As filed with the Securities and Exchange Commission on January 26, 2005
================================================================================
1933 Act File No. 333-108137
1940 Act File No. 811-21417
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X] Pre-Effective Amendment No. 3
[_] Post-Effective Amendment No.
and
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] Amendment No. 3
NFJ Dividend, Interest & Premium Strategy Fund
(Exact Name of Registrant as Specified in Declaration of Trust)
c/o PA Fund Management LLC
1345 Avenue of the Americas
New York, New York 10105
(Address of Principal Executive Offices)
(Number, Street, City, State, Zip Code)
(212) 739-3369
(Registrant's Telephone Number, including Area Code)
Newton B. Schott, Jr.
c/o PA Distributors LLC
2187 Atlantic Street
Stamford, Connecticut 06902
(Name and Address (Number, Street, City, State, Zip Code) of Agent for Service)
Copies of Communications to:
Joseph B. Kittredge, Jr., Esq.
Ropes & Gray LLP
One International Place
Boston, Massachusetts 02110
Approximate Date of Proposed Public Offering:
As soon as practicable after the effective date of this Registration Statement
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If any of the securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box. [_]
It is proposed that this filing will become effective (check appropriate
box)
[X] when declared effective pursuant to section 8(c)
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed Maximum Proposed Maximum
Amount Being Offering Price Per Aggregate Amount of
Title of Securities Being Registered Registered Unit Offering Price/1/ Registration Fee/2/
------------------------------------ ------------ ------------------ ---------------- -------------------
Common Shares, par value $0.00001 1,000 Shares $ 25.00 $ 25,000 $ 2.03
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/1/ Estimated solely for the purpose of calculating the registration fee.
/2/ $2.03 of which was previously paid.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such dates as the Commission, acting pursuant to said Section 8(a),
may determine.
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The information in this prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an
offer to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED JANUARY 26, 2005
PROSPECTUS
[LOGO] Allianz
Global Investors
Shares
NFJ Dividend, Interest & Premium Strategy Fund
Common Shares
$25.00 per share
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Investment Objectives. The Fund is a newly organized, diversified,
closed-end management investment company. The Fund's primary investment
objective is to seek current income and gains, with a secondary objective of
long-term capital appreciation.
Portfolio Management Strategies. The Fund will pursue its investment
objectives by investing in a diversified portfolio of dividend-paying common
stocks (the "Equity Component") and income-producing convertible securities
(the "Convertible Component"). The Fund will also employ a strategy of writing
(selling) call options on equity indexes in an attempt to generate gains from
option premiums (the "Index Option Strategy").
The Equity Component is initially expected to represent approximately 75%,
and the Convertible Component approximately 25%, of the net proceeds of this
offering. Thereafter, the percentage of the Fund's assets represented by each
component is expected to vary based on relative investment performance, market
fluctuations and other factors, but the Fund's entire portfolio will be
rebalanced on an annual basis (so that the Equity Component will represent
approximately 75% and the Convertible Component approximately 25% of the
portfolio immediately after each rebalancing). The first rebalancing will take
place in January, 2006.
The Fund cannot assure you that it will achieve its investment objectives.
(continued on following page)
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Investing in the Fund's common shares involves certain risks. See "Risks"
beginning on page 37 of this prospectus. Certain of these risks are summarized
in "Prospectus Summary--Special Risk Considerations" beginning on page 12.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
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Per Share Total(2)
--------- --------
Public Offering Price $ 25.00 $
Sales Load $ 1.125 $
Estimated Offering Expenses(1)(2) $ .05 $
Proceeds to the Fund $23.825 $
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(1) The Fund will pay or reimburse organizational and offering expenses
estimated at $ from the proceeds of the offering. PA Fund
Management LLC (the "Manager") has agreed to pay the amount by which the
Fund's offering costs (other than the sales load, but inclusive of the
reimbursement of underwriter expenses of $.005 per share) exceed $.05 per
share. While the Manager has agreed to initially pay all of the Fund's
organizational expenses, the Fund has agreed to reimburse the Manager for
such organizational expenses (or a portion thereof) so long as that
reimbursement plus the Fund's offering costs (other than the sales load,
but inclusive of the reimbursement of underwriter expenses of $.005 per
share) does not exceed $.05 per share. Any such reimbursement will be made
prior to the end of the Fund's initial fiscal year.
(2) The Underwriters may also purchase up to an additional common shares
at the public offering price, less the sales load, within 45 days from the
date of this prospectus to cover over-allotments, if any. If such option is
exercised in full, the total public offering price, sales load, estimated
offering expenses and proceeds to the Fund will be , , and
, respectively.
The Underwriters expect to deliver the common shares to purchasers on or
about , 2005.
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Citigroup Merrill Lynch & Co. UBS Investment Bank
A.G. Edwards Wachovia Securities Deutsche Bank Securities
Advest, Inc. Robert W. Baird & Co. H&R Block Financial Advisors, Inc.
Banc of America Crowell, Weedon & Co. Ferris, Baker Watts
Securities LLC Incorporated
J.J.B. Hilliard, W.L. Janney Montgomery Scott
Lyons, Inc. LLC KeyBanc Capital Markets
Legg Mason Wood Walker Oppenheimer & Co. Raymond James
Incorporated
RBC Capital Markets Ryan Beck & Co. Stifel, Nicolaus &
Company
Incorporated
SunTrust Robinson
Humphrey Wedbush Morgan Securities Inc. Wells Fargo Securities
, 2005
(continued from previous page)
PA Fund Management LLC (the "Manager") serves as the investment manager of
the Fund. The Fund utilizes three affiliated sub-advisers to manage different
elements of the Fund's portfolio. NFJ Investment Group L.P. ("NFJ") manages the
Equity Component by focusing on undervalued common stocks with relatively high
dividend yields. Nicholas-Applegate Capital Management LLC ("NACM") manages the
Convertible Component by using traditional credit analysis combined with a
disciplined, fundamental bottom-up research process. PEA Capital LLC ("PEA")
implements the Fund's Index Option Strategy using quantitative and statistical
analysis designed to produce gains from index option premiums.
No Prior History. Because the Fund is newly organized, its common shares
have no history of public trading. Shares of closed-end investment companies
frequently trade at a discount from their net asset value, which creates a risk
of loss for investors purchasing shares in the initial public offering. The
Fund intends to apply for listing of the common shares on the New York Stock
Exchange under the trading or "ticker" symbol "NFJ."
Portfolio Contents. Under normal circumstances, the Fund will invest at
least 80% of its net assets (plus any borrowings for investment purposes) in
securities and other instruments that provide dividends, interest or option
premiums.
The Equity Component will ordinarily consist principally of dividend-paying
common stocks, but may also include preferred stocks and dividend-paying real
estate investment trusts. The assets of the Equity Component will be invested
principally in securities of U.S. issuers, but may also include American
Depository Receipts ("ADRs"). Up to 10% of the component's assets may be
invested in foreign securities other than ADRs, including emerging market
securities.
The Convertible Component will ordinarily consist of convertible securities,
including synthetic convertible securities, and may include convertible
securities that are of below investment grade quality. Securities of below
investment grade quality are regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal,
and are commonly referred to as "high yield" securities or "junk bonds." They
involve greater risk of loss, are subject to greater price volatility and are
less liquid, especially during periods of economic uncertainty or change, than
higher rated securities. Due to the risks involved in investing in high yield
securities, an investment in the Fund should be considered speculative. Up to
20% of the Convertible Component may consist of U.S. dollar-denominated
securities of foreign issuers based in developed countries.
The Fund will employ its Index Option Strategy by writing (selling) call
options on equity indexes such that the underlying value of the indexes are
approximately equal to and do not exceed the value of the Equity Component of
the Fund--i.e., approximately 75% of the Fund's net assets, subject to future
fluctuations in the assets attributable to the Equity Component and annual
rebalancings. For these purposes, the Fund treats options on indexes as being
written on securities held by the Fund having an aggregate value equal to the
face or notional amount of the index subject to the options. Most of the
options written by the Fund will be exchange-traded, although the Fund may
utilize over-the-counter options. The Fund may also utilize other derivative
strategies involving call and put options, futures and forward contracts, swap
agreements, short sales and other derivative instruments in an attempt to hedge
against market and other risks in the portfolio. The Fund may invest up to 15%
of its total assets in illiquid securities.
Although it has no current intention to do so, the Fund may in the future
determine to issue preferred shares, borrow money or issue debt securities to
add leverage to its portfolio, provided that the leverage does not represent
more than 38% of the Fund's total assets. See "Leverage and Borrowings." The
Fund may enter into derivatives transactions that may in certain circumstances
produce effects similar to leverage. See "The Fund's Investment Objectives and
Strategies--Portfolio Contents and Other Information--Other Derivatives."
You should read this prospectus, which contains important information about
the Fund, before deciding whether to invest, and retain it for future
reference. A Statement of Additional Information, dated , 2005
containing additional information about the Fund, has been filed with the
Securities and Exchange Commission and is incorporated by reference in its
entirety into this prospectus, which means that it is part of the prospectus
for legal purposes. You can review the table of contents of the Statement of
Additional Information on page 66 of this prospectus. You may request a free
copy of the Statement of Additional Information by calling (877) 819-2224 or by
writing to the Fund, or obtain a copy (and other information regarding the
Fund) from the Securities and Exchange Commission's Web site
(http://www.sec.gov).
The Fund's common shares do not represent a deposit or obligation of, and
are not guaranteed or endorsed by, any bank or other insured depository
institution, and are not federally insured by the Federal Deposit Insurance
Corporation, the Federal Reserve Board or any other government agency.
You should rely only on the information contained or incorporated by
reference in this prospectus. The Fund has not, and the Underwriters have not,
authorized anyone to provide you with different information. If anyone provides
you with different or inconsistent information, you should not rely on it. The
Fund is not, and the Underwriters are not, making an offer of these securities
in any state where the offer is not permitted. You should not assume that the
information contained in this prospectus is accurate as of any date other than
the date on the front of this prospectus. The Fund's business, financial
condition, results of operations and prospects may have changed since that date.
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TABLE OF CONTENTS
Page
----
Prospectus Summary............................................ 1
Summary of Fund Expenses...................................... 23
The Fund...................................................... 24
Use of Proceeds............................................... 24
The Fund's Investment Objectives and Strategies............... 24
Leverage and Borrowings....................................... 36
Risks......................................................... 37
How the Fund Manages Risk..................................... 46
Management of the Fund........................................ 47
Net Asset Value............................................... 52
Distributions................................................. 53
Dividend Reinvestment Plan.................................... 54
Description of Shares......................................... 55
Anti-Takeover and Other Provisions in the Declaration of Trust 56
Repurchase of Common Shares; Conversion to Open-End Fund...... 57
Tax Matters................................................... 58
Underwriting.................................................. 62
Custodian and Transfer Agent.................................. 65
Legal Matters................................................. 65
Table of Contents for the Statement of Additional Information. 66
Appendix A--Description of Securities Ratings................. 67
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PROSPECTUS SUMMARY
This is only a summary. This summary may not contain all of the information
that you should consider before investing in the common shares. You should
review the more detailed information contained in this prospectus and in the
Statement of Additional Information.
The Fund.................. NFJ Dividend, Interest & Premium Strategy Fund
(the "Fund") is a newly organized, diversified,
closed-end management investment company. See
"The Fund."
The Offering.............. The Fund is offering common shares of
beneficial interest, with a par value of
$.00001 per share, at $25.00 per share through
a group of underwriters (the "Underwriters")
led by Citigroup Global Markets Inc., Merrill
Lynch, Pierce, Fenner & Smith Incorporated, UBS
Securities LLC, A.G. Edwards & Sons, Inc.,
Wachovia Capital Markets, LLC, Deutsche Bank
Securities Inc., Advest, Inc., Robert W. Baird
& Co. Incorporated, Banc of America Securities
LLC, H&R Block Financial Advisors, Inc.,
Crowell, Weedon & Co., Ferris, Baker Watts,
Incorporated, J.J.B. Hilliard, W.L. Lyons,
Inc., Janney Montgomery Scott LLC, KeyBanc
Capital Markets, a Division of McDonald
Investments Inc., Legg Mason Wood Walker,
Incorporated, Oppenheimer & Co. Inc., Raymond
James & Associates, Inc., RBC Capital Markets
Corporation, Ryan Beck & Co., Inc., Stifel,
Nicolaus & Company, Incorporated, SunTrust
Capital Markets, Inc., Wedbush Morgan
Securities Inc., and Wells Fargo Securities,
LLC. The common shares of beneficial interest
are called "Common Shares" in the rest of this
prospectus. You must purchase at least 100
Common Shares. The Fund has given the
Underwriters an option to purchase up to
additional Common Shares to cover orders in
excess of Common Shares. See
"Underwriting." PA Fund Management LLC (the
"Manager") has agreed to pay the amount by
which the Fund's offering costs (other than the
sales load, but inclusive of the reimbursement
of underwriter expenses of $.005 per share)
exceed $.05 per share. While the Manager has
agreed to initially pay all of the Fund's
organizational expenses, the Fund has agreed to
reimburse the Manager for such organizational
expenses (or a portion thereof) so long as that
reimbursement plus the Fund's offering costs
(other than the sales load, but inclusive of
the reimbursement of underwriter expenses of
$.005 per share) does not exceed $.05 per
share. Any such reimbursement will be made
prior to the end of the Fund's initial fiscal
year.
Investment Objectives and
Strategies................ The Fund's primary investment objective is to
seek current income and gains, with a secondary
objective of long-term capital appreciation.
The Fund cannot assure you that it will achieve
its investment objectives.
The Fund will pursue its investment objectives by
investing in a diversified portfolio of
dividend-paying common stocks (the "Equity
Component") and income-producing convertible
securities (the "Convertible Component"). The
Fund will also employ a
1
strategy of writing (selling) call options on
equity indexes in an attempt to generate gains
from option premiums (the "Index Option
Strategy"). The types of investments that will
ordinarily comprise the Equity Component and
the Convertible Component, and the instruments
used to implement the Index Option Strategy,
are summarized under "--Portfolio Contents"
below.
The Manager serves as the investment manager of
the Fund. The Fund utilizes three affiliated
sub-advisers (the "Sub-Advisers") to manage the
Fund's portfolio. NFJ Investment Group L.P.
("NFJ") manages the Equity Component,
Nicholas-Applegate Capital Management LLC
("NACM") manages the Convertible Component and
PEA Capital LLC ("PEA") implements the Index
Option Strategy. See "Sub-Advisers" below. The
portfolio management strategies and techniques
utilized by each Sub-Adviser are described
below.
Asset Allocation and Annual Rebalancing. The
Equity Component is initially expected to
represent approximately 75%, and the
Convertible Component approximately 25%, of the
net proceeds of the offering. The Manager will
cause the Fund's entire portfolio to be
rebalanced annually to this initial asset
allocation between the Equity Component and the
Convertible Component. The first rebalancing
will take place in January, 2006. These annual
rebalancings may result in additional
transaction costs for the Fund and may increase
the amount of capital gains (and, in
particular, short-term gains) realized by the
Fund on which shareholders may pay tax.
Although the portfolio will be rebalanced
annually, it is expected that the relative
percentage of the Fund's assets represented by
the Equity and Convertible Components will vary
during interim periods in relation to the
relative investment performance of each
Component, as well as market fluctuations and
other factors. Therefore, the Fund's assets
attributable to each Component from time to
time may be significantly higher or lower than
the initial 75%/25% allocation described above,
and the risk/return profile of the Fund (taken
as a whole) will vary accordingly.
Investment Selection
Strategies................ Equity Component. In selecting common stocks for
the Equity Component, NFJ considers an initial
selection universe consisting of the 1,000
largest publicly traded companies (in terms of
market capitalization) in the U.S. to identify
150 to 200 companies that exhibit the best
fundamental characteristics. NFJ classifies the
universe by industry, and then identifies the
most undervalued stocks in each industry based
mainly on relative price-to-earnings (P/E)
ratios, calculated both with respect to
trailing operating earnings and forward
earnings estimates. From this group of common
stocks, NFJ buys a number of stocks with the
highest dividend yields. NFJ then screens the
most undervalued companies in each industry by
dividend yield to identify the highest yielding
common stocks in each industry. From this
group, NFJ buys an approximately equal number
of additional stocks with the lowest P/E
ratios. In selecting individual stocks, NFJ
also considers
2
quantitative factors such as price momentum
(based on analysts' earnings per share
estimates and revisions to those estimates),
relative dividend yields, valuations relative
to the overall market and trading liquidity.
NFJ will ordinarily replace an investment when
a similar investment opportunity within the
same industry group has a considerably higher
dividend yield or lower valuation than the
current holding. The Equity Component may
include common stocks outside of the selection
universe described above, consistent with the
Fund's investment objectives and policies.
To the extent that NFJ invests in preferred
stocks or real estate investment trusts for the
Equity Component, NFJ considers quantitative
factors similar to those used for common stocks
as described above, and also uses traditional
credit analysis, taking into account factors
such as changes in credit fundamentals, changes
in attractiveness relative to other securities
and changes in industry fundamentals.
NFJ will also manage the Equity Component with a
view toward reducing the portion of Fund
distributions that are taxed as ordinary income
by focusing investments in common stocks that
pay dividends that may qualify for taxation to
individual Common Shareholders as "qualified
dividend income," and thus be eligible for
taxation at favorable rates applicable to
long-term capital gains. See "Tax Matters."
However, it is expected that a substantial
portion of the Fund's net investment income
(including income derived from the Convertible
Component and a portion of the gains received
from index option premiums) will be taxed to
Common Shareholders at ordinary income tax
rates. Therefore, the Fund should not be viewed
as a vehicle designed to maximize after-tax
returns. See "Tax Risk."
Convertible Component. In selecting convertible
securities for the Convertible Component, NACM
attempts to identify issuers that successfully
adapt to change. NACM evaluates each
convertible security's investment
characteristics as an income-producing
security, using the credit analysis techniques
described below, as well as its potential for
capital appreciation, using techniques that
focus on the security's equity characteristics.
NACM seeks to capture approximately 70-80% of
any increase in the market price of the
underlying equities (upside potential) and 50%
or less of any decrease in the market price of
the underlying equities (downside exposure). In
analyzing specific companies for possible
investment, NACM ordinarily looks for several
of the following characteristics: above-average
per share earnings growth; high return on
invested capital; a healthy balance sheet;
sound financial and accounting policies and
overall financial strength; strong competitive
advantages; effective research and product
development and marketing; development of new
technologies; efficient service; pricing
flexibility; strong management; and general
operating characteristics that will enable the
companies to compete successfully in their
respective markets.
3
NACM also uses traditional credit analysis
combined with a disciplined, fundamental
bottom-up research process that facilitates the
early identification of issuers demonstrating
an ability to improve their fundamental
characteristics. NACM attempts to identify
potential investments that it expects will
exceed minimum credit statistics and exhibit
the highest visibility of future expected
operating performance. NACM relies heavily on
its own analysis of the credit quality and
risks associated with individual securities
considered for the Convertible Component,
rather than relying exclusively on rating
agencies or third-party research. The team
managing the Convertible Component utilizes
this information in an attempt to minimize
credit risk and identify issuers, industries or
sectors that are undervalued or that offer high
current income or attractive capital
appreciation relative to NACM's assessment of
their credit characteristics.
NACM's discipline in selling investments that
have become less attractive is clearly defined
and designed to drive the Convertible Component
continually toward strength, taking into
account factors such as a change in credit
fundamentals, a decline in attractiveness
relative to other securities and a decline in
industry fundamentals.
Index Option Strategy. In implementing the
Fund's Index Option Strategy, PEA will "sell"
or "write" call options on equity indexes such
that the underlying value of the indexes are
approximately equal to (and do not exceed) the
net asset value of the Fund's Equity
Component--i.e., approximately 75% of the
Fund's net assets, subject to future
fluctuations in the assets attributable to the
Equity Component and annual rebalancings as
described above. For these purposes, the Fund
treats options on indexes as being written on
securities having an aggregate value equal to
the face or notional amount of the index
subject to the option. This index option
writing strategy is designed to produce gains
from index option premiums.
Index call options are contracts representing the
right to purchase the cash value of an index at
a specified price (the "strike price") at or
until a specified future date (the "expiration
date"). The Fund will sell index options that
are "European style," meaning that the options
may be exercised only on the expiration date.
For conventional listed call options, the
option's expiration date can be up to nine
months from the date the call options are first
listed for trading. Longer-term call options
can have expiration dates up to three years
from the date of listing. The Fund expects that
it will normally write options whose terms to
expiration range from two months to one year,
although the Fund may write options of both
longer and shorter terms. PEA will not write
call options on individual equity securities,
but may write options on exchange-traded funds
and other similar instruments designed to
correlate with the performance of an equity
index or market segment.
4
As the writer (seller) of an equity index call
option, the Fund would receive cash (the
premium) from the purchaser of the option, and
the purchaser would have the right to receive
from the Fund any appreciation in the cash
value of index over the strike price on the
expiration date. If, at expiration, the
purchaser exercises the index option sold by
the Fund, the Fund would pay the purchaser the
difference between the cash value of the index
and the strike price. In effect, the Fund sells
the potential appreciation in the value of the
index above the strike price in exchange for
the premium. PEA may cause the Fund to
repurchase an index call option prior to its
expiration date, extinguishing the Fund's
obligation, in which case the cost of
repurchasing the option (net of any premiums
received) will determine the gain or loss
realized by the Fund.
Equity index options differ from options on
individual securities in that (i) the exercise
of an index option requires cash payments and
does not involve the actual purchase or sale of
securities, (ii) the holder of an index option
has the right to receive cash upon exercise of
the option if the level of the index upon which
the option is based is greater than the strike
price of the option and (iii) index options
reflect price fluctuations in a group of
securities or segments of the securities market
rather than price fluctuations in a single
common stock.
In pursuing the Index Option Strategy, PEA may
cause the Fund to sell call options on
"broad-based" equity indexes, such as the
Standard & Poor's 500 Index, as well as
narrower market indexes, such as the Standard &
Poor's 100 Index, or on indexes of securities
of companies in a particular industry or
sector, including (but not limited to)
financial services, technology, pharmaceuticals
and consumer products. An equity index assigns
relative values to the securities included in
the index (which change periodically), and the
index fluctuates with changes in the market
values of these securities. PEA will actively
manage the Fund's index options positions using
quantitative and statistical analysis that
focuses on relative value and risk/return. In
determining which equity index options to
utilize, PEA will consider market factors, such
as current market levels and volatility, and
options specific factors, such as premium/cost,
strike price and time to expiration. PEA will
attempt to create a portfolio of equity index
call options that is diversified across
multiple strike prices and expiration dates.
PEA will attempt to maintain for the Fund written
call options positions on equity indexes whose
price movements, taken in the aggregate, are
correlated with the price movements of the
common stocks and other securities held in the
Fund's Equity Component. In doing so, PEA will
take into account periodic data provided by NFJ
with respect to the Equity Component, including
net assets, industry and sector weightings,
historic volatility as well as periodic
(typically 30 days after month-end) reports
detailing portfolio holdings. However, other
than through periodic holdings reports, PEA
will not have access to the actual securities
purchased, sold or held by or for the Equity
Component due to
5
informational barriers in place between NFJ and
PEA. Therefore, the Index Option Strategy
involves significant risk that the changes in
value of the indexes underlying the Fund's
written call options positions will not
correlate closely with changes in the market
value of securities held by the Equity
Component. To the extent that there is a lack
of correlation, movements in the indexes
underlying the options positions may result in
losses to the Fund, which may more than offset
any gains received by the Fund from options
premiums. See "Risks - Index Options Risk."
PEA does not intend to write call options on
equity indexes where the underlying value of
the indexes exceed the net asset value of the
Equity Component (i.e., write "naked"
positions). The Fund will "cover" its written
equity index call positions by segregating
liquid assets in an amount equal to the
contract value of the index and/or by entering
into offsetting positions (e.g., by holding a
call option on the same index as the call
written where the strike price of the call held
is equal to or less than the strike price of
the call written).
The Fund will generally sell index call options
which are "out-of-the-money" or "at-the-money"
at the time of sale. Out-of-the-money call
options are options with a strike price above
the current cash value of the index and
at-the-money call options are options with a
strike price equal to the cash value of the
index. In addition to providing possible gains
through premiums, out-of-the-money index call
options allow the Fund to potentially benefit
from appreciation in the equity securities held
by the Fund with respect to which the option
was written (to the extent correlated with the
index) up to the strike price. The Fund will
generally write out-of-the-money call options
where the strike price is not more than 10%
higher than the cash value of the index at the
time of sale, although PEA reserves the
flexibility to utilize written call options
that are more deeply out-of-the-money if it
deems appropriate depending upon market
conditions and other factors. The Fund also
reserves the flexibility to sell index call
options that are "in-the-money" - i.e., those
with a strike price below the cash value of the
index at the time of sale, and will generally
limit these to options where the strike price
is not more than 5% lower than the cash value
of the index (although the Fund may utilize
options that are more deeply in-the-money
depending upon market conditions and other
factors). When the prices of the equity index
upon which a call option is written rise, call
options that were out-of-the-money when written
may become in-the-money (i.e., the cash value
of the index rises above the strike price of
the option), thereby increasing the likelihood
that the options could be exercised and the
Fund forced to pay the amount of appreciation
over the strike price of the option upon
expiration.
Most option contracts are originated and
standardized by an independent entity called
the Options Clearing Corporation (the "OCC").
The Fund will write (sell) call options that
are generally issued, guaranteed and cleared by
the OCC. Listed call options are currently
traded on the American Stock Exchange, Chicago
Board
6
Options Exchange, International Securities
Exchange, New York Stock Exchange, Pacific
Stock Exchange, Philadelphia Stock Exchange and
various other U.S. options exchanges. The Fund
may also write unlisted (or "over-the counter")
call options.
Diversification. Subject to the availability of
suitable investment opportunities and subject
to the Fund's limitations, NFJ and NACM will
attempt to diversify the investments in their
respective Components broadly in an attempt to
minimize the Component's sensitivity to market
risk, credit risk and/or other risks associated
with a particular issuer, industry or sector,
or to the impact of a single economic,
political or regulatory occurrence.
Portfolio Contents. Under normal circumstances,
the Fund will invest at least 80% of its net
assets (plus any borrowings for investment
purposes) in securities and other instruments
that provide dividends, interest or option
premiums.
The Equity Component will ordinarily consist
principally of dividend-paying common stocks,
but may also include preferred stocks and
dividend-paying real estate investment trusts.
The assets of the Equity Component will be
invested principally in securities of U.S.
issuers, but may include American Depository
Receipts ("ADRs"). Up to 10% of the component's
assets may be invested in foreign securities
other than ADRs, including emerging market
securities.
The Convertible Component will ordinarily consist
of convertible securities, including synthetic
convertible securities, and may include
convertible securities that are of below
investment grade quality (i.e., rated, at the
time of investment, below Baa by Moody's or
below BBB by S&P, or unrated but judged by NACM
to be of comparable quality). NACM may invest
in distressed securities on behalf of the
Convertible Component, but will not invest in
securities which are in default (rated "D" by
Moody's or S&P) at the time of purchase (but
may hold securities which have gone into
default after they have been purchased). Up to
20% of the Convertible Component may consist of
U.S. dollar-denominated securities of foreign
issuers based in developed countries.
Convertible securities are bonds, debentures,
notes, preferred stocks or other securities
that may be converted or exchanged (by the
holder or by the issuer) into shares of the
underlying common stock (or cash or securities
of equivalent value) at a stated exchange ratio
or predetermined price. A synthetic convertible
security represents the combination of separate
securities that possess the two principal
characteristics of a traditional convertible
security, i.e., an income-producing security
and the right to acquire an equity security,
such as the combination of a traditional
corporate bond with a warrant to purchase
equity securities of the issuer of the bond.
The Fund will employ its Index Option Strategy by
writing (selling) call options on equity
indexes such that the underlying value of the
indexes are approximately equal to and do not
exceed the value of the Equity Component of the
Fund - i.e., approximately 75% of
7
the Fund's net assets, subject to future
fluctuations in the assets attributable to the
Equity Component and annual rebalancings. For
these purposes, the Fund treats options on
indexes as being written on securities held by
the Fund having an aggregate value equal to the
face or notional amount of the index subject to
the options. Most of the options written by the
Fund will be exchange-traded, although the Fund
may utilize over-the-counter options.
In addition to the use of written options under
the Index Option Strategy, the Fund may utilize
other derivative strategies involving call and
put options, futures and forward contracts, swap
agreements, short sales and other derivative
instruments in an attempt to hedge against
market and other risks in the portfolio.
The Fund may invest in securities of issuers with
small market capitalizations. The Fund may
invest up to 15% of its total assets in
illiquid securities.
As a diversified fund, the Fund generally may
not, with respect to 75% of its total assets,
purchase the securities of any issuer, except
securities issued or guaranteed by the U.S.
Government or any of its agencies or
instrumentalities or securities of other
investment companies, if, as a result, (i) more
than 5% of the Fund's total assets would be
invested in the securities of that issuer, or
(ii) the Fund would hold more than 10% of the
outstanding voting securities of that issuer.
The Fund will not concentrate its investments
in a particular "industry" by investing more
than 25% of its total assets in that industry.
See "How the Fund Manages Risk--Investment
Limitations." The Fund's industry concentration
policy does not preclude it from focusing
investments in issuers in a group of related
industrial sectors (such as different types of
utilities).
Leverage and Borrowings... Although it has no current intention to do so,
the Fund reserves the flexibility to issue
preferred shares or debt securities or engage
in borrowings to add leverage to its portfolio.
The Fund may also enter into derivative
transactions that may in some circumstances
give rise to a form of financial leverage. Any
leverage used by the Fund would be limited to
38% of the Fund's total assets (including the
proceeds of the leverage). See "Leverage and
Borrowings." To the extent that the Fund uses
leverage, it would seek to obtain a higher
return for shareholders than if the Fund did
not use leverage. Leveraging is a speculative
technique and there are special risks involved.
See "Risks--Leverage Risk."
Investment Manager........ The Manager serves as the investment manager of
the Fund. Subject to the supervision of the
Board of Trustees, the Manager is responsible
for managing, either directly or through others
selected by it, the investment activities of
the Fund and the Fund's business affairs and
other administrative matters. The Manager will
receive an annual fee, payable monthly, in an
amount equal to 0.90% of the Fund's average
daily total managed assets. "Total managed
assets" means the total assets of the Fund
(including assets attributable to any
borrowings that may be outstanding) minus
accrued liabilities (other than liabilities
representing borrowings). The Manager is
located at 1345 Avenue of the Americas, New
York, New York
8
10105. Organized in 2000 as a subsidiary
successor of a business originally organized in
1987, the Manager provides investment
management and advisory services to several
closed-end and open-end investment company
clients. As of December 31, 2004, the Manager
had approximately $37.5 billion in assets under
management. Allianz Global Investors of America
L.P. is the direct parent company of PA Retail
Holdings LLC, of which the Manager is a
wholly-owned subsidiary. As of December 31,
2004, Allianz
Global Investors of America L.P. and its
subsidiaries, including NFJ, NACM and PEA, had
approximately $564.8 billion in assets under
management.
The Manager has retained its affiliates, NFJ,
NACM and PEA (each a "Sub-Adviser" and
collectively, the "Sub-Advisers"), as
sub-advisers to manage the Fund's portfolio
investments. See "--Sub-Advisers" below.
Sub-Advisers.............. NFJ will serve as the Fund's Sub-Adviser
responsible for managing the Fund's Equity
Component. Subject to the supervision of the
Manager and pursuant to the terms of its
portfolio management agreement, NFJ has full
investment discretion and makes all
determinations with respect to the investment
of the Equity Component's assets. NFJ is
located at 2121 San Jacinto, Suite 1840,
Dallas, Texas 75201. NFJ is the successor
investment adviser to NFJ Investment Group,
Inc., which commenced operations in 1989. NFJ
provides investment management services to a
number of institutional accounts, including
investment companies, employee benefit plans,
college endowment funds and foundations. As of
December 31, 2004, NFJ had approximately $9.3
billion in assets under management.
NACM will serve as the Fund's Sub-Adviser
responsible for managing the Convertible
Component. Subject to the supervision of the
Manager and pursuant to the terms of its
portfolio management agreement, NACM has full
investment discretion and makes all
determinations with respect to the investment
of the Convertible Component's assets. NACM is
located at 600 West Broadway, 30th Floor, San
Diego, California 92101. Founded in 1984, NACM
currently manages discretionary assets for
numerous clients, including investment
companies, employee benefit plans,
corporations, public retirement systems and
unions, university endowments, foundations, and
other institutional investors and individuals.
As of December 31, 2004, NACM had approximately
$14.5 billion in assets under management.
PEA will serve as the Fund's Sub-Adviser
responsible for implementing the Index Option
Strategy. Subject to the supervision of the
Manager and pursuant to the terms of its
portfolio management agreement, PEA has full
investment discretion and makes all
determinations with respect to the
implementation of the Index Option Strategy.
PEA is located at 1345 Avenue of the Americas,
50th Floor, New York, New York 10105. PEA
provides equity-related advisory services to
mutual funds and institutional accounts. As of
December 31, 2004, PEA had approximately $14.5
billion in assets under management.
9
The Manager (and not the Fund) will pay a portion
of the fees it receives from the Fund to the
Sub-Advisers in return for their services.
Distributions............. Commencing with the Fund's first dividend, the
Fund intends to make quarterly cash
distributions to Common Shareholders at a rate
that reflects the past and projected
performance of the Fund. The Fund
expects to receive substantially all of its
current income and gains from the following
sources: (i) capital gains (short-term and
long-term) from net index option premiums and
the sale of portfolio securities; (ii)
dividends received by the Fund that are paid on
the common stocks and other equity securities
held in the Equity Component; and (iii)
interest income received by the Fund from the
convertible securities held in the Convertible
Component. Distributions are likely to be
variable, and the Fund's distribution rate will
depend on a number of factors, including the
net earnings on the Fund's portfolio
investments and the rate at which such net
earnings change as a result of changes in the
timing of and rates at which the Fund receives
income from the sources described above. The
net investment income of the Fund consists of
all income (other than net short-term and
long-term capital gains) less all expenses of
the Fund.
The Fund's quarterly distributions will be made
from the Fund's net investment income and net
gains from index option premiums and the sale
of portfolio securities. The tax treatment and
characterization of the Fund's distributions
may vary significantly from time to time
because of the varied nature of the Fund's
investments. Pursuant to the requirements of
the Investment Company Act of 1940, as amended
(the "1940 Act") and other applicable laws, a
notice will accompany each quarterly
distribution with respect to the estimated
source (as between net income and gains) of the
distribution made. (The Fund will indicate the
proportion of its capital gains distributions
that constitute long-term and short-term gains
annually.) The ultimate tax characterization of
the Fund's distributions made in a calendar or
fiscal year cannot finally be determined until
after the end of that fiscal year. As a result,
there is a possibility that the Fund may make
total distributions during a calendar or fiscal
year in an amount that exceeds the Fund's net
investment income and net realized capital
gains for the relevant fiscal year. For
example, the Fund may distribute amounts early
in the calendar or fiscal year that derive from
short-term capital gains, but incur net
short-term capital losses later in the year,
thereby offsetting short-term capital gains out
of which distributions have already been made
by the Fund. In such a situation, the amount by
which the Fund's total distributions exceed net
investment income and net realized capital
gains would generally be treated as a tax-free
return of capital up to the amount of your tax
basis in your shares, with any amounts
exceeding such basis treated as gain from the
sale of shares.
As portfolio and market conditions change, the
rate of dividends on the Common Shares and the
Fund's dividend policy could change. Over time,
the Fund will distribute all of its net
investment income and net short-term capital
gains. In addition, at least annually, the
10
Fund intends to distribute net realized
long-term capital gains not previously
distributed, if any. The 1940 Act currently
limits the number of times the Fund may
distribute long-term capital gains in any tax
year, which may increase the variability of the
Fund's distributions and result in certain
dividends being comprised more heavily of
long-term capital gains eligible for favorable
income tax rates. During periods in which the
Index Option Strategy does not generate
sufficient option premiums or results in net
losses, a substantial portion of the Fund's
dividends may be comprised of capital gains
from the sale of equity securities held in the
Equity Component, which would involve
transaction costs borne by the Fund and may
also result in realization of taxable
short-term capital gains taxed at ordinary
income tax rates (particularly during the
initial year of the Fund's operations when all
of the Fund's portfolio securities will have
been held for less than one year). See "Tax
Matters."
Your initial distribution is expected to be
declared approximately 75 days, and paid
approximately 120 days, from the completion of
this offering, depending on market conditions.
Unless you elect to receive distributions in
cash, all of your distributions will be
automatically reinvested in additional Common
Shares under the Fund's Dividend Reinvestment
Plan. See "Distributions" and "Dividend
Reinvestment Plan." Although it does not now
intend to do so, the Board of Trustees may
change the Fund's distribution policy and the
amount or timing of the distributions, based on
a number of factors, including the amount of
the Fund's undistributed net investment income
and net short- and long-term capital gains and
historical and projected net investment income
and net short- and long-term capital gains.
Listing................... The Fund expects to apply for listing of the
Common Shares on the New York Stock Exchange,
under the trading or "ticker" symbol "NFJ." See
"Description of Shares."
Custodian and Transfer
Agent..................... Brown Brothers Harriman & Co. will serve as
custodian of the Fund's assets. PFPC Inc. will
serve as the Fund's transfer and dividend
disbursement agent. See "Custodian and Transfer
Agent."
Market Price of Shares.... Shares of closed-end investment companies
frequently trade at prices lower than net asset
value. Shares of closed-end investment
companies have during some periods traded at
prices higher than net asset value and during
other periods traded at prices lower than net
asset value. The Fund cannot assure you that
Common Shares will trade at a price higher than
net asset value in the future. Net asset value
will be reduced immediately following the
offering by the sales load and the amount of
organization and offering expenses paid or
reimbursed by the Fund. See "Use of Proceeds."
In addition to net asset value, market price
may be affected by factors relating to the Fund
such as dividend levels and stability (which
will in turn be affected by levels of dividend
and interest payments by the Fund's portfolio
holdings, the timing and success of the Fund's
Index Option Strategy, regulation affecting the
timing and character of Fund distributions,
Fund expenses and other factors), portfolio
credit quality, liquidity, call protection,
11
market supply and demand, and similar factors
relating to the
Fund's portfolio holdings. See "Risks,"
"Description of Shares" and "Repurchase of
Common Shares; Conversion to Open-End Fund" in
this prospectus, and the Statement of
Additional Information under "Repurchase of
Common Shares; Conversion to
Open-End Fund." The Common Shares are designed
primarily for long-term investors, and you
should not view the Fund as a vehicle for
trading purposes.
Special Risk Considerations The following describes various principal risks
of investing in the Fund. A more detailed
description of these and other risks of
investing in the Fund are described under
"Risks" in this prospectus and under
"Investment Objectives and Policies" in the
Fund's Statement of Additional Information.
No Prior History. The Fund is a newly organized,
diversified, closed-end management investment
company with no history of operations.
Market Discount Risk. As with any stock, the
price of the Fund's Common Shares will
fluctuate with market conditions and other
factors. If shares are sold, the price received
may be more or less than the original
investment. Net asset value will be reduced
immediately following the initial offering by a
sales load and organizational and offering
expenses paid or reimbursed by the Fund. The
Common Shares are designed for long-term
investors and should not be treated as trading
vehicles. Shares of closed-end management
investment companies frequently trade at a
discount from their net asset value. The Fund's
shares may trade at a price that is less than
their initial offering price. This risk may be
greater for investors who sell their shares
relatively shortly after completion of the
initial public offering.
Equity Securities and Related Market Risk. The
Fund will ordinarily have substantial exposure
to common stocks and other equity securities in
pursuing its investment objectives and
policies. The market price of common stocks and
other equity securities in which the Fund
invests may go up or down, sometimes rapidly or
unpredictably. Equity securities may decline in
value due to factors affecting equity
securities markets generally, particular
industries represented in those markets or the
issuer itself, including the historical and
prospective earnings of the issuer and the
value of its assets. The values of equity
securities may decline due to general market
conditions which are not specifically related
to a particular company, such as real or
perceived adverse economic conditions, changes
in the general outlook for corporate earnings,
changes in interest or currency rates or
adverse investor sentiment generally. They may
also decline due to factors which affect a
particular industry or industries, such as
labor shortages or increased production costs
and competitive conditions within an industry.
Equity securities generally have greater price
volatility than bonds and other debt securities.
Issuer Risk. The value of securities may decline
for a number of reasons which directly relate
to the issuer, such as management
12
performance, financial leverage and reduced
demand for the issuer's goods and services.
Dividend and Income Risk. The income
shareholders receive from the Fund is based
primarily on the dividends and interest it
earns from its investments as well as the gains
the Fund receives from writing options and
selling portfolio securities, each of which can
vary widely over the short and long term. The
dividend income from the Fund's investments in
equity securities will be influenced by both
general economic activity and issuer-specific
factors. In the event of a recession or adverse
events affecting a specific industry or issuer,
the issuers of the equity securities held by
the Fund may reduce the dividends paid on such
securities. If prevailing market interest rates
decline, distribution rates on convertible
securities and other debt instruments held by
the Fund, and shareholders' income from the
Fund, would likely decline as well. Please see
"Distributions" above for a description of
other risks associated with the level, timing
and character of the Fund's distributions.
Convertible Securities Risk. Convertible
securities generally offer lower interest or
dividend yields than non-convertible debt
securities of similar quality. The market
values of convertible securities tend to
decline as interest rates increase and,
conversely, to increase as interest rates
decline. However, a convertible security's
market value tends to reflect the market price
of the common stock of the issuing company when
that stock price approaches or is greater than
the convertible security's "conversion price."
The conversion price is defined as the
predetermined price at which the convertible
security could be exchanged for the associated
stock. As the market price of the underlying
common stock declines, the price of the
convertible security tends to be influenced
more by the yield of the convertible security.
Thus, it may not decline in price to the same
extent as the underlying common stock. In the
event of a liquidation of the issuing company,
holders of convertible securities would be paid
before the company's common stockholders but
after holders of any senior debt obligations of
the company. Consequently, the issuer's
convertible securities generally entail less
risk than its common stock but more risk than
its debt obligations.
Synthetic Convertible Securities Risk. The value
of a synthetic convertible security will
respond differently to market fluctuations than
a traditional convertible security because a
synthetic convertible is composed of two or
more separate securities or instruments, each
with its own market value. Because the
convertible element of the security is
typically achieved by investing in warrants or
options to buy common stock at a certain
exercise price, or options on a stock index,
synthetic convertible securities are subject to
the risks associated with derivatives. See
"Risks - Other Derivatives Risks." In addition,
if the value of the underlying common stock or
the level of the index involved in the
convertible element falls below the strike
price of the warrant or option, the warrant or
option may lose all value.
13
Index Options Risk. There are various risks
associated with the Fund's Index Option
Strategy. The purchaser of an index option
written by the Fund has the right to any
appreciation in the cash
value of the index over the strike price on the
expiration date. Therefore, as the writer of an
index call option, the Fund forgoes, during the
option's life, the opportunity to profit from
increases in the market value of the equity
securities held by the Fund with respect to
which the option was written (to the extent
that their performance is correlated with that
of the index) above the sum of the premium and
the strike price of the call. However, the Fund
has retained the risk of loss (net of premiums
received) should the price of the Fund's
portfolio securities decline.
In addition, there are significant differences
between the securities and options markets that
could result in an imperfect correlation
between these markets, causing a given
transaction not to achieve its objectives. 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. PEA will
attempt to maintain for the Fund written call
options positions on equity indexes whose price
movements, taken in the aggregate, are
correlated with the price movements of the
common stocks and other securities held in the
Fund's Equity Component. In doing so, PEA will
take into account periodic data provided by NFJ
with respect to the Equity Component, including
net assets, industry and sector weightings,
historic volatility as well as periodic
(typically 30 days after month-end) reports
detailing portfolio holdings. However, other
than through periodic holdings reports, PEA
will not have access to the actual securities
purchased, sold or held by or for the Equity
Component due to informational barriers in
place between NFJ and PEA. Therefore, the Index
Option Strategy involves significant risk that
the changes in value of the indexes underlying
the Fund's written call options positions will
not correlate closely with changes in the
market value of securities held by the Equity
Component. To the extent that there is a lack
of correlation, movements in the indexes
underlying the options positions may result in
losses to the Fund, which may more than offset
any gains received by the Fund from options
premiums. In these and other circumstances, the
Fund may be required to sell portfolio
securities to satisfy its obligations as the
writer of an index call option when it would
not otherwise choose to do so, or may choose to
sell portfolio securities to realize gains to
supplement Fund distributions. Such sales would
involve transaction costs borne by the Fund and
may also result in realization of taxable
capital gains, including short-term capital
gains taxed at ordinary income tax rates, and
may adversely impact the Fund's after-tax
returns.
There can be no assurance that a liquid market
will exist when the Fund seeks to close out an
option position. Reasons for the absence of a
liquid secondary market on an exchange include
the following: (i) there may be insufficient
trading interest in certain options; (ii)
14
restrictions may be imposed by an exchange on
opening transactions or closing transactions or
both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to
particular classes or series of options; (iv)
unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v)
the facilities of an exchange or the OCC may
not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges
could, for economic or other reasons, decide or
be compelled at some future date to discontinue
the trading of options (or a particular class
or series of options). If trading were
discontinued, the secondary market on that
exchange (or in that class or series of
options) would cease to exist. However,
outstanding options on that exchange that had
been issued by the OCC as a result of trades on
that exchange would continue to be exercisable
in accordance with their terms. The Fund's
ability to terminate over-the-counter 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.
The hours of trading for options may not conform
to the hours during which securities held by
the Fund are traded. To the extent that the
options markets close before the markets for
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
securities represented in an index, an increase
in interest rates, changes in the actual or
perceived volatility of the stock market and
underlying securities represented in an index,
and the remaining term to the option's
expiration. The value of options also may be
adversely affected if the market for options is
reduced or becomes illiquid.
The Fund's options transactions will be subject
to limitations established by each of the
exchanges, boards of trade or other trading
facilities on which the options are traded.
These limitations govern the maximum number of
options in each class which may be written by a
single investor or group of investors acting in
concert, regardless of whether the options are
written on the same or different exchanges,
boards of trade or other trading facilities or
are written in one or more accounts or through
one or more brokers. Thus, the number of
options which the Fund may write may be
affected by options written by other investment
advisory clients of PEA, NFJ, NACM or their
affiliates. 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 other
sanctions.
Other Derivatives Risk. In addition to writing
index call options, PEA may write call options
on behalf of the Fund with respect to exchange
traded funds (ETFs) and similar products, which
involves many of the risks associated with
index option writing as discussed above.
However, PEA will not write call options on
individual securities. NACM may buy and sell
put and call options on
15
individual securities and indexes in creating
synthetic convertible securities for the
Convertible Component. The Fund may otherwise
use a variety of derivative instruments for
hedging or risk management purposes, including
purchased call options, purchased or written
put options, futures contracts, options on
futures contracts, forward contracts and swap
agreements. The Fund also may use derivatives
to gain exposure to equity and other securities
in which the Fund may invest (e.g., pending
investment of the proceeds of this offering).
Derivatives are subject to a number of risks
described elsewhere in this prospectus, such as
liquidity risk, issuer risk, interest rate
risk, credit risk, counterparty risk, and
management risk. They also involve the risk of
mispricing or improper valuation, the risk of
ambiguous documentation and the risk that
changes in the value of a derivative may not
correlate perfectly with an underlying asset,
interest rate or index. Suitable derivative
transactions may not be available in all
circumstances and there can be no assurance
that the Fund will engage in these transactions
to reduce exposure to other risks when that
would be beneficial.
The Fund may enter into derivatives transactions
that may in certain circumstances produce
effects similar to leverage and expose the Fund
to related risks. See "Leverage Risk" below.
Tax Risk. Call option premiums received by the
Fund on many equity index call options will be
subject to mark-to-market treatment, and gains
will be recognized based on the fair market
value of the options at the end of the Fund's
taxable year (or, if disposed of, upon
disposition). Under this system, 60% of the
gains or losses from such equity index call
options will be treated as long-term capital
gains or losses and 40% will be treated as
short-term capital gains or losses. Such
short-term gains will be subject to ordinary
income tax rates to the extent not offset by
short-term capital losses. Other call option
premiums received by the Fund will be
recognized upon exercise, lapse or other
disposition of the option and generally will be
treated by the Fund as short-term capital gain
or loss. Some of the call options and other
devices employed by the Fund reduce risk to the
Fund by substantially diminishing its risk of
loss in offsetting positions in substantially
similar or related property, thereby giving
rise to "straddles" under the federal income
tax rules. The straddle rules require the Fund
to defer certain losses on positions within a
straddle, and terminate or suspend the holding
period for certain securities in which the Fund
does not yet have a long-term holding period or
has not yet satisfied the holding period
required for qualified dividend income. Thus,
the Fund cannot assure you as to any level of
regular quarterly net investment income (income
other than net long-term capital gain) that
will be treated as ordinary income, cannot
assure you as to any level of short-term or
long-term capital gains distributions and
cannot assure you assure you as to any ratio of
regular quarterly distributions to capital gain
distributions. In addition, certain of the
Fund's call writing activities and investment
16
in certain debt obligations may affect the
character, timing and
recognition of income and could cause the Fund
to liquidate other investments in order to
satisfy its distributions requirements. See
"Tax Matters."
While the Equity Component will be managed with a
view toward reducing the portion of Fund
distributions that are taxed as ordinary
income, there can be no assurance as to the
percentage (if any) of the Fund's distributions
that will qualify for taxation to individual
Common Shareholders as "qualified dividend
income," and thus be eligible for taxation at
favorable rates applicable to long-term capital
gains. The portion of the Fund's net investment
income (including net income from the
Convertible Component and portions of the gains
received from the Index Option Strategy) that
will be taxed to Common Shareholders at
ordinary income tax rates is unknown at this
time and cannot be predicted with any
certainty. Therefore, the Fund should not be
viewed as a vehicle designed to maximize
after-tax returns. In addition, the tax
treatment of Fund distributions of income
generated by the Equity Component may be
adversely affected as a result of the "sunset"
provisions that will eliminate the favorable
tax treatment of any tax-favored dividend
income unless Congress acts to eliminate the
"sunset" provisions, and may be adversely
affected by future changes in tax laws and
regulations. See "Tax Matters."
The tax treatment and characterization of the
Fund's distributions may vary significantly
from time to time because of the varied nature
of the Fund's investments. The ultimate tax
characterization of the Fund's distributions
made in a taxable year cannot finally be
determined until after the end of that taxable
year. As a result, there is a possibility that
the Fund may make total distributions during a
taxable year in an amount that exceeds the
Fund's net investment income and net realized
capital gains for that year, in which case the
excess would generally be treated as a tax-free
return of capital up to the amount of the
shareholder's tax basis in the applicable
Common Shares, with any amounts exceeding such
basis treated as gain from the sale of Shares.
See "Tax Matters."
Preferred Stock Risk. In addition to equity
securities risk (see "--Equity Securities and
Related Market Risk" above) and credit risk
(see "--Credit Risk/High Yield Risk" below),
investment in preferred stocks involves certain
other risks. Certain preferred stocks contain
provisions that allow an issuer under certain
conditions to skip or defer distributions. If
the Fund owns a preferred stock that is
deferring its distribution, the Fund may be
required to report income for tax purposes
despite the fact that it is not receiving
current income on this position. Preferred
stocks often are subject to legal provisions
that allow for redemption in the event of
certain tax or legal changes or at the issuer's
call. In the event of redemption, the Fund may
not be able to reinvest the proceeds at
comparable rates of return. Preferred stocks
are subordinated to bonds and other debt
securities in an issuer's capital structure in
terms of priority for corporate income and
17
liquidation payments, and therefore will be
subject to greater credit risk than those debt
securities. Preferred stocks may trade less
frequently and in a more limited volume and may
be subject to more abrupt or erratic price
movements than many other securities, such as
common stocks, corporate debt securities and
U.S. Government securities.
Foreign (Non-U.S.) Investment Risk. The Fund's
investments in ADRs and other securities of
foreign issuers, securities denominated in
foreign currencies and/or securities traded
principally in securities markets outside the
United States involve special risks. For
example, the value of these investments may
decline in response to unfavorable political
and legal developments, unreliable or untimely
information, or economic and financial
instability. The value of securities
denominated in foreign currencies may fluctuate
based on changes in the value of those
currencies relative to the U.S. dollar, and a
decline in applicable foreign exchange rates
could reduce the value of such securities held
by the Fund. Although the Sub-Advisers have the
flexibility to hedge against this foreign
currency risk, they may determine not to do so
or to do so only in unusual circumstances or
market conditions. Foreign settlement
procedures may involve additional risks.
Foreign investment risk may be particularly
high to the extent that the Fund invests in
securities of issuers based in or securities
denominated in the currencies of developing or
"emerging market" countries.
Value Securities Risk. The Equity Component will
tend to focus its investments in companies that
may not be expected to experience significant
earnings growth, but whose securities NFJ
believes are selling at a price lower than
their true value. These so-called "value"
securities may be issued by companies that have
experienced adverse business developments or
may be subject to special risks that have
caused their securities to be out of favor. If
NFJ's assessment of a company's prospects is
wrong, or if the market does not recognize the
value of the company, the price of its
securities may decline or may not approach the
value anticipated.
Smaller Company Risk. The general risks
associated with the types of securities in
which the Fund invests are particularly
pronounced for securities issued by companies
with smaller market capitalizations. These
companies may have limited product lines,
markets or financial resources or they may
depend on a few key employees. As a result,
they may be subject to greater levels of
credit, market and issuer risk. Securities of
smaller companies may trade less frequently and
in lesser volume than more widely held
securities and their values may fluctuate more
sharply than other securities. Companies with
medium-sized market capitalizations may have
risks similar to those of smaller companies.
Interest Rate Risk. Generally, when market
interest rates rise, the prices of convertible
securities, preferred stocks paying fixed
dividend rates, REITs and debt obligations
fall, and vice versa.
18
Interest rate risk is the risk that securities
in the Fund's portfolio will decline in value
because of increases in market interest rates.
During periods of declining interest rates, an
issuer of convertible securities or other debt
securities may exercise an option to redeem
securities prior to maturity, forcing the Fund
to invest in lower-yielding securities. During
periods of rising interest rates, the average
life of certain types of securities may be
extended due to slower than expected payments.
This may lock in a below market yield, increase
the security's duration and reduce the
security's value. Rising interest rates may
also have an adverse impact on the equity
markets. Because market interest rates are
currently near their lowest levels in many
years, there is a greater risk that the Fund's
portfolio will decline in value as market
interest rates rise.
Management Risk. The Fund is subject to
management risk because it is an actively
managed portfolio. NFJ, NACM, PEA and the
individual portfolio managers will apply
investment techniques and risk analyses in
making investment decisions for the Fund, but
there can be no guarantee that these will
produce the desired results. Management risk is
particularly significant for the Fund because
the Fund involves three separately managed
components. In particular, the Index Option
Strategy includes sophisticated investment
strategies to be implemented by PEA and there
can be no guarantee that these strategies will
be successful. As described above under "Index
Option Risk," PEA's ability to implement the
Index Option Strategy successfully may be
hindered due to informational barriers between
NFJ and PEA with respect to specific portfolio
holdings and trading data relating to the
Equity Component.
Component Weighting Risk. As noted under
"Investment Objectives and Strategies--Annual
Rebalancing" above, the Manager will cause the
Fund's entire portfolio to be rebalanced
annually to the initial approximate 75%/25%
asset allocation between the Equity Component
and the Convertible Component. These annual
rebalancings may result in additional
transaction costs for the Fund and may increase
the amount of capital gains (and, in
particular, short-term gains) realized by the
Fund, on which shareholders may pay tax.
Although the portfolio will be rebalanced
annually, it is expected that the relative
percentage of the Fund's assets represented by
the Equity and Convertible Components will vary
during interim periods in relation to the
relative investment performance of each
Component, as well as market fluctuations and
other factors. Therefore, the Fund's assets
attributable to each Component may from time to
time be significantly higher or lower than the
initial 75%/25% allocation described above, and
the risk/return profile of the Fund (taken as a
whole) will vary accordingly. For instance, an
investment in the Fund would be more
susceptible to interest rate, high yield and
other risks associated with convertible
securities if the Convertible Component were to
appreciate in value more or depreciate less (in
relative terms) than the Equity Component.
19
Credit Risk/High Yield Risk. Credit risk is the
risk that one or more investments in
convertible securities, preferred stocks or
other debt instruments in the Fund's portfolio
will decline in price, or fail to pay
dividends, interest, liquidation value or
principal when due, because the issuer of the
obligation or the issuer of a reference
security experiences an actual or perceived
decline in its financial status. The
Convertible Component may invest in securities
rated below investment grade (i.e., rated, at
the time of investment, below Baa by Moody's or
below BBB by S&P, or unrated but determined by
NACM to be of comparable quality). NACM may
invest in distressed securities on behalf of
the Convertible Component, but will not invest
in securities which are in default (rated "D"
by Moody's or S&P) at the time of purchase (but
may hold securities which have gone into
default after they have been purchased).
Securities of below investment grade quality
are regarded as having predominantly
speculative characteristics with respect to
capacity to pay interest and repay principal,
and are commonly referred to as "high yield"
securities or "junk bonds." Securities in the
lowest investment grade category may also be
considered to possess some speculative
characteristics by certain rating agencies. The
prices of these lower grade securities are
generally more volatile and sensitive to actual
or perceived negative developments, such as a
decline in the issuer's revenues or a general
economic downturn, than are the prices of
higher grade securities.
Leverage Risk. Although it has no current
intention to do so, the Fund reserves the
flexibility to issue preferred shares or debt
securities or to engage in borrowings to add
leverage to its portfolio. The Fund may also
enter into derivative transactions that may in
some circumstances give rise to a form of
financial leverage. However, the Fund
ordinarily will cover its positions in these
derivative transactions so that there is no
resulting leverage. Any leverage used by the
Fund would be limited to 38% of the Fund's
total assets (including the proceeds of the
leverage).
The Fund manages some of its derivative positions
by segregating an amount of cash or liquid
securities equal to the face value of those
positions. The Fund may also offset derivatives
positions against one another or against other
assets to manage effective market exposure
resulting from derivatives in its portfolio. To
the extent that the Fund does not segregate
liquid assets or otherwise cover its
obligations under such transactions (e.g.,
through offsetting positions), such
transactions will be treated as senior
securities representing indebtedness
("borrowings") for purposes of the requirement
under the 1940 Act that the Fund may not enter
into any such transactions if the Fund's
borrowings would thereby exceed 33 1/3% of its
total assets. See "Leverage and Borrowings." In
addition, to the extent that any offsetting
positions do not behave in relation to one
another as expected, the Fund may perform as if
it is leveraged. The Fund's use of leverage
would create the opportunity for increased
Common Share net income, but also
20
would result in special risks for Common
Shareholders. If used, there is no assurance
that the Fund's leveraging strategies will be
successful. Leverage creates the likelihood of
greater volatility of net asset value and
market price of Common Shares.
Because the fees received by the Manager and the
Sub-Advisers are based on the total managed
assets of the Fund (including assets
attributable to any borrowings that may be
outstanding), the Manager and the Sub-Advisers
have a financial incentive for the Fund to use
borrowings, which may create a conflict of
interest between Manager and the Sub-Advisers,
on the one hand, and the Common Shareholders,
on the other hand.
Counterparty Risk. The Fund will be subject to
credit risk with respect to the counterparties
to the derivative contracts purchased or sold
by the Fund. If a counterparty becomes bankrupt
or otherwise fails to perform its obligations
under a derivative contract due to financial
difficulties, the Fund may experience
significant delays in obtaining any recovery
under the derivative contract in a bankruptcy
or other reorganization proceeding. The Fund
may obtain only a limited recovery or may
obtain no recovery in such circumstances.
Reinvestment Risk. Income from the Fund's
portfolio will decline if and when the Fund
invests the proceeds from matured, traded or
called convertible securities or other debt
other obligations at market interest rates that
are below the Fund's current earnings rate. A
decline in income could affect the Common
Shares' market price or their overall return.
Inflation/Deflation Risk. Inflation risk is the
risk that the value of assets or income from
the Fund's investments will be worth less in
the future as inflation decreases the value of
payments at future dates. As inflation
increases, the real value of the Fund's
portfolio could decline. Deflation risk is the
risk that prices throughout the economy decline
over time. Deflation may have an adverse effect
on the creditworthiness of issuers and may make
issuer default more likely, which may result in
a decline in the value of the Fund's portfolio.
Liquidity Risk. The Fund may invest up to 15% of
its total assets in illiquid securities
(determined using the Securities and Exchange
Commission's standard applicable to open-end
investment companies, i.e., securities that
cannot be disposed of within seven days in the
ordinary course of business at approximately
the value at which the Fund has valued the
securities). Illiquid securities may trade at a
discount from comparable, more liquid
investments, and may be subject to wide
fluctuations in market value. Also, the Fund
may not be able to readily dispose of illiquid
securities when that would be beneficial at a
favorable time or price or at prices
approximating those at which the Fund currently
values them.
21
REITs and Mortgage-Related Risk. Real estate
investment trusts ("REITs") involve certain
unique risks in addition to those of investing
in the real estate industry in general. REITs
are subject to interest rate risks (especially
mortgage REITs) and the risk of non-payment or
default by lessees or borrowers. An equity REIT
may be affected by changes in the value of the
underlying properties owned by the REIT. A
mortgage REIT may be affected by the ability of
the issuers of its portfolio mortgages to repay
their obligations. REITs whose underlying
assets are concentrated in properties used by a
particular industry are also subject to risks
associated with such industry. REITs may have
limited financial resources, may trade less
frequently and in a more limited volume and may
be subject to more abrupt or erratic price
movements than larger company securities.
Mortgage REITs are also subject to prepayment
risk--the risk that borrowers may pay off their
mortgages sooner than expected, particularly
when interest rates decline. This can reduce
the REIT's returns to the Fund or the value of
the Fund's investment in the REIT because the
REIT may have to reinvest that money at lower
prevailing interest rates.
Market Disruption and Geopolitical Risk. The war
with Iraq, its aftermath and the continuing
occupation of Iraq are likely to have a
substantial impact on the U.S. and world
economies and securities markets. The nature,
scope and duration of the war and occupation
and the potential costs of rebuilding the Iraqi
infrastructure cannot be predicted with any
certainty. Terrorist attacks on the World Trade
Center and the Pentagon on September 11, 2001
closed some of the U.S. securities markets for
a four-day period and similar future events
cannot be ruled out. The war and occupation,
terrorism and related geopolitical risks have
led, and may in the future lead to, increased
short-term market volatility and may have
adverse long-term effects on U.S. and world
economies and markets generally. Those events
could also have an acute effect on individual
issuers or related groups of issuers. These
risks could also adversely affect individual
issuers and securities markets, interest rates,
secondary trading, ratings, credit risk,
inflation and other factors relating to the
Common Shares.
Anti-Takeover Provisions.. The Fund's Amended and Restated Agreement and
Declaration of Trust (the "Declaration")
includes provisions that could limit the
ability of other entities or persons to acquire
control of the Fund or convert the Fund to
open-end status. See "Anti-Takeover and Other
Provisions in the Declaration of Trust." These
provisions in the Declaration could have the
effect of depriving the Common Shareholders of
opportunities to sell their Common Shares at a
premium over the then-current market price of
the Common Shares or at net asset value.
22
SUMMARY OF FUND EXPENSES
The following table shows Fund expenses as a percentage of net assets
attributable to Common Shares.
Shareholder Transaction Expenses
Sales Load (as a percentage of offering price)....................... 4.50%
Offering Costs Borne by the Fund (as a percentage of offering price). .20%(1)
Dividend Reinvestment Plan Fees...................................... None(2)
Percentage of Net Assets
Attributable to
Common Shares
------------------------
Annual Expenses
Management Fees(3)................................................... .90%
Other Expenses....................................................... .20%(1)
Total Annual Expenses................................................ 1.10%
--------
(1) The Fund will pay or reimburse organizational and offering expenses
estimated at $ from the proceeds of the offering. The Manager has
agreed to pay the amount by which the Fund's offering costs (other than the
sales load, but inclusive of the reimbursement of underwriter expenses of
$.005 per share) exceed $.05 per share (.20% of the offering price). While
the Manager has agreed to initially pay all of the Fund's organizational
expenses, the Fund has agreed to reimburse the Manager for such
organizational expenses (or a portion thereof) so long as that
reimbursement plus the Fund's offering costs (other than the sales load,
but inclusive of the reimbursement of underwriter expenses of $.005 per
share) does not exceed $.05 per share. Any such reimbursement will be made
prior to the end the Fund's initial fiscal year. The organizational
expenses and offering costs to be paid or reimbursed by the Fund are not
included among the expenses shown in the table. However, these expenses
will be borne by Common Shareholders and result in a reduction of the net
asset value of the Common Shares.
(2) You will pay brokerage charges if you direct the plan agent to sell your
Common Shares held in a dividend reinvestment account.
(3) Although the Fund's management fees are calculated on total managed assets,
the Fund's total managed assets are expected to be the same as its net
assets because the Fund has no present intention to utilize leverage and
borrowings.
The purpose of the table above is to help you understand all fees and
expenses that you, as a Common Shareholder, would bear directly or indirectly.
The Other Expenses shown in the table and related footnotes are based on
estimated amounts for the Fund's first year of operations and assume that the
Fund issues approximately 4,000,000 Common Shares. If the Fund issues fewer
Common Shares, all other things being equal, these expenses would increase. See
"Management of the Fund" and "Dividend Reinvestment Plan."
As required by relevant Securities and Exchange Commission regulations, the
following example illustrates the expenses (including the sales load of $45.00
and estimated offering expenses of this offering of $2) that you would pay on a
$1,000 investment in Common Shares, assuming the sales load and the offering
expenses listed in the parenthetical above, and (a) total annual expenses of
1.10% in years one through 10, and (b) a 5% annual return(1):
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Total Expenses Incurred $58 $80 $105 $175
--------
(1) The example above should not be considered a representation of future
expenses. Actual expenses may be higher or lower than those shown. The
example assumes that the estimated Other Expenses set forth in the Annual
Expenses table are accurate and that all dividends and distributions are
reinvested at net asset value. Actual expenses may be greater or less than
those assumed. Moreover, the Fund's actual rate of return may be greater or
less than the hypothetical 5% annual return shown in the example.
23
THE FUND
The Fund is a newly organized, diversified, closed-end management investment
company registered under the 1940 Act. The Fund was organized as a
Massachusetts business trust on August 20, 2003, pursuant to the Declaration,
which is governed by the laws of The Commonwealth of Massachusetts. The Fund
has no operating history. The Fund's principal office is located at 1345 Avenue
of the Americas, New York, New York 10105, and its telephone number is (800)
331-1710.
USE OF PROCEEDS
The net proceeds of the offering of Common Shares will be approximately
$ (or $ if the Underwriters exercise the overallotment option in full)
after payment or reimbursement of the estimated organizational and offering
costs. The Manager has agreed to pay the amount by which the Fund's offering
costs (other than the sales load, but inclusive of reimbursement of Underwriter
expenses of $.005 per share) exceed $.05 per share. While the Manager has
agreed to initially pay all of the Fund's organizational expenses, the Fund has
agreed to reimburse the Manager for such organizational expenses (or a portion
thereof) so long as that reimbursement plus the Fund's offering costs (other
than the sales load, but inclusive of reimbursement of underwriter expenses of
$.005 per share) does not exceed $.05 per share. The Fund will invest the net
proceeds of the offering in accordance with the Fund's investment objectives
and policies as stated below. It is presently anticipated that the Fund will be
able to invest substantially all of the net proceeds in investments that meet
its investment objectives and policies within three months after the completion
of the offering. Pending such investment, it is anticipated that the proceeds
will be invested in high grade, short-term securities, or in derivative
instruments designed to give the Fund (and its respective components) exposure
to the types of securities and markets in which it will ordinarily invest while
the Sub-Advisers select specific securities. These may include equity index
futures contracts.
THE FUND'S INVESTMENT OBJECTIVES AND STRATEGIES
Investment Objectives
The Fund's primary investment objective is to seek current income and gains,
with a secondary objective of long-term capital appreciation. The Fund cannot
assure you that it will achieve its investment objectives.
The Fund will pursue its investment objectives by investing in a diversified
portfolio of dividend-paying common stocks (the "Equity Component") and
income-producing convertible securities (the "Convertible Component"). The Fund
will also employ a strategy of writing (selling) call options on equity indexes
in an attempt to generate gains from option premiums (the "Index Option
Strategy"). The types of investments that will ordinarily comprise the Equity
Component and the Convertible Component, and the instruments used to implement
the Index Option Strategy, are summarized under "--Portfolio Contents" below.
The Fund utilizes three affiliated Sub-Advisers to manage the Fund's
portfolio. NFJ Investment Group L.P. ("NFJ") manages the Equity Component,
Nicholas-Applegate Capital Management LLC ("NACM") manages the Convertible
Component and PEA Capital LLC ("PEA") implements the Index Option Strategy. See
"Management of the Fund--Sub-Advisers" below. The portfolio management
strategies and techniques utilized by each Sub-Adviser are described below.
Asset Allocation and Annual Rebalancing
The Equity Component is initially expected to represent approximately 75%
and the Convertible Component approximately 25% of the net proceeds of this
offering. The Manager will cause the Fund's entire portfolio to be rebalanced
annually to this initial asset allocation between the Equity Component and the
24
Convertible Component. The first rebalancing will take place in January, 2006.
These annual rebalancings may result in additional transaction costs for the
Fund and may increase the amount of capital gains (and, in particular, short
term gains) realized by the Fund, on which shareholders may pay tax. Although
the portfolio will be rebalanced annually, it is expected that the relative
percentage of the Fund's assets represented by the Equity and Convertible
Components will vary during interim periods in relation to the relative
investment performance of each Component, as well as market fluctuations and
other factors. Therefore, the Fund's assets attributable to each Component from
time to time may be significantly higher or lower than the initial 75%/25%
allocation described above, and the risk/return profile of the Fund (taken as a
whole) will vary accordingly.
Investment Selection Strategies
Equity Component. In selecting common stocks for the Equity Component, NFJ
considers an initial selection universe consisting of the 1,000 largest
publicly traded companies (in terms of market capitalization) in the U.S. to
identify 150 to 200 companies that exhibit the best fundamental
characteristics. NFJ classifies the universe by industry, and then identifies
the most undervalued stocks in each industry based mainly on relative
price-to-earnings (P/E) ratios, calculated both with respect to trailing
operating earnings and forward earnings estimates. From this group of common
stocks, NFJ buys a number of stocks with the highest dividend yields. NFJ then
screens the most undervalued companies in each industry by dividend yield to
identify the highest yielding common stocks in each industry. From this group,
NFJ buys an approximately equal number of additional stocks with the lowest P/E
ratios. In selecting individual stocks, NFJ also considers quantitative factors
such as price momentum (based on analysts' earnings per share estimates and
revisions to those estimates), relative dividend yields, valuations relative to
the overall market and trading liquidity. NFJ will ordinarily replace an
investment when a similar investment opportunity within the same industry group
has a considerably higher dividend yield or lower valuation than the current
holding. The Equity Component may include common stocks outside of the
selection universe described above, consistent with the Fund's investment
objectives and policies.
To the extent that NFJ invests in preferred stocks or real estate investment
trusts for the Equity Component, NFJ considers quantitative factors similar to
that used for common stocks as described above and also uses traditional credit
analysis, taking into account factors such as changes in credit fundamentals,
changes in attractiveness relative to other securities and changes in industry
fundamentals.
NFJ will also manage the Equity Component with a view toward reducing the
portion of Fund distributions that are taxed as ordinary income by focusing
investments in common stocks that pay dividends that may qualify for taxation
to individual Common Shareholders as "qualified dividend income," and thus be
eligible for taxation at favorable rates applicable to long-term capital gains.
See "Tax Matters." However, it is expected that a substantial portion of the
Fund's net investment income (including income derived from the Convertible
Component and a portion of gains received from the Index Option Strategy) will
be taxed to Common Shareholders at ordinary income tax rates. Therefore, the
Fund should not be viewed as a vehicle designed to maximize after-tax returns.
See "Risks--Tax Risk."
Convertible Component. In selecting convertible securities for the
Convertible Component, NACM attempts to identify issuers that successfully
adapt to change. NACM evaluates each convertible security's investment
characteristics as an income-producing security, using the credit analysis
techniques described below, as well as its potential for capital appreciation,
using techniques that focus on the security's equity characteristics. NACM
seeks to capture approximately 70-80% of any increase in the market price of
the underlying equities (upside potential) and 50% or less of any decrease in
the market price of the underlying equities (downside exposure). In analyzing
specific companies for possible investment, NACM ordinarily looks for several
of the following characteristics: above-average per share earnings growth; high
return on invested capital; a healthy balance sheet; sound financial and
accounting policies and overall financial strength; strong competitive
advantages; effective research and product development and marketing;
development of new technologies; efficient service; pricing flexibility; strong
management; and general operating characteristics that will enable the
companies to compete successfully in their respective markets.
25
NACM also uses traditional credit analysis combined with a disciplined,
fundamental bottom-up research process that facilitates the early
identification of issuers demonstrating an ability to improve their fundamental
characteristics. NACM attempts to identify potential investments that it
expects will exceed minimum credit statistics and exhibit the highest
visibility of future expected operating performance. NACM relies heavily on its
own analysis of the credit quality and risks associated with individual
securities considered for the Convertible Component, rather than relying
exclusively on rating agencies or third-party research. The team managing the
Convertible Component utilizes this information in an attempt to minimize
credit risk and identify issuers, industries or sectors that are undervalued or
that offer high current income or attractive capital appreciation relative to
NACM's assessment of their credit characteristics.
NACM's discipline in selling investments that have become less attractive is
clearly defined and designed to drive the Convertible Component continually
toward strength, taking into account factors such as a change in credit
fundamentals, a decline in attractiveness relative to other securities and a
decline in industry fundamentals.
Index Option Strategy. In implementing the Fund's Index Option Strategy,
PEA will "sell" or "write" call options on equity indexes such that the
underlying value of the indexes are approximately equal to (and do not exceed)
the net asset value of the Fund's Equity Component--i.e., approximately 75% of
the Fund's net assets, subject to future fluctuations in the assets
attributable to the Equity Component and annual rebalancings as described
above. For these purposes, the Fund treats options on indexes as being written
on securities having an aggregate value equal to the face or notional amount of
the index subject to the option. This index option writing strategy is designed
to produce gains from index option premiums.
Index call options are contracts representing the right to purchase the cash
value of an index at a specified price (the "strike price") at or until a
specified future date (the "expiration date"). The Fund will sell index options
that are "European style," meaning that the options may be exercised only on
the expiration date. For conventional listed call options, the option's
expiration date can be up to nine months from the date the call options are
first listed for trading. Longer-term call options can have expiration dates up
to three years from the date of listing. The Fund expects that it will normally
write options whose terms to expiration range from two months to one year,
although the Fund may write options of both longer and shorter terms. PEA will
not write call options on individual equity securities, but may write options
on exchange-traded funds and other similar instruments designed to correlate
with the performance of an equity index or market segment.
As the writer (seller) of an equity index call option, the Fund would
receive cash (the premium) from the purchaser of the option, and the purchaser
would have the right to receive from the Fund any appreciation in the cash
value of index over the strike price on the expiration date. If, at expiration,
the purchaser exercises the index option sold by the Fund, the Fund would pay
the purchaser the difference between the cash value of the index and the strike
price. In effect, the Fund sells the potential appreciation in the value of the
index above the strike price in exchange for the premium. PEA may cause the
Fund to repurchase an index call option prior to its expiration date,
extinguishing the Fund's obligation, in which case the cost of repurchasing the
option (net of any premiums received) will determine the gain or loss realized
by the Fund.
Equity index options differ from options on individual securities in that
(i) the exercise of an index option requires cash payments and does not involve
the actual purchase or sale of securities, (ii) the holder of an index option
has the right to receive cash upon exercise of the option if the level of the
index upon which the option is based is greater than the strike price of the
option and (iii) index options reflect price fluctuations in a group of
securities or segments of the securities market rather than price fluctuations
in a single common stock.
In pursuing the Index Option Strategy, PEA may cause the Fund to sell call
options on "broad-based" equity indexes, such as the Standard & Poor's 500
Index, as well as narrower market indexes, such as the Standard & Poor's 100
Index, or on indexes of securities of companies in a particular industry or
sector, including (but not limited to) financial services, technology,
pharmaceuticals and consumer products. An equity index assigns relative values
to the securities included in the index (which change periodically), and the
index fluctuates with
26
changes in the market values of these securities. PEA will actively manage the
Fund's index options positions using quantitative and statistical analysis that
focuses on relative value and risk/return. In determining which equity index
options to utilize, PEA will consider market factors, such as current market
levels and volatility, and options specific factors, such as premium/cost,
strike price and time to expiration. PEA will attempt to create a portfolio of
equity index call options that is diversified across multiple strike prices and
expiration dates.
PEA will attempt to maintain for the Fund written call options positions on
equity indexes whose price movements, taken in the aggregate, are correlated
with the price movements of the common stocks and other securities held in the
Fund's Equity Component. In doing so, PEA will take into account periodic data
provided by NFJ with respect to the Equity Component, including net assets,
industry and sector weightings, historic volatility as well as periodic
(typically 30 days after month-end) reports detailing portfolio holdings.
However, other than through periodic holdings reports, PEA will not have access
to the actual securities purchased, sold or held by or for the Equity Component
due to informational barriers in place between NFJ and PEA. Therefore, the
Index Option Strategy involves significant risk that the changes in value of
the indexes underlying the Fund's written call options positions will not
correlate closely with changes in the market value of securities held by the
Equity Component. To the extent that there is a lack of correlation, movements
in the indexes underlying the options positions may result in losses to the
Fund, which may more than offset any gains received by the Fund from options
premiums. See "Risks--Index Options Risk."
PEA does not intend to write call options on equity indexes where the
underlying value of the indexes exceed the net asset value of the Equity
Component (i.e., write "naked" positions). The Fund will "cover" its written
equity index call options by segregating liquid assets in an amount equal to
the contract value of the index and/or by entering into offsetting positions
(e.g., by holding a call option on the same index as the call written where the
strike price of the call held is equal to or less than the strike price of the
call written).
The Fund will generally sell index call options which are "out-of-the-money"
or "at-the-money" at the time of sale. Out-of-the-money call options are
options with a strike price above the current cash value of the index and
at-the-money call options are options with a strike price equal to the cash
value of the index. In addition to providing possible gains through premiums,
out-of-the-money index call options allow the Fund to potentially benefit from
appreciation in the equity securities held by the Fund with respect to which
the option was written (to the extent correlated with the index) up to the
strike price. The Fund will generally write out-of-the-money call options where
the strike price is not more than 10% higher than the cash value of the index
at the time of sale, although PEA reserves the flexibility to utilize written
call options that are more deeply out-of-the-money if it deems appropriate
depending upon market conditions and other factors. The Fund also reserves the
flexibility to sell index call options that are "in-the-money"--i.e., those
with a strike price below the cash value of the index at the time of sale, and
will generally limit these to options where the strike price is not more than
5% lower than the cash value of the index (although the Fund may utilize
options that are more deeply in-the-money depending upon market conditions and
other factors). When the prices of the equity index upon which a call option is
written rise, call options that were out-of-the-money when written may become
in-the-money (i.e., if the cash value of the index rises above the strike price
of the option), thereby increasing the likelihood that the options could be
exercised and the Fund forced to pay the amount of appreciation over the strike
price of the option upon expiration.
Most option contracts are originated and standardized by an independent
entity called the Options Clearing Corporation (the "OCC"). The Fund will write
(sell) call options that are generally issued, guaranteed and cleared by the
OCC. Listed call options are currently traded on the American Stock Exchange,
Chicago Board Options Exchange, International Securities Exchange, New York
Stock Exchange, Pacific Stock Exchange, Philadelphia Stock Exchange and various
other U.S. options exchanges. The Fund may also write unlisted (or "over-the
counter") call options.
Diversification. Subject to the availability of suitable investment
opportunities and subject to the Fund's limitations, NFJ and NACM will attempt
to diversify the investments in their respective Components broadly in
27
an attempt to minimize the Component's sensitivity to market risk, credit risk
and/or other risks associated with a particular issuer, industry or sector, or
to the impact of a single economic, political or regulatory occurrence.
Portfolio Contents and Other Information
Under normal circumstances, the Fund will invest at least 80% of its net
assets (plus any borrowings for investment purposes) in securities and other
instruments that provide dividends, interest or option premiums.
The Equity Component will ordinarily consist principally of dividend-paying
common stocks, but may also include preferred stocks and dividend-paying real
estate investment trusts. The assets of the Equity Component will be invested
principally in securities of U.S. issuers, but may include American Depository
Receipts ("ADRs"). Up to 10% of the component's assets may be invested in
foreign securities other than ADRs, including emerging market securities.
The Convertible Component will ordinarily consist of convertible securities,
including synthetic convertible securities, and may include convertible
securities that are of below investment grade quality (i.e., rated, at the time
of investment, below Baa by Moody's or below BBB by S&P, or unrated but judged
by NACM to be of comparable quality). NACM may invest in distressed securities
on behalf of the Convertible Component, but will not invest in securities which
are in default (rated "D" by Moody's or S&P) at the time of purchase (but may
hold securities which have gone into default after they have been purchased).
Up to 20% of the Convertible Component may consist of U.S. dollar-denominated
securities of foreign issuers based in developed countries. Convertible
securities are bonds, debentures, notes, preferred stocks or other securities
that may be converted or exchanged (by the holder or by the issuer) into shares
of the underlying common stock (or cash or securities of equivalent value) at a
stated exchange ratio or predetermined price. A synthetic convertible security
represents the combination of separate securities that possess the two
principal characteristics of a traditional convertible security, i.e., an
income-producing security and the right to acquire an equity security, such as
the combination of a traditional corporate bond with a warrant to purchase
equity securities of the issuer of the bond.
The Fund will employ its Index Option Strategy by writing (selling) call
options on equity indexes such that the underlying value of the indexes are
approximately equal to and do not exceed the value of the Equity Component of
the Fund - i.e., approximately 75% of the Fund's net assets, subject to future
fluctuations in the assets attributable to the Equity Component and annual
rebalancings. For these purposes, the Fund treats options on indexes as being
written on securities held by the Fund having an aggregate value equal to the
face or notional amount of the index subject to the options. Most of the
options written by the Fund will be exchange-traded, although the Fund may
utilize over-the-counter options.
In addition to the use of written call options under the Index Option
Strategy, the Fund may utilize other derivative strategies involving call and
put options, futures and forward contracts, swap agreements, short sales and
other derivative instruments in an attempt to hedge against market and other
risks in the portfolio.
The Fund may invest up to 15% of its total assets in illiquid securities
(determined using the Securities and Exchange Commission's standard applicable
to open-end investment companies, i.e., securities that cannot be disposed of
within seven days in the ordinary course of business at approximately the value
at which the Fund has valued the securities). The Fund may invest in securities
of companies with small market capitalizations.
The Fund cannot change its investment objectives without the approval of the
holders of a "majority of the outstanding" Common Shares. A "majority of the
outstanding" shares (whether voting together as a single class or voting as a
separate class) means (i) 67% or more of such shares present at a meeting, if
the holders of more than 50% of those shares are present or represented by
proxy, or (ii) more than 50% of such shares, whichever is less. The Fund may
not change its policy to normally invest at least 80% of its net assets (plus
any borrowings for investment purposes) in securities and other instruments
that provide dividends, interest or option premiums unless it provides
shareholder with at least 60 days written notice of such change.
28
Upon the Manager's or a Sub-Adviser's recommendation, for temporary
defensive purposes and in order to keep its cash fully invested, including
during the period in which the net proceeds of this offering are being
invested, the Fund may deviate from the Fund's investment objectives and
policies and invest some or all of its total assets in investments such as high
grade debt securities, including high quality, short-term debt securities, and
cash and cash equivalents. The Fund may not achieve its investment objectives
when it does so.
The Fund may engage in active and frequent trading of portfolio securities
(i.e., portfolio turnover), particularly during periods of volatile market
movements. In addition, the Fund's portfolio turnover rate will increase to the
extent that the Fund is required to sell portfolio securities to satisfy its
obligations under the Index Option Strategy or to realize additional gains to
be distributed to shareholders if the Index Option Strategy is unsuccessful.
The annual rebalancing of the Fund's portfolio to adjust the asset allocation
between the Equity Component and the Convertible Component, as described above,
may also tend to increase the portfolio turnover rate for the Fund. Portfolio
turnover involves some expense to the Fund, including brokerage commissions or
dealer mark-ups and other transaction costs on the sale of securities and
reinvestment in other securities. Such sales may also result in realization of
taxable capital gains, including short-term capital gains taxed at ordinary
income tax rates, and may adversely impact the Fund's after-tax returns to Fund
shareholders. Please see "Investment Objectives and Policies--Portfolio Trading
and Turnover Rate" in the Statement of Additional Information for more
information regarding portfolio turnover.
The following provides additional information regarding the types of
securities and other instruments in which the Fund will ordinarily invest. A
more detailed discussion of these and other instruments and investment
techniques that may be used by the Fund is provided under "Investment
Objectives and Policies" in the Statement of Additional Information.
Common Stocks
Common stock represents an equity ownership interest in a company. The Fund
may hold or have exposure to common stocks of issuers of any size (in terms of
market capitalization or otherwise) and in any industry or sector. Because the
Fund will ordinarily have substantial exposure to common stocks, historical
trends would indicate that the Fund's portfolio and investment returns will be
subject at times, and over time, to higher levels of volatility and market and
issuer-specific risk than if it invested exclusively in debt securities.
Convertible Securities
Convertible securities are bonds, debentures, notes, preferred stocks or
other securities that may be converted or exchanged (by the holder or by the
issuer) into shares of the underlying common stock (or cash or securities of
equivalent value) at a stated exchange ratio or predetermined price (the
"conversion price"). A convertible security is designed to provide current
income and also the potential for capital appreciation through the conversion
feature, which enables the holder to benefit from increases in the market price
of the underlying common stock. 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 the Fund is called for redemption or conversion,
the Fund could be required to tender it for redemption, convert it into the
underlying common stock or sell it to a third party. Convertible securities
have general characteristics similar to both debt securities and equity
securities. Although to a lesser extent than with debt obligations, the market
value of convertible securities tends to decline as interest rates increase
and, conversely, tends to increase as interest rates decline. In addition,
because of the conversion feature, the market value of convertible securities
tends to vary with fluctuations in the market value of the underlying common
stocks and, therefore, it will also react to variations in the general market
for equity securities. Depending upon the relationship of the conversion price
to the market value of the underlying security, a convertible security may
trade more like an equity security than a debt instrument.
29
Convertible securities are designed to provide for a stable stream of income
with generally higher yields than common stocks. There can be no assurance of
current income because the issuers of the convertible securities may default on
their obligations. Convertible securities, however, generally offer lower
interest or dividend yields than non-convertible securities of similar credit
quality because of the potential for capital appreciation.
Synthetic Convertible Securities
To the extent NACM invests in "synthetic" convertible securities for the
Convertible Component, they will be selected based on the similarity of their
economic characteristics to those of a traditional convertible security through
the combination of separate securities that possess the two principal
characteristics of a traditional convertible security, i.e., an
income-producing security ("income-producing element") and the right to acquire
an equity security ("convertible element"). The income-producing element is
achieved by investing in non-convertible, income-producing securities such as
bonds, preferred stocks and money market instruments. The convertible element
is achieved by investing in warrants or options to buy common stock at a
certain exercise price, or options on a stock index. A simple example of a
synthetic convertible security is the combination of a traditional corporate
bond with a warrant to purchase equity securities of the issuer of the bond.
The Convertible Component may also include synthetic securities created by
other parties, typically investment banks or other financial institutions,
including convertible structured notes. The income-producing and convertible
elements of a synthetic convertible security may be issued separately by
different issuers and at different times. Unlike a traditional convertible
security, which is a single security having a unitary market value, a synthetic
convertible comprises two or more separate securities, each with its own market
value. Therefore, the market value of a synthetic convertible security is the
sum of the values of its debt component and its convertibility component. For
this reason, the values of a synthetic convertible and a traditional
convertible security may respond differently to market fluctuations.
Index Call Options
Index call options are contracts representing the right to purchase the cash
value of an index at a specified price (the "strike price") at or until a
specified future date (the "expiration date"). The Fund will sell index options
that are "European style," meaning that the options may be exercised only on
the expiration date. For conventional listed call options, the option's
expiration date can be up to nine months from the date the call options are
first listed for trading. Longer-term call options can have expiration dates up
to three years from the date of listing. The Fund expects that it will normally
write options whose terms to expiration range from two months to one year,
although the Fund may write options of both longer and shorter terms. PEA will
not write call options on individual equity securities, but may write options
on exchange-traded funds and similar instruments designed to correlate with the
performance of an equity index or market segment.
As the writer (seller) of an equity index call option, the Fund would
receive cash (the premium) from the purchaser of the option, and the purchaser
would have the right to receive from the Fund any appreciation in the cash
value of index over the strike price on the expiration date. If, at expiration,
the purchaser exercises the index option sold by the Fund, the Fund would pay
the purchaser the difference between the cash value of the index and the strike
price. In effect, the Fund sells the potential appreciation in the value of the
index above the strike price in exchange for the premium. PEA may cause the
Fund to repurchase an index call option prior to its expiration date,
extinguishing the Fund's obligation, in which case the cost of repurchasing the
option (net of any premiums received) will determine the gain or loss realized
by the Fund.
Equity index options differ from options on individual securities in that
(i) the exercise of an index option requires cash payments and does not involve
the actual purchase or sale of securities, (ii) the holder of an index option
has the right to receive cash upon exercise of the option if the level of the
index upon which the option is based is greater than the strike price of the
option and (iii) index options reflect price fluctuations in a group of
securities or segments of the securities market rather than price fluctuations
in a single common stock.
30
In pursuing the Index Option Strategy, PEA may cause the Fund to sell call
options on "broad-based" equity indexes, such as the Standard & Poor's 500
Index, as well as narrower market indexes, such as the Standard & Poor's 100
Index, or on indexes of securities of companies in a particular industry or
sector, including (but not limited to) financial services, technology,
pharmaceuticals and consumer products. An equity index assigns relative values
to the securities included in the index (which change periodically), and the
index fluctuates with changes in the market values of these securities.
PEA does not intend to write call options on equity indexes where the
underlying value of the indexes exceed the net asset value of the Equity
Component (i.e., write "naked" positions). The Fund will "cover" its written
equity index call options by segregating liquid assets in an amount equal to
the contract value of the index and/or by entering into offsetting positions
(e.g., by holding a call option on the same index as the call written where the
strike price of the call held is equal to or less than the strike price of the
call written).
The Fund will generally sell index call options which are "out-of-the-money"
or "at-the-money" at the time of sale. Out-of-the-money call options are
options with a strike price above the current cash value of the index and
at-the-money call options are options with a strike price equal to the cash
value of the index. In addition to providing possible gains through premiums,
out-of-the-money index call options allow the Fund to potentially benefit from
appreciation in the equity securities held by the Fund with respect to which
the option was written (to the extent correlated with the index) up to the
strike price. The Fund will generally write out-of-the-money call options where
the strike price is not more than 10% higher than the cash value of the index
at the time of sale, although PEA reserves the flexibility to utilize written
call options that are more deeply out-of-the-money if it deems appropriate
depending upon market conditions and other factors. The Fund also reserves the
flexibility to sell index call options that are "in-the-money" --i.e., those
with a strike price below the cash value of the index at the time of sale, and
will generally limit these to options where the strike price is not more than
5% lower than the cash value of the index (although the Fund may utilize
options that are more deeply in-the-money depending upon market conditions and
other factors). When the prices of the equity index upon which a call option is
written rise, call options that were out-of-the-money when written may become
in-the-money (i.e., if the cash value of the index rises above the strike price
of the option), thereby increasing the likelihood that the options could be
exercised and the Fund forced to pay the amount of appreciation over the strike
price of the option upon expiration.
Most option contracts are originated and standardized by an independent
entity called the Options Clearing Corporation (the "OCC"). The Fund will write
(sell) call options that are generally issued, guaranteed and cleared by the
OCC. Listed call options are currently traded on the American Stock Exchange,
Chicago Board Options Exchange, International Securities Exchange, New York
Stock Exchange, Pacific Stock Exchange, Philadelphia Stock Exchange and various
other U.S. options exchanges. The Fund may also write unlisted (or "over-the
counter") call options.
Other Derivatives
In addition to writing index call options, PEA may write call options on
behalf of the Fund with respect to ETFs and similar instruments. However, PEA
will not write call options on individual securities. NACM may buy and sell put
and call options and warrants on individual securities and indexes in creating
synthetic convertible securities for the convertible component. The Fund also
may (but is not required to) utilize a variety of derivative instruments for
hedging or risk management purposes. The Fund may also use derivatives to gain
exposure to equity and other securities in which the Fund may invest (e.g.,
pending investment of the proceeds of this offering). Generally, derivatives
are financial contracts whose value depends upon, or is derived from, the value
of any underlying asset, reference rate or index, and may relate to, among
others, individual securities, interest rates and related indexes. In addition
to written call options, derivative instruments that may be used by the Fund
include, but are not limited to, warrants, purchased call options, purchased or
written put options, futures contracts, options on futures contracts, forward
contracts, swap agreements and short sales. The Fund's
31
use of derivative instruments involves risks different from, or possibly
greater than, the risks associated with investment directly in securities and
other more traditional investments. See "Risks--Other Derivatives Risk." Please
see "Investment Objectives and Policies--Other Derivative Instruments" in the
Statement of Additional Information for additional information about these and
other derivative instruments that the Fund may use and the risks associated
with such instruments.
The Fund may enter into derivatives transactions designed to hedge against
market risk that may in certain circumstances produce effects similar to
leverage. To the extent that the Fund does not segregate liquid assets or
otherwise cover its obligations under such transactions (e.g., through
offsetting positions), such transactions will be treated as senior securities
representing indebtedness ("borrowings") for purposes of the requirement under
the 1940 Act that the Fund may not enter into any such transactions if the
Fund's borrowings would thereby exceed 33 1/3% of its total assets. See
"Risks--Other Derivatives Risk."
There is no assurance that the Fund's derivative strategies will be
available at any time or that a Sub-Adviser will determine to use them for the
Fund or, if used, that the strategies will be successful. The Sub-Advisers may
determine not to engage in hedging strategies or to do so only in unusual
circumstances or market conditions. Income generated from derivatives hedging
techniques will not be eligible to be treated as qualified dividend income. In
addition, dividends received on securities with respect to which the Fund is
obligated to make payments (pursuant to short sales or otherwise) will be
treated as income taxed at ordinary, rather than long-term capital gains,
rates. See "Tax Matters."
High Yield Securities
As noted above, the Convertible Component may invest in securities rated
lower than Baa by Moody's or BBB by S&P, or in unrated securities judged to be
of comparable quality by NACM. The Fund may invest in distressed securities,
but will not invest in securities which are in default (rated "D" by Moody's or
S&P) at the time of purchase (but may hold securities which have gone into
default after they have been purchased). Below investment grade securities are
sometimes referred to as "high yield" securities or "junk bonds." Investing in
high yield securities involves greater risks (in particular, greater risk of
default) and special risks in addition to the risks associated with investments
in investment grade obligations. While offering a greater potential opportunity
for capital appreciation and higher yields, high yield securities typically
entail greater potential price volatility and may be less liquid than
higher-rated securities. High yield securities may be regarded as predominantly
speculative with respect to the issuer's continuing ability to meet principal
and interest payments. They also may be more susceptible to real or perceived
adverse economic and competitive industry conditions than higher-rated
securities. Securities in the lowest investment grade category also may be
considered to possess some speculative characteristics. The market values of
high yield securities tend to reflect individual developments of the issuer to
a greater extent than do higher-quality securities, which tend to react mainly
to fluctuations in the general level of interest rates. In addition,
lower-quality securities tend to be more sensitive to economic conditions.
Credit Ratings and Unrated Securities
Rating agencies are private services that provide ratings of the credit
quality of debt obligations, including convertible securities. Appendix A to
this Prospectus describes the various ratings assigned to debt obligations by
Moody's, S&P and other ratings agencies. Ratings assigned by a rating agency
are not absolute standards of credit quality and do not evaluate market risks.
Rating agencies may fail to make timely changes in credit ratings and an
issuer's current financial condition may be better or worse than a rating
indicates. The Fund will not necessarily sell a security when its rating is
reduced below its rating at the time of purchase. As described above, NACM does
not rely solely on credit ratings, and develops its own analysis of issuer
credit quality. The ratings of a security may change over time. Ratings
agencies such as Moody's and S&P monitor and evaluate the ratings assigned to
securities on an ongoing basis. As a result, instruments held by the Fund could
receive a higher rating (which would tend to increase their value) or a lower
rating (which would tend to decrease their value) during the period in which
they are held.
32
The Fund may purchase unrated securities (which are not rated by a rating
agency). Unrated securities may be less liquid than comparable rated securities
and involve the risk that the Sub-Adviser may not accurately evaluate the
security's comparative credit rating. Analysis of creditworthiness may be more
complex for issuers of high yield securities than for issuers of higher-quality
obligations.
Preferred Stocks
Preferred stock represents an equity interest in a company that generally
entitles the holder to receive, in preference to the holders of other stocks
such as common stocks, dividends and a fixed share of the proceeds resulting
from liquidation of the company. Unlike common stocks, preferred stocks usually
do not have voting rights. Preferred stocks in some instances are convertible
into common stock, such as those that may be purchased for the Convertible
Component. Some preferred stocks also entitle their holders to receive
additional liquidation proceeds on the same basis as holders of a company's
common stock, and thus also represent an ownership interest in the company.
Some preferred stocks offer a fixed rate of return with no maturity date.
Because they never mature, these preferred stocks act like long-term bonds, can
be more volatile than other types of preferred stocks and may have heightened
sensitivity to changes in interest rates. Other preferred stocks have a
variable dividend, generally determined on a quarterly or other periodic basis,
either according to a formula based upon a specified premium or discount to the
yield on particular U.S. Treasury securities or based on an auction process,
involving bids submitted by holders and prospective purchasers of such stocks.
Because preferred stocks represent an equity ownership interest in a company,
their value usually will react more strongly than bonds and other debt
instruments to actual or perceived changes in a company's financial condition
or prospects, or to fluctuations in the equity markets.
Foreign (Non-U.S.) Investments and Currencies
The Equity Component may invest without limit in American Depository
Receipts ("ADRs"), and may invest up to 10% of its total assets in foreign
securities other than ADRs, including emerging market securities. Up to 20% of
the Convertible Component may consist of U.S. dollar-denominated securities of
foreign issuers based in developed countries.
ADRs are U.S. dollar-denominated receipts issued generally by domestic banks
and representing the deposit with the bank of a security of a foreign issuer,
and are publicly traded on exchanges or over-the-counter in the United States.
Although it expects to do so only in limited circumstances, the Fund may
engage in a variety of transactions involving foreign currencies in order to
hedge against foreign currency risk, to increase exposure to a foreign
currency, or to shift exposure to foreign currency fluctuations from one
currency to another. For instance, the Fund may purchase foreign currencies on
a spot (cash) basis and enter into forward foreign currency exchange contracts,
foreign currency futures contracts and options on foreign currencies and
futures. Suitable hedging transactions may not be available in all
circumstances and there can be no assurance that the Fund will engage in such
transactions at any given time or from time to time when that would be
beneficial. Although the Sub-Advisers have the flexibility to engage in such
transactions, they may determine not to do so or to do so only in unusual
circumstances or market conditions. Also, these transactions may not be
successful and may eliminate any chance for the Fund to benefit from favorable
fluctuations in relevant foreign currencies.
Please see "Investment Objectives and Policies--Foreign (Non-U.S.)
Securities" in the Statement of Additional Information for a more detailed
description of the types of foreign investments and foreign currency
transactions in which the Fund may invest and their related risks.
Other Debt Securities
The Fund may invest in debt securities, including, but not limited to,
corporate bonds, debentures, notes and other similar types of corporate debt
instruments, as well as commercial paper, bank certificates of deposit, fixed
33
time deposits, bankers' acceptances and U.S. Government securities. The Fund's
investments in debt instruments may have fixed or variable principal payments
and all types of interest rate and dividend payment and reset terms, including
fixed rate, adjustable rate, contingent, deferred and auction-rate features.
Warrants
The Fund may invest in equity and index warrants, which are securities that
give the holder the right, but not the obligation, to subscribe for newly
created equity issues of the issuing company or a related company at a
specified price either on a certain date or during a specified period. The
Convertible Component may make significant investments in warrants as part of
its use of synthetic convertible securities. Changes in the value of a warrant
do not necessarily correspond to changes in the value of its underlying
security. The price of a warrant may be more volatile than the price of its
underlying security, and a warrant may offer greater potential for capital
appreciation as well as capital loss. Warrants do not entitle a holder to
dividends or voting rights with respect to the underlying security and do no
represent any rights in the assets of the issuing company. A warrant ceases to
have value if it is not exercised prior to its expiration date. These factors
can make warrants more speculative than other types of investments.
Certain Interest Rate Transactions
The Fund may enter into long and short interest rate swap, cap or floor
transactions for hedging or risk management purposes. One possible use of
interest rate swaps involves the Fund's agreement with the swap counterparty to
pay a fixed rate payment in exchange for the counterparty paying the Fund a
variable rate payment. The payment obligation would be based on the notional
amount of the swap. The Fund may use an interest rate cap or floor, which would
require the Fund to pay a premium to the cap or floor counterparty and would
entitle the Fund, to the extent that a specified variable rate index exceeds a
predetermined fixed rate, to receive from the counterparty payment of the
difference based on the notional amount. The Fund may seek to terminate early
all or a portion of any swap, cap or floor transaction. Such early termination
of a swap could result in a termination payment by or to the Fund. Any
termination of a cap or floor could result in a termination payment by or to
the Fund.
Repurchase Agreements
The Fund may enter into repurchase agreements, in which the Fund purchases a
security from a bank or broker-dealer and the bank or broker-dealer agrees to
repurchase the security at the Fund's cost plus interest within a specified
time. If the party agreeing to repurchase should default, the Fund will seek to
sell the securities which it holds. This could involve transaction costs or
delays in addition to a loss on the securities if their value should fall below
their repurchase price. Repurchase agreements maturing in more than seven days
are considered to be illiquid securities.
Lending of Portfolio Securities
For the purpose of achieving income, the Fund may lend its portfolio
securities to brokers, dealers, and other financial institutions provided a
number of conditions are satisfied, including that the loan is fully
collateralized. Please see "Investment Objectives and Policies--Securities
Loans" in the Statement of Additional Information for details. When the Fund
lends portfolio securities, its investment performance will continue to reflect
changes in the value of the securities loaned although amounts received from
the borrower will not be eligible to be treated as qualified dividend income.
The Fund will also receive a fee or interest on the collateral. Securities
lending involves the risk of loss of rights in the collateral or delay in
recovery of the collateral if the borrower fails to return the security loaned
or becomes insolvent. The Fund may pay lending fees to the party arranging the
loan.
Real Estate Investment Trusts (REITs)
The Fund may invest in a portion of its assets in real estate investment
trusts ("REITs"). REITs primarily invest in income-producing real estate or
real estate related loans or interests. REITs are generally classified as
34
equity REITs, mortgage REITs or a combination of equity and mortgage REITs.
Equity REITs invest the majority of their assets directly in real property and
derive income primarily from the collection of rents. Equity REITs can also
realize capital gains by selling properties that have appreciated in value.
Mortgage REITs invest the majority of their assets in real estate mortgages and
derive income from the collection of interest payments. REITs are not taxed on
income distributed to shareholders provided they comply with the applicable
requirements of the Code. The Fund will indirectly bear its proportionate share
of any management and other expenses paid by REITs in which it invests in
addition to the expenses paid by the Fund. Distributions received by the Fund
from REITs may consist of dividends, capital gains and/or return of capital.
Please see "Investment Objectives and Policies--Real Estate Investment
Trusts (REITs)" in the Statement of Additional Information and "Risks--REIT and
Mortgage-Related Risk" in this prospectus for a more detailed description of
REITs and their related risks.
When Issued, Delayed Delivery and Forward Commitment Transactions
The Fund may purchase securities which it is eligible to purchase on a
when-issued basis, may purchase and sell such securities for delayed delivery
and may make contracts to purchase such securities for a fixed price at a
future date beyond normal settlement time (forward commitments). When-issued
transactions, delayed delivery purchases and forward commitments involve a risk
of loss if the value of the securities declines prior to the settlement date.
This risk is in addition to the risk that the Fund's other assets will decline
in value. Therefore, these transactions may result in a form of leverage and
increase the Fund's overall investment exposure. Typically, no income accrues
on securities the Fund has committed to purchase prior to the time delivery of
the securities is made, although the Fund may earn income on securities it has
segregated to cover these positions.
Variable and Floating Rate Securities
Variable or floating rate securities are securities that pay interest at
rates which adjust whenever a specified interest rate changes, float at a fixed
margin above a generally recognized base lending rate and/or reset or are
redetermined (e.g., pursuant to a auction) on specified dates (such as the last
day of a month or calendar quarter). These instruments may include, without
limitation, variable rate preferred stock, bank loans, money market instruments
and certain types of mortgage-backed and other asset-backed securities. Due to
their variable or floating rate features, these instruments will generally pay
higher levels of income in a rising interest rate environment and lower levels
of income as interest rates decline. For the same reason, the market value of a
variable or floating rate instrument is generally expected to have less
sensitivity to fluctuations in market interest rates than a fixed-rate
instrument, although the value of a floating rate instrument may nonetheless
decline as interest rates rise and due to other factors, such a changes in
credit quality.
Rule 144A Securities
Rule 144A under the Securities Act of 1933, as amended, provides a
non-exclusive safe harbor exemption from the registration requirements of the
Act for the resale of certain "restricted" securities to certain qualified
institutional buyers, such as the Fund. Rule 144A Securities may be deemed
illiquid, although the Fund may determine that certain Rule 144A Securities are
liquid in accordance with procedures adopted by the Board of Trustees.
Commercial Paper
Commercial paper represents short-term unsecured promissory notes issued in
bearer form by corporations such as banks or bank holding companies and finance
companies. The rate of return on commercial paper may be linked or indexed to
the level of exchange rates between the U.S. dollar and a foreign currency or
currencies.
Short Sales
A short sale is a transaction in which the Fund sells an instrument that it
does not own in anticipation that the market price will decline. The Fund may
use short sales for hedging and risk management purposes. When
35
the Fund engages in a short sale, it must borrow the security sold short and
deliver it to the counterparty. The Fund may have to pay a fee to borrow
particular securities and would often be obligated to pay over any payments
received on such borrowed securities. If the Fund is required to pay over any
dividends received by the Fund pursuant to a short sale, such dividends will
not be treated as qualified dividend income. The Fund's obligation to replace
the borrowed security will be secured by collateral deposited with the lender,
which is usually a broker-dealer, and/or with the Fund's custodian. The Fund
may not receive any payments (including interest) on its collateral. Short
sales expose the Fund to the risk that it will be required to cover its short
position at a time when the securities have appreciated in value, thus
resulting in a loss to the Fund. However, the Fund will not engage in so-called
"naked" short sales where it does not own or have the immediate right to
acquire the security sold short at no additional cost.
U.S. Government Securities
The Fund may invest in U.S. Government securities, which are obligations of,
or guaranteed by, the U.S. Government, its agencies or government-sponsored
enterprises. U.S. Government securities include a variety of securities that
differ in their interest rates, maturities and dates of issue. Securities
issued or guaranteed by agencies or instrumentalities of the U.S. Government
may or may not be supported by the full faith and credit of the United States
or by the right of the issuer to borrow from the U.S. Treasury.
Please see "Investment Objectives and Policies" in the Statement of
Additional Information for additional information regarding the investments of
the Fund and their related risks.
LEVERAGE AND BORROWINGS
Although it has no current intention to do so, the Fund reserves the
flexibility to issue preferred shares or debt securities or engage in
borrowings to add leverage to its portfolio. The Fund may also enter into
derivative transactions that may in some circumstances produce effects similar
to leverage. However, the Fund ordinarily will cover its positions in these
transactions so that there is no resulting leverage. Any leverage used by the
Fund would be limited to 38% of the Fund's total assets (including the proceeds
of the leverage). To the extent that the Fund uses leverage, it would seek to
obtain a higher return for shareholders than if the Fund did not use leverage.
Leveraging is a speculative technique and there are special risks involved,
including the risk of increased volatility of the Fund's investment portfolio
and potentially larger losses than if the strategies were not used.
If there is a net decrease (or increase) in the value of the Fund's
investment portfolio, any leverage will decrease (or increase) the net asset
value per Common Share to a greater extent than if the Fund were not leveraged.
During periods in which the Fund is using certain forms of leverage, the fees
paid to the Manager and the Sub-Advisers will be higher than if the Fund did
not use leverage because the fees paid will be calculated on the basis of the
Fund's total managed assets, including borrowings that may be outstanding.
Thus, the Manager and the Sub-Advisers have a financial incentive for the Fund
to utilize certain forms of leverage, which may result in a conflict of
interest between the Manager and the Sub-Advisers, on the one hand, and the
Common Shareholders, on the other hand. Fees and expenses paid by the Fund are
borne entirely by the Common Shareholders. These include costs associated with
any borrowings or other forms of leverage utilized by the Fund.
Under the 1940 Act, the Fund generally is not permitted to have outstanding
senior securities representing indebtedness ("borrowings") (including through
the use of reverse repurchase agreements, dollar rolls, futures contracts,
loans of portfolio securities, swap contracts and other derivatives, as well as
when-issued, delayed delivery or forward commitment transactions, to the extent
that these instruments constitute senior securities) unless immediately after
the financing giving rise to the borrowing, the value of the Fund's total
assets less liabilities (other than such borrowings) is at least 300% of the
principal amount of such borrowing (i.e., the principal amount may not exceed
33 1/3% of the Fund's total assets). In addition, the Fund is not permitted to
declare any cash dividend or other distribution on Common Shares unless, at the
time of such declaration, the
36
value of the Fund's total assets, less liabilities other than borrowings, is at
least 300% of such principal amount. If the Fund enters into these
transactions, it intends, to the extent possible, to prepay all or a portion of
the principal amount due to the extent necessary in order to maintain the
required asset coverage. Failure to maintain certain asset coverage
requirements could result in an event of default and entitle holders of any
senior securities of the Fund to elect a majority of the Trustees of the Fund.
Derivative instruments used by the Fund will not constitute senior securities
(and will not be subject to the Fund's limitations on borrowings) to the extent
that the Fund segregates liquid assets at least equal in amount to its
obligations under the instruments, or enters into offsetting transactions or
owns positions covering its obligations. For instance, the Fund may cover its
position as the writer of a call option agreement by segregating liquid assets
at least equal in amount to its obligation under the contract.
RISKS
The net asset value of the Common Shares will fluctuate with and be affected
by, among other things, market discount risk, equity securities and related
market risk, issuer risk, dividend and income risk, convertible securities
risk, synthetic convertible securities risk, index options risk, other
derivatives risk, tax risk, preferred stock risk, foreign (non-U.S.) investment
risk, value securities risk, smaller company risk, interest rate risk,
management risk, credit risk/high yield risk, component weighting risk,
leverage risk, counterparty risk, reinvestment risk, inflation/deflation risk,
liquidity risk, REIT and mortgage-related risk, market disruption and
geopolitical risk and risks associated with the affiliations of the Fund, the
Manager, NFJ, NACM and/or PEA. An investment in Common Shares will also be
subject to the risk associated with the fact that the Fund is newly organized.
These and other risks are summarized below.
No Prior History
The Fund is a newly organized, diversified, closed-end management investment
company and has no operating history.
Market Discount Risk
As with any stock, the price of the Fund's Common Shares will fluctuate with
market conditions and other factors. If shares are sold, the price received may
be more or less than the original investment. Net asset value will be reduced
immediately following the initial offering by a sales load and organizational
and offering expenses paid or reimbursed by the Fund. The Common Shares are
designed for long-term investors and should not be treated as trading vehicles.
Shares of closed-end management investment companies frequently trade at a
discount from their net asset value. The Fund's shares may trade at a price
that is less than the initial offering price. This risk may be greater for
investors who sell their shares relatively shortly after completion of the
initial offering.
Equity Securities and Related Market Risk
The Fund will ordinarily have substantial exposure to common stocks and
other equity securities in pursuing its investment objectives and policies. The
market price of equity securities, including common and preferred stocks, may
go up or down, sometimes rapidly or unpredictably. Equity securities may
decline in value due to factors affecting equity securities markets generally,
particular industries represented in those markets or the issuer itself,
including the historical and prospective earnings of the issuer and the value
of its assets. The values of equity securities may decline due to general
market conditions which are not specifically related to a particular company,
such as real or perceived adverse economic conditions, changes in the general
outlook for corporate earnings, changes in interest or currency rates or
adverse investor sentiment generally. They may also decline due to factors
which affect a particular industry or industries, such as labor shortages or
increased production costs and competitive conditions within an industry.
Equity securities, and particularly common stocks, generally have greater price
volatility than bonds and other debt securities.
37
Issuer Risk
The value of securities may decline for a number of reasons which directly
relate to the issuer, such as management performance, financial leverage and
reduced demand for the issuer's goods and services.
Dividend and Income Risk
The income shareholders receive from the Fund is based primarily on the
dividends and interest it earns from its investments as well as the gains the
Fund receives from writing options and selling portfolio securities, each of
which can vary widely over the short and long term. The dividend income from
the Fund's investments in equity securities will be influenced by both general
economic activity and issuer-specific factors. In the event of a recession or
adverse events affecting a specific industry or issuer, the issuers of the
equity securities held by the Fund may reduce the dividends paid on such
securities. If prevailing market interest rates decline, distribution rates on
convertible securities and other debt instruments held by the Fund, and
shareholders' income from the Fund, would likely decline as well. Please see
"Distributions" for a description of other risks associated with the level,
timing and character of the Fund's distributions.
Convertible Securities Risk
Convertible securities generally offer lower interest or dividend yields
than non-convertible securities of similar quality. The market values of
convertible securities tend to decline as interest rates increase and,
conversely, to increase as interest rates decline. However, a convertible
security's market value tends to reflect the market price of the common stock
of the issuing company when that stock price approaches or is greater than the
convertible security's "conversion price." The conversion price is defined as
the predetermined price at which the convertible security could be exchanged
for the associated stock. As the market price of the underlying common stock
declines, the price of the convertible security tends to be influenced more by
the yield of the convertible security. Thus, it may not decline in price to the
same extent as the underlying common stock. In the event of a liquidation of
the issuing company, holders of convertible securities would be paid before the
company's common stockholders but after holders of any senior debt obligations
of the company. Consequently, the issuer's convertible securities generally
entail less risk than its common stock but more risk than its debt obligations.
Synthetic Convertible Securities Risk
The value of a synthetic convertible security will respond differently to
market fluctuations than a traditional convertible security because a synthetic
convertible is composed of two or more separate securities or instruments, each
with its own market value. Because the convertible element is typically
achieved by investing in warrants or options to buy common stock at a certain
exercise price, or options on a stock index, synthetic convertible securities
are subject to the risks associated with derivatives. See "Risks--Other
Derivatives Risk." In addition, if the value of the underlying common stock or
the level of the index involved in the convertible element falls below the
exercise price of the warrant or option, the warrant or option may lose all
value.
Index Options Risk
There are various risks associated with the Fund's Index Option Strategy.
The purchaser of an index option written by the Fund has the right to any
appreciation in the cash value of the index over the strike price on the
expiration date. Therefore, as the writer of an index call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the equity securities held by the Fund with respect to
which the option was written (to the extent that their performance is
correlated with that of the index) above the sum of the premium and the strike
price of the call. However, the Fund has retained the risk of loss (net of
premiums received) should the price of the Fund's portfolio securities decline.
38
In addition, there are significant differences between the securities and
options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. 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. PEA will attempt to
maintain for the Fund written call options positions on equity indexes whose
price movements, taken in the aggregate, are correlated with the price
movements of the common stocks and other securities held in the Fund's Equity
Component. In doing so, PEA will take into account periodic data provided by
NFJ with respect to the Equity Component, including net assets, industry and
sector weightings, historic volatility as well as periodic (typically 30 days
after month-end) reports detailing portfolio holdings. However, other than
through periodic holdings reports, PEA will not have access to the actual
securities purchased, sold or held by or for the Equity Component due to
informational barriers in place between NFJ and PEA. Therefore, the Index
Option Strategy involves significant risk that the changes in value of the
indexes underlying the Fund's written call options positions will not correlate
closely with changes in the market value of securities held by the Equity
Component. To the extent that there is a lack of correlation, movements in the
indexes underlying the options positions may result in losses to the Fund,
which may more than offset any gains received by the Fund from options
premiums. In these and other circumstances, the Fund may be required to sell
portfolio securities to satisfy its obligations as the writer of an index call
option when it would not otherwise choose to do so, or may choose to sell
portfolio securities to realize gains to supplement Fund distributions. Such
sales would involve transaction costs borne by the Fund and may also result in
realization of taxable capital gains, including short-term capital gains taxed
at ordinary income tax rates, and may adversely impact the Fund's after-tax
returns.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. Reasons for the absence of a liquid
secondary market on an exchange include the following: (i) there may be
insufficient trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing transactions or both;
(iii) trading halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options; (iv) unusual or unforeseen
circumstances may interrupt normal operations on an exchange; (v) the
facilities of an exchange or the OCC may not at all times be adequate to handle
current trading volume; or (vi) one or more exchanges could, for economic or
other reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options). If trading
were discontinued, the secondary market on that exchange (or in that class or
series of options) would cease to exist. However, outstanding options on that
exchange that had been issued by the OCC as a result of trades on that exchange
would continue to be exercisable in accordance with their terms. The Fund's
ability to terminate over-the-counter 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.
The hours of trading for options may not conform to the hours during which
securities held by the Fund are traded. To the extent that the options markets
close before the markets for 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 securities
represented in an index, an increase in interest rates, changes in the actual
or perceived volatility of the stock market and underlying securities
represented in an index, and the remaining term to the option's expiration. The
value of options also may be adversely affected if the market for options is
reduced or becomes illiquid.
The Fund's options transactions will be subject to limitations established
by each of the exchanges, boards of trade or other trading facilities on which
the options are traded. These limitations govern the maximum number of options
in each class which may be written by a single investor or group of investors
acting in concert, regardless of whether the options are written on the same or
different exchanges, boards of trade or other trading facilities or are written
in one or more accounts or through one or more brokers. Thus, the number of
options which the Fund may write may be affected by options written by other
investment advisory clients of PEA, NFJ, NACM or their affiliates. 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 other sanctions.
39
Other Derivatives Risk
In addition to writing index call options, PEA may write call options on
behalf of the Fund with respect to exchange traded funds (ETFs) and similar
products, which involves many of the risks associated with index option writing
as discussed above. NACM may buy and sell put and call options and warrants on
individual securities and indexes in creating synthetic convertible securities
for the Fund's Convertible Component. However, PEA will not write call options
on individual securities. The Fund may otherwise use a variety of derivative
instruments for hedging or risk management purposes, including purchased call
options, purchased or written put options, futures contracts, options on
futures contracts, forward contracts and swap agreements. The Fund also may use
derivatives to gain exposure to equity and other securities in which the Fund
may invest (e.g., pending investment of the proceeds of this offering).
Derivatives are subject to a number of risks described elsewhere in this
prospectus, such as liquidity risk, issuer risk, interest rate risk, credit
risk, counterparty risk, and management risk. They also involve the risk of
mispricing or improper valuation, the risk of ambiguous documentation and the
risk that changes in the value of a derivative may not correlate perfectly with
an underlying asset, interest rate or index. Suitable derivative transactions
may not be available in all circumstances and there can be no assurance that
the Fund will engage in these transactions to reduce exposure to other risks
when that would be beneficial.
The Fund may enter into derivatives transactions that may in certain
circumstances produce effects similar to leverage and expose the Fund to
related risks. See "Leverage Risk" below.
Tax Risk
Call option premiums received by the Fund on many equity index call options
will be subject to mark-to-market treatment and gains will be recognized based
on the fair market value of the options at the end of the Fund's taxable year
(or, if disposed of, upon disposition). Under this system, 60% of the gains or
losses from such equity index call options will be treated as long term capital
gains or losses and 40% will be treated as short-term capital gains or losses.
Such short-term gains will be subject to ordinary income tax rates to the
extent not offset by short-term capital losses. Other call option premiums
received by the Fund will be recognized upon exercise, lapse or other
disposition of the option and generally will be treated by the Fund as
short-term capital gain or loss. Some of the call options and other devices
employed by the Fund reduce risk to the Fund by substantially diminishing its
risk of loss in offsetting positions in substantially similar or related
property, thereby giving rise to "straddles" under the federal income tax
rules. The straddle rules require the Fund to defer certain losses on positions
within a straddle, and terminate or suspend the holding period for certain
securities in which the fund does not yet have a long-term holding period or
has not yet satisfied the holding period required for qualified dividend
income. Thus, the Fund cannot assure you as to any level of regular quarterly
net investment income (income other than net long-term capital gain) that will
be treated as ordinary income, cannot assure you as to any level of capital
gains distributions and cannot assure you assure you as to any ratio of regular
quarterly distributions to capital gain distributions. In addition, certain of
the Fund's call writing activities and investment in certain debt obligations
may affect the character, timing and recognition of income and could cause the
Fund to liquidate other investments in order to satisfy its distributions
requirements. See "Tax Matters."
While the Equity Component will be managed with a view toward reducing the
portion of Fund distributions that are taxed as ordinary income, there can be
no assurance as to the percentage (if any) of the Fund's distributions that
will qualify for taxation to individual Common Shareholders as "qualified
dividend income," and thus be eligible for taxation at favorable rates
applicable to long-term capital gains. The portion of the Fund's net investment
income (including net income from the Convertible Component and a portion of
the gains received from the Index Option Strategy) that will be taxed to Common
Shareholders at ordinary income tax rates is unknown at this time and cannot be
predicted with any certainty. Therefore, the Fund should not by viewed as a
vehicle designed to maximize after-tax returns. See "Tax Matters."
In addition, the tax treatment of Fund distributions of income generated by
the Equity Component may be adversely affected as a result of the "sunset"
provisions that will eliminate the favorable tax treatment of any tax-
40
favored dividend income unless Congress acts to eliminate the "sunset"
provisions, and may be adversely affected by future changes in tax laws and
regulations. See "Tax Matters."
The tax treatment and characterization of the Fund's distributions may vary
significantly from time to time because of the varied nature of the Fund's
investments. The ultimate tax characterization of the Fund's distributions made
in a taxable year cannot finally be determined until after the end of that
taxable year. As a result, there is a possibility that the Fund may make total
distributions during a taxable year in an amount that exceeds the Fund's net
investment income and net realized capital gains for that year, in which case
the excess would generally be treated as a tax-free return of capital up to the
amount of the shareholder's tax basis in the applicable Common Shares, with any
amounts exceeding such basis treated as gain from the sale of the shares. See
"Tax Matters."
Preferred Stock Risk
In addition to equity securities risk and credit risk, investment in
preferred stocks involves certain other risks. Certain preferred stocks contain
provisions that allow an issuer under certain conditions to skip or defer
distributions. If the Fund owns a preferred stock that is deferring its
distribution, the Fund may be required to report income for tax purposes
despite the fact that it is not receiving current income on this position.
Preferred stocks often are subject to legal provisions that allow for
redemption in the event of certain tax or legal changes or at the issuer's
call. In the event of redemption, the Fund may not be able to reinvest the
proceeds at comparable rates of return. Preferred stocks are subordinated to
bonds and other debt securities in an issuer's capital structure in terms of
priority for corporate income and liquidation payments, and therefore will be
subject to greater credit risk than those debt securities. Preferred stocks may
trade less frequently and in a limited volume and may be subject to more abrupt
or erratic price movements than many other securities, such as common stocks,
corporate debt securities and U.S. Government securities.
Foreign (Non-U.S.) Investment Risk
The Fund's investments in ADRs and other securities of foreign issuers,
securities denominated in foreign currencies and/or securities traded
principally in securities markets outside the United States involve special
risks. For example, the value of these investments may decline in response to
unfavorable political and legal developments, unreliable or untimely
information, or economic and financial instability. There may be less
information publicly available about a foreign issuer than about a U.S. issuer,
and foreign issuers are not generally subject to accounting, auditing and
financial reporting standards and practices comparable to those in the United
States. The securities of some foreign issuers are less liquid and at times
more volatile than securities of comparable U.S. issuers. Foreign brokerage
costs, custodial expenses and other fees are also generally higher than for
securities traded in the United States. With respect to certain foreign
countries, there is also a possibility of expropriation of assets, confiscatory
taxation, political or financial instability and diplomatic developments which
could affect the value of investments in those countries. In addition, income
received by the Fund from sources within foreign countries may be reduced by
withholding and other taxes imposed by such countries. The value of securities
denominated in foreign currencies may fluctuate based on changes in the value
of those currencies relative to the U.S. dollar, and a decline in applicable
foreign exchange rates could reduce the value of such securities held by the
Fund. Although the Sub-Advisers have the flexibility to hedge against this
foreign currency risk, they may determine not to do so or to do so only in
unusual circumstances or market conditions. The values of these foreign
investments and the investment income derived from them also may be affected
unfavorably by changes in currency exchange control regulations.
Foreign investment risk may be particularly high to the extent that the Fund
invests in securities of issuers based in or securities denominated in the
currencies of "emerging market" countries. These securities may present market,
credit, currency, liquidity, legal, political and other risks different from,
and greater than, the risks of investing in developed foreign countries.
Investing in securities of issuers based in underdeveloped or "emerging"
markets entails all of the risks of investing in securities of foreign issuers
to a heightened degree.
41
These heightened risks include: (i) greater risks of expropriation,
confiscatory taxation, nationalization and less social, political and economic
stability; (ii) the smaller size of the market for such securities and a lower
volume of trading, resulting in lack of liquidity and in price volatility; and
(iii) certain national policies which may restrict the Fund's investment
opportunities, including restrictions on investing in issuers or industries
deemed sensitive to relevant national interests.
Value Securities Risk
The Equity Component will tend to focus its investments in companies that
may not be expected to experience significant earnings growth, but whose
securities NFJ believes are selling at a price lower than their true value.
These so-called "value" securities may be issued by companies that have
experienced adverse business developments or may be subject to special risks
that have caused their securities to be out of favor. If NFJ's assessment of a
company's prospects is wrong, or if the market does not recognize the value of
the company, the price of its securities may decline or may not approach the
value anticipated.
Smaller Company Risk
The general risks associated with the types of securities in which the Fund
invests are particularly pronounced for securities issued by companies with
smaller market capitalizations. Companies which are smaller and less well-known
or seasoned than larger, more widely held companies may offer greater
opportunities for capital appreciation, but may also involve risks different
from, or greater than, risks normally associated with larger companies. Larger
companies generally have greater financial resources, more extensive research
and development, manufacturing, marketing and service capabilities, and more
stability and greater depth of management and technical personnel than smaller
companies. Smaller companies may have limited product lines, markets or
financial resources or may depend on a small, inexperienced management group.
Securities of smaller companies may trade less frequently and in lesser volume
than more widely held securities and their values may fluctuate more abruptly
or erratically than securities of larger companies. They may also trade in the
over-the-counter market or on a regional exchange, or may otherwise have
limited liquidity. These securities may therefore be more vulnerable to adverse
market developments than securities of larger companies. Also, there may be
less publicly available information about smaller companies or less market
interest in their securities as compared to larger companies, and it may take
longer for the prices of the securities to reflect the full value of a
company's earnings potential or assets. Companies with medium-sized market
capitalizations may have risks similar to those of smaller companies.
Interest Rate Risk
Generally, when market interest rates rise, the prices of convertible
securities, preferred stocks paying fixed dividend rates, REITs and debt
obligations fall, and vice versa. Interest rate risk is the risk that
securities in the Fund's portfolio will decline in value because of increases
in market interest rates. During periods of declining interest rates, an issuer
of convertible securities or other debt securities may exercise an option to
redeem securities prior to maturity, forcing the Fund to invest in
lower-yielding securities. During periods of rising interest rates, the average
life of certain types of securities may be extended due to slower than expected
payments. This may lock in a below market yield, increase the security's
duration and reduce the security's value. Rising interest rates may also have
an adverse impact on the equity markets. Because market interest rates are
currently near their lowest levels in many years, there is a greater risk that
the Fund's portfolio will decline in value as market interest rates rise.
Management Risk
The Fund is subject to management risk because it is an actively managed
portfolio. NFJ, NACM, PEA and the individual portfolio managers will apply
investment techniques and risk analyses in making investment decisions for the
Fund, but there can be no guarantee that these will produce the desired
results. Management risk is
42
particularly significant for the Fund because the Fund involves three
separately managed components. In particular, the Index Option Strategy
includes sophisticated investment strategies to be implemented by PEA and there
can be no guarantee that these strategies will be successful. As described
above under "Index Call Option Risk," PEA's ability to implement the Index
Option Strategy successfully may be hindered due to informational barriers
between NFJ and PEA with respect to specific portfolio holdings and trading
data relating to the Equity Component.
Component Weighting Risk
As noted under "Investment Objectives and Strategies--Annual Rebalancing"
above, the Manager will cause the Fund's entire portfolio to be rebalanced
annually to the initial approximate 75%/25% asset allocation between the Equity
Component and the Convertible Component. These annual rebalancings may result
in additional transaction costs for the Fund and may increase the amount of
capital gains (and, in particular, short-term gains) realized by the Fund, on
which shareholders may pay tax. Although the portfolio will be rebalanced
annually, it is expected that the relative percentage of the Fund's assets
represented by the Equity and Convertible Components will vary during interim
periods in relation to the relative investment performance of each Component,
as well as market fluctuations and other factors. Therefore, the Fund's assets
attributable to each Component may from time to time be significantly higher or
lower than the initial 75%/25% allocation described above, and the risk/return
profile of the Fund (taken as a whole) will vary accordingly. For instance, an
investment in the Fund would be more susceptible to interest rate, high yield
and other risks associated with convertible securities if the Convertible
Component were to appreciate in value more or depreciate less (in relative
terms) than the Equity Component.
Credit Risk/High Yield Risk
Credit risk is the risk that one or more securities in the Fund's portfolio
will decline in price, or fail to pay interest or principal when due, because
the issuer of the obligation or the issuer of a reference security experiences
a decline in its financial status. The Convertible Component may invest in
securities that are below investment grade quality. NACM may invest in
distressed securities on behalf of the Convertible Component, but will not
invest in securities which are in default (rated "D" by Moody's or S&P) at the
time of purchase (but may hold securities which have gone into default after
they have been purchased). Securities of below investment grade quality
(commonly referred to as "high yield" securities or "junk bonds") are
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal when due, and therefore involve a greater risk of default.
The prices of these lower grade obligations are more sensitive to negative
developments, such as a decline in the issuer's revenues or a general economic
downturn, than are the prices of higher grade securities. Securities in the
lowest investment grade category also may be considered to possess some
speculative characteristics by certain rating agencies. See "The Fund's
Investment Objectives and Strategies--Portfolio Contents and Other
Information--High Yield Securities," for additional information. Due to the
risks involved in investing in high yield securities, an investment in the Fund
should be considered speculative.
High yield securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities.
A projection of an economic downturn or of a period of rising interest rates,
for example, could cause a decline in high yield security prices because the
advent of a recession could lessen the ability of an issuer to make principal
and interest payments on its debt obligations. If an issuer of high yield
securities defaults, in addition to risking non-payment of all or a portion of
interest and principal, the Fund may incur additional expenses to seek
recovery. The market prices of high yield securities structured as zero-coupon,
step-up or payment-in-kind securities will normally be affected to a greater
extent by interest rate changes, and therefore tend to be more volatile than
the prices of securities that pay interest currently and in cash.
The Fund's credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or a Sub-Adviser downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, a Sub-
43
Adviser may consider such factors as its assessment of the credit quality of
the issuer of such security, the price at which such security could be sold and
the rating, if any, assigned to such security by other rating agencies.
Analysis of creditworthiness may be more complex for issuers of high yield
securities than for issuers of higher quality debt securities.
Leverage Risk
Although it has no current intention to do so, the Fund reserves the
flexibility to issue preferred shares or debt securities or engage in
borrowings to add leverage to its portfolio. The Fund may also enter into
transactions that include, among others, reverse repurchase agreements, dollar
rolls, futures contracts, loans of portfolio securities, swap contracts and
other derivatives, as well as when-issued, delayed delivery or forward
commitment transactions, that may in some circumstances give rise to a form of
financial leverage. However, the Fund ordinarily will cover its positions in
these derivative transactions so that there is no resulting leverage. Any
leverage used by the Fund would be limited to 38% of the Fund's total assets
(including the proceeds of the leverage).
The Fund manages some of its derivative positions by segregating an amount
of cash or liquid securities equal to the face value of those positions. The
Fund may also offset derivatives positions against one another or against other
assets to manage effective market exposure resulting from derivatives in its
portfolio. To the extent that the Fund does not segregate liquid assets or
otherwise cover its obligations under these transactions (e.g., through
offsetting positions), these transactions will be treated as senior securities
representing indebtedness ("borrowings") for purposes of the requirement under
the 1940 Act that the Fund may not enter into any such transactions if the
Fund's borrowings would thereby exceed 33 1/3% of its total assets. See
"Leverage and Borrowings." In addition, to the extent that any offsetting
positions do not behave in relation to one another, the Fund may perform as if
it is leveraged. The Fund's use of leverage would create the opportunity for
increased Common Share net income, but also would result in special risks for
Common Shareholders. If used, there is no assurance that the Fund's leveraging
strategies will be successful. Leverage creates the likelihood of greater
volatility of net asset value and market price of Common Shares.
Because the fees received by the Manager and the Sub-Advisers are based on
the total managed assets of the Fund (including assets attributable to any
borrowings that may be outstanding), the Manager and the Sub-Advisers have a
financial incentive for the Fund to utilize borrowings, which may create a
conflict of interest between the Manager and the Sub-Advisers, on the one hand,
and the Common Shareholders, on the other hand.
Counterparty Risk
The Fund will be subject to credit risk with respect to the counterparties
to the derivative contracts purchased or sold by the Fund. If a counterparty
becomes bankrupt or otherwise fails to perform its obligations under a
derivative contract due to financial difficulties, the Fund may experience
significant delays in obtaining any recovery under the derivative contract in a
bankruptcy or other reorganization proceeding. The Fund may obtain only a
limited recovery or may obtain no recovery in such circumstances.
Reinvestment Risk
Income from the Fund's portfolio will decline if and when the Fund invests
the proceeds from matured, traded or called convertible securities or other
debt obligations at market interest rates that are below the Fund's current
earnings rate. A decline in income could affect the Common Shares' market price
or their overall return.
Inflation/Deflation Risk
Inflation risk is the risk that the value of assets or income from the
Fund's investments will be worth less in the future as inflation decreases the
value of payments at future dates. As inflation increases, the real value of
the Fund's portfolio could decline. Deflation risk is the risk that prices
throughout the economy decline over time.
44
Deflation may have an adverse effect on the creditworthiness of issuers and may
make issuer default more likely, which may result in a decline in the value of
the Fund's portfolio.
Liquidity Risk
The Fund may invest up to 15% of its total assets in securities which are
illiquid at the time of investment. The term "illiquid securities" for this
purpose is determined using the Securities and Exchange Commission's standard
applicable to open-end investment companies, i.e., securities that cannot be
disposed of within seven days in the ordinary course of business at
approximately the value at which the Fund has valued the securities. Illiquid
securities may trade at a discount from comparable, more liquid investments,
and may be subject to wide fluctuations in market value. The Fund may be
subject to significant delays in disposing of illiquid securities. Accordingly,
the Fund may be forced to sell these securities at less than fair market value
or may not be able to sell them when a Sub-Adviser believes it is desirable to
do so. Illiquid securities also may entail registration expenses and other
transaction costs that are higher than those for liquid securities. Restricted
securities, i.e., securities subject to legal or contractual restrictions on
resale, may also be illiquid. However, some restricted securities (such as
securities issued pursuant to Rule 144A under the Securities Act of 1933 and
certain commercial paper) may be treated as liquid for these purposes.
REIT and Mortgage-Related Risk
Real estate investment trusts ("REITs") involve certain unique risks in
addition to those of investing in the real estate industry in general. REITs
are subject to interest rate risks (especially mortgage REITs) and the risk of
non-payment or default by lessees or borrowers. An equity REIT may be affected
by changes in the value of the underlying properties owned by the REIT. A
mortgage REIT may be affected by the ability of the issuers of its portfolio
mortgages to repay their obligations. REITs whose underlying assets are
concentrated in properties used by a particular industry are also subject to
risks associated with such industry. REITs may have limited financial
resources, may trade less frequently and in a more limited volume and may be
subject to more abrupt or erratic price movements than larger company
securities. Mortgage REITs are also subject to prepayment risk--the risk that
borrowers may pay off their mortgages sooner than expected, particularly when
interest rates decline. This can reduce the REIT's returns to the Fund or the
value of the Fund's investment in the REIT because the REIT may have to
reinvest that money at lower prevailing interest rates.
Market Disruption and Geopolitical Risk
The war with Iraq, its aftermath and the continuing occupation of Iraq is
likely to have a substantial impact on the U.S. and world economies and
securities markets. The nature, scope and duration of the war and occupation
and the potential costs of rebuilding the Iraqi infrastructure cannot be
predicted with any certainty. Terrorist attacks on the World Trade Center and
the Pentagon on September 11, 2001 closed some of the U.S. securities markets
for a four-day period and similar future events cannot be ruled out. The war
and occupation, terrorism and related geopolitical risks have led, and may in
the future lead to, increased short-term market volatility and may have adverse
long-term effects on U.S. and world economies and markets generally. Those
events could also have an acute effect on individual issuers or related groups
of issuers. These risks could also adversely affect individual issuers and
securities markets, interest rates, secondary trading, ratings, credit risk,
inflation and other factors relating to the Common Shares.
Certain Affiliations
Certain broker-dealers may be considered to be affiliated persons of the
Fund, the Manager, NFJ, NACM and/or PEA due to their possible affiliations with
Allianz AG, the ultimate parent of the Manager, NFJ, NACM and PEA. Absent an
exemption from the Securities and Exchange Commission or other regulatory
relief, the Fund is generally precluded from effecting certain principal
transactions with affiliated brokers, and its ability to purchase securities
being underwritten by an affiliated broker or a syndicate including an
affiliated broker, or to
45
utilize affiliated brokers for agency transactions, is subject to restrictions.
This could limit the Fund's ability to engage in securities transactions and
take advantage of market opportunities. In addition, unless and until the
underwriting syndicate is broken in connection with the initial public offering
of the Common Shares, the Fund will be precluded from effecting principal
transactions with brokers who are members of the syndicate.
Anti-Takeover Provisions
The Fund's Amended and Restated Agreement and Declaration of Trust includes
provisions that could limit the ability of other entities or persons to acquire
control of the Fund or convert the Fund to open-end status. See "Anti-Takeover
and Other Provisions in the Declaration of Trust." These provisions in the
Declaration could have the effect of depriving the Common Shareholders of
opportunities to sell their Common Shares at a premium over the then-current
market price of the Common Shares or at net asset value.
HOW THE FUND MANAGES RISK
Investment Limitations
The Fund has adopted certain investment limitations designed to limit
investment risk and maintain portfolio diversification. These limitations (two
of which are listed below) are fundamental and may not be changed without the
approval of the holders of a majority of the outstanding Common Shares. The
Fund may not:
. Concentrate its investments in a particular "industry," as that term is
used in the 1940 Act and as interpreted, modified, or otherwise permitted
by regulatory authority having jurisdiction, from time to time; and
. With respect to 75% of the Fund's total assets, purchase the securities
of any issuer, except securities issued or guaranteed by the U.S.
Government or any of its agencies or instrumentalities or securities of
other investment companies, if, as a result, (i) more than 5% of the
Fund's total assets would be invested in the securities of that issuer,
or (ii) the Fund would hold more than 10% of the outstanding voting
securities of that issuer.
The Fund would be deemed to "concentrate" its investments in a particular
industry if it invested more than 25% of its total assets in that industry. The
Fund's industry concentration policy does not preclude it from focusing
investments in issuers in a group of related industrial sectors (such as
different types of utilities).
Hedging and Related Strategies
The Fund may (but is not required to) use various investment strategies
designed to limit the risk of price fluctuations of its portfolio securities
and to preserve capital. For instance, the Fund may invest in derivative
instruments for the purpose of hedging its exposure to certain issuers and/or
markets. See "The Fund's Investment Objectives and Strategies." Hedging
strategies that the Fund may use include, but are not limited to, options
contracts (including options on futures contracts), futures contracts, forward
contracts, swap agreements and short sales, including such instruments based on
either an index or other asset or individual securities whose prices, a
Sub-Adviser believes, correlate with the prices of the Fund's investments. The
Fund may also engage in hedging transactions relating to interest rates and
foreign currencies. See "The Fund's Investment Objectives and
Strategies--Certain Interest Rate Transactions" and "The Fund's Investment
Objectives and Strategies--Foreign (Non-U.S.) Investments and Currencies."
Income from these hedging activities will not be eligible to be treated as
qualified dividend income. In addition, dividends received on securities with
respect to which the Fund is obligated to make payments (pursuant to short
sales or otherwise) will be treated as income taxed at ordinary, rather than
long-term capital gains, rates. Income earned by the Fund from many hedging
activities will be treated as capital gain and, if not offset by net realized
capital loss, will be distributed to shareholders in taxable distributions.
There is no assurance that these hedging strategies will be available at any
time or that a Sub-Adviser will determine to use them or, if used, that the
strategies will be successful. The Sub-Adviser may determine not to engage in
hedging strategies or to do so only in unusual circumstances or market
conditions.
46
MANAGEMENT OF THE FUND
Trustees and Officers
The Board of Trustees is responsible for the management of the Fund,
including supervision of the duties performed by the Manager, NFJ, NACM and
PEA. There are currently three Trustees of the Fund, none of whom is treated by
the Fund as an "interested person" (as defined in the 1940 Act). The names and
business addresses of the Trustees and officers of the Fund and their principal
occupations and other affiliations during the past five years are set forth
under "Management of the Fund" in the Statement of Additional Information.
Investment Manager
The Manager serves as the investment manager of the Fund. Subject to the
supervision of the Board of Trustees, the Manager is responsible for managing,
either directly or through others selected by it, the investment activities of
the Fund and the Fund's business affairs and other administrative matters. The
Manager is located at 1345 Avenue of the Americas, New York, New York 10105.
Organized in 2000 as a subsidiary successor of a business originally
organized in 1987, the Manager provides investment management and advisory
services to several closed-end and open-end investment company clients. As of
December 31, 2004, the Manager had approximately $37.5 billion in assets under
management. Allianz Global Investors of America L.P. is the direct parent
company of PA Retail Holdings LLC, of which the Manager is a wholly-owned
subsidiary. As of December 31, 2004, Allianz Global Investors of America L.P.
and its subsidiaries, including NFJ, NACM and PEA, had approximately $564.8
billion in assets under management.
The Manager has retained its affiliates, NFJ, NACM and PEA, to manage the
Fund's investments. See "--Sub-Advisers" below. The Manager, NFJ, NACM and PEA
are each majority-owned indirect subsidiaries of Allianz AG, a publicly traded
German insurance and financial services company.
Sub-Advisers
NFJ. NFJ serves as the Sub-Adviser for the Equity Component pursuant to a
portfolio management agreement between the Manager and NFJ. Subject to the
supervision of the Manager, NFJ has full investment discretion and makes all
determinations with respect to the investment of the Equity Component's assets.
NFJ is located at 2121 San Jacinto, Suite 1840, Dallas, Texas 75201. NFJ is
the successor investment adviser to NFJ Investment Group, Inc., which commenced
operations in 1989. NFJ provides investment management services to a number of
institutional accounts, including investment companies, employee benefit plans,
college endowment funds and foundations. As of December 31, 2004, NFJ had
approximately $9.3 billion in assets under management.
For its services pursuant to the portfolio management agreement, the Manager
(and not the Fund) will pay to NFJ an annual fee payable on a monthly basis at
the annual rate of .25% of the average daily total managed assets attributable
to the Equity Component.
47
The following individuals at NFJ constitute the team that shares primary
responsibility for the day-to-day portfolio management of the Equity Component,
with Mr. Fischer serving as head of the team:
Name Since Recent Professional Experience
----------------------- ----------- ---------------------------------------------------
Benno J. Fischer....... February, Managing Director and founding partner of NFJ.
2005 He has over 31 years' experience in portfolio
(Inception) management, investment analysis and research.
Prior to the formation of NFJ in 1989, he was
Chief Investment Officer (institutional and fixed
income), Senior Vice President and Senior
Portfolio Manager at NationsBank, which he
joined in 1971. Prior to joining NationsBank, Mr.
Fischer was a securities analyst at Chase
Manhattan Bank and Clark, Dodge.
E. Clifton Hoover...... February, Managing Director of NFJ. He is a Portfolio
2005 Manager with 19 years' experience in financial
(Inception) analysis and portfolio management. Prior to
joining NFJ in 1997, he was associated with Credit
Lyonnais from 1991 to 1997, where he served as a
vice-president and was responsible for the
financial analysis and portfolio management of a
diversified portfolio. He began his career as a
financial analyst with NationsBank in 1985.
Jeffrey S. Partenheimer February, Managing Director of NFJ. He is a Portfolio
2005 Manager with over 19 years' experience in
(Inception) financial analysis, portfolio management and large
corporate finance. Prior to joining NFJ in 1999, he
spent 10 years in commercial banking (8 of those
years managing investment portfolios) and 4 years
as a treasury director for DSC Communications in
Plano, Texas. He began his career as a financial
analyst with First City Bank of Dallas in 1985. He
is both a CFA and a CPA.
NACM. NACM serves as the Sub-Adviser for the Convertible Component,
pursuant to a portfolio management agreement between the Manager and NACM.
Subject to this agreement and the supervision of the Manager, NACM has full
investment discretion and makes all determinations with respect to the
investment of the Convertible Component's assets.
NACM is located at 600 West Broadway, 30th Floor, San Diego, California
92101. Founded in 1984, NACM currently manages discretionary assets for
numerous clients, including investment companies, employee benefit plans,
corporations, public retirement systems and unions, university endowments,
foundations, and other institutional investors and individuals. As of December
31, 2004, NACM had approximately $14.5 billion in assets under management.
For its services pursuant to the portfolio management agreement, the Manager
(and not the Fund) will pay to NACM an annual fee payable on a monthly basis at
the annual rate of .40% of the Fund's average daily total managed assets
attributable to the Convertible Component.
48
The following six individuals are part of the Convertibles/High Yield team
at NACM and constitute the team that has primary responsibility for the
day-to-day portfolio management of the Convertible Component, with Mr. Forsyth
serving as the head of the team:
Name Since Recent Professional Experience
---- ----------- ---------------------------------------------------
Douglas Forsyth, CFA..... February, Mr. Forsyth is a Senior Portfolio Manager and
2005 Member of the Executive Committee at NACM. He
(Inception) joined NACM in 1994 after three years of investment
management experience at AEGON USA. Mr.
Forsyth holds a B.B.A. from the University of Iowa.
William L. Stickney...... February, Mr. Stickney is a portfolio manager at NACM. He
2005 joined NACM in 1999 after an aggregate of ten
(Inception) years of investment experience with ABN AMRO,
Inc., Cowen & Company and Wayne Hummer &
Company. Mr. Stickney holds a B.S. from Miami
University and an M.M. from Northwestern
University, J.L. Kellogg School of Management.
Michael E. Yee........... February, Mr. Yee is a portfolio manager at NACM. He
2005 joined NACM in 1995 and has been a portfolio
(Inception) manager since 1998. Mr. Yee holds a B.S. from
the University of California, San Diego and an
M.B.A. from San Diego State University.
Justin Kass.............. February, Mr. Kass is an investment analyst at NACM. He
2005 joined NACM in 2000 after serving as an intern on
(Inception) the Convertibles/High Yield team and has four
years of investment experience. Mr. Kass holds a
B.S. from the University of California, Davis and
an M.B.A. from the Anderson School at the
University of California, Los Angeles.
Elizabeth Lemesevski..... February, Ms. Lemesevski is an investment analyst at
2005 NACM. She joined NACM in 2001 after an
(Inception) aggregate of nine years of investment and research
experience with T.A. McKay & Co., Citibank and
CoreStates Philadelphia International Bank. Ms.
Lemesevski holds a B.S. from Rutgers University
and an M.B.A. from Fordham University.
Nicole Larrabee.......... February, Ms. Larrabee is a trading assistant/analyst at
2005 NACM. She joined NACM in 2000 after an
(Inception) aggregate of four years of investment and research
experience with Salomon Smith Barney
(Schroders), Lehman Brothers, Inc., Heflin and
Co., LLC, Sun Alliance Holdings, Ltd. and Cantor
Fitzgerald and Co., Inc. Ms. Larrabee holds a B.S.
from the University of Arizona.
PEA. PEA serves as the Sub-Adviser responsible for implementing the Fund's
Index Option Strategy pursuant to a portfolio management agreement between the
Manager and PEA. Subject to the supervision of the Manager, PEA has full
investment discretion and makes all determinations with respect to the
implementation of the Index Option Strategy.
49
PEA is located at 1345 Avenue of the Americas, New York, New York 10105. PEA
provides equity-related advisory services to mutual funds and institutional
accounts. As of December 31, 2004, PEA had approximately $14.5 billion in
assets under management.
For its services pursuant to the portfolio management agreement, the Manager
(and not the Fund) will pay to PEA an annual fee payable on a monthly basis at
the annual rate of .20% of the average daily total managed assets attributable
to the Equity Component.
The following individual at PEA has the primary responsibility for the
day-to-day portfolio management of the Index Option Strategy.
Name Since Recent Professional Experience
------------- ----------- -------------------------------------------------
Greg Tournant February, Portfolio Manager for PEA. Prior to joining PEA
2005 in 2001, he was a Senior Research Analyst at
(Inception) Eagle Asset Management, a division of Raymond
James Financial. Before that he spent three years
as a strategy consultant for McKinsey & Co. and
two years as a research analyst for Eagle Asset
Management. He has over eight years of
investment management experience.
Investment Management Agreement
Pursuant to an investment management agreement between the Manager and the
Fund (the "Investment Management Agreement"), the Fund has agreed to pay the
Manager an annual management fee payable on a monthly basis at the annual rate
of 0.90% of the Fund's average daily total managed assets for the services and
facilities it provides.
In addition to the fees of the Manager, the Fund pays all other costs and
expenses of its operations, including compensation of its Trustees (other than
those affiliated with the Manager), custodial expenses, shareholder servicing
expenses, transfer agency and dividend disbursing expenses, legal fees,
expenses of independent auditors, expenses of repurchasing shares, expenses of
preparing, printing and distributing prospectuses, shareholder reports,
notices, proxy statements and reports to governmental agencies, and taxes, if
any.
Because the fees received by the Manager are based on the total managed
assets of the Fund (including assets attributable to any borrowings that may be
outstanding), the Manager has a financial incentive for the Fund to utilize
borrowings, which may create a conflict of interest between the Manager and the
holders of the Fund's Common Shares.
Regulatory and Litigation Matters
On September 13, 2004, the Securities and Exchange Commission announced that
the Manager, PEA and PA Distributors LLC ("PAD") had agreed to a settlement of
charges that they and certain of their officers had, among other things,
violated various antifraud provisions of the federal securities laws in
connection with an alleged market-timing arrangement involving trading of
shares of certain open-end investment companies ("open-end funds") advised or
distributed by the Manager and certain of its affiliates. In their settlement
with the Securities and Exchange Commission, the Manager, PEA and PAD consented
to the entry of an order by the Securities and Exchange Commission and, without
admitting or denying the findings contained in the order, agreed to implement
certain compliance and governance changes and consented to cease-and-desist
orders and censures. In addition, the Manager, PEA and PAD agreed to pay civil
money penalties in the aggregate amount of $40 million and to pay disgorgement
in the amount of $10 million, for an aggregate payment of $50 million. In
connection with the settlement, the Manager, PEA and PAD have been dismissed
from the related complaint by the Securities and Exchange Commission filed on
May 6, 2004 in the U.S. District Court in the Southern District of New York.
50
In a related action, on June 1, 2004, the Attorney General of the State of
New Jersey announced that it had entered into a settlement agreement with PEA
and PAD and their parent, Allianz Global Investors of America L.P. (formerly
Allianz Dresdner Asset Management of America L.P., or "Allianz"), in connection
with a complaint filed by the New Jersey Attorney General ("NJAG") on February
17, 2004. In the settlement, Allianz, PEA and PAD neither admitted nor denied
the allegations or conclusions of law, but did agree to pay New Jersey a civil
fine of $15 million and $3 million for investigative costs and further
potential enforcement initiatives against unrelated parties. They also
undertook to implement certain governance changes. The complaint relating to
the settlement alleged, among other things, that Allianz, PEA and PAD had
failed to disclose that they improperly allowed certain hedge funds to engage
in "market timing" in various open-end funds advised or distributed by the
Manager and certain of its affiliates.
On September 15, 2004, the Securities and Exchange Commission announced that
the Manager, PEA and PAD had agreed to settle a Securities and Exchange
Commission enforcement action in connection with charges that they violated
various antifraud and other provisions of federal securities laws as a result
of, among other things, their failure to disclose to the board of trustees and
shareholders of various open-end funds advised or distributed by the Manager
and its affiliates material facts and conflicts of interest that arose from
their use of brokerage commissions on portfolio transactions to pay for
so-called "shelf space" arrangements with certain broker-dealers. In their
settlement with the Securities and Exchange Commission, the Manager, PEA and
PAD consented to the entry of an order by the Securities and Exchange
Commission without admitting or denying the findings contained in the order. In
connection with their settlement, the Manager, PEA and PAD agreed to undertake
certain compliance and disclosure reforms and consented to cease-and-desist
orders and censures. In addition, the Manager, PEA and PAD agreed to pay a
civil money penalty of $5 million and to pay disgorgement of approximately $6.6
million based upon the aggregate amount of brokerage commissions alleged to
have been paid by such open-end funds in connection with these shelf-space
arrangements (and related interest). In a related action, the California
Attorney General announced on September 15, 2004 that it had entered an
agreement with PAD in resolution of an investigation into matters that are
similar to those discussed in the Securities and Exchange Commission order. The
settlement agreement resolves matters described in a complaint filed
contemporaneously by the California Attorney General in the Superior Court of
the State of California alleging, among other things, that PAD violated certain
antifraud provisions of California law by failing to disclose matters related
to the shelf-space arrangements described above. In the settlement agreement,
PAD did not admit to any liability but agreed to pay $5 million in civil
penalties and $4 million in recognition of the California Attorney General's
fees and costs associated with the investigation and related matters.
Since February 2004, the Manager, PEA, NFJ, NACM and certain of their
affiliates and employees have been named as defendants in a total of 14
lawsuits filed in one of the following: U.S. District Court in the Southern
District of New York, the Central District of California and the Districts of
New Jersey and Connecticut. Ten of those lawsuits concern "market timing," and
they have been transferred to and consolidated for pre-trial proceedings in the
U.S. District Court for the District of Maryland; the remaining four lawsuits
concern "revenue sharing" with brokers offering "shelf space" and have been
consolidated into a single action in the U.S. District Court for the District
of Connecticut. The lawsuits have been commenced as putative class actions on
behalf of investors who purchased, held or redeemed shares of affiliated funds
during specified periods or as derivative actions on behalf of the funds. The
lawsuits generally relate to the same facts that are the subject of the
regulatory proceedings discussed above. The lawsuits seek, among other things,
unspecified compensatory damages plus interest and, in some cases, punitive
damages, the rescission of investment advisory contracts, the return of fees
paid under those contracts and restitution. The Manager, PEA, NFJ and NACM
believe that other similar lawsuits may be filed in federal or state courts
naming as defendants the Manager, Allianz, PEA, NFJ, NACM, open- and closed-end
funds advised or distributed by the Manager, PEA, NFJ, NACM and/or their
affiliates, the boards of trustees of those funds, and/or other affiliates or
employees as defendants.
Under Section 9(a) of the 1940 Act, if any of the various regulatory
proceedings or lawsuits were to result in a court injunction against the
Manager, PEA, Allianz and/or their affiliates, they and their affiliates
(including NACM and NFJ) would, in the absence of exemptive relief granted by
the Securities and Exchange Commission,
51
be barred from serving as an investment adviser/sub-adviser or principal
underwriter for any registered investment company, including the Fund. In
connection with an inquiry from the Securities and Exchange Commission
concerning the status of the New Jersey settlement under Section 9(a), the
Manager, Allianz and certain of their affiliates (together, the "Applicants")
sought exemptive relief from the Securities and Exchange Commission under
Section 9(c) of the 1940 Act. The Securities and Exchange Commission has
granted the Applicants a temporary exemption from the provisions of Section
9(a) with respect to the New Jersey settlement until the earlier of (i)
September 13, 2006 and (ii) the date on which the Securities and Exchange
Commission takes final action on their application for a permanent order. There
is no assurance that the Securities and Exchange Commission will issue a
permanent order.
Various legislative and regulatory proposals are pending in or before, or
have been adopted by the U.S. Congress, state legislatures and the various
regulatory agencies that supervise the operations of the Fund and its service
providers. These proposals, to the extent enacted or adopted, could have a
substantial impact on the regulation and operation of registered funds,
investment advisers and broker-dealers. Additionally, the Securities and
Exchange Commission, the National Association of Securities Dealers and other
regulators, as well as Congress, are investigating certain practices generally
within the investment company industry and also engage in regular, routine
inspections. The Fund, the Manager and the Sub-Advisers intend to cooperate
fully with all regulatory inquiries.
In addition, it is possible that these matters and/or other developments
resulting from these matters could lead to a decrease in the market value of
the Fund's Common Shares or other adverse consequences to the Fund and its
Shareholders. However, the Manager and the Sub-Advisers believe that these
matters are not likely to have a material adverse effect on the Fund or on
their ability to perform their respective investment advisory services relating
to the Fund.
In addition, a putative class action lawsuit captioned Charles Mutchka et
al. v. Brent R. Harris, et al., filed in January 2005 by and on behalf of
individual shareholders of certain open-end funds that hold equity securities
and that are sponsored by the Manager and certain of its affiliates, including
the Sub-Advisers, is currently pending in the federal district court for the
Central District of California. The plaintiff alleges that fund trustees,
investment advisers and affiliates breached fiduciary duties and duties of care
by failing to ensure that the open-end funds participated in securities class
action settlements for which those funds were eligible. The plaintiff has
claimed as damages disgorgement of fees paid to the investment advisers,
compensatory damages and punitive damages. The Manager believes that the claims
made in the lawsuit against the Manager and its affiliates, including the
Sub-Advisers, are baseless, and the Manager, its affiliates and the
Sub-Advisers intend to vigorously defend the lawsuit. As of the date of the
prospectus, the Manager believes a decision, if any, against the defendants
would have no material adverse effect on the Fund, its Common Shares, or the
ability of the Manager or the Sub-Advisers to perform their duties under the
investment management or portfolio management agreements, as the case may be.
NET ASSET VALUE
The net asset value ("NAV") of the Fund equals the total value of the Fund's
portfolio investments and other assets, less any liabilities. For purposes of
calculating NAV, portfolio securities and other assets for which market quotes
are readily available are stated at market value. Market value is generally
determined on the basis of the last reported sales price or, if available, the
closing price reported for an issue traded on an over-the-counter stock market
(including the NASDAQ Official Closing Price for NASD traded securities), or if
no sales or closing prices are reported, based on quotes obtained from a
quotation reporting system, established market makers or pricing services.
Certain securities or investments for which daily market quotations are not
readily available may be valued, pursuant to guidelines established by the
Board of Trustees, with reference to other securities or indexes. For instance,
a pricing service may recommend a fair market value based on prices of
comparable securities. Short-term investments having a maturity of 60 days or
less are generally valued at
52
amortized cost. Exchange traded options, futures and options on futures are
valued at the settlement price determined by the exchange. Other securities for
which market quotes are not readily available are valued at fair value as
determined in good faith by the Board of Trustees or persons acting at their
direction.
The NAV of the Fund will be determined as of the close of regular trading on
the New York Stock Exchange (normally 4:00 p.m., Eastern time) (the "NYSE
Close") on each day that the New York Stock Exchange is open. Domestic debt
securities and foreign securities are normally priced using data reflecting the
earlier closing of the principal markets for those securities. Information that
becomes known to the Fund or its agent after the Fund's NAV has been calculated
on a particular day will not be used to retroactively adjust the price of a
security or the Fund's NAV determined earlier that day.
Investments initially valued in currencies other than the U.S. dollar are
converted to U.S. dollars using exchange rates obtained from pricing services.
As a result, the NAV of the Fund's shares may be affected by changes in the
value of currencies in relation to the U.S. dollar. The value of securities
traded in markets outside the United States or denominated in currencies other
than the U.S. dollar may be affected significantly on a day that the New York
Stock Exchange is closed.
In unusual circumstances, instead of valuing securities in the usual manner,
the Fund may value securities at fair value as determined in good faith by the
Board of Trustees, generally based upon recommendations provided by the
Manager, NACM, NFJ or PEA. Fair valuation also may be required due to material
events that occur after the close of the relevant market but prior to the NYSE
Close.
DISTRIBUTIONS
Commencing with the Fund's first dividend, the Fund intends to make
quarterly cash distributions to Common Shareholders at a rate that reflects the
past and projected performance of the Fund. The Fund expects to receive
substantially all of its current income and gains from the following sources:
(i) capital gains (short-term and long-term) from net index option premiums and
the sale of portfolio securities; (ii) dividends received by the Fund that are
paid on the common stocks and other equity securities held in the Equity
Component; and (iii) interest income received by the Fund from the convertible
securities held in the Convertible Component. Distributions are likely to be
variable, and the Fund's distribution rate will depend on a number of factors,
including the net earnings on the Fund's portfolio investments and the rate at
which such net earnings change as a result of changes in the timing of and
rates at which the Fund receives income from the sources described above. The
net investment income of the Fund consists of all income (other than net
short-term and long-term capital gains) less all expenses of the Fund.
The Fund's quarterly distributions will be made from the Fund's net
investment income and net gains from index option premiums and the sale of
portfolio securities. The tax treatment and characterization of the Fund's
distributions may vary significantly from time to time because of the varied
nature of the Fund's investments. Pursuant to the requirements of the 1940 Act
and other applicable laws, a notice will accompany each quarterly distribution
with respect to the estimated source (as between net income and gains) of the
distribution made. (The Fund will indicate the proportion of its capital gains
distributions that constitute long-term and short-term gains annually.) The
ultimate tax characterization of the Fund's distributions made in a calendar or
fiscal year cannot finally be determined until after the end of that fiscal
year. As a result, there is a possibility that the Fund may make total
distributions during a calendar or fiscal year in an amount that exceeds the
Fund's net investment income and net realized capital gains for the relevant
fiscal year. For example, the Fund may distribute amounts early in the calendar
year that derive from short-term capital gains, but incur net short-term
capital losses later in the year, thereby offsetting short-term capital gains
out of which distributions have already been made by the Fund. In such a
situation, the amount by which the Fund's total distributions exceed net
investment income and net realized capital gains would generally be treated as
a tax-free return of capital up to the amount of your tax basis in your shares,
with any amounts exceeding such basis treated as gain from the sale of shares.
53
As portfolio and market conditions change, the rate of dividends on the
Common Shares and the Fund's dividend policy could change. Over time, the Fund
will distribute all of its net investment income and net short-term capital
gains. In addition, at least annually, the Fund intends to distribute net
realized long-term capital gains not previously distributed, if any. The 1940
Act currently limits the number of times the Fund may distribute long-term
capital gains in any tax year, which may increase the variability of the Fund's
distributions and result in certain dividends being comprised more heavily of
long-term capital gains eligible for favorable income tax rates. During periods
in which the Index Option Strategy does not generate sufficient option premiums
or results in net losses, a substantial portion of the Fund's dividends may be
comprised of capital gains from the sale of equity securities held in the
Equity Component, which would involve transaction costs borne by the Fund and
may also result in realization of taxable short-term capital gains taxed at
ordinary income tax rates (particularly during the initial year of the Fund's
operations when all of the Fund's portfolio securities will have been held for
less than one year). See "Tax Matters."
Your initial distribution is expected to be declared approximately 75 days,
and paid approximately 120 days, from the completion of this offering,
depending on market conditions. Unless you elect to receive distributions in
cash, all of your distributions will be automatically reinvested in additional
Common Shares under the Fund's Dividend Reinvestment Plan. See "Dividend
Reinvestment Plan." Although it does not now intend to do so, the Board of
Trustees may change the Fund's distribution policy and the amount or timing of
the distributions, based on a number of factors, including the amount of the
Fund's undistributed net investment income and net short- and long-term capital
gains and historical and projected net investment income and net short- and
long-term capital gains.
DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Dividend Reinvestment Plan (the "Plan"), all Common
Shareholders whose shares are registered in their own names will have all
dividends, including any capital gain dividends, reinvested automatically in
additional Common Shares by PFPC Inc., as agent for the Common Shareholders
(the "Plan Agent"), unless the shareholder elects to receive cash. An election
to receive cash may be revoked or reinstated at the option of the shareholder.
In the case of record shareholders such as banks, brokers or other nominees
that hold Common Shares for others who are the beneficial owners, the Plan
Agent will administer the Plan on the basis of the number of Common Shares
certified from time to time by the record shareholder as representing the total
amount registered in such shareholder's name and held for the account of
beneficial owners who are to participate in the Plan. Shareholders whose shares
are held in the name of a bank, broker or nominee should contact the bank,
broker or nominee for details. Such shareholders may not be able to transfer
their shares to another bank or broker and continue to participate in the Plan.
All distributions to investors who elect not to participate in the Plan (or
whose broker or nominee elects not to participate on the investor's behalf)
will be paid in cash by check mailed, in the case of direct shareholders, to
the record holder by PFPC Inc., as the Fund's dividend disbursement agent.
Unless you elect (or your broker or nominee elects) not to participate in
the Plan, the number of Common Shares you will receive will be determined as
follows:
(1) If on the payment date the net asset value of the Common Shares is equal
to or less than the market price per Common Share plus estimated
brokerage commissions that would be incurred upon the purchase of Common
Shares on the open market, the Fund will issue new shares at the greater
of (i) the net asset value per Common Share on the payment date or (ii)
95% of the market price per Common Share on the payment date; or
(2) If on the payment date the net asset value of the Common Shares is
greater than the market price per Common Share plus estimated brokerage
commissions that would be incurred upon the purchase of Common Shares on
the open market, the Plan Agent will receive the dividend or
distribution in cash
54
and will purchase Common Shares in the open market, on the New York
Stock Exchange or elsewhere, for the participants' accounts. It is
possible that the market price for the Common Shares may increase before
the Plan Agent has completed its purchases. Therefore, the average
purchase price per share paid by the Plan Agent may exceed the market
price on the payment date, resulting in the purchase of fewer shares
than if the dividend or distribution had been paid in Common Shares
issued by the Fund. The Plan Agent will use all dividends and
distributions received in cash to purchase Common Shares in the open
market on or shortly after the payment date, but in no event later than
the ex-dividend date for the next distribution. Interest will not be
paid on any uninvested cash payments.
You may withdraw from the Plan at any time by giving written notice to the
Plan Agent. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you
wish, the Plan Agent will sell your shares and send you the proceeds, minus
brokerage commissions.
The Plan Agent maintains all shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. The Plan Agent will also furnish each person who
buys Common Shares with written instructions detailing the procedures for
electing not to participate in the Plan and to instead receive distributions in
cash. Common Shares in your account will be held by the Plan Agent in
non-certificated form. Any proxy you receive will include all Common Shares you
have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or
distributions in Common Shares. However, all participants will pay a pro rata
share of brokerage commissions incurred by the Plan Agent when it makes open
market purchases.
Automatically reinvested dividends and distributions are taxed in the same
manner as cash dividends and distributions.
The Fund and the Plan Agent reserve the right to amend or terminate the
Plan. There is no direct service charge to participants in the Plan; however,
the Fund reserves the right to amend the Plan to include a service charge
payable by the participants. Additional information about the Plan may be
obtained from PFPC Inc., P.O. Box 43027, Providence, RI 02940-3027, telephone
number (800) 331-1710.
DESCRIPTION OF SHARES
The Declaration authorizes the issuance of an unlimited number of Common
Shares. The Common Shares will be issued with a par value of $.00001 per share.
All Common Shares have equal rights to the payment of dividends and the
distribution of assets upon liquidation. Common Shares will, when issued, be
fully paid and, subject to matters discussed in "Anti-Takeover and Other
Provisions in the Declaration of Trust," non-assessable, and will have no
pre-emptive or conversion rights or rights to cumulative voting.
The Common Shares are expected to be listed on the New York Stock Exchange.
The Fund intends to hold annual meetings of shareholders so long as the Common
Shares are listed on a national securities exchange and annual meetings are
required as a condition of such listing.
Net asset value will be reduced immediately following the offering by the
amount of the sales load and organization and offering expenses paid by the
Fund. The Manager has agreed to pay the amount by which the Fund's offering
costs (other than the sales load, but inclusive of the reimbursement of
underwriter expenses of $.005 per share) exceed $.05 per share. While the
Manager has agreed to initially pay all of the Fund's organizational expenses,
the Fund has agreed to reimburse the Manager for such organizational expenses
(or a portion thereof) so long as that reimbursement plus the Fund's offering
costs (other than the sales load, but inclusive of the reimbursement of
underwriter expenses of $.005 per share) does not exceed $.05 per share. Any
such reimbursement will be made prior to the end of the Fund's initial fiscal
year.
55
Unlike open-end funds, closed-end funds like the Fund do not continuously
offer shares and do not provide daily redemptions. Rather, if a shareholder
determines to buy additional Common Shares or sell shares already held, the
shareholder may do so by trading on the exchange through a broker or otherwise.
The Fund's Declaration limits the ability of the Fund to convert to open-end
status. See "Anti-Takeover and Other Provisions in the Declaration of Trust."
Shares of closed-end investment companies frequently trade at prices lower
than net asset value. Shares of closed-end investment companies have during
some periods traded at prices higher than net asset value and during other
periods traded at prices lower than net asset value. The Fund cannot assure you
that Common Shares will trade at a price higher than net asset value in the
future. Net asset value will be reduced immediately following the offering by
the sales load and the amount of organization and offering expenses paid or
reimbursed by the Fund. See "Use of Proceeds." In addition to net asset value,
market price may be affected by factors relating to the Fund such as dividend
levels and stability (which will in turn be affected by levels of dividend and
interest payments by the Fund's portfolio holdings, the timing and success of
the Fund's Index Option Strategy, regulation affecting the timing and character
of Fund distributions, Fund expenses and other factors), portfolio credit
quality, liquidity, call protection, market supply and demand, and similar
factors relating to the Fund's portfolio holdings. The Common Shares are
designed primarily for long-term investors, and investors in the Common Shares
should not view the Fund as a vehicle for trading purposes. See the Statement
of Additional Information under "Repurchase of Common Shares; Conversion to
Open-End Fund."
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
The Declaration includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to convert the Fund to
open-end status. The Fund's Trustees are divided into three classes. At each
annual meeting of shareholders, the term of one class will expire and each
Trustee elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the
outstanding shares of the classes or series of shares entitled to vote for the
election of such Trustee, or (ii) by at least seventy-five percent (75%) of the
remaining Trustees.
As described below, the Declaration grants special approval rights with
respect to certain matters to members of the Board who qualify as "Continuing
Trustees," which term means a Trustee who either (i) has been a member of the
Board for a period of at least thirty-six months (or since the commencement of
the Fund's operations, if less than thirty-six months) or (ii) was nominated to
serve as a member of the Board of Trustees by a majority of the Continuing
Trustees then members of the Board.
The Declaration requires the affirmative vote or consent of at least
seventy-five percent (75%) of the Board of Trustees and holders of at least
seventy-five percent (75%) of the Fund's shares to authorize certain Fund
transactions not in the ordinary course of business, including a merger or
consolidation, issuance or transfer by the Fund of the Fund's shares (except as
may be made pursuant to a public offering, the Fund's dividend reinvestment
plan or upon exercise of any stock subscription rights), a sale, transfer or
other disposition of Fund assets, or any shareholder proposal regarding
specific investment decisions, unless the transaction is authorized by both a
majority of the Trustees and seventy-five percent (75%) of the Continuing
Trustees (in which case no shareholder authorization would be required by the
Declaration, but may be required in certain cases under the 1940 Act). The
Declaration also requires the affirmative vote or consent of holders of at
least seventy-five percent (75%) of the Fund's shares entitled to vote on the
matter to authorize a conversion of the Fund from a closed-end to an open-end
investment company, unless the conversion is authorized by both a majority of
the Trustees and seventy-five percent (75%) of the Continuing Trustees (in
which case shareholders would have only the minimum voting rights required by
the 1940 Act with respect to the conversion).
56
Also, the Declaration provides that the Fund may be terminated at any time
by vote or consent of at least seventy-five percent (75%) of the Fund's shares
or, alternatively, by vote or consent of both a majority of the Trustees and
seventy-five percent (75%) of the Continuing Trustees. See "Anti-Takeover and
Other Provisions in the Declaration of Trust" in the Statement of Additional
Information for a more detailed summary of these provisions.
The Trustees may from time to time grant other voting rights to shareholders
with respect to these and other matters in the Fund's Bylaws.
The overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control of the Fund by a third
party. They provide, however, the advantage of potentially requiring persons
seeking control of the Fund to negotiate with its management regarding the
price to be paid and facilitating the continuity of the Fund's investment
objectives and policies. The provisions of the Declaration described above
could have the effect of depriving the Common Shareholders of opportunities to
sell their Common Shares at a premium over the then current market price of the
Common Shares by discouraging a third party from seeking to obtain control of
the Fund in a tender offer or similar transaction. The Board of Trustees of the
Fund has considered the foregoing anti-takeover provisions and concluded that
they are in the best interests of the Fund and its Common Shareholders.
The foregoing is intended only as a summary and is qualified in its entirety
by reference to the full text of the Declaration and the Fund's Bylaws, both of
which are on file with the Securities and Exchange Commission.
Under Massachusetts law, shareholders could, in certain circumstances, be
held personally liable for the obligations of the Fund. However, the
Declaration contains an express disclaimer of shareholder liability for debts
or obligations of the Fund and requires that notice of such limited liability
be given in each agreement, obligation or instrument entered into or executed
by the Fund or the Trustees. The Declaration further provides for
indemnification out of the assets and property of the Fund for all loss and
expense of any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the Fund would be
unable to meet its obligations. The Fund believes that the likelihood of such
circumstances is remote.
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders
will not have the right to cause the Fund to redeem their shares. Instead, the
Common Shares will trade in the open market at a price that will be a function
of factors relating to the Fund such as dividend levels and stability (which
will in turn be affected by dividend and interest payments by the Fund's
portfolio holdings, the timing and sources of the Fund's Index Option Strategy,
regulations affecting the timing and character of Fund distributions, Fund
expenses and other factors), portfolio credit quality, liquidity, call
protection, market supply and demand, and similar factors relating to the
Fund's portfolio holdings. Shares of a closed-end investment company may
frequently trade at prices lower than net asset value. The Fund's Board of
Trustees regularly monitors the relationship between the market price and net
asset value of the Common Shares. If the Common Shares were to trade at a
substantial discount to net asset value for an extended period of time, the
Board may consider the repurchase of its Common Shares on the open market or in
private transactions, the making of a tender offer for such shares or the
conversion of the Fund to an open-end investment company. The Fund cannot
assure you that its Board of Trustees will decide to take or propose any of
these actions, or that share repurchases or tender offers will actually reduce
market discount.
If the Fund were to convert to an open-end company, the Common Shares would
no longer be listed on the New York Stock Exchange. In contrast to a closed-end
investment company, shareholders of an open-end
57
investment company may require the company to redeem their shares at any time
(except in certain circumstances as authorized by or under the 1940 Act) at
their net asset value, less any redemption charge that is in effect at the time
of redemption.
Before deciding whether to take any action to convert the Fund to an
open-end investment company, the Board would consider all relevant factors,
including the extent and duration of the discount, the liquidity of the Fund's
portfolio, the impact of any action that might be taken on the Fund or its
shareholders, and market considerations. Based on these considerations, even if
the Fund's shares should trade at a discount, the Board of Trustees may
determine that, in the interest of the Fund and its shareholders, no action
should be taken. See the Statement of Additional Information under "Repurchase
of Common Shares; Conversion to Open-End Fund" for a further discussion of
possible action to reduce or eliminate such discount to net asset value.
TAX MATTERS
Federal Income Tax Matters
The following federal income tax discussion is based on the advice of Ropes
& Gray LLP, counsel to the Fund, and reflects provisions of the Internal
Revenue Code of 1986, as amended (the "Code"), existing Treasury regulations,
rulings published by the Internal Revenue Service (the "Service"), and other
applicable authority, as of the date of this prospectus. These authorities are
subject to change by legislative or administrative action, possibly with
retroactive effect. The following discussion is only a summary of some of the
important tax considerations generally applicable to investments in the Fund.
For more detailed information regarding tax considerations, see the Statement
of Additional Information. There may be other tax considerations applicable to
particular investors. In addition, income earned through an investment in the
Fund may be subject to state and local taxes.
The Fund intends to qualify each year for taxation as a regulated investment
company eligible for treatment under the provisions of Subchapter M of the
Code. If the Fund so qualifies and satisfies certain distribution requirements,
the Fund will not be subject to federal income tax on income distributed in a
timely manner to its shareholders in the form of dividends or capital gain
distributions.
To satisfy the distribution requirement applicable to regulated investment
companies, amounts paid as dividends by the Fund to its shareholders must
qualify for the dividends-paid deduction.
For federal income tax purposes, distributions of investment income are
generally taxable as ordinary income to the extent of the Fund's current and
accumulated earnings and profits. Taxes on distributions of capital gains are
determined by how long the Fund owned (and is treated under federal income tax
rules as having owned) the investments that generated them, rather than how
long a shareholder has owned his or her shares. Distributions of net capital
gains from the sale of investments that the Fund owned for more than one year
and that are properly designated by the Fund as capital gain dividends will be
taxable as long-term capital gains. Distributions of gains from the sale of
investments that the Fund owned for one year or less will be taxable as
ordinary income. Call option premiums received by the Fund on many (but not
all) equity index call options will be subject to mark-to-market treatment and
gains will be recognized based on the fair market value of the options on
October 31st and at the end of the Fund's taxable year (January 31) (or if the
option is disposed of, upon disposition). Under this system, 60% of the gains
or losses from such equity index call options will be treated as long-term
capital gains or losses and 40% will be treated as short-term capital gains or
losses. Such short-term gains will be subject to ordinary income tax rates to
the extent not offset by short-term losses. Other call option premiums received
by the Fund will be recognized upon exercise, lapse or other disposition of the
option and will be treated by the Fund as short-term capital gain or loss,
unless the option is actually exercised (i.e. does not lapse and is not
cancelled pursuant to a closing transaction) after any related "substantially
similar" stock or other property is treated for federal income tax purposes as
having been held for more than a year. Distributions in
58
excess of the Fund's current and accumulated earnings and profits are treated
as returns of capital to the extent of the shareholder's basis in the shares,
and thereafter as capital gain.
The Fund's call-writing activities may affect the period for which it is
respected as having held stocks that the Fund owns that are also included in
the indices on which such calls are written (or for which such options
substantially diminish the risk, as set forth in Service regulations) for
federal income tax purposes. Some of the call options and other devices
employed by the Fund reduce risk to the Fund by substantially diminishing its
risk of loss in offsetting positions in substantially similar or related
property, thereby giving rise to "straddles" under the federal income tax
rules. The straddle rules require the Fund to defer certain losses on positions
within a straddle and to terminate the holding period for shares which become
part of a straddle before the long-term capital gains period has been reached.
In other words, the Fund will not be respected as having owned the shares for
any time before the options lapse or are otherwise terminated. Because the Fund
intends to sell mainly out-of-the-money and at-the-money options, the Fund
expects that many of its covered call options that are considered to offset
substantially similar or related property will constitute "qualified covered
call options" that are generally excepted from the straddle rules. As such,
they generally will not trigger the loss deferral provisions of the straddle
rules, so that the holding period for the substantially similar property will
not be terminated but instead will be suspended while the call options are
outstanding. At this time, it is unclear the extent to which the gains from the
sale of shares underlying (or substantially similar to) such call options will
be treated as short-term capital gains and thus, in so far as not offset by
short term losses, taxable as ordinary income when distributed.
For taxable years beginning on or before December 31, 2008, the Fund may
designate distributions of investment income derived from dividends of U.S.
corporations and some foreign corporations as "qualified dividend income,"
provided holding period and other requirements are met by the Fund. Qualified
dividend income will be taxed in the hands of individuals at the rates
applicable to long-term capital gain, provided the same holding period and
other requirements are met by the shareholder. Fund dividends representing
distributions of interest income and short-term capital gains (including a
portion of premiums received by the Fund as the seller (writer) of expired
options contracts) cannot be designated as qualified dividend income and will
not qualify for the reduced rates. In addition, the straddle rules described
above, which terminate or suspend the holding period of securities
substantially similar to covered calls and other reduced-risk investments, will
bear adversely on the Fund's ability to designate distributions as qualified
dividend income. There can be no assurance as to the percentage (if any) of the
Fund's distributions that will qualify for taxation to individual Common
Shareholders as qualified dividend income.
In addition to investing in stocks that pay tax-favored dividends, the Fund
intends to invest a portion of its assets in convertible securities, as well as
stocks and other securities that generate ordinary income not taxed at
long-term capital gains rates. For example, income produced by the Convertible
Component, which will constitute 25% of the Fund's portfolio, will be taxed at
ordinary income rates. Also, dividends received by the Fund from REITs will
constitute qualified dividend income only to the extent that the REIT pays an
entity-level tax, and REITs are generally operated in a manner designed to
ensure that they are not required to pay such taxes.
The Fund's investments in certain debt obligations may cause the Fund to
recognize taxable income in excess of the cash generated by such obligations.
Thus, the Fund could be required at times to liquidate other investments in
order to satisfy its distribution requirements.
Some of the debt obligations that may be acquired by the Fund may 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 taxable income (and required to be distributed) over the term of
the debt security, even though payment of that amount is not received until a
later time, usually when the debt security matures. In addition,
payment-in-kind securities will give rise to income which is required to be
distributed and is taxable even though the Fund holding the security receives
no interest payment in cash on the security during the year.
59
The Fund may invest in debt obligations that are in the lowest rating
categories or are unrated, and may hold debt obligations of issuers not
currently paying interest or who are in default. Investments in debt
obligations that are at risk of or in default present special tax issues for
the Fund. Tax rules are not entirely clear about issues such as when the Fund
may cease to accrue interest, original issue discount or market discount, when
and to what extent deductions may be taken for bad debts or worthless
securities and how payments received on obligations in default should be
allocated between principal and income. The Fund will address these and other
related issues when, as and if it holds in such securities, in order to seek to
ensure that it distributes sufficient income to preserve its status as a
regulated investment company and does not become subject to U.S. federal income
or excise tax.
Some of the debt obligations that may be acquired by the Fund in the
secondary market may be treated as having market discount. The Fund may make
one or more of the elections applicable to debt obligations having market
discount, which could affect the character and timing of recognition of income.
Distributions are taxable to shareholders even if they are paid from income
or gains earned by the Fund before a shareholder's investment (and thus were
included in the price the shareholder paid). Distributions are taxable whether
shareholders receive them in cash or reinvest them in additional shares through
the Dividend Reinvestment Plan. Shareholders will be notified annually as to
the U.S. federal tax status of distributions. The ultimate tax characterization
of the Fund's distributions made in a taxable year cannot finally be determined
until after the end of that taxable year. As a result, there is a possibility
that the Fund may make total distributions during a taxable year in an amount
that exceeds the Fund's net investment income and net realized capital gains
for that year. For example, the Fund may distribute amounts early in the
calendar year that derive from short-term capital gains, but incur net
short-term capital losses later in the year, thereby offsetting short-term
capital gains out of which distributions have already been made by the Fund. In
such a situation, the amount by which the Fund's total distributions exceed net
investment income and net realized capital gains would generally be treated as
a tax-free return of capital up to the amount of your tax basis in your Common
Shares, with any amounts exceeding such basis treated as gain from the sale of
shares. Any gain resulting from the sale or exchange of Fund shares generally
will be taxable as capital gains.
The long-term capital gain rates applicable to most shareholders will be 15%
(with lower rates applying to taxpayers in the 10% and 15% ordinary income tax
brackets) for taxable years beginning on or before December 31, 2008. The
Fund's investments in foreign securities may be subject to foreign withholding
taxes. In that case, the Fund's yield on those securities would be decreased.
In addition, the Fund's investments in foreign securities or foreign currencies
may increase or accelerate the Fund's recognition of ordinary income and may
affect the timing or amount of the Fund's distributions.
Under current law, the backup withholding tax rate is 28% for amounts paid
through 2010 and will be 31% for amounts paid after December 31, 2010. The Fund
is required to apply backup withholding to certain taxable distributions and
redemption proceeds including, for example, distributions paid to any
individual shareholder who fails to properly furnish the Fund with a correct
taxpayer identification number. Please see "Tax Matters" in the Statement of
Additional Information for additional information about backup withholding.
In general, dividends (other than capital gain dividends) paid to a
shareholder that is not a "U.S. person" within the meaning of the Code (such
shareholder, a "foreign person") are subject to withholding of U.S. federal
income tax at a rate of 30% (or lower applicable treaty rate). However, under
the American Jobs Creation Act of 2004 (the "2004 Act"), effective for taxable
years of the Fund beginning after December 31, 2004 and before January 1, 2008,
the Fund generally will not be required to withhold any amounts with respect to
distributions of (i) U.S.-source interest income that would not be subject to
U.S. federal income tax if earned directly by an individual foreign person, and
(ii) net short-term capital gains in excess of net long-term capital losses, in
each case to the extent such distributions are properly designated by the Fund.
60
The 2004 Act modifies the tax treatment of distributions from the Fund that
are paid to a foreign person and are attributable to gain from "U.S. real
property interests" ("USRPIs"), which the Code defines to include direct
holdings of U.S. real property and interests (other than solely as a creditor)
in "U.S. real property holding corporations" such as REITs. Under the 2004 Act,
which is generally effective for taxable years of RICs beginning after December
31, 2004, and which applies to dividends paid or deemed paid on or before
December 31, 2007, distributions to foreign persons attributable to gains from
the sale or exchange of USRPIs will give rise to an obligation for those
foreign persons to file a U.S. tax return and pay tax, and may well be subject
to withholding under future regulations.
This section relates only to federal income tax consequences of investing in
the Fund; the consequences under other tax laws may differ. You should consult
your tax advisor as to the possible application of foreign, state and local
income tax laws to Fund dividends and capital distributions as well as possible
estate tax consequences of fund shareholdings by foreign persons. Please see
"Tax Matters" in the Statement of Additional Information for additional
information regarding the tax aspects of investing in the Fund.
61
UNDERWRITING
Subject to the terms and conditions stated in the Fund's underwriting
agreement dated , 2005, each Underwriter named below has severally
agreed to purchase, and the Fund has agreed to sell to such Underwriter, the
number of Common Shares set forth opposite the name of such Underwriter.
Number of
Underwriters Common Shares
------------ -------------
Citigroup Global Markets Inc......................................
Merrill Lynch, Pierce, Fenner & Smith.............................
Incorporated.............................................
UBS Securities LLC................................................
A.G. Edwards & Sons, Inc..........................................
Wachovia Capital Markets, LLC.....................................
Deutsche Bank Securities Inc......................................
Advest, Inc.......................................................
Robert W. Baird & Co. Incorporated................................
Banc of America Securities LLC....................................
H&R Block Financial Advisors, Inc.................................
Crowell, Weedon & Co..............................................
Ferris, Baker Watts, Incorporated.................................
J.J.B. Hilliard, W.L. Lyons, Inc..................................
Janney Montgomery Scott LLC.......................................
KeyBanc Capital Markets, A Division of McDonald Investments Inc. .
Legg Mason Wood Walker, Incorporated..............................
Oppenheimer & Co. Inc.............................................
Raymond James & Associates, Inc...................................
RBC Capital Markets Corporation...................................
Ryan Beck & Co., Inc..............................................
Stifel, Nicolaus & Company, Incorporated..........................
SunTrust Capital Markets, Inc.....................................
Wedbush Morgan Securities Inc.....................................
Wells Fargo Securities, LLC.......................................
--------
Total..........................................................
========
The underwriting agreement provides that the obligations of the Underwriters
to purchase the Common Shares included in this offering are subject to approval
of legal matters by counsel and to other conditions. The Underwriters are
obligated to purchase all the Common Shares (other than those covered by the
over-allotment option described below) if they purchase any of the Common
Shares.
The Underwriters, for whom Citigroup Global Markets Inc., Merrill Lynch,
Pierce, Fenner & Smith Incorporated, UBS Securities LLC, A.G. Edwards & Sons,
Inc., Wachovia Capital Markets, LLC, Deutsche Bank Securities Inc., Advest,
Inc., Robert W. Baird & Co. Incorporated, Banc of America Securities LLC, H&R
Block Financial Advisors, Inc., Crowell, Weedon & Co., Ferris, Baker Watts,
Incorporated, J.J.B. Hilliard, W.L. Lyons, Inc., Janney Montgomery Scott LLC,
KeyBanc Capital Markets, a Division of McDonald Investments Inc., Legg Mason
Wood Walker, Incorporated, Oppenheimer & Co. Inc., Raymond James & Associates,
Inc., RBC Capital Markets Corporation, Ryan Beck & Co., Inc., Stifel, Nicolaus
& Company, Incorporated, SunTrust Capital Markets, Inc., Wedbush Morgan
Securities Inc., and Wells Fargo Securities, LLC are acting as representatives,
propose to offer some of the Common Shares directly to the public at the public
offering price set forth on the cover page of this prospectus and some of the
Common Shares to dealers at the public offering price less a concession not to
exceed $ per Common Share. The sales load the Fund will pay of $1.125 per
Common
62
Share is equal to 4.5% of the initial offering price. The Underwriters may
allow, and such dealers may reallow, a concession not to exceed $ per
Common Share on sales to certain other dealers. If all of the Common Shares are
not sold at the initial offering price, the representatives may change the
public offering price and other selling terms. Investors must pay for any
Common Shares purchased on or before , 2005. The representatives have
advised the Fund that the Underwriters do not intend to confirm any sales to
any accounts over which they exercise discretionary authority.
The Fund has granted to the Underwriters an option, exercisable for 45 days
from the date of this prospectus, to purchase up to additional Common
Shares at the public offering price less the sales load. The Underwriters may
exercise such option solely for the purpose of covering over-allotments, if
any, in connection with this offering. To the extent such option is exercised,
each Underwriter will be obligated, subject to certain conditions, to purchase
a number of additional Common Shares approximately proportionate to such
Underwriter's initial purchase commitment.
The Fund and the Manager have agreed that, for a period of 180 days from the
date of this prospectus, they will not, without the prior written consent of
Citigroup Global Markets Inc, on behalf of the Underwriters, dispose of or
hedge any Common Shares or any securities convertible into or exchangeable for
Common Shares. Citigroup Global Markets Inc., in its sole discretion, may
release any of the securities subject to these agreements at any time without
notice.
Prior to the offering, there has been no public market for the Common
Shares. Consequently, the initial public offering price for the Common Shares
was determined by negotiation among the Fund, the Manager and the
representatives. There can be no assurance, however, that the price at which
the Common Shares will sell in the public market after this offering will not
be lower than the price at which they are sold by the Underwriters or that an
active trading market in the Common Shares will develop and continue after this
offering. The Common Shares are expected to be authorized for listing on the
New York Stock Exchange, subject to notice of issuance.
The Fund and the Manager have each agreed to indemnify the several
Underwriters or contribute to losses arising out of certain liabilities,
including liabilities under the Securities Act of 1933, as amended, or to
contribute to payments the underwriters may be required to make because of any
of these liabilities.
The Fund has agreed to pay the Underwriters $.005 per Common Share as a
partial reimbursement of expenses incurred in connection with the offering. The
Manager has agreed to pay the amount by which the Fund's offering costs (other
than the sales load but inclusive of the reimbursment of Underwriter expenses
of $.005 per share) exceed $.05 per share. While the Manager has agreed to
initially pay all of the Fund's organizational expenses, the Fund has agreed to
reimburse the Manager for such organizational expenses (or a portion thereof)
so long as that reimbursement plus the Fund's offering costs (other than the
sales load, but inclusive of the reimbursment of Underwriter expenses of $.005
per share) does not exceed $.05 per share. Any such reimbursement will be made
prior to the end the Fund's initial fiscal year.
The Manager (and not the Fund) has agreed to pay each of Merrill Lynch,
Pierce, Fenner and Smith Incorporated ("Merrill Lynch") and UBS Securities LLC
("UBS") a fee at an annual rate of .15% of the Fund's average daily total
managed assets attributable to Common Shares sold by such Underwriters. This
fee will not exceed % of the total initial price to the public of the
Common Shares offered hereby and will be payable in arrears at the end of each
calendar quarter during the continuance of the investment management agreement
or other advisory agreement between the Manager and the Fund. In return for
such fees Merrill Lynch and UBS have agreed (i) to provide services related to
the sale and distribution of the Common Shares, (ii) to provide certain
after-market support services designed to maintain the visibility of the Fund
on an ongoing basis, (iii) to provide relevant information, studies or reports
regarding general trends in the closed-end investment company and asset
management industries, if reasonably obtainable, and to consult with
representatives of the Manager in connection therewith and (iv) to provide
information to and consult with the Manager with respect to applicable
strategies designed to address market value discounts, if any. Additionally,
the Manager (and not the Fund) will
63
pay to Citigroup Global Markets Inc. from its own assets a structuring fee for
advice relating to the structure and design of the Fund and the organization of
the Fund as well as services related to the sale and distribution of the Fund's
Common Shares in an amount equal to $ , which in the aggregate is % of
the total initial price to the public of the Common Shares offered hereby. The
sum of the noted fees to be paid to Merrill Lynch, UBS and Citigroup Global
Markets Inc., the amounts paid by the Fund to reimburse certain Underwriters
and other expenses and the sales load to be paid by the Fund will not exceed
9.00% of the total price to the public of the Common Shares offered hereby.
In connection with the requirements for listing the Common Shares on the New
York Stock Exchange, the Underwriters have undertaken to sell lots of 100 or
more Common Shares to a minimum of 2,000 beneficial owners in the United
States. The minimum investment requirement is 100 Common Shares.
Certain Underwriters may make a market in the Common Shares after trading in
the Common Shares has commenced on the New York Stock Exchange. No Underwriter
is, however, obligated to conduct market-making activities and any such
activities may be discontinued at any time without notice, at the sole
discretion of the Underwriter. No assurance can be given as to the liquidity
of, or the trading market for, the Common Shares as a result of any
market-making activities undertaken by any Underwriter. This prospectus is to
be used by any Underwriter in connection with the offering and, during the
period in which a prospectus must be delivered, with offers and sales of the
Common Shares in market-making transactions in the over-the-counter market at
negotiated prices related to prevailing market prices at the time of the sale.
The Underwriters have advised the Fund that, pursuant to Regulation M under
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), certain
persons participating in the offering may engage in transactions, including
stabilizing bids, covering transactions or the imposition of penalty bids,
which may have the effect of stabilizing or maintaining the market price of the
Common Shares at a level above that which might otherwise prevail in the open
market. A "stabilizing bid" is a bid for, or the purchase of, the Common Shares
on behalf of an Underwriter for the purpose of fixing or maintaining the price
of the Common Shares. A "covering transaction" is a bid for, or purchase of,
the Common Shares on behalf of an Underwriter to reduce a short position
incurred by the Underwriters in connection with the offering. A "penalty bid"
is a contractual arrangement whereby if, during a specified period after the
issuance of the Common Shares, the Underwriters purchase Common Shares in the
open market for the account of the underwriting syndicate and the Common Shares
purchased can be traced to a particular Underwriter or member of the selling
group, the underwriting syndicate may require the Underwriter or selling group
member in question to purchase the Common Shares in question at the cost price
to the syndicate or may recover from (or decline to pay to) the Underwriter or
selling group member in question any or all compensation (including, with
respect to a representative, the applicable syndicate management fee)
applicable to the Common Shares in question. As a result, an Underwriter or
selling group member and, in turn, brokers may lose the fees that they
otherwise would have earned from a sale of the Common Shares if their customer
resells the Common Shares while the penalty bid is in effect. The Underwriters
are not required to engage in any of these activities, and any such activities,
if commenced, may be discontinued at any time. These transactions may be
effected on the New York Stock Exchange or otherwise.
The Fund anticipates that, from time to time, the representatives of the
Underwriters and certain other Underwriters may act as brokers or dealers in
connection with the execution of the Fund's portfolio transactions after they
have ceased to be Underwriters and, subject to certain restrictions, may act as
brokers while they are Underwriters.
Prior to the public offering of Common Shares, the Manager will purchase
Common Shares from the Fund in an amount satisfying the net worth requirements
of Section 14(a) of the 1940 Act.
The principal business address of Citigroup Global Markets Inc. is 388
Greenwich Street, New York, NY 10013.
64
CUSTODIAN AND TRANSFER AGENT
The custodian of the assets of the Fund is Brown Brothers Harriman & Co., 40
Water Street, Boston, Massachusetts 02109. The custodian performs custodial and
fund accounting services.
PFPC Inc., P.O. Box 43027, Providence, RI 02940-3027, serves as the Fund's
transfer agent, registrar, dividend disbursement agent and shareholder
servicing agent, as well as agent for the Fund's Dividend Reinvestment Plan.
LEGAL MATTERS
Certain legal matters in connection with the Common Shares will be passed
upon for the Fund by Ropes & Gray LLP, Boston, Massachusetts, and for the
Underwriters by Simpson Thacher & Bartlett LLP. Simpson Thacher & Bartlett LLP
may rely as to certain matters of Massachusetts law on the opinion of Ropes &
Gray LLP.
65
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
Use of Proceeds............................................... 3
Investment Objectives and Policies............................ 3
Investment Restrictions....................................... 42
Management of the Fund........................................ 44
Investment Manager and Sub-Advisers........................... 53
Portfolio Transactions........................................ 58
Distributions................................................. 60
Description of Shares......................................... 62
Anti-Takeover and Other Provisions in the Declaration of Trust 63
Repurchase of Common Shares; Conversion to Open-End Fund...... 65
Tax Matters................................................... 66
Performance Related and Comparative Information............... 77
Custodian, Transfer Agent and Dividend Disbursement Agent..... 77
Independent Auditors.......................................... 78
Counsel....................................................... 78
Registration Statement........................................ 78
Report of Independent Auditors................................ 79
Financial Statements.......................................... 80
Appendix A--Proxy Voting Policies............................. A-1
66
Appendix A
DESCRIPTION OF SECURITIES RATINGS
The Fund's investments may range in quality from securities rated in the
lowest category to securities rated in the highest category (as rated by
Moody's or S&P or, if unrated, determined by the Fund to be of comparable
quality). The percentage of a Fund's assets invested in securities in a
particular rating category will vary. The following terms are generally used to
describe the credit quality of debt securities:
High Quality Debt Securities are those rated in one of the two highest
rating categories (the highest category for commercial paper) or, if unrated,
deemed comparable by the Fund.
Investment Grade Debt Securities are those rated in one of the four highest
rating categories or, if unrated, deemed comparable by the Fund.
Below Investment Grade, High Yield Securities ("Junk Bonds") are those rated
lower than Baa by Moody's or BBB by S&P and comparable securities. They are
deemed predominantly speculative with respect to the issuer's ability to repay
principal and interest.
Following is a description of Moody's and S&P's rating categories applicable
to debt securities.
Moody's Investors Service, Inc.
Corporate and Municipal Bond Ratings
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present that make the long-term risks appear somewhat larger than with Aaa
securities.
A: Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
that suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
67
B: Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Moody's bond ratings, where specified, are applicable to financial
contracts, senior bank obligations and insurance company senior policyholder
and claims obligations with an original maturity in excess of one year.
Obligations relying upon support mechanisms such as letter-of-credit and bonds
of indemnity are excluded unless explicitly rated. Obligations of a branch of a
bank are considered to be domiciled in the country in which the branch is
located.
Unless noted as an exception, Moody's rating on a bank's ability to repay
senior obligations extends only to branches located in countries which carry a
Moody's Sovereign Rating for Bank Deposits. Such branch obligations are rated
at the lower of the bank's rating or Moody's Sovereign Rating for the Bank
Deposits for the country in which the branch is located. When the currency in
which an obligation is denominated is not the same as the currency of the
country in which the obligation is domiciled, Moody's ratings do not
incorporate an opinion as to whether payment of the obligation will be affected
by the actions of the government controlling the currency of denomination. In
addition, risk associated with bilateral conflicts between an investor's home
country and either the issuer's home country or the country where an issuer
branch is located are not incorporated into Moody's ratings.
Moody's makes no representation that rated bank obligations or insurance
company obligations are exempt from registration under the U.S. Securities Act
of 1933 or issued in conformity with any other applicable law or regulation.
Nor does Moody's represent any specific bank or insurance company obligation is
legally enforceable or a valid senior obligation of a rated issuer.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic rating
classified from Aa through Caa in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Corporate Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well-established industries; high rates of return
on funds employed; conservative capitalization structure with moderate reliance
on debt and ample asset protection; broad margins in
68
earnings coverage of fixed financial charges and high internal cash generation;
and well-established access to a range of financial markets and assured sources
of alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term obligations. The effect
of industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial
leverage. Adequate alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime
rating categories.
Standard & Poor's
Issue Credit Rating Definitions
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program
(including ratings on medium term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation and takes into account the
currency in which the obligation is denominated. The issue credit rating is not
a recommendation to purchase, sell, or hold a financial obligation, inasmuch as
it does not comment as to market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short term in
the relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days--including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition
to the usual long-term rating. Medium-term notes are assigned long-term ratings.
Issue credit ratings are based, in varying degrees, on the following
considerations: likelihood of payment--capacity and willingness of the obligor
to meet its financial commitment on an obligation in accordance with the terms
of the obligation; nature of and provisions of the obligation; protection
afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy
and other laws affecting creditors' rights.
The issue rating definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured obligations, or
operating company and holding company obligations.) Accordingly, in the case of
junior debt, the rating may not conform exactly with the category definition.
69
Corporate and Municipal Bond 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
in 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 predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least degree of speculation and C the highest.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major exposures to adverse
conditions.
BB: An obligation rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B: An obligation rated B is more vulnerable to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC: An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC: An obligation rated CC is currently highly vulnerable to nonpayment.
C: A subordinated debt or preferred stock obligation rated C is CURRENTLY
HIGHLY VULNERABLE to nonpayment. The C rating may be used to cover a situation
where a bankruptcy petition has been filed or similar action taken, but
payments on this obligation are being continued. A C also will be assigned to a
preferred stock issue in arrears on dividends or sinking fund payments, but
that is currently paying.
CI: The rating CI is reserved for income bonds on which no interest is being
paid.
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 even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar action
if payments on an obligation are jeopardized.
70
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.
Provisional ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon failure of, such completion. The
investor should exercise his own judgment with respect to such likelihood and
risk.
r: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
The absence of an "r" symbol should not be taken as an indication that an
obligation will exhibit no volatility or variability in total return.
N.R.: 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.
Debt obligations of issuers outside the United States and its territories
are rated on the same basis as domestic corporate and municipal issues. The
ratings measure the creditworthiness of the obligor but do not take into
account currency exchange and related uncertainties.
Commercial Paper Rating Definitions
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into several categories, ranging from A for
the highest quality obligations to D for the lowest. These categories are as
follows:
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 having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C: A short-term obligation rated C is currently vulnerable to nonpayment and
is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation.
71
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
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The D rating
also will be used upon the filing of a bankruptcy petition or the taking of a
similar action if payments on an obligation are jeopardized.
A commercial paper rating is not a recommendation to purchase, sell or hold
a security inasmuch as it does not comment as to market price or suitability
for a particular investor. The ratings are based on current information
furnished to Standard & Poor's by the issuer or obtained from other sources it
considers reliable. Standard & Poor's does not perform an audit in connection
with any rating and may, on occasion, rely on unaudited financial information.
The ratings may be changed, suspended, or withdrawn as a result of changes in
or unavailability of such information.
72
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Shares
NFJ Dividend, Interest & Premium Strategy Fund
Common Shares
[LOGO] Allianz
Global Investors
--------
P R O S P E C T U S
, 2005
--------
Citigroup
Merrill Lynch & Co.
UBS Investment Bank
A.G. Edwards
Wachovia Securities
Deutsche Bank Securities
Advest, Inc.
Robert W. Baird & Co.
Banc of America Securities LLC
H&R Block Financial Advisors, Inc.
Crowell, Weedon & Co.
Ferris, Baker Watts
Incorporated
J.J.B. Hilliard, W.L. Lyons, Inc.
Janney Montgomery Scott LLC
KeyBanc Capital Markets
Legg Mason Wood Walker
Incorporated
Oppenheimer & Co.
Raymond James
RBC Capital Markets
Ryan Beck & Co.
Stifel, Nicolaus & Company
Incorporated
SunTrust Robinson Humphrey
Wedbush Morgan Securities Inc.
Wells Fargo Securities, LLC
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Until , 2005 (25 days after the date of this prospectus), all
dealers that buy, sell or trade the common shares, whether or not participating
in this offering, may be required to deliver a prospectus. This is in addition
to the dealers' obligation to deliver a prospectus when acting as Underwriters
and with respect to their unsold allotments or subscriptions.
CENFJP_12471
THE INFORMATION IN THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT COMPLETE
AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION
STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
STATEMENT OF ADDITIONAL INFORMATION IS NOT AN OFFER TO SELL THESE SECURITIES AND
IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE
OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION - DATED JANUARY 26, 2005
NFJ DIVIDEND, INTEREST & PREMIUM STRATEGY FUND
STATEMENT OF ADDITIONAL INFORMATION
, 2005
-------
NFJ Dividend, Interest & Premium Strategy Fund (the "Fund") is a newly
organized, diversified closed-end management investment company.
This Statement of Additional Information relating to common shares of the
Fund ("Common Shares") is not a prospectus, and should be read in conjunction
with the Fund's prospectus relating thereto dated , 2005 (the
----------
"Prospectus"). This Statement of Additional Information does not include all
information that a prospective investor should consider before purchasing Common
Shares, and investors should obtain and read the Prospectus prior to purchasing
such shares. A copy of the Prospectus may be obtained without charge by calling
(877) 819-2224. You may also obtain a copy of the Prospectus on the web site
(http://www.sec.gov) of the Securities and Exchange Commission ("SEC").
Capitalized terms used but not defined in this Statement of Additional
Information have the meanings ascribed to them in the Prospectus.
-1-
TABLE OF CONTENTS
USE OF PROCEEDS................................................................3
INVESTMENT OBJECTIVES AND POLICIES.............................................3
INVESTMENT RESTRICTIONS.......................................................42
MANAGEMENT OF THE FUND........................................................44
INVESTMENT MANAGER AND PORTFOLIO MANAGERS.....................................53
PORTFOLIO TRANSACTIONS........................................................58
DISTRIBUTIONS.................................................................60
DESCRIPTION OF SHARES.........................................................62
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST................63
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN END FUND......................65
TAX MATTERS...................................................................66
PERFORMANCE RELATED AND COMPARATIVE INFORMATION...............................77
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT.....................77
INDEPENDENT AUDITORS..........................................................78
COUNSEL.......................................................................78
REGISTRATION STATEMENT........................................................78
REPORT OF INDEPENDENT AUDITORS................................................79
FINANCIAL STATEMENTS..........................................................80
APPENDIX A -- Proxy Voting Policies..........................................A-1
This Statement of Additional Information is dated , 2005.
------
-2-
USE OF PROCEEDS
The net proceeds of the offering of Common Shares of the Fund will be
approximately $ (or $ if the Underwriters exercise the
------ ------
over-allotment option in full) after payment or reimbursement of organization
and offering costs and the sales load.
PA Fund Management LLC (the "Manager") has agreed to pay the amount by
which the Fund's offering costs (other than the sales load, but inclusive of
reimbursement of underwriter expenses of $.005 per common share) exceed $.05 per
share. While the Manager has agreed initially to pay all of the Fund's
organizational expenses, the Fund has agreed to reimburse the Manager for such
organizational expenses (or a portion thereof) so long as the total of that
reimbursement plus the Fund's offering costs (other than the sales load, but
inclusive of reimbursement of underwriter expenses of $.005 per common share)
does not exceed $.05 per share. Any such reimbursement will be made prior to the
end of the Fund's initial fiscal year.
Pending investment in securities and investments that meet the Fund's
investment objectives and policies, it is anticipated that the net proceeds of
the offering will be invested in high grade, short-term securities, or in
derivative instruments designed to give the Fund exposure to the types of
securities and markets in which the Fund will ordinarily invest while the Fund's
sub-advisers select specific securities. This may include, without limitation,
equity index futures contracts.
INVESTMENT OBJECTIVES AND POLICIES
The investment objectives and general investment policies of the Fund are
described in the Prospectus. The Fund has three sub-advisers, NFJ Investment
Group L.P. ("NFJ"), Nicholas-Applegate Capital Management LLC ("NACM") and PEA
Capital LLC ("PEA") (each a "Sub-Adviser" and collectively the "Sub-Advisers")
each of which manages a separate portion of the Fund's portfolio. The portion of
the Fund's portfolio sub-advised by NFJ (the "Equity Component") will ordinarily
focus its investments in dividend-paying common stocks, but may also include
preferred stocks and dividend-paying real estate investment trusts. The portion
of the Fund's portfolio sub-advised by NACM (the "Convertible Component") will
ordinarily consist of convertible securities, including synthetic convertible
securities. On behalf of the Fund, PEA will also employ a strategy of writing
(selling) call options on equity indexes in an attempt to generate gains from
option premiums (the "Index Option Strategy"). Additional information concerning
the characteristics of certain of the Fund's investments is set forth below.
Investments in Equity Securities
The Fund may hold or have exposure to equity securities of issuers of any
size (in terms of market capitalization or otherwise) and in any industry or
sector. Because the Fund will ordinarily have substantial exposure to equity
securities, historical trends would indicate that the Fund's portfolio and
investment returns will be subject at times, and over time, to higher levels of
volatility and market and issuer-specific risk than if it invested exclusively
in debt securities. An adverse event, such as an unfavorable earnings report,
may depress the value of a particular equity security held by the Fund. Also,
the price of an equity security, particularly a common
-3-
stock, is sensitive to general movements in the stock market. A decline in the
stock market may depress the price of equity securities held by the Fund. The
value of a company's preferred stock may fall as a result of factors relating
directly to that company's products or services. A preferred stock's value may
also fall because of factors affecting not just the company, but companies in
the same industry or in a number of different industries, such as increases in
production costs. The value of preferred stocks may also be affected by changes
in financial markets that are relatively unrelated to the company or its
industry, such as changes in interest rates or currency exchange rates.
Preferred Stock
Preferred stock represents an equity interest in a company that generally
entitles the holder to receive, in preference to the holders of other stocks
such as common stocks, dividends and a fixed share of the proceeds resulting
from a liquidation of the company. Some preferred stocks also entitle their
holders to receive additional liquidation proceeds on the same basis as holders
of a company's common stock, and thus also represent an ownership interest in
that company.
As described below, the Fund may invest in preferred stocks that pay fixed
or adjustable rates of return. Preferred shares are subject to issuer-specific
and market risks applicable generally to equity securities. See "--Investments
in Equity Securities" above. In addition, a company's preferred stock generally
pays dividends only after the company makes required payments to holders of its
bonds and other debt. For this reason, the value of preferred stocks will
usually react more strongly than bonds and other debt to actual or perceived
changes in the company's financial condition or prospects. Preferred stocks of
smaller companies may be more vulnerable to adverse developments than those of
larger companies.
Fixed Rate Preferred Stocks. Some fixed rate preferred stocks in which the
Fund may invest, known as perpetual preferred stocks, offer a fixed return with
no maturity date. Because they never mature, perpetual preferred stocks act like
long-term bonds and can be more volatile than other types of preferred stocks
that have a maturity date and may have heightened sensitivity to changes in
interest rates. The Fund may also invest in sinking fund preferred stocks. These
preferred stocks also offer a fixed return, but have a maturity date and are
retired or redeemed on a predetermined schedule. The shorter duration of sinking
fund preferred stocks makes them perform somewhat like intermediate-term bonds
and they typically have lower yields than perpetual preferred stocks.
Adjustable Rate and Auction Preferred Stocks. Typically, the dividend rate
on an adjustable rate preferred stock is determined prospectively each quarter
by applying an adjustment formula established at the time of issuance of the
stock. Although adjustment formulas vary among issues, they typically involve a
fixed premium or discount relative to rates on specified debt securities issued
by the U.S. Treasury. Typically, an adjustment formula will provide for a fixed
premium or discount adjustment relative to the highest base yield of three
specified U.S. Treasury securities: the 90-day Treasury bill, the 10-year
Treasury note and the 20-year Treasury bond. The premium or discount adjustment
to be added to or subtracted from this highest U.S. Treasury base rate yield is
fixed at the time of issue and cannot be changed without the approval of the
holders of the stock. The dividend rate on other preferred stocks in
-4-
which the Fund may invest, commonly known as auction preferred stocks, is
adjusted at intervals that may be more frequent than quarterly, such as every 49
days, based on bids submitted by holders and prospective purchasers of such
stocks and may be subject to stated maximum and minimum dividend rates. The
issues of most adjustable rate and auction preferred stocks currently
outstanding are perpetual, but are redeemable after a specified date at the
option of the issuer. Certain issues supported by the credit of a high-rated
financial institution provide for mandatory redemption prior to expiration of
the credit arrangement. No redemption can occur if full cumulative dividends are
not paid. Although the dividend rates on adjustable and auction preferred stocks
are generally adjusted or reset frequently, the market values of these preferred
stocks may still fluctuate in response to changes in interest rates. Market
values of adjustable preferred stocks also may substantially fluctuate if
interest rates increase or decrease once the maximum or minimum dividend rate
for a particular stock is approached.
Convertible Securities
Convertible securities are bonds, debentures, notes, preferred stocks or
other securities that may be converted or exchanged (by the holder or by the
issuer) into shares of the underlying common stock (or cash or securities of
equivalent value) at a stated exchange ratio or predetermined price (the
"conversion price"). A convertible security is designed to provide current
income and also the potential for capital appreciation through the conversion
feature, which enables the holder to benefit from increases in the market price
of the underlying common stock. 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 the Fund is called for redemption or conversion,
the 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 the Fund's ability to achieve its investment objectives. Convertible
securities have general characteristics similar to both debt and equity
securities.
A convertible security generally entitles the holder to receive interest
paid or accrued until the convertible security matures or is redeemed, converted
or exchanged. Convertible securities rank senior to common stock in a
corporation's capital structure and, therefore, generally entail less risk than
the corporation's common stock, although the extent to which such risk is
reduced depends in large measure upon the degree to which the convertible
security sells above its value as a debt obligation. Before conversion,
convertible securities have characteristics similar to non-convertible debt
obligations and are designed to provide for a stable stream of income with
generally higher yields than common stocks. However, there can be no assurance
of current income because the issuers of the convertible securities may default
on their obligations. Convertible securities are subordinate in rank to any
senior debt obligations of the issuer, and, therefore, an issuer's convertible
securities entail more risk than its debt obligations. Moreover, convertible
securities are often rated below investment grade or not rated because they fall
below debt obligations and just above common equity in order of preference or
priority on an issuer's balance sheet. See "--High Yield Securities" below.
Convertible securities generally offer lower interest or dividend yields
than non-convertible debt securities of similar credit quality because of the
potential for capital
-5-
appreciation. The common stock underlying convertible securities may be issued
by a different entity than the issuer of the convertible securities.
The value of convertible securities is influenced by both the yield of
non-convertible securities of comparable issuers and by the value of the
underlying common stock. The value of a convertible security viewed without
regard to its conversion feature (i.e., strictly on the basis of its yield) is
sometimes referred to as its "investment value." The investment value of the
convertible security typically will fluctuate based on the credit quality of the
issuer and will fluctuate inversely with changes in prevailing interest rates.
However, at the same time, the convertible security will be influenced by its
"conversion value," which is the market value of the underlying common stock
that would be obtained if the convertible security were converted. Conversion
value fluctuates directly with the price of the underlying common stock, and
will therefore be subject to risks relating to the activities of the issuer
and/or general market and economic conditions. Depending upon the relationship
of the conversion price to the market value of the underlying security, a
convertible security may trade more like an equity security than a debt
instrument.
If, because of a low price of the common stock, the conversion value is
substantially below the investment value of the convertible security, the price
of the convertible security is governed principally by its investment value. If
the conversion value of a convertible security increases to a point that
approximates or exceeds its investment value, the value of the security will be
principally influenced by its conversion value. A convertible security will sell
at a premium over its conversion value to the extent investors place value on
the right to acquire the underlying common stock while holding an
income-producing security.
Synthetic Convertible Securities
The Fund may also create a "synthetic" convertible security by combining
separate securities that possess the two principal characteristics of a
traditional convertible security, i.e., an income-producing security
("income-producing element") and the right to acquire an equity security
("convertible element"). The income-producing element is achieved by investing
in non-convertible, income-producing securities such as bonds, preferred stocks
and money market instruments. The convertible element is achieved by investing
in warrants or options to buy common stock at a certain exercise price, or
options on a stock index. Unlike a traditional convertible security, which is a
single security having a unitary market value, a synthetic convertible comprises
two or more separate securities, each with its own market value. Therefore, the
"market value" of a synthetic convertible security is the sum of the values of
its income-producing element and its convertible element. For this reason, the
values of a synthetic convertible security and a traditional convertible
security may respond differently to market fluctuations.
More flexibility is possible in the assembly of a synthetic convertible
security than in the purchase of a convertible security. Although synthetic
convertible securities may be selected where the two elements are issued by a
single issuer, thus making the synthetic convertible security similar to the
traditional convertible security, the character of a synthetic convertible
security allows the combination of elements representing distinct issuers, when
NACM (the Sub-Adviser of the Fund's Convertible Component) believes that such a
combination would better
-6-
promote the Fund's investment objectives. A synthetic convertible security also
is a more flexible investment in that its two elements may be purchased
separately. For example, the Fund may purchase a warrant for inclusion in a
synthetic convertible security but temporarily hold short-term investments while
postponing the purchase of a corresponding bond pending development of more
favorable market conditions.
A holder of a synthetic convertible security faces the risk of a decline in
the price of the security or the level of the index involved in the convertible
element, causing a decline in the value of the call option or warrant purchased
to create the synthetic convertible security. Should the price of the stock fall
below the exercise price and remain there throughout the exercise period, the
entire amount paid for the call option or warrant would be lost. Because a
synthetic convertible security includes the income-producing element as well,
the holder of a synthetic convertible security also faces the risk that interest
rates will rise, causing a decline in the value of the income-producing element.
The Fund may also purchase synthetic convertible securities created by
other parties, including convertible structured notes. Convertible structured
notes are income-producing debentures linked to equity, and are typically issued
by investment banks. Convertible structured notes have the attributes of a
convertible security; however, the investment bank that issued the convertible
note, rather than the issuer of the underlying common stock into which the note
is convertible, assumes the credit risk associated with the investment.
Equity Index Call Options
As described in the Prospectus, PEA will implement the Index Option
Strategy by "selling" or "writing" call options on equity indexes such that the
underlying value of the indexes are approximately equal to (and do not exceed)
the net asset value of the Fund's Equity Component. This "index option writing"
strategy is designed to generate gains from index option premiums.
Index call options are contracts representing the right to purchase the
cash value of an index at a specified price (the "strike price") at or until a
specified future date (the "expiration date"). The Fund will sell index options
that are "European style," meaning that the options may be exercised only on the
expiration date. For conventional listed call options, the option's expiration
date can be up to nine months from the date the call options are first listed
for trading. Longer-term call options can have expiration dates up to three
years from the date of listing. The Fund expects that it will normally write
options whose terms to expiration range from two months to one year, although
the Fund may write options of both longer and shorter terms. PEA will not write
call options on individual equity securities, but may write options on
exchange-traded funds and other similar instruments designed to correlate with
the performance of an equity index or market segment.
As the writer (seller) of an equity index call option, the Fund would
receive cash (the premium) from the purchaser of the option, and the purchaser
would have the right to receive from the Fund any appreciation in the cash value
of index over the strike price on the expiration date. If, at expiration, the
purchaser exercises the index option sold by the Fund, the Fund would pay the
purchaser the difference between the cash value of the index and the strike
price. In
-7-
effect, the Fund sells the potential appreciation in the value of the index
above the strike price in exchange for the premium. PEA may cause the Fund to
repurchase an index call option prior to its expiration date, extinguishing the
Fund's obligation, in which case the cost of repurchasing the option (net of any
premiums received) will determine the gain or loss realized by the Fund.
Equity index options differ from options on individual securities in that
(i) the exercise of an index option requires cash payments and does not involve
the actual purchase or sale of securities, (ii) the holder of an index option
has the right to receive cash upon exercise of the option if the level of the
index upon which the option is based is greater than the strike price of the
option and (iii) index options reflect price fluctuations in a group of
securities or segments of the securities market rather than price fluctuations
in a single common stock.
In pursuing the Index Option Strategy, PEA may cause the Fund to sell call
options on "broad-based" equity indexes, such as the Standard & Poor's 500
Index, as well as narrower market indexes, such as the Standard & Poor's 100
Index, or on indexes of securities of companies in a particular industry or
sector, including (but not limited to) financial services, technology,
pharmaceuticals and consumer products. An equity index assigns relative values
to the securities included in the index (which change periodically), and the
index fluctuates with changes in the market values of these securities. PEA will
actively manage the Fund's index options positions using quantitative and
statistical analysis that focuses on relative value and risk/return. In
determining which equity index options to utilize, PEA will consider market
factors, such as current market levels and volatility, and options specific
factors, such as premium/cost, strike price and time to expiration. PEA will
attempt to create a portfolio of equity index call options that is diversified
across multiple strike prices and expiration dates.
PEA will attempt to maintain for the Fund written call options positions on
equity indexes whose price movements, taken in the aggregate, are correlated
with the price movements of the common stocks and other securities held in the
Fund's Equity Component. In doing so, PEA will take into account periodic data
provided by NFJ with respect to the Equity Component, including net assets,
industry and sector weightings, historic volatility as well as periodic
(typically 30 days after month-end) reports detailing portfolio holdings.
However, other than through periodic holdings reports, PEA will not have access
to the actual securities purchased, sold or held by or for the Equity Component
due to informational barriers in place between NFJ and PEA. Therefore, the Index
Option Strategy involves significant risk that the changes in value of the
indexes underlying the Fund's written call options positions will not correlate
closely with changes in the market value of securities held by the Equity
Component. To the extent that there is a lack of correlation, movements in the
indexes underlying the options positions may result in losses to the Fund, which
may more than offset any gains received by the Fund from options premiums. See
"--Risks Associated with Index Call Options" below.
PEA does not intend to write call options on equity indexes where the
underlying value of the indexes exceed the net asset value of the Equity
Component (i.e., write "naked" positions). The Fund will "cover" its written
equity index call option positions by segregating liquid assets in an amount
equal to the contract value of the index and/or by entering into offsetting
positions (e.g., by holding a call option on the same index as the call written
where the strike price of the call held is equal to or less than the strike
price of the call written).
-8-
The Fund will generally sell index call options which are
"out-of-the-money" or "at-the-money" at the time of sale. Out-of-the-money call
options are options with a strike price above the current cash value of the
index and at-the-money call options are options with a strike price equal to the
cash value of the index. In addition to providing possible gains through
premiums, out-of-the-money index call options allow the Fund to potentially
benefit from appreciation in the equity securities held by the Fund with respect
to which the option was written (to the extent correlated with the index) up to
the strike price. The Fund will generally write out-of-the-money call options
where the strike price is not more than 10% higher than the cash value of the
index at the time of sale, although PEA reserves the flexibility to utilize
written call options that are more deeply out-of-the-money if it deems
appropriate depending upon market conditions and other factors. The Fund also
reserves the flexibility to sell index call options that are "in-the-money" -
i.e., those with a strike price below the cash value of the index at the time of
sale, and will generally limit these to options where the strike price is not
more than 5% lower than the cash value of the index (although the Fund may
utilize options that are more deeply in-the-money depending upon market
conditions and other factors). When the prices of the equity index upon which a
call option is written rise, call options that were out-of-the-money when
written may become in-the-money (i.e., the cash value of the index rises above
the strike price of the option), thereby increasing the likelihood that the
options could be exercised and the Fund forced to pay the amount of appreciation
over the strike price of the option upon expiration.
Please see "Other Derivative Instruments - Options on Securities, Swap
Agreements and Indexes" for other information regarding the Fund's use of equity
index options and other types of options.
Risks Associated with Index Call Options. There are various risks
associated with the Fund's Index Option Strategy. The purchaser of an index
option written by the Fund has the right to any appreciation in the cash value
of the index over the strike price on the expiration date. Therefore, as the
writer of an index call option, the Fund forgoes, during the option's life, the
opportunity to profit from increases in the market value of the equity
securities held by the Fund with respect to which the option was written (to the
extent that their performance is correlated with that of the index) above the
sum of the premium and the strike price of the call. However, the Fund has
retained the risk of loss (net of premiums received) should the price of the
Fund's portfolio securities decline.
In addition, there are significant differences between the securities and
options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. 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. PEA will attempt to
maintain for the Fund written call options positions on equity indexes whose
price movements, taken in the aggregate, are correlated with the price movements
of the common stocks and other securities held in the Fund's Equity Component.
In doing so, PEA will take into account periodic data provided by NFJ with
respect to the Equity Component, including net assets, industry and sector
weightings, historic volatility as well as periodic (typically 30 days after
month-end) reports detailing portfolio holdings. However, other than through
periodic holdings reports, PEA will
-9-
not have access to the actual securities purchased, sold or held by or for the
Equity Component due to informational barriers in place between NFJ and PEA.
Therefore, the Index Option Strategy involves significant risk that the changes
in value of the indexes underlying the Fund's written call options positions
will not correlate closely with changes in the market value of securities held
by the Equity Component. To the extent that there is a lack of correlation,
movements in the indexes underlying the options positions may result in losses
to the Fund, which may more than offset any gains received by the Fund from
options premiums. In these and other circumstances, the Fund may be required to
sell portfolio securities to satisfy its obligations as the writer of an index
call option when it would not otherwise choose to do so, or may choose to sell
portfolio securities to realize gains to supplement Fund distributions. Such
sales would involve transaction costs borne by the Fund and may also result in
realization of taxable capital gains, including short-term capital gains taxed
at ordinary income tax rates, and may adversely impact the Fund's after-tax
returns.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. Reasons for the absence of a liquid
secondary market on an exchange include the following: (i) there may be
insufficient trading interest in certain options; (ii) restrictions may be
imposed by an exchange on opening transactions or closing transactions or both;
(iii) trading halts, suspensions or other restrictions may be imposed with
respect to particular classes or series of options; (iv) unusual or unforeseen
circumstances may interrupt normal operations on an exchange; (v) the facilities
of an exchange or the OCC may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the trading
of options (or a particular class or series of options). If trading were
discontinued, the secondary market on that exchange (or in that class or series
of options) would cease to exist. However, outstanding options on that exchange
that had been issued by the OCC as a result of trades on that exchange would
continue to be exercisable in accordance with their terms. The Fund's ability to
terminate over-the-counter 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.
The hours of trading for options may not conform to the hours during which
securities held by the Fund are traded. To the extent that the options markets
close before the markets for 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 securities
represented in an index, an increase in interest rates, changes in the actual or
perceived volatility of the stock market and underlying securities represented
in an index, and the remaining time to the options' expiration. The value of
options also may be adversely affected if the market for options is reduced or
becomes illiquid.
The Fund's options transactions will be subject to limitations established
by each of the exchanges, boards of trade or other trading facilities on which
the options are traded. These limitations govern the maximum number of options
in each class which may be written by a single investor or group of investors
acting in concert, regardless of whether the options are written on the same or
different exchanges, boards of trade or other trading facilities or are
-10-
written in one or more accounts or through one or more brokers. Thus, the number
of options which the Fund may write may be affected by options written by other
investment advisory clients of PEA, NFJ, NACM or their affiliates. 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 other sanctions.
Other Derivative Instruments
In addition to writing index call options, PEA may write call options on
ETFs or similar instruments; however, PEA will not write call options on
individual securities. NACM may buy and sell put and call options on individual
securities and indexes in creating synthetic convertible securities for the
Convertible Component. The Fund otherwise may (but is not required to) utilize a
variety of derivative instruments for hedging or risk management purposes. The
Fund may also use derivatives to gain exposure to equity and other securities in
which the Fund may invest (e.g., pending investment of the proceeds of this
offering) or as components of synthetic convertible securities. Generally,
derivatives are financial contracts whose value depends upon, or is derived
from, the value of any underlying asset, reference rate or index, and may relate
to, among others, individual securities, interest rates and related indexes. In
addition to written Equity Index call options, derivative instruments that may
be used by the Fund include, but are not limited to, warrants, purchased call
options, purchased or written put options, futures contracts, options on futures
contracts, forward contracts, swap agreements and short sales.
The Fund may enter into derivatives transactions that may in certain
circumstances produce effects similar to leverage. To the extent that the Fund
does not segregate liquid assets or otherwise cover its obligations under such
transactions (e.g., through offsetting positions), such transactions will be
treated as senior securities representing indebtedness ("borrowings") for
purposes of the requirement under the 1940 Act that the Fund may not enter into
any such transactions if the Fund's borrowings would thereby exceed 33 1/3% of
its total assets. See "Leverage and Borrowings" below.
No assurance can be given that any strategy used (including the use of
equity index call options) will succeed. As is the case with the other
investments of the Fund, the ability of the Fund to successfully use derivative
instruments may depend in part upon the ability of a Sub-Adviser to assess the
issuer's credit characteristics and to forecast stock and other market movements
and other economic factors correctly. If a Sub-Adviser incorrectly forecasts
these factors and has taken positions in derivative instruments contrary to
prevailing market trends, the Fund could be exposed to the risk of loss. If a
Sub-Adviser incorrectly forecasts stock and other market movements or other
economic factors in employing a derivatives strategy for the Fund, the Fund
might have been in a better position if it had not employed that derivatives
strategy at all. Also, suitable derivative transactions may not be available in
all circumstances.
The Fund's use of derivative strategies involves some special risks,
including the risk of a possible imperfect correlation, or even no correlation,
between price movements of derivative instruments and price movements of related
investments. While some strategies involving derivative instruments can reduce
the 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
-11-
otherwise, due to, among other reasons, (a) the possible inability of the Fund
to purchase or sell a portfolio security at a time that otherwise would be
favorable, (b) the possible need to sell a portfolio security at a
disadvantageous time because the Fund is required to maintain asset coverage or
offsetting positions in connection with transactions in derivative instruments,
and (c) the possible inability of the Fund to close out or to liquidate its
derivatives positions. Income earned by the Fund from many derivative strategies
will be treated as capital gain and, if not offset by net realized capital loss,
will be distributed to shareholders in taxable distributions.
If other types of derivative instruments not described in this section are
traded in the future, the Fund may also use those instruments, provided that
their use is consistent with the Fund's investment objectives.
Options on Securities, Swap Agreements and Indexes. As described in the
Prospectus, the Fund will normally utilize a principal strategy of writing
(selling) call options on equity indexes. While PEA will not write call options
on individual securities, the Fund may also purchase and sell both covered put
and call options on securities, swap agreements, ETFs, and other indexes in
standardized contracts traded on domestic or other securities exchanges, boards
of trade, or similar entities, or quoted on NASDAQ.
An option on a security is a contract that gives the holder of the option,
in return for a premium, the right to buy from (in the case of a call) or sell
to (in the case of a put) the writer of the option the security underlying the
option (or the cash value of the index) at a specified exercise price at any
time during the term of the option. The writer of an option on a security has
the obligation upon exercise of the option to deliver the underlying security
upon payment of the exercise price or to pay the exercise price upon delivery of
the underlying security. As described in "Equity Index Call Options" above, upon
exercise, the writer of an option on an index is obligated to pay the difference
between the cash value of the index and the exercise price multiplied by the
specified multiplier for the index option. (An index is designed to reflect
features of a particular securities market, a specific group of financial
instruments or securities, or certain economic indicators.)
A put option on a security or an index is covered if the Fund segregates
assets determined to be liquid by the Fund in accordance with procedures
established by the Board of Trustees equal to the entire exercise price. A put
option is also covered if the Fund holds a put on the same security or index as
the put written where the exercise price of the put held is (i) equal to or
greater than the exercise price of the put written, or (ii) less than the
exercise price of the put written, provided the difference is maintained by the
Fund in segregated assets determined to be liquid in accordance with procedures
established by the Board of Trustees. The Fund may also cover a put option by
entering into a short position in the underlying security or index. Obligations
under written call and put options so covered will not be construed to be
"senior securities" for purposes of the Fund's investment restrictions
concerning senior securities and borrowings.
If an option written by the Fund expires unexercised, the Fund realizes on
the expiration date a capital gain equal to the premium the Fund received at the
time the option was written. If an option purchased by the Fund expires
unexercised, the Fund realizes a capital loss equal to the premium paid. Before
the earlier of exercise or expiration, an exchange-traded option may be
-12-
closed out by an offsetting purchase or sale of an option of the same series
(type, exchange, underlying security or index, exercise price and expiration).
There can be no assurance, however, that a closing purchase or sale transaction
can be effected when the Fund desires.
The Fund may sell put or call options it has previously purchased, which
could result in a net gain or loss depending on whether the amount realized on
the sale is more or less than the premium and other transaction costs paid on
the put or call option which is sold. Before exercise or expiration, an option
may be closed out by an offsetting purchase or sale of an option of the same
series. The Fund will realize a capital gain from a closing purchase transaction
if the cost of the closing option is less than the premium received from writing
the option, or, if it is more, the Fund will realize a capital loss. If the
premium received from a closing sale transaction is more than the premium paid
to purchase the option, the Fund will realize a capital gain or, if it is less,
the Fund will realize a capital loss. The principal factors affecting the market
value of a put or a call option include supply and demand, interest rates, the
current market price of the underlying security or index in relation to the
exercise price of the option, the volatility of the underlying security or
index, and the time remaining until the expiration date.
The premium paid for a put or call option purchased by the Fund is a cost
of the Fund. The premium received for an option written by the Fund is recorded
as a deferred credit. The value of an option purchased or written is marked to
market daily and is valued at the closing price on the exchange on which it is
traded or, if not traded on an exchange or no closing price is available, at the
mean between the last bid and asked prices.
The 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 the Fund may write or purchase may be
affected by options written or purchased by other investment advisory clients of
the Sub-Advisers. 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.
Option contracts are originated and standardized by an independent entity
called the OCC. The Fund will write (sell) call options that are generally
issued, guaranteed and cleared by the OCC. Listed call options are currently
traded on the American Stock Exchange, Chicago Board Options Exchange,
International Securities Exchange, New York Stock Exchange, Pacific Stock
Exchange, Philadelphia Stock Exchange and various other U.S. options exchanges.
The Fund may also write unlisted (or "over-the counter") call options.
Spreads. The Fund may pursue an option strategy that includes the purchase
and sale of calls and puts, called spreads. All of these positions will be
limited loss positions in which the maximum loss will be known and fixed at the
time of investment. These strategies may produce a considerably higher return
than the Fund's primary strategy of written call writing, but involve a higher
degree of risk and potential volatility. Because spreads involve multiple
trades, they result in higher transaction costs and may be more difficult to
open and close out.
-13-
Straddles. The Fund may write straddles consisting of a combination of a
call and a put written on the same underlying security or index. A straddle will
be covered when sufficient liquid assets are segregated to meet the Fund's
immediate obligations. The Fund may use the same liquid assets to cover both the
call and put options where the exercise price of the call and put are the same,
or the exercise price of the call is higher than that of the put. In such cases,
the Fund will also segregate liquid assets equivalent to the amount, if any, by
which the put is "in the money." Because straddles involve multiple trades, they
result in higher transaction costs and may be more difficult to open and close
out.
Risks Associated with Options on Securities and Indexes. In addition to
those risks discussed in "--Equity Index Call Options - Risks Associated with
Index Call Options" above, there are several other risks associated with
transactions in options on securities and on indexes. For example, during the
option period, a call writer that has written the option on a portfolio security
has, in return for the premium on the option, given up the opportunity to profit
from a price increase in the underlying security above the exercise price, but,
as long as its obligation as a writer continues, has retained the risk of loss
should the price of the underlying security decline. The writer of an option has
no control over the time when it may be required to fulfill its obligation as a
writer of the option. Once an option writer has received an exercise notice, 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. If a put or call option purchased by the Fund is not sold when
it has remaining value, and if the market price of the underlying security or
the value of the equity index remains equal to or greater than the exercise
price (in the case of a put), or remains less than or equal to the exercise
price (in the case of a call), the Fund will lose its entire investment in the
option. Also, where a put or call option on a particular security or index is
purchased to hedge against price movements in a related security or basket of
securities, the price of the put or call option may move more or less than the
price of the related security or securities.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the 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.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercises were
imposed, the Fund might be unable to exercise an option it purchased. Except to
the extent that a call option on an index written by the Fund is covered by an
option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
OTC Options. OTC options differ from traded options in that they are
two-party contracts, with price and other terms negotiated between buyer and
seller, and generally do not have as much market liquidity as exchange-traded
options. The Fund may be required to treat as illiquid over-the-counter options
purchased and securities being used to cover certain written
-14-
over-the-counter options, and they will treat the amount by which such formula
price exceeds the intrinsic value of the option (i.e., the amount, if any, by
which the market price of the underlying security exceeds the exercise price of
the option) as an illiquid investment. OTC options are subject to the risk that
the counter-party will not fulfill its obligations under the contract.
Foreign Currency Options. The Fund may buy or sell put and call options on
foreign currencies for investment purposes or as a hedge against changes in the
value of the U.S. dollar (or another currency) in relation to a foreign currency
in which the Fund's securities may be denominated. The Fund may additionally use
currency options to cross-hedge or to increase total return when a Sub-Adviser
anticipates that the currency will appreciate or depreciate in value, but the
securities quoted or denominated in that currency do not present attractive
investment opportunities and are not held in the Fund's portfolio. In addition,
the Fund may buy or sell put and call options on foreign currencies either on
exchanges or in the over-the-counter market. A put option on a foreign currency
gives the purchaser of the option the right to sell a foreign currency at the
exercise price until the option expires. A call option on a foreign currency
gives the purchaser of the option the right to purchase the currency at the
exercise price until the option expires. Currency options traded on U.S. or
other exchanges may be subject to position limits which may limit the ability of
the Fund to reduce foreign currency risk using such options.
Futures Contracts and Options on Futures Contracts. The Fund may invest in
futures contracts and options thereon ("futures options"), including with
respect to equity securities, indexes, or other instruments or assets, as well
as purchase put and call options on such futures contracts. The Fund may incur
commission expenses when it opens or closes a futures position.
A futures contract is an agreement to buy or sell a security (or deliver a
cash settlement price, in the case of a contract relating to an index or
otherwise not calling for physical delivery of the security) at a specified
price and time. A futures contract on an index (an "Index Future") is an
agreement in which two parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day of the contract and the price at which the index contract was
originally written. Although the value of an index might be a function of the
value of certain specified securities, physical delivery of these securities is
generally not made. A public market exists in futures contracts covering a
number of indexes as well as financial instruments, including, without
limitation: the S&P 500; the S&P Midcap 400; the Nikkei 225; the NYSE composite;
U.S. Treasury bonds; U.S. Treasury notes; GNMA Certificates; three-month U.S.
Treasury bills; 90-day commercial paper; bank certificates of deposit;
Eurodollar certificates of deposit; the Australian dollar; the Canadian dollar;
the British pound; the Japanese yen; the Swiss franc; the Mexican peso; and
certain multinational currencies, such as the euro. It is expected that other
futures contracts will be developed and traded in the future.
The Fund may close open positions on the futures exchanges on which Index
Futures are traded at any time up to and including the expiration day. All
positions which remain open at the close of the last business day of the
contract's life are required to settle on the next business day (based upon the
value of the relevant index on the expiration day), with settlement made with
the appropriate clearing house. Because the specific procedures for trading
foreign stock Index Futures on futures exchanges are still under development,
additional or different margin
-15-
requirements as well as settlement procedures may be applicable to foreign stock
Index Futures at the time the Fund purchases such instruments. Positions in
Index Futures may be closed out by the Fund only on the futures exchanges upon
which the Index Futures are then traded.
The following example illustrates generally the manner in which Index
Futures operate. The Standard & Poor's 100 Index is composed of 100 selected
common stocks, most of which are listed on the New York Stock Exchange. The S&P
100 Index assigns relative weightings to the common stocks included in the
Index, and the Index fluctuates with changes in the market values of those
common stocks. In the case of the S&P 100 Index, contracts are to buy or sell
100 units. Thus, if the value of the S&P 100 Index were $180, one contract would
be worth $18,000 (100 units x $180). The Index Future specifies that no delivery
of the actual stocks making up the Index will take place. Instead, settlement in
cash must occur upon the termination of the contract, with the settlement being
the difference between the contract price and the actual level of the Index at
the expiration of the contract. For example, if the Fund enters into a futures
contract to buy 100 units of the S&P 100 Index at a specified future date at a
contract price of $180 and the S&P 100 Index is at $184 on that future date, the
Fund will gain $400 (100 units x gain of $4). If the Fund enters into a futures
contract to sell 100 units of the Index at a specified future date at a contract
price of $180 and the S&P 100 Index is at $182 on that future date, the Fund
will lose $200 (100 units x loss of $2).
The Fund may purchase and write call and put futures options. Futures
options possess many of the same characteristics as options on securities and
indexes (discussed above). A futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
The Fund may enter into futures contracts and futures options that are
standardized and traded on a U.S. or other exchange, board of trade, or similar
entity, or quoted on an automated quotation system, and the Fund may also enter
into OTC options on futures contracts.
When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of assets determined to be liquid by the Fund in accordance
with procedures established by the Board of Trustees ("initial margin"). The
margin required for a futures contract is set by the exchange on which the
contract is traded and may be modified during the term of the contract. The
initial margin is in the nature of a performance bond or good faith deposit on
the futures contract and is returned to the Fund upon termination of the
contract, assuming all contractual obligations have been satisfied. The Fund
expects to earn taxable interest income on its initial margin deposits. A
futures contract held by the Fund is valued daily at the official settlement
price of the exchange on which it is traded. Each day the Fund pays or receives
cash, called "variation margin," equal to the daily change in value of the
futures contract. This process is known as "marking to market." Variation margin
does not represent a borrowing or loan by the Fund but is instead a settlement
between the Fund and the broker of the amount one would owe the other if the
futures contract expired. In computing daily net asset value, the Fund will mark
to market its open futures positions.
-16-
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, index or other asset, in many cases these obligations are
closed out prior to delivery by offsetting purchases or sales of matching
futures contracts (involving the same exchange, underlying security, index or
other asset, and delivery month). If an offsetting purchase price is less than
the original sale price, the Fund realizes a capital gain, or if it is more, the
Fund realizes a capital loss. Conversely, if an offsetting sale price is more
than the original purchase price, the Fund realizes a capital gain, or if it is
less, the Fund realizes a capital loss. The transaction costs must also be
included in these calculations.
Straddles of Futures. The Fund may write straddles consisting of a call and
a put written on the same underlying futures contract. A straddle will be
covered when sufficient liquid assets are segregated to meet the Fund's
immediate obligations. The Fund may use the same liquid assets to cover both the
call and put options where the exercise price of the call and put are the same,
or the exercise price of the call is higher than that of the put. In these
cases, the Fund will also segregate liquid assets equivalent to the amount, if
any, by which the put is "in the money." Because straddles involve multiple
trades, they result in higher transaction costs and may be more difficult to
open and close out.
Combined Positions. The Fund may purchase and write options in combination
with each other, or in combination with futures or forward contracts, to adjust
the risk and return characteristics of the overall position. For example, a Fund
could construct a combined position whose risk and return characteristics are
similar to selling a futures contract by purchasing a put option and writing a
call option on the same underlying instrument. Alternatively, a Fund could write
a call option at one strike price and buy a call option at a lower price to
reduce the risk of the written call option in the event of a substantial price
increase. Because combined options positions involve multiple trades, they
result in higher transaction costs and may be more difficult to open and close
out.
The Fund is operated by a person who has claimed an exclusion from the
definition of the term "commodity pool operator" under the Commodity Exchange
Act (the "CEA"), and, therefore, such person is not subject to registration or
regulation as a pool operator under the CEA.
Limitations on Use of Futures and Futures Options. When purchasing a
futures contract, the Fund will maintain with its custodian (and mark to market
on a daily basis) assets determined to be liquid by the Fund in accordance with
procedures established by the Board of Trustees, that, when added to the amounts
deposited with a futures commission merchant as margin, are equal to the market
value of the futures contract. Alternatively, the Fund may "cover" its
position by purchasing a put option on the same futures contract with a strike
price as high as or higher than the price of the contract held by the Fund.
-17-
When selling a futures contract, the Fund will maintain with its custodian
(and mark to market on a daily basis) assets determined to be liquid by the Fund
in accordance with procedures established by the Board of Trustees, that are
equal to the market value of the instruments underlying the contract.
Alternatively, the Fund may "cover" its position by owning the instruments
underlying the contract (or, in the case of an index futures contract, a
portfolio with a volatility substantially similar to that of the index on which
the futures contract is based), or by holding a call option permitting the Fund
to purchase the same futures contract at a price no higher than the price of the
contract written by the Fund (or at a higher price if the difference is
maintained in liquid assets with the Fund's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark to market on a daily basis) assets determined to be
liquid by the Fund in accordance with procedures established by the Board of
Trustees, that, when added to the amounts deposited with a futures commission
merchant as margin, equal the total market value of the futures contract
underlying the call option. Alternatively, the Fund may cover its position by
entering into a long position in the same futures contract at a price no higher
than the strike price of the call option, by owning the instruments underlying
the futures contract, or by holding a separate call option permitting the Fund
to purchase the same futures contract at a price not higher than the strike
price of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark to market on a daily basis) assets determined to be
liquid by the Fund in accordance with procedures established by the Board of
Trustees, that equal the purchase price of the futures contract, less any margin
on deposit. Alternatively, the Fund may cover the position either by entering
into a short position in the same futures contract, or by owning a separate put
option permitting it to sell the same futures contract so long as the strike
price of the purchased put option is the same as or higher than the strike price
of the put option sold by the Fund.
The requirements for qualification as a regulated investment company also
may limit the extent to which the Fund may enter into futures, futures options
or forward contracts. See "Tax Matters."
Risks Associated with Futures and Futures Options. There are several risks
associated with the use of futures contracts and futures options, including as
hedging techniques. A purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract. There can be no
guarantee that there will be a correlation between price movements in the
hedging vehicle and in the Fund securities being hedged. In addition, there are
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objective. The degree of imperfection of correlation depends
on circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
-18-
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a futures contract or a futures option position, and
the Fund would remain obligated to meet margin requirements until the position
is closed. In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Forward Foreign Currency Exchange Contracts. A forward foreign currency
contract involves an obligation to purchase or sell a specific amount of
currency at a future date or date range at a specific price. In the case of a
cancelable forward contract, the holder has the unilateral right to cancel the
contract at maturity by paying a specified fee. Forward foreign currency
exchange contracts differ from foreign currency futures contracts in certain
respects. These contracts may be bought or sold to protect the Fund against a
possible loss resulting from an adverse change in the relationship between
foreign currencies and the U.S. dollar or to increase exposure to a particular
foreign currency. Although forwards are intended to minimize the risk of loss
due to a decline in the value of the hedged currencies, at the same time, they
tend to limit any potential gain which might result should the value of such
currencies increase.
By entering into a forward foreign currency exchange contract, the Fund
"locks in" the exchange rate between the currency it will deliver and the
currency it will receive for the duration of the contract. As a result, the Fund
reduces its exposure to changes in the value of the currency it will deliver and
increases its exposure to changes in the value of the currency it will exchange
into. Contracts to sell foreign currencies would limit any potential gain which
might be realized by the Fund if the value of the hedged currency increases. The
Fund may enter into these contracts for the purpose of hedging against foreign
exchange risks arising from the Fund's investment or anticipated investment in
securities denominated in foreign currencies. Suitable hedging transactions may
not be available in all circumstances. Also, such hedging transactions may not
be successful.
The Fund may also enter into forward foreign currency exchange contracts
for purposes of increasing exposure to a foreign currency or to shift exposure
to foreign currency fluctuations from one currency to another. To the extent
that it does so, the Fund will be subject to the additional risk that the
relative value of currencies will be different than anticipated by The Fund. The
Fund may additionally enter into forward contracts to protect against
anticipated changes in future foreign currency exchange rates. The Fund may use
one currency (or a basket of currencies) to hedge against adverse changes in the
value of another currency (or a basket of currencies) when exchange rates
between the two currencies are positively correlated. The Fund
-19-
may also use related options on currencies for the same reasons for which
forward foreign currency exchange contracts are used.
Unlike futures contracts, forward contracts:
(i) do not have standard maturity dates or amounts (i.e., the parties to
the contract may fix the maturity date and the amount);
(ii) are traded in the inter-bank markets conducted directly between
currency traders (usually large commercial banks) and their customers,
as opposed to futures contracts, which are traded only on exchanges
regulated by the Commodity Futures Trading Commission;
(iii) do not require an initial margin deposit; and
(iv) may be closed by entering into a closing transaction with the currency
trader who is a party to the original forward contract, as opposed to
a commodities exchange.
Tax Consequences of Hedging. It is important to note that hedging costs are
treated as capital transactions and are not, therefore, deducted from the Fund's
dividend distribution and are not reflected in its yield. Under applicable tax
law, the Fund's hedging activities may result in the application of the
mark-to-market and straddle provisions of the Internal Revenue Code of 1986 (the
"Code"). Those provisions could result in an increase (or decrease) in the
amount of taxable dividends paid by the Fund and could affect whether dividends
paid by the Fund are classified as capital gains or ordinary income. See "Tax
Matters."
Additional Risks of Options on Securities and Indexes, Futures Contracts,
Options on Futures Contracts and Forward Currency Exchange Contracts and Options
thereon. Options on securities and Indexes, futures contracts, options on
futures contracts and options on currencies may be traded on foreign exchanges.
Such transactions may not be regulated as effectively as similar transactions in
the United States, may not involve a clearing mechanism and related guarantees,
and are subject to the risk of governmental actions affecting trading in, or the
prices of, foreign securities. Some foreign exchanges may be principal markets
so that no common clearing facility exists and a trader may look only to the
broker for performance of the contract. The value of positions also could be
adversely affected by (i) other complex foreign political, legal and economic
factors, (ii) lesser availability than in the United States of data on which to
make trading decisions, (iii) delays in the Fund's ability to act upon economic
events occurring in foreign markets during non-business hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States and (v) lesser
trading volume. In addition, unless the Fund hedges against fluctuations in the
exchange rate between the U.S. dollar and the currencies in which trading is
done on foreign exchanges, any profits that the Fund might realize in trading
could be eliminated by adverse changes in the exchange rate, or the Fund could
incur losses as a result of those changes. The Fund's use of such instruments
may cause the Fund to realize higher amounts of short-term capital gains
(generally taxed to shareholders at ordinary income tax rates) than if the Fund
had not used such instruments.
Swap Agreements. A swap is a financial instrument that typically involves
the exchange of cash flows between two parties on specified dates (settlement
dates), where the cash flows are
-20-
based on agreed-upon prices, rates, indices, etc. Swaps are individually
negotiated and structured to include exposure to a variety of different types of
investments or market factors.
The Fund may enter into swap agreements with respect to individual
securities, indexes of securities, interest rates, currencies and other assets
or measures of risk or return. The Fund may also enter into options on swap
agreements ("swaptions"). These transactions are entered into in an attempt to
obtain a particular return when it is considered desirable to do so, possibly at
a lower cost to the Fund than if the Fund had invested directly in an instrument
that yielded that desired return. Swap agreements are two-party contracts
entered into primarily by institutional investors for periods ranging from a few
weeks to more than one year. In a standard "swap" transaction, two parties agree
to exchange the returns (or differentials in rates of return) earned or realized
on particular predetermined investments or instruments, which may be adjusted
for an interest factor. The gross returns to be exchanged or "swapped" between
the parties are generally calculated with respect to a "notional amount," i.e.,
the return on or increase in value of a particular dollar amount invested at a
particular interest rate or in a "basket" of securities representing a
particular index. Forms of swap agreements include caps, under which, in return
for a premium, one party agrees to make payments to the other to the extent
that, for example, the return on a given equity index exceeds a specified rate,
or "cap"; floors, under which, in return for a premium, one party agrees to make
payments to the other to the extent that, for example, the return on a given
equity index falls below a specified rate, or "floor"; and collars, under which
a party sells a cap and purchases a floor or vice versa in an attempt to protect
itself against movements exceeding given minimum or maximum levels. A swaption
is a contract that gives a counterparty the right (but not the obligation) to
enter into a new swap agreement or to shorten, extend, cancel or otherwise
modify an existing swap agreement, at some designated future time on specified
terms. The Fund may write (sell) and purchase put and call swaptions.
The Fund may have exposure to credit default swaps through investments in
credit-linked trust certificates. In connection with such investments, the Fund
would be in the position of a seller of a credit default swap contract because
the trust that issues the certificates would be selling one or more credit
default swap contracts. The seller of a credit default swap contract is required
to pay the par (or other agreed-upon) value of a referenced debt obligation to
the counterparty in the event of a default or similar triggering event by a
third party, such as a U.S. or foreign corporate issuer, on the debt obligation.
In return, the trust issuing the certificates receives from the counterparty a
periodic stream of payments over the term of the contract provided that no event
of default or similar triggering event has occurred. The trust in turn passes
the stream of payments along to the holders of the certificates it has issued.
If no default or other triggering event occurs, the trust, and thus the Fund,
would keep the stream of payments and would have no payment obligations. In
connection with its investments in credit-linked trust certificates, the Fund is
therefore subject to credit risk relating to the counterparty to any credit
default swap contract entered into by the trust and also the issuer and/or any
guarantor of any referenced debt obligation.
Many swap agreements entered into by the Fund would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, the
Fund's current obligations (or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received under the agreement based on
the relative values of the positions held by each party to
-21-
the agreement (the "net amount"). The Fund's current obligations under a swap
agreement will be accrued daily (offset against any amounts owed to the Fund).
Although it has no current intention to do so, the Fund may use swap agreements
to add leverage to the portfolio. The Fund may (but is not required to) cover
any accrued but unpaid net amounts owed to a swap counterparty through the
segregation of assets determined to be liquid by the Fund in accordance with
procedures established by the Board of Trustees. Obligations under swap
agreements so covered will not be construed to be "senior securities" for
purposes of the Fund's investment restriction concerning senior securities and
borrowings.
Whether the Fund's use of swap agreements or swaptions will be successful
in furthering its investment objectives will depend on the Fund's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Because they are two-party contracts and
because they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. Moreover, if a
counter-party's creditworthiness declined, the value of a swap agreement would
be likely to decline, potentially resulting in losses. The performance of swap
agreements may be affected by a change in the specific currency, or by other
factors that determine the amount of payments due. If a swap agreement calls for
a payment by the Fund, the Fund must be prepared to make such payments when due.
The swaps market is a relatively new market and is largely unregulated. The
Fund's ability to terminate or transfer a swap agreement is generally very
limited. Swap agreements may increase the overall volatility of the investments
of a Fund. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect the Fund's ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Depending on the terms of the particular option agreement, the Fund will
generally incur a greater degree of risk when it writes a swaption than it will
incur when it purchases a swaption. When the Fund purchases a swaption, it risks
losing only the amount of the premium it has paid should it decide to let the
option expire unexercised. However, when the Fund writes a swaption, upon
exercise of the option the Fund will become obligated according to the terms of
the underlying agreement.
Certain swap agreements are exempt from most provisions of the CEA and,
therefore, are not regulated as futures or commodity option transactions under
the CEA.
High Yield Securities ("Junk Bonds")
The Convertible Component may consist of securities that are, at the time
of purchase, rated below investment grade (below Baa by Moody's Investors
Service, Inc. ("Moody's"), or below BBB by Standard & Poor's ("S&P")) or in
securities that are unrated but judged to be of comparable quality by the Fund.
These securities are sometimes referred to as "high yield" securities or "junk
bonds." NACM may invest in distressed securities on behalf of the Convertible
Component, but will not invest in securities which are in default (rated "D" by
-22-
Moody's or S&P) at the time of purchase (but may hold securities which have gone
into default after they have been purchased).
Investments in high yield securities generally provide greater income and
increased opportunity for capital appreciation than investments in higher
quality securities, but they also typically entail greater price volatility and
principal and income risk, including the possibility of issuer default and
bankruptcy. High yield securities are regarded as predominantly speculative with
respect to the issuer's continuing ability to meet principal and interest
payments. Securities in the lowest investment grade category also may be
considered to possess some speculative characteristics by certain rating
agencies. In addition, analysis of the creditworthiness of issuers of high yield
securities may be more complex than for issuers of higher quality securities.
High yield securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a decline in high yield security prices because the advent
of a recession could lessen the ability of an issuer to make principal and
interest payments on its debt obligations. If an issuer of high yield securities
defaults, in addition to risking non-payment of all or a portion of interest and
principal, the Fund may incur additional expenses to seek recovery. The market
prices of high yield securities structured as zero-coupon, step-up or
payment-in-kind securities will normally be affected to a greater extent by
interest rate changes, and therefore tend to be more volatile than the prices of
securities that pay interest currently and in cash.
The secondary market on which high yield securities are traded may be less
liquid than the market for investment grade securities. Less liquidity in the
secondary trading market could adversely affect the price at which the Fund
could sell a high yield security, and could adversely affect the net asset value
of the Fund's shares. Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the values and liquidity of high
yield securities, especially in a thinly traded market. When secondary markets
for high yield securities are less liquid than the market for investment grade
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is less reliable, objective data available.
During periods of thin trading in these markets, the spread between bid and
asked prices is likely to increase significantly and the Fund may have greater
difficulty selling its portfolio securities. The Fund will be more dependent on
a Sub-Adviser's research and analysis when investing in high yield securities.
A general description of the ratings of securities by Moody's, S&P and
other ratings agencies is set forth in Appendix A to the Prospectus. The ratings
of Moody's and S&P represent their opinions as to the quality of the securities
they rate. It should be emphasized, however, that ratings are general and are
not absolute standards of quality. Consequently, debt obligations with the same
maturity, coupon and rating may have different yields while debt obligations
with the same maturity and coupon with different ratings may have the same
yield. For these reasons, the use of credit ratings as the sole method of
evaluating high yield securities can involve certain risks. For example, credit
ratings evaluate the safety of principal and interest payments, not the market
value risk of high yield securities. Also, credit rating agencies may fail to
change credit ratings in a timely fashion to reflect events since the security
was last rated.
-23-
The Fund's credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or a Sub-Adviser downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, a Sub-Adviser may consider such factors as its own assessment
of the credit quality of the issuer of such security, the price at which such
security could be sold and the rating, if any, assigned to such security by
other rating agencies. However, analysis of creditworthiness may be more complex
for issuers of high yield securities than for issuers of higher quality debt
securities.
Warrants and Rights
A right is a privilege granted to existing shareholders of a corporation to
subscribe to shares of a new issue of common stock before it is issued. Rights
normally have a short life, usually two to four weeks, are freely transferable
and entitle the holder to buy the new common stock at a lower price than the
public offering price. Warrants are securities that are usually issued together
with a debt security or preferred stock and that give the holder the right to
buy a proportionate amount of common stock at a specified price. Warrants are
freely transferable and are traded on major exchanges. Unlike rights, warrants
normally have a life that is measured in years and entitle the holder to buy
common stock of a company at a price that is usually higher than the market
price at the time the warrant is issued. Corporations often issue warrants to
make the accompanying debt security more attractive.
Warrants and rights may entail greater risks than certain other types of
investments. Generally, rights and warrants do not carry the right to receive
dividends or exercise voting rights with respect to the underlying securities,
and they do not represent any rights in the assets of the issuer. In addition,
their value does not necessarily change with the value of the underlying
securities, and they cease to have value if they are not exercised on or before
their expiration date. If the market price of the underlying stock does not
exceed the exercise price during the life of the warrant or right, the warrant
or right will expire worthless. Rights and warrants may increase the potential
profit or loss to be realized from the investment as compared with investing the
same amount in the underlying securities. Similarly, the percentage increase or
decrease in the value of an equity security warrant may be greater than the
percentage increase or decrease in the value of the underlying common stock.
Warrants may relate to the purchase of equity or debt securities. Debt
obligations with warrants attached to purchase equity securities have many
characteristics of convertible securities and their prices may, to some degree,
reflect the performance of the underlying stock. Debt obligations also may be
issued with warrants attached to purchase additional debt securities at the same
coupon rate. A decline in interest rates would permit the Fund to sell such
warrants at a profit. If interest rates rise, these warrants would generally
expire with no value.
Foreign (Non-U.S.) Securities
As described in the Prospectus, the Fund may invest in foreign securities.
The Equity Component may invest without limit in American Depository Receipts
("ADRs") and may invest up to 10% its total assets in securities of foreign
issues or securities traded in foreign securities markets, including "emerging
market" securities. The Convertible Component may invest up to
-24-
20% of its total assets in U.S. dollar-denominated convertible securities of
foreign issuers based in developed countries.
ADRs are U.S. dollar-denominated receipts issued generally by domestic
banks and represent the deposit with the bank of a security of a foreign issuer.
The Fund also may invest in European Depository Receipts ("EDRs"). EDRs are
foreign currency-denominated receipts similar to ADRs and are issued and traded
in Europe, and are publicly traded on exchanges or over-the-counter in the
United States. The Fund may also invest in Global Depository Receipts ("GDRs"),
which may be offered privately in the United States and also trade in public or
private markets in other countries. ADRs, EDRs and GDRs may be issued as
sponsored or unsponsored programs. In sponsored programs, an issuer has made
arrangements to have its securities trade in the form of ADRs, EDRs or GDRs. In
unsponsored programs, the issuer may not be directly involved in the creation of
the program. Although regulatory requirements with respect to sponsored and
unsponsored programs are generally similar, in some cases it may be easier to
obtain financial information from an issuer that has participated in the
creation of a sponsored program.
Other foreign securities in which the Fund may invest include Eurodollar
obligations and "Yankee Dollar" obligations. Eurodollar obligations are U.S.
dollar-denominated certificates of deposit and time deposits issued outside the
U.S. capital markets by foreign branches of U.S. banks and by foreign banks.
Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the
U.S. capital markets by foreign banks. Eurodollar and Yankee Dollar obligations
are generally subject to the same risks that apply to domestic debt issues,
notably credit risk, market risk and liquidity risk. Additionally, Eurodollar
(and to a limited extent, Yankee Dollar) obligations are subject to certain
sovereign risks. One such risk is the possibility that a sovereign country might
prevent capital, in the form of U.S. 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 issuers.
The Fund may invest in Brady Bonds. Brady Bonds are securities created
through the exchange of existing commercial bank loans to sovereign entities for
new obligations in connection with debt restructurings under a debt
restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas
F. Brady (the "Brady Plan"). Brady Plan debt restructurings have been
implemented in a number of countries, including: Argentina, Bolivia, Brazil,
Bulgaria, Costa Rica, the Dominican Republic, Ecuador, Jordan, Mexico, Niger,
Nigeria, Panama, Peru, the Philippines, Poland, Uruguay and Venezuela.
Brady Bonds may be collateralized or uncollateralized, are issued in
various currencies (primarily the U.S. dollar) and are actively traded in the
over-the-counter secondary market. Brady Bonds are not considered to be U.S.
Government securities. U.S. dollar-denominated, collateralized Brady Bonds,
which may be fixed rate par bonds or floating rate discount bonds, are generally
collateralized in full as to principal by U.S. Treasury zero-coupon bonds having
the same maturity as the Brady Bonds. Interest payments on these Brady Bonds
generally are collateralized on a one-year or longer rolling-forward basis by
cash or securities in an amount that, in the case of fixed rate bonds, is equal
to at least one year of interest payments or, in the case of floating rate
bonds, initially is equal to at least one year's interest payments based on the
-25-
applicable interest rate at that time and is adjusted at regular intervals
thereafter. Certain Brady Bonds are entitled to "value recovery payments" in
certain circumstances, which in effect constitute supplemental interest payments
but generally are not collateralized. Brady Bonds are often viewed as having
three or four valuation components: (i) the collateralized repayment of
principal at final maturity; (ii) the collateralized interest payments; (iii)
the uncollateralized interest payments; and (iv) any uncollateralized repayment
of principal at maturity (the uncollateralized amounts constitute the "residual
risk").
Most Mexican Brady Bonds issued to date have principal repayments at final
maturity fully collateralized by U.S. Treasury zero-coupon bonds (or comparable
collateral denominated in other currencies) and interest coupon payments
collateralized on an 18-month rolling-forward basis by funds held in escrow by
an agent for the bondholders. A significant portion of the Venezuelan Brady
Bonds and the Argentine Brady Bonds issued to date have repayments at final
maturity collateralized by U.S. Treasury zero-coupon bonds (or comparable
collateral denominated in other currencies) and/or interest coupon payments
collateralized on a 14-month (for Venezuela) or 12-month (for Argentina)
rolling-forward basis by securities held by the Federal Reserve Bank of New York
as collateral agent.
Brady Bonds involve various risk factors including residual risk and the
history of defaults with respect to commercial bank loans by public and private
entities of countries issuing Brady Bonds. There can be no assurance that Brady
Bonds in which the Fund may invest will not be subject to restructuring
arrangements or to requests for new credit, which may cause the Fund to suffer a
loss of interest or principal on any of its holdings.
Sovereign Debt. The Fund may invest in sovereign debt issued by foreign
developed and emerging market governments and their respective sub-divisions,
agencies or instrumentalities, government sponsored enterprises and
supra-national government entities. Supra-national entities include
international organizations that are organized or supported by one or more
government entities to promote economic reconstruction or development and by
international banking institutions and related governmental agencies. Investment
in sovereign debt can involve a high degree of risk. The governmental entity
that controls the repayment of sovereign debt may not be able or willing to
repay the principal and/or interest when due in accordance with the terms of the
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
depend on expected disbursements from foreign governments, multilateral agencies
and others 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
-26-
debt (including the Fund) may be requested to participate in the rescheduling of
such debt and to extend further loans to governmental entities. There is no
bankruptcy proceeding by which sovereign debt on which governmental entities
have defaulted may be collected in whole or in part.
Foreign Currencies. The Fund may invest directly in foreign currencies and
may enter into forward foreign currency exchange contracts to reduce the risks
of adverse changes in foreign exchange rates. In addition, the Fund may buy and
sell foreign currency futures contracts and options on foreign currencies and
foreign currency futures. Although the Sub-Advisers have the flexibility to
hedge against foreign currency risk, they may determine not to do so or to do so
only in unusual circumstances or market conditions. The Fund may employ currency
management techniques to enhance the Fund's total return. See "other Derivative
Instruments" above for a description of various foreign currency transactions
and instruments that the Fund may use.
The Fund's investments in foreign securities involve special risks. There
may be less information publicly available about a foreign issuer than about a
U.S. issuer, and foreign issuers are not generally subject to accounting,
auditing and financial reporting standards and practices comparable to those in
the United States. The securities of some foreign issuers are less liquid and at
times more volatile than securities of comparable U.S. issuers. Foreign
brokerage costs, custodial expenses and other fees are also generally higher
than for securities traded in the United States. With respect to certain foreign
countries, there is also a possibility of expropriation of assets, confiscatory
taxation, adverse changes in investment or exchange control regulations (which
may include suspension of the ability to transfer currency from a country),
potential restrictions on the flow of international capital, political or
financial instability and diplomatic developments which could affect the value
of investments in those countries. In addition, income received by the Fund from
sources within foreign countries may be reduced by withholding and other taxes
imposed by such countries. Changes in foreign exchange rates will affect the
value of those securities which are denominated or quoted in currencies other
than the U.S. dollar.
The risks of investing in foreign securities are particularly high when
securities of issuers based in developing (or "emerging market") countries are
involved. These risks include: greater risks of nationalization or expropriation
of assets or confiscatory taxation; currency devaluations and other currency
exchange rate fluctuations; greater social, economic and political uncertainty
and instability (including the risk of war); more substantial government
involvement in the economy; less government supervision and regulation of the
securities markets and participants in those markets; controls on foreign
investment and limitations on repatriation of invested capital and on the Fund's
ability to exchange local currencies for U.S. dollars; unavailability of
currency hedging techniques in certain emerging market countries; the fact that
companies in emerging market countries may be smaller, less seasoned and newly
organized; the difference in, or lack of, auditing and financial reporting
standards, which may result in unavailability of material information about
issuers; the risk that it may be more difficult to obtain and/or enforce a
judgment in a court outside the United States; and greater price volatility,
substantially less liquidity and significantly smaller market capitalization of
securities markets. In addition, a number of emerging market countries restrict,
to various degrees, foreign investment in securities, and high rates of
inflation and rapid fluctuations in
-27-
inflation rates have had, and may continue to have, negative effects on the
economies and securities markets of certain emerging market countries. Also, 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
Real Estate Investment Trusts ("REITs")
REITs are pooled investment vehicles which invest primarily in
income-producing real estate or real estate related loans or interests. REITs
are generally classified as equity REITs, mortgage REITs or a combination of
equity and mortgage REITs. Equity REITs invest the majority of their assets
directly in real property and derive income primarily from the collection of
rents. Equity REITs can also realize capital gains by selling properties that
have appreciated in value. Mortgage REITs invest the majority of their assets in
real estate mortgages and derive income from the collection of interest
payments. REITs are not taxed on income distributed to shareholders provided
they comply with the applicable requirements of the Code. The Fund will
indirectly bear its proportionate share of any management and other expenses
paid by REITs in which it invests in addition to the expenses paid by the Fund.
Debt securities issued by REITs are, for the most part, general and unsecured
obligations and are subject to risks associated with REITs.
Investing in REITs involves certain unique risks in addition to those risks
associated with investing in the real estate industry in general. An equity REIT
may be affected by changes in the value of the underlying properties owned by
the REIT. A mortgage REIT may be affected by changes in interest rates and the
ability of the issuers of its portfolio mortgages to repay their obligations.
REITs are dependent upon the skills of their managers and are not diversified.
REITs are generally dependent upon maintaining cash flows to repay borrowings
and to make distributions to shareholders and are subject to the risk of default
by lessees or borrowers. REITs whose underlying assets are concentrated in
properties used by a particular industry, such as health care, are also subject
to risks associated with such industry.
REITs (especially mortgage REITs) are also subject to interest rate risks.
When interest rates decline, the value of a REIT's investment in fixed rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of a REIT's investment in fixed rate obligations can be expected to
decline. If the REIT invests in adjustable rate mortgage loans the interest
rates on which are reset periodically, yields on a REIT's investments in such
loans will gradually align themselves to reflect changes in market interest
rates. This causes the value of such investments to fluctuate less dramatically
in response to interest rate fluctuations than would investments in fixed rate
obligations.
REITs may have limited financial resources, may trade less frequently and
in a more limited volume and may be subject to more abrupt or erratic price
movements than larger company securities. Historically REITs have been more
volatile in price than the larger capitalization stocks included in Standard &
Poor's 500 Stock Index.
-28-
Stocks of Small and Medium Capitalization Companies
The Fund may invest in securities of companies with market capitalizations
that are small compared to those of other publicly traded companies. Investments
in larger companies present certain advantages in that such companies generally
have greater financial resources, more extensive research and development,
manufacturing, marketing and service capabilities, and more stability and
greater depth of management and technical personnel. Investments in smaller,
less seasoned companies may present greater opportunities for growth but also
may involve greater risks than customarily are associated with more established
companies. The securities of smaller companies may be subject to more abrupt or
erratic market movements than larger, more established companies. These
companies may have limited product lines, markets or financial resources, or
they may be dependent upon a limited management group. Their securities may be
traded in the over-the-counter market or on a regional exchange, or may
otherwise have limited liquidity. Owning large positions in this type of
security involves the additional risk of possibly having to sell portfolio
securities at disadvantageous times and prices if redemptions require the Fund
to liquidate its securities positions.
The Fund may also invest in securities of companies with medium market
capitalizations. These investments share some of the risk characteristics of
investments in securities of companies with small market capitalizations
described above, although such companies tend to have longer operating
histories, broader product lines and greater financial resources, and their
securities tend to be more liquid and less volatile than those of smaller
capitalization issuers.
Corporate Bonds
The Fund may invest in a variety of bonds and related debt obligations of
varying maturities issued by U.S. corporations, foreign corporations, domestic
banks, foreign banks and other business entities. Bonds include bills, notes,
debentures, money market instruments and similar instruments and securities.
Bonds generally are used by corporations and other issuers to borrow money from
investors. The issuer pays the investor a variable or fixed rate of interest and
normally must repay the amount borrowed on or before maturity. Certain bonds are
"perpetual" in that they have no maturity date.
The Fund's investments in corporate bonds are subject to a number of risks
described in the Prospectus and elaborated upon elsewhere in this section of the
Statement of Additional Information, including interest rate risk, credit risk,
high yield risk, issuer risk, foreign (non-U.S.) investment risk,
inflation/deflation risk, liquidity risk, smaller company risk and management
risk.
Commercial Paper
Commercial paper represents short-term unsecured promissory notes issued in
bearer form by corporations such as banks or bank holding companies and finance
companies. The Fund may invest in commercial paper of any credit quality
consistent with the Fund's investment objectives and policies, including unrated
commercial paper for which a Sub-Adviser has made a credit quality assessment.
See Appendix A to the Prospectus for a description of the ratings assigned by
Moody's and S&P to commercial paper. The rate of return on commercial paper
-29
may be linked or indexed to the level of exchange rates between the U.S. dollar
and a foreign currency or currencies.
Bank Obligations
Bank obligations in which the Fund may invest include certificates of
deposit, bankers' acceptances, and fixed time deposits. Certificates of deposit
are negotiable certificates that are issued against funds deposited in a
commercial bank for a definite period of time and that earn a specified return.
Bankers' acceptances are negotiable drafts or bills of exchange, normally drawn
by an importer or exporter to pay for specific merchandise, which are "accepted"
by a bank, meaning, in effect, that the bank unconditionally agrees to pay the
face value of the instrument on maturity. Fixed time deposits are bank
obligations payable at a stated maturity date and bearing interest at a fixed
rate. Fixed time deposits may be withdrawn on demand by the investor, but may be
subject to early withdrawal penalties which vary depending upon market
conditions and the remaining maturity of the obligation. There are generally no
contractual restrictions on the right to transfer a beneficial interest in a
fixed time deposit to a third party, although there is no market for such
deposits. The Fund may also hold funds on deposit with its custodian bank in an
interest-bearing account for temporary purposes.
Loan Participations and Assignments
The Fund may purchase participations in commercial loans. Such indebtedness
may be secured or unsecured. Loan participations typically represent direct
participations in a loan to a corporate borrower, and generally are offered by
banks or other financial institutions or lending syndicates. The Fund may
participate in such syndications, or can buy part of a loan, becoming a part
lender. When purchasing loan participations, the Fund assumes the credit risk
associated with the corporate borrower and may assume the credit risk associated
with an interposed bank or other financial intermediary. The participation
interests in which the Fund intends to invest may not be rated by any nationally
recognized rating service. Given the current structure of the markets for loan
participations and assignments, the Fund expects to treat these securities as
illiquid.
A loan is often administered by an agent bank acting as agent for all
holders. The agent bank administers the terms of the loan, as specified in the
loan agreement. In addition, the agent bank is normally responsible for the
collection of principal and interest payments from the corporate borrower and
the apportionment of these payments to the credit of all institutions which are
parties to the loan agreement. Unless, under the terms of the loan or other
indebtedness, the Fund has direct recourse against the corporate borrower, the
Fund may have to rely on the agent bank or other financial intermediary to apply
appropriate credit remedies against a corporate borrower. Loans and other types
of direct indebtedness may not be readily marketable and may be subject to
restrictions on resale.
Investments in loans through assignments (i.e., a direct assignment of the
financial institution's interests with respect to the loan) may involve
additional risks to the Fund. For example, if a loan is foreclosed, the Fund
could become part owner of any collateral, and would bear the costs and
liabilities associated with owning and disposing of the collateral. In addition,
it is conceivable that, under emerging legal theories of lender liability, the
Fund could be held
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liable as co-lender. It is unclear whether loans and other forms of direct
indebtedness offer securities law protections against fraud and
misrepresentation. In the absence of definitive regulatory guidance, the Fund
relies on a Sub-Adviser's research in an attempt to avoid situations where fraud
or misrepresentations could adversely affect the Fund.
Zero-Coupon Bonds, Step-Ups and Payment-In-Kind Securities
Zero-coupon securities are debt obligations that do not entitle the holder
to any periodic payments of interest either for the entire life of the
obligation or for an initial period after the issuance of the obligations. Like
zero-coupon bonds, "step-up" bonds pay no interest initially but eventually
begin to pay a coupon rate prior to maturity, which rate may increase at stated
intervals during the life of the security. Payment-in-kind securities ("PIKs")
pay dividends or interest in the form of additional securities of the issuer,
rather than in cash. Each of these instruments is typically issued and traded at
a deep discount from its face amount. The amount of the discount varies
depending on such factors as the time remaining until maturity of the
securities, prevailing interest rates, the liquidity of the security and the
perceived credit quality of the issuer. The market prices of zero-coupon bonds,
step-ups and PIKs generally are more volatile than the market prices of debt
instruments that pay interest currently and in cash and are likely to respond to
changes in interest rates to a greater degree than do other types of securities
having similar maturities and credit quality. In order to satisfy a requirement
for qualification as a "regulated investment company" under the Code of 1986, an
investment company, such as the Fund, must distribute each year at least 90% of
its net investment income, including the original issue discount accrued on
zero-coupon bonds, step-ups and PIKs. Because the Fund will not on a current
basis receive cash payments from the issuer of these securities in respect of
any accrued original issue discount, in some years the Fund may have to
distribute cash obtained from selling other portfolio holdings of the Fund. In
some circumstances, such sales might be necessary in order to satisfy cash
distribution requirements even though investment considerations might otherwise
make it undesirable for the Fund to sell securities at such time. Under many
market conditions, investments in zero-coupon bonds, step-ups and PIKs may be
illiquid, making it difficult for the Fund to dispose of them or determine their
current value.
Mortgage-Related and Other Asset-Backed Securities
The Fund may invest in mortgage-related securities and in other
asset-backed securities. Mortgage-related securities include mortgage
pass-through securities, collateralized mortgage obligations ("CMOs"),
commercial mortgage-backed securities, mortgage dollar rolls, CMO residuals,
stripped mortgage-backed securities ("SMBSs") and other securities that directly
or indirectly represent a participation in, or are secured by and payable from,
mortgage loans on real property.
The value of some mortgage-related and other asset-backed securities may be
particularly sensitive to changes in prevailing interest rates. Early repayment
of principal on some mortgage-related securities may expose a Portfolio to a
lower rate of return upon reinvestment of principal. When interest rates rise,
the value of a mortgage-related security generally will decline; however, when
interest rates are declining, the value of mortgage-related securities with
prepayment features may not increase as much as other fixed income securities.
The rate of prepayments on underlying mortgages will affect the price and
volatility of a
-31-
mortgage-related security, and may shorten or extend the effective maturity of
the security beyond what was anticipated at the time of purchase. If
unanticipated rates of prepayment on underlying mortgages increase the effective
maturity of a mortgage-related security, the volatility of the security can be
expected to increase. The value of these securities may fluctuate in response to
the market's perception of the creditworthiness of the issuers. Additionally,
although mortgages and mortgage-related securities are generally supported by
some form of government or private guarantee and/or insurance, there is no
assurance that private guarantors or insurers will meet their obligations.
One type of SMBS has one class receiving all of the interest from the
mortgage assets (the interest-only, or "IO" class), while the other class will
receive all of the principal (the principal-only, or "PO" class). The yield to
maturity on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on a Portfolio's yield to
maturity from these securities.
The Fund may invest in collateralized debt obligations ("CDOs"), which
include collateralized bond obligations ("CBOs"), collateralized loan
obligations ("CLOs") and other similarly structured securities. CBOs and CLOs
are types of asset-backed securities. A CBO is a trust which is backed by a
diversified pool of high-risk, below investment grade fixed income securities. A
CLO is a trust typically collateralized by a pool of loans, which may include,
among others, domestic and foreign senior secured loans, senior unsecured loans,
and subordinate corporate loans, including loans that may be rated below
investment grade or equivalent unrated loans. The Fund may invest in other
asset-backed securities that have been offered to investors.
Rising interest rates tend to extend the duration of mortgage-related
securities, making them more sensitive to changes in interest rates, and may
reduce the market value of the securities. In addition, mortgage-related
securities are subject to prepayment risk--the risk that borrowers may pay off
their mortgages sooner than expected, particularly when interest rates decline.
This can reduce the Fund's returns because the Fund may have to reinvest that
money at lower prevailing interest rates. The Fund's investments in other
asset-backed securities are subject to risks similar to those associated with
mortgage-backed securities, as well as additional risks associated with the
nature of the assets and the servicing of those assets.
Credit-Linked Trust Certificates
Among the income-producing securities in which the Convertible Component
may invest are credit-linked trust certificates, which are investments in a
limited purpose trust or other vehicle formed under State law which, in turn,
invests in a basket of derivative instruments, such as credit default swaps,
interest rate swaps and other securities, in order to provide exposure to the
high yield or another fixed income market. The Fund may invest in credit-linked
trust certificates during the period when the net proceeds of this offering are
being invested. Thereafter, the Fund may invest up to 5% of its total assets in
these instruments.
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Like an investment in a bond, investments in these credit-linked trust
certificates represent the right to receive periodic income payments (in the
form of distributions) and payment of principal at the end of the term of the
certificate. However, these payments are conditioned on the trust's receipt of
payments from, and the trust's potential obligations to, the counterparties to
the derivative instruments and other securities in which the trust invests. For
instance, the trust may sell one or more credit default swaps, under which the
trust would receive a stream of payments over the term of the swap agreements
provided that no event of default has occurred with respect to the referenced
debt obligation upon which the swap is based. If a default occurs, the stream of
payments may stop and the trust would be obligated to pay to the counterparty
the par (or other agreed upon value) of the referenced debt obligation. This, in
turn, would reduce the amount of income and principal that the Fund would
receive as an investor in the trust. Please see "Investment Objectives and
Policies-- Other Derivative Instruments" for additional information about credit
default swaps. The Fund's investments in these instruments are indirectly
subject to the risks associated with derivative instruments, including, among
others, credit risk, default or similar event risk, counterparty risk, interest
rate risk, leverage risk and management risk. It is expected that the trusts
which issue credit-linked trust certificates will constitute "private"
investment companies, exempt from registration under the 1940 Act. Therefore,
the certificates will not be subject to applicable investment limitations
and other regulation imposed by the 1940 Act (although the Fund will remain
subject to such limitations and regulation, including with respect to its
investments in the certificates). Although the trusts are typically private
investment companies, they are generally not actively managed such as a "hedge
fund" might be. It is also expected that the certificates will be exempt from
registration under the Securities Act of 1933. Accordingly, there may be no
established trading market for the certificates and they may constitute illiquid
investments. See "Risks --Liquidity Risk" in the Prospectus. If market
quotations are not readily available for the certificates, they will be valued
by the Fund at fair value as determined by the Board of Trustees or persons
acting at its direction. The Fund may lose its entire investment in a
credit-linked trust certificate.
Variable and Floating Rate Securities
Variable or floating rate securities are securities that pay interest at
rates which adjust whenever a specified interest rate changes, float at a fixed
margin above a generally recognized base lending rate and/or reset or are
redetermined (e.g., pursuant to an auction) on specified dates (such as the last
day of a month or calendar quarter). These instruments may include, without
limitation, variable rate preferred stock, bank loans, money market instruments
and certain types of mortgage-backed and other asset-backed securities. Due to
their variable or floating rate features, these instruments will generally pay
higher levels of income in a rising interest rate environment and lower levels
of income as interest rates decline. For the same reason, the market value of a
variable or floating rate instrument is generally expected to have less
sensitivity to fluctuations in market interest rates than a fixed-rate
instrument, although the value of a floating rate instrument may nonetheless
decline as interest rates rise and due to other factors, such as changes in
credit quality.
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Event-Linked Bonds
The Fund may invest in "event-linked bonds." Event-linked bonds, which are
sometimes referred to as "catastrophe bonds," are debt obligations for which the
return of principal and payment of interest is contingent on the non-occurrence
of a specific "trigger" event, such as a hurricane or an earthquake. They may be
issued by government agencies, insurance companies, reinsurers, special purpose
corporations or other on-shore or off-shore entities. If a trigger event causes
losses exceeding a specific amount in the geographic region and time period
specified in a bond, the Fund may lose a portion or all of its principal
invested in the bond. If no trigger event occurs, the Fund will recover its
principal plus interest. For some event-linked bonds, the trigger event or
losses may be based on company-wide losses, index-portfolio losses, industry
indexes or readings of scientific instruments rather than specified actual
losses. Often event-linked bonds provide for extensions of maturity that are
mandatory, or optional at the discretion of the issuer, in order to process and
audit loss claims in those cases when a trigger event has, or possibly has,
occurred. In addition to the specified trigger events, event-linked bonds may
also expose the Fund to certain unanticipated risks including but not limited to
issuer (credit) default, adverse regulatory or jurisdictional interpretations
and adverse tax consequences.
Event-linked bonds are a relatively new type of financial instrument. As
such, there is no significant trading history of these securities, and there can
be no assurance that a liquid market in these instruments will develop. Lack of
a liquid market may impose the risk of higher transaction costs and the
possibility that the Fund may be forced to liquidate positions when it would not
be advantageous to do so. Event-linked bonds are typically rated.
U.S. Government Securities
U.S. Government securities are obligations of, or guaranteed by, the U.S.
Government, its agencies or instrumentalities. The U.S. Government does not
guarantee the net asset value of the Fund's shares. Some U.S. Government
securities, such as Treasury bills, notes and bonds, and securities guaranteed
by the GNMA, are supported by the full faith and credit of the United States;
others, such as those of the Federal Home Loan Banks, are supported by the right
of the issuer to borrow from the U.S. Treasury; others, such as those of the
FNMA and the FHLMC, are supported by the discretionary authority of the U.S.
Government to purchase the agency's obligations; and still others, such as those
of the Student Loan Marketing Association, are supported only by the credit of
the instrumentality. Although U.S. Government sponsored enterprises such as
Federal Home Loan Banks, FNMA, FHLMC, and the Student Loan Marketing Association
may be chartered or sponsored by Congress, they are not funded by Congressional
appropriations and their securities are not issued by the U.S. Treasury or
supported by the full faith and credit of the U.S. Government, and include
increased credit risks. U.S. Government securities include securities that have
no coupons, or have been stripped of their unmatured interest coupons,
individual interest coupons from such securities that trade separately, and
evidences of receipt of such securities. Such securities may pay no cash income,
and are purchased at a deep discount from their value at maturity. Custodial
receipts issued in connection with so-called trademark zero-coupon securities,
such as CATs and TIGRs, are not issued by the U.S. Treasury, and are therefore
not U.S. Government securities, although the underlying bond represented by such
receipt is a debt obligation of the U.S. Treasury. Other
-34-
zero-coupon Treasury securities (e.g., STRIPs and CUBEs) are direct obligations
of the U.S. Government.
Rule 144A Securities
The Fund may invest in securities that have not been registered for public
sale, but that are eligible for purchase and sale pursuant to Rule 144A under
the 1933 Act ("Rule 144A Securities"). Rule 144A permits certain qualified
institutional buyers, such as the Fund, to trade in privately placed securities
that have not been registered for sale under that Act. Rule 144A Securities may
be deemed illiquid and thus subject to the Fund's limit on illiquid securities,
although the Fund may determine that certain Rule 144A Securities are liquid in
accordance with procedures adopted by the Board of Trustees.
Initial Public Offerings
The Fund may purchase securities in initial public offerings ("IPOs").
These securities are subject to many of the same risks of investing in companies
with smaller market capitalizations. Securities issued in IPOs have no trading
history, and information about the companies may be available for very limited
periods. In addition, the prices of securities sold in IPOs may be highly
volatile. At any particular time or from time to time the Fund may not be able
to invest in securities issued in IPOs, or invest to the extent desired because,
for example, only a small portion (if any) of the securities being offered in an
IPO may be made available to the Fund. In addition, under certain market
conditions a relatively small number of companies may issue securities in IPOs.
Similarly, as the number of accounts to which IPO securities are allocated
increases, the number of securities issued to any one account (including the
Fund) may decrease. The investment performance of the Fund during periods when
it is unable to invest significantly or at all in IPOs may be lower than during
periods when the Fund is able to do so. In addition, if the Fund increases in
size, the impact of IPOs on the Fund's performance will generally decrease.
When-Issued, Delayed Delivery and Forward Commitment Transactions
The Fund may purchase or sell securities on a when-issued, delayed delivery
or forward commitment basis. When such purchases are outstanding, the Fund will
segregate until the settlement date assets determined to be liquid by the Fund
in accordance with procedures established by the Board of Trustees, in an amount
sufficient to meet the purchase price. Typically, no income accrues on
securities the Fund has committed to purchase prior to the time delivery of the
securities is made, although the Fund may earn income on securities it has
segregated.
When purchasing a security on a when-issued, delayed delivery or forward
commitment basis, the Fund assumes the rights and risks of ownership of the
security, including the risk of price and yield fluctuations, and takes such
fluctuations into account when determining its net asset value. Because the Fund
is not required to pay for the security until the delivery date, these risks are
in addition to the risks associated with the Fund's other investments. If the
Fund remains substantially fully invested at a time when when-issued, delayed
delivery or forward commitment purchases are outstanding, the purchases may
result in a form of leverage.
-35-
When the Fund has sold a security on a when-issued, delayed delivery or
forward commitment basis, the Fund does not participate in future gains or
losses with respect to the security. If the other party to a transaction fails
to deliver or pay for the securities, the Fund could miss a favorable price or
yield opportunity or could suffer a loss. The Fund may dispose of or renegotiate
a transaction after it is entered into, and may sell when-issued, delayed
delivery or forward commitment securities before they are delivered, which may
result in a capital gain or loss. There is no percentage limitation on the
extent to which the Fund may purchase or sell securities on a when-issued,
delayed delivery or forward commitment basis.
Leverage and Borrowings
Although it has no current intention to do so, the Fund reserves the
flexibility to issue preferred shares or debt securities or engage in borrowings
to add leverage to its portfolio. The Fund may also enter into derivative
transactions that may in some circumstances give rise to a form of financial
leverage. However, the Fund ordinarily will cover its positions in these
transactions so that there is no resulting leverage. Any leverage used by the
Fund would be limited to 38% of the Fund's total assets (including the proceeds
of the leverage). To the extent that the Fund uses leverage, it would seek to
obtain a higher return for shareholders than if the Fund did not use leverage.
Leveraging is a speculative technique and there are special risks involved,
including the risk of increased volatility of the Fund's investment portfolio
and potentially larger losses than if the strategies were not used.
If there is a net decrease (or increase) in the value of the Fund's
investment portfolio, any leverage will decrease (or increase) the net asset
value per Common Share to a greater extent than if the Fund were not leveraged.
During periods in which the Fund is using certain forms of leverage, the fees
paid to the Manager and the Sub-Advisers will be higher than if the Fund did not
use leverage because the fees paid will be calculated on the basis of the Fund's
total managed assets, including borrowings that may be outstanding. Thus, the
Manager and the Sub-Advisers have a financial incentive for the Fund to utilize
certain forms of leverage, which may result in a conflict of interest between
the Manager and the Sub-Advisers, on the one hand, and the Common Shareholders,
on the other hand. Fees and expenses paid by the Fund are borne entirely by the
Common Shareholders. These include costs associated with any borrowings or other
forms of leverage utilized by the Fund.
Under the 1940 Act, the Fund generally is not permitted to have outstanding
senior securities representing indebtedness ("borrowings") (including through
the use of reverse repurchase agreements, dollar rolls, futures contracts, loans
of portfolio securities, swap contracts and other derivatives, as well as
when-issued, delayed delivery or forward commitment transactions, to the extent
that these instruments constitute senior securities) unless immediately after
the financing giving rise to the borrowing, the value of the Fund's total assets
less liabilities (other than such borrowings) is at least 300% of the principal
amount of such borrowing (i.e., the principal amount may not exceed 331/3% of
the Fund's total assets). In addition, the Fund is not permitted to declare any
cash dividend or other distribution on Common Shares unless, at the time of such
declaration, the value of the Fund's total assets, less liabilities other than
borrowings, is at least 300% of such principal amount. If the Fund enters into
these transactions, it intends, to the extent possible, to prepay all or a
portion of the principal amount due to the extent necessary in order to maintain
the required asset coverage. Failure to maintain certain
-36-
asset coverage requirements could result in an event of default and entitle
holders of any senior securities of the Fund to elect a majority of the Trustees
of the Fund. Derivative instruments used by the Fund will not constitute senior
securities (and will not be subject to the Fund's limitations on borrowings) to
the extent that the Fund segregates liquid assets at least equal in amount to
its obligations under the instruments, or enters into offsetting transactions or
owns positions covering its obligations. For instance, the Fund may cover its
position in a reverse repurchase agreement by segregating liquid assets at least
equal in amount to its forward purchase commitment.
The Fund may determine in the future to issue preferred shares to add
leverage to its portfolio. Any such preferred shares would have complete
priority upon distribution of assets over the Common Shares. Under the 1940 Act,
the Fund would not be permitted to issue preferred shares unless immediately
after such issuance the value of the Fund's total net assets was at least 200%
of the liquidation value of the outstanding preferred shares plus the aggregate
amount of any senior securities of the Fund representing indebtedness (i.e.,
such liquidation value plus the aggregate amount of senior securities
representing indebtedness may not exceed 50% of the Fund's total net assets). In
addition, the Fund would not be permitted to declare any cash dividend or other
distribution on its Common Shares unless, at the time of such declaration, the
value of the Fund's total net assets satisfies the above-referenced 200%
coverage requirement. If any preferred shares are issued, the Fund intends, to
the extent possible, to purchase or redeem such preferred shares from time to
time to the extent necessary in order to maintain coverage of at least 200%. As
noted above, if the Fund were to issue preferred shares, the leverage obtained
through the preferred shares, together with any other borrowings utilized by the
Fund, would not exceed 38% of the Fund's total assets. If the Fund were to have
preferred shares outstanding, two of the Fund's Trustees would be elected by the
holders of the preferred shares, voting separately as a class. The remaining
Trustees of the Fund would be elected by holders of Common Shares and the
preferred shares voting together as a single class. In the event the Fund were
to fail to pay dividends on any preferred shares it issues for a period of two
years, the Fund's preferred shareholders would be entitled to elect a majority
of the Trustees of the Fund.
As used in this Statement of Additional Information and in the Prospectus,
unless otherwise noted, the Fund's "net assets" include assets of the Fund
attributable to any outstanding preferred shares, with no deduction for the
liquidation preference of the preferred shares. Solely for financial reporting
purposes, however, the Fund is required to exclude the liquidation preference of
and preferred shares from "net assets," so long as any preferred shares have
redemption features that are not solely within the control of the Fund. For all
regulatory and tax purposes, and preferred shares issued by the Fund will be
treated as stock (rather than indebtedness).
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements and economically
similar transactions for hedging or cash management purposes. Although it has
not current intention to do so, the Fund may also utilize these transactions to
add leverage to its portfolio. A reverse repurchase agreement involves the sale
of a portfolio-eligible security by the Fund, coupled with its agreement to
repurchase the instrument at a specified time and price. Generally, the effect
of
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such a transaction is that the Fund can recover and reinvest all or most of
the cash invested in the portfolio securities involved during the term of the
reverse repurchase agreement and still be entitled to the returns associated
with those portfolio securities. Such transactions are advantageous if the
interest cost to the Fund of the reverse repurchase transaction is less than the
returns it obtains on investments purchased with the cash.
Reverse repurchase agreements involve leverage risk and also the risk that
the market value of the securities that the Fund is obligated to repurchase
under the agreement may decline below the repurchase price. In the event the
buyer of securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, the Fund's use of the proceeds of the agreement may be
restricted pending a determination by the other party, or its trustee or
receiver, whether to enforce the Fund's obligation to repurchase the securities.
The Fund may (but is not required to) segregate assets determined to be
liquid by the Fund in accordance with procedures established by the Board of
Trustees, equal (on a daily mark-to-market basis) to its obligations under
reverse repurchase agreements. To the extent that positions in reverse
repurchase agreements are not so covered, such transactions would be subject to
the Fund's limitations on borrowings. See "Leverage and Borrowings" above.
The Fund also may effect simultaneous purchase and sale transactions that
are known as "sale buybacks." A sale buyback is similar to a reverse repurchase
agreement, except that in a sale buyback, the counterparty who purchases the
security is entitled to receive any payments made on the underlying security
pending settlement of the Fund's repurchase of the underlying security.
Repurchase Agreements
For the purposes of maintaining liquidity and achieving income, the Fund
may enter into repurchase agreements with domestic commercial banks or
registered broker/dealers. A repurchase agreement is a contract under which the
Fund would acquire a security for a relatively short period (usually not more
than one week) subject to the obligation of the seller to repurchase and the
Fund to resell such security at a fixed time and price (representing the Fund's
cost plus interest). In the case of repurchase agreements with broker-dealers,
the value of the underlying securities (or collateral) will be at least equal at
all times to the total amount of the repurchase obligation, including the
interest factor. The Fund bears a risk of loss in the event that the other party
to a repurchase agreement defaults on its obligations and the Fund is delayed or
prevented from exercising its rights to dispose of the collateral securities.
This risk includes the risk of procedural costs or delays in addition to a loss
on the securities if their value should fall below their repurchase price. The
applicable Sub-Adviser will monitor the creditworthiness of the counter parties.
Short Sales
The Fund may make short sales of securities for hedging or risk management
purposes. A short sale is a transaction in which the Fund sells a security it
does not own in anticipation that the market price of that security will
decline.
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When the Fund makes a short sale on a security, it must borrow the security
sold short and deliver it to the broker-dealer through which it made the short
sale as collateral for its obligation to deliver the security upon conclusion of
the sale. The Fund may have to pay a fee to borrow particular securities and is
often obligated to pay over any accrued interest and dividends on such borrowed
securities. If the Fund is required to pay over any dividends received by the
Fund pursuant to a short sale, such dividends will not be treated as qualified
dividend income.
If the price of the security sold short increases between the time of the
short sale and the time the Fund replaces the borrowed security, the Fund will
incur a loss; conversely, if the price declines, the Fund will realize a capital
gain. Any gain will be decreased, and any loss increased, by the transaction
costs described above. The successful use of short selling may be adversely
affected by imperfect correlation between movements in the price of the security
sold short and the securities being hedged.
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer. The Fund will engage in short sales that are
"against the box" -- i.e., where the Fund contemporaneously owns, or has the
right to obtain at no added cost, securities identical to those sold short. The
Fund will not engage in so-called "naked" short sales where it does not own or
have the immediate right to acquire the security sold short at no additional
cost. Otherwise, the Fund has the flexibility to engage in short selling to the
extent permitted by the 1940 Act and rules and interpretations thereunder.
Illiquid Securities
The Fund may invest up to 15% of its total assets in securities which are
illiquid at the time of investment. The term "illiquid securities" for this
purpose is determined using the SEC's standard applicable to open-end investment
companies, i.e., securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the value at which the Fund has
valued the securities. Illiquid securities are considered to include, among
other things, written over-the-counter options, securities or other liquid
assets being used as cover for such options, repurchase agreements with
maturities in excess of seven days, certain loan participation interests, fixed
time deposits which are not subject to prepayment or provide for withdrawal
penalties upon prepayment (other than overnight deposits), and other securities
whose disposition is restricted under the federal securities laws (other than
securities issued pursuant to Rule 144A under the 1933 Act and certain
commercial paper that a Sub-Adviser has determined to be liquid under procedures
approved by the Board of Trustees).
Illiquid securities may include privately placed securities, which are sold
directly to a small number of investors, usually institutions. Unlike public
offerings, such securities are not registered under the federal securities laws.
Although certain of these securities may be readily sold, others may be
illiquid, and their sale may involve substantial delays and additional costs.
Portfolio Trading and Turnover Rate
Portfolio trading may be undertaken to accomplish the investment objectives
of the Fund. In addition, a security may be sold and another of comparable
quality purchased at approximately the same time to take advantage of what a
Sub-Adviser believes to be a temporary
-39-
price disparity between the two securities. Temporary price disparities between
two comparable securities may result from supply and demand imbalances where,
for example, a temporary oversupply of certain securities may cause a
temporarily low price for such securities, as compared with other securities of
like quality and characteristics. Securities may be sold in anticipation of a
market decline or purchased in anticipation of a market rise and later sold, or
to recognize a gain.
A change in the securities held by the Fund is known as "portfolio
turnover." The Fund's Index Option Strategy may result in increased portfolio
turnover to the extent that the Fund is required to sell portfolio securities to
satisfy its obligations as the writer of an index call option or to realize
additional gains to be distributed to shareholders if the Index Option Strategy
is unsuccessful. The use of certain other derivative instruments with relatively
short maturities may tend to exaggerate the portfolio turnover rate for the
Fund. The annual rebalancing of the Fund's portfolio to adjust the asset
allocation between the Equity Component and the Convertible Component, as
described in the Prospectus, is likely to increase the portfolio turnover rate
for the Fund. There is no stated limit on the Fund's portfolio turnover rate.
High portfolio turnover (e.g., greater than 100%) involves correspondingly
greater expenses to the Fund, including brokerage commissions or dealer mark-ups
and other transaction costs on the sale of securities and reinvestments in other
securities. Trading in equity securities generally involves the payment of
brokerage commissions. Trading in debt obligations does not generally involve
the payment of brokerage commissions, but does involve indirect transaction
costs. The use of futures contracts may involve the payment of commissions to
futures commission merchants. The higher the rate of portfolio turnover of the
Fund, the higher the transaction costs borne by the Fund generally will be.
Transactions in the Fund's portfolio securities may result in realization of
taxable capital gains (including short-term capital gains which are generally
taxed to shareholders at ordinary income tax rates). The trading costs and tax
effects associated with portfolio turnover may adversely affect the Fund's
performance.
The portfolio turnover rate of the Fund is calculated by dividing (a) the
lesser of purchases or sales of portfolio securities for the particular fiscal
year by (b) the monthly average of the value of the portfolio securities owned
by the Fund during the particular fiscal year. In calculating the rate of
portfolio turnover, there is excluded from both (a) and (b) all securities,
including options, whose maturities or expiration dates at the time of
acquisition were one year or less.
Securities Loans
Subject to the Fund's "Investment Restrictions" listed below, the Fund may
make secured loans of its portfolio securities to brokers, dealers and other
financial institutions amounting to no more than one-third of the Fund's total
assets. The risks in lending portfolio securities, as with other extensions of
credit, consist of possible delay in recovery of the securities or possible loss
of rights in the collateral should the borrower fail financially. However, such
loans will be made only to broker-dealers that are believed by the Fund to be of
relatively high credit standing. Securities loans are made to broker-dealers
pursuant to agreements requiring that loans be continuously secured by
collateral consisting of U.S. Government securities, cash or cash equivalents
(negotiable certificates of deposit, bankers' acceptances or letters of credit)
maintained on a daily mark-to-market basis in an amount at least equal at all
times to the market
-40-
value of the securities lent. The borrower pays to the Fund, as the lender, an
amount equal to any dividends or interest received on the securities lent. Such
amounts will not be eligible to be treated as qualified dividend income. The
Fund may invest only the cash collateral received in interest-bearing,
short-term securities or receive a fee from the borrower. In the case of cash
collateral, the Fund typically pays a rebate to the lender. Although voting
rights or rights to consent with respect to the loaned securities pass to the
borrower, the Fund, as the lender, retains the right to call the loans and
obtain the return of the securities loaned at any time on reasonable notice, and
it will do so in order that the securities may be voted by the Fund if the
holders of such securities are asked to vote upon or consent to matters
materially affecting the investment. The Fund may also call such loans in order
to sell the securities involved. When engaged in securities lending, the Fund's
performance will continue to reflect changes in the value of the securities
loaned and will also reflect the receipt of either interest, through investment
of cash collateral by the Fund in permissible investments, or a fee, if the
collateral is U.S. Government securities.
Participation on Creditors Committees
The Fund may from time to time participate on committees formed by
creditors to negotiate with the management of financially troubled issuers of
securities held by the Fund. Such participation may subject the Fund to expenses
such as legal fees and may make the Fund an "insider" of the issuer for purposes
of the federal securities laws, and therefore may restrict the Fund's ability to
trade in or acquire additional positions in a particular security when it might
otherwise desire to do so. Participation by the Fund on such committees also may
expose the Fund to potential liabilities under the federal bankruptcy laws or
other laws governing the rights of creditors and debtors. The Fund would
participate on such committees only when a the Manager believes that such
participation is necessary or desirable to enforce the Fund's rights as a
creditor or to protect the value of securities held by the Fund.
Short-Term Investments / Temporary Defensive Strategies
Upon recommendation of a Sub-Adviser, for temporary defensive purposes, the
Fund may deviate from its investment objectives and the typical portfolio
securities in which the Fund invests by investing some or all of its total
assets in investments such as high grade debt securities, including high
quality, short-term debt securities, and cash and cash equivalents. The Fund may
not achieve its investment objectives when this occurs. The Fund also may
deviate from its investment objectives in order to keep its assets fully
invested, including during the period in which the net proceeds of this offering
are being invested. See "Use of Proceeds" in the Prospectus.
-41-
INVESTMENT RESTRICTIONS
Fundamental Investment Restrictions
Except as described below, the Fund, as a fundamental policy, may not,
without the approval of the holders of a majority of the Fund's outstanding
shares:
(1) Concentrate its investments in a particular "industry," as that
term is used in the 1940 Act, and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to time.
(2) With respect to 75% of the Fund's total assets, purchase the
securities of any issuer, except securities issued or guaranteed by the
U.S. Government or any of its agencies or instrumentalities or securities
issued by other investment companies, if, as a result, (i) more than 5% of
the Fund's total assets would be invested in the securities of that issuer,
or (ii) the Fund would hold more than 10% of the outstanding voting
securities of that issuer.
(3) Purchase or sell real estate, although it may purchase securities
secured by real estate or interests therein, or securities issued by
companies which invest in real estate, or interests therein.
(4) Act as an underwriter of securities of other issuers, except to
the extent that in connection with the disposition of portfolio securities,
it may be deemed to be an underwriter under the federal securities laws.
(5) Purchase or sell commodities or commodities contracts or oil, gas
or mineral programs. This restriction shall not prohibit the Fund, subject
to restrictions described in the Prospectus and elsewhere in this Statement
of Additional Information, from purchasing, selling or entering into
futures contracts, options on futures contracts, forward contracts, or any
interest rate, securities-related or other hedging instrument, including
swap agreements and other derivative instruments, subject to compliance
with any applicable provisions of the federal securities or commodities
laws.
(6) Borrow money or issue any senior security, except to the extent
permitted under the 1940 Act, and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to time.
(7) Make loans, except to the extent permitted under the 1940 Act, and
as interpreted, modified, or otherwise permitted by regulatory authority
having jurisdiction, from time to time.
Currently, under the 1940 Act, the Fund generally is not permitted to
engage in borrowings unless immediately after a borrowing the value of the
Fund's total assets less liabilities (other than the borrowing) is at least 300%
of the principal amount of such borrowing (i.e., such principal amount may not
exceed 33 1/3% of the Fund's total assets). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on Common Shares
-42-
unless, at the time of such declaration, the value of the Fund's total assets,
less liabilities other than borrowing, is at least 300% of such principal
amount.
For purposes of the foregoing, "majority of the outstanding," when used
with respect to particular shares of the Fund (whether voting together as a
single class or voting as separate classes), means (i) 67% or more of such
shares present at a meeting, if the holders of more than 50% of such shares are
present or represented by proxy, or (ii) more than 50% of such shares, whichever
is less.
Unless otherwise indicated, all limitations applicable to the Fund's or a
particular Component's investments (as stated above and elsewhere in this
Statement of Additional Information) apply only at the time a transaction is
entered into. Any subsequent change in a rating assigned by any rating service
to a security (or, if unrated, deemed by a Sub-Adviser to be of comparable
quality), or change in the percentage of the Fund's or a Component's total
assets invested in certain securities or other instruments, or change in the
average maturity or duration of the Fund's or a Component's investment
portfolio, resulting from market fluctuations or other changes in the Fund's or
a Component's total assets, will not require the Fund to dispose of an
investment until the applicable Sub-Adviser determines that it is practicable to
sell or close out the investment without undue market or tax consequences to the
Fund or a Component. In the event that rating agencies assign different ratings
to the same security, the applicable Sub-Adviser will determine which rating it
believes best reflects the security's quality and risk at that time, which may
be the higher of the several assigned ratings.
Under the 1940 Act, a "senior security" does not include any promissory
note or evidence of indebtedness where such loan is for temporary purposes only
and in an amount not exceeding 5% of the value of the total assets of the issuer
at the time the loan is made. A loan is presumed to be for temporary purposes if
it is repaid within sixty days and is not extended or renewed.
The Fund would be deemed to "concentrate" in a particular industry if it
invested 25% or more of its total assets in that industry. The Fund's industry
concentration policy does not preclude it from focusing investments in issuers
in a group of related industrial sectors (such as different types of utilities).
The Fund may not change its policy normally to invest at least 80% of its
net assets (plus any borrowings for investment purposes) in securities and other
instruments that provide dividends, interest or option premiums unless it
provides shareholders with written notice of such change if and to the extent
required by the 1940 Act and the rules thereunder.
To the extent the Fund covers its commitment under a reverse repurchase
agreement or derivative instrument or other borrowing by the segregation of
liquid assets, equal in value to the amount of the Fund's commitment, or by
entering into offsetting positions, such instrument will not be considered a
"senior security" for purposes of the asset coverage requirements otherwise
applicable to borrowings by the Fund.
The Fund interprets its policies with respect to borrowing and lending to
permit such activities as may be lawful for the Fund, to the full extent
permitted by the 1940 Act or by exemption from the provisions therefrom pursuant
to an exemptive order of the SEC.
-43-
MANAGEMENT OF THE FUND
Trustees and Officers
The business of the Fund is managed under the direction of the Fund's Board
of Trustees. Subject to the provisions of the Fund's Fourth Amended Agreement
and Declaration of Trust (the "Declaration"), its Bylaws and Massachusetts law,
the Trustees have all powers necessary and convenient to carry out this
responsibility, including the election and removal of the Fund's officers.
The Trustees and officers of the Fund, their ages, the position they hold
with the Fund, their term of office and length of time served, a description of
their principal occupations during the past five years, the number of portfolios
in the fund complex (as defined in SEC regulations) that the Trustee oversees
and any other directorships held by the Trustee are listed in the two tables
immediately following. Except as shown, each Trustee's and officer's principal
occupation and business experience for the last five years have been with the
employer(s) indicated, although in some cases the Trustee may have held
different positions with such employer(s). Unless otherwise indicated, the
business address of the persons listed below is c/o PA Fund Management LLC, 1345
Avenue of the Americas, New York, New York 10105.
-44-
Independent Trustees
Number of
Term of Portfolios in
Position(s) Office and Fund Complex Other
Held with Length of Principal Occupation(s) During the Overseen by Directorships
Name, Address and Age Fund Time Served Past 5 Years Trustee Held by Trustee
--------------------- ----------- ----------- ---------------------------------- ------------- ---------------
Robert E. Connor* Trustee Since Trustee, Fixed Income SHares, 21 None.
Age 70 Inception Nicholas-Applegate Convertible &
(February, Income Fund, Nicholas Applegate
2005.) Convertible & Income Fund II,
PIMCO Corporate Opportunity Fund,
PIMCO Corporate Income Fund, PIMCO
High Income Fund, PIMCO Municipal
Income Fund, PIMCO California
Municipal Income Fund, PIMCO New
York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO
California Municipal Income Fund
II, PIMCO New York Municipal
Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California
Municipal Income Fund III, PIMCO
New York Municipal Income Fund
III, PIMCO Floating Rate Income
Fund and PIMCO Floating Rate
Strategy Fund; Director, Municipal
Advantage Fund, Inc.; Corporate
Affairs Consultant. Formerly,
Senior Vice President, Corporate
Office, Smith Barney.
-45-
Number of
Term of Portfolios in
Position(s) Office and Fund Complex Other
Held with Length of Principal Occupation(s) During the Overseen by Directorships
Name, Address and Age Fund Time Served Past 5 Years Trustee Held by Trustee
--------------------- ----------- ----------- ---------------------------------- ------------- ---------------
John J. Dalessandro Trustee Since President and Director, J.J. 16 None.
II Inception D'Alessandro II Ltd., registered
Age 66 (February, broker-dealer and member of the
2005) New York Stock Exchange; Trustee,
Nicholas-Applegate Convertible &
Income Fund, Nicholas-Applegate
Convertible & Income Fund II,
PIMCO Corporate Opportunity Fund,
PIMCO Corporate Income Fund, PIMCO
High Income Fund, PIMCO Municipal
Income Fund, PIMCO California
Municipal Income Fund, PIMCO New
York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO
California Municipal Income Fund
II, PIMCO New York Municipal
Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California
Municipal Income Fund III, PIMCO
New York Municipal Income Fund
III, PIMCO Floating Rate Income
Fund and PIMCO Floating Rate
Strategy Fund.
Hans W. Kertess Trustee Since President, H. Kertess & Co.; 16 None.
Age 65 Inception Trustee, PIMCO Corporate Income
(February, Fund, PIMCO High Income Fund,
2005) Nicholas Applegate Convertible &
Income Fund II, PIMCO Municipal
Income Fund, PIMCO California
Municipal Income Fund, PIMCO New
York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO
California Municipal Income Fund
II, PIMCO New York Municipal
Income Fund II, PIMCO Municipal
Income Fund III, PIMCO Municipal
California Municipal Income Fund
III, PIMCO New York Municipal
Income Fund III, PIMCO Floating
Rate Income Fund and PIMCO
Floating Rate Strategy Fund;
Formerly, Managing Director and
Consultant, Royal Bank of Canada
Capital Markets.
-46-
In accordance with the Fund's staggered board (see "Anti-Takeover and Other
Provisions in the Declaration of Trust"), the Common Shareholders of the Fund
will elect Trustees to fill the vacancies of Trustees whose terms expire at each
annual meeting of shareholders.
Officers
Position(s) Term of Office
Held with and Length of
Name, Address and Age Fund Time Served Principal Occupation(s) During the Past 5 Years
--------------------- ----------- -------------- -----------------------------------------------
Brian S. Shlissel President Since Executive Vice President and Chief
Age 39 and Chief inception Administrative Officer, PA Fund Management LLC;
Executive (February, President and Chief Executive Officer, PIMCO
Officer 2005). Advisors VIT (formerly OCC Accumulation Trust);
President and Chief Executive Officer, Fixed
Income SHares, Nicholas-Applegate Convertible &
Income Fund, Nicholas-Applegate Convertible &
Income Fund II, PIMCO Corporate Opportunity
Fund, PIMCO Corporate Income Fund, PIMCO
Municipal Income Fund, PIMCO California
Municipal Income Fund, PIMCO New York Municipal
Income Fund, PIMCO Municipal Income Fund II,
PIMCO California Municipal Income Fund II,
PIMCO New York Municipal Income Fund II, PIMCO
Municipal Income Fund III, PIMCO California
Municipal Income Fund III, PIMCO New York
Municipal Income Fund III, Municipal Advantage
Fund, Inc., PIMCO High Income Fund, PIMCO
Floating Rate Income Fund and PIMCO Floating
Rate Strategy Fund.
Lawrence G. Altadonna Treasurer; Since Senior Vice President, PA Fund Management LLC;
Age 38 Principal inception Treasurer and Principal Financial and
Financial (February, Accounting Officer, Nicholas-Applegate
and 2005). Convertible & Income Fund, Nicholas-Applegate
Accounting Convertible & Income Fund II, PIMCO Corporate
Officer Opportunity Fund, PIMCO Corporate Income Fund,
PIMCO Municipal Income Fund, PIMCO California
Municipal Income Fund, PIMCO New York Municipal
Income Fund, PIMCO Municipal Income Fund II,
PIMCO California Municipal Income Fund II,
PIMCO New York Municipal Income Fund II, PIMCO
Municipal Income Fund III, PIMCO California
Municipal Income Fund III, PIMCO New York
Municipal Income Fund III, Municipal Advantage
Fund, Inc., PIMCO High Income Fund, PIMCO
Floating Rate Income Fund and PIMCO Floating
Rate Strategy Fund; Treasurer, Fixed Income
SHares; Assistant Treasurer, PIMCO Advisors VIT
(formerly OCC Accumulation Trust). Formerly,
Director of Fund Administration, Prudential
Investments.
-47-
Position(s) Term of Office
Held with and Length of
Name, Address and Age Fund Time Served Principal Occupation(s) During the Past 5 Years
--------------------- ----------- -------------- -----------------------------------------------
Thomas J. Fuccillo Secretary Since Vice President, Senior Fund Attorney, Allianz
1345 Avenue of the and Chief inception Global Investors of America L.P., Secretary,
Americas Legal (February, PIMCO Municipal Income Fund, PIMCO California
New York, NY 10105 Officer 2005). Municipal Income Fund, PIMCO New York Municipal
Age 36 Income Fund, PIMCO Municipal Income Fund II,
PIMCO California Municipal Income Fund II,
PIMCO New York Municipal Income Fund II, PIMCO
Municipal Income Fund III, PIMCO California
Municipal Income Fund III, PIMCO New York
Municipal Income Fund III, PIMCO Corporate
Income Fund, PIMCO Corporate Opportunity Fund,
PIMCO High Income Fund, Nicholas-Applegate
Convertible & Income Fund, Nicholas-Applegate
Convertible & Income Fund II, PIMCO Floating
Rate Income Fund, PIMCO Floating Rate Strategy
Fund, Municipal Advantage Fund Inc., Fixed
Income SHares and PIMCO Advisors VIT. Formerly,
Vice President and Associate General Counsel,
Neuberger Berman Management Inc.
Youse Guia Chief Since Senior Vice President, Group Compliance
888 San Clemente Compliance inception Manager, Allianz Global Investors of America
Drive, Officer (February, L.P. (since 2004). Chief Compliance Officer,
Suite 100 2005). PIMCO Funds: Multi-Manager Series, PIMCO
Newport Beach, Municipal Income Fund, PIMCO California
CA 92660 Municipal Income Fund, PIMCO New York Municipal
Age 32 Income Fund, PIMCO Municipal Income Fund II,
PIMCO California Municipal Income Fund II,
PIMCO New York Municipal Income Fund II, PIMCO
Municipal Income Fund III, PIMCO California
Municipal Income Fund III, PIMCO New York
Municipal Income Fund III, PIMCO Corporate
Income Fund, PIMCO Corporate Opportunity Fund,
Nicholas-Applegate Convertible & Income Fund,
PIMCO High Income Fund, Nicholas-Applegate
Convertible & Income Fund II, PIMCO Floating
Rate Income Fund, PIMCO Floating Rate Strategy
Fund, Municipal Advantage Fund, Inc, Fixed
Income SHares and PIMCO Advisors VIT. Formerly,
Vice President, Group Compliance Manager,
Allianz Global Investors of America L.P.
(since 2002). Audit Manager,
PricewaterhouseCoopers LLP (1996-2002).
-48-
Position(s) Term of Office
Held with and Length of
Name, Address and Age Fund Time Served Principal Occupation(s) During the Past 5 Years
--------------------- ----------- -------------- -----------------------------------------------
Newton B. Schott, Jr. Vice Since Managing Director, Chief Administrative
2187 Atlantic Street President inception Officer, General Counsel and Secretary, PA
Stamford, CT 06902 (February, Distributors LLC; Managing Director, Chief
Age 62 2005). Legal Officer and Secretary, PA Fund Management
LLC; Vice President and Secretary, PIMCO Funds:
Multi-Manager Series; Vice President, Fixed
Income SHares, PIMCO Municipal Income Fund,
PIMCO California Municipal Income Fund, PIMCO
New York Municipal Income Fund, PIMCO Municipal
Income Fund II, PIMCO California Municipal
Income Fund II, PIMCO New York Municipal Income
Fund II, PIMCO Municipal Income Fund III, PIMCO
California Municipal Income Fund III, PIMCO New
York Municipal Income Fund III, PIMCO Corporate
Income Fund, PIMCO Corporate Opportunity Fund,
Nicholas-Applegate Convertible & Income Fund,
PIMCO High Income Fund, Nicholas-Applegate
Convertible & Income Fund II, PIMCO Floating
Rate Income Fund and PIMCO Floating Rate
Strategy Fund; Executive Vice President,
Municipal Advantage Fund, Inc.
For interested Trustees and officers, positions held with affiliated
persons or principal underwriters of the Fund are listed in the following table:
Positions Held with Affiliated Persons or
Name Principal Underwriters of the Fund
--------------------- -----------------------------------------
Brian S. Shlissel See above.
Lawrence Altadonna See above.
Newton B. Schott, Jr. See above.
Thomas J. Fuccillo See above.
Youse Guia See above.
Committees of the Board of Trustees
Audit Oversight Committee
The Fund has established an Audit Oversight Committee in accordance with
Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The
Fund's Audit Oversight Committee provides oversight with respect to the internal
and external accounting and auditing procedures of the Fund and, among other
things, determines the selection of independent registered public accounting
firm for the Fund and considers the scope of the audit, approves all audit and
permitted non-audit services proposed to be performed by the independent
registered public accounting firm on behalf of the Fund, and services to be
performed by the independent registered public accounting firm for certain
affiliates, including the Manager and the Sub- Advisers, and the entities in a
control relationship with the Manager or Sub-Advisers that provide services to
the Fund where the engagement relates directly to the operations and financial
reporting of the Fund. Messrs. Connor, Kertess and D'Alessandro, each of whom is
an Independent Trustee, serve on this committee.
-49-
Nominating Committee
The Nominating Committee is responsible for reviewing and recommending
qualified candidates to the Board in the event that a position is vacated or
created. The Nominating Committee will review and consider nominees recommended
by shareholders to serve as Trustee, provided any such recommendation is
submitted in writing to the Fund, c/o Thomas J. Fuccillo, Secretary, at the
address of the principal executive offices of the Fund. The Nominating Committee
has full discretion to reject nominees recommended by shareholders, and there is
no assurance that any such person so recommended and considered by a committee
will be nominated for election to the Board. Messrs. Connor and Kertess, each of
whom is an Independent Trustee, serve on this committee.
Valuation Committee
The Board has a Valuation Committee, to which the Board has delegate the
responsibility to determine or cause to be determined the fair value of the
Fund's portfolio securities and other assets when market quotations are not
readily available. The Valuation Committee reviews and approves procedures for
the fair valuation of the Fund's portfolio securities and periodically reviews
information from the Manager and Sub-Advisers regarding fair value and liquidity
determinations made pursuant to the Board-approved procedures, and makes related
recommendations to the full Board and assists the full Board in resolving
particular fair valuation and other valuation matters. Messrs. Connor and
Kertess, each of whom is an Independent Trustee, serve on this committee.
Compensation Committee
The Compensation Committee meets as the Board deems necessary to review and
make recommendations regarding compensation payable to the Trustees of the Fund
who are not directors, officers, partners or employees of the Manager,
Sub-Advisers or any entity controlling, controlled by or under common control
with the Manager or Sub-Advisers. Messrs. Connor and Kertess, each of whom is an
Independent Trustee, serve on this committee.
Securities Ownership
For each Trustee, the following table discloses the dollar range of equity
securities beneficially owned by the Trustee in the Fund and, on an aggregate
basis, in any registered investment companies overseen by the Trustee within the
Fund's family of investment companies as of December 31, 2004:
Aggregate Dollar Range of Equity Securities in
Dollar Range of Equity All Registered Investment Companies Overseen
Name of Trustee Securities in the Fund by Trustee in Family of Investment Companies
----------------------- ---------------------- ----------------------------------------------
Robert E. Connor None. None.
John J. D'Alessandro II None. None.
Hans W. Kertess None. None.
For independent Trustees and their immediate family members, the following
table provides information regarding each class of securities owned beneficially
in an investment
-50-
adviser or principal underwriter of the Fund, or a person (other than a
registered investment company) directly or indirectly controlling, controlled
by, or under common control with an investment adviser or principal underwriter
of the Fund as of December 31, 2004:
Name of Owners
and Relationships Value of Percent of
Name of Trustee to Trustee Company Title of Class Securities Class
----------------------- ----------------- ------- -------------- ---------- ----------
Robert E. Connor None.
John J. D'Alessandro II None.
Hans W. Kertess None.
As of , 2005, the Fund's officers and Trustees as a group owned
--------
less than 1% of the outstanding Common Shares.
As of , 2005, the following persons owned of record the number of
--------
Common Shares noted below, representing the indicated percentage of the Fund's
outstanding equity securities as of such date. Many of these shares are believed
to be held only as nominee. To the knowledge of the Fund, no other person owned
of record or beneficially 5% or more of the Fund's outstanding equity securities
on such date.
Percentage of the
Fund's outstanding
Number of Common shares as of
Shareholder Shares February , 2005
---------------------------------------- ---------------- ------------------
Allianz Global Investors of America L.P.
1345 Avenue of the Americas
New York, New York 10105
Compensation
Messrs. Connor, Kertess and D'Alessandro also serve as Trustees of PIMCO
Municipal Income Fund, PIMCO California Municipal Income Fund, PIMCO New York
Municipal Income Fund, PIMCO Municipal Income Fund II, PIMCO California
Municipal Income Fund II, PIMCO New York Municipal Income Fund II, PIMCO
Municipal Income Fund III, PIMCO California Municipal Income Fund III and PIMCO
New York Municipal Income Fund III (together, the "Municipal Funds"),
Nicholas-Applegate Convertible & Income Fund, Nicholas-Applegate Convertible &
Income Fund II, PIMCO Corporate Opportunity Fund, PIMCO High Income Fund, PIMCO
Corporate Income Fund, PIMCO Floating Rate Income Fund and PIMCO
Floating Rate Strategy Fund, sixteen closed-end funds for which the Manager
serves as investment manager and affiliates of the Manager serve as portfolio
manager. Mr. Connor also is a director or trustee, as the case may be, of one
open-end investment company (comprising four separate investment portfolios). As
indicated above, certain of the officers of the Fund are affiliated with the
Manager.
The Municipal Funds, Nicholas-Applegate Convertible & Income Fund,
Nicholas-Applegate Convertible & Income Fund II, PIMCO Corporate Opportunity
Fund, PIMCO High Income Fund, PIMCO Corporate Income Fund, PIMCO Floating Rate
Income Fund, PIMCO
-51-
Floating Rate Strategy Fund and the Fund (together, the "PA Closed-End Funds")
are expected to hold joint meetings of their Boards of Trustees whenever
possible. Each Trustee, other than any Trustee who is a director, officer,
partner or employee of the Manager, NFJ, NACM, PEA or any entity controlling,
controlled by or under common control with the Manager, NFJ, NACM or PEA,
receives compensation for their attendance at joint meetings and their service
on Board committees. For their service as Trustees of the PA Closed-End Funds,
Messrs. Connor, Kertess and Dalessandro receive $25,000 for each joint meeting
for the first four joint meetings in each year and $5,000 for each additional
joint meeting in such year if the meetings are attended in person. Messrs.
Connor, Kertess and Dalessandro receive $1,000 per joint meeting if the meetings
are attended telephonically. For their services as members of various Audit
Oversight Committees, Messrs. Connor, Kertess and Dalessandro will each receive
$1,000 per fund per meeting respectively, for each of those PA Closed-End Funds
for which they serve as Trustee. Mr. Kertess receives $500 per fund per year for
each of the PA Closed-End Funds for which he serves as Chair of the Audit
Committee. Trustees will also be reimbursed for meeting-related expenses. As
Chairman of the PA Closed-end Funds, Mr. Connor receives $2,500 per fund per
year.
Each Trustee's compensation and other costs of joint meetings will be
allocated pro rata among the PA Closed-End Funds for which such Trustee serves
as Trustee based on each such Fund's relative net assets.
It is estimated that the Trustees will receive the amounts set forth in the
following table from the Fund for its initial fiscal year ending January 31,
2006. For the calendar year ended December 31, 2004, the Trustees received the
compensation set forth in the following table for serving as trustees of other
funds in the "Fund Complex." Each officer or Trustee who is a director, officer,
partner or employee of the Manager, a Sub-Adviser or any entity controlling,
controlled by or under common control with the Manager or a Sub-Adviser serves
without any compensation from the Fund.
Total Compensation
Estimated Compensation from the Fund Complex
from the Fund for the Paid to the Trustees for the
Fiscal Year Ending Calendar Year Ending
Name of Trustee January 31, 2006* December 31, 2004
----------------------- ---------------------- ----------------------------
Robert E. Connor $4,050 $151,286
John J. Dalessandro II $1,550 $121,539
Hans W. Kertess $2,050 $131,705
----------
* Since the Fund has not completed its first full fiscal year, compensation
is estimated based upon future payments to be made by the Fund during the
current fiscal year and upon estimated relative net assets of the PA
Closed-End Funds for which the particular Trustee serves.
The Fund has no employees. Its officers are compensated by the Manager
and/or the Sub-Advisers.
-52-
Codes of Ethics
The Fund, the Manager, NFJ, NACM and PEA have each adopted separate codes
of ethics governing personal trading activities of, as applicable, all Trustees
and officers of the Fund, and directors, officers and employees of the Manager
and Sub-Advisers, who, in connection with their regular functions, play a role
in the recommendation of any purchase or sale of a security by the Fund or
obtain information pertaining to such purchase or sale or who have the power to
influence the management or policies of the Fund, the Manager or a Sub-Adviser,
as applicable. Such persons are prohibited from effecting certain transactions,
allowed to effect certain exempt transactions (including with respect to
securities that may be purchased or held by the Fund), and are required to
preclear certain security transactions with the applicable compliance officer or
his designee and to report certain transactions on a regular basis. The Fund,
the Manager, NFJ, NACM and PEA have each developed procedures for administration
of their respective codes. Text-only versions of the codes of ethics can be
viewed online or downloaded from the EDGAR Database on the SEC's internet web
site at www.sec.gov. You may also review and copy those documents by visiting
the SEC's Public Reference Room in Washington, DC. Information on the operation
of the Public Reference Room may be obtained by calling the SEC at (202)
942-8090. In addition, copies of the codes of ethics may be obtained, after
mailing the appropriate duplicating fee, by writing to the SEC's Public
Reference Section, 450 5th Street, N.W., Washington, DC 20549-0102 or by e-mail
request at publicinfo@sec.gov.
INVESTMENT MANAGER AND PORTFOLIO MANAGERS
Investment Manager
The Manager serves as investment manager to the Fund pursuant to an
investment management agreement (the "Investment Management Agreement") between
it and the Fund. The Manager is a wholly-owned indirect subsidiary of Allianz
Global Investors of America L.P. ("Allianz of America"). Allianz of America was
organized as a limited partnership under Delaware law in 1987. Allianz of
America's sole general partner is Allianz-Paclife Partners LLC. Allianz-Paclife
Partners LLC is a Delaware limited liability company with three members, ADAM
U.S. Holding LLC, a Delaware limited liability company, Pacific Asset Management
LLC, a Delaware limited liability company and the managing member, and Pacific
Life Insurance Company ("Pacific Life"), a California stock life insurance
company. Pacific Asset Management LLC is a wholly-owned subsidiary of Pacific
Life, which is a wholly-owned subsidiary of Pacific Mutual Holding Company.
Pacific Life owns an indirect minority equity interest in Allianz of America.
The sole member of ADAM U.S. Holding LLC is Allianz Dresdner Asset Management of
America LLC. Allianz Dresdner Asset Management of America LLC has two members,
Allianz of America, Inc. ("Allianz of America"), a Delaware corporation which
owns a 99.9% non-managing interest, and Allianz Dresdner Asset Management of
America Holding Inc., a Delaware corporation which owns a 0.01% managing
interest. Allianz of America is a wholly-owned subsidiary of Allianz
Aktiengesellschaft ("Allianz AG"). Allianz Dresdner Asset Management of America
Holding Inc. is a wholly-owned subsidiary of Allianz Dresdner Asset Management
Aktiengesellschaft, which is a wholly-owned subsidiary of Allianz AG. Allianz AG
indirectly holds a controlling interest in Allianz of America. Allianz AG is a
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European-based, multinational insurance and financial services holding company.
Allianz AG's address is Koeniginstrasse 28, D-80802, Munich, Germany. Pacific
Life's address is 700 Newport Center Drive, Newport Beach, California 92660.
Allianz of America's address is 888 San Clemente Drive, Suite 100, Newport
Beach, California 92660.
The general partner of Allianz of America has substantially delegated its
management and control of Allianz of America to an Executive Committee. The
Executive Committee of Allianz of America is comprised of William S. Thompson,
Jr. and David C. Flattum.
The Manager is located at 1345 Avenue of the Americas, New York, New York
10105. As of December 31, 2004, the Manager had approximately $37.5 billion in
assets under management. As of December 31, 2004, Allianz of America and its
subsidiaries, including NFJ, NACM and PEA, had approximately $564.8 billion in
assets under management.
Allianz of America, Inc. ("AZOA") has entered into a put/call arrangement
for the possible disposition of Pacific Life's indirect interest in Allianz of
America. Pursuant to this agreement, in any month subsequent to March 2004,
Pacific Life and AZOA can put or call, respectively, all of the Class E Units.
The repurchase price for the remaining Class E Units is calculated based on the
financial performance of Pacific Investment Management Company over the
preceding four calendar quarters prior to repurchase, but the amount can
increase or decrease in value by a maximum of 2% per year from the per unit
amount as defined in the agreement, calculated as of December 31 of the
preceding calendar year.
As of the date of this Statement of Additional Information, significant
institutional shareholders of Allianz AG currently include Munchener
Ruckversicherungs-Gesellschaft AG ("Munich Re"). Allianz AG in turn owns
Dresdner Bank AG. Munich Re, as well as certain broker-dealers that might be
controlled by or affiliated with these entities or Dresdner Bank AG, such as
Dresdner Klienwort Wasserstein and Dresdner Kleinwort Benson, may be considered
to be affiliated persons of the Manager, NFJ, NACM and PEA. (Broker-dealer
affiliates of such significant institutional shareholders are sometimes referred
to herein as "Affiliated Brokers.") Absent an SEC exemption or other relief, the
Fund generally is precluded from effecting principal transactions with the
Affiliated Brokers, and its ability to purchase securities being underwritten by
an Affiliated Broker or a syndicate including an Affiliated Broker is subject to
restrictions. Similarly, the Fund's ability to utilize the Affiliated Brokers
for agency transactions is subject to the restrictions of Rule 17e-1 under the
1940 Act. NFJ, NACM and PEA do not believe that the restrictions on transactions
with the Affiliated Brokers described above will materially adversely affect its
ability to provide services to the Fund, the Fund's ability to take advantage of
market opportunities, or the Fund's overall performance.
The Manager, subject to the supervision of the Board of Trustees, is
responsible for managing, either directly or through others selected by the
Manager, the investments of the Fund. The Manager also furnishes to the Board of
Trustees periodic reports on the investment performance of the Fund. As more
fully discussed below, the Manager has retained NFJ, NACM and PEA to serve as
the Fund's Sub-Advisers.
Under the terms of the Investment Management Agreement, subject to such
policies as the Trustees of the Fund may determine, the Manager, at its expense,
will furnish continuously
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an investment program for the Fund and will make investment decisions on behalf
of the Fund and place all orders for the purchase and sale of portfolio
securities subject always to the Fund's investment objectives, policies and
restrictions; provided that, so long as NFJ, NACM and PEA serve as the
Sub-Advisers for the Fund, the Manager's obligation under the Investment
Management Agreement with respect to the Fund is, subject always to the control
of the Trustees, to determine and review with NFJ, NACM and PEA the investment
policies of the Fund.
Subject to the control of the Trustees, the Manager also manages,
supervises and conducts the other affairs and business of the Fund, furnishes
office space and equipment, provides bookkeeping and certain clerical services
(excluding determination of the net asset value of the Fund, shareholder
accounting services and the accounting services for the Fund) and pays all
salaries, fees and expenses of officers and Trustees of the Fund who are
affiliated with the Manager. As indicated under "Portfolio
Transactions--Brokerage and Research Services," the Fund's portfolio
transactions may be placed with broker-dealers which furnish the Manager, NFJ,
NACM and PEA, without cost, certain research, statistical and quotation services
of value to them or their respective affiliates in advising the Fund or their
other clients. In so doing, the Fund may incur greater brokerage commissions and
other transactions costs than it might otherwise pay.
Pursuant to the Investment Management Agreement, the Fund has agreed to pay
the Manager an annual management fee, payable on a monthly basis, at the annual
rate of .90% of the Fund's average weekly total managed assets for the services
and facilities it provides. "Total managed assets" means the total assets of the
Fund (including any borrowings that may be outstanding) minus accrued
liabilities (other than liabilities representing borrowings). All fees and
expenses are accrued daily and deducted before payment of dividends to
investors.
Except as otherwise described in the Prospectus, the Fund pays, in addition
to the investment management fee described above, all expenses not assumed by
the Manager, including, without limitation, fees and expenses of Trustees who
are not "interested persons" of the Manager or the Fund, interest charges,
taxes, brokerage commissions, expenses of issue of shares, fees and expenses of
registering and qualifying the Fund and its classes of shares for distribution
under federal and state laws and regulations, charges of custodians, auditing
and legal expenses, expenses of determining net asset value of the Fund, reports
to shareholders, expenses of meetings of shareholders, expenses of printing and
mailing prospectuses, proxy statements and proxies to existing shareholders, and
its proportionate share of insurance premiums and professional association dues
or assessments. The Fund is also responsible for such nonrecurring expenses as
may arise, including litigation in which the Fund may be a party, and other
expenses as determined by the Trustees. The Fund may have an obligation to
indemnify its officers and Trustees with respect to such litigation.
Sub-Advisers
NFJ, NACM and PEA each serve as sub-advisers for the Fund pursuant to
separate portfolio management agreements (the "Portfolio Management Agreements,"
and individually, a "Portfolio Management Agreement") between each Sub-Adviser
and the Manager. NFJ is responsible for managing the portfolio investments of
the Fund's Equity Component, NACM is
-55-
responsible for managing the portfolio investments of the Fund's Convertible
Component and PEA is responsible for implementing the Fund's Index Option
Strategy. Under each Portfolio Management Agreement, subject always to the
control of the Trustees and the supervision of the Manager, the Sub-Adviser's
obligation is to furnish continuously an investment program with respect to its
component or strategy of the Fund, to make related investment decisions on
behalf of the Fund and to place all orders for the purchase and sale of
portfolio securities and/or other investments for the component or strategy.
Under the Portfolio Management Agreement with NFJ, the Manager (and not the
Fund) has agreed to pay to NFJ a portfolio management fee, payable on a monthly
basis, at the annual rate of 0.25% of the average daily total managed assets
attributable to the Equity Component for the services it provides. Under the
Portfolio Management Agreement with NACM, the Manager (and not the Fund) has
agreed to pay to NACM a portfolio management fee, payable on a monthly basis, at
the annual rate of 0.40% of the average daily total managed assets attributable
to the Convertible Component for the services it provides. Under the Portfolio
Management Agreement with PEA, the Manager (and not the Fund) has agreed to pay
to PEA a portfolio management fee, payable on a monthly basis, at the annual
rate of 0.20% of the average daily total managed assets attributable to the
Equity Component for the services it provides.
NFJ is an investment management firm organized as a limited partnership.
NFJ is the successor investment adviser to NFJ Investment Group Inc., which
commenced operations in 1989. NFJ has two partners: The Manager as the
supervisory partner and NFJ Management Inc. as the managing partner. Allianz of
America is the direct parent company of PA Services Holdings LLC, of which the
Manager is a wholly-owned subsidiary.
NFJ provides investment management services to a number of institutional
accounts, including investment companies, employee benefit plans, college
endowment funds and foundations. As of December 31, 2004, NFJ had approximately
$9.3 billion in assets under management. NFJ is located at 2121 San Jacinto,
Suite 1840, Dallas, Texas 75201.
NACM is an investment management firm organized as a Delaware limited
liability company (formerly Nicholas-Applegate Capital Management, a California
limited partnership). NACM is wholly owned by Nicholas-Applegate Holdings LLC, a
Delaware limited liability company, which is a wholly owned subsidiary of
Allianz Dresdner Asset Management U.S. Equities LLC ("ADAM Equities"), a
Delaware limited liability company. ADAM Equities is a wholly owned subsidiary
of Allianz of America.
NACM was organized in 1984 to manage discretionary accounts investing
primarily in publicly traded equity securities and securities convertible into
or exercisable for publicly traded equity securities, with the goal of capital
appreciation. As of December 31, 2004, NACM had approximately $14.5 billion in
assets under management. NACM is located at 600 West Broadway, 30th Floor, San
Diego, California 92101.
PEA, an indirect wholly-owned subsidiary of Allianz of America, provides
equity-related advisory services to mutual funds and institutional accounts. As
of December 31, 2004, PEA had approximately $14.5 billion in assets under
management. PEA is located at 1345 Avenue of the Americas, 50th Floor, New York,
New York 10105.
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Certain Terms of the Investment Management and Portfolio Management Agreements
The Investment Management Agreement and the Portfolio Management Agreements
were each approved by the Trustees of the Fund (including all of the Trustees
who are not "interested persons" of the Manager or the Sub-Advisers). The
Investment Management Agreement and Portfolio Management Agreements will each
continue in force with respect to the Fund for two years from their respective
dates, and from year to year thereafter, but only so long as their continuance
is approved at least annually by (i) vote, cast in person at a meeting called
for that purpose, of a majority of those Trustees who are not "interested
persons" of the Manager, the applicable Sub-Adviser, or the Fund, and (ii) the
majority vote of either the full Board of Trustees or the vote of a majority of
the outstanding shares of all classes of the Fund. The Investment Management
Agreement and each of the Portfolio Management Agreements automatically
terminates on assignment. The Investment Management Agreement may be terminated
on not less than 60 days' notice by the Manager to the Fund or by the Fund to
the Manager. Each Portfolio Management Agreement may be terminated on not less
than 60 days' notice by the Manager to the applicable Sub-Adviser or by the
Sub-Adviser to the Manager, or by the Fund at any time by notice to the Manager
and the applicable Sub-Adviser.
The Investment Management Agreement and the Portfolio Management Agreements
each provide that the Manager or Sub-Adviser, as applicable, shall not be
subject to any liability in connection with the performance of its services
thereunder in the absence of willful misfeasance, bad faith, gross negligence or
reckless disregard of its obligations and duties.
Basis for Approval of the Investment Management and Portfolio Management
Agreements
[In determining to approve the Investment Management Agreement and the
Portfolio Management Agreements, the Trustees met with the relevant investment
advisory personnel from the Manager and the Sub-Advisers and considered
information relating to the education, experience and number of investment
professionals and other personnel who would provide services under the
applicable agreement. See "Management of the Fund" in the Prospectus and this
Statement of Additional Information. The Trustees also took into account the
time and attention to be devoted by senior management to the Fund and the other
funds in the complex. The Trustees evaluated the level of skill required to
manage the Fund and concluded that the human resources to be available at the
Manager and the Sub-Advisers were appropriate to fulfill effectively the duties
of the Manager and Sub-Advisers on behalf of the Fund under the applicable
agreement. The Trustees also considered the business reputation of the Manager
and the Sub-Advisers, their financial resources and professional liability
insurance coverage and concluded that they would be able to meet any reasonably
foreseeable obligations under the applicable agreement.
The Trustees received information concerning the investment philosophy and
investment process to be applied by the Sub-Advisers in managing the Fund. In
this connection, the Trustees considered the Sub-Advisers' in-house research
capabilities as well as other resources available to the Sub-Advisers'
personnel, including research services available to the Sub-Advisers as a result
of securities transactions effected for the Fund and other investment advisory
clients. The Trustees concluded that the Sub-Advisers' investment process,
research capabilities and philosophy were well suited to the Fund, given the
Fund's investment objective and policies.
-57-
The Trustees considered the scope of the services provided by the Manager
and Sub-Advisers to the Fund under the Investment Management Agreement and
Portfolio Management Agreements, respectively, relative to services provided by
third parties to other mutual funds. The Trustees noted that the Manager's and
Sub-Advisers' standard of care was comparable to that found in most investment
company advisory agreements. See "--Certain Terms of the Investment Management
and Portfolio Management Agreements" above. The Trustees concluded that the
scope of the Manager's and the Sub-Advisers' services to be provided to the Fund
was consistent with the Fund's operational requirements, including, in addition
to its investment objective, compliance with the Fund's investment restrictions,
tax and reporting requirements and related shareholder services.
The Trustees considered the quality of the services to be provided by the
Manager and the Sub-Advisers to the Fund. The Trustees also evaluated the
procedures of the Manager and the Sub-Advisers designed to fulfill their
fiduciary duty to the Fund with respect to possible conflicts of interest,
including their codes of ethics (regulating the personal trading of their
officers and employees) (see "Management of the Fund--Code of Ethics" above),
the procedures by which the Sub-Advisers allocate trades among their various
investment advisory clients, the integrity of the systems in place to ensure
compliance with the foregoing and the record of the Sub-Advisers in these
matters. The Trustees also received information concerning standards of the
Manager and the Sub-Advisers with respect to the execution of portfolio
transactions. See "Portfolio Transactions" below.]
Proxy Voting Policies
The Fund and its Board of Trustees have delegated to the Manager, and the
Manager has in turn delegated to NFJ and NACM, responsibility for voting any
proxies relating to portfolio securities held in the particular Sub-Adviser's
Component in accordance with NFJ's and NACM's proxy voting policies and
procedures. Copies of the proxy voting policies and procedures to be followed by
NFJ and NACM on behalf of the Fund, including procedures to be used when a vote
presents a conflict of interest, are attached hereto as Appendix A ("Proxy
Voting Policies").
PORTFOLIO TRANSACTIONS
Investment Decisions and Portfolio Transactions
Investment decisions for the Fund and for the other investment advisory
clients of the Manager and each Sub-Adviser are made with a view to achieving
their respective investment objectives. Investment decisions are the product of
many factors in addition to basic suitability for the particular client involved
(including the Fund). Some securities considered for investments by the Fund may
also be appropriate for other clients served by the Manager and the
Sub-Advisers. Thus, a particular security may be bought or sold for certain
clients even though it could have been bought or sold for other clients at the
same time. If a purchase or sale of securities consistent with the investment
policies of the Fund and one or more of these clients served by the Manager or a
Sub-Adviser is considered at or about the same time, transactions in
-58-
such securities will be allocated among the Fund and clients in a manner deemed
fair and reasonable by the Manager or a Sub-Adviser, as applicable. The Manager
or a Sub-Adviser may aggregate orders for the Fund with simultaneous
transactions entered into on behalf of its other clients so long as price and
transaction expenses are averaged either for that transaction or for the day.
Likewise, a particular security may be bought for one or more clients when one
or more clients are selling the security. In some instances, one client may sell
a particular security to another client. It also sometimes happens that two or
more clients simultaneously purchase or sell the same security, in which event
each day's transactions in such security are, insofar as possible, averaged as
to price and allocated between such clients in a manner which the Manager or a
Sub-Adviser, as applicable, believes is equitable to each and in accordance with
the amount being purchased or sold by each. There may be circumstances when
purchases or sales of portfolio securities for one or more clients will have an
adverse effect on other clients.
Brokerage and Research Services
There is generally no stated commission in the case of debt securities,
which are traded in the over-the-counter markets, but the price paid by the Fund
usually includes an undisclosed dealer commission or mark-up. In underwritten
offerings, the price paid by the Fund includes a disclosed, fixed commission or
discount retained by the underwriter or dealer. Transactions on U.S. stock
exchanges and other agency transactions involve the payment by the Fund of
negotiated brokerage commissions. Such commissions vary among different brokers.
Also, a particular broker may charge different commissions according to such
factors as the difficulty and size of the transaction.
Subject to the supervision of the Manager, each Sub-Adviser places all
orders for the purchase and sale of portfolio securities, options, futures
contracts and other instruments for the Component of the Fund managed by the
Sub-Adviser (or in the case of PEA, in implementing the Index Option Strategy)
and buys and sells such securities, options, futures contracts and other
instruments for the Fund through a substantial number of brokers and dealers. In
so doing, each Sub-Adviser uses its best efforts to obtain for the Fund the most
favorable price and execution available, except to the extent it may be
permitted to pay higher brokerage commissions, if applicable, as described
below. In seeking the most favorable price and execution, each Sub-Adviser,
having in mind the Fund's best interests, considers all factors it deems
relevant, including, by way of illustration, price, the size of the transaction,
the nature of the market for the security or instrument, the amount of the
commission, the timing of the transaction taking into account market prices and
trends, the reputation, experience and financial stability of the broker-dealer
involved and the quality of service rendered by the broker-dealer in other
transactions.
Subject to the supervision of the Manager, each Sub-Adviser places orders
for the purchase and sale of portfolio investments for the Fund's account with
brokers or dealers selected by it in its discretion. In effecting purchases and
sales of portfolio securities for the account of the Fund, each Sub-Adviser will
seek the best price and execution of the Fund's orders. In doing so, the Fund
may pay higher commission rates than the lowest available when a Sub-Adviser
believes it is reasonable to do so in light of the value of the brokerage and
research services provided by the broker effecting the transaction, as discussed
below.
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It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research services from broker-dealers which execute portfolio
transactions for the clients of such advisers. Consistent with this practice,
each Sub-Adviser may receive research services from many broker-dealers with
which the Sub-Adviser places the Fund's portfolio transactions. A Sub-Adviser
may also receive research or research credits from brokers which are generated
from underwriting commissions when purchasing new issues of debt securities or
other assets for the Fund. These services, which in some cases may also be
purchased for cash, include such matters as general economic and security market
reviews, industry and company reviews, evaluations of securities and
recommendations as to the purchase and sale of securities. Some of these
services are of value to a Sub-Adviser in advising various of its clients
(including the Fund), although not all of these services are necessarily useful
and of value in managing the Fund. Neither the management fee paid by the Fund
to the Manager nor the portfolio management fee paid by the Manager to a
Sub-Adviser is reduced because the Sub-Adviser and its affiliates receive such
services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, each
Sub-Adviser may cause the Fund to pay a broker-dealer which provides "brokerage
and research services" (as defined in such Act) to that Sub-Adviser an amount of
disclosed commission for effecting a securities transaction for the Fund in
excess of the commission which another broker-dealer would have charged for
effecting that transaction.
The Fund may use broker-dealers that are affiliates (or affiliates of
affiliates) of the Fund, the Manager and/or a Sub-Adviser, subject to certain
restrictions discussed above under "Investment Manager and
Sub-Advisers--Investment Manager."
References to each Sub-Adviser in this section would apply equally to the
Manager if the Manager were to assume portfolio management responsibilities for
the Sub-Adviser and place orders for the purchase and sale of portfolio
investments.
DISTRIBUTIONS
Commencing with the Fund's first dividend, the Fund intends to make
quarterly cash distributions to Common Shareholders at a rate that reflects the
past and projected performance of the Fund. The Fund expects to receive
substantially all of its current income and gains from the following sources:
(i) capital gains (short-term and long-term) from net index option premiums and
the sale of portfolio securities; (ii) dividends received by the Fund that are
paid on the common stocks and other equity securities held in the Equity
Component; and (iii) interest income received by the Fund from the convertible
securities held in the Convertible Component. Distributions are likely to be
variable, and the Fund's distribution rate will depend on a number of factors,
including the net earnings on the Fund's portfolio investments and the rate at
which such net earnings change as a result of changes in the timing of and rates
at which the Fund receives income from the sources described above. The net
investment income of the Fund consists of all income (other than net short-term
and long-term capital gains) less all expenses of the Fund.
-60-
The Fund's quarterly distributions will be made from the Fund's net
investment income and net gains from index option premiums and the sale of
portfolio securities. The tax treatment and characterization of the Fund's
distributions may vary significantly from time to time because of the varied
nature of the Fund's investments. Pursuant to the requirements of the 1940 Act
and other applicable laws, a notice will accompany each quarterly distribution
with respect to the estimated source (as between net income and gains) of the
distribution made. (The Fund will indicate the proportion of its capital gains
distributions that constitute long-term and short-term gains annually.) The
ultimate tax characterization of the Fund's distributions made in a calendar or
fiscal year cannot finally be determined until after the end of the fiscal
year. As a result, there is a possibility that the Fund may make total
distributions during a calendar or fiscal year in an amount that exceeds the
Fund's net investment income and net realized capital gains for the relevant
fiscal year. For example, the Fund may distribute amounts early in the calendar
year that derive from short-term capital gains, but incur net short-term capital
losses later in the year, thereby offsetting short-term capital gains out of
which distributions have already been made by the Fund. In such a situation, the
amount by which the Fund's total distributions exceed net investment income and
net realized capital gains would generally be treated as a tax-free return of
capital up to the amount of your tax basis in your shares, with any amounts
exceeding such basis treated as gain from the sale of shares.
As portfolio and market conditions change, the rate of dividends on the
Common Shares and the Fund's dividend policy could change. Over time, the Fund
will distribute all of its net investment income and net short-term capital
gains. In addition, at least annually, the Fund intends to distribute net
realized long-term capital gains not previously distributed, if any. The 1940
Act currently limits the number of times the Fund may distribute long-term
capital gains in any tax year, which may increase the variability of the Fund's
distributions and result in certain dividends being comprised more heavily of
long-term capital gains eligible for favorable income tax rates. During periods
in which the Index Option Strategy does not generate sufficient option premiums
or results in net losses, a substantial portion of the Fund's dividends may be
comprised of capital gains from the sale of equity securities held in the Equity
Component, which would involve transaction costs borne by the Fund and may also
result in realization of taxable short-term capital gains taxed at ordinary
income tax rates (particularly during the initial year of the Fund's
operations).
To permit the Fund to maintain a more stable quarterly distribution, the
Fund will initially distribute less than the entire amount of net investment
income earned in a particular period. The undistributed net investment income
would be available to supplement future distributions. As a result, the
distributions paid by the Fund for any particular period may be more or less
than the amount of net investment income actually earned by the Fund during the
period. Undistributed net investment income will be added to the Fund's net
asset value and, correspondingly, distributions from undistributed net
investment income will be deducted from the Fund's net asset value.
Your initial distribution is expected to be declared approximately 75 days,
and paid approximately 120 days, from the completion of this offering, depending
on market conditions. Unless you elect to receive distributions in cash, all of
your distributions will be automatically reinvested in additional Common Shares
under the Fund's Dividend Reinvestment Plan. See
-61-
"Distributions" and "Dividend Reinvestment Plan." Although it does not now
intend to do so, the Board of Trustees may change the Fund's distribution policy
and the amount or timing of the distributions, based on a number of factors,
including the amount of the Fund's undistributed net investment income and net
short- and long-term capital gains and historical and projected net investment
income and net short- and long-term capital gains.
DESCRIPTION OF SHARES
Common Shares
The Declaration authorizes the issuance of an unlimited number of Common
Shares. The Common Shares will be issued with a par value of $0.00001 per share.
All Common Shares of the Fund have equal rights as to the payment of dividends
and the distribution of assets upon liquidation of the Fund. The Common Shares
will, when issued, be fully paid and, subject to matters discussed in
"Anti-Takeover and Other Provisions in the Declaration of Trust--Shareholder
Liability" below, non-assessable, and will have no pre-emptive or conversion
rights or rights to cumulative voting.
The Fund will apply for the listing of the Common Shares on the New York
Stock Exchange, subject to notice of issuance. The Fund intends to hold annual
meetings of shareholders so long as the Common Shares are listed on a national
securities exchange and such meetings are required as a condition to such
listing.
Shares of closed-end investment companies may frequently trade on an
exchange at prices lower than net asset value, although they have during some
periods traded at prices equal to or higher than net asset value. There can be
no assurance that Common Shares or shares of other similar funds will trade at a
price higher than net asset value in the future. Although it has no present
intention to do so, net asset value will be reduced immediately following the
offering of Common Shares after payment of the sales load and organization and
offering expenses. Net asset value fluctuations are expected to be greater if
the Fund has a leveraged capital structure. Whether investors will realize gains
or losses upon the sale of Common Shares will not depend upon the Fund's net
asset value but will depend entirely upon whether the market price of the Common
Shares at the time of sale is above or below the original purchase price for the
shares. Since the market price of the Fund's Common Shares will be determined by
factors beyond the control of the Fund, the Fund cannot predict whether the
Common Shares will trade at, below or above net asset value or at, below or
above the initial public offering price. Accordingly, the Common Shares are
designed primarily for long-term investors, and investors in the Common Shares
should not view the Fund as a vehicle for trading purposes. See "Repurchase of
Common Shares; Conversion to Open-End Fund" and the Prospectus under "Leverage
and Borrowings" and "Description of Shares--Common Shares."
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ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
Shareholder Liability
Under Massachusetts law, shareholders could, under certain circumstances,
be held personally liable for the obligations of the Fund. However, the
Declaration contains an express disclaimer of 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 the Fund or
the Trustees. The Declaration also provides for indemnification out of the
Fund's property for all loss and expense of any shareholder held personally
liable on account of being or having been a shareholder. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which such disclaimer is inoperative or the Fund is
unable to meet its obligations, and thus should be considered remote.
Anti-Takeover Provisions
As described below, the Declaration includes provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Trustees, and could
have the effect of depriving shareholders of opportunities to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund.
The Fund's Trustees are divided into three classes (Class I, Class II and
Class III), having initial terms of one, two and three years, respectively. At
each annual meeting of shareholders, the term of one class will expire and each
Trustee elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the outstanding
shares of the classes or series of shares entitled to vote for the election of
such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining
Trustees.
Except as provided in the next paragraph, the affirmative vote or consent
of at least seventy-five percent (75%) of the Board of Trustees and at least
seventy-five percent (75%) of the shares of the Fund outstanding and entitled to
vote thereon are required to authorize any of the following transactions (each a
"Material Transaction"): (1) a merger, consolidation or share exchange of the
Fund or any series or class of shares of the Fund with or into any other person
or company, or of any such person or company with or into the Fund or any such
series or class of shares; (2) the issuance or transfer by the Fund or any
series or class of shares (in one or a series of transactions in any
twelve-month period) of any securities of the Fund or such series or class to
any other person or entity for cash, securities or other property (or
combination thereof) having an aggregate fair market value of $1,000,000 or
more, excluding sales of securities of the Fund or such series or class in
connection with a public offering, issuances of securities of the Fund or such
series or class pursuant to a dividend reinvestment plan adopted by the Fund and
issuances of securities of the Fund or such series or class upon the exercise of
any stock subscription rights distributed by the Fund; or (3) a sale, lease,
exchange, mortgage, pledge, transfer or other disposition by the Fund or any
series or class of shares (in one or a series of
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transactions in any twelve-month period) to or with any person of any assets of
the Fund or such series or class having an aggregate fair market value of
$1,000,000 or more, except for transactions in securities effected by the Fund
or such series or class in the ordinary course of its business. The same
affirmative votes are required with respect to any shareholder proposal as to
specific investment decisions made or to be made with respect to the Fund's
assets or the assets of any series or class of shares of the Fund.
Notwithstanding the approval requirements specified in the preceding
paragraph, the Declaration requires no vote or consent of the Fund's
shareholders to authorize a Material Transaction if the transaction is approved
by a vote of both a majority of the Board of Trustees and seventy-five percent
(75%) of the Continuing Trustees (as defined below), so long as all other
conditions and requirements, if any, provided for in the Fund's Bylaws and
applicable law (including any shareholder voting rights under the 1940 Act) have
been satisfied.
In addition, the Declaration provides that the Fund may be terminated at
any time by vote or consent of at least seventy-five percent (75%) of the Fund's
shares or, alternatively, by vote or consent of both a majority of the Board of
Trustees and seventy-five percent (75%) of the Continuing Trustees (as defined
below).
In certain circumstances, the Declaration also imposes shareholder voting
requirements that are more demanding than those required under the 1940 Act in
order to authorize a conversion of the Fund from a closed-end to an open-end
investment company. See "Repurchase of Common Shares; Conversion to Open-End
Fund" below.
As noted, the voting provisions described above could have the effect of
depriving Common Shareholders of an opportunity to sell their Common Shares at a
premium over prevailing market prices by discouraging a third party from seeking
to obtain control of the Fund in a tender offer or similar transaction. In the
view of the Fund's Board of Trustees, however, these provisions offer several
possible advantages, including: (1) requiring persons seeking control of the
Fund to negotiate with its management regarding the price to be paid for the
amount of Common Shares required to obtain control; (2) promoting continuity and
stability; and (3) enhancing the Fund's ability to pursue long-term strategies
that are consistent with its investment objectives and management policies. The
Board of Trustees has determined that the voting requirements described above,
which are generally greater than the minimum requirements under the 1940 Act,
are in the best interests of the Fund's Common Shareholders generally.
A "Continuing Trustee," as used in the discussion above, is any member of
the Fund's Board of Trustees who either (i) has been a member of the Board for a
period of at least thirty-six months (or since the commencement of the Fund's
operations, if less than thirty-six months) or (ii) was nominated to serve as a
member of the Board of Trustees by a majority of the Continuing Trustees then
members of the Board.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's Bylaws,
both of which have been filed as exhibits to the Fund's registration statement
on file with the SEC.
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Liability of Trustees
The Declaration provides that the obligations of the Fund are not binding
upon the Trustees of the Fund individually, but only upon the assets and
property of the Fund, and that the Trustees shall not be liable for errors of
judgment or mistakes of fact or law. Nothing in the Declaration, however,
protects a Trustee against any liability to which he would otherwise be subject
by reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of his office.
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders
will not have the right to cause the Fund to redeem their shares. Instead, the
Fund's Common Shares will trade in the open market at a price that will be a
function of factors relating to the Fund such as dividend levels and stability
(which will in turn be affected by dividend and interest payments by the Fund's
portfolio holdings, the timing and success of the Fund's Index Option Strategy,
regulations affecting the timing and character of Fund distributions, Fund
expenses and other factors), portfolio credit quality, liquidity, call
protection, market supply and demand, and similar factors relating to the Fund's
portfolio holdings. Shares of a closed-end investment company may frequently
trade at prices lower than net asset value. The Fund's Board of Trustees
regularly monitors the relationship between the market price and net asset value
of the Common Shares. If the Common Shares were to trade at a substantial
discount to net asset value for an extended period of time, the Board may
consider the repurchase of its Common Shares on the open market or in private
transactions, or the making of a tender offer for such shares. There can be no
assurance, however, that the Board of Trustees will decide to take or propose
any of these actions, or that share repurchases or tender offers, if undertaken,
will reduce market discount. The Fund has no present intention to repurchase its
Common Shares and would do so only in the circumstances described in this
section.
Subject to its investment limitations, the Fund may borrow to finance the
repurchase of shares or to make a tender offer. Interest on any borrowings to
finance share repurchase transactions or the accumulation of cash by the Fund in
anticipation of share repurchases or tenders will reduce the Fund's net income.
Any share repurchase, tender offer or borrowing that might be approved by the
Board of Trustees would have to comply with the 1934 Act, as amended, and the
1940 Act and the rules and regulations thereunder.
The Fund's Board of Trustees may also from time to time consider submitting
to the holders of the shares of beneficial interest of the Fund a proposal to
convert the Fund to an open-end investment company. In determining whether to
exercise its sole discretion to submit this issue to shareholders, the Board of
Trustees would consider all factors then relevant, including the relationship of
the market price of the Common Shares to net asset value, the extent to which
the Fund's capital structure is leveraged and the possibility of re-leveraging
(if any) and general market and economic conditions.
The Declaration requires the affirmative vote or consent of holders of at
least seventy-five percent (75%) of each class of the Fund's shares entitled to
vote on the matter to authorize a
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conversion of the Fund from a closed-end to an open-end investment company,
unless the conversion is authorized by both a majority of the Board of Trustees
and seventy-five percent (75%) of the Continuing Trustees (as defined above
under "Anti-Takeover and Other Provisions in the Declaration of
Trust--Anti-Takeover Provisions"). This seventy-five percent (75%) shareholder
approval requirement is higher than is required under the 1940 Act. In the event
that a conversion is approved by the Trustees and the Continuing Trustees as
described above, the minimum shareholder vote required under the 1940 Act would
be necessary to authorize the conversion. Currently, the 1940 Act would require
approval of the holders of a "majority of the outstanding" Common Shares in
order to authorize a conversion.
If the Fund converted to an open-end company, the Fund's Common Shares
likely would no longer be listed on the New York Stock Exchange. Shareholders of
an open-end investment company may require the company to redeem their shares on
any business day (except in certain circumstances as authorized by or under the
1940 Act) at their net asset value, less such redemption charge, if any, as
might be in effect at the time of redemption. In order to avoid maintaining
large cash positions or liquidating favorable investments to meet redemptions,
open-end companies typically engage in a continuous offering of their shares.
Open-end companies are thus subject to periodic asset in-flows and out-flows
that can complicate portfolio management.
The repurchase by the Fund of its Common Shares at prices below net asset
value will result in an increase in the net asset value of those shares that
remain outstanding. However, there can be no assurance that share repurchases or
tenders at or below net asset value will result in the Fund's Common Shares
trading at a price equal to their net asset value. Nevertheless, the fact that
the Fund's Common Shares may be the subject of repurchase or tender offers at or
below net asset value from time to time, or that the Fund may be converted to an
open-end company, may reduce any spread between market price and net asset value
that might otherwise exist.
In addition, a purchase by the Fund of its Common Shares will decrease the
Fund's total assets. This would likely have the effect of increasing the Fund's
expense ratio.
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of Trustees would consider all relevant
factors, including the extent and duration of the discount, the liquidity of the
Fund's portfolio, and the impact of any action that might be taken on the Fund
or its shareholders and market considerations. Based on these considerations,
even if the Fund's Common Shares should trade at a discount, the Board of
Trustees may determine that, in the interest of the Fund and its shareholders,
no action should be taken.
TAX MATTERS
Taxation of the Fund. The Fund intends to elect to be treated and to
qualify each year as a regulated investment company under Subchapter M of the
Code. In order to qualify for the special tax treatment accorded regulated
investment companies and their shareholders, the Fund must, among other things:
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(a) derive at least 90% of its gross income for each taxable year
from dividends, interest, payments with respect to certain securities
loans, and gains from the sale of 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;
(b) distribute with respect to each taxable year at least 90% of
the sum of its investment company taxable income (as that term is
defined in the Code without regard to the deduction for dividends
paid--generally taxable ordinary income and the excess, if any, of net
short-term capital gains over net long-term capital losses) and net
tax-exempt interest income, for such year; and
(c) diversify its holdings so that, at the end of each quarter of
the Fund's taxable year, (i) at least 50% of the value of the Fund's
total assets is represented by cash and cash items, U.S. Government
securities, securities of other regulated investment companies, and
other securities limited in respect of any one issuer to a value not
greater than 5% of the value of the Fund's total assets and not more
than 10% of the outstanding voting securities of such issuer, and (ii)
not more than 25% of the value of the Fund's total assets is invested
in the securities (other than those of the U.S. 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.
In general, for purposes of the 90% gross income requirement described in
paragraph (a) above, income derived from a partnership will be treated as
qualifying income only to the extent such income is attributable to items of
income of the partnership which would be qualifying income if realized by the
regulated investment company. However, the American Jobs Creation Act of 2004
(the "2004 Act"), provides that for taxable years of a regulated investment
company beginning after October 22, 2004, 100% of the net income derived from an
interest in a "qualified publicly traded partnership" (defined as a partnership
(i) interests in which are traded on an established securities market or readily
tradable on a secondary market or the substantial equivalent thereof and (ii)
that derives less than 90% of its income from the qualifying income described in
paragraph (a) above) will be treated as qualifying income. In addition, although
in general the passive loss rules of the Code do not apply to regulated
investment companies, such rules do apply to a regulated investment company with
respect to items attributable to an interest in a qualified publicly traded
partnership. Finally, for purposes of paragraph (c) above, the term "outstanding
voting securities of such issuer" will include the equity securities of a
qualified publicly traded partnership, and no more than 25% of the value of a
regulated investment company's total assets may be invested in securities of one
or more qualified publicly traded partnerships.
If the Fund qualifies as a regulated investment company that is accorded
special tax treatment, the Fund will not be subject to federal income tax on
income distributed in a timely manner to its shareholders in the form of
dividends (including Capital Gain Dividends, as defined below).
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If the Fund were to fail to qualify as a regulated investment company
accorded special tax treatment in any taxable year, the Fund would be subject to
tax on its taxable income at corporate rates, and all distributions from
earnings and profits, including any distributions of net tax-exempt income and
net long-term capital gains, would be taxable to shareholders as ordinary
income. Some portions of such distributions may be eligible for the dividends
received deduction in the case of corporate shareholders and reduced rates of
taxation on qualified dividend income in the case of individuals. In addition,
the 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 tax treatment.
The Fund intends to distribute at least annually to its shareholders all or
substantially all of its investment company taxable income and any net
tax-exempt interest, and may distribute its net capital gain. The Fund may also
retain for investment its net capital gain (the excess, if any, of net long-term
capital gains over net short-term capital losses). If the Fund does retain any
net capital gain or any investment company taxable income, it will be subject to
tax at regular corporate rates on the amount retained. If the Fund retains any
net capital gain, it may designate the retained amount as undistributed capital
gains in a notice to its shareholders who, if subject to federal income tax on
long-term capital gains, (i) will be required to include in income for federal
income tax purposes, as long-term capital gain, their shares of such
undistributed amount, and (ii) will be entitled to credit their proportionate
shares of the tax paid by the Fund on such undistributed amount against their
federal income tax liabilities, if any, and to claim refunds to the extent the
credit exceeds such liabilities. For federal income tax purposes, the tax basis
of shares owned by a shareholder of the Fund will be increased by an amount
equal under current law to the difference between the amount of undistributed
capital gains included in the shareholder's gross income and the tax deemed paid
by the shareholder under clause (ii) of the preceding sentence. Although the
Fund may generate tax-exempt income, it does not expect to satisfy the criteria
necessary to pass through the tax-free nature of the income to its shareholders.
Treasury regulations permit a regulated investment company, in determining
its investment company taxable income and net capital gain, to elect to treat
all or part of any net capital loss, any net long-term capital loss or any net
foreign currency loss incurred after October 31 as if it had been incurred in
the succeeding year.
If the Fund fails to distribute in a calendar year at least an amount equal
to the sum of 98% of its ordinary income for such year and 98% of its capital
gain net income for the one-year period ending October 31 of such year, plus any
retained amount from the prior year, the Fund will be subject to a nondeductible
4% excise tax on the undistributed amounts. For these purposes, the Fund will be
treated as having distributed any amount for which it is subject to income tax.
A dividend paid to shareholders in January of a year generally is deemed to have
been paid by the Fund on December 31 of the preceding year, if the dividend was
declared and payable to shareholders of record on a date in October, November or
December of that preceding year. The Fund intends generally to make
distributions sufficient to avoid imposition of the 4% excise tax, although
there can be no assurance that it will be able to do so.
Fund Distributions. For federal income tax purposes, distributions of
investment income are generally taxable as ordinary income to the extent of the
Fund's current and accumulated
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earnings and profits. Taxes on distributions of capital gains are determined by
how long the Fund owned (and is treated for federal income tax purposes as
having owned) the investments that generated them, rather than how long a
shareholder has owned his or her shares. Distributions of net capital gains from
the sale of investments that the Fund owned for more than one year and that are
properly designated by the Fund as capital gain dividends ("Capital Gain
Dividends") will be taxable as long-term capital gains. Distributions from
capital gains are generally made after applying any available capital loss
carryovers. Capital losses may be carried forward to each of the eight taxable
years succeeding the loss year. Distributions of gains from the sale of
investments that the Fund owned for one year or less will be taxable as ordinary
income.
For taxable years beginning on or before December 31, 2008, "qualified
dividend income" received by an individual will be taxed at the rates applicable
to long- term capital gain. In order for some portion of the dividends received
by a Fund shareholder to be qualified dividend income, the Fund must meet
holding period and other requirements with respect to some portion of the
dividend-paying stocks in its portfolio and the shareholder must meet holding
period and other requirements with respect to the Fund's shares. A dividend will
not be treated as qualified dividend income (at either the Fund or shareholder
level) (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 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. In general, distributions of investment income designated by
the Fund as derived from qualified dividend income will be treated as qualified
dividend income by a shareholder taxed as an individual provided the shareholder
meets the holding period and other requirements described above with respect to
the Fund's shares. NFJ will select stocks in an attempt to maximize qualified
dividend income with respect to the Equity Component. Fund dividends
representing distributions of interest income and short-term capital gains
cannot be designated as qualified dividend income and will not qualify for the
reduced rates. The Convertible Component will generally produce income that will
not be considered qualified dividend income and a substantial portion of the
Fund's gains from index options premiums and all gains from sales of portfolio
securities held for a year or less will not qualify for such treatment. In light
of this, the Fund expects that a substantial portion of Fund distributions will
not consist of qualified dividend income.
Distributions are taxable to shareholders even if they are paid from income
or gains earned by the Fund before a shareholder's investment (and thus were
included in the price the shareholder paid). Distributions are taxable whether
shareholders receive them in cash or reinvest them in additional shares through
the Dividend Reinvestment Plan. A shareholder whose distributions are reinvested
in shares will be treated as having received a dividend equal to either (i) the
fair market value of the new shares issued to the shareholder, or (ii) if the
shares are trading below net asset value, the amount of cash allocated to the
shareholder for the purchase of
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shares on its behalf in the open market. Any gain resulting from the sale or
exchange of Fund shares generally will be taxable as capital gains.
The long-term capital gain rates applicable to most individual shareholders
will be 15% (with lower rates applying to taxpayers in the 10% and 15% ordinary
income tax brackets) for taxable years beginning on or before December 31, 2008.
Dividends of net investment income designated by the Fund and received by
corporate shareholders of the Fund will qualify for the 70% dividends received
deduction generally available to corporations to the extent of the amount of
qualifying dividends received by the Fund from domestic corporations for the
taxable year. A dividend received by the Fund will not be treated as a
qualifying dividend (1) if the stock on which the dividend is paid is considered
to be "debt-financed" (generally, acquired with borrowed funds), (2) if it has
been received with respect to any share of stock that the Fund has held for less
than 46 days (91 days in the case of certain preferred stock) during the 90-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 91 days before such date in the case of certain preferred
stock) or (3) to the extent that the Fund is under an obligation (pursuant to a
short sale or otherwise) to make related payments with respect to positions in
substantially similar or related property. Moreover, the dividends received
deduction may be disallowed or reduced (1) if the corporate shareholder fails to
satisfy the foregoing requirements with respect to its shares of the Fund or (2)
by application of the Code.
Return of Capital Distributions. If the Fund makes a distribution to a
shareholder in excess of the Fund's current and accumulated earnings and profits
(including earnings and profits arising from tax-exempt income) in any taxable
year, the excess distribution will be treated as a return of capital to the
extent of such shareholder's tax basis in its shares, and thereafter as capital
gain. A return of capital is not taxable, but it reduces a shareholder's tax
basis in its shares, thus reducing any loss or increasing any gain on a
subsequent taxable disposition by the shareholder of its shares. Although the
Fund may generate tax-exempt income, it does not expect to satisfy the criteria
necessary to pass through the tax-free nature of the income to its shareholders.
Dividends and distributions on the Fund's shares are generally subject to
federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses.
Sale or Redemption of Shares. The sale, exchange or redemption of Fund
shares may give rise to a gain or loss. In general, any gain or loss realized
upon a taxable disposition of shares will be treated as long-term capital gain
or loss if the shares have been held for more than one year. Otherwise, the gain
or loss on the taxable disposition of Fund shares will be treated as short-term
capital gain or loss. However, any loss realized upon a taxable disposition of
shares held for six months or less will be treated as long-term, rather than
short-term, to the extent of
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any long-term capital gain distributions received (or deemed received) by the
shareholder with respect to the shares. All or a portion of any loss realized
upon a taxable disposition of Fund shares will be disallowed if other
substantially identical shares of the Fund are purchased within 30 days before
or after the disposition. In such a case, the basis of the newly purchased
shares will be adjusted to reflect the disallowed loss.
From time to time the Fund may make a tender offer for its Common Shares.
It is expected that the terms of any such offer will require a tendering
shareholder to tender all Common Shares. Shareholders who tender all Common
Shares will be treated as having sold their shares and generally will realize a
capital gain or loss. If a shareholder tenders fewer than all of its Common
Shares such shareholder may be treated as having received a taxable dividend
upon the tender of its Common Shares. In such a case, there is a remote risk
that non-tendering shareholders will be treated as having received taxable
distributions from the Fund. To the extent that the Fund recognizes net gains on
the liquidation of portfolio securities to meet such tenders of Common Shares,
the Fund will be required to make additional distributions to its Common
Shareholders.
Options, Futures, Forward Contracts and Swap Agreements. The Fund's
transactions in options, futures contracts, hedging transactions, forward
contracts, swap agreements, straddles and foreign currencies will be subject to
special tax rules (including mark-to-market, constructive sale, straddle, wash
sale and short sale rules), the effect of which may be to accelerate income to
the Fund, defer losses to the Fund, cause adjustments in the holding periods of
the Fund's securities, convert long-term capital gains into short-term capital
gains and convert short-term capital losses into long-term capital losses. These
rules could therefore affect the amount, timing and character of distributions
to shareholders. The Fund will monitor its transactions, will make appropriate
tax elections and will make appropriate entries in its books and records in
order to mitigate the effect of these rules.
Call option premiums received by the Fund on many equity index call options
will be subject to mark-to-market treatment and gains will be recognized based
on the fair market value of on October 31 and at the end of the Fund's taxable
year (January 31) (or if the option is disposed of, upon disposition). Under
this system, 60% of the gains or losses from such equity index call options will
be treated as capital gains or losses and 40% will be treated as short-term
gains or losses. Such short-term gains will be subject to ordinary income tax
rates to the extent not offset by short-term capital losses. Other call option
premiums received by the Fund will be recognized upon exercise, lapse or other
disposition of the option and will be treated by the Fund as short-term capital
gain or loss, unless the option is actually exercised (i.e., does not lapse and
is not cancelled pursuant to a closing transaction) after the Fund has met the
one-year holding period for the underlying stock; consequently, distributions of
such premiums will generally be taxable to the shareholders as ordinary income.
Call options that are considered "covered" for federal income tax purposes
-- that is, options on indexes that include stocks may significantly overlap
with the stocks owned by the Fund and that are considered to substantially
diminish the Fund's risk of loss in either position under IRS regulations -- and
other devices used by the Fund may be subject to the loss-deferral and holding
period adjustment provisions of the federal income tax straddle rules. In
general,
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such covered call options that are out-of-the-money constitute "qualified
covered call options" and are generally excepted from the straddle rules. For
qualified covered call options, however, the holding period for the offsetting
property is calculated without regard to the time when the options are
outstanding. Consequently, gains that would otherwise constitute long-term
capital gains may be treated as short-term, and distributions that would
otherwise constitute "qualified dividend income" may not satisfy the holding
period requirements and therefore may be taxed as ordinary gain.
The call options that are covered by shares but do not constitute
"qualified covered call options" (as defined in section 1092 of the Code), puts
purchased for stocks that the Fund owns and other devices employed by the Fund
that substantially diminish its risk of loss in offsetting positions in
"substantially similar or related property" (also as defined therein) are
treated as straddles. The straddle rules require that certain losses be
deferred. In addition, the holding period for positions considered part of a
straddle will generally not begin until after the offsetting position is no
longer outstanding. These rules could therefore affect the amount, timing and
character of distributions to shareholders.
Certain of the Fund's hedging activities (including its transactions, if
any, in foreign currencies or foreign currency-denominated instruments) are
likely to produce a difference between its book income and its taxable income.
If the Fund's book income exceeds its taxable income, the distribution (if any)
of such excess generally will be treated as described under "--Return of Capital
Distributions." If the Fund's book income is less than taxable income, the Fund
could be required to make distributions exceeding book income to qualify as a
regulated investment company that is accorded special tax treatment.
Original Issue Discount and Payment-in-Kind Securities. Some of the debt
obligations (with a fixed maturity date of more than one year from the date of
issuance) that may be acquired by the Fund may be (and all zero-coupon debt
obligations acquired by the 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 taxable income
(and required to be distributed) over the term of the debt security, even though
payment of that amount is not received until a later time, usually when the debt
security matures. Increases in the principal amount of an inflation indexed bond
will be treated as OID. In addition, payment-in-kind securities will give rise
to income which is required to be distributed and is taxable even though the
Fund holding the security receives no interest payment in cash on the security
during the year.
Some of the debt obligations (with a fixed maturity date of more than one
year from the date of issuance) that may be acquired by the Fund in the
secondary market may be treated as having market discount. Generally, any gain
recognized on the disposition of, and any partial payment of principal on, a
debt security having market discount is treated as ordinary income to the extent
the gain, or principal payment, does not exceed the "accrued market discount" on
such debt security. Market discount generally accrues in equal daily
installments. The Fund may make one or more of the elections applicable to debt
obligations having market discount, which could affect the character and timing
of recognition of income.
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Some debt obligations (with a fixed maturity date of one year or less from
the date of issuance) that may be acquired by the Fund may be treated as having
acquisition discount, or OID in the case of certain types of debt obligations.
Generally, the Fund will be required to include the acquisition discount, or
OID, in income over the term of the debt security, even though payment of that
amount is not received until a later time, usually when the debt security
matures. The Fund may make one or more of the elections applicable to debt
obligations having acquisition discount, or OID, which could affect the
character and timing of recognition of income.
If the 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 the Fund actually received. Such distributions may
be made from the cash assets of the Fund or by liquidation of portfolio
securities, if necessary. The Fund may realize gains or losses from such
liquidations. In the event the Fund realizes net capital gains from such
transactions, its shareholders may receive a larger capital gain distribution
than they would in the absence of such transactions.
Higher-Risk Securities. The Fund may invest to a significant extent in debt
obligations that are in the lowest rating categories or are unrated, including
debt obligations of issuers not currently paying interest or who are in default.
Investments in debt obligations that are at risk of or in default present
special tax issues for the Fund. Tax rules are not entirely clear about issues
such as when the Fund may cease to accrue interest, original issue discount or
market discount, when and to what extent deductions may be taken for bad debts
or worthless securities and how payments received on obligations in default
should be allocated between principal and income. These and other related issues
will be addressed by the Fund when, as and if it invests in such securities, in
order to seek to ensure that it distributes sufficient income to preserve its
status as a regulated investment company and does not become subject to U.S.
federal income or excise tax.
Issuer Deductibility of Interest. A portion of the interest paid or accrued
on certain high yield discount obligations owned by the Fund may not be
deductible to the issuer. This may affect the cash flow of the issuer. If a
portion of the interest paid or accrued on certain high yield discount
obligations is not deductible, that portion will be treated as a dividend for
purposes of the corporate dividends received deduction. In such cases, if the
issuer of the high yield discount obligations is a domestic corporation,
dividend payments by the Fund may be eligible for the dividends received
deduction to the extent of the deemed dividend portion of such accrued interest.
Interest paid on debt obligations owned by the Fund, if any, that are
considered for tax purposes to be payable in the equity of the issuer or a
related party will not be deductible to the issuer, possibly affecting the cash
flow of the issuer.
Certain Investments in REITs. The Fund may invest in REITs that hold
residual interests in real estate mortgage investment conduits ("REMICs"). Under
Treasury regulations that have not yet been issued, but may apply retroactively,
a portion of the Fund's income from a REIT that is attributable to the REIT's
residual interest in a REMIC (referred to in the Code as an "excess inclusion")
will be subject to federal income tax in all events. These regulations are also
-73-
expected to provide that excess inclusion income of a regulated investment
company, such as the Fund, will be allocated to shareholders of the regulated
investment company in proportion to the dividends received by such shareholders,
with the same consequences as if the shareholders held the related REMIC
residual interest directly. Dividends paid by REITs generally will not be
eligible to be treated as "qualified dividend income."
In general, excess inclusion income allocated to shareholders (i) cannot be
offset by net operating losses (subject to a limited exception for certain
thrift institutions), (ii) will constitute unrelated business taxable income to
entities (including a qualified pension plan, an individual retirement account,
a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax on
unrelated business income, thereby potentially requiring such an entity that is
allocated excess inclusion income, and otherwise might not be required to file a
tax return, to file a tax return and pay tax on such income, and (iii) in the
case of a non-U.S. shareholder, will not qualify for any reduction in U.S.
federal withholding tax (discussed below). In addition, if at any time during
any taxable year a "disqualified organization" (as defined in the Code) is a
record holder of a share in a regulated investment company, then the regulated
investment company will be subject to a tax equal to that portion of its excess
inclusion income for the taxable year that is allocable to the disqualified
organization, multiplied by the highest federal income tax rate imposed on
corporations. The Fund does not intend to invest directly in residual interests
in REMICs or to invest in REITs in which a substantial portion of the assets
will consist of residual interests in REMICs.
Foreign Currency Transactions. Gains or losses attributable to foreign
currency contracts or fluctuations in exchange rates that occur between the time
a Fund accrues income or expenses denominated in a foreign currency and the time
the Fund actually collects such income or pays such expenses are treated as
ordinary income or loss for tax purposes. The portion of any gain or loss on the
disposition of a debt security denominated in a foreign currency that is
attributable to fluctuations in the value of the foreign currency during the
holding period of the debt security will likewise be treated as ordinary income
or loss for tax purposes. This may produce a difference between the Fund's book
income and its taxable income, possibly accelerating distributions or converting
distributions of book income and gains to returns of capital for book purposes.
Foreign Taxation. Income received by the Fund from sources within foreign
countries may be subject to withholding and other taxes imposed by such
countries. Tax conventions between certain countries and the U.S. may reduce or
eliminate such taxes. As the Fund many not pass through its foreign taxes to
shareholders, shareholders generally will not be entitled to claim a credit or
deduction with respect to foreign taxes.
Passive Foreign Investment Companies. Equity investments by the Fund in
certain "passive foreign investment companies" ("PFICs") could potentially
subject the Fund to a U.S. federal income tax (including interest charges) on
distributions received from the company or on proceeds received from the
disposition of shares in the company, which tax cannot be eliminated by making
distributions to Fund shareholders. However, the Fund may elect to avoid the
imposition of that tax. For example, the Fund may elect to treat a PFIC as a
"qualified electing fund" (a "QEF election"), in which case the Fund will be
required to include its share of the
-74-
company's income and net capital gains annually, regardless of whether it
receives any distribution from the company. The Fund also may make an election
to mark the gains (and to a limited extent losses) in such holdings "to the
market" as though it had sold and repurchased its holdings in those PFICs on the
last day of the Fund's taxable year. Such gains and losses are treated as
ordinary income and loss. The QEF and mark-to-market elections may accelerate
the recognition of income (without the receipt of cash) and increase the amount
required to be distributed by the Fund to avoid taxation. Making either of these
elections therefore may require the Fund to liquidate other investments
(including when it is not advantageous to do so) to meet its distribution
requirement, which also may accelerate the recognition of gain and affect the
Fund's total return. Dividends paid by PFICs will not be eligible to be treated
as "qualified dividend income."
Shares Purchased Through Tax-Qualified Plans. Special tax rules apply to
investments through defined contribution plans and other tax-qualified plans.
Shareholders should consult their tax advisers to determine the suitability of
shares of the Fund as an investment through such plans and the precise effect of
an investment on their particular tax situation.
Non-U.S. Shareholders. In general, dividends (other than Capital Gain
Dividends) paid by the Fund to a shareholder that is not a "U.S. person" within
the meaning of the Code (a "foreign person") are subject to withholding of U.S.
federal income tax at a rate of 30% (or lower applicable treaty rate) even if
they are funded by income or gains (such as portfolio interest, short-term
capital gains, or foreign-source dividend and interest income) that, if paid to
a foreign person directly, would not be subject to withholding. However, under
the 2004 Act, effective for taxable years of the Fund beginning after December
31, 2004 and before January 1, 2008, the Fund will not be required to withhold
any amounts (i) with respect to distributions (other than distributions to a
foreign person (w) that has not provided a satisfactory statement that the
beneficial owner is not a U.S. person, (x) to the extent that the dividend is
attributable to certain interest on an obligation if the foreign person is the
issuer or is a 10% shareholder of the issuer, (y) that is within certain foreign
countries that have inadequate information exchange with the United States, or
(z) to the extent the dividend is attributable to interest paid by a person that
is a related person of the foreign person and the foreign person is a controlled
foreign corporation) from U.S. source interest income that would not be subject
to U.S. federal income tax if earned directly by an individual foreign person,
to the extent such distributions are properly designated by the Fund, and (ii)
with respect to distributions (other than distributions to an individual foreign
person who is present in the United States for a period or periods aggregating
183 days or more during the year of the distribution) of net short-term capital
gains in excess of net long-term capital losses, to the extent such
distributions are properly designated by the Fund. In addition, as indicated
below, Capital Gain Dividends will not be subject to withholding of U.S. federal
income tax.
If a beneficial holder who is a foreign person has a trade or business in
the United States, and the dividends are effectively connected with the conduct
by the beneficial holder of a trade or business in the United States, the
dividend will be subject to U.S. federal net income taxation at regular income
tax rates.
The 2004 Act modifies the tax treatment of distributions from the Fund that
are paid to a foreign person and are attributable to gain from "U.S. real
property interests" ("USRPIs"), which
-75-
the Code defines to include direct holdings of U.S. real property and interests
(other than solely as a creditor) in "U.S. real property holding corporations"
such as REITs. The Code deems any corporation that holds (or held during the
previous five-year period) USRPIs with a fair market value equal to 50% or more
of the fair market value of the corporation's U.S. and foreign real property
assets and other assets used or held for use in a trade or business to be a U.S.
real property holding corporation; however, if any class of stock of a
corporation is traded on an established securities market, stock of such class
shall be treated as a USRPI only in the case of a person who holds more than 5%
of such class of stock at any time during the previous five-year period. Under
the 2004 Act, which is generally effective for taxable years of regulated
investment companies beginning after December 31, 2004 and which applies to
dividends paid or deemed paid on or before December 31, 2007, distributions to
foreign persons attributable to gains from the sale or exchange of USRPIs will
give rise to an obligation for those foreign persons to file a U.S. tax return
and pay tax, and may well be subject to withholding under future regulations.
Under U.S. federal tax law, a beneficial holder of shares who is a foreign
person is not, in general, subject to U.S. federal income tax on gains (and is
not allowed a deduction for losses) realized on the sale of shares of the Fund
or on Capital Gain Dividends unless (i) such gain or Capital Gain Dividend is
effectively connected with the conduct of a trade or business carried on by such
holder within the United States, (ii) in the case of an individual holder, the
holder is present in the United States for a period or periods aggregating 183
days or more during the year of the sale or Capital Gain Dividend and certain
other conditions are met, or (iii) the shares constitute USRPIs or the Capital
Gain Dividends are paid or deemed paid on or before December 31, 2007 and are
attributable to gains from the sale or exchange of USRPIs. Effective after
December 31, 2004, and before January 1, 2008, if the Fund is a U.S. real
property holding corporation (as described above) the Fund's shares will
nevertheless not constitute USRPIs if the Fund is a "domestically controlled
qualified investment entity," which is defined to include a regulated investment
company that, at all times during the shorter of the 5-year period ending on the
date of the disposition or the period during which the regulated investment
company was in existence, had less than 50 percent in value of its stock held
directly or indirectly by foreign persons.
A beneficial holder of shares who is a foreign person may be subject to
state and local tax and to the U.S. federal estate tax in addition to the
federal tax on income referred to above.
Backup Withholding. The Fund generally is required to withhold and remit to
the U.S. Treasury a percentage of the taxable distributions and redemption
proceeds paid to any individual shareholder who fails to properly furnish the
Fund with a correct taxpayer identification number ("TIN"), who has
under-reported dividend or interest income, or who fails to certify to the Fund
that he or she is not subject to such withholding. The backup withholding tax
rate is 28% for amounts paid through December 31, 2010. The backup withholding
tax rate will be 31% for amounts paid after December 31, 2010.
In order for a foreign investor to qualify for exemption from the backup
withholding tax rates under income tax treaties, the foreign investor must
comply with special certification and filing requirements. Foreign investors in
the Fund should consult their tax advisers in this regard. Backup withholding is
not an additional tax. Any amounts withheld may be credited
-76-
against the shareholder's U.S. federal income tax liability, provided the
appropriate information is furnished to the Internal Revenue Service.
Tax Shelter Reporting Regulations. Under Treasury regulations, if a
shareholder recognizes a loss with respect to Common Share of $2 million or more
for an individual shareholder or $10 million or more for a corporate
shareholder, the shareholder will likely have to file with the Internal Revenue
Service a disclosure statement on Form 8886. Direct shareholders of portfolio
securities are in many cases excepted from this reporting requirement, but under
current guidance, shareholders of a regulated investment company are not
excepted. Future guidance may extend the current exception from this reporting
requirement to shareholders of most or all regulated investment companies. The
fact that a loss is reportable under these regulations does not affect the legal
determination of whether the taxpayer's treatment of the loss is proper.
Shareholders should consult their tax advisers to determine the applicability of
these regulations in light of their individual circumstances.
General. The federal income tax discussion set forth above is for general
information only. Prospective investors should consult their tax advisers
regarding the specific federal tax consequences of purchasing, holding, and
disposing of shares of the Fund, as well as the effects of state, local and
foreign tax law and any proposed tax law changes.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may quote certain performance-related information and may compare
certain aspects of its portfolio and structure to other substantially similar
closed-end funds as categorized by Lipper, Inc. ("Lipper"), Morningstar Inc. or
other independent services. Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may obtain data from sources or reporting services, such
as Bloomberg Financial ("Bloomberg") and Lipper, that the Fund believes to be
generally accurate.
The Fund, in its advertisements, may refer to pending legislation from time
to time and the possible impact of such legislation on investors, investment
strategy and related matters. At any time in the future, yields and total return
may be higher or lower than past yields and there can be no assurance that any
historical results will continue.
Past performance is not indicative of future results. At the time Common
Shareholders sell their shares, they may be worth more or less than their
original investment.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts
02109, serves as custodian for assets of the Fund. The custodian performs
custodial and fund accounting services.
-77-
PFPC Inc., P.O. Box 43027, Providence, RI 02940-3027, serves as the
transfer agent, registrar and dividend disbursement agent for the Common Shares,
as well as agent for the Dividend Reinvestment Plan relating to the Common
Shares.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036, serves as independent auditors for the Fund. PricewaterhouseCoopers LLP
provides audit services, tax return preparation and assistance and consultation
in connection with review of SEC filings to the Fund.
COUNSEL
Ropes & Gray LLP, One International Place, Boston, Massachusetts 02110,
passes upon certain legal matters in connection with shares offered by the Fund,
and also acts as counsel to the Fund.
REGISTRATION STATEMENT
A Registration Statement on Form N-2, including any amendments thereto (the
"Registration Statement"), relating to the shares of the Fund offered hereby,
has been filed by the Fund with the SEC, Washington, D.C. The Prospectus and
this Statement of Additional Information are parts of but do not contain all of
the information set forth in the Registration Statement, including any exhibits
and schedules thereto. For further information with respect to the Fund and the
shares offered or to be offered hereby, reference is made to the Fund's
Registration Statement. Statements contained in the Prospectus and this
Statement of Additional Information as to the contents of any contract or other
document referred to are not necessarily complete and in each instance reference
is made to the copy of such contract or other document filed as an exhibit to
the Registration Statement, each such statement being qualified in all respects
by such reference. Copies of the Registration Statement may be inspected without
charge at the SEC's principal office in Washington, D.C., and copies of all or
any part thereof may be obtained from the SEC upon the payment of certain fees
prescribed by the SEC.
-78-
REPORT OF INDEPENDENT AUDITORS
[TO BE PROVIDED]
-79-
FINANCIAL STATEMENTS
[TO BE PROVIDED]
-80-
APPENDIX A
PROXY VOTING POLICIES
[TO BE PROVIDED]
A-1
PART C - OTHER INFORMATION
Item 24: Financial Statements and Exhibits
1. Financial Statements:
Registrant has not conducted any business as of the date of this
filing, other than in connection with its organization. Financial
Statements indicating that the Registrant has met the net worth
requirements of Section 14(a) of the 1940 Act will be filed as part of
the Statement of Additional Information.
2. Exhibits:
a.1 Agreement and Declaration of Trust dated August 20, 2003.(1)
a.2 Second Amended and Restated Declaration of Trust dated December 16,
2004.(2)
a.3 Fourth Amended and Restated Declaration of Trust, dated January 24, 2005,
filed herewith.
b. Bylaws of Registrant dated August 20, 2003.(1)
c. None.
d.1 Article III (Shares) and Article V (Shareholders' Voting Powers and
Meetings) of the Agreement and Declaration of Trust.(1)
d.2 Article 10 (Shareholders' Voting Powers and Meetings) of the Bylaws of
Registrant.(1)
d.3 Form of Share Certificate of the Common Shares.*
e. Terms and Conditions of Dividend Reinvestment Plan.*
f. None.
g.1 Form of Investment Management Agreement between Registrant and PA Fund
Management LLC.*
g.2 Form of Portfolio Management Agreement between PA Fund Management LLC and
NFJ Investment Group L.P.*
g.3 Form of Portfolio Management Agreement between PA Fund Management LLC and
Nicholas-Applegate Capital Management LLC.*
g.4 Form of Portfolio Management Agreement between PA Fund Management LLC and
PEA Capital LLC.
h.1 Form of Underwriting Agreement.*
h.2 Form of Master Selected Dealer Agreement.*
h.3 Form of Master Agreement Among Underwriters.*
i. None.
j. Form of Custodian Agreement between Registrant and Brown Brothers Harriman
& Co.*
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc.*
C-1
k.2 Form of Organizational and Offering Expenses Reimbursement Agreement
between Registrant and PA Fund Management LLC.*
l. Opinion and consent of Ropes & Gray LLP.*
m. None.
n. Consent of Registrant's independent accountants.*
o. None.
p. Subscription Agreement of Allianz Global Investors of America L.P.
dated _________ 2005.*
q. None.
r.1 Code of Ethics of Registrant dated ________ 2005.*
r.2 Code of Ethics of PA Fund Management LLC.*
r.3 Code of Ethics of NFJ Investment Group L.P.*
r.4 Code of Ethics of Nicholas-Applegate Capital Management LLC.*
r.5 Code of Ethics of PEA Capital, LLC *
s.1 Power of Attorney for Mr. Connor, filed herewith.
s.2 Power of Attorney for Mr. Kertess, filed herewith.
s.3 Power of Attorney for Mr. Dalessandro, filed herewith.
--------------------------
* To be filed by amendment.
(1) Incorporated by reference to the Registrant's Initial Registration
Statement on Form N-2, File No. 333-108137, filed on August 21,
2003.
(2) Incorporated by referance to the Registrant's Pre-effective
Amendent No.2 to the Fund's Registration Statement, File No.
333-108137, filed on December 20, 2004.
C-2
Item 25: Marketing Arrangements
To be filed by amendment.
Item 26: Other Expenses of Issuance and Distribution
Securities and Exchange Commission Fees $ *
National Association of Securities Dealers, Inc. Fees *
Printing and engraving expenses *
Legal fees *
New York Stock Exchange listing fees *
Accounting expenses *
Transfer Agent fees *
Marketing expenses *
Miscellaneous expenses *
---------
Total *
* To be completed by amendment. Expenses may be reduced pursuant to an
expected contractual arrangement of PA Fund Management LLC to pay (i)
the amount by which the Fund's offering costs (other than the sales
load but inclusive of the reimbursement of underwriter expenses of
$.005 per share) exceed $0.05 per share and (ii) all of the Fund's
organizational expenses, except that the Fund has agreed to reimburse
PIMCO Advisors Fund Management LLC for such organizational expenses
to the extent that the aggregate of all such organizational expenses
and all offering costs (other than the sales load but inclusive of
the reimbursement of underwriter expenses of $.005 per share) does
not exceed $0.05 per share.
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At January 24, 2005
Number of
Title of Class Record Holders
-------------- --------------
Common Shares, par value $0.00001 0
Item 29: Indemnification
Reference is made to Article VIII, Sections 1 through 4, of the
Registrant's Agreement and Declaration of Trust, which is incorporated by
reference herein.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to trustees, officers and
controlling persons of the Registrant by the Registrant pursuant to the Trust's
Agreement and Declaration of Trust, its Bylaws or otherwise, the Registrant is
aware that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Act and, therefore,
is unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by trustees, officers or controlling persons of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
trustees, officers or controlling persons in connection with the securities
being registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
C-3
Item 30: Business and Other Connections of Investment Adviser
Descriptions of the business of PA Fund Management LLC, the Registrant's
investment manager, and PEA Capital LLC, NFJ Investment Group L.P. and
Nicholas-Applegate Capital Management LLC., the Registrant's portfolio managers,
are set forth under the captions "Investment Manager" and "Portfolio Managers"
under "Management of the Fund" in both the prospectus and Statement of
Additional Information forming part of this Registration Statement. The
following sets forth business and other connections of each director and
executive officer (and persons performing similar functions) of PA Fund
Management LLC and PEA Capital LLC, NFJ Investment Group L.P. and
Nicholas-Applegate Capital Management LLC.
PA Fund Management LLC
1345 Avenue of the Americas
New York, NY 10105
Name Position with Advisor Other Connections
---------------- ---------------------------------- --------------------------------------------
Larry Altadonna Senior Vice President Vice President, OpCap Advisors LLC
Andrew Bocko Senior Vice President Senior Vice President, Allianz Global
and Director of IT Investors U.S. Equities LLC, Allianz
Global Investors of America L.P.
Cindy Columbo Vice President
Derek Hayes Senior Vice President
Steve Jobe Senior Vice President
Alan Kwan Vice President
John C. Maney Executive Vice President and Chief Executive Vice President and
Financial Officer Chief Financial Officer,
Allianz Global Investors of
America L.P., Chief Financial
Officer, Allianz Global
Investors U.S. Equities LLC,
Cadence Capital Management
LLC, NFJ Investment Group L.P.,
OCC Distributors LLC, OpCap
Advisors LLC, Oppenheimer
Capital LLC, Pacific Investment
Management Company LLC, PA
Managed Accounts LLC, PA CD
Distributors LLC, PEA Capital
LLC, PA Advertising Agency
Inc., PA Distributors LLC,
Allianz Private Client Services
LLC, and StocksPLUS Management Inc.
Andrew Meyers Managing Director and Chief Operating
Officer
Vinh T. Nguyen Senior Vice President and Controller Senior Vice President and
Controller, Allianz Global
Investors of America L.P.,
Allianz Global Investors U.S.
Equities LLC, Cadence Capital
Management LLC, NFJ Investment
Group L.P., OCC Distributors
LLC, OpCap Advisors LLC,
Oppenheimer Capital LLC,
Pacific Investment Management
Company LLC, PA Managed
Accounts LLC, PA CD Distributors
LLC, PEA Capital LLC, PEA
Partners LLC, PA Advertising
Agency Inc., PA Distributors LLC,
Allianz Private Client Services LLC,
and StocksPLUS Management Inc.
Name Position with Advisor Other Connections
---------------- ---------------------------------- --------------------------------------------
Francis C. Poli Executive Vice President, Chief Legal and Compliance Officer, Allianz
Director of Compliance, Chief Global Investors of America L.P., Allianz
Legal Officer and Assistant Global Investors U.S. Equities LLC, Allianz
Secretary Hedge Fund Partners L.P., Allianz Private
Client Services LLC, Cadence Capital
Management LLC, NFJ Investment Group L.P.,
OCC Distributors LLC, OpCap Advisors LLC,
Oppenheimer Capital LLC, PA Retail Holdings
LLC, PA Managed Accounts LLC, PA CD
Distributors LLC, PEA Capital Advisors LLC
Bob Rokose Vice President and
Assistant Controller
Jennifer L. Ryan Senior Vice President
Newton B. Schott, Jr. Managing Director, General Vice President, PA Managed Accounts LLC,
Counsel and Secretary Executive Vice President, Chief Legal
Officer and Secretary, PA Advertising Agency
Inc., Managing Director, Executive Vice
President, General Counsel and Secretary, PA
Distributors LLC
Brian S. Shlissel Executive Vice President Executive Vice President and Treasurer,
OpCap Advisors LLC
Stewart A. Smith Vice President and Assistant Secretary, PA Fund Management LLC, Allianz
Secretary Global Investors of America L.P., Allianz
Global Investors U.S. Equities LLC, Allianz
Hedge Fund Partners L.P., Allianz Private
Client Services LLC, Cadence Capital
Management LLC, NFJ Investment Group L.P.,
PA Retail Holdings LLC, PA Managed Accounts
LLC, PA CD Distributors LLC and PEA Capital
LLC, Assistant Secretary, Oppenheimer
Capital LLC, OpCap Advisors and OCC
Distributors LLC
James G. Ward Executive Vice President and Executive Vice President, Allianz Global
Director of Human Resources Investors of America L.P., Director of Human
Resources, Allianz Global Investors U.S.
Equities LLC, PA Distributors LLC
C-4
NFJ Investment Group L.P.
2121 San Jacinto, Suite 1840
Dallas, Texas 75201
Name Position with Advisor Other Affiliations
--------------------- ----------------------------- ------------------------------------
Benno J. Fischer Managing Director Director, Managing Director,
Co-Chairman, NFJ Management Inc.
John L. Johnson Managing Director Director, Managing Director,
Co-Chairman, NFJ Management Inc.
Jack C. Najork Managing Director Director, Managing Director,
Co-Chairman, NFJ Management Inc.
John C. Maney Chief Financial Officer See PA Fund Management LLC
Vinh T. Nguyen Controller See PA Fund Management LLC
Stewart A. Smith Secretary See PA Fund Management LLC
Nicholas-Applegate Capital Management LLC
600 West Broadway
San Diego, CA 92101
Name Position with Advisor Other Affiliations
--------------------- ----------------------------- ------------------------------------
Charles H. Field General Counsel and
Chief of Compliance
Peter J. Johnson Senior Vice President
and Director of Institutional
Sales
C. William Maher Managing Director and Chief Chief Financial Officer and
Financial Officer Treasurer, Nicholas-Applegate
Securities; Treasurer,
Nicholas-Applegate Institutional
Funds
Eric S. Sagerman Managing Director, Head
of Global Marketing and
Executive Committee
Horacio Valeiras, Chief Investment Officer
CFA
Marna Whittington Managing Director, President
and Executive Committee
PEA Capital LLC
1345 Avenue of the Americas, 50th Floor
New York, NY 10105
Name Position with Advisor Other Affiliations
--------------------- ----------------------------- ------------------------------------
Bruce Koepfgen Chief Executive Officer Chief Executive Officer, Oppenheimer
Capital LLC
Taegan D. Goddard Managing Director and
Chief Operating Officer
John C. Maney Chief Financial Officer See PA Fund Management LLC and NFJ
Investment Group L.P.
Francis C. Poli Executive Vice President, See PA Fund Management LLC
Chief Legal Officer and
Assistant Secretary
Anne-Marie Pitale Vice President, Director
of Compliance
Vinh T. Nguyen Vice President and Controller See PA Fund Management LLC and NFJ
Investment Group L.P.
Stewart A. Smith Vice President and Secretary See PA Fund Management LLC and NFJ
Investment Group L.P.
Dennis P. McKechnie Managing Director
Jeffrey D. Parker Managing Director
John K. Schneider Managing Director, Marketing
and Client Services
John E. Cashwell, Jr. Senior Vice President
James P. Leavy Senior Vice President
C-5
Item 31: Location of Accounts and Records
The account books and other documents required to be maintained by the
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the Rules thereunder will be maintained at the offices of Brown Brothers
Harriman & Co., 40 Water street, Boston, MA 02109 and/or PFPC Inc., 400 Bellevue
Parkway, Wilmington, Delaware 19809.
Item 32: Management Services
Not applicable.
Item 33: Undertakings
1. Registrant undertakes to suspend the offering of its Common Shares
until it amends the prospectus filed herewith if (1) subsequent to the effective
date of its registration statement, the net asset value declines more than 10
percent from its net asset value as of the effective date of the registration
statement, or (2) the net asset value increases to an amount greater than its
net proceeds as stated in the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
a. For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and
contained in the form of prospectus filed by the Registrant under Rule
497(h) under the Securities Act of 1933 shall be deemed to be part of this
registration statement as of the time it was declared effective; and
b. For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of the securities at that
time shall be deemed to be the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or other means
designed to ensure equally prompt delivery, within two business days of receipt
of a written or oral request, any Statement of Additional Information.
Notice
A copy of the Agreement and Declaration of Trust of NFJ Dividend, Interest &
Premium Strategy Fund (the "Fund"), together with all amendments thereto, is on
file with the Secretary of State of The Commonwealth of Massachusetts, and
notice is hereby given that this instrument is executed on behalf of the Fund
by any officer of the Fund as an officer and not individually and that the
obligations of or arising out of this instrument are not binding upon any of
the Trustees of the Fund or shareholders of the Fund individually, but are
binding only upon the assets and property of the Fund.
C-6
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of New York, and the State of New York on the 26th day
of January, 2005.
NFJ Dividend, Interest & Premium Strategy Fund
By: /s/ Brian S. Shlissel
------------------------------------------
Brian S. Shlissel,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
Name Capacity Date
---- -------- ----
/s/ Brian S. Shlissel President, Chief Executive January 26, 2005
---------------------------- Officer
Brian S. Shlissel
Robert E. Connor * Trustee January 26, 2005
----------------------------
Robert E. Connor
John J. Dalessandro II * Trustee January 26, 2005
----------------------------
John J. Dalessandro II
Hans W. Kertess * Trustee January 26, 2005
----------------------------
Hans W. Kertess
/s/ Lawrence G. Altadonna Treasurer, Principal Financial January 26, 2005
---------------------------- and Accounting Officer
Lawrence G. Altadonna
*By: /s/ Brian S. Shlissel
-----------------------------------------
Brian S. Shlissel
Attorney-In-Fact
Date: January 26, 2005
INDEX TO EXHIBITS
Exhibit Exhibit Name
------- -----------------
a.3 Fourth Amended and Restated Declaration of Trust dated January 24,
2005.
s.1 Power of Attorney for Mr. Connor.
s.2 Power of Attorney for Mr. Kertess.
s.3 Power of Attorney for Mr. Dalessandro.