximum rates, or maximum rates set by state law, limit the
degree to which interest on such instruments may fluctuate; to the extent it
does, increases or decreases in value of such instruments may be somewhat
greater than would be the case without such limits. Because the adjustment of
interest rates on the variable rate securities is made in relation to movements
of the applicable rate adjustment index, the instruments are not comparable to
long-term fixed interest rate securities. Accordingly, interest rates on the
variable rate securities may be higher or lower than current market rates for
fixed rate obligations of comparable quality with similar final maturities. A
money market fund determines the maturity of variable rate securities in
accordance with Rule 2a-7, which allows a fund to consider certain of such
instruments as having maturities shorter than the maturity date on the face of
the instrument.
The Advisor will consider the earning power, cash flows and other liquidity
ratios of the issuers and guarantors of such instruments and, if the instrument
is subject to a demand feature (described below), will continuously monitor the
issuer's financial ability to meet payment on demand. Where necessary to ensure
that a variable or floating rate instrument is equivalent to the quality
standards applicable to a fund's fixed income investments, the issuer's
obligation to pay the principal of the instrument will be backed by an
unconditional bank letter or line of credit, guarantee or commitment to lend.
Any bank providing such a bank letter, line of credit, guarantee or loan
commitment will meet a fund's investment quality standards relating to
investments in bank obligations. The Advisor will also monitor the
creditworthiness of issuers of such instruments to determine whether a fund
should continue to hold the investments.
The absence of an active secondary market for certain variable and floating
rate notes could make it difficult to dispose of the instruments, and a fund
could suffer a loss if the issuer defaults or during periods in which a fund is
not entitled to exercise its demand rights. When a reliable trading market for
the variable and floating rate instruments held by a fund does not exist and a
fund may not demand payment of the principal amount of such instruments within
seven days, the instruments will be subject to a fund's limitation on
investments in illiquid securities.
Variable Rate Demand Securities. A fund may purchase variable rate demand
securities, which are variable rate securities that permit a fund to demand
payment of the unpaid principal balance plus accrued interest upon a specified
number of days' notice to the issuer or its agent. The demand feature may be
backed by a bank letter of credit or guarantee issued with respect to such
instrument. A bank that issues a repurchase commitment may receive a fee from a
fund for this arrangement. The issuer of a variable rate demand security may
have a corresponding right to prepay in its discretion the outstanding
principal of the instrument plus accrued interest upon notice comparable to
that required for the holder to demand payment.
Variable Rate Master Demand Notes. A fund may purchase variable rate master
demand notes, which are unsecured instruments that permit the indebtedness
thereunder to vary and provide for periodic adjustments in the interest rate.
Because variable rate master demand notes are direct lending arrangements
between a fund and the issuer, they are not ordinarily traded. Although no
active secondary market may exist for these notes, a fund will purchase only
those notes under which it may demand and receive payment of principal and
accrued interest daily or may resell the note at any time to a third party.
These notes are not typically rated by credit rating agencies.
II-82
VARIABLE RATE DEMAND PREFERRED SECURITIES. A fund may purchase certain variable
rate demand preferred securities (VRDPs) issued by closed-end municipal bond
funds, which, in turn, invest primarily in portfolios of tax-exempt municipal
bonds. A fund may invest in securities issued by single-state or national
closed-end municipal bond funds. VRDPs are issued by closed-end funds to
leverage returns for common shareholders. Under the 1940 Act, a closed-end fund
that issues preferred shares must maintain an asset coverage ratio of at least
200% immediately after the time of issuance and at the time of certain
distributions on repurchases of its common stock. It is anticipated that the
interest on the VRDPs will be exempt from federal income tax and, with respect
to any such securities issued by single-state municipal bond funds, exempt from
the applicable state's income tax, although interest on VRDPs may be subject to
the federal alternative minimum tax. The VRDPs will pay a variable dividend
rate, determined weekly, typically through a remarketing process, and include a
demand feature that provides a fund with a contractual right to tender the
securities to a liquidity provider. A fund could lose money if the liquidity
provider fails to honor its obligation, becomes insolvent, or files for
bankruptcy. A fund has no right to put the securities back to the closed-end
municipal bond funds or demand payment or redemption directly from the
closed-end municipal bond funds. Further, the VRDPs are not freely transferable
and, therefore, a fund may only transfer the securities to another investor in
compliance with certain exemptions under the 1933 Act, including Rule 144A.
A fund's purchase of VRDPs issued by closed-end municipal bond funds is subject
to the restrictions set forth under the heading "Investment Company and Other
Pooled Investment Vehicles."
WARRANTS. The holder of a warrant has the right, until the warrant expires, to
purchase a given number of shares of a particular issuer at a specified price.
Such investments can provide a greater potential for profit or loss than an
equivalent investment in the underlying security. Prices of warrants do not
necessarily move, however, in tandem with the prices of the underlying
securities and are, therefore, considered speculative investments. Warrants pay
no dividends and confer no rights other than a purchase option. Thus, if a
warrant held by a fund were not exercised by the date of its expiration, a fund
would lose the entire purchase price of the warrant.
WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES. A fund may purchase securities on
a when-issued or delayed-delivery basis. Delivery of and payment for these
securities can take place a month or more after the date of the purchase
commitment. The payment obligation and the interest rate that will be received
on when-issued and delayed-delivery securities are fixed at the time the buyer
enters into the commitment. Due to fluctuations in the value of securities
purchased or sold on a when-issued or delayed-delivery basis, the yields
obtained on such securities may be higher or lower than the yields available in
the market on the dates when the investments are actually delivered to the
buyers. When-issued securities may include securities purchased on a "when, as
and if issued" basis, under which the issuance of the security depends on the
occurrence of a subsequent event, such as approval of a merger, corporate
reorganization or debt restructuring. The value of such securities is subject
to market fluctuation during this period and no interest or income, as
applicable, accrues to a fund until settlement takes place.
At the time a fund makes the commitment to purchase securities on a when-issued
or delayed delivery basis, it will record the transaction, reflect the value
each day of such securities in determining its net asset value and, if
applicable, calculate the maturity for the purposes of average maturity from
that date. At the time of settlement a when-issued security may be valued at
less than the purchase price. To facilitate such acquisitions, a fund
identifies on its books cash or liquid assets in an amount at least equal to
such commitments. It may be expected that a fund's net assets will fluctuate to
a greater degree when it sets aside portfolio securities to cover such purchase
commitments than when it sets aside cash. On delivery dates for such
transactions, a fund will meet its obligations from maturities or sales of the
segregated securities and/or from cash flow. If a fund chooses to dispose of
the right to acquire a when-issued security prior to its acquisition, it could,
as with the disposition of any other portfolio obligation, incur a gain or loss
due to market fluctuation. When a fund engages in when-issued or
delayed-delivery transactions, it relies on the other party to consummate the
trade and is, therefore, exposed to counterparty risk. Failure of the seller to
do so may result in a fund's incurring a loss or missing an opportunity to
obtain a price considered to be advantageous.
YANKEE BONDS. Yankee Bonds are US dollar-denominated bonds sold in the US by
non-US issuers. As compared with bonds issued in the US, such bond issues
normally pay interest but are less actively traded. Investing in the securities
of foreign companies involves more risks than investing in securities of US
companies. Their value is subject to economic and political developments in the
countries where the companies operate and to changes in foreign currency
values.
II-83
Values may also be affected by foreign tax laws, changes in foreign economic or
monetary policies, exchange control regulations and regulations involving
prohibitions on the repatriation of foreign currencies. In many foreign
countries, there is less publicly available information about foreign issuers,
and there is less government regulation and supervision of foreign stock
exchanges, brokers and listed companies. Also in many foreign countries,
companies are not subject to uniform accounting, auditing, and financial
reporting standards comparable to those applicable to domestic issuers.
Security trading practices and custody arrangements abroad may offer less
protection to a fund's investments and there may be difficulty in enforcing
legal rights outside the United States. Settlement of transactions in some
foreign markets may be delayed or may be less frequent than in the United
States which could affect the liquidity of a fund's portfolio. Additionally, in
some foreign countries, there is the possibility of expropriation or
confiscatory taxation, limitations on the removal of securities, property, or
other fund assets, political or social instability or diplomatic developments
which could affect investments in foreign securities. In addition, the relative
performance of various countries' fixed income markets historically has
reflected wide variations relating to the unique characteristics of each
country's economy. Year-to-year fluctuations in certain markets have been
significant, and negative returns have been experienced in various markets from
time to time.
YIELDS AND RATINGS. The yields on certain obligations in which a fund may
invest (such as commercial paper and bank 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 Moody's Investors Service (Moody's), the Standard &
Poor's (S&P) Division of The McGraw-Hill Companies and Fitch Ratings, Inc.
(Fitch) represent their opinions as to the quality of the securities that they
undertake to rate. Ratings, however, are general and are not absolute standards
of quality or value. Consequently, obligations with the same rating, maturity
and interest rate may have different market prices. See "Ratings of
Investments" for descriptions of the ratings provided by certain recognized
rating organizations.
ZERO COUPON SECURITIES AND DEFERRED INTEREST BONDS. A fund may invest in zero
coupon securities that are "stripped" US Treasury notes and bonds and in
deferred interest bonds. Zero coupon securities are the separate income or
principal components of a debt instrument. Zero coupon and deferred interest
bonds are debt obligations which are issued at a significant discount from face
value. The original discount approximates the total amount of interest the
bonds will accrue and compound over the period until maturity or the first
interest accrual date at a rate of interest reflecting the market rate of the
security at the time of issuance. Zero coupon securities are redeemed at face
value at their maturity date without interim cash payments of interest or
principal. The amount of this discount is accrued over the life of the
security, and the accrual constitutes the income earned on the security for
both accounting and federal income tax purposes. Because of these features, the
market prices of zero coupon securities are generally more volatile than the
market prices of securities that have similar maturity but that pay interest
periodically.
While zero coupon bonds do not require the periodic payment of interest,
deferred interest bonds generally provide for a period of delay before the
regular payment of interest begins. Although this period of delay is different
for each deferred interest bond, a typical period is approximately one-third of
the bond's term to maturity. Such investments benefit the issuer by mitigating
its initial need for cash to meet debt service, but some also provide a higher
rate of return to attract investors who are willing to defer receipt of such
cash.
A fund will accrue income on such investments for tax and accounting purposes,
as required, which will generally be prior to the receipt of the corresponding
cash payments. Because a fund is required to distribute to shareholders
substantially all of its net investment income, including such accrued income,
to avoid federal income and excise taxes, a fund may be required to liquidate
portfolio securities to satisfy a fund's distribution obligations (including at
a time when it may not be advantageous to do so). Under many market conditions,
investments in zero coupon, step-coupon and pay-in-kind securities may be
illiquid, making it difficult for a fund to dispose of them or to determine
their current value.
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PART II: APPENDIX II-H - TAXES
TAXES
The following is intended to be a general summary of certain federal income tax
consequences of investing in a fund. This discussion does not address all
aspects of taxation (including state, local, and foreign taxes) that may be
relevant to particular shareholders in light of their own investment or tax
circumstances, or to particular types of shareholders (including insurance
companies, tax-deferred retirement plans, financial institutions or
broker-dealers, foreign corporations, and persons who are not citizens or
residents of the United States) subject to special treatment under the US
federal income tax laws. Current and prospective investors are therefore
advised to consult with their tax advisors before making an investment in a
fund. This summary is based on the laws in effect on the date of this SAI and
on existing judicial and administrative interpretations thereof, all of which
are subject to change, possibly with retroactive effect.
Feeder Funds. Certain funds (Feeder Funds) invest all or substantially all of
their assets in either the DWS Equity 500 Index Portfolio or the Cash
Management Portfolio (each, a Master Portfolio), which are partnerships for US
federal income tax purposes. For a discussion of the US federal income tax
treatment of a Master Portfolio, please see the registration statement for that
Master Portfolio. The amount and character of a Feeder Fund's income, gains,
losses, deductions and other tax items will generally be determined at the
Master Portfolio level and the Feeder Fund will be allocated, and is required
to take into account, its share of its Master Portfolio's income, gains, losses
and other tax items for each taxable year. Consequently, references herein to a
fund's income, gains, losses and other tax items, as well as its activities,
investment and holdings, as applied to a Feeder Fund, generally include the tax
items, activities, investments and holdings realized, recognized, conducted or
held, as applicable, either by the Feeder Fund directly or through its Master
Portfolio. See "Investments in the Master Portfolios" for more information.
TAXATION OF A FUND AND ITS INVESTMENTS
QUALIFICATION AS A REGULATED INVESTMENT COMPANY. A fund has elected (or in the
case of a new fund, intends to elect) to be treated, and intends to qualify
each year, as a regulated investment company under Subchapter M of the Internal
Revenue Code of 1986 (Code). If a fund qualifies for treatment as a regulated
investment company that is accorded special tax treatment, such fund will not
be subject to federal income tax on income distributed in a timely manner to
its shareholders in the form of dividends (including Capital Gain Dividends, as
defined below). In order to qualify for the special tax treatment accorded
regulated investment companies and their shareholders under the Code, a fund
must, among other things:
(a) derive at least 90% of its gross income for each taxable year from (i)
dividends, interest, payments with respect to certain securities loans, gains
from the sale or other disposition of stock, securities or foreign currencies,
or other income (including but not limited to gains from options, futures, or
forward contracts) derived with respect to its business of investing in such
stock, securities, or currencies and (ii) net income derived from interests in
"qualified publicly traded partnerships" (as defined below);
(b) diversify its holdings so that, at the end of each quarter of its taxable
year, (i) at least 50% of the market value of its total assets are represented
by cash and cash items, US Government securities, securities of other regulated
investment companies, and other securities limited in respect of any one issuer
to a value not greater than 5% of the value of a fund's total assets and not
more than 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets are invested (x) in the securities
(other than those of the US Government or other regulated investment companies)
of any one issuer or of two or more issuers which the fund controls and which
are engaged in the same, similar, or related trades or businesses, or (y) in
the securities of one or more qualified publicly traded partnerships (as
defined below); and
(c) distribute with respect to each taxable year at least 90% of the sum of its
investment company taxable income (as that term is defined in the Code without
regard to the deduction for dividends paid; investment company taxable income
generally consists of taxable ordinary income and the excess, if any, of net
short-term capital gains over net long-term capital losses) and net tax-exempt
interest income, if any, for such year.
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In general, for purposes of the 90% gross income requirement described in
paragraph (a) above, income derived from a partnership will be treated as
qualifying income only to the extent such income is attributable to items of
income of the partnership which would be qualifying income if realized directly
by a fund. However, 100% of net income derived from an interest in a "qualified
publicly traded partnership" (generally, a partnership (x) the interests in
which are traded on an established securities market or readily tradable on a
secondary market or the substantial equivalent thereof, and (y) that derives
less than 90% of its income from the qualifying income described in paragraph
(a)(i) above) will be treated as qualifying income. In general, "qualified
publicly traded partnerships" in which a fund will invest will be treated as
partnerships for federal income tax purposes because they meet the passive
income requirement under Code section 7704(c)(2).
For purposes of the diversification test in paragraph (b) above, the term
"outstanding voting securities of such issuer" will include the equity
securities of a qualified publicly traded partnership. It is possible that
certain partnerships in which a fund may invest will be master limited
partnerships constituting qualified publicly traded partnerships. Such
investments will be limited by a fund's intention to qualify as a regulated
investment company under the Code. In addition, although the passive loss rules
of the Code do not generally apply to regulated investment companies, such
rules do apply to a regulated investment company with respect to items
attributable to an interest in a qualified publicly traded partnership. Fund
investments in partnerships, including in qualified publicly traded
partnerships, may result in a fund being subject to state, local or foreign
income, franchise or withholding taxes.
Pursuant to current Internal Revenue Service (IRS) guidance, a Feeder Fund
investing in a Master Portfolio will be treated as holding directly the
underlying assets of the Master Portfolio for purposes of the diversification
test in (b) above.
In addition, for purposes of the diversification test in paragraph (b) above,
the identification of the issuer (or, in some cases, issuers) of a particular
fund investment can depend on the terms and conditions of that investment. In
some cases, identification of the issuer (or issuers) is uncertain under
current law, and an adverse determination or future guidance by the IRS with
respect to issuer identification for a particular type of investment may
adversely affect a fund's ability to meet the diversification test in paragraph
(b) above.
FAILURE TO QUALIFY AS A REGULATED INVESTMENT COMPANY. If a fund were to fail to
meet the income, diversification or distribution tests described above, the
fund could in some cases cure such failure, including by paying a fund-level
tax, paying interest, making additional distributions or disposing of certain
assets. If a fund were ineligible to or otherwise did not cure such failure for
any year, the fund would fail to qualify as a "regulated investment company"
for such year. All of the fund's taxable income would be subject to federal
income tax at regular corporate rates (without any deduction for distributions
to its shareholders), and all distributions from earnings and profits,
including any distributions of net tax-exempt income and net long-term capital
gains, would be taxable to shareholders as ordinary income. Some portions of
such distributions, however, could be eligible (i) to be treated as qualified
dividend income in the case of shareholders taxed as individuals and other
noncorporate shareholders and (ii) for the dividends-received deduction in the
case of corporate shareholders provided, in both cases, the shareholder meets
certain holding period and other requirements in respect of the fund's shares
(as described below). In addition, a fund could be required to recognize
unrealized gains, pay substantial taxes and interest and make substantial
distributions before requalifying as a regulated investment company that is
accorded special federal income tax treatment.
A fund is subject to a 4% nondeductible excise tax on amounts that have been
retained rather than distributed, as required, under a prescribed formula. The
formula requires payment to shareholders during a calendar year of
distributions representing at least 98% of a fund's taxable ordinary income for
the calendar year and at least 98.2% of the excess of its capital gains over
capital losses realized during the one-year period ending October 31 of such
year (or the last day of a fund's taxable year if a fund's taxable year ends in
November or December and a fund makes an election to use such later date), as
well as amounts that were neither distributed by nor taxed to a fund during the
prior calendar year. For purposes of the required excise tax distribution,
ordinary gains and losses from the sale, exchange or other taxable disposition
of property that would be taken into account after October 31 (or later if the
fund is permitted to so elect and does so elect) are treated as arising on
January 1 of the following calendar year. Also for purposes of the excise tax,
a fund will be treated as having distributed any ordinary income or capital
gain net income on which
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it has been subject to corporate income tax in the taxable year ending within
the calendar year. Although a fund's distribution policies should enable it to
avoid this excise tax, a fund may retain (and be subject to income or excise
tax on) a portion of its capital gain or other income if it appears to be in
the interest of such fund.
SPECIAL TAX PROVISIONS THAT APPLY TO CERTAIN INVESTMENTS. Certain of a fund's
investment practices are subject to special and complex federal income tax
provisions, including rules relating to short sales, constructive sales,
"straddle" and "wash sale" transactions and section 1256 contracts (as defined
below), 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 into higher taxed short-term capital gains or ordinary
income, (iii) convert an ordinary loss or a deduction into a capital loss, (iv)
cause a fund to recognize income or gain without a corresponding receipt of
cash, and/or (v) adversely alter the characterization of certain fund
investments. Moreover, the straddle rules and short sale rules may require the
capitalization of certain related expenses of a fund.
Certain debt obligations. Some debt obligations with a fixed maturity date of
more than one year from the date of issuance (and zero-coupon debt obligations
with a fixed maturity date of more than one year from the date of issuance)
that are acquired by a fund will be treated as debt obligations that are issued
originally at a discount. Generally, the amount of the original issue discount
(OID) is treated as interest income and is included in a fund's income (and
required to be distributed by a fund) over the term of the debt security, even
though payment of that amount is not received until a later time, upon partial
or full repayment or disposition of the debt security. In addition,
payment-in-kind securities will give rise to income which is required to be
distributed and is taxable even though a fund holding the security receives no
interest payment in cash on the security during the year.
Some debt obligations with a fixed maturity date of more than one year from the
date of issuance that are acquired by a fund in the secondary market may be
treated as having "market discount." Very generally, market discount is the
excess of the stated redemption price of a debt obligation (or in the case of
an obligation issued with OID, its "revised issue price") over the purchase
price of such obligation. Generally, any gain recognized on the disposition of,
and any partial payment of principal on, a debt security having market discount
is treated as ordinary income to the extent the gain, or principal payment,
does not exceed the "accrued market discount" on such debt security.
Alternatively, a fund may elect to accrue market discount currently, in which
case a fund will be required to include the accrued market discount in a fund's
income (as ordinary income) and thus distribute it over the term of the debt
security, even though payment of that amount is not received until a later
time, upon partial or full repayment or disposition of the debt security. The
rate at which the market discount accrues, and thus is included in a fund's
income, will depend upon which of the permitted accrual methods a fund elects.
Some debt obligations with a fixed maturity date of one year or less from the
date of issuance that are acquired by a fund may be treated as having OID or,
in certain cases, "acquisition discount" (very generally, the excess of the
stated redemption price over the purchase price). A fund will be required to
include the OID or acquisition discount in income (as ordinary income) and thus
distribute it over the term of the debt security, even though payment of that
amount is not received until a later time, upon partial or full repayment or
disposition of the debt security. The rate at which OID or acquisition discount
accrues, and thus is included in a fund's income, will depend upon which of the
permitted accrual methods a fund elects.
If a fund holds the foregoing kinds of securities, it may be required to pay
out as an income distribution each year an amount which is greater than the
total amount of cash interest a fund actually received. Such distributions may
be made from the cash assets of a fund or by liquidation of portfolio
securities that it might otherwise have continued to hold. A fund may realize
gains or losses from such liquidations. In the event a fund realizes net gains
from such transactions, its shareholders may receive larger distributions than
they would have received in the absence of such transactions. These investments
may also affect the character of income recognized by a fund.
A portion of the OID accrued on certain high yield discount obligations may not
be deductible to the issuer and will instead be treated as a dividend paid by
the issuer for purposes of the dividends received deduction. In such cases, if
the issuer of the high yield discount obligations is a domestic corporation,
dividend payments by a fund may be eligible for the dividends received
deduction to the extent attributable to the deemed dividend portion of such
OID.
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Investments in debt obligations that are at risk of or in default present
special tax issues for a fund. Federal income tax rules are not entirely clear
about issues such as whether and, if so, to what extent a fund should recognize
market discount on such a debt obligation, when a fund may cease to accrue
interest, OID 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 exchanges of debt obligations in a workout context are taxable. These
and other issues will be addressed by a fund, when, as and if it invests in
such securities, in order to seek to ensure that it distributes sufficient
income to preserve its status as a regulated investment company and does not
become subject to US federal income or excise tax.
Very generally, where a fund purchases a bond at a price that exceeds the
stated principal amount (i.e., a premium), the premium is amortizable over the
remaining term of the bond. In the case of a taxable bond, if a fund makes an
election applicable to all such bonds it purchases, which election is
irrevocable, the fund reduces the current taxable income from the bond by the
amortizable premium and reduces its tax basis in the bond by the amount of such
offset; upon the disposition or maturity of such bonds acquired on or after
January 4, 2013, the fund is permitted to deduct, against stated interest from
other bonds, any premium not previously deducted. In the case of a tax-exempt
bond, tax rules require such a fund to reduce its tax basis by the amount of
amortizable premium.
Derivatives. In addition to the special rules described below in respect of
options transactions and futures, a fund's transactions in other derivative
instruments (e.g. forward contracts and swap agreements), as well as any of its
other hedging, short sale or similar transactions, may be subject to special
provisions of the Code (including provisions relating to "hedging transactions"
and "straddles") that, among other things, may affect the character of gains
and losses realized by a fund (i.e., may affect whether gains or losses are
ordinary or capital), accelerate recognition of income to a fund and defer fund
losses. These rules could therefore affect the character, amount and timing of
distributions to shareholders. These provisions may also (i) require a fund to
mark to market annually certain types of the positions in its portfolio (i.e.,
treat them as if they were closed out at the end of each year), or (ii) cause a
fund to recognize income without receiving cash with which to pay dividends or
make distributions in amounts necessary to satisfy the distribution
requirements described above in order to avoid certain income and excise taxes.
A fund may be required to liquidate other investments (including when it is not
advantageous to do so) to meet its distribution requirements, which may also
accelerate the recognition of gain by the fund. A fund will monitor its
transactions, make the appropriate tax elections and make the appropriate
entries in its books and records when it acquires any foreign currency, forward
contract, option, futures contract or hedged investment in order to mitigate
the effect of these rules and prevent disqualification of a fund as a regulated
investment company.
In general, option premiums received by a fund are not immediately included in
the income of a fund. Instead, the premiums are recognized when the option
contract expires, the option is exercised by the holder, or a fund transfers or
otherwise terminates the option (e.g., through a closing transaction). If a
call option written by a fund is exercised and a fund sells or delivers the
underlying stock, a fund generally will recognize capital gain or loss equal to
(a) the sum of the strike price and the option premium received by a fund minus
(b) a fund's basis in the stock. Such gain or loss generally will be short-term
or long-term depending upon the holding period of the underlying stock. If
securities are purchased by a fund pursuant to the exercise of a put option
written by it, a fund generally will subtract the premium received from its
cost basis in the securities purchased. The gain or loss with respect to any
termination of a fund's obligation under an option other than through the
exercise of the option and related sale or delivery of the underlying stock
generally will be short-term gain or loss depending on whether the premium
income received by a fund is greater or less than the amount paid by a fund (if
any) in terminating the transaction. Thus, for example, if an option written by
a fund expires unexercised, a fund generally will recognize short-term gain
equal to the premium received.
Certain covered call writing activities of a fund may trigger the US federal
income tax straddle rules of Section 1092 of the Code, requiring that losses be
deferred and holding periods be tolled on offsetting positions in options and
stocks deemed to constitute substantially similar or related property. Options
on single stocks that are not "deep in the money" may give rise to qualified
covered calls, which generally are not subject to the straddle rules; the
holding period on stock underlying qualified covered calls that are "in the
money" although not "deep in the money" will be suspended during the period
that such calls are outstanding. Thus, the straddle rules and the rules
governing qualified covered calls could cause gains that would otherwise
constitute long-term capital gains to be treated as short-term capital gains,
and distributions that would otherwise constitute "qualified dividend income"
(as discussed below) or
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qualify for the dividends-received deduction (as discussed below) to fail to
satisfy the holding period requirements and therefore to be taxed at ordinary
income tax rates or to fail to qualify for the 70% dividends-received
deduction, as the case may be.
A fund's investment in so called "section 1256 contracts," which include
certain futures contracts as well as listed non-equity options written or
purchased by a fund on US exchanges (including options on futures contracts,
equity indices and debt securities), are subject to special federal income tax
rules. All section 1256 contracts held by a fund at the end of its taxable year
are required to be marked to their market value, and any unrealized gain or
loss on those positions will be included in a fund's income as if each position
had been sold for its fair market value at the end of the taxable year. The
resulting gain or loss will be combined with any gain or loss realized by a
fund from positions in section 1256 contracts closed during the taxable year.
Provided such positions were held as capital assets and were neither part of a
"hedging transaction" nor part of a "straddle," 60% of the resulting net gain
or loss will be treated as long-term capital gain or loss, and 40% of such net
gain or loss will be treated as short-term capital gain or loss (although
certain foreign currency gains and losses from such contracts may be treated as
ordinary in character), regardless of the period of time the positions were
actually held by a fund.
As a result of entering into swap contracts, a fund may make or receive
periodic net payments. A fund may also make or receive a payment when a swap is
terminated prior to maturity through an assignment of the swap or other closing
transaction. Periodic net payments will generally constitute ordinary income or
deductions, while termination of a swap will generally result in capital gain
or loss (which will be a long-term capital gain or loss if a fund has been a
party to the swap for more than one year). With respect to certain types of
swaps, a fund may be required to currently recognize income or loss with
respect to future payments on such swaps or may elect under certain
circumstances to mark such swaps to market annually for federal income tax
purposes as ordinary income or loss. The federal income tax treatment of many
types of credit default swaps is uncertain under current law.
In general, gain or loss on a short sale is recognized when a fund closes the
sale by delivering the borrowed property to the lender, not when the borrowed
property is sold. Gain or loss from a short sale is generally treated as
capital gain or loss to the extent that the property used to close the short
sale constitutes a capital asset in a fund's hands. Except with respect to
certain situations where the property used by a fund to close a short sale has
a long-term holding period on the date of the short sale, special rules would
generally treat the gains on short sales as short-term capital gains. These
rules may also terminate the running of the holding period of "substantially
identical property" held by a fund. Moreover, a loss on a short sale will be
treated as a long-term capital loss if, on the date of the short sale,
"substantially identical property" has been held by a fund for more than a
year. In general, a fund will not be permitted to deduct payments made to
reimburse the lender of securities for dividends paid on borrowed stock if the
short sale is closed on or before the 45th day after the short sale is entered
into.
Income from certain commodity-linked derivatives does not constitute qualifying
income to a fund. The federal income tax treatment of commodity-linked notes
and certain other derivative instruments in which a fund might invest is not
certain, in particular with respect to whether income and gains from such
instruments constitutes qualifying income. If a fund treats income from a
particular instrument as qualifying income and the income is later determined
not to constitute qualifying income, and, together with any other nonqualifying
income, causes the fund's nonqualifying income to exceed 10% of its gross
income in any taxable year, the fund will fail to qualify as a regulated
investment company unless it is eligible to and does pay a tax at the fund
level. Certain funds (including the DWS Enhanced Commodity Strategy Fund, DWS
Gold and Precious Metals Fund, and DWS Global Inflation Fund) have obtained
private letter rulings from the IRS confirming that the income and gain earned
through a wholly-owned subsidiary that invests in certain types of
commodity-linked derivatives constitute qualifying income under the Code.
Because the rules described above and other federal income tax rules applicable
to these types of transactions are in some cases uncertain under current law,
an adverse determination or future guidance by the IRS with respect to these
rules (which determination or guidance could be retroactive) may affect whether
a fund has made sufficient distributions, and otherwise satisfied the relevant
requirements, to maintain its qualification as a regulated investment company
and avoid a fund-level tax. A fund intends to limit its activities in options,
futures contracts, forward contracts, short sales, swaps and related
transactions to the extent necessary to meet the requirements for qualification
and treatment as a regulated investment company under the Code.
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REITs. A fund's investments in equity securities of real estate investment
trusts (REITs) may result in a fund's receipt of cash in excess of the REIT's
earnings; if a fund distributes these amounts, the distributions could
constitute a return of capital to fund shareholders for federal income tax
purposes. In addition, such investments in REIT equity securities also may
require a fund to accrue and distribute income not yet received. To generate
sufficient cash to make the requisite distributions, a fund may be required to
sell securities in its portfolio (including when it is not advantageous to do
so) that it otherwise would have continued to hold. Dividends received by a
fund from a REIT will not qualify for the corporate dividends-received
deduction and generally will not constitute qualified dividend income.
Under a notice issued by the IRS in October 2006 and Treasury regulations that
have yet to be issued but may apply retroactively, a portion of a fund's income
from a residual interest in a real estate mortgage investment conduit (REMIC)
or an equity interest in a taxable mortgage pool (TMP) including such income
received indirectly through a REIT or other pass-through entity (referred to in
the Code as an "excess inclusion") will be subject to federal income tax in all
events. This notice also provides, and the regulations are expected to provide,
that excess inclusion income of a regulated investment company will be
allocated to shareholders of the regulated investment company in proportion to
the dividends received by such shareholders, with the same consequences as if
the shareholders held the related REMIC or TMP interest directly (see Taxation
of US Shareholders - Dividends and distributions - Additional considerations
and see also Tax-exempt Shareholders for a summary of certain federal income
tax consequences to shareholders of distributions reported as excess inclusion
income).
Standby commitments. A fund may purchase municipal securities together with the
right to resell the securities to the seller at an agreed upon price or yield
within a specified period prior to the maturity date of the securities. Such a
right to resell is commonly known as a "put" and is also referred to as a
"standby commitment." A fund may pay for a standby commitment either in cash or
in the form of a higher price for the securities which are acquired subject to
the standby commitment, thus increasing the cost of securities and reducing the
yield otherwise available. Additionally, a fund may purchase beneficial
interests in municipal securities held by trusts, custodial arrangements or
partnerships and/or combined with third-party puts or other types of features
such as interest rate swaps; those investments may require a fund to pay
"tender fees" or other fees for the various features provided. The IRS has
issued a revenue ruling to the effect that, under specified circumstances, a
regulated investment company will be the owner of tax-exempt municipal
obligations acquired subject to a put option. The IRS has also issued private
letter rulings to certain taxpayers (which do not serve as precedent for other
taxpayers) to the effect that tax-exempt interest received by a regulated
investment company with respect to such obligations will be tax-exempt in the
hands of the company and may be distributed to its shareholders as
exempt-interest dividends. The IRS has subsequently announced that it will not
ordinarily issue advance ruling letters as to the identity of the true owner of
property in cases involving the sale of securities or participation interests
therein if the purchaser has the right to cause the security, or the
participation interest therein, to be purchased by either the seller or a third
party. A fund, where relevant, intends to take the position that it is the
owner of any municipal obligations acquired subject to a standby commitment or
other third party put and that tax-exempt interest earned with respect to such
municipal obligations will be tax-exempt in its hands. There is no assurance
that the IRS will agree with such position in any particular case. If a fund is
not viewed as the owner of such municipal obligations, it will not be permitted
to treat the exempt interest paid on such obligations as belonging to it. This
may affect the fund's eligibility to pay exempt-interest dividends to its
shareholders. Additionally, the federal income tax treatment of certain other
aspects of these investments, including the treatment of tender fees paid by a
fund, in relation to various regulated investment company tax provisions is
unclear. However, the Advisor intends to manage a fund's portfolio in a manner
designed to minimize any adverse impact from the tax rules applicable to these
investments.
As described herein, in certain circumstances a fund may be required to
recognize taxable income or gain even though no corresponding amounts of cash
are received concurrently. A fund may therefore be required to obtain cash to
satisfy its distribution requirements by selling securities at times when it
might not otherwise be desirable to do so or by borrowing the necessary cash,
thereby incurring interest expense. In certain situations, a fund will, for a
taxable year, defer all or a portion of its capital losses and currency losses
realized after October 31 until the next taxable year in computing its
investment company taxable income and net capital gain, which will defer the
recognition of such realized losses. Such deferrals and other rules regarding
gains and losses realized after October 31 may affect the federal income tax
character of shareholder distributions.
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Foreign investments. Income (including, in some cases, capital gains) from
investments in foreign stocks or securities may be subject to foreign taxes,
including withholding and other taxes imposed by foreign jurisdictions. Tax
conventions between certain countries and the US may reduce or eliminate such
taxes. It is not possible to determine a fund's effective rate of foreign tax
in advance since the amount of a fund's assets to be invested in various
countries is not known. Payment of such taxes will reduce a fund's yield on
those investments.
If a fund is liable for foreign taxes and if more than 50% of the value of a
fund's total assets at the close of its taxable year consists of stocks or
securities of foreign corporations (including foreign governments), a fund may
make an election pursuant to which certain foreign taxes paid by a fund would
be treated as having been paid directly by shareholders of a fund. Pursuant to
such election, shareholders may be able to claim a credit or deduction on their
federal income tax returns for their pro rata portions of qualified taxes paid
by a fund to foreign countries in respect of foreign securities that such fund
has held for at least the minimum period specified in the Code. In such a case,
shareholders will include in gross income from foreign sources their pro rata
shares of such taxes paid by a fund. Each shareholder of a fund will be
notified whether the foreign taxes paid by a fund will "pass through" for that
year and, if so, such notification will report the shareholder's portion of (i)
the foreign taxes paid by a fund and (ii) a fund's foreign source income.
Certain fund of funds also may qualify to pass through to shareholders foreign
taxes paid by underlying funds in which the fund of funds invests. See
Fund-of-Funds Structure, below.
A shareholder's ability to claim an offsetting foreign tax credit or deduction
in respect of foreign taxes paid by a fund is subject to certain limitations
imposed by the Code, which may result in the shareholder not receiving a full
credit or deduction (if any) for the amount of such taxes. Shareholders who do
not itemize on their US federal income tax returns may claim a credit (but not
a deduction) for such foreign taxes. The amount of foreign taxes that a
shareholder may claim as a credit in any year will generally be subject to a
separate limitation for "passive income," which includes, among other types of
income, dividends, interest and certain foreign currency gains. Because capital
gains realized by a fund on the sale of foreign securities will be treated as
US source income, the available credit of foreign taxes paid with respect to
such gains may be restricted. Shareholders that are not subject to US federal
income tax, and those who invest in a fund through tax-advantaged accounts
(including those who invest through individual retirement accounts or other
tax-advantaged retirement plans), generally will receive no benefit from any
tax credit or deduction passed through by a fund.
If a fund does not satisfy the requirements for passing through to its
shareholders their proportionate shares of any foreign taxes paid by a fund,
shareholders generally will not be entitled to claim a credit or deduction with
respect to foreign taxes incurred by a fund and will not be required to include
such taxes in their gross income.
A fund's transactions in foreign currencies, foreign-currency-denominated debt
obligations and certain foreign currency options, futures contracts and forward
contracts (and similar instruments) may give rise to ordinary income or loss to
the extent such income or loss results from fluctuations in the value of the
foreign currency concerned. Under section 988 of the Code, gains or losses
attributable to fluctuations in exchange rates between the time a fund accrues
income or receivables or expenses or other liabilities denominated in a foreign
currency and the time a fund actually collects such income or pays such
liabilities are generally treated as ordinary income or ordinary loss. In
general, gains (and losses) realized on debt instruments will be treated as
section 988 gain (or loss) to the extent attributable to changes in exchange
rates between the US dollar and the currencies in which the instruments are
denominated. Similarly, gains or losses on foreign currency, foreign currency
forward contracts and certain foreign currency options or futures contracts, to
the extent attributable to fluctuations in exchange rates between the
acquisition and disposition dates, are also treated as ordinary income or loss
unless a fund elects otherwise. Such ordinary income treatment may accelerate
fund distributions to shareholders and increase the distributions taxed to
shareholders as ordinary income. Any net ordinary losses so created cannot be
carried forward by a fund to offset income or gains earned in subsequent
taxable years.
Investment in passive foreign investment companies (PFICs). If a fund purchases
shares in certain foreign investment entities, called "passive foreign
investment companies" (PFICs), it may be subject to US federal income tax on a
portion of any "excess distribution" or gain from the disposition of such
shares, which tax cannot be eliminated by
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making distributions to fund shareholders. Such excess distributions and gains
will be considered ordinary income. Additional charges in the nature of
interest may be imposed on a fund in respect of deferred taxes arising from
such distributions or gains.
However, a fund may elect to avoid the imposition of that tax. For example, a
fund may in certain cases elect to treat the PFIC as a "qualified electing
fund" under the Code (i.e., make a "QEF election"), in which case a fund would
be required to include in income each year its share of the ordinary earnings
and net capital gains of the qualified electing fund, even if such amounts were
not distributed to a fund. In order to make this election, a fund would be
required to obtain certain annual information from the PFICs in which it
invests, which may be difficult or not possible to obtain.
Alternatively, a fund may make a mark-to-market election that will result in a
fund being treated as if it had sold (and, solely for purposes of this
mark-to-market election, repurchased) its PFIC stock at the end of such fund's
taxable year. In such case, a fund would report any such gains as ordinary
income and would deduct any such losses as ordinary losses to the extent of
previously recognized gains. The QEF and mark-to-market elections must be made
separately for each PFIC owned by a fund and, once made, would be effective for
all subsequent taxable years, unless revoked with the consent of the IRS. By
making the election, a fund could potentially ameliorate the adverse federal
income tax consequences with respect to its ownership of shares in a PFIC, but
in any particular year may be required to recognize income in excess of the
distributions it receives from PFICs and its proceeds from dispositions of PFIC
stock. A fund may have to distribute this "phantom" income and gain to satisfy
the 90% distribution requirement and/or to avoid imposition of the 4% excise
tax. Making either of these elections therefore may require a fund to liquidate
other investments (including when it is not advantageous to do so) to meet its
distribution requirement, which also may accelerate the recognition of gain and
affect a fund's total return. A fund will make the appropriate tax elections,
if possible, and take any additional steps that are necessary to mitigate the
effect of these rules. Because it is not always possible to identify a foreign
corporation as a PFIC, a fund may incur the tax and interest charges described
above in some instances. Dividends paid by PFICs will not be eligible to be
treated as "qualified dividend income."
Investments in the Master Portfolios. Special tax considerations apply to a
Feeder Fund investing in a Master Portfolio. As noted above, each Master
Portfolio is treated as a partnership for US federal income tax purposes. For
US federal income tax purposes, a Feeder Fund generally will be allocated its
distributive share (as determined in accordance with the governing instruments
of the applicable Master Portfolio, as well as with the Code, the Treasury
regulations thereunder, and other applicable authority) of the income, gains,
losses, deductions, credits, and other tax items of its Master Portfolio so as
to reflect the Feeder Fund's interests in the Master Portfolio. A Master
Portfolio may modify its partner allocations to comply with applicable tax
regulations, including, without limitation, the income tax regulations under
Sections 704, 734, 743, 754, and 755 of the Code. It also may make special
allocations of specific tax items, including gross income, gain, deduction, or
loss. These modified or special allocations could result in a Feeder Fund, as a
partner, receiving more or less items of income, gain, deduction, or loss
(and/or income, gain, deduction, or loss of a different character) than it
would in the absence of such modified or special allocations. A Feeder Fund
will be required to include in its income its share of its Master Portfolio's
tax items, including gross income, gain, deduction, or loss, for any taxable
year regardless of whether or not the Master Portfolio distributes any cash to
the Feeder Fund in such year.
A Master Portfolio is not required, and generally does not expect, to make
distributions (other than distributions in redemption of Master Portfolio
interests) to its investors each year. Accordingly, the income recognized by a
Feeder Fund in respect of its investment in a Master Portfolio could exceed
amounts distributed (if any) by the Master Portfolio to the Feeder Fund in a
particular taxable year, and thus the Feeder Fund could be required to redeem a
portion of its interests in the Master Portfolio in order to obtain sufficient
cash to satisfy its annual distribution requirements (described above) and to
otherwise avoid fund-level US federal income and excise taxes.
A Feeder Fund's receipt of a non-liquidating cash distribution from a Master
Portfolio generally will result in recognized gain (but not loss) only to the
extent that the amount of the distribution exceeds the Feeder Fund's adjusted
basis in its interests of the Master Portfolio before the distribution. A
Feeder Fund that receives a liquidating cash distribution from a Master
Portfolio generally will recognize capital gain to the extent of the difference
between the proceeds received by the Feeder Fund and the Feeder Fund's adjusted
tax basis in interests of such Master Portfolio; however,
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the Feeder Fund generally will recognize ordinary income, rather than capital
gain, to the extent that the Feeder Fund's allocable share of "unrealized
receivables" (including any accrued but untaxed market discount) and
substantially appreciated inventory, if any, exceeds the Feeder Fund's share of
the basis in those unrealized receivables and substantially appreciated
inventory. Any capital loss realized on a liquidating cash distribution may be
recognized by a Feeder Fund only if it redeems all of its Master Portfolio
interests for cash. A Feeder Fund generally will not recognize gain or loss on
an in-kind distribution of property from a Master Portfolio, including on an
in-kind redemption of Master Portfolio interests. However, certain exceptions
to this general rule may apply.
TAXATION OF US SHAREHOLDERS
DIVIDENDS AND DISTRIBUTIONS. A fund intends to distribute substantially all of
its net investment company taxable income (computed without regard to the
dividends-paid deduction) and net capital gain (that is, the excess of net
realized long-term capital gains over net realized short-term capital losses),
if any, to shareholders each year. Unless a shareholder instructs the
Trust/Corporation to pay such dividends and distributions in cash, they will be
automatically reinvested in additional shares of a fund.
Dividends and other distributions by a fund are generally treated under the
Code as received by the shareholders at the time the dividend or distribution
is made, whether you receive them in cash or reinvest them in additional
shares. However, any dividend or distribution declared by a fund in October,
November or December of any calendar year and payable to shareholders of record
on a specified date in such a month shall be deemed to have been received by
each shareholder on December 31 of such calendar year and to have been paid by
a fund not later than such December 31, provided such dividend is actually paid
by a fund on or before January 31 of the following calendar year. Dividends and
distributions received by a retirement plan qualifying for tax-exempt treatment
under the Code will not be subject to US federal income tax.
If a fund retains for investment an amount equal to all or a portion of its net
capital gain, it will be subject to federal income tax at the fund level at
regular corporate rates on the amount retained. In that event, a fund may
designate such retained amount as undistributed capital gains in a notice to
its shareholders who (i) will be required to include in income for US federal
income tax purposes, as long-term capital gains, their proportionate shares of
the undistributed amount, and (ii) will be entitled to credit their
proportionate shares of the federal income tax paid by a fund on the
undistributed amount against their US federal income tax liabilities, if any,
and to claim refunds to the extent their credits exceed their liabilities. The
tax basis of shares owned by a fund shareholder, for US federal income tax
purposes, will be increased by an amount equal to the difference between the
amount of undistributed capital gains included in the shareholder's gross
income and the federal income tax deemed paid by the shareholder under clause
(ii) of the preceding sentence. Organizations or persons not subject to federal
income tax on such capital gains will be entitled to a refund of their pro rata
share of such taxes paid by a fund upon filing appropriate returns or claims
for refund with the IRS.
For federal income tax purposes, distributions of investment income (other than
"exempt-interest dividends," see below) are generally taxable to shareholders
as ordinary income. Taxes on distributions of capital gains are determined by
how long a fund owned (or is deemed to have owned) the investments that
generated them, rather than how long a shareholder has owned his or her shares.
In general, the fund will recognize long-term capital gain or loss on assets it
has owned (or is deemed to have owned) for more than one year, and short-term
capital gain or loss on investments it has owned (or is deemed to have owned)
for one year or less. Distributions of net capital gains that are properly
reported by a fund as capital gain dividends (Capital Gain Dividends) will be
taxable as long-term capital gains includible in and taxed at the reduced rates
applicable to net capital gain. Distributions from capital gains are generally
made after applying any available capital loss carryovers. Except as discussed
below, all other dividends of a fund (including dividends from short-term
capital gains) from current and accumulated earnings and profits are generally
subject to federal income tax as ordinary income.
For taxable years beginning on or after January 1, 2013, Section 1411 of the
Code generally imposes a 3.8% Medicare contribution tax on the net investment
income of certain individuals whose income exceeds certain threshold amounts,
and of certain trusts and estates under similar rules. The details of the
implementation of this tax and of the calculation of net investment income,
among other issues, are currently unclear and remain subject to future
guidance. For these
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purposes, "net investment income" generally includes, among other things, (i)
distributions paid by a fund of net investment income and capital gains (other
than exempt-interest dividends, described below) as described above, and (ii)
any net gain from the sale, redemption or exchange of a fund's shares.
Shareholders are advised to consult their tax advisors regarding the possible
implications of this additional tax on their investment in a fund.
Qualified dividend income. Dividends reported by a fund as derived from
"qualified dividend income" will be taxed to individuals and other noncorporate
shareholders at the reduced federal income tax rates generally applicable to
net capital gains, provided certain holding period and other requirements are
met at both the shareholder and fund levels. Dividends subject to these special
rules are not actually treated as capital gains, however, and thus are not
included in the computation of an individual's net capital gain and generally
cannot be offset by capital losses.
If 95% or more of a fund's gross income (excluding net long-term capital gain
over net short-term capital loss) in a taxable year is attributable to
qualified dividend income received by a fund, 100% of the dividends paid by a
fund (other than distributions reported by a fund as Capital Gain Dividends) to
individuals and other noncorporate shareholders during such taxable year will
be eligible to be treated as qualified dividend income. If less than 95% of a
fund's gross income is attributable to qualified dividend income, then only the
portion of the fund's dividends that is attributable to qualified dividend
income and reported as such by the fund will be eligible to be treated as
qualified dividend income.
For these purposes, qualified dividend income generally means income from
dividends received by a fund from US corporations and certain foreign
corporations. Dividend income received by a fund and distributed to a fund
shareholder may not be treated as qualified dividend income by the shareholder
unless a fund satisfies certain holding period and other requirements with
respect to the stock in its portfolio generating such dividend income and the
shareholder meets certain holding period and other requirements with respect to
a fund's shares. A dividend will not be treated as qualified dividend income
(at either a fund or shareholder level) (1) if the dividend is received with
respect to any share of stock held for fewer than 61 days during the 121-day
period beginning on the date which is 60 days before the date on which such
share becomes ex-dividend with respect to such dividend (or, in the case of
certain preferred stock, 91 days during the 181-day period beginning 90 days
before such date), (2) to the extent that the recipient is under an obligation
(whether pursuant to a short sale or otherwise) to make related payments with
respect to positions in substantially similar or related property, (3) if the
recipient elects to have the dividend income treated as investment income for
purposes of the limitation on deductibility of investment interest, or (4) if
the dividend is received from a foreign corporation that is (a) not eligible
for the benefits of a comprehensive income tax treaty with the United States
(with the exception of dividends paid on stock of such a foreign corporation
readily tradable on an established securities market in the United States) or
(b) treated as a passive foreign investment company. For purposes of
determining the holding period for stock on which a dividend is received, such
holding period is reduced for any period the recipient has an option to sell,
is under a contractual obligation to sell or has made (and not closed) a short
sale of substantially identical stock or securities, and in certain other
circumstances.
Qualified dividend income does not include any dividends received from
tax-exempt corporations or interest from fixed income securities. Also,
dividends received by a fund from a REIT or another regulated investment
company are generally qualified dividend income only to the extent the dividend
distributions are made out of qualified dividend income received by such REIT
or other regulated investment company. In the case of securities lending
transactions, payments in lieu of dividends are not qualified dividend income.
Dividends-received deduction. If dividends from domestic corporations
constitute a portion of a fund's gross income, a portion of the income
distributions of a fund may be eligible for the 70% dividends-received
deduction generally available to corporations to the extent of the amount of
eligible dividends received by a fund from domestic corporations for the
taxable year. A dividend received by a fund will not be treated as a dividend
eligible for the dividends-received deduction (i) if it has been received with
respect to any share of stock that the fund has held for less than 46 days (91
days in the case of certain preferred stock) during the 91-day period beginning
on the date which is 45 days before the date on which such share becomes
ex-dividend with respect to such dividend (during the 181-day period beginning
90 days before such date in the case of certain preferred stock) or (ii) to the
extent that the fund is under an obligation (pursuant to a short sale or
otherwise) to make related payments with respect to positions in substantially
similar or related property. Moreover, the dividends-received deduction may
otherwise be disallowed or reduced (i) if a corporate shareholder fails to
satisfy the foregoing requirements with respect to its shares of a fund or (ii)
by application of
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various provisions of the Code (for instance, the dividends-received deduction
is reduced in the case of a dividend received on debt-financed portfolio stock
(generally, stock acquired with borrowed funds)). For purposes of determining
the holding period for stock on which a dividend is received, such holding
period is reduced for any period the recipient has an option to sell, is under
a contractual obligation to sell or has made (and not closed) a short sale of
substantially identical stock or securities, and in certain other
circumstances.
Distributions from REITs do not qualify for the deduction for dividends
received. Shareholders will be informed of the portion of fund dividends that
so qualifies.
Capital gains. In determining its net capital gain, including in connection
with determining the amount available to support a Capital Gain Dividend, its
taxable income and its earnings and profits, a fund may elect to treat any
post-October capital loss (defined as the greatest of net capital loss, net
long-term capital loss, or net short-term capital loss, in each case
attributable to the portion of the taxable year after October 31) and late-year
ordinary loss (generally, (i) net ordinary losses from the sale, exchange or
other taxable disposition of property, attributable to the portion of the
taxable year after October 31, plus (ii) other net ordinary losses attributable
to the portion of the taxable year after December 31) as if incurred in the
succeeding taxable year.
Capital gains distributions may be reduced if a fund has capital loss
carryforwards available. Capital losses in excess of capital gains ("net
capital losses") are not permitted to be deducted against a fund's net
investment income. Instead, subject to certain limitations, a fund may carry
forward a net capital loss from any taxable year to offset capital gains, if
any, realized during a subsequent taxable year. If a fund incurs or has
incurred net capital losses in taxable years beginning after December 22, 2010
("post-2010 losses"), those losses will be carried forward to one or more
subsequent taxable years without expiration; any such carryforward losses will
retain their character as short-term or long-term. If a fund incurred net
capital losses in a taxable year beginning on or before December 22, 2010
("pre-2011 losses"), the fund is permitted to carry such losses forward for
eight taxable years; in the year to which they are carried forward, such losses
are treated as short-term capital losses that first offset any short-term
capital gains, and then offset any long-term capital gains. A fund must use any
post-2010 losses, which will not expire, before it uses any pre-2011 losses.
This increases the likelihood that pre-2011 losses will expire unused at the
conclusion of the eight-year carryforward period. Capital loss carryforwards
are reduced to the extent they offset current-year net realized capital gains,
whether the fund retains or distributes such gains. Any capital loss
carryforwards and any post-October loss deferrals to which a fund is entitled
are disclosed in a fund's annual reports to shareholders.
Additional considerations. Certain of a fund's investments in derivative
instruments and foreign currency-denominated instruments, and any of a fund's
transactions in foreign currencies and hedging activities, are likely to
produce a difference between its book income and the sum of its taxable income
and net tax-exempt income. If there are differences between a fund's book
income and the sum of its taxable income and net tax-exempt income, a fund may
be required to distribute amounts in excess of its book income or a portion of
fund distributions may be treated as a return of capital to shareholders. If a
fund's book income exceeds the sum of its taxable income (including realized
capital gains) and net tax-exempt income, the distribution of such excess
generally will be treated as (i) a dividend to the extent of a fund's remaining
earnings and profits, (ii) thereafter, as a return of capital to the extent of
the recipient's basis in its shares, and (iii) thereafter, as gain from the
sale or exchange of a capital asset. If a fund's book income is less than the
sum of its taxable income and net tax-exempt income, a fund could be required
to make distributions exceeding its book income to qualify for treatment as a
regulated investment company.
Distributions to shareholders reported as excess inclusion income (see Special
tax provisions that apply to certain investments - REITs) (i) may constitute
"unrelated business taxable income" (UBTI) for those shareholders who would
otherwise be exempt from federal income tax, such as individual retirement
accounts, 401(k) accounts, Keogh plans, pension plans and certain charitable
entities, thereby potentially requiring such an entity that is allocated excess
inclusion income, and otherwise might not be required to file a federal income
tax return, to file a tax return and pay tax on such income, (ii) cannot be
offset by net operating losses (subject to a limited exception for certain
thrift institutions), (iii) will not be eligible for reduced US withholding tax
rates for non-US shareholders (including non-US shareholders eligible for the
benefits of a US income tax treaty), and (iv) may cause a fund to be subject to
tax if certain "disqualified
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organizations," as defined in the Code, are fund shareholders. A shareholder
will be subject to US federal income tax on such inclusions notwithstanding any
exemption from such income tax otherwise available under the Code. See
Tax-exempt shareholders below.
All distributions by a fund result in a reduction in the net asset value of a
fund's shares. Should a distribution reduce the net asset value below a
shareholder's cost basis, such distribution would nevertheless be taxable to
the shareholder as ordinary income, qualified dividend income or capital gain
as described above, even though, from an investment standpoint, it may
constitute a partial return of capital. In particular, investors should be
careful to consider the tax implications of buying shares just prior to a
distribution. The price of shares purchased at that time includes the amount of
the forthcoming distribution. Those purchasing fund shares just prior to a
distribution will receive a partial return of capital upon the distribution,
which nevertheless may be taxable to them for federal income tax purposes.
After the end of each calendar year, a fund will inform shareholders of the
federal income tax status of dividends and distributions paid (or treated as
paid) during such calendar year.
Exempt-interest dividends. Any dividends paid by a fund that are reported by a
fund as exempt-interest dividends will not be subject to regular federal income
tax. A fund will be qualified to pay exempt-interest dividends to its
shareholders if, at the end of each quarter of a fund's taxable year, at least
50% of the total value of a fund's assets consists of obligations of a state or
political subdivision thereof the interest on which is exempt from federal
income tax under Code section 103(a). Distributions that a fund reports as
exempt-interest dividends are treated as interest excludable from shareholders'
gross income for federal income tax purposes but may result in liability for
federal alternative minimum tax purposes and for state and local tax purposes,
both for individual and corporate shareholders. For example, if a fund invests
in "private activity bonds," certain shareholders may be subject to alternative
minimum tax on the part of a fund's distributions derived from interest on such
bonds.
Certain fund of funds may also qualify to pay exempt-interest dividends to
shareholders, to the extent of exempt-interest dividends received from
underlying funds in which the fund of funds invests. See Fund-of-Funds
structure, below.
Interest on indebtedness incurred directly or indirectly to purchase or carry
shares of a fund will not be deductible to the extent it is deemed related to
exempt-interest dividends paid by a fund. The portion of interest that is not
deductible is equal to the total interest paid or accrued on the indebtedness,
multiplied by the percentage of a fund's total distributions (not including
Capital Gain Dividends) paid to the shareholder that are exempt-interest
dividends. Under rules used by the IRS to determine when borrowed funds are
considered incurred for the purpose of purchasing or carrying particular
assets, the purchase of shares may be considered to have been made with
borrowed funds even though such funds are not directly traceable to the
purchase of shares. In addition, the Code may require a shareholder that
receives exempt-interest dividends to treat as taxable income a portion of
certain otherwise non-taxable social security and railroad retirement benefit
payments. A portion of any exempt-interest dividend paid by a fund that
represents income derived from certain revenue or private activity bonds held
by a fund may not retain its tax-exempt status in the hands of a shareholder
who is a "substantial user" of a facility financed by such bonds, or a "related
person" thereof. Moreover, some or all of the exempt-interest dividends
distributed by a fund may be a specific preference item, or a component of an
adjustment item, for purposes of the federal individual and corporate
alternative minimum taxes. The receipt of dividends and distributions from a
fund may affect a foreign corporate shareholder's federal "branch profits" tax
liability and the federal "excess net passive income" tax liability of a
shareholder that is a Subchapter S corporation. Shareholders should consult
their own tax advisors as to whether they are (i) "substantial users" with
respect to a facility or "related" to such users within the meaning of the Code
or (ii) subject to a federal alternative minimum tax, the federal "branch
profits" tax or the federal "excess net passive income" tax.
Shareholders that are required to file tax returns are required to report
tax-exempt interest income, including exempt-interest dividends, on their
federal income tax returns. A fund will inform shareholders of the federal
income tax status of its distributions after the end of each calendar year,
including the amounts, if any, that qualify as exempt-interest dividends and
any portions of such amounts that constitute tax preference items under the
federal alternative minimum tax. Shareholders who have not held shares of a
fund for a full taxable year may have designated as tax-exempt or as a
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tax preference item a percentage of their distributions which is different from
the percentage of a fund's income that was tax-exempt or comprising tax
preference items during the period of their investment in a fund. Shareholders
should consult their tax advisors for more information.
TRANSACTIONS IN FUND SHARES. Upon the sale or exchange of his or her shares, a
shareholder generally will realize a taxable gain or loss equal to the
difference between the amount realized and his or her basis in the shares. A
redemption of shares by a fund generally will be treated as a sale for this
purpose. Such gain or loss will be treated as capital gain or loss if the
shares are capital assets in the shareholder's hands, and will be long-term
capital gain or loss if the shares are held for more than one year and
short-term capital gain or loss if the shares are held for one year or less.
Any loss realized on a sale or exchange will be disallowed to the extent the
shares disposed of are replaced, including replacement through the reinvesting
of dividends and capital gains distributions in a fund, within a 61-day period
beginning 30 days before and ending 30 days after the disposition of the
shares. In such a case, the basis of the shares acquired will be increased to
reflect the disallowed loss.
Any loss realized upon a taxable disposition of a fund's shares held by a
shareholder for six months or less will be treated as long-term, rather than
short-term, to the extent of any capital gain dividends received (or deemed
received) by the shareholder with respect to the shares. Any loss realized by a
shareholder on the sale of fund shares held by the shareholder for six months
or less will be disallowed to the extent of any exempt-interest dividends
received by the shareholder with respect to such shares, unless a fund declares
exempt-interest dividends on a daily basis in an amount equal to at least 90%
of its net tax-exempt interest and distributes such dividends on a monthly or
more frequent basis. A shareholder's ability to utilize capital losses may be
limited under the Code. If a shareholder incurs a sales charge in acquiring
shares of a fund, disposes of those shares within 90 days and then acquires by
January 31 of the calendar year following the calendar year in which the
disposition occurred shares in a mutual fund for which the otherwise applicable
sales charge is reduced by reason of a reinvestment right (e.g., an exchange
privilege), the original sales charge will not be taken into account in
computing gain or loss on the original shares to the extent the subsequent
sales charge is reduced. Instead, the disregarded portion of the original sales
charge will be added to the tax basis of the newly acquired shares.
Furthermore, the same rule also applies to a disposition of the newly acquired
shares made within 90 days of the second acquisition. This provision prevents a
shareholder from immediately deducting the sales charge by shifting his or her
investment within a family of mutual funds.
The sale or other disposition of shares of a fund by a retirement plan
qualifying for tax-exempt treatment under the Code will not be subject to US
federal income tax. Because the federal income tax treatment of a sale or
exchange of fund shares depends on your purchase price and your personal tax
position, you should keep your regular account statements to use in determining
your federal income tax liability.
COST BASIS REPORTING. A fund or, for a shareholder that purchased fund shares
through a financial intermediary, the financial intermediary, is generally
required to report to the IRS, and furnish to such shareholder "cost basis" and
"holding period" information for fund shares the shareholder acquired on or
after January 1, 2012 and redeemed on or after that date (covered shares).
These requirements do not apply to investments through a tax-deferred
arrangement or to shares of money market funds (except DWS Variable NAV Money
Fund). For covered shares, the fund or the financial intermediary, as
appropriate, will report the following information to the IRS and to the
shareholder on Form 1099-B: (i) the adjusted basis of such shares, (ii) the
gross proceeds received on the redemption, and (iii) whether any gain or loss
with respect to the redeemed shares is long-term or short-term.
With respect to fund shares in accounts held directly with a fund, the fund
will calculate and report cost basis using a fund's default method of average
cost, unless the shareholder instructs the fund to use a different calculation
method. Please visit the DWS Investments Web site at www.dws-investments.com
(the Web site does not form a part of this Statement of Additional Information)
for more information.
Shareholders who hold fund shares through a financial intermediary should
contact the financial intermediary regarding the cost basis reporting default
method used by the financial intermediary and the reporting elections
available.
Shareholders should contact a tax advisor regarding the application of the cost
basis reporting rules to their particular situation, including whether to elect
a cost basis calculation method or use a fund's default method of average cost.
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TAX-EXEMPT SHAREHOLDERS. Under current law, a fund generally serves to "block"
(that is, prevent the attribution to shareholders of) UBTI from being realized
by tax-exempt shareholders. Notwithstanding this "blocking" effect, a
tax-exempt shareholder could recognize UBTI by virtue of its investment in a
fund if shares in a fund constitute debt-financed property in the hands of the
tax-exempt shareholder within the meaning of Code Section 514(b).
Furthermore, a tax-exempt shareholder may recognize UBTI if a fund recognizes
"excess inclusion income" derived from direct or indirect investments in REMIC
residual interests or TMPs if the amount of such income recognized by a fund
exceeds a fund's investment company taxable income (after taking into account
deductions for dividends paid by a fund). Any investment in residual interests
of a Collateralized Mortgage Obligation (CMO) that has elected to be treated as
a REMIC likewise can create complex tax problems, especially if a fund has
state or local governments or other tax-exempt organizations as shareholders.
In addition, special tax consequences apply to charitable remainder trusts
(CRTs) that invest in regulated investment companies that invest directly or
indirectly in residual interests in REMICs or equity interests in TMPs. Under
legislation enacted in December 2006, if a CRT (defined in section 664 of the
Code) realizes any UBTI for a taxable year, it must pay an excise tax annually
of an amount equal to such UBTI. Under IRS guidance issued in October 2006, a
CRT will not recognize UBTI as a result of investing in a fund that recognizes
"excess inclusion income." Rather, if at any time during any taxable year a CRT
(or one of certain other tax-exempt shareholders, such as the United States, a
state or political subdivision, or an agency or instrumentality thereof, and
certain energy cooperatives) is a record holder of a share in a fund that
recognizes "excess inclusion income," then a fund will be subject to a tax on
that portion of its "excess inclusion income" for the taxable year that is
allocable to such shareholders at the highest federal corporate income tax
rate. The extent to which this IRS guidance remains applicable in light of the
December 2006 legislation is unclear. To the extent permitted under the 1940
Act and the Code, a fund may elect to specially allocate any such tax to the
applicable CRT, or other shareholder, and thus reduce such shareholder's
distributions for the year by the amount of the tax that relates to such
shareholder's interest in a fund. CRTs and other tax-exempt investors are urged
to consult their tax advisors concerning the consequences of investing in a
fund.
BACKUP WITHHOLDING AND OTHER TAX CONSIDERATIONS.
A fund generally is required to withhold US federal income tax on distributions
(including exempt-interest dividends) and redemption proceeds payable to
shareholders who fail to provide a fund with their correct taxpayer
identification number or to make required certifications, who have
underreported dividend or interest income, or who have been notified (or when a
fund is notified) by the IRS that they are subject to backup withholding. The
backup withholding tax rate is currently 28%. Corporate shareholders and
certain other shareholders specified in the Code generally are exempt from such
backup withholding. Backup withholding is not an additional tax. Any amounts
withheld may be credited against the shareholder's US federal income tax
liability.
Special tax rules apply to investments through defined contribution plans and
other tax-qualified plans. Shareholders should consult their tax advisors to
determine the suitability of shares of a fund as an investment through such
plans and the precise effect of an investment on their particular tax
situation.
A fund's shareholders may be subject to state and local taxes on distributions
received from a fund and on redemptions of a fund's shares. Rules of state and
local taxation of dividend and capital gains distributions from regulated
investment companies often differ from rules for federal income taxation
described above. You are urged to consult your tax advisor as to the
consequences of these and other state and local tax rules affecting an
investment in a fund.
If a shareholder recognizes a loss with respect to a fund's shares of $2
million or more for an individual shareholder or $10 million or more for a
corporate shareholder, the shareholder must file with the IRS a disclosure
statement on Form 8886. Direct shareholders of portfolio securities are in many
cases excepted from this reporting requirement, but under current guidance
shareholders of a regulated investment company are not excepted. The fact that
a loss is reportable under these regulations does not affect the legal
determination of whether the taxpayer's treatment of the loss is proper.
Shareholders should consult their tax advisors to determine the applicability
of these regulations in light of their individual circumstances.
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SHAREHOLDER REPORTING OBLIGATIONS WITH RESPECT TO FOREIGN BANK AND FINANCIAL
ACCOUNTS. Shareholders that are US persons and own, directly or indirectly,
more than 50% of a fund by vote or value could be required to report annually
their "financial interest" in a fund's "foreign financial accounts," if any, on
Treasury Department Form TD F 90-22.1, Report of Foreign Bank and Financial
Accounts (FBAR). Shareholders should consult a tax advisor regarding the
applicability to them of this reporting requirement.
OTHER REPORTING AND WITHHOLDING REQUIREMENTS.
Rules enacted in March 2010 known as the Foreign Account Tax Compliance Act
(FATCA) require the reporting to the IRS of direct and indirect ownership of
foreign financial accounts and foreign entities by US persons. Failure to
provide this required information can result in a 30% withholding tax on
certain payments of U.S. source income (withholdable payments); this
withholding tax will be phased in beginning with certain withholdable payments
made on January 1, 2014. Specifically, withholdable payments subject to this
30% withholding tax include payments of US-source dividends or interest and
payments of gross proceeds from the sale or other disposal of property that can
produce US-source dividends or interest.
The IRS has issued preliminary guidance with respect to these rules; this
guidance is potentially subject to material change. Pursuant to this guidance,
distributions (other than exempt-interest dividends) made by a fund to a
shareholder subject to the phase in noted above, including a distribution in
redemption of shares and a distribution of income or gains otherwise exempt
from withholding under the rules applicable to non-US shareholders described
below (e.g., Capital Gain Dividends and short-term capital gain and
interest-related dividends), will be withholdable payments subject to
withholding. Payments to shareholders will generally not be subject to
withholding, so long as such shareholders provide a fund with such
certifications, waivers or other documentation as the fund requires to comply
with these rules, including, to the extent required, with regard to their
direct and indirect owners. In general, it is expected that a shareholder that
is a US person or non-US individual will be able to avoid being withheld upon
by timely providing a fund with a valid IRS Form W-9 or W-8, respectively.
Subject to any applicable intergovernmental agreement, payments to a
shareholder that is a "foreign financial institution" (as defined under these
rules) will generally be subject to withholding unless such shareholder (i)(a)
enters into a valid agreement with the IRS to, among other requirements, report
required information about certain direct and indirect US investors or
accounts, or (b) qualifies for an exception from entering into such an
agreement and (ii) provides the fund with appropriate certifications or other
documentation concerning its status.
A fund may disclose the information that it receives from its shareholders to
the IRS, non-US taxing authorities or other parties as necessary to comply with
FATCA, including current or future Treasury regulations or IRS guidance issued
thereunder, in each case as modified by any applicable intergovernmental
agreement between the United States and a non-US government to implement FATCA
and improve international tax compliance.
Each prospective investor is urged to consult its tax adviser regarding the
applicability of FATCA and any other reporting requirements with respect to the
prospective investor's own situation. Persons investing in a fund through an
intermediary should contact their intermediary regarding the application of
this reporting and withholding regime to their investments in a fund.
TAXATION OF NON-US SHAREHOLDERS. In general, dividends other than Capital Gain
Dividends and exempt-interest dividends paid by a fund to a shareholder that is
not a "US person" within the meaning of the Code (non-US shareholder) are
subject to withholding of US federal income tax at a rate of 30% (or lower
applicable treaty rate) even if they are funded by income or gains (such as
portfolio interest, short-term capital gains, or foreign-source dividend and
interest income) that, if paid to a non-US shareholder directly, would not be
subject to withholding. Distributions properly reported as Capital Gain
Dividends and exempt-interest dividends generally are not subject to
withholding of federal income tax.
Effective for distributions with respect to taxable years of a fund beginning
before January 1, 2014, however, a fund is not required to withhold any amounts
(i) with respect to distributions from US-source interest income of types
similar to those not subject to US federal income tax if earned directly by an
individual non-US shareholder, to the extent such distributions are properly
reported by a fund (interest-related dividends), and (ii) with respect to
distributions
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of net short-term capital gains in excess of net long-term capital losses, to
the extent such distributions are properly reported by the fund (short-term
capital gain dividends). The exception to withholding for interest-related
dividends does not apply to distributions to a non-US shareholder (A) that has
not provided a satisfactory statement that the beneficial owner is not a US
person, (B) to the extent that the dividend is attributable to certain interest
on an obligation if the non-US shareholder is the issuer or is a 10%
shareholder of the issuer, (C) that is within certain foreign countries that
have inadequate information exchange with the United States, or (D) to the
extent the dividend is attributable to interest paid by a person that is a
related person of the non-US shareholder and the non-US shareholder is a
controlled foreign corporation. The exception to withholding for short-term
capital gain dividends does not apply to (A) distributions to an individual
non-US shareholder who is present in the United States for a period or periods
aggregating 183 days or more during the year of the distribution and (B)
distributions subject to special rules regarding the disposition of US real
property interests (USRPIs) as defined below. Depending on the circumstances, a
fund make designations of interest-related and/or short-term capital gain
dividends with respect to all, some or none of its potentially eligible
dividends and/or treat such dividends, in whole or in part, as ineligible for
these exemptions from withholding. A fund does not currently intend to make
designations of interest-related dividends. It is currently unclear whether
Congress will extend this exemption for taxable years of a fund beginning on or
after January 1, 2014 or what the terms of any such extension would be.
A non-US shareholder is not, in general, subject to US federal income tax on
gains (and is not allowed a deduction for losses) realized on the sale of
shares of a fund or on Capital Gain Dividends unless (i) such gain or dividend
is effectively connected with the conduct by the non-US shareholder of a trade
or business within the United States, (ii) in the case of a non-US shareholder
that is an individual, the shareholder is present in the United States for a
period or periods aggregating 183 days or more during the year of the sale or
the receipt of the Capital Gain Dividend and certain other conditions are met,
or (iii) the shares constitute USRPIs or the Capital Gain Dividends are
attributable to gains from the sale or exchange of USRPIs in accordance with
the rules set forth below.
The withholding tax does not apply to dividends paid to a non-US shareholder
who provides a Form W-8ECI, certifying that the dividends are effectively
connected with the non-US shareholder's conduct of a trade or business within
the United States. Instead, foreign shareholders with respect to whom income
from a fund is effectively connected with a trade or business conducted by the
foreign shareholder within the United States will in general be subject to US
federal income tax on the income derived from a fund at the graduated rates
applicable to US citizens, residents or domestic corporations, whether such
income is received in cash or reinvested in shares of a fund and, in the case
of a foreign corporation, may also be subject to a branch profits tax. If a
foreign shareholder is eligible for the benefits of a tax treaty, any
effectively connected income or gain will generally be subject to US federal
income tax on a net basis only if it is also attributable to a permanent
establishment maintained by the shareholder in the US. More generally, foreign
shareholders who are residents in a country with an income tax treaty with the
US may obtain different tax results than those described herein, and are urged
to consult their tax advisors.
In order to qualify for any exemption from withholding tax or a reduced rate of
withholding tax under an applicable income tax treaty, a non-US shareholder
will need to comply with applicable certification requirements relating to its
non-US status (including, in general, furnishing an IRS Form W-8BEN or
substitute form). In the case of shares held through an intermediary, the
intermediary may withhold tax even if a fund reports a dividend as an
interest-related dividend or short-term capital gain dividend. Non-US
shareholders should contact their intermediaries with respect to the
application of these rules to their accounts.
A non-US shareholder who fails to provide an IRS Form W-8BEN or other
applicable form may be subject to backup withholding at the appropriate rate.
In general, except as noted in this subsection, US federal withholding tax will
not apply to any gain or income realized by a non-US shareholder in respect of
any distributions of net long-term capital gains over net short-term capital
losses, exempt-interest dividends, or upon the sale or other disposition of
shares of a fund.
Special rules apply to distributions to certain non-US shareholders from a fund
if a fund is either a "US real property holding corporation" (USRPHC) or would
be a USRPHC but for the operation of the exceptions to the definition thereof
described below. Additionally, special rules apply to the sale of shares in a
fund if a fund is a USRPHC or former USRPHC.
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Very generally, a USRPHC is a domestic corporation that holds US real property
interests (USRPIs) the fair market value of which equals or exceeds 50% of the
sum of the fair market values of the corporation's USRPIs plus interests in
real property located outside the United States and other assets. USRPIs are
defined as any interest in US real property or any interest (other than a
creditor) in a USRPHC or former USRPHC. If a fund holds (directly or
indirectly) significant interests in REITs, it may be a USRPHC. The special
rules discussed in the next paragraph also apply to distributions from a fund
if it would be a USRPHC absent exclusions from USRPI treatment for interests in
domestically controlled REITs (or prior to January 1, 2014, regulated
investment companies) and not-greater-than-5% interests in publicly traded
classes of stock in REITs or regulated investment companies.
If a fund is a USRPHC or would be a USRPHC but for the exceptions from the
definition of USRPI (described above), distributions by a fund that are
attributable to (a) gains realized on the disposition of USRPIs by a fund and
(b) distributions received by a fund from a lower-tier regulated investment
company or REIT that a fund is required to treat as USRPI gain in its hands
will retain their character as gains realized from USRPIs in the hands of a
fund's non-US shareholders. However, absent the enactment of legislation, on or
after January 1, 2014, this "look-through" treatment for distributions by a
fund to foreign persons applies only to such distributions that are
attributable to distributions received by a fund from a lower-tier REIT and are
required to be treated as USRPI gain in a fund's hands. If the foreign
shareholder holds (or has held at any time during the prior year) more than a
5% interest in a class of stock of a fund, such distributions received by the
shareholder with respect to such class of stock will be treated as gains
"effectively connected" with the conduct of a "US trade or business," and
subject to tax at graduated rates. Moreover, such shareholders will be required
to file a US income tax return for the year in which the gain was recognized
and a fund will be required to withhold 35% of the amount of such distribution.
In the case of all other foreign persons (i.e., those whose interest in a fund
did not exceed 5% at any time during the prior year), the USRPI distribution
generally will be treated as ordinary income (regardless of any designation by
a fund that such distribution is qualified short-term capital gain or a Capital
Gain Dividend), and a fund must withhold 30% (or a lower applicable treaty
rate) of the amount of the distribution paid to such non-US shareholder. It is
currently unclear whether Congress will extend the "look-through" provisions
described above for distributions made on or after January 1, 2014, and what
the terms of any such extension would be.
Non-US shareholders are also subject to "wash sale" rules to prevent the
avoidance of the tax-filing and payment obligations discussed above through the
sale and repurchase of fund shares.
In addition, if a fund is a USRPHC or former USRPHC, a fund may be required to
withhold US tax upon a redemption of shares by a greater-than-5% shareholder
that is a non-US shareholder, and that shareholder would be required to file a
US income tax return for the year of the disposition of the USRPI and pay any
additional tax due on the gain. Prior to January 1, 2014, no such withholding
is generally required with respect to amounts paid in redemption of shares of a
fund if a fund is a domestically controlled qualified investment entity, or, in
certain other limited cases, if a fund (whether or not domestically controlled)
holds substantial investments in regulated investment companies that are
domestically controlled qualified investment entities. It is currently unclear
whether Congress will extend the exemptions from withholding described above
for redemptions or distributions made on or after January 1, 2014, and what the
terms of any such extension would be.
Shares of a fund held by a non-US shareholder at death will be considered
situated within the United States and will be subject to the US estate tax.
The tax consequences to a foreign shareholder entitled to claim the benefits of
an applicable tax treaty may be different from those described herein. Foreign
shareholders should consult their own tax advisors with respect to the
particular tax consequences to them of an investment in a fund, including the
applicability of foreign taxes.
Fund-of-Funds Structure. If a fund invests substantially all of its assets in
shares of other mutual funds, Exchange Traded Funds or other companies that are
regulated investment companies (collectively, "underlying funds"), its
distributable income and gains will normally consist entirely of distributions
from underlying funds and gains and losses on the disposition of shares of
underlying funds. To the extent that an underlying fund realizes net losses on
its investments for a given taxable year, a fund will not be able to benefit
from those losses until (i) the underlying fund realizes gains that it can
reduce by those losses, or (ii) the fund recognizes its shares of those losses
(so as to offset distributions
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of net income or capital gains from other underlying funds) when it disposes of
shares of the underlying fund. Moreover, even when a fund does make such a
disposition, a portion of its loss may be recognized as a long-term capital
loss, which will not be treated as favorably for US federal income tax purposes
as a short-term capital loss or an ordinary deduction. In particular, a fund
will not be able to offset any capital losses from its dispositions of
underlying fund shares against its ordinary income (including distributions of
any net short-term capital gains realized by an underlying fund).
In addition, in certain circumstances, the "wash sale" rules under Section 1091
of the Code may apply to a fund's sales of underlying fund shares that have
generated losses. A wash sale occurs if shares of an underlying fund are sold
by a fund at a loss and the fund acquires additional shares of that same
underlying fund or other substantially identical stock or securities 30 days
before or after the date of the sale. The wash-sale rules could defer losses in
the fund's hands on sales of underlying fund shares (to the extent such sales
are wash sales) for extended (and, in certain cases, potentially indefinite)
periods of time.
As a result of the foregoing rules, and certain other special rules, it is
possible that the amounts of net investment income and net capital gain that a
fund will be required to distribute to shareholders will be greater than such
amounts would have been had the fund invested directly in the securities held
by the underlying funds, rather than investing in shares of the underlying
funds. For similar reasons, the character of distributions from a fund (e.g.,
long-term capital gain, exempt interest, eligibility for dividends-received
deduction, etc.) will not necessarily be the same as it would have been had the
fund invested directly in the securities held by the underlying funds.
If a fund receives dividends from an underlying fund, and the underlying fund
reports such dividends as "qualified dividend income," then the fund is
permitted, in turn, to report a portion of its distributions as "qualified
dividend income," provided the fund meets the holding period and other
requirements with respect to shares of the underlying fund.
If a fund receives dividends from an underlying fund, and the underlying fund
reports such dividends as eligible for the dividends-received deduction, then
the fund is permitted, in turn, to report a portion of its distributions as
eligible for the dividends-received deduction, provided the fund meets the
holding period and other requirements with respect to shares of the underlying
fund.
If a fund receives tax credit bond credits from an underlying fund, and the
underlying fund made an election to pass through such tax credits to its
shareholders, then the fund is permitted in turn to elect to pass through its
proportionate share of those tax credits to its shareholders, provided that the
fund meets the shareholder notice and other requirements.
If at the close of each quarter of a fund's taxable year, at least 50% of its
total assets consists of interests in other regulated investment companies, a
fund will be a "qualified fund of funds." In that case, the fund is permitted
to elect to pass through to its shareholders foreign income and other similar
taxes paid by the fund of funds or by an underlying fund that itself elected to
pass such taxes through to shareholders, so that shareholders of the qualified
fund of funds will be eligible to claim a tax credit or deduction for such
taxes.
A qualified fund of funds (defined above) is permitted to distribute
exempt-interest dividends and thereby pass through to its shareholders the
tax-exempt character of interest on tax-exempt obligations and exempt-interest
dividends it receives from underlying funds.
Variable annuity funds. Certain special tax considerations apply to the
variable annuity funds (DWS Variable Series I, DWS Variable Series II and DWS
Investments VIT Funds). These funds intend to comply with the separate
diversification requirements imposed by Section 817(h) of the Code and the
regulations thereunder on certain insurance company separate accounts. These
requirements limit the percentage of total assets used to fund variable
contracts that an insurance company separate account may invest in any single
investment. Because Section 817(h) and those regulations treat the assets of a
regulated investment company owned exclusively by insurance company separate
accounts and certain other permitted investors as assets of the separate
accounts investing in that regulated investment company, these regulations are
imposed on the assets of the variable annuity funds in addition to the
diversification requirements imposed on the funds by the 1940 Act and
Subchapter M of the Code. Specifically, the regulations provide that, except
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as permitted by the "safe harbor" described below (and, in general, during a
one year start-up period), as of the end of each calendar quarter or within 30
days thereafter no more than 55% of the total assets of a separate account may
be represented by any one investment, no more than 70% by any two investments,
no more than 80% by any three investments, and no more than 90% by any four
investments. For this purpose, all securities of the same issuer are generally
considered a single investment, and each US Government agency and
instrumentality is considered a separate issuer. Section 817(h) provides, as a
safe harbor, that a separate account will be treated as being adequately
diversified if the diversification requirements under Subchapter M are
satisfied and no more than 55% of the value of the account's total assets is
attributable to cash and cash items (including receivables), US Government
securities and securities of other regulated investment companies.
Failure by a variable annuity fund to qualify as a regulated investment company
or to satisfy the Section 817(h) requirements by failing to comply with the
"55%-70%-80%-90%" diversification test or the safe harbor described above could
cause the variable contracts to lose their favorable tax status and require a
contract holder to include in ordinary income any income accrued under the
contracts for the current and all prior taxable years. Under certain
circumstances described in the applicable Treasury regulations, inadvertent
failure to satisfy the Section 817(h) diversification requirements may be
corrected, but such a correction could require a payment to the IRS with
respect to the period or periods during which the investments of the account
did not meet the diversification requirements. The amount of any such payment
could be based on the tax contract holders would have incurred if they were
treated as receiving the income on the contract for the period during which the
diversification requirements were not satisfied. Any such failure could also
result in adverse tax consequences for the insurance company issuing the
contracts.
The 4% excise tax described above does not apply to any regulated investment
company whose sole shareholders are tax-exempt pension trusts, separate
accounts of life insurance companies funding variable contracts and certain
other tax-exempt entities. In determining the sole shareholders of a regulated
investment company for purposes of this exception to the excise tax, shares
attributable to an investment in the regulated investment company (not
exceeding $250,000) made in connection with the organization of the regulated
investment company are not taken into account.
The IRS has indicated that too great a degree of investor control over the
investment options underlying variable contracts may result in the loss of
tax-deferred treatment for such contracts. The Treasury Department has issued
rulings addressing the circumstances in which a variable contract owner's
control of the investments of the separate account may cause the contract
owner, rather than the insurance company, to be treated as the owner of the
assets held by the separate account, and is likely to issue additional rulings
in the future. If the contract owner is considered the owner of the securities
underlying the separate account, income and gains produced by those securities
would be included currently in the contract owner's gross income.
In determining whether an impermissible level of investor control is present,
one factor the IRS considers when a separate account invests in one or more
regulated investment companies is whether a regulated investment company's
investment strategies are sufficiently broad to prevent a contract holder from
being deemed to be making particular investment decisions through its
investment in the separate account. Current IRS guidance indicates that typical
regulated investment company investment strategies, even those with a specific
sector or geographical focus, are generally considered sufficiently broad to
prevent a contract holder from being deemed to be making particular investment
decisions through its investment in a separate account. For example, the IRS
has issued a favorable ruling concerning a separate account offering
sub-accounts (each funded through a single regulated investment company) with
the following investment strategies: money market, bonds, large company stock,
international stock, small company stock, mortgage-backed securities, health
care industry, emerging markets, telecommunications, financial services, South
American stock, energy, and Asian markets. Each variable annuity fund has an
investment objective and strategies that are not materially narrower than the
investment strategies described in this IRS ruling.
The above discussion addresses only one of several factors that the IRS
considers in determining whether a contract holder has an impermissible level
of investor control over a separate account. Contract holders should consult
with their insurance companies, their tax advisers, as well as the prospectus
relating to their particular contract for more information concerning this
investor control issue.
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In the event that additional rules, regulations or other guidance are issued by
the IRS or the Treasury Department concerning this issue, such guidance could
affect the treatment of a variable annuity fund as described above, including
retroactively. In addition, there can be no assurance that a variable annuity
fund will be able to continue to operate as currently described, or that a
variable annuity fund will not have to change its investment objective or
investment policies in order to prevent, on a prospective basis, any such rules
and regulations from causing variable contract owners to be considered the
owners of the shares of the variable annuity fund.
THE FOREGOING IS ONLY A SUMMARY OF CERTAIN MATERIAL US FEDERAL INCOME TAX
CONSEQUENCES AFFECTING A FUND AND ITS SHAREHOLDERS. CURRENT AND PROSPECTIVE
SHAREHOLDERS ARE ADVISED TO CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE
PARTICULAR TAX CONSEQUENCES TO THEM OF AN INVESTMENT IN A FUND.
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PART II: APPENDIX II-I - PROXY VOTING POLICY AND GUIDELINES
I. INTRODUCTION
Deutsche Asset Management (AM) has adopted and implemented the following
policies and procedures, which it believes are reasonably designed to ensure
that proxies are voted in the best economic interest of clients, in accordance
with its fiduciary duties and local regulation. These Proxy Voting Policies,
Procedures and Guidelines shall apply to all accounts managed by US domiciled
advisers and to all US client accounts managed by non US regional offices. Non
US regional offices are required to maintain procedures and to vote proxies as
may be required by law on behalf of their non US clients. In addition, AM's
proxy policies reflect the fiduciary standards and responsibilities for ERISA
accounts.
The attached guidelines represent a set of global recommendations that were
determined by the Global Proxy Voting Sub-Committee (GPVSC). These guidelines
were developed to provide AM with a comprehensive list of recommendations that
represent how AM will generally vote proxies for its clients. The
recommendations derived from the application of these guidelines are not
intended to influence the various AM legal entities either directly or
indirectly by parent or affiliated companies. In addition, the organizational
structures and documents of the various AM legal entities allows, where
necessary or appropriate, the execution by individual AM subsidiaries of the
proxy voting rights independently of any DB parent or affiliated company. This
applies in particular to non-US fund management companies. The individuals that
make proxy voting decisions are also free to act independently, subject to the
normal and customary supervision by the management/boards of these AM legal
entities.
II. AM'S PROXY VOTING RESPONSIBILITIES
Proxy votes are the property of AM's advisory clients./1 /As such, AM's
authority and responsibility to vote such proxies depend upon its contractual
relationships with its clients. AM has delegated responsibility for effecting
its advisory clients' proxy votes to Institutional Shareholder Services (ISS),
an independent third-party proxy voting specialist. ISS votes AM's advisory
clients' proxies in accordance with AM's proxy guidelines or AM's specific
instructions. Where a client has given specific instructions as to how a proxy
should be voted, AM will notify ISS to carry out those instructions. Where no
specific instruction exists, AM will follow the procedures in voting the
proxies set forth in this document. Certain Taft-Hartley clients may direct AM
to have ISS vote their proxies in accordance with Taft Hartley voting
Guidelines.
Clients may in certain instances contract with their custodial agent and notify
AM that they wish to engage in securities lending transactions. In such cases,
it is the responsibility of the custodian to deduct the number of shares that
are on loan so that they do not get voted twice.
/1/ For purposes of these Policies and Procedures, "clients" refers to persons
or entities: for which AM serves as investment adviser or sub-adviser; for
which AM votes proxies; and that have an economic or beneficial ownership
interest in the portfolio securities of issuers soliciting such proxies.
III. POLICIES
1. PROXY VOTING ACTIVITIES ARE CONDUCTED IN THE BEST ECONOMIC INTEREST OF
CLIENTS
AM has adopted the following policies and procedures to ensure that proxies are
voted in accordance with the best economic interest of its clients, as
determined by AM in good faith after appropriate review.
2. THE GLOBAL PROXY VOTING SUB-COMMITTEE
The Global Proxy Voting Sub-Committee (GPVSC) is an internal working group
established by the applicable AM's Investment Risk Oversight Committee pursuant
to a written charter. The GPVSC is responsible for overseeing AM's proxy voting
activities, including:
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(i) adopting, monitoring and updating guidelines, attached as Exhibit A
(Guidelines), that provide how AM will generally vote proxies
pertaining to a comprehensive list of common proxy voting matters;
(ii) voting proxies where (A) the issues are not covered by specific
client instruction or the Guidelines; (B) the Guidelines specify
that the issues are to be determined on a case-by-case basis; or (C)
where an exception to the Guidelines may be in the best economic
interest of AM's clients; and
(iii) monitoring the Proxy Vendor Oversight's proxy voting activities (see
below).
AM's Proxy Vendor Oversight, a function of AM's Operations Group, is
responsible for coordinating with ISS to administer AM's proxy voting process
and for voting proxies in accordance with any specific client instructions or,
if there are none, the Guidelines, and overseeing ISS' proxy responsibilities
in this regard.
3. AVAILABILITY OF PROXY VOTING POLICIES AND PROCEDURES AND PROXY VOTING
RECORD
Copies of these Policies and Procedures, as they may be updated from time to
time, are made available to clients as required by law and otherwise at AM's
discretion. Clients may also obtain information on how their proxies were voted
by AM as required by law and otherwise at AM's discretion; however, AM must not
selectively disclose its investment company clients' proxy voting records. The
Proxy Vendor Oversight will make proxy voting reports available to advisory
clients upon request. The investment companies' proxy voting records will be
disclosed to shareholders by means of publicly-available annual filings of each
company's proxy voting record for 12-month periods ended June 30 (see
Recordkeeping, below), if so required by relevant law.
IV. PROCEDURES
The key aspects of AM's proxy voting process are as follows:
1. THE GPVSC'S PROXY VOTING GUIDELINES
The Guidelines set forth the GPVSC's standard voting positions on a
comprehensive list of common proxy voting matters. The GPVSC has developed, and
continues to update the Guidelines based on consideration of current corporate
governance principles, industry standards, client feedback, and the impact of
the matter on issuers and the value of the investments.
The GPVSC will review the Guidelines as necessary to support the best economic
interests of AM's clients and, in any event, at least annually. The GPVSC will
make changes to the Guidelines, whether as a result of the annual review or
otherwise, taking solely into account the best economic interests of clients.
Before changing the Guidelines, the GPVSC will thoroughly review and evaluate
the proposed change and the reasons therefore, and the GPVSC Chair will ask
GPVSC members whether anyone outside of the AM organization (but within
Deutsche Bank and its affiliates) or any entity that identifies itself as an AM
advisory client has requested or attempted to influence the proposed change and
whether any member has a conflict of interest with respect to the proposed
change. If any such matter is reported to the GPVSC Chair, the Chair will
promptly notify the Conflicts of Interest Management Sub-Committee (see below)
and will defer the approval, if possible. Lastly, the GPVSC will fully document
its rationale for approving any change to the Guidelines.
The Guidelines may reflect a voting position that differs from the actual
practices of the public company(ies) within the Deutsche Bank organization or
of the investment companies for which AM or an affiliate serves as investment
adviser or sponsor. Investment companies, particularly closed-end investment
companies, are different from traditional operating companies. These
differences may call for differences in voting positions on the same matter.
Further, the manner in which AM votes investment company proxies may differ
from proposals for which a AM-advised or sponsored investment company solicits
proxies from its shareholders. As reflected in the Guidelines, proxies
solicited by closed-end (and open-end) investment companies are generally voted
in accordance with the pre-determined guidelines of ISS. See Section IV.3.B.
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Funds (Underlying Funds) in which Topiary Fund Management Fund of Funds (each,
a Fund) invest, may from time to time seek to revise their investment terms
(i.e. liquidity, fees, etc.) or investment structure. In such event, the
Underlying Funds may require approval/consent from its investors to effect the
relevant changes. Topiary Fund Management has adopted Proxy Voting Procedures
which outline the process for these approvals.
2. SPECIFIC PROXY VOTING DECISIONS MADE BY THE GPVSC
The Proxy Vendor Oversight will refer to the GPVSC all proxy proposals (i) that
are not covered by specific client instructions or the Guidelines; or (ii)
that, according to the Guidelines, should be evaluated and voted on a
case-by-case basis.
Additionally, if, the Proxy Vendor Oversight, the GPVSC Chair or any member of
the GPVSC, a portfolio manager, a research analyst or a sub-adviser believes
that voting a particular proxy in accordance with the Guidelines may not be in
the best economic interests of clients, that individual may bring the matter to
the attention of the GPVSC Chair and/or the Proxy Vendor Oversight./2/
If the Proxy Vendor Oversight refers a proxy proposal to the GPVSC or the GPVSC
determines that voting a particular proxy in accordance with the Guidelines is
not in the best economic interests of clients, the GPVSC will evaluate and vote
the proxy, subject to the procedures below regarding conflicts.
The GPVSC endeavors to hold meetings to decide how to vote particular proxies
sufficiently before the voting deadline so that the procedures below regarding
conflicts can be completed before the GPVSC's voting determination.
/2/ The Proxy Vendor Oversight generally monitors upcoming proxy solicitations
for heightened attention from the press or the industry and for novel or
unusual proposals or circumstances, which may prompt the Proxy Vendor
Oversight to bring the solicitation to the attention of the GPVSC Chair. AM
portfolio managers, AM research analysts and sub-advisers also may bring a
particular proxy vote to the attention of the GPVSC Chair, as a result of
their ongoing monitoring of portfolio securities held by advisory clients
and/or their review of the periodic proxy voting record reports that the
GPVSC Chair distributes to AM portfolio managers and AM research analysts.
3. CERTAIN PROXY VOTES MAY NOT BE CAST
In some cases, the GPVSC may determine that it is in the best economic
interests of its clients not to vote certain proxies. If the conditions below
are met with regard to a proxy proposal, AM will abstain from voting:
o Neither the Guidelines nor specific client instructions cover an issue;
o ISS does not make a recommendation on the issue;
o The GPVSC cannot convene on the proxy proposal at issue to make a
determination as to what would be in the client's best interest. (This
could happen, for example, if the Conflicts of Interest Management
Sub-committee found that there was a material conflict or if despite all
best efforts being made, the GPVSC quorum requirement could not be met).
In addition, it is AM's policy not to vote proxies of issuers subject to laws
of those jurisdictions that impose restrictions upon selling shares after
proxies are voted, in order to preserve liquidity. In other cases, it may not
be possible to vote certain proxies, despite good faith efforts to do so. For
example, some jurisdictions do not provide adequate notice to shareholders so
that proxies may be voted on a timely basis. Voting rights on securities that
have been loaned to third-parties transfer to those third-parties, with loan
termination often being the only way to attempt to vote proxies on the loaned
securities. Lastly, the GPVSC may determine that the costs to the client(s)
associated with voting a particular proxy or group of proxies outweighs the
economic benefits expected from voting the proxy or group of proxies.
The Proxy Vendor Oversight will coordinate with the GPVSC Chair regarding any
specific proxies and any categories of proxies that will not or cannot be
voted. The reasons for not voting any proxy shall be documented.
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4. CONFLICT OF INTEREST PROCEDURES
A. PROCEDURES TO ADDRESS CONFLICTS OF INTEREST AND IMPROPER INFLUENCE
Overriding Principle. In the limited circumstances where the GPVSC votes
proxies, the GPVSC will vote those proxies in accordance with what it, in good
faith, determines to be the best economic interests of AM's clients./4/
Independence of the GPVSC. As a matter of Compliance policy, the GPVSC and the
Proxy Vendor Oversight are structured to be independent from other parts of
Deutsche Bank. Members of the GPVSC and the employee responsible for Proxy
Vendor Oversight are employees of AM. As such, they may not be subject to the
supervision or control of any employees of Deutsche Bank Corporate and
Investment Banking division ("CIB"). Their compensation cannot be based upon
their contribution to any business activity outside of AM without prior
approval of Legal and Compliance. They can have no contact with employees of
Deutsche Bank outside of the Private Client and Asset Management division
("PCAM") regarding specific clients, business matters or initiatives without
the prior approval of Legal and Compliance. They furthermore may not discuss
proxy votes with any person outside of AM (and within AM only on a need to know
basis).
Conflict Review Procedures. There will be a committee (Conflicts of Interest
Management Sub-Committee) established within AM that will monitor for potential
material conflicts of interest in connection with proxy proposals that are to
be evaluated by the GPVSC. Promptly upon a determination that a vote shall be
presented to the GPVSC, the GPVSC Chair shall notify the Conflicts of Interest
Management Sub-Committee. The Conflicts of Interest Management Sub-Committee
shall promptly collect and review any information deemed reasonably appropriate
to evaluate, in its reasonable judgment, if AM or any person participating in
the proxy voting process has, or has the appearance of, a material conflict of
interest. For the purposes of this policy, a conflict of interest shall be
considered "material" to the extent that a reasonable person could expect the
conflict to influence, or appear to influence, the GPVSC's decision on the
particular vote at issue. GPVSC should provide the Conflicts of Interest
Management Sub-Committee a reasonable amount of time (no less than 24 hours) to
perform all necessary and appropriate reviews. To the extent that a conflicts
review cannot be sufficiently completed by the Conflicts of Interest Management
Sub-Committee the proxies will be voted in accordance with the standard
guidelines.
The information considered by the Conflicts of Interest Management
Sub-Committee may include without limitation information regarding (i) AM
client relationships; (ii) any relevant personal conflict known by the
Conflicts of Interest Management Sub-Committee or brought to the attention of
that sub-committee; (iii) and any communications with members of the GPVSC (or
anyone participating or providing information to the GPVSC) and any person
outside of the AM organization (but within Deutsche Bank and its affiliates) or
any entity that identifies itself as a AM advisory client regarding the vote at
issue. In the context of any determination, the Conflicts of Interest
Management Sub-Committee may consult with, and shall be entitled to rely upon,
all applicable outside experts, including legal counsel.
Upon completion of the investigation, the Conflicts of Interest Management
Sub-Committee will document its findings and conclusions. If the Conflicts of
Interest Management Sub-Committee determines that (i) AM has a material
conflict of interest that would prevent it from deciding how to vote the
proxies concerned without further client consent or (ii) certain individuals
should be recused from participating in the proxy vote at issue, the Conflicts
of Interest Management Sub-Committee will so inform the GPVSC chair.
If notified that AM has a material conflict of interest as described above, the
GPVSC chair will obtain instructions as to how the proxies should be voted
either from (i) if time permits, the affected clients, or (ii) in accordance
with the standard guidelines. If notified that certain individuals should be
recused from the proxy vote at issue, the GPVSC Chair shall do so in accordance
with the procedures set forth below.
/3/ As mentioned above, the GPVSC votes proxies (i) where neither a specific
client instruction nor a Guideline directs how the proxy should be voted,
(ii) where the Guidelines specify that an issue is to be determined on a
case by case basis or (iii) where voting in accordance with the Guidelines
may not be in the best economic interests of clients.
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/4/ The Proxy Vendor Oversight, who serves as the non-voting secretary of the
GPVSC, may receive routine calls from proxy solicitors and other parties
interested in a particular proxy vote. Any contact that attempts to exert
improper pressure or influence shall be reported to the Conflicts of
Interest Management Sub-Committee.
Note: Any AM employee who becomes aware of a potential, material conflict of
interest in respect of any proxy vote to be made on behalf of clients shall
notify Compliance. Compliance shall call a meeting of the conflict review
committee to evaluate such conflict and determine a recommended course of
action.
Procedures to be followed by the GPVSC. At the beginning of any discussion
regarding how to vote any proxy, the GPVSC Chair (or his or her delegate) will
inquire as to whether any GPVSC member (whether voting or ex officio) or any
person participating in the proxy voting process has a personal conflict of
interest or has actual knowledge of an actual or apparent conflict that has not
been reported to the Conflicts of Interest Management Sub-Committee.
The GPVSC Chair also will inquire of these same parties whether they have
actual knowledge regarding whether any director, officer or employee outside of
the AM organization (but within Deutsche Bank and its affiliates) or any entity
that identifies itself as an AM advisory client, has: (i) requested that AM,
the Proxy Vendor Oversight (or any member thereof) or a GPVSC member vote a
particular proxy in a certain manner; (ii) attempted to influence AM, the Proxy
Vendor Oversight (or any member thereof), a GPVSC member or any other person in
connection with proxy voting activities; or (iii) otherwise communicated with a
GPVSC member or any other person participating or providing information to the
GPVSC regarding the particular proxy vote at issue, and which incident has not
yet been reported to the Conflicts of Interest Management Sub-Committee.
If any such incidents are reported to the GPVSC Chair, the Chair will promptly
notify the Conflicts of Interest Management Sub-Committee and, if possible,
will delay the vote until the Conflicts of Interest Management Sub-Committee
can complete the conflicts report. If a delay is not possible, the Conflicts of
Interest Management Sub-Committee will instruct the GPVSC whether anyone should
be recused from the proxy voting process, or whether AM should vote the proxy
in accordance with the standard guidelines, seek instructions as to how to vote
the proxy at issue from ISS or, if time permits, the affected clients. These
inquiries and discussions will be properly reflected in the GPVSC's minutes.
Duty to Report. Any AM employee, including any GPVSC member (whether voting or
ex officio), that is aware of any actual or apparent conflict of interest
relevant to, or any attempt by any person outside of the AM organization (but
within Deutsche Bank and its affiliates) or any entity that identifies itself
as an AM advisory client to influence, how AM votes its proxies has a duty to
disclose the existence of the situation to the GPVSC Chair (or his or her
designee) and the details of the matter to the Conflicts of Interest Management
Sub-Committee. In the case of any person participating in the deliberations on
a specific vote, such disclosure should be made before engaging in any
activities or participating in any discussion pertaining to that vote.
Recusal of Members. The GPVSC will recuse from participating in a specific
proxy vote any GPVSC members (whether voting or ex officio) and/or any other
person who (i) are personally involved in a material conflict of interest; or
(ii) who, as determined by the Conflicts of Interest Management Sub-Committee,
have actual knowledge of a circumstance or fact that could affect their
independent judgment, in respect of such vote. The GPVSC will also exclude from
consideration the views of any person (whether requested or volunteered) if the
GPVSC or any member thereof knows, or if the Conflicts of Interest Management
Sub-Committee has determined, that such other person has a material conflict of
interest with respect to the particular proxy, or has attempted to influence
the vote in any manner prohibited by these policies.
If, after excluding all relevant GPVSC voting members pursuant to the paragraph
above, there are three or more GPVSC voting members remaining, those remaining
GPVSC members will determine how to vote the proxy in accordance with these
Policies and Procedures. If there are fewer than three GPVSC voting members
remaining, the GPVSC Chair will vote the proxy in accordance with the standard
guidelines, will obtain instructions as to how to have the proxy voted from, if
time permits, the affected clients and otherwise from ISS.
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B. INVESTMENT COMPANIES AND AFFILIATED PUBLIC COMPANIES
Investment Companies. As reflected in the Guidelines, all proxies solicited by
open-end and closed-end investment companies are voted in accordance with the
pre-determined guidelines of ISS, unless the investment company client directs
AM to vote differently on a specific proxy or specific categories of proxies.
However, regarding investment companies for which AM or an affiliate serves as
investment adviser or principal underwriter, such proxies are voted in the same
proportion as the vote of all other shareholders (i.e., "mirror" or "echo"
voting). Master fund proxies solicited from feeder funds are voted in
accordance with applicable provisions of Section 12 of the Investment Company
Act of 1940.
Subject to participation agreements with certain Exchange Traded Funds (ETF)
issuers that have received exemptive orders from the U.S. Securities and
Exchange Commission allowing investing DWS funds to exceed the limits set forth
in Section 12(d)(1)(A) and (B) of the Investment Company Act of 1940, DeAM will
echo vote proxies for ETFs in which Deutsche Bank holds more than 25% of
outstanding voting shares globally when required to do so by participation
agreements and SEC orders.
Affiliated Public Companies. For proxies solicited by non-investment company
issuers of or within the Deutsche Bank organization, e.g., Deutsche bank
itself, these proxies will be voted in the same proportion as the vote of other
shareholders (i.e., mirror or echo voting).
Note: With respect to the Central Cash Management Fund (registered under the
Investment Company Act of 1940), the Fund is not required to engage in echo
voting and the investment adviser will use these Guidelines, and may determine,
with respect to the Central Cash Management Fund, to vote contrary to the
positions in the Guidelines, consistent with the Fund's best interest.
C. OTHER PROCEDURES THAT LIMIT CONFLICTS OF INTEREST
AM and other entities in the Deutsche Bank organization have adopted a number
of policies, procedures and internal controls that are designed to avoid
various conflicts of interest, including those that may arise in connection
with proxy voting, including but not limited to:
o Code of Business Conduct and Ethics - DB Group
o Conflicts of Interest Policy - DB Group
o Information Sharing Procedures - DeAM
o Code of Ethics - DeAM
o Code of Professional Conduct - US
The GPVSC expects that these policies, procedures and internal controls will
greatly reduce the chance that the GPVSC (or, its members) would be involved
in, aware of or influenced by, an actual or apparent conflict of interest.
V. RECORDKEEPING
At a minimum, the following types of records must be properly maintained and
readily accessible in order to evidence compliance with this policy.
o AM will maintain a record of each vote cast by AM that includes among other
things, company name, meeting date, proposals presented, vote cast and
shares voted.
o The Proxy Vendor Oversight maintains records for each of the proxy ballots
it votes. Specifically, the records include, but are not limited to:
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- The proxy statement (and any additional solicitation materials) and
relevant portions of annual statements.
- Any additional information considered in the voting process that may be
obtained from an issuing company, its agents or proxy research firms.
- Analyst worksheets created for stock option plan and share increase
analyses.
- Proxy Edge print-screen of actual vote election.
AM will retain these Policies and Procedures and the Guidelines; will maintain
records of client requests for proxy voting information; and will retain any
documents the Proxy Vendor Oversight or the GPVSC prepared that were material
to making a voting decision or that memorialized the basis for a proxy voting
decision.
The GPVSC also will create and maintain appropriate records documenting its
compliance with these Policies and Procedures, including records of its
deliberations and decisions regarding conflicts of interest and their
resolution.
With respect to AM's investment company clients, ISS will create and maintain
records of each company's proxy voting record for 12-month periods ended June
30. AM will compile the following information for each matter relating to a
portfolio security considered at any shareholder meeting held during the period
covered by the report and with respect to which the company was entitled to
vote:
- The name of the issuer of the portfolio security;
- The exchange ticker symbol of the portfolio security (if symbol is
available through reasonably practicable means);
- The Council on Uniform Securities Identification Procedures number for
the portfolio security (if the number is available through reasonably
practicable means);
- The shareholder meeting date;
- A brief identification of the matter voted on;
- Whether the matter was proposed by the issuer or by a security holder;
- Whether the company cast its vote on the matter;
- How the company cast its vote (e.g., for or against proposal, or
abstain; for or withhold regarding election of directors); and
- Whether the company cast its vote for or against management.
Note: This list is intended to provide guidance only in terms of the records
that must be maintained in accordance with this policy. In addition, please
note that records must be maintained in accordance with the applicable AM
Records Management Policy.
With respect to electronically stored records, "properly maintained" is defined
as complete, authentic (unalterable) usable and backed-up. At a minimum,
records should be retained for a period of not less than six years (or longer,
if necessary to comply with applicable regulatory requirements), the first
three years in an appropriate AM office.
VI. THE GPVSC'S OVERSIGHT ROLE
In addition to adopting the Guidelines and making proxy voting decisions on
matters referred to it as set forth above, the GPVSC will monitor the proxy
voting process by reviewing summary proxy information presented by ISS. The
GPVSC will use this review process to determine, among other things, whether
any changes should be made to the Guidelines. This review will take place at
least quarterly and will be documented in the GPVSC's minutes.
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ATTACHMENT A - GLOBAL PROXY VOTING GUIDELINES
DEUTSCHE ASSET MANAGEMENT
GLOBAL PROXY VOTING GUIDELINES
AS AMENDED FEBRUARY 2013
[GRAPHIC OMITTED]
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TABLE OF CONTENTS
I BOARD OF DIRECTORS AND EXECUTIVES
A Election Of Directors
B Classified Boards Of Directors
C Board And Committee Independence
D Liability And Indemnification Of Directors
E Qualifications Of Directors
F Removal Of Directors And Filling Of Vacancies
G Proposals To Fix The Size Of The Board
H Proposals to Restrict Chief Executive Officer's
Service on Multiple Boards
I Proposals to Restrict Supervisory Board
Members Service on Multiple Boards
J Proposals to Establish Audit Committees
II CAPITAL STRUCTURE
A Authorization Of Additional Shares
B Authorization Of "Blank Check" Preferred Stock
C Stock Splits/Reverse Stock Splits
D Dual Class/Supervoting Stock
E Large Block Issuance
F Recapitalization Into A Single Class Of Stock
G Share Repurchases
H Reductions In Par Value
III CORPORATE GOVERNANCE ISSUES
A Confidential Voting
B Cumulative Voting
C Supermajority Voting Requirements
D Shareholder Right To Vote
IV COMPENSATION
A Establishment of a Remuneration Committee
B Executive And Director Stock Option Plans
C Employee Stock Option/Purchase Plans
D Golden Parachutes
E Proposals To Limit Benefits Or Executive
Compensation
F Option Expensing
G Management board election and motion
H Remuneration (variable pay)
I Long-term incentive plans
J Shareholder Proposals Concerning "Pay For
Superior Performance"
K Executive Compensation Advisory
L Advisory Votes on Executive Compensation
M Frequency of Advisory Vote on Executive
Compensation
V ANTI-TAKEOVER RELATED ISSUES
A Shareholder Rights Plans ("Poison Pills")
B Reincorporation
C Fair-Price Proposals
D Exemption From State Takeover Laws
|
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E Non-Financial Effects Of Takeover Bids
VI MERGERS & ACQUISITIONS
VII ENVIRONMENTAL, SOCIAL & POLITICAL ISSUES
A Principles for Responsible Investment ("PRI")
B ESG Issues
C Labor & Human Rights
D Diversity & Equality
E Health & Safety
F Government/Military
G Tobacco
VIII MISCELLANEOUS ITEMS
A Ratification Of Auditors
B Limitation Of Non-Audit Services Provided By
Independent Auditor
C Audit Firm Rotation
D Transaction Of Other Business
E Motions To Adjourn The Meeting
F Bundled Proposals
G Change Of Company Name
H Proposals Related To The Annual Meeting
I Reimbursement Of Expenses Incurred From
Candidate Nomination
J Investment Company Proxies
K International Proxy Voting
|
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These Guidelines may reflect a voting position that differs from the actual
practices of the public company(ies) within the Deutsche Bank organization or
of the investment companies for which AM or an affiliate serves as investment
adviser or sponsor.
NOTE: Because of the unique structure and regulatory scheme applicable to
closed-end investment companies, the voting guidelines (particularly those
related to governance issues) generally will be inapplicable to holdings of
closed-end investment companies. As a result, determinations on the appropriate
voting recommendation for closed-end investment company shares will be made on
a case-by-case basis.
I. BOARD OF DIRECTORS AND EXECUTIVES
A. ELECTION OF DIRECTORS
Routine: AM Policy is to vote "for" the uncontested election of directors.
Votes for a director in an uncontested election will be withheld in cases where
a director has shown an inability to perform his/her duties in the best
interests of the shareholders.
Proxy contest: In a proxy contest involving election of directors, a
case-by-case voting decision will be made based upon analysis of the issues
involved and the merits of the incumbent and dissident slates of directors. AM
will incorporate the decisions of a third party proxy research vendor,
currently, Institutional Shareholder Services (ISS) subject to review by the
Proxy Voting Sub-Committee (GPVSC) as set forth in the AM's Proxy Voting
Policies and Procedures.
Rationale: The large majority of corporate directors fulfill their fiduciary
obligation and in most cases support for management's nominees is warranted. As
the issues relevant to a contested election differ in each instance, those
cases must be addressed as they arise.
B. CLASSIFIED BOARDS OF DIRECTORS
AM policy is to vote against proposals to classify the board and for proposals
to repeal classified boards and elect directors annually.
Rationale: Directors should be held accountable on an annual basis. By
entrenching the incumbent board, a classified board may be used as an
anti-takeover device to the detriment of the shareholders in a hostile
take-over situation.
C. BOARD AND COMMITTEE INDEPENDENCE
AM policy is to vote:
1. "For" proposals that require that a certain percentage (majority up to 66
2/3%) of members of a board of directors be comprised of independent or
unaffiliated directors.
2. ."For" proposals that require all members of a company's compensation,
audit, nominating, or other similar committees be comprised of independent
or unaffiliated directors.
3. "Against" shareholder proposals to require the addition of special interest,
or constituency, representatives to boards of directors.
4. "For" separation of the Chairman and CEO positions.
5. "Against" proposals that require a company to appoint a Chairman who is an
independent director.
Rationale: Board independence is a cornerstone of effective governance and
accountability. A board that is sufficiently independent from management
assures that shareholders' interests are adequately represented. However, the
Chairman of the board must have sufficient involvement in and experience with
the operations of the company to perform the functions required of that
position and lead the company.
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No director qualifies as 'independent' unless the board of directors
affirmatively determines that the director has no material relationship with
the listed company (either directly or as a partner, shareholder or officer of
an organization that has a relationship with the company).
Whether a director is in fact not "independent" will depend on the laws and
regulations of the primary market for the security and the exchanges, if any,
on which the security trades.
D. LIABILITY AND INDEMNIFICATION OF DIRECTORS
AM policy is to vote "for" management proposals to limit directors' liability
and to broaden the indemnification of directors, unless broader indemnification
or limitations on directors' liability would affect shareholders' interests in
pending litigation.
Rationale: While shareholders want directors and officers to be responsible for
their actions, it is not in the best interests of the shareholders for them to
be to risk averse. If the risk of personal liability is too great, companies
may not be able to find capable directors willing to serve. We support
expanding coverage only for actions taken in good faith and not for serious
violations of fiduciary obligation or negligence.
E. QUALIFICATIONS OF DIRECTORS
AM policy is to follow management's recommended vote on either management or
shareholder proposals that set retirement ages for directors or require
specific levels of stock ownership by directors.
Rationale: As a general rule, the board of directors, and not the shareholders,
is most qualified to establish qualification policies.
F. REMOVAL OF DIRECTORS AND FILLING OF VACANCIES
AM policy is to vote "against" proposals that include provisions that directors
may be removed only for cause or proposals that include provisions that only
continuing directors may fill board vacancies.
Rationale: Differing state statutes permit removal of directors with or without
cause. Removal of directors for cause usually requires proof of self-dealing,
fraud or misappropriation of corporate assets, limiting shareholders' ability
to remove directors except under extreme circumstances. Removal without cause
requires no such showing.
Allowing only incumbent directors to fill vacancies can serve as an
anti-takeover device, precluding shareholders from filling the board until the
next regular election.
G. PROPOSALS TO FIX THE SIZE OF THE BOARD
AM policy is to vote:
1. "For" proposals to fix the size of the board unless: (a) no specific reason
for the proposed change is given; or (b) the proposal is part of a package
of takeover defenses.
2. "Against" proposals allowing management to fix the size of the board without
shareholder approval.
Rationale: Absent danger of anti-takeover use, companies should be granted a
reasonable amount of flexibility in fixing the size of its board.
H. PROPOSALS TO RESTRICT CHIEF EXECUTIVE OFFICER'S SERVICE ON MULTIPLE BOARDS
AM policy is to vote "For" proposals to restrict a Chief Executive Officer from
serving on more than three outside boards of directors.
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Rationale: Chief Executive Officer must have sufficient time to ensure that
shareholders' interests are represented adequately.
Note: A director's service on multiple closed-end fund boards within a fund
complex are treated as service on a single Board for the purpose of the proxy
voting guidelines.
I. PROPOSALS TO RESTRICT SUPERVISORY BOARD MEMBERS SERVICE ON MULTIPLE BOARDS
(FOR FFT SECURITIES)
AM policy is to vote "for" proposals to restrict a Supervisory Board Member
from serving on more than five supervisory boards.
Rationale: We consider a strong, independent and knowledgeable supervisory
board as important counter-balance to executive management to ensure that the
interests of shareholders are fully reflected by the company.
Full information should be disclosed in the annual reports and accounts to
allow all shareholders to judge the success of the supervisory board
controlling their company.
Supervisory Board Member must have sufficient time to ensure that shareholders'
interests are represented adequately.
Note: A director's service on multiple closed-end fund boards within a fund
complex are treated as service on a single Board for the purpose of the proxy
voting guidelines.
J. PROPOSALS TO ESTABLISH AUDIT COMMITTEES (FOR FFT AND U.S. SECURITIES)
AM policy is to vote "for" proposals that require the establishment of audit
committees.
Rationale: The audit committee should deal with accounting and risk management
related questions, verifies the independence of the auditor with due regard to
possible conflicts of interest. It also should determine the procedure of the
audit process.
II. CAPITAL STRUCTURE
A. AUTHORIZATION OF ADDITIONAL SHARES (FOR U.S. SECURITIES)
AM policy is to vote "for" proposals to increase the authorization of existing
classes of stock that do not exceed a 3:1 ratio of shares authorized to shares
outstanding for a large cap company, and do not exceed a 4:1 ratio of shares
authorized to shares outstanding for a small-midcap company (companies having a
market capitalization under one billion U.S. dollars.).
Rationale: While companies need an adequate number of shares in order to carry
on business, increases requested for general financial flexibility must be
limited to protect shareholders from their potential use as an anti-takeover
device. Requested increases for specifically designated, reasonable business
purposes (stock split, merger, etc.) will be considered in light of those
purposes and the number of shares required.
B. AUTHORIZATION OF "BLANK CHECK" PREFERRED STOCK (FOR U.S. SECURITIES)
AM policy is to vote:
1. "Against" proposals to create blank check preferred stock or to increase the
number of authorized shares of blank check preferred stock unless the
company expressly states that the stock will not be used for anti-takeover
purposes and will not be issued without shareholder approval.
2. "For" proposals mandating shareholder approval of blank check stock
placement.
Rationale: Shareholders should be permitted to monitor the issuance of classes
of preferred stock in which the board of directors is given unfettered
discretion to set voting, dividend, conversion and other rights for the shares
issued.
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C. STOCK SPLITS/REVERSE STOCK SPLITS
AM policy is to vote "for" stock splits if a legitimate business purpose is set
forth and the split is in the shareholders' best interests. A vote is cast
"for" a reverse stock split only if the number of shares authorized is reduced
in the same proportion as the reverse split or if the effective increase in
authorized shares (relative to outstanding shares) complies with the proxy
guidelines for common stock increases (see Section II.A, above).
Rationale: Generally, stock splits do not detrimentally affect shareholders.
Reverse stock splits, however, may have the same result as an increase in
authorized shares and should be analyzed accordingly.
D. DUAL CLASS/SUPERVOTING STOCK
AM policy is to vote "against" proposals to create or authorize additional
shares of super-voting stock or stock with unequal voting rights.
Rationale: The "one share, one vote" principal ensures that no shareholder
maintains a voting interest exceeding their equity interest in the company.
E. LARGE BLOCK ISSUANCE (FOR U.S. SECURITIES)
AM policy is to address large block issuances of stock on a case-by-case basis,
incorporating the recommendation of an independent third party proxy research
firm (currently ISS) subject to review by the GPVSC as set forth in AM's Proxy
Policies and Procedures.
Additionally, AM supports proposals requiring shareholder approval of large
block issuances.
Rationale: Stock issuances must be reviewed in light of the business
circumstances leading to the request and the potential impact on shareholder
value.
F. RECAPITALIZATION INTO A SINGLE CLASS OF STOCK
AM policy is to vote "for" recapitalization plans to provide for a single class
of common stock, provided the terms are fair, with no class of stock being
unduly disadvantaged.
Rationale: Consolidation of multiple classes of stock is a business decision
that may be left to the board and/or management if there is no adverse effect
on shareholders.
G. SHARE REPURCHASES
AM policy is to vote "for" share repurchase plans provided all shareholders are
able to participate on equal terms.
Rationale: Buybacks are generally considered beneficial to shareholders because
they tend to increase returns to the remaining shareholders.
H. REDUCTIONS IN PAR VALUE
AM policy is to vote "for" proposals to reduce par value, provided a legitimate
business purpose is stated (e.g., the reduction of corporate tax
responsibility).
Rationale: Usually, adjustments to par value are a routine financial decision
with no substantial impact on shareholders.
III. CORPORATE GOVERNANCE ISSUES
A. CONFIDENTIAL VOTING
AM policy is to vote "for" proposals to provide for confidential voting and
independent tabulation of voting results and to vote "against" proposals to
repeal such provisions.
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Rationale: Confidential voting protects the privacy rights of all shareholders.
This is particularly important for employee-shareholders or shareholders with
business or other affiliations with the company, who may be vulnerable to
coercion or retaliation when opposing management. Confidential voting does not
interfere with the ability of corporations to communicate with all
shareholders, nor does it prohibit shareholders from making their views known
directly to management.
B. CUMULATIVE VOTING (FOR U.S. SECURITIES)
AM policy is to vote "against" shareholder proposals requesting cumulative
voting and "for" management proposals to eliminate it. The protections afforded
shareholders by cumulative voting are not necessary when a company has a
history of good performance and does not have a concentrated ownership
interest. Accordingly, a vote is cast "against" cumulative voting and "for"
proposals to eliminate it if:
a) The company has a five year return on investment greater than the relevant
industry index,
b) All directors and executive officers as a group beneficially own less than
10% of the outstanding stock, and
c) No shareholder (or voting block) beneficially owns 15% or more of the
company.
Thus, failure of any one of the three criteria results in a vote for cumulative
voting in accordance with the general policy.
Rationale: Cumulative voting is a tool that should be used to ensure that
holders of a significant number of shares may have board representation;
however, the presence of other safeguards may make their use unnecessary.
C. SUPERMAJORITY VOTING REQUIREMENTS
AM policy is to vote "against" management proposals to require a supermajority
vote to amend the charter or bylaws and to vote "for" shareholder proposals to
modify or rescind existing supermajority requirements.
* Exception made when company holds a controlling position and seeks to
lower threshold to maintain control and/or make changes to corporate
by-laws.
Rationale: Supermajority voting provisions violate the democratic principle
that a simple majority should carry the vote. Setting supermajority
requirements may make it difficult or impossible for shareholders to remove
egregious by-law or charter provisions. Occasionally, a company with a
significant insider held position might attempt to lower a supermajority
threshold to make it easier for management to approve provisions that may be
detrimental to shareholders. In that case, it may not be in the shareholders
interests to lower the supermajority provision.
D. SHAREHOLDER RIGHT TO VOTE
AM policy is to vote "against" proposals that restrict the right of
shareholders to call special meetings, amend the bylaws, or act by written
consent. Policy is to vote "for" proposals that remove such restrictions.
Rationale: Any reasonable means whereby shareholders can make their views known
to management or affect the governance process should be supported.
IV. COMPENSATION
Annual Incentive Plans or Bonus Plans are often submitted to shareholders for
approval. These plans typically award cash to executives based on company
performance. Deutsche Bank believes that the responsibility for executive
compensation decisions rest with the board of directors and/or the compensation
committee, and its policy is not to second-guess the board's award of cash
compensation amounts to executives unless a particular award or series of
awards is deemed excessive. If stock options are awarded as part of these bonus
or incentive plans, the provisions must meet Deutsche Bank's criteria regarding
stock option plans, or similar stock-based incentive compensation schemes, as
set forth below.
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A. ESTABLISHMENT OF A REMUNERATION COMMITTEE (FOR FFT SECURITIES)
AM policy is to vote "for" proposals that require the establishment of a
remuneration committee.
Rationale: Corporations should disclose in each annual report or proxy
statement their policies on remuneration. Essential details regarding executive
remuneration including share options, long-term incentive plans and bonuses,
should be disclosed in the annual report, so that investors can judge whether
corporate pay policies and practices meet the standard.
The remuneration committee shall not comprise any board members and should be
sensitive to the wider scene on executive pay. It should ensure that
performance-based elements of executive pay are designed to align the interests
of shareholders.
B. EXECUTIVE AND DIRECTOR STOCK OPTION PLANS
AM policy is to vote "for" stock option plans that meet the following criteria:
(1) The resulting dilution of existing shares is less than (a) 15 percent of
outstanding shares for large capital corporations or (b) 20 percent of
outstanding shares for small-mid capital companies (companies having a
market capitalization under one billion U.S. dollars).
(2) The transfer of equity resulting from granting options at less than FMV
is no greater than 3% of the over-all market capitalization of large
capital corporations, or 5% of market cap for small-mid capital
companies.
(3) The plan does not contain express repricing provisions and, in the
absence of an express statement that options will not be repriced; the
company does not have a history of repricing options.
(4) The plan does not grant options on super-voting stock.
AM will support performance-based option proposals as long as a) they do not
mandate that all options granted by the company must be performance based, and
b) only certain high-level executives are subject to receive the performance
based options.
AM will support proposals to eliminate the payment of outside director
pensions.
Rationale: Determining the cost to the company and to shareholders of
stock-based incentive plans raises significant issues not encountered with
cash-based compensation plans. These include the potential dilution of existing
shareholders' voting power, the transfer of equity out of the company resulting
from the grant and execution of options at less than FMV and the authority to
reprice or replace underwater options. Our stock option plan analysis model
seeks to allow reasonable levels of flexibility for a company yet still protect
shareholders from the negative impact of excessive stock compensation.
Acknowledging that small mid-capital corporations often rely more heavily on
stock option plans as their main source of executive compensation and may not
be able to compete with their large capital competitors with cash compensation,
we provide slightly more flexibility for those companies.
C. EMPLOYEE STOCK OPTION/PURCHASE PLANS
AM policy is to vote for employee stock purchase plans (ESPP's) when the plan
complies with Internal Revenue Code 423, allowing non-management employees to
purchase stock at 85% of FMV.
AM policy is to vote "for" employee stock option plans (ESOPs) provided they
meet the standards for stock option plans in general. However, when computing
dilution and transfer of equity, ESOPs are considered independently from
executive and director option plans.
Rationale: ESOPs and ESPP's encourage rank-and-file employees to acquire an
ownership stake in the companies they work for and have been shown to promote
employee loyalty and improve productivity.
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D. GOLDEN PARACHUTES
AM policy is to vote "for" proposals to require shareholder approval of golden
parachutes and for proposals that would limit golden parachutes to no more than
three times base compensation. Policy is to vote "against" more restrictive
shareholder proposals to limit golden parachutes.
Rationale: In setting a reasonable limitation, AM considers that an effective
parachute should be less attractive than continued employment and that the IRS
has opined that amounts greater than three times annual salary, are excessive.
E. PROPOSALS TO LIMIT BENEFITS OR EXECUTIVE COMPENSATION
AM policy is to vote "against"
1. Proposals to limit benefits, pensions or compensation and
2. Proposals that request or require disclosure of executive compensation
greater than the disclosure required by Securities and Exchange Commission
(SEC) regulations.
Rationale: Levels of compensation and benefits are generally considered to be
day-to-day operations of the company, and are best left unrestricted by
arbitrary limitations proposed by shareholders.
F. OPTION EXPENSING
AM policy is to support proposals requesting companies to expense stock
options.
Rationale: Although companies can choose to expense options voluntarily, the
Financial Accounting Standards Board (FASB) does not yet require it, instead
allowing companies to disclose the theoretical value of options as a footnote.
Because the expensing of stock options lowers earnings, most companies elect
not to do so. Given the fact that options have become an integral component of
compensation and their exercise results in a transfer of shareholder value, AM
agrees that their value should not be ignored and treated as "no cost"
compensation. The expensing of stock options would promote more modest and
appropriate use of stock options in executive compensation plans and present a
more accurate picture of company operational earnings.
G. MANAGEMENT BOARD ELECTION AND MOTION (FOR FFT SECURITIES)
AM policy is to vote "against":
o the election of board members with positions on either remuneration or audit
committees;
o the election of supervisory board members with too many supervisory board
mandates;
o "automatic" election of former board members into the supervisory board.
Rationale: Management as an entity, and each of its members, are responsible
for all actions of the company, and are - subject to applicable laws and
regulations - accountable to the shareholders as a whole for their actions.
Sufficient information should be disclosed in the annual company report and
account to allow shareholders to judge the success of the company.
H. REMUNERATION (VARIABLE PAY): (FOR FFT SECURITIES)
EXECUTIVE REMUNERATION FOR MANAGEMENT BOARD
AM policy is to vote "for" remuneration for Management Board that is
transparent and linked to results.
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Rationale: Executive compensation should motivate management and align the
interests of management with the shareholders. The focus should be on criteria
that prevent excessive remuneration; but enable the company to hire and retain
first-class professionals.
Shareholder interests are normally best served when management is remunerated
to optimise long-term returns. Criteria should include suitable measurements
like return on capital employed or economic value added.
Interests should generally also be correctly aligned when management own shares
in the company - even more so if these shares represent a substantial portion
of their own wealth.
Its disclosure shall differentiate between fixed pay, variable (performance
related) pay and long-term incentives, including stock option plans with
valuation ranges as well as pension and any other significant arrangements.
EXECUTIVE REMUNERATION FOR SUPERVISORY BOARD
AM policy is to vote "for" remuneration for Supervisory Board that is at least
50% in fixed form.
Rationale: It would normally be preferable if performance linked compensation
were not based on dividend payments, but linked to suitable result based
parameters. Consulting and procurement services should also be published in the
company report.
I. LONG-TERM INCENTIVE PLANS (FOR FFT SECURITIES)
AM policy is to vote "for" long-term incentive plans for members of a
management board that reward for above average company performance.
Rationale: Incentive plans will normally be supported if they:
o directly align the interests of members of management boards with those of
shareholders;
o establish challenging performance criteria to reward only above average
performance;
o measure performance by total shareholder return in relation to the market or
a range of comparable companies;
o are long-term in nature and encourage long-term ownership of the shares once
exercised through minimum holding periods;
o do not allow a repricing of the exercise price in stock option plans.
J. SHAREHOLDER PROPOSALS CONCERNING "PAY FOR SUPERIOR PERFORMANCE"
AM policy is to address pay for superior performance proposals on a
case-by-case basis, incorporating the recommendation of an independent third
party proxy research firm (currently ISS) subject to review by the GPVSC as set
forth in AM's Proxy Policies and Procedures.
Rationale: While AM agrees that compensation issues are better left to the
discretion of management, they appreciate the need to monitor for excessive
compensation practices on a case by case basis. If, after a review of the ISS
metrics, AM is comfortable with ISS's applying this calculation and will vote
according to their recommendation.
K. EXECUTIVE COMPENSATION ADVISORY
AM policy is to follow management's recommended vote on shareholder proposals
to propose an advisory resolution seeking to ratify the compensation of the
company's named executive officers (NEOs) on an annual basis.
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Rationale: AM believes that controls exist within senior management and
corporate compensation committees, ensuring fair compensation to executives.
This might allow shareholders to require approval for all levels of
management's compensation.
L. ADVISORY VOTES ON EXECUTIVE COMPENSATION
AM policy is to evaluate Executive Compensation proposals on a case-by-case
basis, where locally defined this may be done by incorporating the
recommendation of an independent third party proxy research firm. AM will
oppose Advisory Votes on Executive Compensation if:
o there is a significant misalignment between CEO pay and company performance;
o the company maintains significant problematic pay practices;
o the board exhibits a significant level of poor communication and
responsiveness to shareholders.
Rationale: While AM agrees that compensation issues are better left to the
discretion of management, they appreciate the need to take action on this
nonbinding proposal if excessive compensation practices exist.
M. FREQUENCY OF ADVISORY VOTE ON EXECUTIVE COMPENSATION
AM policy is to vote "for" annual advisory votes on compensation, which provide
the most consistent and clear communication channel for shareholder concerns
about companies' executive pay programs.
Rationale: AM believes that annual advisory vote gives shareholders the
opportunity to express any compensation concerns to the Executive Compensation
proposal which is an advisory voting.
V. ANTI-TAKEOVER RELATED ISSUES
A. SHAREHOLDER RIGHTS PLANS ("POISON PILLS")
AM policy is to vote "for" proposals to require shareholder ratification of
poison pills or that request boards to redeem poison pills, and to vote
"against" the adoption of poison pills if they are submitted for shareholder
ratification.
Rationale: Poison pills are the most prevalent form of corporate takeover
defenses and can be (and usually are) adopted without shareholder review or
consent. The potential cost of poison pills to shareholders during an attempted
takeover outweighs the benefits.
B. REINCORPORATION
AM policy is to examine reincorporation proposals on a case-by-case basis. The
voting decision is based on: (1) differences in state law between the existing
state of incorporation and the proposed state of incorporation; and (2)
differences between the existing and the proposed charter/bylaws/articles of
incorporation and their effect on shareholder rights. If changes resulting from
the proposed reincorporation violate the corporate governance principles set
forth in these guidelines, the reincorporation will be deemed contrary to
shareholder's interests and a vote cast "against."
Rationale: Reincorporations can be properly analyzed only by looking at the
advantages and disadvantages to their shareholders. Care must be taken that
anti-takeover protection is not the sole or primary result of a proposed
change.
C. FAIR-PRICE PROPOSALS
AM policy is to vote "for" management fair-price proposals, provided that: (1)
the proposal applies only to two-tier offers; (2) the proposal sets an
objective fair-price test based on the highest price that the acquirer has paid
for a company's shares; (3) the supermajority requirement for bids that fail
the fair-price test is no higher than two-thirds of the outstanding shares; (4)
the proposal contains no other anti-takeover provisions or provisions that
restrict shareholders rights.
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A vote is cast for shareholder proposals that would modify or repeal existing
fair-price requirements that do not meet these standards.
Rationale: While fair price provisions may be used as anti-takeover devices, if
adequate provisions are included, they provide some protection to shareholders
who have some say in their application and the ability to reject those
protections if desired.
D. EXEMPTION FROM STATE TAKEOVER LAWS
AM policy is to vote "for" shareholder proposals to opt out of state takeover
laws and to vote "against" management proposals requesting to opt out of state
takeover laws.
Rationale: Control share statutes, enacted at the state level, may harm
long-term share value by entrenching management. They also unfairly deny
certain shares their inherent voting rights.
E. NON-FINANCIAL EFFECTS OF TAKEOVER BIDS
Policy is to vote "against" shareholder proposals to require consideration of
non-financial effects of merger or acquisition proposals.
Rationale: Non-financial effects may often be subjective and are secondary to
AM's stated purpose of acting in its client's best economic interest.
VI. MERGERS & ACQUISITIONS
Evaluation of mergers, acquisitions and other special corporate transactions
(i.e., takeovers, spin-offs, sales of assets, reorganizations, restructurings
and recapitalizations) are performed on a case-by-case basis incorporating
information from an independent proxy research source (currently ISS.)
Additional resources including portfolio management and research analysts may
be considered as set forth in AM's Policies and Procedures.
VII. ENVIRONMENTAL, SOCIAL & GOVERNANCE ISSUES
Environmental, social and governance issues (ESG) are becoming increasingly
important to corporate success. We incorporate ESG considerations into both our
investment decisions and our proxy voting decisions - particularly if the
financial performance of the company could be impacted. Companies or states
that seriously contravene internationally accepted ethical principles will be
subject to heightened scrutiny.
A. PRINCIPLES FOR RESPONSIBLE INVESTMENT
AM policy is to actively engage with companies on ESG issues and participate in
ESG initiatives. In this context, AM (a) votes "for increased disclosure on ESG
issues; (b) is willing to participate in the development of policy, regulation
and standard setting (such as promoting and protecting shareholder rights); (c)
could support shareholder initiatives and also file shareholder resolutions
with long term ESG considerations and improved ESG disclosure, when applicable;
(d) could support standardized ESG reporting and issues to be integrated within
annual financial reports; and (e) on a case by case basis, will generally
follow management's recommended vote on other matters related to ESG issues.
Rationale: ESG issues can affect the performance of investment portfolios (to
varying degrees across companies, sectors, regions, asset classes and through
time).
B. ESG ISSUES
AM policy is to vote in line with the CERES recommendation on Environmental
matters covered under the CERES Principles, and Social and Sustainability
issues not specifically addressed elsewhere in the Guidelines. AM will rely on
ISS to identify shareholder proposals addressing CERES Principles and proxies
will be voted in accordance with ISS's predetermined voting guidelines on CERES
Principles.
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Any matter that is to be voted on, consented to or approved by the voting
members, may take place in person, telephonically or via other electronic
means. In addition, voting members may act in writing, including without
limitation, via e-mail.
Rationale: Deutsche Asset Management supports the CERES Principles and as such
generally votes proxies in line with the CERES recommendation.
C. LABOR & HUMAN RIGHTS
AM policy is to vote "against" adopting global codes of conduct or workplace
standards exceeding those mandated by law.
Rationale: Additional requirements beyond those mandated by law are deemed
unnecessary and potentially burdensome to companies
D. DIVERSITY & EQUALITY
1. AM policy is to vote "against" shareholder proposals to force equal
employment opportunity, affirmative action or board diversity.
Rationale: Compliance with State and Federal legislation along with information
made available through filings with the EEOC provides sufficient assurance that
companies act responsibly and make information public.
2. AM policy is also to vote "against" proposals to adopt the Mac Bride
Principles. The Mac Bride Principles promote fair employment, specifically
regarding religious discrimination.
Rationale: Compliance with the Fair Employment Act of 1989 makes adoption of
the Mac Bride Principles redundant. Their adoption could potentially lead to
charges of reverse discrimination.
E. HEALTH & SAFETY
1. AM policy is to vote "against" adopting a pharmaceutical price restraint
policy or reporting pricing policy changes.
Rationale: Pricing is an integral part of business for pharmaceutical companies
and should not be dictated by shareholders (particularly pursuant to an
arbitrary formula). Disclosing pricing policies may also jeopardize a company's
competitive position in the marketplace.
2. AM policy is to vote "against" shareholder proposals to control the use or
labeling of and reporting on genetically engineered products.
Rationale: Additional requirements beyond those mandated by law are deemed
unnecessary and potentially burdensome to companies.
F. GOVERNMENT/MILITARY
1. AM policy is to vote against shareholder proposals regarding the production
or sale of military arms or nuclear or space-based weapons, including
proposals seeking to dictate a company's interaction with a particular
foreign country or agency.
Rationale: Generally, management is in a better position to determine what
products or industries a company can and should participate in. Regulation of
the production or distribution of military supplies is, or should be, a matter
of government policy.
2. AM policy is to vote "against" shareholder proposals regarding political
contributions and donations.
Rationale: The Board of Directors and Management, not shareholders, should
evaluate and determine the recipients of any contributions made by the company.
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3. AM policy is to vote "against" shareholder proposals regarding charitable
contributions and donations.
Rationale: The Board of Directors and Management, not shareholders, should
evaluate and determine the recipients of any contributions made by the company.
G. TOBACCO
1. AM policy is to vote "against" shareholder proposals requesting additional
standards or reporting requirements for tobacco companies as well as
"against" requesting companies to report on the intentional manipulation of
nicotine content.
Rationale: Where a tobacco company's actions meet the requirements of legal and
industry standards, imposing additional burdens may detrimentally affect a
company's ability to compete. The disclosure of nicotine content information
could affect the company's rights in any pending or future litigation.
2. Shareholder requests to spin-off or restructure tobacco businesses will be
opposed.
Rationale: These decisions are more appropriately left to the Board and
management, and not to shareholder mandate.
VIII. MISCELLANEOUS ITEMS
A. RATIFICATION OF AUDITORS
AM policy is to vote "for" a) the management recommended selection of auditors
and b) proposals to require shareholder approval of auditors.
Rationale: Absent evidence that auditors have not performed their duties
adequately, support for management's nomination is warranted.
B. LIMITATION OF NON-AUDIT SERVICES PROVIDED BY INDEPENDENT AUDITOR
AM policy is to support proposals limiting non-audit fees to 50% of the
aggregate annual fees earned by the firm retained as a company's independent
auditor.
Rationale: In the wake of financial reporting problems and alleged audit
failures at a number of companies, AM supports the general principle that
companies should retain separate firms for audit and consulting services to
avoid potential conflicts of interest. However, given the protections afforded
by the recently enacted Sarbanes-Oxley Act of 2002 (which requires Audit
Committee pre-approval for non-audit services and prohibits auditors from
providing specific types of services), and the fact that some non-audit
services are legitimate audit-related services, complete separation of audit
and consulting fees may not be warranted. A reasonable limitation is
appropriate to help ensure auditor independence and it is reasonable to expect
that audit fees exceed non-audit fees.
C. AUDIT FIRM ROTATION
AM policy is to vote against proposals seeking audit firm rotation.
Rationale: While the Sarbanes-Oxley Act mandates that the lead audit partner be
switched every five years, AM believes that rotation of the actual audit firm
would be costly and disruptive.
D. TRANSACTION OF OTHER BUSINESS
AM policy is to vote against "transaction of other business" proposals.
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Rationale: This is a routine item to allow shareholders to raise other issues
and discuss them at the meeting. As the nature of these issues may not be
disclosed prior to the meeting, we recommend a vote against these proposals.
This protects shareholders voting by proxy (and not physically present at a
meeting) from having action taken at the meeting that they did not receive
proper notification of or sufficient opportunity to consider.
E. MOTIONS TO ADJOURN THE MEETING
AM Policy is to vote against proposals to adjourn the meeting.
Rationale: Management may seek authority to adjourn the meeting if a favorable
outcome is not secured. Shareholders should already have had enough information
to make a decision. Once votes have been cast, there is no justification for
management to continue spending time and money to press shareholders for
support.
F. BUNDLED PROPOSALS
AM policy is to vote against bundled proposals if any bundled issue would
require a vote against it if proposed individually.
Rationale: Shareholders should not be forced to "take the good with the bad" in
cases where the proposals could reasonably have been submitted separately.
G. CHANGE OF COMPANY NAME
AM policy is to support management on proposals to change the company name.
Rationale: This is generally considered a business decision for a company.
H. PROPOSALS RELATED TO THE ANNUAL MEETING
AM Policy is to vote in favor of management for proposals related to the
conduct of the annual meeting (meeting time, place, etc.)
Rationale: These are considered routine administrative proposals.
I. REIMBURSEMENT OF EXPENSES INCURRED FROM CANDIDATE NOMINATION
AM policy is to follow management's recommended vote on shareholder proposals
related to the amending of company bylaws to provide for the reimbursement of
reasonable expenses incurred in connection with nominating one or more
candidates in a contested election of directors to the corporation's board of
directors.
Rationale: Corporations should not be liable for costs associated with
shareholder proposals for directors.
J. INVESTMENT COMPANY PROXIES
Proxies solicited by investment companies are voted in accordance with the
recommendations of an independent third party, currently ISS. However,
regarding investment companies for which AM or an affiliate serves as
investment adviser or principal underwriter, such proxies are voted in the same
proportion as the vote of all other shareholders. Proxies solicited by master
funds from feeder funds will be voted in accordance with applicable provisions
of Section 12 of the Investment Company Act of 1940.
Investment companies, particularly closed-end investment companies, are
different from traditional operating companies. These differences may call for
differences in voting positions on the same matter. For example, AM could vote
"for" staggered boards of closed-end investment companies, although AM
generally votes "against" staggered boards for operating companies. Further,
the manner in which AM votes investment company proxies may differ from
proposals for which a AM-advised investment company solicits proxies from its
shareholders. As reflected in the Guidelines, proxies solicited by closed-end
(and open-end) investment companies are voted in accordance with the
pre-determined guidelines of an independent third-party.
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Subject to participation agreements with certain Exchange Traded Funds (ETF)
issuers that have received exemptive orders from the U.S. Securities and
Exchange Commission allowing investing DWS funds to exceed the limits set forth
in Section 12(d)(1)(A) and (B) of the Investment Company Act of 1940, DeAM will
echo vote proxies for ETFs in which Deutsche Bank holds more than 25% of
outstanding voting shares globally when required to do so by participation
agreements and SEC orders.
Note: With respect to the Central Cash Management Fund (registered under the
Investment Company Act of 1940), the Fund is not required to engage in echo
voting and the investment adviser will use these Guidelines, and may determine,
with respect to the Central Cash Management Fund, to vote contrary to the
positions in the Guidelines, consistent with the Fund's best interest.
K. INTERNATIONAL PROXY VOTING
The above guidelines pertain to issuers organized in the United States, Canada
and Germany. Proxies solicited by other issuers are voted in accordance with
international guidelines or the recommendation of ISS and in accordance with
applicable law and regulation.
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