As filed
with the Securities and Exchange Commission on December 31, 2009
1933 Act
Registration No. 333-148082
1940 Act
Registration No. 811-22154
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM N-1A
REGISTRATION
STATEMENT UNDER THE SECURITIES ACT OF 1933
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x
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Pre-Effective
Amendment No.
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o
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Post-Effective
Amendment No. 7
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x
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REGISTRATION
STATEMENT UNDER
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THE
INVESTMENT COMPANY ACT OF 1940
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x
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Amendment
No. 10
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x
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(Check appropriate
box or boxes.)
Grail Advisors ETF Trust
(Exact name of
registrant as specified in charter)
One Ferry
Building
Suite 255
San
Francisco, CA 94111
(Address of
principal executive offices)
Registrants
telephone number, including area code:
(415) 677-5870
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With a copy to:
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William
M. Thomas
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One
Ferry Building
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Stacy
L. Fuller
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Suite 255
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K&L Gates LLP
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San
Francisco, CA 94111
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1601 K Street, NW
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(Name and address of
agent for service)
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Washington,
DC 20006
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Telephone:
(202) 778-9475
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Approximate Date of Proposed Public Offering:
It is proposed that the filing will become
effective:
x
immediately upon filing pursuant to paragraph
(b)
o
on
pursuant to paragraph (b)
o
60 days after filing pursuant to paragraph
(a)(1)
o
on pursuant to paragraph (a)(1)
o
75 days after filing pursuant to paragraph
(a)(2)
o
on
pursuant to paragraph (a)(2) of Rule 485
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Prospectus | December 31, 2009
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Grail Advisors Actively Managed ETFs
Grail McDonnell Intermediate Municipal Bond
ETF(GMMB)
Grail McDonnell Core Taxable Bond ETF (GMTB)
This Prospectus provides
important information about the ETFs that you should know before
investing. Please read it carefully and
keep it for future reference.
These securities have not
been approved or disapproved by the Securities and Exchange Commission nor has
the Securities and Exchange Commission passed upon the accuracy or adequacy of
this Prospectus. Any representation to
the contrary is a criminal offense.
www.grailadvisors.com
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1-415-677-5870
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TABLE OF CONTENTS
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Page
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INTRODUCTION TO THE ETFS
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6
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GRAIL McDONNELL INTERMEDIATE MUNICIPAL BOND ETF
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7
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INVESTMENT OBJECTIVE
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7
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ETF PERFORMANCE
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8
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FEES AND EXPENSES
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8
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GRAIL McDONNELL CORE TAXABLE BOND ETF
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11
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INVESTMENT OBJECTIVE
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11
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ETF PERFORMANCE
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12
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FEES AND EXPENSES
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12
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DESCRIPTION OF PRINCIPAL RISKS
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15
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ETF MANAGEMENT
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20
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OTHER SERVICE PROVIDERS
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25
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BUYING AND SELLING ETF SHARES
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27
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ACTIVE INVESTORS AND MARKET TIMING
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32
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DISTRIBUTION AND SERVICE PLAN
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33
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NET ASSET VALUE
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33
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ETF WEBSITE AND DISCLOSURE OF PORTFOLIO HOLDINGS
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34
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PORTFOLIO TURNOVER
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35
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SECTION 12(d)(1) INFORMATION
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35
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DIVIDENDS, DISTRIBUTIONS AND TAXES
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35
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FINANCIAL HIGHLIGHTS
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38
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No
person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and the Statement
of Additional Information dated December 31, 2009 (which is incorporated
by reference into this Prospectus and is legally a part of this Prospectus)
and, if given or made, such information or representations may not be relied
upon as having been authorized by us.
2
GRAIL ADVISORS ACTIVELY MANAGED ETFS
GRAIL MCDONNELL INTERMEDIATE MUNICIPAL BOND ETF
GRAIL MCDONNELL CORE TAXABLE BOND ETF
This Prospectus describes
the Grail McDonnell Intermediate Municipal Bond ETF and the Grail McDonnell
Core Taxable Bond ETF (each an ETF and collectively the ETFs), each of
which is a series of Grail Advisors ETF Trust (Trust). Grail Advisors, LLC is each ETFs investment
manager (Manager). McDonnell
Investment Management, LLC (McDonnell) serves as each ETFs sub-adviser.
The Manager oversees the
business affairs of the ETFs, provides or oversees the provision of all
administrative and investment advisory services to the ETFs and coordinates the
investment activities of the ETFs sub-adviser: McDonnell. McDonnell provides day-to-day portfolio
management services to the ETFs.
Information regarding the Manager and McDonnell is included under the
section entitled ETF Management in this Prospectus.
Each ETF is an exchange
traded fund.
The ETFs are
actively managed ETFs.
T
he ETFs are not index
funds and thus do not seek to replicate the performance of a specified index.
Shares of each of the ETFs (Shares) will be listed
and traded on NYSE Arca, Inc. (Exchange). Market prices for the Shares may be different
from their net asset value (NAV).
Unlike mutual funds, Shares are not individually redeemable
securities. Rather, each ETF issues and
redeems Shares on a continuous basis at NAV only in large blocks of Shares,
typically 50,000 Shares, called Creation Units.
Creation Units are issued
and redeemed in-kind for securities included in a specified universe, partially
in cash and partially in-kind or in cash.
Once created, Shares generally trade in amounts less than a Creation
Unit in the secondary market at market prices that change throughout the
day.
Investors
purchasing Shares in the secondary market through a brokerage account or with
the assistance of a broker may be subject to brokerage commissions and charges.
Except when aggregated in
Creation Units, Shares are not redeemable securities.
An investment in the ETFs is
not a deposit in a bank and it is not guaranteed by the Federal Deposit
Insurance Corporation (FDIC) or any other governmental agency.
This Prospectus provides
information about investing in the ETFs.
Please read this Prospectus carefully before making any investment
decision.
3
Note to
Retail Investors
Shares
can be purchased directly from the ETFs only in amounts expected to be worth
more than a million dollars. Most
individual investors, therefore, will not be able to purchase Shares directly
from an ETF. Instead, these investors
will purchase Shares on the Exchange or otherwise in the secondary market with
the assistance of a broker. Thus, certain information in this Prospectus
is not relevant to most retail investors.
For example, information about buying and redeeming Shares directly with
the ETFs and about transaction fees imposed on purchases and redemptions of
Creation Units is not relevant to most retail investors.
How Are The
ETFs Different From Index ETFs?
Whereas
index-based ETFs seek to replicate the holdings of a specified index, each ETF
uses an actively managed investment strategy to meet its investment objective.
Thus, each ETFs sub-adviser has the
discretion on a daily basis to choose securities for the ETFs portfolio
consistent with the ETFs investment objective.
The ETFs are designed for
investors who seek exposure to a relatively low-cost actively managed portfolio
of fixed income securities. The ETFs may
be suitable for long-term investment and may also be used as an asset
allocation tool or as a trading instrument.
How Are The
ETFs Different From Mutual Funds?
Redeemability
. Mutual fund shares may be bought from, and
redeemed with, the issuing fund for cash at NAV typically calculated once at
the end of the day. Shares of an ETF, by
contrast, cannot be purchased from or redeemed with the issuing ETF except by
or through Authorized Participants (defined below), and then only for cash
and/or an in-kind basket of securities expected to be worth more than a million
dollars.
Exchange
Listing
. Unlike mutual fund shares,
Shares will be listed for trading on the Exchange. An organized trading market is expected to
exist for the Shares. Investors can
purchase and sell Shares on the secondary market through a broker. Secondary-market transactions occur not at
NAV, but at market prices that change throughout the day, based on the supply
of, and demand for, Shares and on changes in the prices of an ETFs portfolio
holdings. The market price of Shares may
differ from the NAV of an ETF. The
difference between market price of Shares and the NAV of an ETF is expected to
be small most of the time, though it may be significant, especially in times of
extreme market volatility.
Tax Treatment
. Shares have been designed to be relatively
more tax-efficient than mutual fund shares.
Specifically, by redeeming Shares partially in-kind, ETF shareholders
may be protected from part of the adverse tax consequences associated with cash
transactions in mutual fund shares, including cash redemptions. Such transactions can have an adverse tax
impact on taxable shareholders due to the mutual funds need to sell portfolio
securities to obtain cash to meet such redemptions and, as necessary, recognize
taxable gains in connection with such sales.
By contrast, to the extent the ETF redeems Shares in-kind, as opposed to
for cash, the ETFs in-kind redemption mechanism would reduce, relative to a
mutual fund, taxable gains resulting from redemptions.
4
Because
the ETFs intend to effect redemptions partially in cash and partially in-kind,
investments in Shares may be less tax efficient than investments in index-based
ETFs, which typically effect redemptions primarily in-kind. Thus, the ETFs may be required to sell
portfolio securities in order to obtain the cash needed to distribute redemption
proceeds. An ETF may recognize a capital
gain on these sales that might not have been incurred if the ETF had made a
redemption entirely in-kind, and this may decrease the tax efficiency of the
ETF compared to index-based ETFs that use an entirely in-kind redemption
process.
The
active management of the ETFs portfolios is not expected to impact the in-kind
redemption mechanism and the ETFs ability to reduce taxable gains resulting
from redemptions. Nevertheless, to the
extent redemptions are effected for cash and for other reasons, an ETF may
realize capital gains or losses, including in some cases short-term capital
gains, upon the sale of portfolio securities to effect a cash redemption. Because the ETFs are actively managed, they
may generate more taxable gains for shareholders than an index-based ETF,
particularly during the ETFs initial stages when portfolio changes are more
likely to be implemented within the ETF rather than through the in-kind
redemption mechanism.
Transparency of Portfolio
.
Each ETFs portfolio
holdings as of the time the ETF calculated its NAV will be disclosed daily on
the ETFs website after the close of trading on the Exchange and prior to the
opening of trading on the Exchange on the following day.
A description of the ETFs
policies and procedures with respect to the disclosure of the ETFs portfolio
holdings is available in the ETFs Statement of Additional Information.
5
INTRODUCTION TO THE ETFS
The ETFs described in this
Prospectus are listed below, along with their investment objectives. More information about each ETF appears later
in this Prospectus, as noted below.
ETF
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Investment Objective(s)
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For more information about
the ETF, please see page:
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Grail McDonnell Intermediate Municipal Bond ETF
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High level of current tax-exempt income and higher
risk-adjusted returns relative to its benchmark
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[ ]
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Grail McDonnell Core Taxable Bond ETF
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High level of current income and higher
risk-adjusted returns relative to its benchmark
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[ ]
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The Board of Trustees of the
Trust (Board) may change an ETFs investment objective(s) and principal
investment strategies without shareholder approval.
6
GRAIL McDONNELL
INTERMEDIATE MUNICIPAL BOND ETF
INVESTMENT OBJECTIVE
High level of current
tax-exempt income and higher risk-adjusted returns relative to its benchmark.
PRINCIPAL INVESTMENT STRATEGIES
The
ETF invests, under normal circumstances, at least 80% of its net assets (plus
the amount of any borrowings for investment purposes) in debt securities with
interest payments exempt from federal income taxes. The ETF will typically invest in municipal
securities and will invest, under normal market conditions, primarily in tax
exempt general obligation, revenue and private activity bonds and notes, which
are issued by or on behalf of states, territories or possessions of the U.S.
and the District of Columbia and their political subdivisions, agencies and instrumentalities
(including Puerto Rico, the Virgin Islands and Guam). Tax-exempt means that the bonds pay interest
that is excluded from gross income for regular federal income tax purposes. The ETFs investments generally include
municipal securities with a full range of maturities and broad issuer and
geographic diversification. While the
ETF may invest in securities of any maturity, under normal circumstances, the
dollar-weighted average maturity of the portfolio is expected to range from
three to ten years.
McDonnell, as the ETFs
sub-adviser, employs a total return investment strategy which emphasizes sector
and security selection and yield curve positioning. Sector and security decisions are reached
through robust fundamental credit analysis as well as an assessment that
incorporates the sector and securitys credit momentum. The total return strategy places a limited
dependence on adjusting the portfolio in anticipation of a change in the level
of interest rates.
The
ETF invests primarily in investment grade securities, which are securities
rated in one of the top four credit quality categories by at least one
nationally recognized statistical rating organization rating that security (a rating
agency). The ETF considers pre-refunded
bonds or escrowed to maturity municipal securities, regardless of rating, to be
investment grade securities. The ETF may
invest up to 20% of its net assets in high yield securities or below
investment-grade securities rated BB+ (or comparable) or below by a rating agency
or, if unrated, determined by McDonnell to be of comparable quality.
The
ETF may invest up to 20% of its assets in taxable debt securities. These may include securities issued by the
U.S. Government, its agencies and instrumentalities, corporate debt securities,
mortgage-backed and other asset-backed securities, and securities of other
investment companies, including other ETFs.
The ETF may only invest in U.S. dollar-denominated securities.
The
ETF may invest in derivative instruments, such as futures and interest rate,
total return and credit default swaps.
Investments in derivatives must be consistent with the ETFs investment
7
objective
and may only be used to manage risk and not to enhance leverage. Use of certain derivative instruments may
give rise to taxable income.
Unless
otherwise stated, all percentage limitations on ETF investments apply at the
time of investment. Under adverse market
conditions, the ETF may, for temporary defensive purposes, invest up to 100% of
its assets in cash or cash equivalents, including investment grade short-term
obligations. To the extent the ETF
invokes this strategy, its ability to achieve its investment objective may be
affected adversely.
PRINCIPAL RISKS
The
ETF is subject to a number of risks that may affect the value of its shares,
including:
Acquired Fund Risk
Credit Risk
Derivatives Risk
ETF Risk
Foreign Investing Risk
Interest Rate Risk
Liquidity Risk
Management Risk
Market Risk
Mortgage-Related and Other Asset-Backed Securities
Risk
Municipal Securities Risk
Non-Investment Grade Securities Risk
Prepayment Risk
Temporary Defensive Position Risk
Trading Risk
See Description of
Principal Risks on pages [ ]
for a discussion of each of these risks.
ETF PERFORMANCE
Because the ETF has only
recently begun operations, performance information is not yet available.
FEES AND EXPENSES
This table describes the
fees and expenses that you may pay if you buy and hold Shares of the ETF. Transaction costs incurred by the ETF for
buying and selling securities are not reflected in the table. An investor buying or selling Shares of the
ETF in the secondary market will not pay the transaction fees described in note
1, but would pay a commission to his or her broker in an amount established by
the broker.
Operating Expenses are
expressed as a percentage of average daily net assets and are based upon
estimated amounts for the current fiscal year.
8
Shareholder
Fees
(fees paid directly by Authorized
Participants)
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Sales Charge (load) Imposed on Purchases:
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None
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Transaction Fee on Purchases and Redemptions:
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Varies
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(1)
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Annual Fund Operating Expenses
(expenses that are deducted from ETF
assets)
|
|
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Management Fee:
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0.30
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%
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Distribution and/or service (12b-1) fees: (2)
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0.00
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%
|
Other Expenses: (3)
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0.28
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%
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Total Annual Fund Operating Expenses:
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0.58
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%
|
Less: Expense Reduction/Reimbursement: (4)
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0.23
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%
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Net Annual Operating Expenses: (4)
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0.35
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%
|
Example
The
following example is intended to help retail investors compare the cost of
investing in the ETF with the cost of investing in other funds. The ETF sells and redeems Shares only in
Creation Units. The example illustrates
the hypothetical expenses that such investors would incur over various periods
if they invest $10,000 in the ETF. The
example assumes that the ETF provides a return of 5% a year and that operating
expenses remain the same. This example
does not include the brokerage commissions that retail investors will pay to
buy and sell Shares. It also does not
include the transaction fees on purchases and redemptions of Creation Units,
because these fees will not be imposed on retail investors.
One Year:
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|
Three Years:
|
|
|
|
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$
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36
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$
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163
|
|
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|
|
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|
This example should not be
considered to represent actual expenses or performance from the past or for the
future.
(1)
An investor purchasing or redeeming
Creation Units of the ETF in-kind will generally pay the ETF a standard
Transaction Fee of $500, though the fee may be higher if the investor does not
create or redeem through the NSCC (as defined on page [ ]). In
addition, to the extent that the investor purchases or redeems wholly or partly
in cash, the investor will be subject to a variable charge of up to 3% of the
value of the cash (portion of the) transaction.
An investor buying or selling Shares of the ETF in the secondary market
will pay a commission to his or her broker in an amount established by the broker. All investors will pay the Net Annual
Operating Expenses in the table above.
(2) The ETF has adopted a Distribution and
Service (12b-1) Plan pursuant to which the ETF may bear a 12b-1 fee not to
exceed 0.25% per annum of the ETFs average daily net assets. However, no such fee is currently paid by the
ETF, and the Board has not approved any payments for the current fiscal year.
(3) Other Expenses
are based on estimated amounts for the current fiscal year.
(4) The Manager has
contractually agreed to reduce its fees and/or reimburse ETF expenses
(excluding interest, taxes, brokerage commissions, acquired fund fees and
expenses, and extraordinary expenses) in order to limit Net Annual Operating
Expenses for shares of the ETF to 0.35% of the ETFs average net assets (Expense
Cap). The Expense Cap will remain in
effect until at least January 31, 2011.
The Manager may recoup fees reduced or expenses reimbursed at any time
within three years from the year such expenses were incurred, so long as the
repayment does not cause the Expense Cap to be exceeded.
9
Creation
Unit Transaction Fees and Redemption Transaction Fees
The
ETF issues and redeems Shares at NAV only in Creation Unit blocks of 50,000
Shares.
Shares in
less than Creation Units are not redeemable
. As a practical matter, only institutions or
large investors purchase or redeem Creation Units. A standard Transaction Fee of $500 is charged
for in-kind purchases and redemptions of Creation Units, regardless of the
number of Creation Units acquired or redeemed.
A higher charge may be imposed on purchases and redemptions outside the
enhanced clearing process of the National Securities Clearing Corporation (NSCC),
and a variable fee will be imposed for cash transactions in an amount of up to
3% of the value of the cash (portion of the) transaction. These Transaction Fees are not expenses of
the ETF and do not impact the ETFs expense ratio.
The
value of a Creation Unit of the ETF, as of the date of this Prospectus, was
approximately $2,500,000. Investors
holding Creation Units will also pay the Net Annual Operating Expenses
described in the table above. Assuming
an investment in a Creation Unit of $2,500,000, a 5% return, and assuming that
the ETFs operating expenses remain the same and the Creation Units are
redeemed at the end of each period, a purchaser of Creation Units will incur
the following costs:
One Year:
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|
Three Years:
|
|
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|
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|
$
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9,953
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$
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41,658
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|
|
|
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|
10
GRAIL McDONNELL CORE
TAXABLE BOND ETF
INVESTMENT OBJECTIVE
High level of current income
and higher risk-adjusted returns relative to its benchmark.
PRINCIPAL INVESTMENT STRATEGIES
The
ETF invests, under normal circumstances, at least 80% of its net assets (plus
the amount of any borrowings for investment purposes) in debt securities. The ETF will invest primarily in
investment-grade securities, including securities issued by the U.S.
Government, its agencies and instrumentalities, municipal securities,
mortgage-backed and other asset-backed securities, and corporate and bank
obligations, including commercial paper, corporate notes and bonds. While the ETF may invest in securities of any
maturity, under normal circumstances, the average duration of the portfolio is
typically expected to range from three to six years. Duration is a measure of the underlying
portfolios price sensitivity to changes in interest rates.
McDonnell, as the ETFs
sub-adviser, employs a total return investment strategy which emphasizes sector
and security selection and yield curve positioning. Sector and security decisions are reached
through robust fundamental credit analysis as well as an assessment that
incorporates the sector and securitys credit momentum. The total return strategy places a limited
dependence on adjusting the portfolio in anticipation of a change in the level
of interest rates.
The
ETF invests primarily in investment grade securities, which are securities
rated in one of the top four credit quality categories by at least one
nationally recognized statistical rating organization rating that security (a rating
agency). The ETF may invest up to 20%
of its net assets in high yield securities or below investment-grade securities
rated BB+ (or comparable) or below by a rating agency or, if unrated,
determined by McDonnell to be of comparable quality.
The
ETF may invest without limit in securities issued by the U.S. Government, its
agencies and instrumentalities, up to 90% of its assets in mortgage-backed and
other asset-backed securities, and up to 80% of its assets in corporate
bonds. In addition, the ETF may invest
up to 30% of its assets in municipal securities. The ETF may only invest in U.S.
dollar-denominated securities. It may
also invest in securities of other investment companies, including other ETFs
and money market funds.
The
ETF may invest in derivative instruments, such as futures and interest rate,
total return and credit default swaps.
Investments in derivatives must be consistent with the ETFs investment
objective and may only be used to manage risk and not to enhance leverage. Use of certain derivative instruments may
give rise to taxable income.
Unless
otherwise stated, all percentage limitations on ETF investments apply at the
time of investment. Under adverse market
conditions, the ETF may, for temporary defensive purposes, invest up to 100% of
its assets in cash or cash equivalents, including investment grade short-term
11
obligations. To the extent the ETF invokes this strategy,
its ability to achieve its investment objective may be affected adversely.
PRINCIPAL RISKS
The
ETF is subject to a number of risks that may affect the value of its shares,
including:
Acquired Fund Risk
Credit Risk
Derivatives Risk
ETF Risk
Foreign Investing Risk
Interest Rate Risk
Liquidity Risk
Management Risk
Market Risk
Mortgage-Related and Other Asset-Backed Securities
Risk
Municipal Securities Risk
Non-Investment Grade Securities Risk
Prepayment Risk
Temporary Defensive Position Risk
Trading Risk
See Description of
Principal Risks on pages [ ]
for a discussion of each of these risks.
ETF PERFORMANCE
Because the ETF has only
recently begun operations, performance information is not yet available.
FEES AND EXPENSES
This table describes the
fees and expenses that you may pay if you buy and hold Shares of the ETF. Transaction costs incurred by the ETF for
buying and selling securities are not reflected in the table. An investor buying or selling Shares of the
ETF in the secondary market will not pay the transaction fees described in note
1, but would pay a commission to his or her broker in an amount established by
the broker.
Operating Expenses are
expressed as a percentage of average daily net assets and are based upon
estimated amounts for the current fiscal year.
Shareholder Fees
(fees paid directly by Authorized
Participants)
|
|
|
|
Sales Charge (load) Imposed on Purchases:
|
|
None
|
|
Transaction Fee on Purchases and Redemptions:
|
|
Varies
|
(1)
|
Annual Fund Operating Expenses
(expenses that are deducted from ETF
assets)
|
|
|
|
Management Fee:
|
|
0.30
|
%
|
Distribution and/or service (12b-1) fees: (2)
|
|
0.00
|
%
|
Other Expenses: (3)
|
|
0.28
|
%
|
Total Annual Fund Operating Expenses:
|
|
0.58
|
%
|
Less: Expense Reduction/Reimbursement: (4)
|
|
0.23
|
%
|
Net Annual Operating Expenses: (4)
|
|
0.35
|
%
|
12
Example
The
following example is intended to help retail investors compare the cost of
investing in the ETF with the cost of investing in other funds. The ETF sells and redeems Shares only in
Creation Units. The example illustrates
the hypothetical expenses that such investors would incur over various periods
if they invest $10,000 in the ETF. The
example assumes that the ETF provides a return of 5% a year and that operating
expenses remain the same. This example
does not include the brokerage commissions that retail investors will pay to
buy and sell Shares. It also does not
include the transaction fees on purchases and redemptions of Creation Units,
because these fees will not be imposed on retail investors.
One Year:
|
|
Three Years:
|
|
|
|
|
|
$
|
36
|
|
$
|
163
|
|
|
|
|
|
|
|
This example should not be
considered to represent actual expenses or performance from the past or for the
future.
(1)
An investor purchasing or redeeming
Creation Units of the ETF in-kind will generally pay the ETF a standard
Transaction Fee of $500. In addition, to
the extent that the investor purchases or redeems wholly or partly in cash, the
investor will be subject to a variable charge of up to 3% of the cash (portion
of the) transaction. An investor buying
or selling Shares of the ETF in the secondary market will pay a commission to
his or her broker in an amount established by the broker. All investors will pay the Net Annual
Operating Expenses in the table above.
(2) The ETF has adopted a Distribution and
Service (12b-1) Plan pursuant to which the ETF may bear a 12b-1 fee not to
exceed 0.25% per annum of the ETFs average daily net assets. However, no such fee is currently paid by the
ETF, and the Board has not approved any payments for the current fiscal year.
(3) Other Expenses
are based on estimated amounts for the current fiscal year.
(4) The Manager has
contractually agreed to reduce its fees and/or reimburse ETF expenses
(excluding interest, taxes, brokerage commissions, acquired fund fees and
expenses, and extraordinary expenses) in order to limit Net Annual Operating
Expenses for shares of the ETF to 0.35% of the ETFs average net assets (Expense
Cap). The Expense Cap will remain in
effect until at least January 31, 2011.
The Manager may recoup fees reduced or expenses reimbursed at any time
within three years from the year such expenses were incurred, so long as the
repayment does not cause the Expense Cap to be exceeded.
Creation
Unit Transaction Fees and Redemption Transaction Fees
The
ETF issues and redeems Shares at NAV only in Creation Unit blocks of 50,000
Shares.
Shares in
less than Creation Units are not redeemable
. As a practical matter, only institutions or
large investors purchase or redeem Creation Units. A standard Transaction Fee of $500 is charged
for in-kind purchases and redemptions of Creation Units, regardless of the
number of Creation Units acquired or redeemed. In addition, to the extent an investor
purchases or redeems wholly or partly in cash, the investor will be subject to
a variable charge in an amount of up to
13
3%
of the value of the cash (portion of the) transaction. These Transactions Fees are not expenses of
the ETF and do not impact the ETFs expense ratio.
The
value of a Creation Unit of the ETF, as of the date of this Prospectus, was
approximately $2,500,000. Investors
holding Creation Units will also pay the Net Annual Operating Expenses
described in the table above. Assuming
an investment in a Creation Unit of $2,500,000, a 5% return, and assuming that
the ETFs operating expenses remain the same and the Creation Units are
redeemed at the end of each period, a purchaser of Creation Units will incur
the following costs:
One Year:
|
|
Three Years:
|
|
|
|
|
|
$
|
9,953
|
|
$
|
41,658
|
|
|
|
|
|
|
|
14
DESCRIPTION OF PRINCIPAL
RISKS
An investment in either of
the ETFs entails risks. The ETFs could
lose money, or their performance could trail that of other investment
alternatives. The Manager or McDonnell
cannot guarantee that the ETFs will achieve their objective(s). It is important that investors closely review
and understand these risks before making an investment in an ETF. The table below provides the principal risks
of investing in the ETFs. Following the
table, each risk is explained.
|
|
Grail McDonnell Intermediate
Municipal ETF
|
|
Grail McDonnell Core
Taxable ETF
|
|
Acquired Fund
Risk
|
|
X
|
|
X
|
|
Credit Risk
|
|
X
|
|
X
|
|
Derivatives Risk
|
|
X
|
|
X
|
|
ETF Risk
|
|
X
|
|
X
|
|
Foreign
Investing Risk
|
|
X
|
|
X
|
|
Interest Rate
Risk
|
|
X
|
|
X
|
|
Liquidity Risk
|
|
X
|
|
X
|
|
Management Risk
|
|
X
|
|
X
|
|
Market Risk
|
|
X
|
|
X
|
|
Mortgage-Related
and Other Asset-Backed Securities Risk
|
|
X
|
|
X
|
|
Municipal
Securities Risk
|
|
X
|
|
X
|
|
Non-Investment
Grade Securities Risk
|
|
X
|
|
X
|
|
Prepayment Risk
|
|
X
|
|
X
|
|
Temporary
Defensive Position Risk
|
|
X
|
|
X
|
|
Trading Risk
|
|
X
|
|
X
|
|
Acquired Fund Risk.
The ETF may invest in
securities of other investment companies, including other ETFs, to the extent
permitted by law and consistent with the ETFs investment objective. Like equity investments, these investments
may go up or down in value. An ETF will
pay additional fees through its investments in other investment companies. Shareholders will bear their proportionate
share of the ETFs expenses (including operating expenses and advisory fees),
and also similar expenses of the acquired investment company, and the ETFs
returns could therefore be lower than if it had invested directly in the
underlying securities.
Credit Risk.
Credit risk is the risk that
the inability or perceived inability of the issuer to make interest and
principal payments will cause the value of its securities to decrease, and
cause the ETF a loss. If an issuers
financial health deteriorates, it may result in a reduction of the credit
rating of the issuers securities and may lead to the issuers inability to
honor its obligations, including making timely payment of interest and
principal. Although a downgrade of a
bonds credit ratings may not affect its price, a decline in credit quality may
make bonds less attractive,
15
thereby increasing the yield
on the bond and driving down the price.
Declines in credit quality can result in bankruptcy for the issuer and
permanent loss of investment.
The fixed income securities
held by the ETF are subject to the risk that the issuer will be unwilling or
unable to satisfy its obligations to the ETF, including the periodic payment of
interest or the payment of principal upon maturity.
Rating agencies are private
services that provide ratings of the credit quality of fixed income
securities. 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 issuers current financial condition
may be better or worse than a rating indicates.
Further, rating agencies may also lose credibility or end coverage of a
previously-rated security. The ETF will
not necessarily sell a security if its rating is reduced. The ETFs sub-adviser does not rely solely on
credit ratings, and develops its own analysis of issuer credit quality. The ETF may purchase unrated securities
(which are not rated by a rating agency) if the sub-adviser determines that the
security is of comparable quality to a rated security that the ETF may
purchase. Unrated securities may be less
liquid than comparable rated securities and involve the risk that the
sub-adviser may not accurately evaluate the securitys comparative credit
rating.
Derivatives Risk
. Derivatives are financial contracts whose
value depends on, or is derived from, the value of underlying assets, such as a
reference security, rate or index. Since
the value of derivatives is calculated and derived from the value of other
assets, instruments or references, there is a risk that they will be improperly
valued. For certain derivatives, it is
possible to lose more than the amount invested in the derivative. There can be no assurance that any strategy
using derivatives will succeed.
The use of derivatives may
give rise to a form of leverage. To
mitigate the risk from leverage, the ETF will, as required, segregate or earmark
liquid assets or otherwise cover transactions that may give rise to such
risk. The use of derivatives may require
the ETF to liquidate portfolio positions to satisfy its obligations or to meet
segregation requirements when it may not be advantageous to do so. Derivatives may cause the ETF to be more
volatile because leverage embedded in a derivative may exaggerate the effect of
the instrument.
Derivatives also are subject
to market risk, liquidity risk, and credit and counterparty risk. Counterparty risk is the risk that the
counterparty on a derivative transaction will be unable or unwilling to honor
its financial obligations to the ETF.
Derivatives also involve the risk that changes in their value may not
correlate perfectly with the assets, rates, or indices that are designed to
hedge or closely track. The ETFs
Statement of Additional Information contains more information on the various
derivatives the ETF may utilize.
ETF Risk
. The Shares may trade above or below their
NAV. The NAV of the ETF will generally
fluctuate with changes in the market value of the ETFs holdings. The market prices of Shares, however, will
generally fluctuate in accordance with changes in NAV as well as the relative
supply of, and demand for, Shares on the Exchange. The trading price of Shares may deviate
significantly from NAV during periods of market volatility. The Manager cannot predict whether Shares
will trade below, at or above their NAV.
Price differences may be due to the fact
16
that supply and demand
forces at work in the secondary trading market for Shares are closely related
to, but not identical to, the same forces influencing the prices of the
securities held by the ETF. However,
given that Shares can be purchased and redeemed in Creation Units (unlike
shares of closed-end funds, which frequently trade at appreciable discounts
from, and sometimes at premiums to, their NAV), and the ETFs portfolio
holdings are disclosed on a daily basis, large discounts or premiums to the NAV
of Shares should not be sustained.
Foreign Investing Risk
. Foreign investing, including investments in
U.S. registered and U.S. dollar denominated notes (i.e., Yankees), carries
potential risks not associated with domestic investments. Such risks include, but are not limited to: (1) currency
exchange rate fluctuations, (2) social, political and financial
instability, (3) less liquidity, (4) lack of uniform accounting,
auditing and financial reporting standards, (5) less government regulation
and supervision of foreign stock exchanges, brokers and listed companies, (6) increased
price volatility, and (7) less availability of information for an
investment sub-adviser to determine a companys financial condition.
Interest Rate Risk.
Interest rate risk is the
risk that fixed income securities will decline in value because of changes in
interest rates. Generally, the value of
debt securities falls as interest rates rise.
Specific fixed income securities differ in their sensitivities to
changes in interest rates depending on their particular characteristics. Fixed income securities with longer durations
tend to be more sensitive to changes in interest rates, usually making them
more volatile than securities with shorter durations. Duration is determined by a number of factors
including coupon rate, whether the coupon is fixed or floating, time to
maturity, call or put features, and various repayment features.
Liquidity Risk
. Liquidity risk exists when particular
investments are difficult to purchase or sell.
During periods of market turbulence or low trading activity, in order to
meet redemptions it may be necessary for the ETF to sell securities at prices
or times that are disadvantageous to the ETF.
Additionally, the market for certain investments may be or become
illiquid independent of any specific adverse changes in the conditions of a
particular issuer. To the extent the ETF
uses derivatives or invests in lower-reated securities, it will tend to have
increased exposure to liquidity risk.
The ETF may invest in
unregistered securities, including Rule 144A securities, that are
purchased directly from the issuer or in the secondary market and are subject
to limitations on resale. Limitations on
resale may have an adverse effect on the marketability of portfolio securities
and the ETF might be unable to dispose of restricted or other illiquid
securities promptly or at reasonable prices.
The absence of a trading market can make it difficult to ascertain a
market value for illiquid investments.
Management Risk
. Securities selected by the sub-adviser for
the ETF may not perform to expectations.
This could result in the ETFs underperformance compared to other funds
with similar investment objectives.
Market Risk
. Market risk involves the possibility that the
value of the ETFs investments will decline, sometimes unpredictably or
rapidly, due to drops in the securities markets generally or
17
particular industries
represented in the securities markets.
The prices of and the income generated by securities held by the ETF may
decline in response to certain events, including those directly involving the
companies and governments whose securities are owned by the ETF, general
economic and market conditions, regional or global instability, and interest
rate fluctuations. Market turbulence in
financial markets occurs from time to time at various levels, and can be
extreme, resulting in reduced liquidity in credit and fixed income markets,
which would likely have a negatively affect on many issuers worldwide and an
adverse effect on the ETF.
Mortgage-Related and Other
Asset-Backed Securities Risk
. Generally, rising interest rates tend to
extend the duration of fixed rate mortgage-related securities, making them more
sensitive to changes in interest rates.
As a result, in a period of rising interest rates, if the ETF holds
mortgage-related securities, it may exhibit additional volatility. In addition, adjustable and fixed rate
mortgage-related securities are subject to prepayment risk. When interest rates decline, borrowers may
repay their mortgages sooner than expected.
This can reduce the ETFs returns because the ETF may have to reinvest
that money at the lower prevailing interest rates. Conversely, when interest rates rise,
prepayments may happen more slowly, causing the underlying loans to be
outstanding for a longer time, which can cause the market value of the security
to fall because the market may view the interest rate as too low for a
longer-term investment. An ETFs
investments in other asset-backed securities are subject to risks similar to
those associated with mortgage-related securities, as well as additional risks
associated with the nature of the assets and the servicing of those assets.
Municipal Securities Risk
. Municipal securities are subject to interest
rate, credit and market risk. The ETFs
investments in municipal securities will be sensitive to events that affect municipal
markets, including legislative or political changes and the financial condition
of the issuers of municipal securities.
The ETF will be more sensitive to a particular adverse economic,
business or political development if it invests a substantial portion of its
assets in the bonds of similar projects (such as those relating to education,
health care, housing, transportation or utilities), industrial development
bonds, or in bonds from issuers in a single state.
There
is no guarantee that all of the ETFs income from municipal securities will be
exempt from federal or state income taxes.
Income from municipal bonds held by the ETF could be declared taxable
due to unfavorable changes in tax laws, adverse interpretations by the Internal
Revenue Service or state tax authorities, or noncompliant conduct of a bond
issuer. Events occurring after the date
of issuance of a municipal bond or after the ETFs acquisition of a municipal
bond may result in a determination that interest on that bond is includible in
gross income for federal income tax purposes retroactively to its date of
issuance. Such a determination may cause
a portion of prior distributions by the ETF to its shareholders to be taxable
to those shareholders in the year of receipt.
Federal or state changes in income or alternative minimum tax rates or
in the tax treatment of municipal bonds may make municipal bonds less
attractive as investments and cause them to lose value.
Non-Investment Grade Securities
Risk
. Below investment-grade securities,
or junk bonds, are more likely to pose a credit risk, as the issuers of these
securities are more likely to have problems making interest and principal
payments than issuers of higher-rated securities. Lower-
18
rated securities may be more
susceptible to real or perceived adverse economic and competitive industry
conditions than higher-grade securities, and prices of these securities may be
more sensitive to adverse economic downturns or individual corporate
developments. If the issuer of the
securities defaults, the ETF may incur additional expenses to seek
recovery. The secondary market in which
below investment-grade securities are traded may be less liquid than the market
for higher grade securities. Less
liquidity in the secondary trading markets could adversely affect the price at
which the ETF could sell a particular security, and could cause large
fluctuations in the ETFs NAV. Adverse
publicity and investor perceptions may decrease the value and liquidity of
lower-rated securities.
Prepayment Risk
. If interest rates fall, it is possible that
issuers of certain bonds will call, or prepay, their bonds before their
maturity date. If a call were exercised
by the issuer during a period of declining interest rates, the ETF is likely to
have to replace the called security with a lower yielding security. If that were to happen, it would decrease the
ETFs net investment income.
Temporary Defensive Position
Risk.
Under adverse market
conditions, the ETF may, for temporary defensive purposes, invest up to 100% of
its assets in cash or cash equivalents, including investment grade short-term
obligations. A larger percentage of such
investments could moderate an ETFs investment results. An ETF may not achieve its investment
objective using this type of investing.
Trading Risk
. Although the Shares will be listed on the
Exchange, there can be no assurance that an active or liquid trading market for
them will develop or be maintained. In
addition, trading in Shares on the Exchange may be halted due to market
conditions or for reasons that, in the view of the Exchange, make trading in
Shares inadvisable. Further, trading in
Shares on the Exchange is subject to trading halts caused by extraordinary
market volatility pursuant to the Exchange circuit breaker rules. There can be no assurance that the
requirements of the Exchange necessary to maintain the listing of the ETF will
continue to be met or will remain unchanged.
19
ETF MANAGEMENT
Grail
Advisors, LLC
The
Manager, a majority-owned subsidiary of Grail Partners, LLC and investment
adviser registered with the Securities and Exchange Commission (SEC), acts as
each ETFs investment manager. The
Manager is a Delaware limited liability company with its principal offices
located at One Ferry Building, Suite 255, San Francisco, CA 94111.
The Manager is responsible for overseeing the management of the ETFs but
does not oversee the day-to-day investment of the ETFs portfolios. The Manager oversees the business affairs of
the ETFs, provides or oversees the provision of all administrative and
investment advisory services to the ETFs and coordinates the investment
activities of McDonnell. These services
are provided under the terms of an Investment Management Agreement dated December 31,
2009 (Investment Management Agreement) between the Trust, on behalf of each
ETF, and the Manager.
Pursuant to the Investment
Management Agreement, each ETF pays the Manager a management fee for the
services and facilities it provides payable on a monthly basis at the annual
rates set forth in the table below, calculated as a percentage of the ETFs
average daily net assets. From time to
time, the Manager may waive all or a portion of its fee; any such waiver would
increase an ETFs performance. The
Manager is responsible for compensating McDonnell out of the management fees it
receives from each ETF.
ETF
|
|
Management
Fee
|
|
Grail McDonnell
Intermediate Municipal Bond ETF
|
|
0.30
|
%
|
Grail McDonnell Core
Taxable Bond ETF
|
|
0.30
|
%
|
McDonnell Investment Management, LLC
McDonnell acts as
sub-adviser of each ETF. McDonnell is
registered as an investment adviser with the SEC and is located at 1515 W. 22
nd
Street, 11
th
Floor, Oak
Brook, IL 60523. McDonnell, a Delaware
limited liability company, began operations in 2001, and it is 100% employee
owned. As of September 30, 2009,
McDonnell had more than 80 employees and managed over 500 client relationships
with over $13 billion in assets under management. In addition to the services it provides the
ETFs, McDonnell offers its advisory services to separate accounts for
institutional and private clients, and sub-advised mutual funds.
McDonnell
provides day-to-day portfolio management services to each ETF and has
discretion to purchase and sell securities in accordance with the ETFs
objectives, policies, and restrictions.
McDonnell has entered into
an Investment Sub-Advisory Agreement between the Manager and McDonnell, dated December 31,
2009 (McDonnell Subadvisory Agreement), with respect to each ETF. Pursuant to the McDonnell Subadvisory
Agreement, McDonnell receives fees from the Manager to provide the services
described above. These fees are paid by
the Manager out of
20
the advisory fees it receives from an ETF; they are not separately paid
by an ETF. From time to time, McDonnell
may waive all or a portion of its fee.
Portfolio
Managers
The
ETFs are managed by teams of investment professionals under the oversight of Michael
Kamradt, McDonnells Chief Investment Officer.
Mr. Kamradt is Executive Managing Director and Chief Investment
Officer of McDonnell. He has over thirty
years of investment industry experience.
Mr. Kamradt is responsible for overseeing the implementation of
McDonnells investment strategies. In
this capacity, Mr. Kamradt is charged with coordinating all investment
operations, including portfolio management and trading, relating to McDonnells
assets under management. From 1990 to October 2001,
he served as Senior Vice President and Senior Portfolio Manager of the Separate
Account Management group at Van Kampen Management Inc. Prior to joining Van Kampen, he was a
portfolio manager at J.P. Morgan. He was
also a Manager of the Risk Management Group at Continental Bank and the Chicago
Board of Trade. Mr. Kamradt
received his B.S. Degree in Economics and Finance from Western Illinois
University and his M.B.A. in Finance from the University of Chicago.
Generally, the teams portfolio managers are not assigned to specific
portfolios, with each individual assigned to a particular fixed income sector
and/or maturity range. Rather, portfolio
managers on each team perform all trading functions as well as risk management
assessments, and work in an integrated fashion with McDonnells fixed income
research analysts. The members of the
portfolio management teams are as follows:
Tax-Exempt
Group
:
Steve
Wlodarski, CFA Managing Director, Municipal Portfolio Management, has been
responsible for the ETFs since 2009 and has been associated with McDonnell
since 2001.
James
Grabovac, CFA Vice President, Senior Portfolio Manager, has been responsible
for the ETFs since 2009 and has been associated with McDonnell since 2002.
Dawn Daggy-Mangerson Vice President, Senior Portfolio Manager, has
been responsible for the ETFs since 2009 and has been associated with McDonnell
since 2006. Prior to joining McDonnell, Ms. Daggy-Mangerson
served as Managing Director and Fixed Income Portfolio Manager at ABN AMRO/Chicago
Capital Management, beginning in 2000.
Lawrence Jones Portfolio
Manager, has been responsible for the ETFs since 2009 and has been associated
with McDonnell since 2001.
Taxable
Group
:
Mark
J. Giura Managing Director, Taxable Portfolio Management, has been
responsible for the ETFs since 2009 and has been associated with McDonnell
since 2001.
21
Dirk
D. Davis Vice President, Senior Portfolio Manager, has been responsible for
the ETFs since 2009 and has been associated with McDonnell since 2001.
Thomas
W. OConnell Vice President Portfolio Manager, has been responsible for the
ETFs since 2009 and has been associated with McDonnell since 2005. Prior to joining McDonnell, Mr. OConnell
served as Vice President and Corporate Bond Trader for J.P. Morgan Securities.
The McDonnell Portfolio Managers Performance Information
The
following tables contain performance information for McDonnells National 3-15
Year Municipal Performance Composite (the Municipal Composite) and McDonnells
Core Taxable Bond Composite (the Taxable Composite). The Composites represent composites of all
fully discretionary, fee-paying accounts valued with minimum assets of $5
million managed by McDonnell with substantially similar objectives, policies,
strategies and risks to those of the Grail McDonnell Intermediate Municipal
Bond ETF (in the case of the Municipal Composite) or the Grail McDonnell Core
Taxable Bond ETF (in the case of the Taxable Composite).
The
performance information is limited and may not reflect performance in all
economic cycles. The accounts in the
Composites were not subject to certain investment limitations, diversification
requirements and other restrictions imposed on registered investment companies
such as the ETFs, including those under the Investment Company Act of 1940, as
amended (Investment Company Act), and the Internal Revenue Code of 1986, as
amended, which, if applicable, might have adversely affected the performance of
the accounts in the Composites. Further,
none of the accounts in the Composites have operated as an ETF, and different
performance results for the ETFs are likely due to, among other things,
anticipated differences between the cash positions of the ETFs and the accounts
in the Composites.
The
performance information below is presented after deduction of fees applicable
to the accounts in the Composites, as described in the notes to the Composites,
which vary from the ETFs estimated fees and expenses, as described in the ETFs
fee tables (see Fees and Expenses above).
For the Municipal Composite,
annual return data is presented for each full calendar year since the inception
of the Composite in September 2005, and information for the current year
is through September 30, 2009.
Average annual total returns are presented for the one-year and
three-year periods through September 30, 2009, as well as the period from
inception through September 30, 2009.
For the Taxable Composite, annual return data is presented for each full
calendar year since the inception of the Composite in 1997, and information for
the current year is through September 30, 2009. Average annual total returns are presented
for the one-year, three-year, five-year and ten-year periods through September 30,
2009, as well as the period from inception through September 30, 2009.
This performance information is
not the historical performance of either ETF.
Past performance is no guarantee of future results, and the past
performance of the Composites is not indicative of the future performance of
either ETF.
22
Municipal
Composite:
Performance Results (as of 9/30/09)
|
|
1 Year
|
|
3 Years
|
|
Inception (09/05)
|
|
3-15 Year National Muni
(Net of Fees)
|
|
12.82
|
%
|
5.81
|
%
|
4.93
|
%
|
Barclays Capital 3-15 Muni
Index
|
|
13.12
|
%
|
5.81
|
%
|
5.07
|
%
|
Year End
|
|
2009*
|
|
2008
|
|
2007
|
|
2006
|
|
3-15Year National
Municipal
|
|
9.91
|
%
|
3.08
|
%
|
4.98
|
%
|
4.09
|
%
|
BC 3-15 Municipal Index
|
|
9.96
|
%
|
2.27
|
%
|
4.46
|
%
|
4.18
|
%
|
* Year to Date as of 9/30/09
Notes:
The Composite consists of
all fully discretionary, fee-paying accounts valued with minimum assets of $5
million managed in the National Three to Fifteen Year municipal fixed-income
income style. This style is composed of
taxable client portfolios with target duration between 4.5 to 6.5 years and/or
a laddered benchmark with exposure to longer maturity bonds (greater then 12
years). As of September 30, 2009,
the Composite consisted of 17 accounts, and Composite assets represented
approximately 22.4% of total firm assets.
The Composite benchmark is the Barclays 3 to 15 Year National Municipal
Bond Index, which is
a rules-based, market-value-weighted index engineered for the long-term
tax-exempt bond market. To be included
in the index, bonds must be rated investment-grade (Baa3/BBB- or higher) by at
least two of the following ratings agencies: Moodys, S&P, Fitch. If only two of the three agencies rate the
security, the lower rating is used to determine index eligibility. If only one of the three agencies rates a
security, the rating must be investment-grade.
They must have an outstanding par value of at least $7 million and be
issued as part of a transaction of at least $75 million. The bonds must be fixed rate, have a
dated-date after December 31, 1990, and must be at least one year from
their maturity date. Remarketed issues,
taxable municipal bonds, bonds with floating rates, and derivatives are
excluded from the benchmark. Effective
maturity is limited from 2 years up to but not including 17 years.
23
The Composite inception date is September 2005. Results were calculated in U.S. dollars on a
monthly basis using a time-weighted methodology. Composites are asset-weighted using
beginning-of-month market values. Annual
returns are derived from the geometric linking of monthly returns. Accounts are removed from the Composite for
greater than 20% cash flows. The grace
period for returning accounts to the Composite is the same as new accounts,
following two full months of management.
Results reflect the reinvestment of dividends, interest and other
earnings
.
Net-of-fee results are
calculated by taking the highest applicable advisory fee an institutional
account would be charged based on the current applicable institutional fee
schedule, 0.40%, and deducting one-twelfth of this annual fee from each monthly
gross return.
Taxable
Composite:
Performance Results (as
of 9/30/09)
|
|
1 Year
|
|
3 Years
|
|
5 Years
|
|
10 Years
|
|
Inception (01/95)
|
|
Core Taxable Bond
(Net of Fees)
|
|
11.96
|
%
|
6.44
|
%
|
5.03
|
%
|
5.94
|
%
|
6.76
|
%
|
Barclays Capital Aggregate
Index
|
|
10.56
|
%
|
6.41
|
%
|
5.13
|
%
|
6.30
|
%
|
6.90
|
%
|
Annual Performance Results
Year End
|
|
2009*
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
Core Taxable Bond
|
|
9.60
|
%
|
3.09
|
%
|
6.66
|
%
|
4.40
|
%
|
2.42
|
%
|
4.70
|
%
|
4.43
|
%
|
BC Aggregate Index
|
|
5.72
|
%
|
5.24
|
%
|
6.97
|
%
|
4.33
|
%
|
2.43
|
%
|
4.34
|
%
|
4.10
|
%
|
Year End
|
|
2002
|
|
2001
|
|
2000
|
|
1999
|
|
1998
|
|
1997
|
|
|
|
Core Taxable Bond
|
|
9.13
|
%
|
8.66
|
%
|
11.04
|
%
|
-0.59
|
%
|
8.92
|
%
|
10.15
|
%
|
|
|
BC Aggregate Index
|
|
10.26
|
%
|
8.44
|
%
|
11.63
|
%
|
-0.82
|
%
|
8.69
|
%
|
9.65
|
%
|
|
|
24
* Year to Date as of
9/30/09
Notes:
The Composite consists of
all fully discretionary, fee-paying accounts valued with minimum assets of $5
million managed in a core aggregate fixed-income income style. This style is investment grade and focuses on
the active management of portfolio duration, structure, and sector mix against
a broad market index. As of September 30,
2009, the Composite consisted of 8 accounts, and Composite assets represented
approximately 2.7% of total firm assets.
Accounts in the Composite are not tax sensitive (i.e., do not invest in
municipal bonds as a tax-advantaged investment). Accounts in the Composite invest in U.S.
dollar domestic securities with an opportunistic component (less than 20%) in
BB rated taxable fixed income securities.
The Composite benchmark is the Barclays Aggregate Index, which
represents securities that are SEC-registered, taxable, and dollar
denominated. The index covers the U.S.
investment grade fixed rate bond market, with index components for government
and corporate securities, mortgage pass-through securities, and asset-backed
securities.
The Composite inception date is January 1995. Results were calculated in U.S. dollars on a
monthly basis using a time-weighted methodology. Composites are asset-weighted using
beginning-of-month market values. Annual
returns are derived from the geometric linking of monthly returns.
The Composite performance results for periods prior to
October 31, 2001 reflect performance achieved by McDonnells investment
team while employed by the fixed income separate account business of a
different firm, which was acquired by McDonnell on October 31, 2001. As a result of the acquisition, the
investment team responsible for the performance of the accounts in the
Composite prior to October 31, 2001 became employees of McDonnell and
currently are responsible for the management of all bond strategies for the
same accounts at McDonnell. The
investment team has used substantially the same investment discipline during
the entire period of the performance results portrayed.
Net-of-fee results are
calculated by taking the highest applicable advisory fee an institutional
account would be charged based on the current applicable institutional fee
schedule, 0.40%, and deducting one-twelfth of this annual fee from each monthly
gross return.
The ETFs Statement of
Additional Information provides additional information about the portfolio
managers at McDonnell, including other accounts they manage, their ownership in
the ETFs they manage, and their compensation.
Approval of
Advisory Agreements
A discussion regarding the
basis for the Boards approval of the Investment Management Agreement and the
McDonnell Subadvisory Agreement will be available in the ETFs first report to
shareholders.
OTHER SERVICE PROVIDERS
ALPS Distributors, Inc.
(Distributor), 1290 Broadway, Suite 1100, Denver, CO 80203, serves as
the distributor of Creation Units for each ETF on an agency basis. The Distributor does not maintain a secondary
market in Shares.
The Bank of New York Mellon
Corporation (BNY Mellon), One Wall Street, New York, New York 10286, is the
administrator, fund accountant and transfer agent for the ETFs.
25
BNY Mellon, One Wall Street,
New York, New York 10286, is also the custodian for the ETFs.
K&L Gates LLP, 1601 K
Street, NW, Washington, DC 20006 serves as legal counsel to the ETFs.
KPMG LLP, 1601 Market
Street, Philadelphia, Pennsylvania 19103, serves as the ETFs independent
registered public accounting firm. The
independent registered public accounting firm is responsible for auditing the
annual financial statements of the ETFs.
26
BUYING AND SELLING ETF
SHARES
Shares will be issued or redeemed by each
ETF at NAV per Share only in Creation Units,
which are likely to cost over a million dollars. Shares will trade on the secondary market,
however, which is where most retail investors will buy and sell Shares. It is expected that only a limited number of
institutional investors will purchase and redeem shares directly from the ETFs.
Thus, certain information in this Prospectus is not relevant to most
retail investors. For example,
information about buying and redeeming Shares directly with the ETFs and about Transaction Fees imposed on such
purchases and redemptions is not relevant to most retail investors.
Except when
aggregated in Creation Units, Shares are not redeemable with the ETFs.
Additional
information about the procedures regarding creation and redemption of Creation
Units (including the cut-off times for receipt of creation and redemption
orders) is included in the Statement of Additional Information.
Buying and
Selling Shares on the Secondary Market
Most investors will buy and
sell Shares in secondary market transactions through brokers and therefore,
must have a brokerage account to buy and sell Shares. Shares can be bought or sold throughout the
trading day like shares of any publicly traded issuer. When buying or selling Shares through a
broker, you will incur customary brokerage commissions and charges, and you may
pay some or all of the spread between the bid and the offered prices in the
secondary market for Shares. The price
at which you buy or sell Shares (i.e., the market price) may be more or less
than the NAV of the Shares. Unless
imposed by your broker, there is no minimum dollar amount you must invest in an
ETF and no minimum number of Shares you must buy.
The
Shares will be listed on NYSE Arca, Inc. (the Exchange) under the
following symbols:
ETF
|
|
Trading
Symbol
|
Grail McDonnell
Intermediate Municipal Bond ETF
|
|
GMMB
|
Grail McDonnell Core
Taxable Bond ETF
|
|
GMTB
|
The Exchange is generally
open Monday through Friday and is closed for weekends and the following
holidays: New Years Day, Martin Luther King, Jr. Day, Presidents Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day.
For information about buying
and selling Shares on the Exchange or in the secondary markets, please contact
your broker or dealer.
Book Entry
. Shares are held in book entry form, which
means that no stock certificates are issued.
The Depository Trust Company (DTC), or its nominee, will be the registered
owner of all outstanding Shares of the ETFs and is recognized as the owner of
all Shares. Participants in DTC include
securities brokers and dealers, banks, trust companies, clearing corporations
and other institutions that directly or indirectly maintain a custodial
relationship with DTC. As a beneficial
owner of Shares, you are not entitled to receive physical delivery of stock
certificates or to have Shares registered in your name, and you are not considered
a registered owner of
27
Shares. Therefore, to exercise any right as an owner
of Shares, you must rely on the procedures of DTC and its participants. These procedures are the same as those that
apply to any stocks that you hold in book entry or street name through your
brokerage account. Your account
information will be maintained by your broker, which will provide you with
account statements, confirmations of your purchases and sales of Shares, and
tax information. Your broker also will
be responsible for distributing income and capital gains distributions and for
ensuring that you receive shareholder reports and other communications from the
ETFs.
Share
Trading Prices
. The trading
prices of an ETFs Shares may differ from the ETFs daily NAV and can be
affected by market forces of supply and demand for the ETFs Shares, the prices
of the ETFs portfolio securities, economic conditions and other factors.
Interactive
Data Corporation or another market information provider intends to disseminate
the approximate value of each ETFs portfolio every fifteen seconds. This approximate value should not be viewed
as a real-time update of the NAV of an ETF because the approximate value may
not be calculated in the same manner as the NAV, which is computed once a
day. The ETFs are not involved in, or
responsible for, the calculation or dissemination of the approximate values and
make no warranty as to the accuracy of these values.
Buying
Shares Directly from the ETFs
You
can purchase Shares directly from the ETFs only in Creation Units or multiples
thereof. Though the current number of
Shares in a Creation Unit is 50,000, it may, but is not expected to, change
over time. The ETFs will not issue
fractional Creation Units. The ETFs
reserve the right to reject any purchase request at any time, for any reason,
and without notice. The ETFs can stop
selling Shares or postpone payment of redemption proceeds at times when the
Exchange is closed or under any emergency circumstances as determined by the
SEC.
Creation
Units may be purchased in exchange for a Fund Deposit. A Fund Deposit consists of (i) a basket
of securities - known as the
In-Kind
Creation Basket -
and a
Balancing Amount,
as described
below, (ii) a basket of certain in-kind securities and cash (Partial Cash
Value, and together with the in-kind basket, an In-Kind/Cash Basket) or (iii) all
cash (the Cash Value). In all
instances the value of the Fund Deposit will be equal to the value of the
Creation Unit.
To purchase Shares directly
from an ETF, you must be an Authorized Participant or you must purchase through
a broker that is an Authorized Participant.
An Authorized Participant is a participant of the Continuous Net
Settlement System of the NSCC or the DTC that has executed a Participant
Agreement with the Distributor. The
Distributor will provide a list of Authorized Participants upon request. Authorized Participants may purchase Creation
Units of Shares, and sell individual Shares on the Exchange. See Continuous Offering below.
In-Kind
Creation Basket
. On each
business day, prior to the opening of trading on the Exchange, BNY Mellon will
post on the NSCC bulletin board the In-Kind Creation Basket for each ETF for
that day. The In-Kind Creation Basket
will identify the name and number of shares of each security that must be
contributed to an ETF for such a Creation Unit purchase. Each ETF reserves the right to accept a
nonconforming or custom In-Kind Creation Basket.
28
Balancing
Amount and Cash Component.
In addition to the In-Kind Creation Basket, a
purchaser will typically pay to the ETF a Balancing Amount equal to the
difference between the NAV of a Creation Unit and the value of the securities
in the In-Kind Creation Basket. The
Balancing Amount ensures that the consideration paid by an investor for a
Creation Unit is exactly equal to the value of the Creation Unit. BNY Mellon will publish, on a daily basis,
information about the previous days Balancing Amount. With respect to Fund Deposits of an In-Kind
Creation Basket, the Balancing Amount and the Transaction Fee may be referred
to collectively as the Cash Component.
In-Kind/Cash Basket.
In lieu of depositing the
In-Kind Creation Basket and Balancing Amount, the purchaser of a Creation Unit
may make a Fund Deposit of an In-Kind/Cash Basket. The cash portion of such a Fund Deposit is
known as the Partial Cash Value and will be subject to a variable charge, as
explained below. With respect to Fund
Deposits of In-Kind/Cash Baskets, the Partial Cash Value and the Transaction
Fee may be referred to collectively as the Cash Component.
Cash Value
. In lieu of
depositing the In-Kind Creation Basket and Balancing Amount or an In-Kind/Cash
Basket, a Fund Deposit may consist solely of cash in an amount equal to the NAV
of a Creation Unit, which amount is referred to as the Cash Value. Any such purchases will be subject to a
variable charge, as explained below. BNY
Mellon will publish, on a daily basis, information about the Cash Value of a
Creation Unit. With respect to any Fund
Deposit of a Cash Value, the Cash Value and Transaction Fee may be referred to
collectively as the Cash Component.
Placement
of Purchase Orders
. All
purchase orders must be placed by or through an Authorized Participant. Purchase orders will be processed either
through a manual clearing process run by DTC or through an enhanced clearing
process that is available only to those DTC participants that also are
participants in the Continuous Net Settlement System of the NSCC. Authorized Participants that do not use the
NSCCs enhanced clearing process for Fund Deposits of In-Kind Creation Baskets
of the Grail McDonnell Intermediate Municipal Bond ETF may be charged a higher
transaction fee (discussed below). Fund
Deposits of In-Kind Creation Baskets generally must be received by the
Distributor prior to the close of regular trading on the NYSE (usually 4:00 p.m.,
Eastern time) and Fund Deposits of In-Kind/Cash Baskets and Cash Values
generally must be received two hours prior (with respect to each, the Order
Cut-Off Time) on the day the order is placed, and all other procedures set
forth in the Participant Agreement must be followed, in order to receive the
NAV determined on that day. On days when
the NYSE or the bond markets close earlier than normal (for example, the day
before a holiday), the ETF may require purchase orders to be placed earlier in
the day.
Transaction
Fees on Purchases of Creation Units.
Each ETF imposes a Transaction Fee on
purchases of Creation Units to be paid by the purchaser in cash. The Transaction Fee is paid to the relevant
ETF. The fee protects existing
shareholders of an ETF from the costs associated with issuing Creation Units.
The Transaction Fees applied
to purchases of the ETFs include two components a standard fee and a variable
charge:
29
|
|
Transaction Fees
|
|
ETF
|
|
Standard
Transaction Fee
|
|
Variable Charge
|
|
Grail McDonnell Intermediate Municipal Bond ETF
|
|
$
|
500
|
*
|
Up to 3.0%
|
|
Grail McDonnell Core Taxable Bond ETF
|
|
$
|
500
|
|
Up to 3.0%
|
|
* The Transaction Fee may be higher for
transactions outside NSCCs enhanced clearing process.
With respect to creations
involving the in-kind deposit of securities with an ETF through the NSCCs
enhanced clearing process, a flat (or standard) Transaction Fee applies,
regardless of the number of Creation Units purchased on a business day
(assuming, in the case of multiple orders on the same day, that the orders are
received at or near the same time). With
respect to creations involving the in-kind deposit of securities with an ETF outside
the NSCCs enhanced clearing process, a higher standard transaction fee may be
imposed on each Creation Unit purchase of the Grail McDonnell Intermediate
Municipal Bond ETF.
The Transaction Fees imposed
in creation transactions of both ETFs involving an In-Kind/Cash Basket,
including a Partial Cash Value, will also include a variable charge of up to 3%
of the Partial Cash Value. Similarly,
the Transaction Fees imposed in creation transactions of the ETFs involving a
Cash Value will include a variable charge of up to 3% of the Cash Value. Investors who, directly or indirectly, use
the services of a broker or other such intermediary to compile the securities
in the In-Kind Creation Basket or In-Kind/Cash Basket may pay additional fees
for these services.
Redeeming
Shares Directly From an ETF
You may redeem Shares of the
ETFs only in Creation Units or multiples thereof. To redeem Shares directly with an ETF, you
must be an Authorized Participant or you must redeem through an Authorized
Participant.
Creation
Units generally may be redeemed in exchange for a Fund Redemption. A Fund Redemption consists of (i) a
basket of securities known as the
In-Kind Redemption Basket
and
Balancing Amount,
(ii) a
basket of in-kind securities and Partial Cash Value or (iii) a Cash Value,
in all instances equal to the value of a Creation Unit.
In-Kind
Redemption Basket.
If different
from the In-Kind Creation Basket, the composition of the In-Kind Redemption
Basket will be available on the NSCC bulletin board; otherwise, the In-Kind
Creation Basket posted may be assumed to be the In-Kind Redemption Basket,
too. An ETF may honor a redemption
request with a nonconforming or custom In-Kind Redemption Basket.
Balancing
Amount and Cash Component.
In addition to the In-Kind Redemption Basket,
a redeeming investor will receive from (or pay to) the ETF a Balancing Amount
in cash, depending on whether the NAV of a Creation Unit is higher (or
30
lower) than the value of the
securities in the In-Kind Redemption Basket.
If due to receive a Balancing Amount, the amount actually received will
be reduced by the amount of the applicable Transaction Fee. The Balancing Amount and the Transaction Fee
may be referred to collectively as the Cash Component.
In-Kind/Cash Basket.
In lieu of receiving the
In-Kind Redemption Basket and Balancing Amount as a Fund Redemption, the
redeemer of a Creation Unit may instead elect to receive an In-Kind/Cash
Basket. The cash portion is known as the
Partial Cash Value and will be subject to a variable charge, as explained
above. With respect to Fund Redemptions
consisting of an In-Kind/Cash Basket, the Partial Cash Value and Transaction
Fee may be referred to collectively as the Cash Component.
Cash Value
. In lieu of the In-Kind Redemption Basket and
a Balancing Amount or an In-Kind/Cash Basket, Creation Units may be redeemed
for a Fund Redemption consisting solely of cash in an amount equal to the NAV
of a Creation Unit, which amount is referred to as the Cash Value. Such redemptions will be subject to a
variable charge, as explained above. BNY
Mellon will publish, on a daily basis, information about the Cash Value of a
Creation Unit. With respect to any Fund
Redemption consisting of a Cash Value, the Cash Value and Transaction Fee may
be referred to collectively as the Cash Component.
Placement
of Redemption Orders.
As
with purchases, redemptions must be placed by or through an Authorized
Participant and processed through DTC or the enhanced NSCC process. A redemption order is deemed received on the
date of transmittal if it is received by the Distributor prior to the Order
Cut-Off Time on that date, unless the NYSE or the bond markets close early that
day in which case the ETF may require redemption orders to be received earlier
in the day, and if all other procedures set forth in the Participant Agreement
are followed.
Transaction
Fees on Redemptions of Creation Units.
The ETFs impose a Transaction Fee on
redemptions of Creation Units to be paid by the redeeming investor in
cash. The Transaction Fee is paid to the
ETF. The fee protects existing
shareholders of the ETF from the costs associated with redeeming Creation
Units. The amount of the Transaction
Fees on redemptions effected through the NSCC and DTC, are the same as those
applied to creations. (See Transaction
Fees on Purchases of Creation Units, page [XX]).
Legal Restrictions on
Transactions in Certain Securities.
An investor
subject to a legal
restriction
with respect to a particular security required to be deposited in connection
with the purchase of a Creation Unit may, at the ETFs discretion, be permitted
to deposit an equivalent amount of cash in substitution for any security which
would otherwise be included in the In-Kind Creation Basket applicable to the
purchase of a Creation Unit.
Creations and redemptions of
Shares will be subject to compliance with applicable federal and state
securities laws, including that securities accepted for deposit and securities
used to satisfy redemption requests are sold in transactions that would be
exempt from registration under the Securities Act of 1933, as amended (Securities
Act). The ETFs (whether or not they
otherwise permit cash redemptions) reserve the right to redeem Creation Units
for cash to the extent that an
31
investor could not lawfully
purchase or an ETF could not lawfully deliver specific securities under such
laws or the local laws of a jurisdiction in which the ETF invests. An Authorized Participant or an investor for
which it is acting subject to a legal restriction with respect to a particular
stock included in an In-Kind Redemption Basket may be paid an equivalent amount
of cash. An Authorized Participant that
is not a qualified institutional buyer (QIB) as defined in Rule 144A under
the Securities Act will not be able to receive, as part of a redemption,
restricted securities eligible for resale under Rule 144A.
Continuous Offering
. You should be aware of certain legal risks
unique to investors purchasing Creation Units directly from an ETF. Because Shares may be issued on an ongoing
basis, a distribution of Shares could be occurring at any time. Certain activities that you perform with
respect to the sale of Shares could, depending on the circumstances, result in
your being deemed to be a participant in the distribution, in a manner that
could render you a statutory underwriter and subject you to the prospectus
delivery and liability provisions of the Securities Act. For example, you could be deemed a statutory
underwriter if you purchase Creation Units from the issuing ETF, break them
down into the constituent Shares, and sell those Shares directly to customers,
or if you choose to couple the creation of a supply of new Shares with an
active selling effort involving solicitation of secondary-market demand for
Shares. Whether a person is an
underwriter depends upon all of the facts and circumstances pertaining to that
persons activities, and the examples mentioned here should not be considered a
complete description of all the activities that could cause you to be deemed an
underwriter.
Broker-dealer firms should
also note that dealers who are not underwriters but are effecting
transactions in Shares, whether or not participating in the distribution of
Shares, are generally required to deliver a prospectus. This is because the prospectus delivery
exemption in Section 4(3) of the Securities Act is not available in
respect of such transactions as a result of Section 24(d) of the
Investment Company Act. As a result,
broker-dealer firms should note that dealers who are not underwriters but are
participating in a distribution (as opposed to engaging in ordinary
secondary-market transactions), and thus dealing with Shares as part of an unsold
allotment within the meaning of Section 4(3)(C) of the Securities
Act, will be unable to take advantage of the prospectus delivery exemption
provided by Section 4(3) of the Securities Act. For delivery of prospectuses to exchange
members, the prospectus delivery mechanism of Rule 153 under the
Securities Act is only available with respect to transactions on a national
exchange.
ACTIVE INVESTORS AND
MARKET TIMING
The Board has determined not
to adopt policies and procedures designed to prevent or monitor for frequent
purchases and redemptions of the ETFs Shares because investors primarily
transact in ETF Shares on the secondary market.
Frequent trading of Shares on the secondary market does not disrupt
portfolio management, increase an ETFs trading costs, lead to realization of
capital gains or otherwise harm ETF shareholders because these trades do not
involve the issuance or redemption of ETF Shares.
The
ETFs sell and redeem their Shares at NAV only in Creation Units pursuant to the
terms of a Participant Agreement between the Authorized Participant and the Distributor. With respect to
32
such
trades directly with the ETFs, to the extent effected in-kind (i.e., for
securities), they do not cause the harmful effects that may result from
frequent cash trades.
The Board recognized that to
the extent that the ETFs allow or require trades to be effected in whole or in
part in cash, those trades could result in dilution to an ETF and increased
transaction costs, which could negatively impact an ETFs ability to achieve
its investment objective. The Board also
recognized, however, that direct trading by Authorized Participants is critical
to ensuring that the ETFs Shares trade at or close to NAV. Further, the ETFs may employ fair valuation
pricing to minimize the potential for dilution from market timing. Moreover, each ETF imposes Transaction Fees
on purchases and redemptions of ETF Shares, which increase if an investor
substitutes cash in part or in whole for securities, reflecting the fact that
an ETFs costs increase in those circumstances.
Each ETF reserves the right to impose additional restrictions on
disruptive, excessive or short-term purchases.
DISTRIBUTION AND SERVICE
PLAN
Each ETF has adopted a
distribution and service plan (Plan) pursuant to Rule 12b-1 under the
Investment Company Act. Under the Plan,
an ETF is authorized to pay distribution fees to the Distributor and other
firms that provide distribution and shareholder services (Service Providers). If a Service Provider provides such services,
an ETF may pay fees at an annual rate not to exceed 0.25% of average daily net
assets, pursuant to Rule 12b-1 under the Investment Company Act. In addition, if the payment of management
fees by the ETF is deemed to be indirect financing by the ETF of the
distribution of Shares, such payment is authorized by the Plan.
No distribution or service
fees are currently paid by any ETF, however, and there are no current plans to
impose these fees. In the event Rule 12b-1
fees were charged, over time they would increase the cost of an investment in
an ETF.
NET ASSET VALUE
The
net asset value, or NAV, of Shares is calculated each business day as of the
close of regular trading on the NYSE, generally 4:00 p.m., Eastern time ,
however, U.S. fixed income assets may be valued as of the announced closing
time for trading in fixed-income instruments on any day that an early closing
time is announced.
Each ETF calculates its NAV
per Share by:
·
Taking the
current market value of its total assets,
·
Subtracting any
liabilities, and
·
Dividing that
amount by the total number of Shares owned by shareholders.
If you buy or sell Shares on
the secondary market, you will pay or receive the market price, which may be
higher or lower than NAV. Your
transaction will be priced at NAV only if you purchase or redeem your Shares in
Creation Units.
33
When calculating the NAV of
an ETFs Shares, expenses are accrued and applied daily and stocks held by the
ETF are valued at their market value when reliable market quotations are
readily available. Common stocks and
other equity securities are valued at the last sales price that day based on
the official closing price of the exchange where the security is primarily
traded. Debt securities (other than
short-term securities) usually are valued on the basis of prices provided by a
third-party independent pricing service using the mean between the bid and ask
price. Prices obtained from independent
pricing services use various observable inputs including but not limited to
pricing formulas, such as dividend discount models, option valuation formulas
and discounted cash flow models that might be applicable. In some cases, the price of debt securities
is determined using quotes obtained from brokers. Certain short-term debt instruments used to
manage an ETFs cash are valued on the basis of amortized cost. Exchange-traded derivatives are valued at the
last sale price on the exchange. The
values of any foreign securities held by an ETF are converted into U.S. dollars
using an exchange rate obtained from an independent third party.
When reliable market
quotations are not readily available, securities are priced at their fair value
as determined in good faith using methods approved by the Board. An ETF may use fair-value pricing if the
value of a security it holds has been materially affected by events occurring
before the ETFs pricing time but after the close of the primary markets or
exchanges on which the security is traded.
Intervening events might be company-specific (e.g., earnings report,
merger announcement), country-specific (e.g., natural disaster, economic or
political news, act of terrorism, interest rate change), or global. Intervening events include price movements in
U.S. markets that are deemed to affect the value of foreign securities. Fair-value pricing also may be used for
domestic securities for example, if (1) trading in a security is halted
and does not resume before the ETFs pricing time or if a security does not
trade in the course of a day, and (2) the ETF holds enough of the security
that its price could affect the ETFs NAV.
Fair-value prices are
determined by the Valuation Committee, composed of representatives of Grail and
McDonnell, according to procedures adopted by the Board. When fair-value pricing is employed, the
prices of securities used by the ETF to calculate its NAV may differ from quoted
or published prices for the same securities.
ETF WEBSITE AND
DISCLOSURE OF PORTFOLIO HOLDINGS
The Trust maintains a
website for the ETFs at www.grailadvisors.com.
Among other things, this website includes this Prospectus and the
Statement of Additional Information, and will include the ETFs holdings, the
ETFs last annual and semi-annual reports (when available), pricing information
about Shares trading on the Exchange, daily NAV calculations and a historical
comparison of the trading prices to NAV.
The
ETFs publicly disseminate their full portfolio holdings each day the ETF is
open for business through its website at www.grailadvisors.com. In addition, the In-Kind Creation Basket and
In-Kind Redemption Basket, which identify, respectively, the securities and
share quantities which are delivered in exchange for purchases and redemptions
of Creation Units, are publicly disseminated daily prior to the opening of
trading on the Exchange via the NSCC.
34
PORTFOLIO TURNOVER
In contrast to certain ETFs
that seek to replicate the performance of a specified index, the ETFs are
actively-managed and may trade securities actively. Portfolio turnover may result in transaction
costs, including brokerage commissions and generate relatively higher capital
gains to an ETF than commonly associated with index-based ETFs. However, the ETFs expect to have an annual
portfolio turnover rate of less than 100% and the ETFs will impose Transaction
Fees, which should offset brokerage costs.
Shareholders should consult their own tax adviser for individual tax
advice.
SECTION 12(d)(1) INFORMATION
The Trust and the ETFs are
part of the Grail Advisors Actively Managed ETFs family of funds and are
related for purposes of investor and investment services, as defined in Section 12(d)(1)(G) of
the Investment Company Act.
For purposes of the
Investment Company Act, Shares are issued by a registered investment company
and purchases of such Shares by registered investment companies and companies
relying on Section 3(c)(1) or 3(c)(7) of the Investment Company
Act are subject to the restrictions set forth in Section 12(d)(1) of
the Investment Company Act, except as permitted by an exemptive order of the
SEC. The SEC has granted the Trust such
an order to permit registered investment companies to invest in Shares beyond
the limits in Section 12(d)(1)(A), subject to certain terms and
conditions, including that the registered investment company first enter into a
written agreement with the Trust regarding the terms of the investment. Accordingly, registered investment companies
that wish to rely on the order must first enter into such a written agreement
with the Trust and should contact the Trust to do so.
DIVIDENDS, DISTRIBUTIONS
AND TAXES
ETF
Distributions
Each
ETF pays out dividends from its net investment income to shareholders
monthly. Each ETF distributes its net
capital gains, if any, annually. Each
ETF typically earns income dividends from its investments. These amounts, net of expenses, are passed
along to ETF shareholders as income dividend distributions. Each ETF realizes capital gains or losses
whenever it sells securities. Net
long-term capital gains are distributed to shareholders as capital gains
distributions.
You will receive other
services (e.g., dividend reinvestment and average cost information) only if
your broker offers these services.
Brokers may make available
to their customers who own Shares the DTC book-entry dividend reinvestment
service. To determine whether the
dividend reinvestment service is available and whether there is a commission or
other charge for using this service, consult your broker. Brokers may require ETF shareholders to
adhere to specific procedures and timetables.
If this service is available and used, dividend distributions of both income
and realized gains will be
35
automatically reinvested in
additional whole Shares of the same ETF purchased in the secondary market. Without this service, investors would receive
their distributions in cash.
Taxes
As with any investment, you should consider how your
investment in Shares of an ETF will be taxed.
The tax information in this Prospectus is provided as general
information. You should consult your own
tax professional about the tax consequences of an investment in Shares of an
ETF.
ETF distributions and your sale of your Shares in an
ETF will have tax consequences to you.
Such consequences may not apply if you hold your Shares through a
tax-exempt entity or tax-deferred retirement account, such as an IRA.
Taxes on Distributions
Distributions of an ETFs
investment company taxable income (which is, generally, ordinary income plus
net short-term capital gains in excess of net long-term capital losses) will be
taxable as ordinary income to the extent of the ETFs current or accumulated
earnings and profits.
Dividends paid by the
Grail McDonnell Intermediate Municipal Bond ETF that are properly designated as
exempt-interest dividends will not be subject to federal income tax. The Grail McDonnell Intermediate Municipal
Bond ETF intends to invest its assets in a manner such that a significant
portion of its dividend distributions to shareholders will generally be exempt
from federal income taxes (although interest paid on municipal securities may
be subject to the alternative minimum tax in the hands of corporate shareholders). Depending on your state of residence,
exempt-interest dividends from interest earned on municipal securities of your
state of residence or its political subdivisions may be exempt from income tax
in that state, but income from municipal securities of other states generally
will not qualify for tax-free treatment.
Distributions of an ETFs
net capital gains (which are net long-term capital gains in excess of net
short-term capital losses) properly designated by the ETF as capital gain
dividends will be taxable to you as long-term capital gains at a maximum rate
of 15% (20% after 2010) in the case of individuals, trusts or estates,
regardless of your holding period in an ETFs Shares and regardless of whether
paid in cash or reinvested in additional Shares. Distributions in excess of an ETFs earnings
and profits first will reduce your adjusted tax basis in ETF Shares and, after
the adjusted basis is reduced to zero, will constitute capital gains. Such capital gain will be long-term capital
gain and thus, will be taxed at a maximum rate of 15% for taxable years
beginning on or before December 31, 2010, and 20% thereafter, if the
distributions are attributable to Shares held by you for more than one year.
Under a dividend reinvestment service, you may have
the option that all cash distributions are automatically reinvested in
additional ETF Shares. Any distributions
reinvested under such a service will nevertheless be taxable to you. You will have an adjusted basis in the
additional Shares purchased through such a reinvestment service equal to the
amount of the reinvested distribution.
The additional Shares will have a new holding period commencing on the
day following the day on which the Shares are credited to your account.
36
If you lend your Grail
McDonnell Intermediate Municipal Bond ETF Shares pursuant to securities lending
or similar arrangements, you may lose the ability to treat the ETF dividends
(paid while the Shares are held by the borrower) as tax-exempt income. Also, interest on indebtedness incurred by a
shareholder to purchase or carry Shares of the ETF will not be deductible for
federal income tax purposes. You should consult your financial intermediary or
tax adviser before entering into such arrangements.
Exempt-interest dividends
from the Grail McDonnell Intermediate Municipal Bond ETF are taken into account
in determining the taxable portion of any Social Security or railroad
retirement benefit that you receive.
A distribution will
reduce the ETFs NAV per Share and may be taxable to you as ordinary income or
capital gain even though, from an investment standpoint, the distribution may
constitute a return of capital. Any
market discount recognized by an ETF on a bond is taxable as ordinary
income. A market discount bond is a bond
acquired in the secondary market at a price below redemption value or adjusted
issue price if issued with original issue discount. Absent an election by the ETF to include the
market discount in income as it accrues, gain on the ETFs disposition of such
an obligation will be treated as ordinary income rather than capital gain to
the extent of the accrued market discount.
In general, non-exempt
distributions are subject to federal income tax for the year when they are
paid. However, certain distributions
paid in January may be treated as paid on December 31 of the prior
year.
You may be subject to Federal back-up withholding, at
a current rate of 28%, if you have not provided a taxpayer identification
number or social security number and made other required certifications.
You may also be subject
to state and local taxes on distributions, sales and redemptions.
Taxes When Shares are Sold
Generally, you will
recognize taxable gain or loss if you sell or otherwise dispose of your
Shares. Any gain arising from such sale
or disposition generally will be treated as long-term capital gain if you held
the Shares for more than one year.
Otherwise, it would be classified as short-term capital gain. However, any capital loss arising from the
sale or disposition of Shares held for six months or less will be treated as
long-term capital loss to the extent of the amount of capital gain dividends
received, or undistributed capital gain deemed received, with respect to such
Shares. In addition, any capital loss
arising from the sale or disposition of Grail McDonnell Intermediate Municipal
Bond ETF Shares held for six months or less will be disallowed to the extent of
the amount of exempt-interest dividends received with respect to such
Shares. All or a portion of any loss
recognized upon a disposition of Shares may be disallowed under wash sale rules if
other Shares of the same ETF are purchased (whether through reinvestment of
distributions or otherwise) within 30 days before or after the
disposition. If disallowed, the loss
will be reflected in an adjustment to the basis of the Shares acquired.
37
Taxes on Purchase and Redemption of Creation Units
An Authorized Participant who exchanges securities for
Creation Units generally will recognize a gain or a loss. The gain or loss will
be equal to the difference between the market value of the Creation Units at
the time and the exchangers aggregate basis in the securities surrendered and
the Cash Component paid. A person who
exchanges Creation Units for securities will generally recognize a gain or loss
equal to the difference between the exchangers basis in the Creation Units and
the aggregate market value of the securities received and the Cash
Component. The Internal Revenue Service,
however, may assert that a loss realized upon an exchange of securities for
Creation Units cannot be deducted currently under the rules governing wash
sales, or on the basis that there has been no significant change in economic
position. Persons exchanging securities
should consult their own tax advisor with respect to whether wash sale rules apply
and when a loss might be deductible.
Under current federal tax laws, any capital gain or
loss realized upon redemption of Creation Units is generally treated as
long-term capital gain or loss if the Shares have been held for more than one
year and as short-term capital gain or loss if the Shares have been held for
one year or less.
If you purchase or redeem Creation Units, you will be
sent a confirmation statement showing how many Shares you purchased or sold and
at what price.
The foregoing is only a summary of certain tax
considerations under current law, which may be subject to change in the
future. Shareholders such as
non-resident aliens, foreign trusts or estates, or foreign corporations or
partnerships, may be subject to different United States federal income tax
treatment.
You should consult your tax
adviser for further information regarding federal, state, local and/or foreign
tax consequences relevant to your specific situation. More information about taxes is in the ETFs
Statement of Additional Information.
FINANCIAL HIGHLIGHTS
The ETFs are newly organized
and therefore have not yet had any operations as of the date of this
Prospectus.
38
GRAIL ADVISORS ACTIVELY MANAGED ETFS
If you would like more
information about the ETFs and the Trust, the following documents are available
free, upon request:
ANNUAL/SEMI-ANNUAL REPORTS TO
SHAREHOLDERS
Additional information about
the ETFs will be in their annual and semi-annual reports to shareholders, when
available. The annual report will
explain the market conditions and investment strategies affecting each ETFs
performance during the last fiscal year.
STATEMENT OF ADDITIONAL
INFORMATION
A
Statement of Additional Information dated December 31, 2009, which
contains more details about the ETFs, is incorporated by reference in its
entirety into this Prospectus, which means that it is legally part of this
Prospectus.
To receive a free copy of the
latest annual or semi-annual report, when available, or the Statement of
Additional Information, or to request additional information about the ETFs,
please contact us as follows:
Call:
1-415-677-5870
Write:
Grail Advisors ETF Trust
c/o
Grail Advisors, LLC
One
Ferry Building, Suite 255
San
Francisco, CA 94111
Visit:
www.grailadvisors.com
INFORMATION PROVIDED BY THE
SECURITIES AND EXCHANGE COMMISSION
Information
about the ETFs, including their reports and the Statement of Additional
Information, has been filed with the SEC.
It can be reviewed and copied at the SECs Public Reference Room in
Washington, DC or on the EDGAR database on the SECs internet site
(http://www.sec.gov). Information on the
operation of the SECs Public Reference Room may be obtained by calling
the SEC at (202) 551-8090. You can
also request copies of these materials, upon payment of a duplicating fee, by
electronic request at the SECs e-mail address (publicinfo@sec.gov) or by
writing the Public Reference section of the SEC, 100 F Street NE, Room 1580,
Washington, DC 20549.
Investment Company Act
File No. 811-22154.
40
STATEMENT OF ADDITIONAL
INFORMATION
GRAIL ADVISORS ETF TRUST
Grail McDonnell Intermediate
Municipal Bond ETF (GMMB)
Grail McDonnell Core Taxable
Bond ETF (GMTB)
ONE FERRY BUILDING, SUITE 255, SAN FRANCISCO, CA 94111
PHONE: 1-415-677-5870
December 31,
2009
This
SAI describes the Grail Advisors ETF Trust, which was formed on December 7,
2007. The Trust is an open-end
registered management investment company under the Investment Company Act, and
is currently comprised of eight ETFs.
Grail McDonnell Intermediate Municipal Bond ETF and Grail McDonnell Core
Taxable Bond ETF are discussed in this SAI.
RP Growth ETF, RP Focused Large Cap Growth ETF, RP Technology ETF and RP
Financials ETF are discussed in a separate Prospectus and Statement of Additional
Information, each dated September 10, 2009. Grail American Beacon Large Cap Value ETF and
Grail American Beacon International Equity ETF are discussed in a separate
Prospectus and Statement of Additional Information, each dated May 1,
2009.
Shares of
the ETFs are neither guaranteed nor insured by the U.S. Government.
This
SAI, dated December 31, 2009 is not a prospectus. It should be read in conjunction with the
ETFs Prospectus, dated December 31, 2009, which incorporates this SAI by
reference. Capitalized terms used herein
that are not defined have the same meaning as in the Prospectus, unless
otherwise noted. A copy of the
Prospectus may be obtained without charge by writing to the Distributor,
calling 1-415-677-5870 or visiting www.grailadvisors.com. An annual report for the ETFs will be
available in the same manner once the ETFs have completed their first annual
period.
1
TABLE OF CONTENTS
|
Page
|
|
|
GLOSSARY
|
3
|
|
|
TRUST
AND ETFS OVERVIEW
|
4
|
|
|
EXCHANGE
LISTING AND TRADING
|
5
|
|
|
DISCLOSURE
OF PORTFOLIO HOLDINGS
|
6
|
|
|
INTRADAY
INDICATIVE VALUE
|
6
|
|
|
INVESTMENT POLICIES AND RESTRICTIONS
|
6
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|
|
INVESTMENT OBJECTIVE, INVESTMENT STRATEGIES AND RISKS
|
8
|
|
|
MANAGEMENT
|
33
|
|
|
CONTROL
PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
|
39
|
|
|
INVESTMENT ADVISORY AND OTHER SERVICES
|
39
|
|
|
Grail
Advisors, LLC
|
39
|
|
|
McDonnell
Investment Management, LLC
|
41
|
|
|
Custodian
|
42
|
|
|
Administrator,
Fund Accountant and Transfer Agent
|
42
|
|
|
PORTFOLIO MANAGERS
|
43
|
|
|
PORTFOLIO TRANSACTIONS AND BROKERAGE
|
45
|
|
|
THE DISTRIBUTOR
|
46
|
|
|
ACCOUNTING AND LEGAL SERVICE PROVIDERS
|
47
|
|
|
ADDITIONAL INFORMATION CONCERNING SHARES
|
47
|
|
|
TRANSACTIONS IN CREATION UNITS
|
50
|
|
|
Purchasing
Creation Units
|
50
|
|
|
Creation
and Redemption Transaction Fees
|
54
|
|
|
Redeeming
Creation Units
|
55
|
|
|
DETERMINATION OF NET ASSET VALUE
|
58
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|
|
TAXATION
|
58
|
|
|
Appendix A Proxy Voting Policies and Procedures for the Trust
|
A-1
|
|
|
Appendix B Proxy Voting Policies and Procedures for McDonnell
|
B-1
|
|
|
Appendix C Description Of
Securities Ratings
|
C-1
|
No person has been
authorized to give any information or to make any representations other than
those contained in this SAI and the Prospectus and, if given or made, such
information or representations may not be relied upon as having been authorized
by the Trust. The SAI does not
constitute an offer to sell securities.
2
GLOSSARY
The
following terms are used throughout this SAI, and have the meanings used below:
1933 Act
means the
Securities Act of 1933, as amended.
1934 Act
means the
Securities Exchange Act of 1934, as amended.
Authorized
Participant
means a broker-dealer or other participant in the
Continuous Net Settlement System of the NSCC or a participant in DTC with
access to the DTC system, and who has executed an agreement with the
Distributor that governs transactions in the ETFs Creation Units.
Balancing
Amount
means an amount equal to the difference between the NAV
of a Creation Unit and the market value of the In-Kind Creation (or Redemption)
Basket, used to ensure that the NAV of a Fund Deposit (or Redemption) is
identical to the NAV of the Creation Unit.
Board
means the Board of
Trustees of the Trust.
Business
Day
means any day on which the Trust is open for business.
CFTC
means the Commodity
Futures Trading Commission.
Code
means the Internal
Revenue Code of 1986, as amended.
Creation
Unit
means an aggregation of 50,000 Shares that each ETF issues
and redeems on a continuous basis at NAV.
Shares will not be issued or redeemed except in Creation Units.
Distributor
means ALPS
Distributors, Inc.
DTC
means the Depository
Trust Company.
ETF
means a series of the
Trust discussed in this SAI: Grail McDonnell Intermediate Municipal Bond ETF
and Grail McDonnell Core Taxable Bond ETF.
Exchange
means the NYSE Arca, Inc.
FINRA
means the Financial
Industry Regulatory Authority.
Fund
Deposit
means the cash or in-kind securities deposited in
connection with the purchase of a Creation Unit of an ETF.
Fund
Redemption
means the cash or in-kind securities received in
connection with the redemption of a Creation Unit of an ETF.
IIV
means an approximate per-Share value of an ETFs portfolio, disseminated every
fifteen seconds throughout the trading day by Interactive Data Corporation (IDC)or
other information providers, known as the Intraday Indicative Value.
In-Kind
Creation Basket
means the basket of securities specified by the
ETF to be deposited with it in connection with the purchase of Creation Units,
including the name and number of shares of each security to be contributed.
3
In-Kind
Redemption Basket
means the basket of securities specified by
the ETF to be received in connection with the redemption of Creation Units.
Investment Company Act
means
the Investment Company Act of 1940, as amended.
Manager
means Grail
Advisors, LLC.
McDonnell
means McDonnell
Investment Management, LLC.
NAV
means the net asset
value of an ETF.
NSCC
means the National Securities Clearing Corporation.
NYSE
means the New York
Stock Exchange, Inc.
Prospectus
means the ETFs prospectus, dated December 31, 2009, as amended and
supplemented from time to time.
SAI
means this Statement of
Additional Information, as amended and supplemented from time to time.
SEC
means the United States
Securities and Exchange Commission.
Shares
means the shares of
an ETF.
Transaction
Fees
are fees imposed to compensate the Trust for costs
incurred in connection with transactions for Creation Units. The Transaction Fee is comprised of a flat
(or standard) fee and a variable fee.
For each ETF,
the standard fee will generally be $500, though a higher fee may be imposed in
connection with Creation Unit transactions of the Grail McDonnell Intermediate
Municipal Bond ETF effected outside of the enhanced NSCC clearing process. In addition, with respect to Creation Unit
transactions composed wholly or partially of cash, the Transaction Fee will
include a variable charge of up to 3% of the cash (portion of the) transaction.
Trust
means the Grail
Advisors ETF Trust, a Delaware statutory trust.
TRUST
AND ETFS OVERVIEW
The
Trust is a Delaware statutory trust formed on December 7, 2007 and an
open-end registered management investment company comprised of eight ETFs: Grail McDonnell Intermediate Municipal Bond
ETF, Grail McDonnell Core Taxable Bond ETF, RP Growth ETF, RP Focused
Large Cap Growth ETF, RP Technology ETF, RP Financials ETF, Grail American
Beacon Large Cap Value ETF and Grail American Beacon International Equity
ETF. RP Growth ETF, RP Focused Large Cap
Growth ETF, RP Technology ETF and RP Financials ETF are discussed in a separate
Prospectus and Statement of Additional Information, each dated December 31,
2009. Grail American Beacon Large Cap
Value ETF and Grail American Beacon International Equity ETF are discussed in a
separate Prospectus and Statement of Additional Information, each dated May 1,
2009. As of the date of this SAI, Grail
American Beacon International Equity ETF has not been opened for
investment. Each of the ETFs, with the
exception of RP Focused Large Cap Growth ETF, is a diversified, actively
managed exchange-traded fund. RP Focused
Large Cap
4
Growth
ETF is a non-diversified, actively-managed exchange-traded fund. Other ETFs may be added to the Trust in the
future. The offering of the Shares is
registered under the 1933 Act.
Each
ETF offers and issues Shares at NAV only in aggregations of a specified number
of Shares, in exchange for cash or a basket of securities together with the
deposit of a specified cash payment.
Shares of each ETF will be listed and traded on the Exchange. Shares will trade on the Exchange at market
prices that may be below, at, or above NAV.
Unlike mutual funds, Shares are not individually
redeemable securities. Rather, each
ETF issues and redeems Shares on a continuous
basis at NAV, only in Creation Units of 50,000 Shares. Further, under certain circumstances, such as
in the event of the liquidation of an ETF, the Trust may lower the number of
Shares in a Creation Unit.
In the instance of creations
and redemptions, Transaction Fees may be imposed. Such fees will be limited in accordance with
requirements of the SEC applicable to management investment companies offering
redeemable securities. Some of the
information contained in this SAI and the Prospectus such as information
about purchasing and redeeming Shares from an ETF and Transaction Fees is not
relevant to most retail investors.
Once created, Shares
generally trade in the secondary market, at market prices that change
throughout the day, in amounts less than a Creation Unit.
Investors purchasing
Shares in the secondary market through a brokerage account or with the
assistance of a broker may be subject to brokerage commissions and charges.
Unlike index-based ETFs, the ETFs
are actively managed and do not seek to replicate the performance of a specified
index.
EXCHANGE
LISTING AND TRADING
Shares
of each ETF will be listed and traded on the Exchange. Shares trade on the Exchange or in secondary
markets at prices that may differ from their NAV or IIV, including because such
prices may be affected by market forces (such as supply and demand for
Shares). As is the case of other
securities traded on an exchange, when you buy or sell Shares on the Exchange
or in the secondary markets your broker will normally charge you a commission
or other transaction charges. Further,
the Trust reserves the right to adjust the price of Shares in the future to
maintain convenient trading ranges for investors (namely, to maintain a price
per Share that is attractive to investors) by share splits or reverse share splits,
which would have no effect on the NAV.
There can be no assurance
that the requirements of the Exchange necessary to maintain the listing of
Shares of each ETF will continue to be met.
The Exchange may, but is not required to, remove the Shares of an ETF
from listing if: (i) following the initial 12-month period beginning at
the commencement of trading of an ETF, there are fewer than 50 beneficial
owners of the Shares of the ETF for 30 or more consecutive trading days, or (ii) such
other event shall occur or condition exist that, in the opinion of the
Exchange, makes further dealings on the Exchange inadvisable. The Exchange will remove the Shares of an ETF
from listing and trading upon termination of an ETF.
5
The ETFs are not sponsored,
endorsed, sold or promoted by the Exchange.
The Exchange makes no representation or warranty, express or implied, to
the owners of Shares of the ETFs or any member of the public regarding the
advisability of investing in securities generally or in the ETFs particularly
or the ability of the ETFs to achieve their objectives. The Exchange has no obligation or liability
in connection with the administration, marketing or trading of the ETFs.
DISCLOSURE
OF PORTFOLIO HOLDINGS
The
Board has adopted a policy regarding the disclosure of information about the
ETFs portfolio securities. Under the
policy, portfolio holdings of the ETFs, which will form the basis for the
calculation of NAV on a Business Day, are publicly disseminated prior to the
opening of trading on the Exchange that Business Day through financial
reporting and news services, including the website www.grailadvisors.com. In addition, each Business Day a portfolio
composition file, which displays the In-Kind Creation Basket and Balancing
Amount (and if different, the In-Kind Redemption Basket and Cash Redemption
Amount), is publicly disseminated prior to the opening of the Exchange via the
NSCC.
INTRADAY
INDICATIVE VALUE
The
IIV is an approximate per-Share value of an ETFs portfolio holdings, which is
disseminated every fifteen seconds throughout the trading day by the IDC or
other information provider. The IIV is
based on the current per Share market value of the ETFs In-Kind Creation
Basket and Balancing Amount. The IIV
does not necessarily reflect the precise composition of the current portfolio
of securities held by the ETF at a particular point in time. The IIV should not be viewed as a real-time
update of the NAV of the ETF because the approximate value may not be
calculated in the same manner as the NAV.
The ETFs are not involved in, or responsible for, the calculation or
dissemination of the IIV and make no warranty as to the accuracy of the IIV.
INVESTMENT
POLICIES AND RESTRICTIONS
Pursuant to the investment
policies enumerated in this section, which may be changed with respect to an
ETF only by a vote of the holders of a majority of the ETFs outstanding voting
securities, except as noted below, no ETF may:
1. Purchase or sell
real estate
limited
partnership interests, provided, however, that an ETF may invest in securities
secured by real estate or interests therein or issued by companies which invest
in real estate or interests therein when consistent with the other policies and
limitations described in the Prospectus.
2. Invest in
physical
commodities
unless acquired as a result of ownership of securities or other
instruments (but this shall not prevent an ETF from purchasing or selling
foreign currency, options, futures contracts, options on futures contracts,
forward contracts, swaps, caps, floors, collars, securities on a
forward-commitment or delayed-delivery basis, and other similar financial
instruments).
6
3. Engage in
the business of
underwriting
securities issued by others, except to the
extent that, in connection with the disposition of securities, an ETF may be
deemed an underwriter under federal securities law.
4. Lend any
security or make any other
loan
except: (i) as otherwise permitted
under the Investment Company Act, (ii) pursuant to a rule, order or
interpretation issued by the SEC or its staff, (iii) through the purchase
of debt securities in accordance with an ETFs investment objective, policies
and limitations, or (iv) by engaging in repurchase agreements with respect
to portfolio securities.
5. Issue any
senior
security
except as otherwise permitted: (i) under the Investment
Company Act or (ii) pursuant to a rule, order or interpretation issued by
the SEC or its staff.
6.
Borrow
money, except as otherwise permitted under the Investment Company Act or
pursuant to a rule, order or interpretation issued by the SEC or its staff,
including: (i) as a temporary measure, (ii) by entering into reverse
repurchase agreements, and (iii) by lending portfolio securities as
collateral. For purposes of this
investment limitation, the purchase or sale of options, futures contracts,
options on futures contracts, forward contracts, swaps, caps, floors, collars
and other similar financial instruments shall not constitute borrowing.
7. Regarding
diversification
,
invest more than 5% of its total assets (taken at market value) in securities
of any one issuer, other than obligations issued or guaranteed by the U.S.
Government, its agencies and instrumentalities, or purchase more than 10% of
the voting securities of any one issuer, with respect to 75% of an ETFs total
assets.
8. Regarding
concentration
,
invest more than 25% of its total assets in the securities of companies primarily
engaged in any one industry or group of industries provided that: (i) this
limitation does not apply to obligations issued or guaranteed by the U.S.
Government, its agencies and instrumentalities; and (ii) municipalities
and their agencies and authorities are not deemed to be industries.
The
following non-fundamental investment restrictions apply to each ETF and may be
changed with respect to an ETF by a vote of a majority of the Board.
No
ETF may:
1. Invest more than 15% of its net assets in
illiquid securities, including time deposits and repurchase agreements that
mature in more than seven days; or
2. Purchase securities on margin or effect short
sales, except that an ETF may obtain such short term credits as may be
necessary for the clearance of purchases or sales of securities.
If a percentage limitation
is satisfied at the time of investment, a later increase or decrease in such
percentage resulting from a change in the value of an ETFs investments will
not constitute
7
a violation of such
limitation. Thus, an ETF may continue to
hold a security even though it causes the ETF to exceed a percentage limitation
because of fluctuation in the value of the ETFs assets, except that any
borrowing by an ETF that exceeds the fundamental investment limitations stated
above must be reduced to meet such limitations within the period required by
the Investment Company Act or the relevant rules, regulations or
interpretations thereunder.
For purposes of determining
concentration in the securities of companies primarily engaged in any one
industry or group of industries, the ETFs intend to use the Standard Industrial
Classifications Code (SIC) list. Also,
for purposes of the concentration restriction, mortgage-backed securities that
are issued or guaranteed by the U.S. Government, its agencies or
instrumentalities are not subject to an ETFs concentration limitation, by
virtue of the exclusion from that test available to all U.S. Government
securities. Similarly, municipal bonds
issued by states, municipalities and other political subdivisions, agencies,
authorities and instrumentalities of states and multi-state agencies and
authorities are not subject to an ETFs industry concentration restriction.
For purposes of the
diversification restriction, each state and each separate subdivision, agency,
authority or instrumentality of such state, and each guarantor, if any, are
treated as separate issuers of municipal securities.
INVESTMENT
OBJECTIVE, INVESTMENT STRATEGIES AND RISKS
The investment objective and
principal strategies of, and risks of investing in, each ETF are described in
the Prospectus. Unless otherwise
indicated in the Prospectus or this SAI, the investment objective and policies
of an ETF may be changed without shareholder approval.
Credit Quality Standards
: When investing in fixed income securities,
the ETFs maintain the following credit quality standards, which apply at the
time of investment:
For
securities that carry a rating assigned by a nationally recognized statistical
rating organization (rating agency), the sub-adviser will use the highest
rating assigned by the rating agency to determine a securitys credit
rating. Commercial paper must be rated
at least A-1 or equivalent by a rating agency. Corporate debt obligations, mortgage-backed
and other asset-backed securities and municipal securities bonds must be rated
at least B-or equivalent by a rating agency.
For securities that are not rated by a rating agency, McDonnells internal
credit rating will apply and be subject to the equivalent rating minimums
described here.
Dollar
Rolls, Delayed Delivery Transactions and When Issued or Forward Commitment
Securities
The purchase or sale of
when-issued securities enables an investor to hedge against anticipated changes
in interest rates and prices by locking in an attractive price or yield. The price of delayed delivery transactions,
including when-issued securities, is fixed at the time the commitment to
purchase or sell is made, but delivery and payment for the securities takes
place at a later date, normally one to two months after the date of
purchase. During the period between
purchase and settlement, no payment is made by the purchaser to the issuer and
no interest accrues to the purchaser.
Such transactions therefore involve a risk of loss if the value of the
8
security to be purchased
declines prior to the settlement date or if the value of the security to be
sold increases prior to the settlement date.
A sale of a when-issued security also involves the risk that the other
party will be unable to settle the transaction.
Dollar rolls are a type of forward commitment transaction. Purchases and sales of securities on a forward
commitment basis involve a commitment to purchase or sell securities with
payment and delivery to take place at some future date, normally one to two
months after the date of the transaction.
As with when-issued securities, these transactions involve certain
risks, but they also enable an investor to hedge against anticipated changes in
interest rates and prices. Forward
commitment transactions are executed for existing obligations, whereas in a
when-issued transaction, the obligations have not yet been issued. When purchasing securities on a when-issued
or forward commitment basis, a segregated or earmarked account of liquid
assets at least equal to the value of purchase commitments for such securities
will be maintained until the settlement date.
To
Be Announced Securities (TBAs)
As with other delayed
delivery transactions, a seller agrees to issue a TBA security at a future
date. However, the seller does not
specify the particular securities to be delivered. Instead, the ETF agrees to accept any
security that meets specified terms. For example, in a TBA mortgage-backed
transaction, the ETF and the seller would agree upon the issuer, interest rate
and terms of the underlying mortgages.
The seller would not identify the specific underlying mortgages until it
issues the security. TBA mortgage-backed
securities increase market risks because the underlying mortgages may be less
favorable than anticipated by the ETF.
Preferred
Stocks
Preferred stocks include
convertible and non-convertible preferred and preference stocks that are senior
to common stock. Preferred stocks are
equity securities that are senior to common stock with respect to the right to
receive dividends and a fixed share of the proceeds resulting from the issuers
liquidation. Some preferred stocks also
entitle their holders to receive additional liquidation proceeds on the same
basis as holders of the issuers common stock, and thus represent an ownership
interest in the issuer. Depending on the
features of the particular security, holders of preferred stock may bear the
risks disclosed in the Prospectus or this SAI regarding equity or fixed income
securities.
Mortgage-Related
and Other Asset-Backed Securities
The
ETFs may invest in mortgage- or 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.
Some of these securities are described in greater detail below. The value of some mortgage- or asset-backed
securities may be particularly sensitive to changes in prevailing interest
rates. Early repayment of principal on
some mortgage-related securities may expose the ETF 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
9
volatility
of a 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 markets 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.
Mortgage Pass-Through Securities
. Interests in pools of mortgage-related
securities differ from other forms of debt securities, which normally provide
for periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates.
Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a pass-through
of the monthly payments made by the individual borrowers on their residential
or commercial mortgage loans, net of any fees paid to the issuer or guarantor
of such securities. Additional payments
are caused by repayments of principal resulting from the sale of the underlying
property, refinancing or foreclosure, net of fees or costs which may be
incurred. Some mortgage-related
securities (such as securities issued by GNMA) are described as modified
pass-through. These securities entitle
the holder to receive all interest and principal payments owed on the mortgage
pool, net of certain fees, at the scheduled payment dates regardless of whether
or not the mortgagor actually makes the payment.
The rate of pre-payments on underlying mortgages
will affect the price and volatility of a mortgage-related security, and may
have the effect of shortening or extending the effective duration of the
security relative to what was anticipated at the time of purchase. To the extent that unanticipated rates of
pre-payment on underlying mortgages increase the effective duration of a
mortgage-related security, the volatility of such security can be expected to
increase. The residential mortgage
market in the United States recently has experienced difficulties that may
adversely affect the performance and market value of certain of an ETFs
mortgage-related investments.
Delinquencies and losses on residential mortgage loans (especially
subprime and second-lien mortgage loans) generally have increased recently and
may continue to increase, and a decline in or flattening of housing values (as
has recently been experienced and may continue to be experienced in many
housing markets) may exacerbate such delinquencies and losses. Borrowers with adjustable rate mortgage loans
are more sensitive to changes in interest rates, which affect their monthly
mortgage payments, and may be unable to secure replacement mortgages at
comparably low interest rates. Also, a
number of residential mortgage loan originators have recently experienced
serious financial difficulties or bankruptcy.
Owing largely to the foregoing, reduced investor demand for mortgage
loans and mortgage-related securities and increased investor yield requirements
have caused limited liquidity in the secondary market for mortgage-related
securities, which can adversely affect the market value of mortgage-related
securities. It is possible that such
limited liquidity in such secondary markets could continue or worsen.
The principal governmental guarantor of
mortgage-related securities is GNMA.
GNMA is a wholly owned United States Government corporation within the
Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the
United States Government, the timely payment of principal and interest on
securities issued by
10
institutions
approved by GNMA (such as savings and loan institutions, commercial banks and
mortgage bankers) and backed by pools of mortgages insured by the Federal
Housing Administration (the FHA), or guaranteed by the Department of Veterans
Affairs (the VA).
Government-related
guarantors (i.e., not backed by the full faith and credit of the United States
Government) include FNMA and the Federal Home Loan Mortgage Corporation
(FHLMC). FNMA is a
government-sponsored corporation the common stock of which is owned entirely by
private stockholders. FNMA purchases
conventional (i.e., not insured or guaranteed by any government agency)
residential mortgages from a list of approved seller/servicers which include state
and federally chartered savings and loan associations, mutual savings banks,
commercial banks and credit unions and mortgage bankers. Pass-through securities issued by FNMA are
guaranteed as to timely payment of principal and interest by FNMA, but are not
backed by the full faith and credit of the United States Government. FHLMC was created by Congress in 1970 for the
purpose of increasing the availability of mortgage credit for residential
housing. It is a government-sponsored
corporation formerly owned by the twelve Federal Home Loan Banks but now the
common stock is owned entirely by private stockholders. FHLMC issues Participation Certificates
(PCs), which are pass-through securities, each representing an undivided
interest in a pool of residential mortgages.
FHLMC guarantees the timely payment of interest and ultimate collection
of principal, but PCs are not backed by the full faith and credit of the United
States Government.
In September 2008, the
Federal Housing Finance Agency (FHFA) placed FNMA and FHLMC into
conservatorship. As the conservator,
FHFA succeeded to all rights, titles, powers and privileges of FNMA and FHLMC
and of any stockholder, officer or director of FNMA and FHLMC with respect to
FNMA and FHLMC and the assets of FNMA and FHLMC. FNMA and FHLMC are continuing to operate as
going concerns while in conservatorship and each remain liable for all of its
obligations, including its guaranty obligations, associated with its
mortgage-backed securities.
Under
the Federal Housing Finance Regulatory Reform Act of 2008 (the Reform Act),
which was included as part of the Housing and Economic Recovery Act of 2008,
FHFA, as conservator or receiver, has the power to repudiate any contract
entered into by FNMA or FHLMC prior to FHFAs appointment as conservator or
receiver, as applicable, if FHFA determines, in its sole discretion, that
performance of the contract is burdensome and that repudiation of the contract
promotes the orderly administration of FNMAs or FHLMCs affairs. The Reform Act requires FHFA to exercise its right
to repudiate any contract within a reasonable period of time after its
appointment as conservator or receiver.
FHFA,
in its capacity as conservator, has indicated that it has no intention to
repudiate the guaranty obligations of FNMA or FHLMC because FHFA views
repudiation as incompatible with the goals of the conservatorship. However, in the event that FHFA, as
conservator or if it is later appointed as receiver for FNMA or FHLMC, were to
repudiate any such guaranty obligation, the conservatorship or receivership
estate, as applicable, would be liable for actual direct compensatory damages
in accordance with the provisions of the Reform Act. Any such liability could be satisfied only to
the extent of FNMAs or FHLMCs assets available therefor.
In
the event of repudiation, the payments of interest to holders of FNMA or FHLMC
mortgage-backed securities would be reduced if payments on the mortgage loans
represented in the
11
mortgage
loan groups related to such mortgage-backed securities are not made by the
borrowers or advanced by the servicer.
Any actual direct compensatory damages for repudiating these guaranty
obligations may not be sufficient to offset any shortfalls experienced by such
mortgage-backed security holders.
Further,
in its capacity as conservator or receiver, FHFA has the right to transfer or
sell any asset or liability of FNMA or FHLMC without any approval, assignment
or consent. Although FHFA has stated that it has no present intention to do so,
if FHFA, as conservator or receiver, were to transfer any such guaranty
obligation to another party, holders of FNMA or FHLMC mortgage-backed
securities would have to rely on that party for satisfaction of the guaranty
obligation and would be exposed to the credit risk of that party.
In
addition, certain rights provided to holders of mortgage-backed securities
issued by FNMA and FHLMC under the operative documents related to such
securities may not be enforced against FHFA, or enforcement of such rights may
be delayed, during the conservatorship or any future receivership. The operative documents for FNMA and FHLMC
mortgage-backed securities may provide (or with respect to securities issued
prior to the date of the appointment of the conservator may have provided) that
upon the occurrence of an event of default on the part of FNMA or FHLMC, in its
capacity as guarantor, which includes the appointment of a conservator or
receiver, holders of such mortgage-backed securities have the right to replace
FNMA or FHLMC as trustee if the requisite percentage of mortgage-backed
securities holders consent. The Reform
Act prevents mortgage-backed security holders from enforcing such rights if the
event of default arises solely because a conservator or receiver has been
appointed.
Commercial
banks, savings and loan institutions, private mortgage insurance companies,
mortgage bankers and other secondary market issuers also create pass-through
pools of conventional residential mortgage loans. Such issuers may be the originators and/or
servicers of the underlying mortgage loans as well as the guarantors of the
mortgage-related securities. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than government and government-related pools because there are no
direct or indirect government or agency guarantees of payments in the former
pools. However, timely payment of
interest and principal of these pools may be supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance and letters of credit, which may be issued by governmental entities
or private insurers. Such insurance and
guarantees and the creditworthiness of the issuers thereof will be considered
in determining whether a mortgage-related security meets an ETFs investment
quality standards. There can be no
assurance that the private insurers or guarantors can meet their obligations
under the insurance policies or guarantee arrangements. An ETF may buy mortgage-related securities
without insurance or guarantees if, through an examination of the loan
experience and practices of the originators/servicers and poolers, its
sub-adviser determines that the securities meet the ETFs quality standards. Securities issued by certain private
organizations may not be readily marketable.
An ETF will not purchase mortgage-related securities or any other assets
which in its sub-advisers opinion are illiquid if, as a result, more than 15%
of the value of the ETFs net assets will be illiquid.
Mortgage-backed
securities that are issued or guaranteed by the U.S. Government, its agencies
or instrumentalities, are not subject to an ETFs industry concentration
restrictions by virtue of the exclusion from that test available to all U.S.
Government securities. The assets
underlying such
12
securities
may be represented by a portfolio of first lien residential mortgages
(including both whole mortgage loans and mortgage participation interests) or
portfolios of mortgage pass-through securities issued or guaranteed by GNMA,
FNMA or FHLMC. Mortgage loans underlying
a mortgage-related security may in turn be insured or guaranteed by the FHA or
the VA. In the case of private issue
mortgage-related securities whose underlying assets are neither U.S. Government
securities nor U.S. Government-insured mortgages, to the extent that real
properties securing such assets may be located in the same geographical region,
the security may be subject to a greater risk of default than other comparable
securities in the event of adverse economic, political or business developments
that may affect such region and, ultimately, the ability of residential
homeowners to make payments of principal and interest on the underlying
mortgages.
Collateralized Mortgage Obligations (CMOs)
. A CMO is a debt obligation of a legal entity
that is collateralized by mortgages and divided into classes. Similar to a bond, interest and prepaid
principal is paid, in most cases, on a monthly basis. CMOs may be collateralized by whole mortgage
loans or private mortgage bonds, but are more typically collateralized by
portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
CMOs
are structured into multiple classes, often referred to as tranches, with
each class bearing a different stated maturity and entitled to a different
schedule for payments of principal and interest, including pre-payments. Actual maturity and average life will depend
upon the pre-payment experience of the collateral. In the case of certain CMOs (known as
sequential pay CMOs), payments of principal received from the pool of
underlying mortgages, including pre-payments, are applied to the classes of CMOs
in the order of their respective final distribution dates. Thus, no payment of principal will be made to
any class of sequential pay CMOs until all other classes having an earlier
final distribution date have been paid in full.
In
a typical CMO transaction, a corporation (issuer) issues multiple series
(e.g., A, B, C, Z) of CMO bonds (Bonds).
Proceeds of the Bond offering are used to purchase mortgages or mortgage
pass-through certificates (Collateral).
The Collateral is pledged to a third party trustee as security for the
Bonds. Principal and interest payments
from the Collateral are used to pay principal on the Bonds in the order A, B,
C, Z. The Series A, B, and C Bonds
all bear current interest. Interest on
the Series Z Bond is accrued and added to principal and a like amount is
paid as principal on the Series A, B, or C Bond currently being paid
off. When the Series A, B, and C
Bonds are paid in full, interest and principal on the Series Z Bond begins
to be paid currently. CMOs may be less
liquid and may exhibit greater price volatility than other types of mortgage-
or asset-backed securities.
Commercial
Mortgage-Backed Securities include securities that reflect an interest in, and
are secured by, mortgage loans on commercial real property. Many of the risks of investing in commercial
mortgage-backed securities reflect the risks of investing in the real estate
securing the underlying mortgage loans.
These risks reflect the effects of local and other economic conditions
on real estate markets, the ability of tenants to make loan payments, and the
ability of a property to attract and retain tenants. Commercial mortgage-backed securities may be
less liquid and exhibit greater price volatility than other types of mortgage-
or asset-backed securities.
13
Other Mortgage-Related Securities
. Other mortgage-related securities include
securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage
loans on real property, including mortgage dollar rolls, CMO residuals or
stripped mortgage-backed securities (SMBS).
Other mortgage-related securities may be equity or debt securities
issued by agencies or instrumentalities of the U.S. Government or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, homebuilders, mortgage banks, commercial banks, investment banks,
partnerships, trusts and special purpose entities of the foregoing.
CMO Residuals
. CMO residuals are mortgage securities issued
by agencies or instrumentalities of the U.S. Government or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, homebuilders, mortgage banks, commercial banks, investment banks
and special purpose entities of the foregoing.
The
cash flow generated by the mortgage assets underlying a series of CMOs is
applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses and any management fee of
the issuer. The residual in a CMO
structure generally represents the interest in any excess cash flow remaining
after making the foregoing payments.
Each payment of such excess cash flow to a holder of the related CMO
residual represents income and/or a return of capital. The amount of residual cash flow resulting
from a CMO will depend on, among other things, the characteristics of the
mortgage assets, the coupon rate of each class of CMO, prevailing interest
rates, the amount of administrative expenses and the pre-payment experience on
the mortgage assets. In particular, the
yield to maturity on CMO residuals is extremely sensitive to pre-payments on
the related underlying mortgage assets, in the same manner as an interest-only
(IO) class of stripped mortgage-backed securities. In addition, if a series of a CMO includes a
class that bears interest at an adjustable rate, the yield to maturity on the
related CMO residual will also be extremely sensitive to changes in the level
of the index upon which interest rate adjustments are based. As described below
with respect to stripped mortgage-backed securities, in certain circumstances
an ETF may fail to recoup fully its initial investment in a CMO residual.
CMO
residuals are generally purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers. Transactions in CMO residuals are generally
completed only after careful review of the characteristics of the securities in
question. In addition, CMO residuals
may, or pursuant to an exemption therefrom, may not have been registered under
the 1933 Act. CMO residuals, whether or
not registered under the 1933 Act, may be subject to certain restrictions on
transferability, and may be deemed illiquid and subject to an ETFs
limitations on investment in illiquid securities.
Adjustable Rate Mortgage-Backed Securities
. Adjustable rate mortgage-backed securities
(ARMBSs) have interest rates that reset at periodic intervals. Acquiring ARMBSs permits an ETF to
participate in increases in prevailing current interest rates through periodic
adjustments in the coupons of mortgages underlying the pool on which ARMBSs are
based. Such ARMBSs generally have higher
current yield and lower price fluctuations than is the case with more
traditional fixed income debt securities of comparable rating and
maturity. In addition, when prepayments
of principal are made on the underlying mortgages during periods of rising
interest rates, an ETF can reinvest the proceeds of such prepayments at rates
higher than those at which they were previously invested. Mortgages underlying most ARMBSs, however,
have limits on
14
the
allowable annual or lifetime increases that can be made in the interest rate
that the mortgagor pays. Therefore, if
current interest rates rise above such limits over the period of the
limitation, an ETF, when holding an ARMBS, does not benefit from further
increases in interest rates. Moreover,
when interest rates are in excess of coupon rates (i.e., the rates being paid
by mortgagors) of the mortgages, ARMBSs behave more like fixed income
securities and less like adjustable rate securities and are subject to the
risks associated with fixed income securities.
In addition, during periods of rising interest rates, increases in the
coupon rate of adjustable rate mortgages generally lag current market interest
rates slightly, thereby creating the potential for capital depreciation on such
securities.
Stripped Mortgage-Backed Securities
. SMBS are derivative multi-class mortgage
securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks and special purpose entities
of the foregoing.
SMBS
are usually structured with two classes that receive different proportions of
the interest and principal distributions on a pool of mortgage assets. A common type of SMBS will have one class
receiving some of the interest and most of the principal from the mortgage
assets, while the other class will receive most of the interest and the remainder
of the principal. In the most extreme
case, one class will receive all of the interest (the 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
pre-payments) on the related underlying mortgage assets, and a rapid rate of
principal payments may have a material adverse effect on an ETFs yield to
maturity from these securities. If the
underlying mortgage assets experience greater than anticipated pre-payments of
principal, an ETF may fail to recoup some or all of its initial investment in
these securities even if the security is in one of the highest rating
categories.
Collateralized Debt Obligations
. An ETF 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. CDOs
may charge management fees and administrative expenses.
For
both CBOs and CLOs, the cash flows from the trust are split into two or more
portions, called tranches, varying in risk and yield. The riskiest portion is the equity tranche
which bears the bulk of defaults from the bonds or loans in the trust and serves
to protect the other, more senior tranches from default in all but the most
severe circumstances. Since it is
partially protected from defaults, a senior tranche from a CBO trust or CLO
trust typically have higher ratings and lower yields than their underlying
securities, and can be rated investment grade.
Despite the protection from the equity tranche, CBO or CLO tranches can
experience substantial losses due to actual defaults, increased sensitivity to
defaults due to collateral default and disappearance of protecting tranches,
market anticipation of defaults, as well as aversion to CBO or CLO securities
as a class.
15
The
risks of an investment in a CDO depend largely on the type of the collateral
securities and the class of the CDO in which an ETF invests. Normally, CBOs, CLOs and other CDOs are
privately offered and sold, and thus, are not registered under the securities
laws. As a result, investments in CDOs may
be characterized by an ETF as illiquid securities, however an active dealer
market may exist for CDOs allowing a CDO to qualify for Rule 144A
transactions. In addition to the normal
risks associated with fixed income securities discussed elsewhere in this SAI
and the Prospectus (e.g., interest rate risk and default risk), CDOs carry
additional risks including, but are not limited to: (i) the possibility
that distributions from collateral securities will not be adequate to make
interest or other payments; (ii) the quality of the collateral may decline
in value or default; (iii) an ETF may invest in CDOs that are subordinate
to other classes; and (iv) the complex structure of the security may not
be fully understood at the time of investment and may produce disputes with the
issuer or unexpected investment results.
Asset-Backed Securities
. Asset-backed securities (ABS) are bonds
backed by pools of loans or other receivables.
ABS are created from many types of assets, including auto loans, credit
card receivables, home equity loans, and student loans. ABS are issued through special purpose
vehicles that are bankruptcy remote from the issuer of the collateral. The credit quality of an ABS transaction
depends on the performance of the underlying assets. To protect ABS investors from the possibility
that some borrowers could miss payments or even default on their loans, ABS
include various forms of credit enhancement.
Some
ABS, particularly home equity loan transactions, are subject to interest-rate
risk and prepayment risk. A change in
interest rates can affect the pace of payments on the underlying loans, which
in turn, affects total return on the securities. ABS also carry credit or default risk. If many borrowers on the underlying loans
default, losses could exceed the credit enhancement level and result in losses
to investors in an ABS transaction.
Finally, ABS have structure risk due to a unique characteristic known as
early amortization, or early payout, risk.
Built into the structure of most ABS are triggers for early payout,
designed to protect investors from losses.
These triggers are unique to each transaction and can include: a big
rise in defaults on the underlying loans, a sharp drop in the credit
enhancement level, or even the bankruptcy of the originator. Once early amortization begins, all incoming
loan payments are used to pay investors as quickly as possible.
Consistent
with an ETFs investment objectives and policies, the sub-adviser also may
invest in other types of asset-backed securities.
Derivatives
In
pursuing their individual objectives, the ETFs may, to the extent permitted by
their investment objective and policies, purchase and sell (write) both put
options and call options on securities, swap agreements, securities indexes,
and enter into interest rate and index futures contracts and purchase and sell
options on such futures contracts (futures options) for hedging purposes or
to seek to replicate the composition and performance of a particular index,
except that an ETF does not intend to enter into transactions involving
currency futures or options. An ETF also
may enter into swap agreements with respect to interest rates and indexes of
securities. An ETF may invest in
structured notes. If other types of
financial instruments, including other types of options, futures contracts, or
futures options are traded in the future, an ETF also may use those
instruments, provided that their use is consistent with the ETFs investment
objective.
16
The
value of some derivative instruments in which an ETF invests may be
particularly sensitive to changes in prevailing interest rates, and, like the
other investments of the ETF, the ability of the ETF to successfully utilize
these instruments may depend in part upon the ability of the sub-adviser to
forecast interest rates and other economic factors correctly. If the sub-adviser incorrectly forecasts such
factors and has taken positions in derivative instruments contrary to
prevailing market trends, an ETF could be exposed to the risk of loss.
An ETF
might not employ any of the strategies described below, and no assurance can be
given that any strategy used will succeed.
If the sub-adviser incorrectly forecasts interest rates, market values
or other economic factors in using a derivatives strategy for an ETF, the ETF
might have been in a better position if it had not entered into the transaction
at all. Also, suitable derivative
transactions may not be available in all circumstances. The use of these strategies involves certain
special risks, including a possible imperfect correlation, or even no
correlation, between price movements of 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 otherwise, due
to the possible inability of an ETF to purchase or sell a portfolio security at
a time that otherwise would be favorable or the possible need to sell a
portfolio security at a disadvantageous time because an ETF is required to
maintain asset coverage or offsetting positions in connection with transactions
in derivative instruments, and the possible inability of an ETF to close out or
to liquidate its derivatives positions.
In addition, an ETFs use of such instruments may cause the ETF to
realize higher amounts of short-term capital gains (generally taxed at ordinary
income tax rates) than if it had not used such instruments.
Options on Securities and Indexes
. An ETF may, to the extent specified in this
SAI or in the Prospectus, purchase and sell both put and call options on fixed
income or other securities or indexes in standardized contracts traded on
foreign or domestic securities exchanges, boards of trade, or similar entities,
or quoted on NASDAQ or on an over-the-counter market, and agreements, sometimes
called cash puts, which may accompany the purchase of a new issue of bonds from
a dealer.
An
option on a security (or index) 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. 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 financial or securities market, a
specific group of financial instruments or securities, or certain economic
indicators.)
An
ETF will write call options and put options only if they are covered. In the case of a call option on a security,
the option is covered if an ETF owns the security underlying the call or has
an absolute and immediate right to acquire that security without additional
cash consideration (or, if additional cash consideration is required, cash or
other assets determined to be liquid by the sub-adviser in such amount are
segregated or earmarked) upon conversion or
17
exchange
of other securities held by the ETF. For
a call option on an index, the option is covered if an ETF maintains with its
custodian assets determined to be liquid in an amount equal to the contract
value of the index. A call option is
also covered if an ETF holds a call on the same security or index as the call
written where the exercise price of the call held is (i) equal to or less
than the exercise price of the call written, or (ii) greater than the
exercise price of the call written, provided the difference is maintained by
the ETF in segregated or earmarked assets.
A put option on a security or an index is covered if an ETF segregates
or earmarks assets equal to the exercise price. A put option is also covered if an ETF 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 ETF in segregated or earmarked
assets.
If
an option written by an ETF expires unexercised, the ETF realizes a capital
gain equal to the premium received at the time the option was written. If an option purchased by an ETF expires
unexercised, the ETF realizes a capital loss equal to the premium paid. Prior to the earlier of exercise or
expiration, an exchange traded option may be closed out by an offsetting
purchase or sale of an option of the same series (type, 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 an ETF desires.
An
ETF 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. Prior
to exercise or expiration, an option may be closed out by an offsetting
purchase or sale of an option of the same series. An ETF 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 ETF will
realize a capital loss. If the premium
received from a closing sale transaction is more than the premium paid to
purchase the option, an ETF will realize a capital gain or, if it is less, the
ETF 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 an ETF is an asset of the
ETF. The premium received for an option
written by an ETF 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.
An ETF
may write covered straddles consisting of a combination of a call and a put
written on the same underlying security.
A straddle will be covered when sufficient assets are deposited to meet
an ETFs immediate obligations. An ETF
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, an ETF will also segregate or earmark liquid assets equivalent to
the amount, if any, by which the put is in the money.
18
Risks Associated with Options on Securities and
Indexes
. There are several risks
associated with transactions in options on securities and on indexes. For example, there are significant
differences between the securities and options markets that could result in an
imperfect correlation between these markets, causing a given transaction not to
achieve its objectives. 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.
During
the option period, the covered call writer 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 an ETF
is not sold when it has remaining value, and if the market price of the
underlying security 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), an ETF will lose its entire investment in the option. Also, where a put or call option on a
particular security is purchased to hedge against price movements in a related
security, the price of the put or call option may move more or less than the
price of the related security.
There
can be no assurance that a liquid market will exist when an ETF seeks to close
out an option position. If an ETF 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 an ETF 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. As the writer of a covered
call option, an ETF forgoes, during the options life, the opportunity to
profit from increases in the market value of the security covering the call option
above the sum of the premium and the exercise price of the call.
If
trading were suspended in an option purchased by an ETF, the ETF would not be
able to close out the option. If
restrictions on exercise were imposed, an ETF might be unable to exercise an
option it has purchased. Except to the
extent that a call option on an index written by an ETF is covered by an option
on the same index purchased by the ETF, movements in the index may result in a
loss to the ETF; however, such losses may be mitigated by changes in the value
of the ETFs securities during the period the option was outstanding.
Futures Contracts and Options on Futures Contracts
. A futures contract is an agreement between
two parties to buy and sell a security for a set price on a future date. These contracts are traded on exchanges, so
that, in most cases, either party can close out its position on the exchange
for cash, without delivering the security.
An option on a futures contract gives the holder of the option the right
to buy or sell a position in a futures contract to the writer of the option, at
a specified price and on or before a specified expiration date.
An
ETF may invest in futures contracts and options thereon (futures options)
with respect to, but not limited to, interest rates and security indexes.
19
An
interest rate or index futures contract provides for the future sale by one
party and purchase by another party of a specified quantity of a financial
instrument or the cash value of an index at a specified price and time. A futures contract on an index is an
agreement pursuant to 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, no physical delivery of these securities is made. A public market exists in futures contracts
covering a number of indexes as well as financial instruments.
An
ETF 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. A call option is in the money if
the value of the futures contract that is the subject of the option exceeds the
exercise price. A put option is in the
money if the exercise price exceeds the value of the futures contract that is
the subject of the option.
Pursuant
to a claim for exemption filed with the CFTC on behalf of an ETF, neither the
Trust nor the ETF is deemed to be a commodity pool or commodity pool
operator under the Commodity Exchange Act, and they are not subject to
registration or regulation as such under the Commodity Exchange Act.
Limitations on Use of Futures and Futures Options
. An ETF will only enter into futures contracts
and futures options which are standardized and traded on a U.S. exchange, board
of trade, or similar entity, or quoted on an automated quotation system.
When
a purchase or sale of a futures contract is made by an ETF, the ETF is required
to deposit with its custodian (or broker, if legally permitted) a specified
amount of assets determined to be liquid (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 which is returned to the ETF upon termination of the contract,
assuming all contractual obligations have been satisfied. An ETF expects to earn interest income on its
initial margin deposits. A futures
contract held by an ETF is valued daily at the official settlement price of the
exchange on which it is traded. Each day
an ETF 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 an ETF but is instead a settlement between the ETF and the
broker of the amount one would owe the other if the futures contract
expired. In computing daily net asset
value, an ETF will mark to market its open futures positions.
An
ETF 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 an ETF.
20
Although some futures
contracts call for making or taking delivery of the underlying securities or
commodities, generally these obligations are closed out prior to delivery by
offsetting purchases or sales of matching futures contracts (same exchange, underlying
security or index, and delivery month).
Closing out a futures contract sale is effected by purchasing a futures
contract for the same aggregate amount of the specific type of financial
instrument with the same delivery date.
If an offsetting purchase price is less than the original sale price, an
ETF realizes a capital gain, or if it is more, the ETF realizes a capital
loss. Conversely, if an offsetting sale
price is more than the original purchase price, an ETF realizes a capital gain,
or if it is less, the ETF realizes a capital loss. The transaction costs must also be included
in these calculations.
An ETF may write covered
straddles consisting of a call and a put written on the same underlying futures
contract. A straddle will be covered when
sufficient assets are deposited to meet the ETFs immediate obligations. An ETF 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, an ETF will also
segregate or earmark liquid assets equivalent to the amount, if any, by which
the put is in the money.
When purchasing a futures
contract, an ETF will maintain with its custodian (and mark-to-market on a
daily basis) assets determined to be liquid, 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, an ETF may cover its position by purchasing a put
option on the same futures contract with a strike price as high or higher than
the price of the contract held by the ETF.
When selling a futures
contract, an ETF will maintain with its custodian (and mark-to-market on a
daily basis) assets determined to be liquid that are equal to the market value
of the futures contract. Alternatively,
an ETF may cover its position by owning the instruments underlying the
futures 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 ETF to
purchase the same futures contract at a price no higher than the price of the
contract written by the ETF (or at a higher price if the difference is
maintained in liquid assets with the Trusts custodian).
With respect to futures
contracts that are not legally required to cash settle, an ETF may cover the
open position by setting aside or earmarking liquid assets in an amount equal
to the market value of the futures contract.
With respect to futures that are required to cash settle, however, an
ETF is permitted to set aside or earmark liquid assets in an amount equal to
the ETFs daily marked to market (net) obligation, if any, (in other words, the
ETFs daily net liability, if any) rather than the market value of the futures
contract. By setting aside or earmarking
assets equal to only its net obligation under cash-settled futures, an ETF will
have the ability to utilize these contracts to a greater extent than if the ETF
were required to segregate or earmark assets equal to the full market value
of the futures contract.
When selling a call option
on a futures contract, an ETF will maintain with its custodian (and
mark-to-market on a daily basis) assets determined to be liquid, 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, an ETF may cover
its position by entering into a long position in the same futures contract at a
price no higher than the strike price
21
of the call option, by
owning the instruments underlying the futures contract, or by holding a
separate call option permitting the ETF to purchase the same futures contract
at a price not higher than the strike price of the call option sold by the ETF.
When selling a put option on
a futures contract, an ETF will maintain with its custodian (and mark-to-market
on a daily basis) assets determined to be liquid, that equal the purchase price
of the futures contract, less any margin on deposit. Alternatively, an ETF 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 or higher than
the strike price of the put option sold by the ETF.
To the extent that
securities with maturities greater than one year are used to segregate or earmark
assets to cover an ETFs obligations under futures contracts and related
options, such use will not eliminate the risk of a form of leverage, which may
tend to exaggerate the effect on net asset value of any increase or decrease in
the market value of the ETFs portfolio, and may require liquidation of
portfolio positions when it is not advantageous to do so.
The requirements for
qualification as a regulated investment company also may limit the extent to
which an ETF may enter into futures, futures options and forward
contracts. See Taxation.
Risks
Associated with Futures and Futures Options
. There are several risks associated with the
use of futures contracts and futures options.
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 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 objectives. 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.
Changes in the price of
futures contracts may not correlate perfectly with price movements in the
relevant index due to market distortions.
First, all participants in the futures market are subject to margin
deposit and maintenance requirements.
Rather than meeting margin calls, investors may close futures contracts
through offsetting transactions which could distort normal correlations. Second, the margin deposit requirements in
the futures market are less onerous than margin requirements in the securities
market, resulting in more speculators who may cause temporary price
distortions.
Futures contracts on U.S.
Government securities historically have reacted to an increase or decrease in
interest rates in a manner similar to that in which the underlying U.S.
Government securities reacted. To the extent,
however, that an ETF enters into such futures contracts, the value of such
futures will not vary in direct proportion to the value of such ETFs holdings
of U.S. Government securities. Thus, the
anticipated spread between the price of the futures contract and the hedged
security may be distorted due to differences in the nature of the markets.
22
The spread also may be distorted by
differences in initial and variation margin requirements, the liquidity of such
markets and the participation of speculators in such markets.
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 days 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.
An ETFs ability to engage
in the futures and options on futures strategies described above depends on the
liquidity of the markets in those instruments.
Trading interest in various types of futures and options on futures
cannot be predicted. There can be no
assurance that a liquid market will exist at a time when an ETF seeks to close
out a futures or a futures option position, and the ETF 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.
Swap
Agreements and Options on Swap Agreements
. An ETF may engage in swap transactions,
including, but not limited to, swap agreements on interest rates or security
indexes and specific securities. An ETF
also may enter into options on swap agreements (swap options).
An ETF may enter into swap
transactions for any legal purpose consistent with its investment objectives
and policies, such as for the purpose of attempting to obtain or preserve a
particular return or spread at a lower cost than obtaining a return or spread
through purchases and/or sales of instruments in other markets, as a duration
management technique, to protect against any increase in the price of
securities the ETF anticipates purchasing at a later date, or to gain exposure
to certain markets in the most economical way possible.
Swap agreements are two
party contracts entered into primarily by institutional 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.
A quanto or differential swap combines both an interest rate and a
currency transaction. Other forms of
swap agreements include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or cap; interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified rate, or floor; and
interest rate collars, under which a party sells a cap and
23
purchases a floor or vice
versa in an attempt to protect itself against interest rate movements exceeding
given minimum or maximum levels.
An ETF may directly or
indirectly use credit default swaps to take an active long or short position
with respect to the likelihood of default by corporate (including asset-backed
security) or sovereign issuers. In a
credit default swap, one party pays, in effect, an insurance premium through a
stream of payments to another party in exchange for the right to receive a
specified return in the event of default (or similar events) by one or more
third parties on their obligations. For
example, in purchasing a credit default swap, an ETF may pay a premium in
return for the right to put specified bonds or loans to the counterparty, such
as a U.S. or foreign issuer or basket of such issuers, upon issuer default (or
similar events) at their par (or other agreed-upon) value. An ETF, as the purchaser in a credit default
swap, bears the risk that the investment might expire worthless. It also would be subject to counterparty risk
the risk that the counterparty may fail to satisfy its payment obligations to
the ETF in the event of a default (or similar event). In addition, as a purchaser in a credit
default swap, an ETFs investment would only generate income in the event of an
actual default (or similar event) by the issuer of the underlying obligation.
An ETF also may use credit
default swaps for investment purposes by selling a credit default swap, in
which case the ETF will receive a premium from its counterparty in return for
the ETFs taking on the obligation to pay the par (or other agreed-upon) value
to the counterparty upon issuer default (or similar events). As the seller in a credit default swap, an
ETF effectively adds economic leverage to its portfolio because, in addition to
its total net assets, the ETF is subject to investment exposure on the notional
amount of the swap. If no event of
default (or similar event) occurs, an ETF would keep the premium received from
the counterparty and would have no payment obligations.
An ETF also may enter into
swap options. A swap option is a
contract that gives a counterparty the right (but not the obligation) in return
for payment of a premium, to enter into a new swap agreement or to shorten,
extend, cancel or otherwise modify an existing swap agreement, at some
designated future time on specified terms.
An ETF may write (sell) and purchase put and call swap options.
Depending on the terms of
the particular option agreement, an ETF will generally incur a greater degree of
risk when it writes a swap option than it will incur when it purchases a swap
option. When an ETF purchases a swap
option, it risks losing only the amount of the premium it has paid should it
decide to let the option expire unexercised.
However, when an ETF writes a swap option, upon exercise of the option
the ETF will become obligated according to the terms of the underlying
agreement.
Most other types of swap
agreements entered into by an ETF would calculate the obligations of the
parties to the agreement on a net basis.
Consequently, an ETFs 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 the agreement (the net amount).
An ETFs current obligations under a swap agreement will be accrued
daily (offset against any amounts owed to the ETF) and any accrued but unpaid
net amounts owed to a swap counterparty will be covered by the segregation or earmarking
of assets determined to be liquid to avoid any potential leveraging of the ETFs
portfolio.
24
Obligations under swap agreements so covered
will not be construed to be senior securities for purposes of an ETFs
investment restriction concerning senior securities.
Whether an ETFs use of swap
agreements or swap options will be successful in furthering its investment
objective will depend on the sub-advisers ability to predict correctly whether
certain types of investments are likely to produce greater returns than other
investments. Moreover, an ETF 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. An ETF will enter into swap agreements only
with counterparties that meet certain standards of creditworthiness. Certain restrictions imposed on an ETF by the
Internal Revenue Code may limit the ETFs ability to use swap agreements. The swaps market is largely unregulated. It is possible that developments in the swaps
market, including potential government regulation, could adversely affect an
ETFs ability to terminate existing swap agreements or to realize amounts to be
received under such agreements.
Swaps are highly specialized
instruments that require investment techniques, risk analyses, and tax planning
different from those associated with traditional investments. The use of a swap requires an understanding not
only of the referenced asset, reference rate, or index but also of the swap
itself, without the benefit of observing the performance of the swap under all
possible market conditions. Because they
are two party contracts that may be subject to contractual restrictions on
transferability and termination and because they may have terms of greater than
seven days, swap agreements may be considered to be illiquid and subject to an
ETFs limitation on investments in illiquid securities. To the extent that a swap is not liquid, it
may not be possible to initiate a transaction or liquidate a position at an
advantageous time or price, which may result in significant losses.
In addition, an ETF
generally may only close out a swap with its particular counterparty, and may
only transfer a position with the consent of that counterparty. If the counterparty defaults, an ETF will
have contractual remedies, but there can be no assurance that the counterparty
will be able to meet its contractual obligations or that the ETF will succeed
in enforcing its rights. For example, an
ETF is subject to the risk that a counterparty may interpret contractual terms
(e.g., the definition of default) differently than the ETF when the ETF seeks
to enforce its contractual rights. The
cost and unpredictability of the legal proceedings required for an ETF to
enforce its contractual rights may lead it to decide not to pursue its claims
against the counterparty. An ETF,
therefore, assumes the risk that it may be unable to obtain payments owed to it
or that those payments may be delayed or made only after the ETF has incurred
the costs of litigation.
Like most other investments,
swap agreements are subject to the risk that the market value of the instrument
will change in a way detrimental to an ETFs interest. An ETF bears the risk that the sub-adviser
will not accurately forecast future market trends or the values of assets,
reference rates, indexes, or other economic factors in establishing swap
positions for the ETF. If the
sub-adviser attempts to use a swap as a hedge against, or as a substitute for,
a portfolio investment, an ETF will be exposed to the risk that the swap will
have or will develop imperfect or no correlation with the portfolio
investment. This could cause substantial
losses for an ETF. While hedging
strategies involving swap 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 other ETF investments. Many swaps are complex and often valued
subjectively.
25
Certain swap agreements are
exempt from most provisions of the Commodity Exchange Act and, therefore, are
not regulated as futures or commodity option transactions under such Act,
pursuant to regulations approved by the CFTC.
This exemption is not exclusive, and participants may continue to rely
on existing exclusions for swaps.
Risk of
Potential Government Regulation of Derivatives
. It is possible that government regulation of
various types of derivative instruments, including futures and swap agreements,
may limit or prevent an ETF from using such instruments as a part of its
investment strategy, and could ultimately prevent the ETF from being able to
achieve its investment objective. While
no current regulatory or legislative activity is anticipated to have a direct,
immediate effect upon an ETF, it is not possible to predict the course of
future legislation or regulation in this area.
It is possible that if certain proposed measures were to become law,
they could potentially limit the ability of an ETF to use certain instruments
as a part of its investment strategy.
Limits or restrictions applicable to the counterparties with which an
ETF engage in derivative transactions could also prevent the ETF from using
certain instruments.
Warrants
and Rights
The ETFs may purchase or
otherwise receive warrants or rights.
Warrants and rights generally give the holder the right to receive, upon
exercise, a security of the issuer at a stated price. An ETF typically uses warrants and rights in
a manner similar to their use of options on securities, as described in Options
and Futures below. Risks associated
with the use of warrants and rights are generally similar to risks associated
with the use of options. Unlike most
options, however, warrants and rights are issued in specific amounts, and
warrants generally have longer terms than options. Warrants and rights are not likely to be as
liquid as exchange-traded options backed by a recognized clearing agency. In addition, the terms of warrants or rights
may limit an ETFs ability to exercise the warrants or rights at such time, or
in such quantities, as the ETF would otherwise wish.
Repurchase
Agreements
The ETFs may enter into repurchase
agreements with banks and broker-dealers.
A repurchase agreement is an agreement under which securities are
acquired by an ETF from a securities dealer or bank subject to resale at an
agreed upon price on a later date. The
acquiring ETF bears a risk of loss in the event that the other party to a
repurchase agreement defaults on its obligations and the ETF is delayed or
prevented from exercising its rights to dispose of the collateral
securities. Such a default may subject
an ETF to expenses, delays, and risks of loss including: (i) possible
declines in the value of the underlying security while the ETF seeks to enforce
its rights, (ii) possible reduced levels of income and lack of access to
income during this period, and (iii) the inability to enforce its rights
and the expenses involved in attempted enforcement. However, an ETFs sub-adviser attempts to
minimize this risk by entering into repurchase agreements only with financial
institutions that are deemed to be of good financial standing.
Zero Coupon
Securities
Zero coupon securities may
be issued by a wide variety of corporate and governmental issuers. Zero coupon securities tend to be subject to
greater market risk than interest-paying securities of
26
similar maturities. When an investor purchases a traditional
coupon-bearing bond, it is paid periodic interest at a predetermined rate. Zero coupon securities tend to be subject to
greater price fluctuations in response to changes in interest rates than are
ordinary interest-paying debt securities with similar maturities. The value of zero coupon securities
appreciates more during periods of declining interest rates and depreciates
more during periods of rising interest rates than ordinary interest-paying debt
securities with similar maturities.
Bank
Obligations
Bank obligations include
certificates of deposit, bankers acceptances, and fixed time deposits. Certificates of deposit are negotiable
certificates issued against funds deposited in a commercial bank for a definite
period of time and earning a specified return.
Bankers acceptances are negotiable drafts or bills of exchange,
normally drawn by an importer or exporter to pay for specific merchandise,
which are accepted by a bank, meaning, in effect, that the bank
unconditionally agrees to pay the face value of the instrument on
maturity. Fixed time deposits are bank
obligations payable at a stated maturity date and bearing interest at a fixed
rate. Fixed time deposits may be withdrawn
on demand by the investor, but may be subject to early withdrawal penalties
which vary depending upon market conditions and the remaining maturity of the
obligation. There are no contractual
restrictions on the right to transfer a beneficial interest in a fixed time
deposit to a third party, although there is no market for such deposits. An ETF will not invest in fixed time deposits
which (1) are not subject to prepayment or (2) provide for withdrawal
penalties upon prepayment (other than overnight deposits) if, in the aggregate,
more than 15% of its net assets would be invested in such deposits, repurchase
agreements maturing in more than seven days and other illiquid assets. An ETF may invest in U.S. dollar-denominated
bank obligations.
Corporate
Debt Securities
The rate of interest on a
corporate debt security may be fixed, floating or variable, and may vary
inversely with respect to a reference rate.
Debt securities may be acquired with warrants attached. An ETF may invest in commercial interests,
including commercial paper, master notes and other short-term corporate
instruments that are denominated in U.S. dollars. Commercial paper consists of short-term
promissory notes issued by corporations.
Commercial paper may be traded in the secondary market after its
issuance. Master notes are demand notes
that permit the investment of fluctuating amounts of money at varying rates of
interest pursuant to arrangements with issuers who meet the quality criteria of
an ETF. The interest rate on a master
note may fluctuate based upon changes in specified interest rates, be reset
periodically according to a prescribed formula or be a set rate. Although there is no secondary market in
master demand notes, if such notes have a demand future, the payee may demand
payment of the principal amount of the note upon relatively short notice. Master notes are generally illiquid and
therefore subject to an ETFs percentage limitations for investments in
illiquid securities.
Securities rated Baa and BBB
are the lowest which are considered investment grade obligations. Moodys describes securities rated Baa as subject
to moderate credit risk. They are
considered medium-grade and as such may possess certain speculative
characteristics. S&P describes
securities rated BBB as regarded as having 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. For securities rated
27
BBB, Fitch states that
expectations
of default risk are currently low
capacity for payment of financial commitments
is considered adequate, but adverse business or economic conditions are more
likely to impair this capacity.
High Yield
Securities
Securities rated lower than
Baa by Moodys, or equivalently rated by S&P or Fitch, are sometimes
referred to as high yield securities or junk bonds. Investing in these securities involves special
risks in addition to the risks associated with investments in higher-rated
fixed income securities. 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. An ETF may have difficulty selling certain
junk bonds because they may have a thin trading market. The lack of a liquid secondary market may
have an adverse effect on the market price and an ETFs ability to dispose of
particular issues and may also make it more difficult for the ETF to obtain
accurate market quotations in valuing these assets. High yield securities may be regarded as
predominately speculative with respect to the issuers continuing ability to
meet principal and interest payments.
They may also be more susceptible to real or perceived adverse economic
and competitive industry conditions than higher-rated securities. Issuers of securities in default may fail to
resume principal or interest payments, in which case an ETF may lose its entire
investment.
Companies that issue high
yield bonds are often highly leveraged and may not have more traditional
methods of financing available to them.
During an economic downturn or recession, highly leveraged issuers of
high-yield securities may experience financial stress, and may not have
sufficient revenues to meet their interest payment obligations. Economic downturns tend to disrupt the market
for high yield bonds, lowering their values and increasing their price
volatility. The risk of issuer default
is higher with respect to high yield bonds because such issues may be
subordinated to other creditors of the issuer.
The credit rating of a high
yield bond does not necessarily address its market value risk, and ratings may
from time to time change to reflect developments regarding the issuers
financial condition. The lower the
rating of a high yield bond, the more speculative its characteristics.
Debt and
Other Fixed Income Securities Generally
Debt and other fixed income
securities include fixed and floating rate securities of any maturity. Fixed rate securities pay a specified rate of
interest or dividends. Floating rate
securities pay a rate that is adjusted periodically by reference to a specified
index or market rate. Fixed and floating
rate securities include securities issued by federal, state, local, and foreign
governments and related agencies, and by a wide range of private issuers, and
generally are referred to in this SAI as fixed income securities. Indexed bonds are a type of fixed income
security whose principal value and/or interest rate is adjusted periodically
according to a specified instrument, index, or other statistic (e.g., another
security, inflation index, currency, or commodity).
Holders of fixed income
securities are exposed to both market and credit risk. Market risk (or interest rate risk) relates
to changes in a securitys value as a result of changes in interest rates. In general, the values of fixed income
securities increase when interest rates fall and decrease when interest rates
rise. Credit risk relates to the ability
of an issuer to make payments of
28
principal and interest. Obligations of issuers are subject to
bankruptcy, insolvency and other laws that affect the rights and remedies of
creditors.
Because interest rates vary,
the future income an ETF cannot be predicted with certainty. The future income of an ETF if it invests in
indexed securities also will be affected by changes in those securities
indices over time (e.g., changes in inflation rates, currency rates, or
commodity prices).
Cash and
Cash Items
An ETF may invest a portion
of its assets in cash or cash items pending other investments or to maintain
liquid assets required in connection with some of the ETFs investments. These cash items may include money market
instruments, such as securities issued by the U.S. Government and its agencies,
bankers acceptances, commercial paper, and bank certificates of deposit. An ETF may also use some of these securities
as part of its investment program.
U.S.
Government Securities and Foreign Government Securities
U.S. government securities
include securities issued or guaranteed by the U.S. government or its
authorities, agencies, or instrumentalities.
Foreign government securities include securities issued or guaranteed by
foreign governments (including political subdivisions) or their authorities,
agencies, or instrumentalities or by supra-national agencies. Different kinds of U.S. government securities
and foreign government securities have different kinds of government
support. For example, some U.S.
government securities (e.g., U.S. Treasury bonds) are supported by the full
faith and credit of the U.S. Other U.S.
government securities are issued or guaranteed by federal agencies or
government-chartered or -sponsored enterprises but are neither guaranteed nor
insured by the U.S. government (e.g., debt securities issued by the Federal
Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage
Association (Fannie Mae), and Federal Home Loan Banks (FHLBs)). Similarly, some foreign government securities
are supported by the full faith and credit of a foreign national government or
political subdivision and some are not.
Foreign government securities of some countries may involve varying
degrees of credit risk as a result of financial or political instability in
those countries or the possible inability of an ETF to enforce its rights
against the foreign government. As with
issuers of other fixed income securities, sovereign issuers may be unable or
unwilling to make timely principal or interest payments.
It
is possible that the availability and the marketability (that is, liquidity) of
the securities discussed in this section could be adversely affected by actions
of the U.S. and foreign governments to tighten the availability of credit. In September 2008, the Federal Housing
Finance Agency (FHFA), an agency of the U.S. government, placed Fannie Mae and
Freddie Mac into conservatorship, a statutory process with the objective of
returning the entities to normal business operations. FHFA will act as the conservator to operate
Fannie Mae and Freddie Mac until they are stabilized. It is unclear what effect this
conservatorship will have on the securities issued or guaranteed by Fannie Mae
or Freddie Mac.
Supra-national agencies are
agencies whose member nations make capital contributions to support the agencies
activities. Examples include the
International Bank for Reconstruction and Development (the World Bank), the
Asian Development Bank, the European Coal and Steel Community, and the
Inter-American Development Bank.
29
As with other fixed income
securities, U.S. government securities and foreign government securities expose
their holders to market risk because their values typically change as interest
rates fluctuate. For example, the value
of U.S. government securities or foreign government securities may fall during
times of rising interest rates. Yields
on U.S. government securities and foreign government securities tend to be
lower than those of corporate securities of comparable maturities.
In addition to investing
directly in U.S. government securities and foreign government securities, an
ETF may purchase certificates of accrual or similar instruments evidencing
undivided ownership interests in interest payments and/or principal payments of
U.S. government securities and foreign government securities. Certificates of accrual and similar
instruments may be more volatile than other government securities.
Municipal
Securities
Each ETF may invest in
municipal securities. Municipal
securities include debt obligations issued by governmental entities to obtain
funds for various public purposes, such as the construction of a wide range of
public facilities, the refunding of outstanding obligations, the payment of
general operating expenses, and the extension of loans to other public
institutions and facilities. Other types
of municipal securities include short-term General Obligation Notes, Tax
Anticipation Notes, Bond Anticipation Notes, Revenue Anticipation Notes,
Project Notes, Tax-Exempt Commercial Paper, Construction Loan Notes and other
forms of short-term tax-exempt loans.
Such instruments are issued with a short-term maturity in anticipation
of the receipt of tax funds, the proceeds of bond placements or other
revenues. An issuers obligations under
its municipal securities are subject to the provisions of bankruptcy,
insolvency, and other laws affecting the rights and remedies of creditors, such
as the federal bankruptcy code, and laws, if any, which may be enacted by
Congress or state legislatures extending the time for payment of principal or
interest, or both, or imposing other constraints upon the enforcement of such
obligations or upon the ability of municipalities to levy taxes. The power or
ability of an issuer to meet its obligations for the payment of interest on and
principal of its municipal securities may be materially adversely affected by
litigation or other conditions.
Municipal securities can be
significantly affected by political changes as well as uncertainties in the
municipal market related to taxation, legislative changes, or the rights of
municipal security holders. Because many
municipal securities are issued to finance similar projects, especially those
relating to education, health care, transportation and utilities, conditions in
those sectors can affect the overall municipal market. In addition, changes in the financial
condition of an individual municipal insurer can affect the overall municipal
market.
Municipal bonds, which
generally have maturities of more than one year when issued, are designed to
meet longer-term capital needs. Some
longer-term municipal bonds allow an investor to put or sell the security at
a specified time and price to the issuer or other put provider. If a put
provider fails to honor its commitment to purchase the security, the ETF
holding the security may have to treat the securitys final maturity as its
effective maturity, potentially increasing the volatility of the ETF.
30
Each
ETF may invest in municipal lease obligations.
Municipal leases frequently carry risks distinct from those associated
with general obligation or revenue bonds.
State constitutions and statutes set requirements that states and
municipalities must meet to incur debt. These may include voter referenda,
interest rate limits or public sale requirements. Many leases and contracts include
nonappropriation clauses, which provide that the governmental issuer has no obligation
to make future payments under the lease or contract unless money is
appropriated for such purposes by the appropriate legislative body on a yearly
or other periodic basis. Municipal lease
obligations also may be subject to abatement risk. For example, construction delays or
destruction of a facility as a result of an uninsurable disaster that prevents
occupancy could result in all or a portion of a lease payment not being made.
An
ETF that invests in the municipal bond market is subject to certain risks. The amount of public information available
about the municipal bonds held by an ETF is generally less than that for
corporate equities or bonds, and the investment performance of the ETF may
therefore be more dependent on the analytical abilities of its sub-adviser. The secondary market for municipal bonds,
particularly the lower-rated bonds, also tends to be less well developed or
liquid than many other securities markets, which may adversely affect an ETFs
ability to sell its bonds at attractive prices.
The ability of municipal issuers to make timely payments of interest and
principal may be diminished during general economic downturns and as
governmental cost burdens are reallocated among federal, state and local
governments. In addition, laws enacted
in the future by Congress or state legislatures or referenda could extend the
time for payment of principal and/or interest, or impose other constraints on
enforcement of such obligations, or on the ability of municipal issuers to levy
taxes. Issuers of municipal securities
might seek protection under the bankruptcy laws. In the event of bankruptcy of such an issuer,
an ETF could experience delays in collecting principal and interest and the ETF
may not, in all circumstances, be able to collect all principal and interest to
which it is entitled.
Real Estate Investment
Trusts and other Real Estate-Related Investments
The ETFs may invest in
pooled real estate investment vehicles (so-called real estate investment
trusts or REITs) and other real estate-related investments such as securities
of companies principally engaged in the real estate industry. In addition to REITs, companies in the real
estate industry and real estate-related investments may include, for example,
entities that either own properties or make construction or mortgage loans,
real estate developers, and companies with substantial real estate
holdings. Each of these types of
investments is subject to risks similar to those associated with direct
ownership of real estate. Factors
affecting real estate values include the supply of real property in certain
markets, changes in zoning laws, delays in completion of construction,
environmental liability risks, changes in real estate values, changes in
property taxes and operating expenses, levels of occupancy, adequacy of rent to
cover operating expenses, and local and regional markets for competing asset
classes. The value of real estate also
may be affected by changes in interest rates and social and economic trends.
REITs are pooled investment
vehicles that invest in real estate or real estate-related companies. An ETF may invest in different types of
REITs, including equity REITs, which own real estate directly; mortgage REITs,
which make construction, development, or long-term mortgage loans; and hybrid
REITs, which share characteristics of equity REITs and mortgage REITs. In general, the value of a REITs shares
changes in light of factors affecting the real estate industry. REITs
31
are also subject to the risk
of poor performance by the REITs manager, defaults by borrowers,
self-liquidation, adverse changes in the tax laws, and, with regard to U.S.
REITs, the risk of failing to qualify for tax-free pass-through of income under
the Internal Revenue Code of 1986 and/or to maintain exempt status under the
Investment Company Act. See Taxes
below for a discussion of special tax considerations relating to an ETFs
investment in U.S. REITs.
Illiquid Securities, Private
Placements, Restricted Securities, and IPOs and Other Limited Opportunities
An ETF may invest up to 15%
of its net assets in illiquid securities.
For this purpose, illiquid securities are securities that an ETF may
not sell or dispose of within seven days in the ordinary course of business at
approximately the amount at which the ETF has valued the securities.
A repurchase agreement
maturing in more than seven days is considered illiquid, unless it can be
terminated after a notice period of seven days or less.
An ETFs sub-adviser also
may deem certain securities to be illiquid as a result of the sub-advisers
receipt from time to time of material, non-public information about an issuer,
which may limit the sub-advisers ability to trade such securities for the
account of any of its clients, including an ETF. In some instances, these trading restrictions
could continue in effect for a substantial period of time.
As long as the SEC maintains
the position that most swap contracts, caps, floors, and collars are illiquid,
an ETF will continue to designate these instruments as illiquid unless the
instrument includes a termination clause or has been determined to be liquid
based on a case-by-case analysis pursuant to procedures approved by the Board.
Private
Placements and Restricted Investments.
Illiquid securities include securities of
private issuers, securities traded in unregulated or shallow markets, and
securities that are purchased in private placements and are subject to legal or
contractual restrictions on resale.
Because relatively few purchasers of these securities may exist,
especially in the event of adverse market or economic conditions or adverse
changes in the issuers financial condition, an ETF could have difficulty
selling them when its sub-adviser believes it advisable to do so or may be able
to sell them only at prices that are lower than if they were more widely
held. Disposing of illiquid securities
may involve time-consuming negotiation and legal expenses, and selling them
promptly at an acceptable price may be difficult or impossible.
While private placements may
offer attractive opportunities not otherwise available in the open market, the
securities purchased are usually restricted securities or are not readily
marketable. Securities purchased in
private placement offerings made in reliance on the private placement
exemption from registration afforded by Section 4(2) of the 1933 Act,
and resold to qualified institutional buyers under Rule 144A under the
1933 Act, are restricted securities.
Restricted
securities cannot be sold without being registered under the 1933 Act, unless
they are sold pursuant to an exemption from registration (such as Rules 144
or 144A). Securities that are not
readily marketable are subject to other legal or contractual restrictions on resale. An ETF may have to bear the expense of
registering restricted securities for resale and the risk of substantial delay
in effecting registration. An ETF may be
deemed to be an underwriter for purposes of Section 11 of the 1933 Act
when selling its securities in a
32
registered offering. In such event, an ETF may be liable to
purchasers of the securities under Section 11 if the registration
statement prepared by the issuer, or the prospectus forming a part of it, is
materially inaccurate or misleading, although the ETF may have a due diligence
defense.
At times, the inability to
sell illiquid securities can make it more difficult to determine their fair
value for purposes of computing an ETFs net asset value. The judgment of the ETFs sub-adviser
normally plays a greater role in valuing these securities than in valuing
publicly traded securities.
Not all restricted
securities are necessarily deemed to be illiquid. An ETF may invest in Rule 144A securities. Rule 144A securities are securities
which, while privately placed, are eligible for purchase and resale pursuant to
Rule 144A under the 1933 Act. This Rule permits
certain qualified institutional buyers, such as the ETFs, to trade in privately
placed securities even though such securities are not registered under the 1933
Act. The sub-adviser will consider
whether securities purchased under Rule 144A are illiquid and thus subject
to the ETFs limitations on illiquid securities. Determination of whether a Rule 144A
security is liquid or not is a question of fact. In making this determination, the sub-adviser
will consider the trading markets for the specific security taking into account
the unregistered nature of a Rule 144A security, among other factors. The sub-adviser will also monitor the
liquidity of Rule 144A securities, and if, as a result of changed
conditions, the sub-adviser determines that a Rule 144A security is no
longer liquid, the sub-adviser will review the ETFs holdings of illiquid
securities to determine what, if any, action is required to comply with its
limitations on investment of illiquid securities. Investing in Rule 144A securities could
increase the amount of the ETFs investments in illiquid securities if
qualified institutional buyers are unwilling to purchase such securities.
Investments in Other
Investment Companies or Other Pooled Investments
Each ETF may invest in the
securities of other investment companies to the extent permitted by law. Subject to applicable regulatory
requirements, an ETF may invest in shares of both open- and closed-end
investment companies (including money market funds and ETFs). The market price for ETF and closed-end fund
shares may be higher or lower than, respectively, the ETFs and closed-end funds
NAV. Investing in another investment
company exposes an ETF to all the risks of that investment company and, in
general, subjects it to a
pro rata
portion of the other investment companys fees and expenses. An ETF also may invest in private investment
funds, vehicles, or structures.
MANAGEMENT
Board of
Trustees and Officers
As a Delaware trust, the
business and affairs of the Trust are managed by its officers under the
oversight of its Board. The Board sets
broad policies for the Trust and may appoint Trust officers. The Board oversees the performance of the
Manager, McDonnell and the Trusts other service providers. Each Trustee serves until his or her
successor is duly elected or appointed and qualified.
33
One of the Trustees is an
officer and employee of the Manager.
This Trustee is an interested person (as defined in Section 2(a)(19)
of the Investment Company Act) of the Trust (an Interested Trustee). The other Trustees are not interested persons
of the Trust (the Independent Trustees).
The
Trusts fund complex currently consists of eight ETFs. Each Trustee or officer may be contacted by
writing to the Trustee or officer c/o Grail Advisors, LLC, One Ferry Building, Suite 255,
San Francisco, California 94111. The
name, age, address, and principal occupations during the past five years with
respect to each of the Trustees and officers of the Trust is set forth below,
along with the other public directorships held by the Trustees.
Name,
Address,
Age
|
|
Position(s)
Held with
the Trust
|
|
Term of
Office
and
Length
of Time
Served
|
|
Principal
Occupation(s) During
Past 5 Years
|
|
Number of
Portfolios
in the
Trust
Complex
Overseen
by Trustee
|
|
Other
Directorships
Held by Trustee
|
INDEPENDENT
TRUSTEES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bradford K.
Gallagher
Age: 65
|
|
Chairman of the Board
|
|
Since
2009
|
|
Founder, Spyglass Investments LLC (a private investment vehicle)
(since 2001); Founder, President and CEO of Cypress Holding Company,
CypressTree Investment Management Company and North American Funds
(1995-2001); President, Allmerica Life & Annuity Company
(1990-1995); Managing Director, Fidelity Investments, Founder of
Institutional Investments (1979-1990).
|
|
8
|
|
Trustee,
The Common Fund (since 2005); Trustee, Nicholas Applegate Institutional Funds
(since 2007); Director, Shielding Technology Inc. (since 2006).
|
Charles H. Salisbury, Jr.
Age: 68
|
|
Trustee
|
|
Since
2009
|
|
Private investor.
|
|
8
|
|
Hobart & William Smith Colleges, Investment Committee
Chair
|
34
Name,
Address,
Age
|
|
Position(s)
Held with
the Trust
|
|
Term of
Office
and
Length
of Time
Served
|
|
Principal
Occupation(s) During
Past 5 Years
|
|
Number of
Portfolios
in the
Trust
Complex
Overseen
by Trustee
|
|
Other
Directorships
Held by Trustee
|
|
|
|
|
|
|
|
|
|
|
(since 2006); Maryland Institute, College of Art, Chair of
Investment Committee (since 1994);
Trustee, Johns Hopkins
Hospital (since 2000); Trustee, Guadalupe Center of Immokalee (since 2007);
Director, CeraTech, Inc. (since 2003).
|
Dennis G. Schmal
Age: 62
|
|
Trustee
|
|
Since
2009
|
|
Self-employed consultant (since 2003).
|
|
8
|
|
Trustee,
AssetMark Funds (since 2007); Director/ Chairman, Pacific Metrics Corp.
(educational services) (since 2005); Director, Varian Semiconductor Equipment
Associates, Inc. (since 2004); Director, MCF Corp. (financial services)
(since 2003); Trustee, Wells Fargo Multi-Strategy 100 Hedge Fund (since
2008).
|
35
Name,
Address,
Age
|
|
Position(s)
Held with
the Trust
|
|
Term of
Office
and
Length
of Time
Served
|
|
Principal
Occupation(s) During
Past 5 Years
|
|
Number of
Portfolios
in the
Trust
Complex
Overseen
by Trustee
|
|
Other
Directorships
Held by Trustee
|
INTERESTED TRUSTEES
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
William M. Thomas
Age: 46
|
|
Chief Executive Officer
|
|
Since
2008
|
|
Chief
Executive Officer, Grail Advisors, LLC (since 2008); Senior Vice President,
Charles Schwab (2000-2008).
|
|
8
|
|
None
|
OFFICERS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chester G.
Chappell
Age: 44
|
|
Assistant Secretary
|
|
Since
2008
|
|
Head of Distribution, Grail Advisors, LLC (since 2008); Vice
President, National Sales Manager, Charles Schwab (2003-2008); Director,
Asset Management Strategic Alliances, Charles Schwab (2000-2003).
|
|
N/A
|
|
N/A
|
Bryan M. Hiser
Age: 36
|
|
Chief Financial Officer
|
|
Since
2008
|
|
Director of Investment Research, Grail Advisors, LLC (since
2008); Assistant Vice President Fund Administration, Citi Fund Services
(2007-2008); Financial Analyst, Harbor Capital Advisors (1999-2007).
|
|
N/A
|
|
N/A
|
Equity Ownership of Trustees.
The table below shows the dollar range of (i) Shares
of the ETFs discussed in this SAI, and (ii) shares of all ETFs in the
Trusts family of investment companies, owned by the Trustees as of December 1,
2009. As of that date, the ETFs discussed
in this SAI had not issued any Shares.
36
Name
|
|
Dollar Range of Equity
Securities in the ETFs
|
|
Aggregate Dollar Range
of Equity
Securities in All Registered Investment
Companies Overseen by Trustee in
Family of Investment Companies*
|
|
Bradford K.
Gallagher
|
|
$
|
0
|
|
$0
|
|
Charles H.
Salisbury, Jr.
|
|
$
|
0
|
|
$10,001-$50,000
|
|
Dennis G. Schmal
|
|
$
|
0
|
|
$0
|
|
William M. Thomas
|
|
$
|
0
|
|
$1-$10,000
|
|
* The Family of Investment Companies
currently consists of eight ETFs.
Committees
The Board currently has
three standing committees: an Audit Committee, a Nomination Committee and a
Qualified Legal Compliance Committee.
Currently, each Independent Trustee serves on each of these committees.
The
purposes of the Audit Committee are to: (1) oversee generally each ETFs
accounting and financial reporting policies and practices, their internal
controls and, as appropriate, the internal controls of certain service
providers; (2) oversee the quality, integrity, and objectivity of each ETFs
financial statements and the independent audit thereof; (3) assist the
full Board with its oversight of the Trusts compliance with legal and
regulatory requirements that relate to each ETFs accounting and financial
reporting, internal controls and independent audits; (4) approve, prior to
appointment, the engagement of the Trusts independent auditors and, in
connection therewith, to review and evaluate the qualifications, independence
and performance of the Trusts independent auditors; and (5) act as a
liaison between the Trusts independent auditors and the full Board. The Audit Committee met twice during the last
fiscal year.
The purposes of the
Nomination Committee are, among other things, to: (1) identify and
recommend for nomination candidates to serve as Trustees and/or on Board
committees who are not Interested Persons of the Trust and who meet any
independence requirements of Exchange Rule 5.3(k)(1) or the
applicable rule of any other exchange on which shares of the Trust are
listed; (2) evaluate and make recommendations to the full Board regarding
potential trustee candidates who are not Interested Persons of the Trust and
who meet any independence requirements of Exchange Rule 5.3(k)(1) or
the applicable rule of any other exchange on which shares of the Trust are
listed; and (3) review periodically the workload and capabilities of the
Trustees and, as the Committee deems appropriate, to make recommendations to
the Board if such a review suggests that changes to the size or composition of
the Board and/or its committees are warranted.
The Committee will generally not consider potential candidates for
nomination identified by shareholders.
The
purposes of the Qualified Legal Compliance Committee are to: (1) receive, review and take appropriate
action with respect to any report made or referred to the Committee by an
attorney of
37
evidence
of a material violation of applicable U.S. federal or state securities law,
material breach of a fiduciary duty under U.S. federal or state law or a
similar material violation by the Trust or by any Trustee, officer, director,
employee, or agent of the Trust; (2) otherwise fulfill the
responsibilities of a qualified legal compliance committee pursuant to Section 307
of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder;
and (3) perform such other duties as may be assigned to it, from time to
time, by the Board.
Compensation
of Trustees and Officers
Interested
Trustees are not compensated by the Trust.
The Trust pays each Independent Trustee $20,000 per year for attendance
at meetings of the Board. All Trustees
are eligible for reimbursement for their travel expenses and other reasonable
out-of-pocket expenses incurred in connection with attending Board
meetings. The Trust does not accrue
pension or retirement benefits as part of the ETFs expenses, and Trustees are
not entitled to benefits upon retirement from the Board. The Trusts officers receive no compensation
directly from the Trust.
The Trust commenced
operations in 2009 and has not had operations for a full year. The table below shows the estimated
compensation that is contemplated to be paid to Trustees for a full year:
Name
|
|
Aggregate
Compensation
from Trust
|
|
Pension or
Retirement
Benefits Accrued
as part of Trust
Expenses
|
|
Estimated Annual
Benefits upon
Retirement
|
|
Total
Compensation
from Fund
Complex* Paid to
Trustees
|
|
Bradford K. Gallagher
|
|
$
|
20,000
|
|
None
|
|
None
|
|
$
|
20,000
|
|
Charles H. Salisbury, Jr.
|
|
$
|
20,000
|
|
None
|
|
None
|
|
$
|
20,000
|
|
Dennis G. Schmal
|
|
$
|
20,000
|
|
None
|
|
None
|
|
$
|
20,000
|
|
* The Fund Complex currently consists of
eight ETFs. For the fiscal period ended December 31,
2009, each Trustee received $15,000 from the Fund Complex.
Codes of
Ethics
The Trust, Manager,
McDonnell and Distributor each have adopted a code of ethics (Code of Ethics),
as required by applicable law, which is designed to prevent their affiliated
persons from engaging in deceptive, manipulative, or fraudulent activities in
connection with securities held or to be acquired by the ETFs (which may also
be held by persons subject to a Code of Ethics). There can be no assurance that the Codes of
Ethics will be effective in preventing such activities. The Codes of Ethics may permit personnel
subject to them to purchase and sell securities, including securities that may
be sold, held or purchased by the ETFs.
The Manager and McDonnell do not use inside information in making
investment decisions on behalf of an ETF.
The Codes of Ethics are on file with the SEC and are available to the
public.
38
Proxy
Voting Policies
The Board believes that the
voting of proxies with respect to securities held by the ETFs is an important
element of the overall investment process.
In this regard, the Trust has adopted Proxy Voting Policies and
Procedures (Policies) that delegate the responsibility for the voting of
proxies on the ETFs portfolio securities to their sub-advisers. Please see Appendix A for a copy of the
Policies.
Although the voting of
proxies for the fixed income investments held by the ETFs is expected to be
rare, proxy voting for the ETFs has been delegated to McDonnell. McDonnells proxy voting policies and
procedures dictate the voting of proxies in the best interests of ETF
shareholders and include procedures to address potential conflicts of
interest. These policies and procedures
are summarized (or included in their entirety) in Appendix B.
Information on how the ETFs
voted proxies relating to portfolio securities during the most recent
twelve-month period ended June 30 will be available: (1) without
charge, upon request, by calling 1-415-677-5870 and (2) on the SECs
website at www.sec.gov.
CONTROL PERSONS AND PRINCIPAL
HOLDERS OF SECURITIES
A
control person is one who owns beneficially or through controlled companies
more than 25% of the voting securities of an ETF or acknowledges the existence
of control. As of December 31,
2009, the ETFs could be deemed to be under the control of the Manager because
it had voting authority with respect to 100% of the value of the outstanding
interests in each ETF on such date. As a
result, the Manager could have the ability to approve or reject those matters
submitted to the shareholders of the ETFs for their approval, including changes
to the ETFs fundamental policies. It is
expected that, once the ETFs commence investment operations, the Manager will
not control either of the ETFs.
INVESTMENT ADVISORY AND OTHER
SERVICES
Grail Advisors, LLC
The
Manager, Grail Advisors, LLC, oversees the performance of the ETFs and arranges
for transfer agency, custody and all other services necessary for the ETFs to
operate, but does not exercise day-to-day oversight over the ETFs sub-advisers. The Manager oversees the business affairs of
the ETFs, provides or oversees the provision of all administrative and
investment advisory services to the ETFs and coordinates the investment
activities of McDonnell. These services
are provided under the terms of an Investment Management Agreement dated December 31,
2009 (Investment Management Agreement) between the Trust, on behalf of each
ETF, and the Manager.
Pursuant to the Investment
Management Agreement, each ETF pays the Manager a management fee for the
services and facilities it provides payable on a monthly basis at the annual
rates set forth in the table below, calculated as a percentage of an ETFs
average daily net assets. From time to
time, the Manager may waive all or a portion of its fee; any such waiver would
increase an ETFs performance. The
Manager is responsible for compensating McDonnell out of the management fees it
receives from each ETF.
39
ETF
|
|
Management
Fee
|
|
Grail McDonnell Intermediate Municipal Bond ETF
|
|
0.30
|
%
|
Grail McDonnell Core Taxable Bond ETF
|
|
0.30
|
%
|
The Manager is a
majority-owned subsidiary of Grail Partners, LLC. Grail Partners, LLC is engaged in merchant
banking activities and provides consultative services and capital to global
investment management firms and financial services businesses. Grail Partners, LLC is registered as a
broker-dealer, but is not principally or otherwise engaged in securities
dealing, market making, floor brokerage, exchange specialist activities,
proprietary trading or similar securities-related activities. The Manager is a registered investment
adviser and is located at One Ferry Building, Suite 255, San Francisco, CA
94111.
Under the Investment
Management Agreement, the Manager (or its affiliates) pays all salaries,
expenses, and fees of the Trustees and officers of the Trust who are officers,
directors/trustees, partners, or employees of the Manager or its
affiliates. The Trust pays all expenses
of its organization, operations, and business not specifically assumed or
agreed to be paid by the Manager or McDonnell.
Without limiting the generality of the foregoing, the Trust pays or
arranges for the payment of the following: the costs of preparing, setting in
type, printing and mailing of Prospectuses, Prospectus supplements, SAIs,
annual, semiannual and periodic reports, and notices and proxy solicitation
materials required to be furnished to shareholders of the Trust or regulatory
authorities, and all tax returns; compensation of the officers and Trustees of
the Trust who are not officers, directors/trustees, partners or employees of
Manager or its affiliates; all legal and other fees and expenses incurred in
connection with the affairs of the Trust, including those incurred with respect
to registering its shares with regulatory authorities and all fees and expenses
incurred in connection with the preparation, setting in type, printing, and
filing with necessary regulatory authorities of any registration statement and
Prospectus, and any amendments or supplements that may be made from time to
time, including registration, filing and other fees in connection with
requirements of regulatory authorities; all expenses of the transfer, receipt,
safekeeping, servicing and accounting for the Trusts cash, securities, and
other property, including all charges of depositories, custodians, and other
agents, if any; the charges for the services and expenses of the independent
accountants and legal counsel retained by the Trust, for itself or its Independent
Trustees (as defined above); the charges and expenses of maintaining
shareholder accounts, including all charges of transfer, bookkeeping, and
dividend disbursing agents appointed by the Trust; all brokers commissions and
issue and transfer taxes chargeable to the Trust in connection with securities
transactions to which the Trust is a party; all taxes and corporate fees
payable by or with respect to the Trust to federal, state, or other
governmental agencies, including preparation of such documents as required by
any governmental agency in connection with such taxes; any membership fees,
dues or expenses incurred in connection with the Trusts membership in any
trade association or similar organizations; all insurance premiums for fidelity
and other coverage; all expenses incidental to holding shareholders and
Trustees meetings, including the printing of notices and proxy materials and
proxy solicitation fees and expenses; all expenses of pricing of the net asset
value per share of each ETF, including the cost of any equipment or services to
obtain price quotations; and extraordinary expenses, such as indemnification
payments or damages awarded in litigation or settlements made.
The
Manager has contractually agreed to reduce its fees and/or reimburse each ETFs
expenses (excluding interest, taxes, brokerage commissions, acquired fund fees
and expenses, and
40
extraordinary
expenses) in order to limit Net Annual Operating Expenses for Shares of each
ETF to 0.35% of its average net assets (Expense Cap). The Expense Cap will remain in effect until
at least January 31, 2011. The
Manager may recoup fees reduced or expenses reimbursed at any time within three
years from the year such expenses were incurred, so long as the repayment does
not cause the Expense Cap to be exceeded.
The Investment Management
Agreement with respect to an ETF will remain in effect for two (2) years
from its effective date and thereafter continue in effect for as long as its
continuance is specifically approved at least annually, by (1) the Board,
or by the vote of a majority (as defined in the Investment Company Act) of the
outstanding shares of an ETF, and (2) by the vote of a majority of the
Trustees who are not parties to the Investment Management Agreement or
interested persons of the Manager, cast in person at a meeting called for the
purpose of voting on such approval. The
Investment Management Agreement provides that it may be terminated at any time,
without the payment of any penalty, by the Board or by vote of a majority of an
ETFs shareholders, on 60 calendar days written notice to the Manager, and by
the Manager on the same notice to the Trust and that it shall be automatically
terminated if it is assigned.
The Investment Management
Agreement provides that the Manager will not be liable for any error of
judgment or mistake of law or for any loss suffered by the Trust in connection
with the matters to which the Investment Management Agreement relates, but will
be liable only for willful misconduct, bad faith, gross negligence or reckless
disregard of its duties or obligations in rendering its services to the Trust
as specified in that Agreement. The
Investment Management Agreement also provides that the Manager may engage in
other businesses, devote time and attention to any other business whether of a
similar or dissimilar nature, and render investment advisory services to others.
The ETFs are newly organized
and as of the date of this SAI have not yet incurred any management fees under
the Investment Management Agreement.
McDonnell Investment Management,
LLC
McDonnell acts as sub-adviser of each ETF. McDonnell is registered as an investment
adviser with the Securities and Exchange Commission (SEC) and is located at
1515 W. 22
nd
Street, 11
th
Floor, Oak
Brook, IL 60523. McDonnell, a Delaware
limited liability company, began operations in 2001, and it is 100% employee
owned. As of September 30, 2009,
McDonnell had more than 80 employees and managed over 500 client relationships
with over $13 billion in assets under management. In addition to the services it provides the
ETFs, McDonnell offers its advisory services to separate accounts for
institutional and private clients, and sub-advised mutual funds.
McDonnell
provides day-to-day portfolio management services to each ETF and has
discretion to purchase and sell securities in accordance with the ETFs
objectives, policies, and restrictions.
McDonnell has entered into an Investment Sub-Advisory Agreement between
the Manager and McDonnell, dated December 31, 2009 (McDonnell Subadvisory
Agreement), with respect to each ETF.
Pursuant to the McDonnell Subadvisory Agreement, McDonnell receives fees
from the Manager to provide the services described above. These fees are paid by the Manager out of the
advisory fees it receives from an ETF; they are not separately paid by an ETF. These fees are
41
payable on a monthly basis at the annual rates set forth in the table
below, calculated as a percentage of an ETFs average daily net assets. From time to time, McDonnell may waive all or
a portion of its fee.
ETF
|
|
McDonnell
Subadvisory Fee
|
|
Grail McDonnell Intermediate Municipal Bond ETF
|
|
0.20
|
%
|
Grail McDonnell Core Taxable Bond ETF
|
|
0.20
|
%
|
The McDonnell Subadvisory
Agreement will automatically terminate if assigned, and may be terminated
without penalty at any time by the Manager, by a vote of a majority of the
Board or by a vote of a majority of the outstanding voting securities of the
applicable ETF on no more than 60 days written notice to McDonnell, or by
McDonnell upon 60 days written notice to the Trust. The McDonnell Subadvisory Agreement with
respect to an ETF will remain in effect for two (2) years from its
effective date and thereafter continue in effect for as long as its continuance
is specifically approved at least annually, by (1) the Board, or by the vote
of a majority (as defined in the Investment Company Act) of the outstanding
shares of an ETF, and (2) by the vote of a majority of the Trustees who
are not parties to the McDonnell Subadvisory Agreement or interested persons of
any such party, cast in person at a meeting called for the purpose of voting on
such approval.
The ETFs are newly organized
and as of the date of this SAI McDonnell has not yet received any management
fees under the McDonnell Subadvisory Agreement.
Custodian
The Bank of New York Mellon
Corporation (BNY Mellon), located at One Wall Street, New York, New York
10286, serves as Custodian of each ETFs assets. As Custodian, BNY Mellon has agreed to: (1) make
receipts and disbursements of money on behalf of the ETF, (2) collect and
receive all income and other payments and distributions on account of the ETFs
portfolio investments, (3) respond to correspondence from shareholders,
security brokers and others relating to its duties; and (4) make periodic
reports to the ETF concerning the ETFs operations. BNY Mellon does not exercise any supervisory
function over the purchase and sale of securities. Pursuant to the Custody Agreement between BNY
Mellon and the Trust the Trust has agreed to pay an annual custody fee of .50
basis points on the first $1 billion of its gross adjusted assets, and .25
basis points on gross adjusted assets in excess of $1 billion, plus certain
transaction charges and additional global custody fees.
Administrator, Fund Accountant
and Transfer Agent
The Bank of New York Mellon
Corporation, located at One Wall Street, New York, New York 10286 serves as
Administrator, Fund Accountant and Transfer Agent to each ETF. As administrator, BNY Mellon provides each
ETF with all required general administrative services, including, without
limitation, office space, equipment, and personnel; clerical and general back
office services; bookkeeping, internal accounting and secretarial services; the
calculation of NAV; and the preparation and filing of all reports, updates to
registration statements, and all
42
other materials required to
be filed or furnished by an ETF under federal and state securities laws.
As fund accountant and
transfer agent, BNY Mellon has agreed to: (1) perform and facilitate
purchases and redemptions of Creation Units of each ETF, (2) make dividend
and other distributions on Shares of each ETF, (3) record the issuance of
Shares and maintain records of outstanding Shares of each ETF, (4) maintain
certain accounts, (5) make and transmit periodic reports to an ETF and its
other service providers, and (6) otherwise perform the customary services
of a transfer agent and dividend disbursing agent. For the services to be provided by BNY Mellon
to the ETFs, the Trust has agreed to pay a $1,000 monthly ETF administration
fee per ETF, a monthly transfer agency services fee of $1,000 per ETF (which
minimum is reduced for the first two years from inception of the ETFs), a fund
accounting fee of 1.50 basis points on the first $1 billion of its gross
adjusted assets, and 1.00 basis points on gross adjusted assets in excess of $1
billion, and a fund administration fee of 2.50 basis points on the first $1
billion of its gross adjusted assets, and 2.00 basis points on gross adjusted
assets in excess of $1 billion, plus certain out-of-pocket expenses. There is a minimum fund accounting and fund
administration fee of $75,000 per ETF (which minimum is reduced for the first
two years from inception of the ETFs).
PORTFOLIO MANAGERS
Portfolio
managers at McDonnell (the Portfolio Managers) may have responsibility for
the day-to-day management of accounts other than the ETFs. Information regarding these other accounts
has been provided by McDonnell and is set forth below. The number of accounts and assets is shown as
of October 31, 2009.
Name
of
|
|
Number
of Other Accounts Managed
and Assets by Account Type
|
|
Number
of Accounts and Assets for Which Advisory
Fee is Performance-Based
|
|
Investment
Advisor
and Portfolio
Manager
|
|
Registered
Investment
Companies
|
|
Other
Pooled
Investment
Vehicles
|
|
Other
accounts
|
|
Registered
Investment
Companies
|
|
Other
Pooled
Investment
Vehicles
|
|
Other
accounts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
McDonnell Investment
Management, LLC
|
|
|
|
|
|
|
|
|
|
|
|
Michael
Kamradt
|
|
0
|
|
0
|
|
196 ($6 billion)
|
|
0
|
|
0
|
|
2 ($36 million)
|
|
Steve
Wlodarski
|
|
3 ($316 million)
|
|
0
|
|
447 ($6.9 billion)
|
|
0
|
|
0
|
|
0
|
|
James
Grabovac
|
|
3 ($316 million)
|
|
0
|
|
45 ($2.8 billion)
|
|
0
|
|
0
|
|
0
|
|
Dawn
Daggy-Mangerson
|
|
3 ($316 million)
|
|
0
|
|
83 ($1.4 billion)
|
|
0
|
|
0
|
|
0
|
|
Lawrence
Jones
|
|
0
|
|
0
|
|
249 ($1.9 billion
|
|
0
|
|
0
|
|
0
|
|
Mark
Giura
|
|
0
|
|
0
|
|
182 ($3.5 billion)
|
|
0
|
|
0
|
|
2 ($36 million)
|
|
Dirck
Davis
|
|
0
|
|
0
|
|
168 ($2.7 billion)
|
|
0
|
|
0
|
|
2 ($36 million)
|
|
Tom
OConnell
|
|
0
|
|
0
|
|
182 ($3.5 billion)
|
|
0
|
|
0
|
|
2 ($36 million)
|
|
Conflicts of Interest
As noted in the table above,
the Portfolio Managers manage accounts other than the ETFs. This side-by-side management may present
potential conflicts between a Portfolio Managers management of an ETFs
investments, on the one hand, and the investments of the other accounts, on the
other hand.
Set forth below is a
description, provided by McDonnell, of any other foreseeable material conflicts
of interest that may arise from the concurrent management of ETFs and other
accounts.
43
McDonnell
. The Portfolio Managers may manage accounts
other than the ETFs, which may present potential conflicts between the ETFs and
those other accounts. The management of
multiple funds, including the ETFs, and other accounts may require the
Portfolio Manager to devote less than all of his or her time to an ETF,
particularly if the ETF and other accounts have different objectives,
benchmarks and time horizons. The
Portfolio Manager may also be required to allocate his or her investment ideas
across multiple funds and accounts, including the ETFs. In addition, if the Portfolio Manager
identifies a limited investment opportunity, such as an initial public offering
that may be suitable for more than one ETF or other account, an ETF may not be
able to take full advantage of that opportunity due to an allocation of that
investment across all eligible funds and accounts. Further, security purchase and sale orders
for multiple accounts often are aggregated for purpose of execution. Although such aggregation generally benefits
clients, it may cause the price or brokerage costs to be less favorable to a
particular client than if similar transactions were not being executed
concurrently for other accounts.
In addition,
other accounts managed by the Portfolio Manager may have a higher advisory fee
and/or performance-based fees which may provide a greater incentive to perform
for those accounts than the ETF. The
policies of McDonnell, however, require that Portfolio Managers treat all accounts
they manage equitably and fairly.
As noted above,
Portfolio Managers may also experience certain conflicts between the interests
of the accounts they manage and their own personal interests (which may include
interests in advantaging McDonnell). The
structure of a Portfolio Managers compensation may create an incentive for the
Portfolio Manager to favor accounts whose performance has a greater impact on
such compensation. The Portfolio Manager
may, for example, have an incentive to allocate favorable or limited
opportunity investments or structure the timing of investments to favor such
accounts. Similarly, if a Portfolio
Manager holds a larger personal investment in one fund or an ETF than he or she
does in another, the Portfolio Manager may have an incentive to favor the fund
or ETF in which he or she holds a larger stake.
In general, McDonnell has policies and
procedures to address the various potential conflicts of interest described
above. The firm has policies and
procedures designed to ensure that Portfolio Managers have sufficient time and
resources to devote to the various accounts they manage. Similarly, the firm has policies and
procedures designed to ensure that investments and investment opportunities are
allocated fairly across accounts, and that the interests of client accounts are
placed ahead of a Portfolio Managers personal interests. However, there is no guarantee that such
procedures will detect or address each and every situation where a conflict
arises.
Compensation
The
Portfolio Managers are compensated in various forms by McDonnell. Following is a description provided by
McDonnell regarding the structure of and criteria for determining the
compensation of each Portfolio Manager:
McDonnells Portfolio Managers are offered
compensation levels that are viewed as competitive within the investment
industry and are reviewed with independent industry data to benchmark
44
compensation.
The Portfolio Managers source of compensation is tied to the overall
revenues of the firm. Specifically, the
components of compensation for the Portfolio Managers include:
Competitive base salary
Bonus pool which is not
formula-driven but includes five subjective components
1.
Portfolio performance
2.
Client Satisfaction and Client retention
3.
New Assets
4.
Product Development
5.
Overall Firm earnings/performance
Quality benefits program
Company equity participation
Many of McDonnells professional personnel have equity
ownership in McDonnell, which is typically purchased by such members. Determination of eligibility for equity
ownership is made by McDonnells Executive Committee, in conjunction with
recommendations by certain other members of senior management. The criteria for ownership centers around
whether an individual is deemed to be a k
ey employee who demonstrates
leadership and vision in his or her area of responsibility and who is deemed to
be an integral part of the growth and success of McDonnells business. Other factors include tenure with McDonnell,
as well as years of relevant professional experience.
Ownership of ETFs
Because the
ETFs are newly organized, the Portfolio Managers do not own Shares of the ETFs.
Once the ETFs commence investment operations, the Portfolio Managers may
purchase Shares of the ETFs in the secondary market. In addition, McDonnell, for its own account
or for the accounts of its clients, may purchase Shares of the ETFs in the
secondary market.
PORTFOLIO TRANSACTIONS AND
BROKERAGE
When
executing portfolio transactions, McDonnell will place its own orders to
execute securities transactions that are designed to implement the applicable
ETFs investment objective and policies.
In placing such orders, McDonnell will seek the most favorable net price
and execution under the circumstances consistent with its obligation under the
Sub-Advisory Agreement. In
selecting broker-dealers and in
negotiating prices on such transactions,
McDonnell considers a number of factors, including but not limited to: the
nature of the security being traded; the size and type of the transaction; the
nature and character of the markets for the security to be purchased or sold;
the desired timing of the trade; the activity existing and expected in the
market for the particular security; confidentiality, including trade anonymity;
the quality of the execution, clearance and settlement services; financial
stability of the broker-dealer, and the broker-dealers execution capabilities,
including ability to locate bonds suitable for our inquiries.
In
selecting broker-dealers to execute particular transactions, McDonnell is
authorized to consider brokerage and research services (as those terms are
defined in Section 28(e) of the 1934 Act), provision of statistical
quotations (including the quotations necessary to determine an
45
ETFs
NAV), and other information provided to the ETF, and/or to McDonnell, as the
case may be, provided, however, that McDonnell determines that it has received
the best net price and execution available.
McDonnell is also authorized to cause an ETF to pay to a broker-dealer
who provides such brokerage and research services a commission (as defined in
SEC interpretations) in excess of the amount another broker-dealer would have
charged for effecting the same transaction.
McDonnell must determine in good faith, however, that such commission is
reasonable in relation to the value of the brokerage and research services
provided, viewed in terms of that particular transaction or in terms of all the
accounts over which McDonnell exercises investment discretion. Under these circumstances, McDonnells fees
are not reduced by reason of receipt of such brokerage and research
services. However, the ETFs do not allow
McDonnell to enter into arrangements to direct transactions to broker-dealers
as compensation for the promotion or sale of ETF shares by those
broker-dealers.
An
ETFs turnover rate, or the frequency of portfolio transactions, will vary from
year to year depending on market conditions.
High portfolio activity may increase an ETFs transaction costs, including
brokerage commissions, and result in a greater number of taxable transactions.
Because
the ETFs are newly organized, they have not incurred brokerage commissions or
other transaction costs as of the date of this SAI.
THE DISTRIBUTOR
The Distributor is located
at 1290 Broadway, Suite 1100, Denver, CO 80203. The Distributor is a broker-dealer registered
under the 1934 Act and a member of FINRA.
Shares will be continuously
offered for sale by the Trust through the Distributor only in Creation Units,
as described in this SAI. The
Distributor acts as an agent for the Trust.
The Distributor will deliver a Prospectus to persons purchasing Shares
in Creation Units and will maintain records of both orders placed with it and
confirmations of acceptance furnished by it.
The Distributor has no role in determining the investments or investment
policies of the ETFs.
The
Board has adopted a Distribution and Service Plan pursuant to Rule 12b-1
under the Investment Company Act (Plan).
In accordance with its Plan, each ETF is authorized to pay an amount up
to 0.25% of its average daily net assets each year for certain
distribution-related activities. In
addition, if the payment of management fees by an ETF is deemed to be indirect
financing by the ETF of the distribution of its shares, such payment is
authorized by the Plan. The Plan
specifically recognizes that the Manager and other persons, including
McDonnell, may use management fee revenue, as well as past profits or other
resources, to pay for expenses incurred in connection with providing services
intended to result in the sale of Shares.
The Manager and such other persons, as well as their affiliates, may pay
amounts to third parties for distribution or marketing services on behalf of
the ETFs. The Manager may also make
payments to certain market makers in the ETFs Shares for providing
bona fide
consulting and educational services regarding the
ETFs. The making of the types of
payments described in this paragraph could create a conflict of interest for a
financial intermediary or market maker receiving such payments.
46
The Plan was adopted in
order to permit the implementation of an ETFs method of distribution. No fees are currently paid by any ETF under a
Plan, however; and there are no current plans to impose such fees. In the event such fees were to be charged,
over time they would increase the cost of an investment in an ETF.
Under each Plan, the
Trustees would receive and review at the end of each quarter a written report
provided by the Distributor of the amounts expended under the Plan and the
purpose for which such expenditures were made.
ACCOUNTING AND LEGAL SERVICE
PROVIDERS
Independent
Registered Public Accounting Firm
KPMG LLP, located at 1601
Market Street, Philadelphia, Pennsylvania 19103, serves as the independent
registered public accounting firm to the ETFs.
KPMG LLP provides audit services, tax return preparation and assistance
and consultation in connection with certain SEC filings.
Legal
Counsel
K&L Gates LLP, located
at 1601 K Street NW, Washington, DC 20006, serves as the Trusts legal counsel.
ADDITIONAL INFORMATION
CONCERNING SHARES
Organization
and Description of Shares of Beneficial Interest
The
Trust is a Delaware statutory trust and registered open-end investment
company. The Trust was organized on December 7,
2007 and has authorized capital of unlimited Shares of beneficial interest of
no par value which may be issued in more than one class or series. Currently, the Trust consists of eight
actively managed, exchange-traded series, one of which has not yet been opened
for investment. The Board may designate
additional series and classify Shares of a particular series into one or more
classes of that series.
Under Delaware law, the
Trust is not required to hold an annual shareholders meeting if the Investment
Company Act does not require such a meeting.
Generally, there will not be annual meetings of Trust shareholders. If requested by shareholders of at least 10%
of the outstanding Shares of the Trust, the Trust will call a meeting of
shareholders for the purpose of voting upon the question of removal of a
Trustee and will assist in communications with other Trust shareholders. Shareholders holding two-thirds of Shares
outstanding of all series of the Trust may remove Trustees from office by votes
cast at a meeting of Trust shareholders or by written consent.
All Shares will be freely
transferable. Shares will not have
preemptive rights or cumulative voting rights, and none of the Shares will have
any preference to conversion, exchange, dividends, retirements, liquidation,
redemption, or any other feature. Shares
have equal voting rights, except that in a matter affecting only a particular
ETF, only Shares of that ETF may be entitled to vote on the matter. The Trust Instrument confers upon the Board
the power, by resolution, to alter the number of Shares constituting a Creation
Unit or to specify that Shares of an ETF may be individually redeemable. The Trust reserves the right to adjust the
stock prices of Shares to maintain convenient trading ranges for
investors. Any such adjustments would be
47
accomplished through stock
splits or reverse stock splits which would have no effect on the NAV of an ETF.
The Trust Instrument of the
Trust disclaims liability of the shareholders or the officers of the Trust for
acts or obligations of the Trust which are binding only on the assets and
property of the Trust. The Trust
Instrument provides for indemnification out of an ETFs property for all loss
and expense of an ETFs shareholders being held personally liable solely by
reason of his or her being or having been a shareholder and not because of his
or her acts or omissions or for some other reason. The risk of a Trust shareholder incurring
financial loss on account of shareholder liability is limited to circumstances
in which an ETF itself would not be able to meet the Trusts obligations and
this risk should be considered remote.
If an ETF does not grow to a
size to permit it to be economically viable, the ETF may cease operations. In such an event, shareholders may be
required to liquidate or transfer their Shares at an inopportune time and
shareholders may lose money on their investment.
Book Entry
Only System
DTC acts as securities
depositary for Shares. Shares are
registered in the name of the DTC or its nominee, Cede & Co., and
deposited with, or on behalf of, DTC.
Certificates generally will not be issued for Shares.
DTC
has advised the Trust as follows: it is
a limited-purpose trust company organized under the laws of the State of New
York, a member of the Federal Reserve System, a clearing corporation within
the meaning of the New York Uniform Commercial Code, and a clearing agency
registered pursuant to the provisions of Section 17A of the 1934 Act. DTC was created to hold securities of its
participants and to facilitate the clearance and settlement of securities
transactions among the DTC Participants in such securities through electronic
book-entry changes in accounts of the DTC Participants, thereby eliminating the
need for physical movement of securities certificates. DTC Participants include securities brokers
and dealers, banks, trust companies, clearing corporations and certain other
organizations, some of whom (and/or their representatives) own DTC. More specifically, DTC is owned by a number
of its DTC Participants and by the NYSE, and FINRA. Access to the DTC system is also available to
Indirect Participants such as banks, brokers, dealers and trust companies
that clear through or maintain a custodial relationship with a DTC Participant,
either directly or indirectly. DTC
agrees with and represents to DTC Participants that it will administer its
book-entry system in accordance with its rules and by-laws and
requirements of law. Beneficial
ownership of Shares is limited to DTC Participants, Indirect Participants and
persons holding interests through DTC Participants and Indirect
Participants. Ownership of beneficial
interests in Shares is shown on, and the transfer of ownership is effected only
through, records maintained by DTC (with respect to DTC Participants) and on
the records of DTC Participants (with respect to Indirect Participants and
beneficial owners that are not DTC Participants). Beneficial owners will receive from or
through the DTC Participant a written confirmation relating to their purchase
of Shares. The laws of some
jurisdictions may require that certain purchasers of securities take physical
delivery of such securities in definitive form.
Such laws may impair the ability of certain investors to acquire
beneficial interests in Shares.
48
Beneficial
owners are not entitled to have Shares registered in their names, will not
receive or be entitled to receive physical delivery of certificates in
definitive form and are not considered the registered holder thereof. Accordingly, each beneficial owner must rely
on the procedures of DTC, the DTC Participant and any Indirect Participant
through which such beneficial owner holds its interests, to exercise any rights
as a holder of Shares. The Trust
understands that under existing industry practice, in the event the Trust
requests any action of holders of Shares, or a beneficial owner desires to take
any action that DTC, as the record owner of all outstanding Shares, is entitled
to take, DTC would authorize the DTC Participants to take such action and that
the DTC Participants would authorize the Indirect Participants and beneficial
owners (acting through such DTC Participants) to take such action and would
otherwise act upon the instructions of beneficial owners owning through them.
Conveyance
of all notices, statements and other communications to beneficial owners is
effected as follows. Pursuant to the
Depositary Agreement between the Trust and DTC, DTC is required to make
available to the Trust, upon request and for a fee to be charged to the Trust,
a listing of Share holdings of each DTC Participant. The Trust shall inquire of each such DTC
Participant as to the number of beneficial owners holding Shares, directly or
indirectly, through such DTC Participant.
The Trust shall provide each such DTC Participant with copies of such
notice, statement or other communication, in such form, number and at such
place as such DTC Participant may reasonably request, in order that such
notice, statement or communication may be transmitted by such DTC Participant,
directly or indirectly, to such beneficial owners. In addition, the Trust shall pay to each such
DTC Participant a fair and reasonable amount as reimbursement for the expenses
attendant to such transmittal, all subject to applicable statutory and
regulatory requirements.
Distributions
of Shares shall be made to DTC or its nominee, Cede & Co., as the
registered holder of all Shares. DTC or
the nominee, upon receipt of any such distributions, shall credit immediately
DTC Participants accounts with payments in amounts proportionate to their
respective beneficial interests in Shares as shown on the records of DTC or the
nominee. Payments by DTC Participants to
Indirect Participants and beneficial owners of Shares (held through DTC Participants)
will be governed by standing instructions and customary practices, as is now
the case with securities held for the accounts of customers in bearer form or
registered in a street name, and will be the responsibility of such DTC
Participants. The Trust has no
responsibility or liability for any aspects of the records relating to or
notices to beneficial owners, or payments made on account of beneficial
ownership interests in such Shares, or for maintaining, supervising or
reviewing any records relating to such beneficial ownership interests or for
any other aspect of the relationship between DTC and the DTC Participants or
the relationship between such DTC Participants and the Indirect Participants
and beneficial owners owning through such DTC Participants.
The Trust will not make the
DTC book-entry Dividend Reinvestment Service available for use by beneficial
owners for reinvestment of their cash proceeds but certain brokers may make a
dividend reinvestment service available to their clients. Brokers offering such services may require
investors to adhere to specific procedures and timetables in order to
participate. Investors interested in
such a service should contact their broker for availability and other necessary
details. DTC may determine to
discontinue providing its service with respect to
49
Shares at any time by giving
reasonable notice to the Trust and discharging its responsibilities with
respect thereto under applicable law.
Under such circumstances, the Trust shall take action either to find a
replacement for DTC to perform the functions described or make other
arrangements to represent Share ownership satisfactory to the Exchange.
TRANSACTIONS IN CREATION UNITS
Each ETF sells and redeems
Shares in Creation Units on a continuous basis through the Distributor, without
a sales load, at the NAV next determined after receipt of an order in proper
form on any Business Day. No ETF will
issue fractional Creation Units.
To purchase or redeem any
Creation Units from an ETF, you must be, or transact through, an Authorized
Participant. In order to be an
Authorized Participant, you must be either a broker-dealer or other participant
(Participating Party) in the Continuous Net Settlement System (Clearing
Process) of the National Securities Clearing Corporation (NSCC) or a
participant in DTC with access to the DTC system (DTC Participant), and you
must execute an agreement (Participant Agreement) with the Distributor that
governs transactions in the ETFs Creation Units.
Transactions by an
Authorized Participant that is a Participating Party using the NSCC system are
referred to as transactions through the Clearing Process. Transactions by an Authorized Participant
that is a DTC Participant using the DTC system are referred to as transactions outside
the Clearing Process.
Investors who are not
Authorized Participants but want to transact in Creation Units may contact the
Distributor for the names of Authorized Participants. Investors should be aware that their broker
may not be an Authorized Participant and, therefore, may need to place any
order to purchase or redeem Creation Units through another broker or person
that is an Authorized Participant, which may result in additional charges.
Orders must be transmitted
by an Authorized Participant by telephone or other transmission method
acceptable to the Distributor pursuant to procedures set forth in the
Participant Agreement. Market
disruptions and telephone or other communication failures may impede the
transmission of orders.
Purchasing
Creation Units
Fund Deposit.
Creation Units
may be purchased in exchange for a Fund Deposit. A Fund Deposit consists of (i) a basket
of securities - known as the
In-Kind
Creation Basket
and a
Balancing Amount,
as described below,
(ii) a basket of in-kind securities and cash (Partial Cash Value, and
together with the in-kind basket, an In-Kind/Cash Basket) or (iii) all
cash (the Cash Value). In all
instances the value of the Fund Deposit will be equal to the value of the
Creation Unit.
In-Kind Creation Basket
. BNY Mellon, in a portfolio composition file
sent via the NSCC, makes available on each Business Day, prior to the opening
of business on the Exchange (currently 9:30 a.m., Eastern time), a list of
the names and the required number of shares of each security in the In-Kind
Creation Basket (based on information about the
50
ETFs
portfolio at the end of the previous Business Day). The In-Kind Creation Basket is applicable for
purchases of Creation Units of the ETF until such time as the next-announced
In-Kind Creation Basket is made available.
The composition of the In-Kind Creation Basket may change, however, as,
among other things, corporate actions and investment decisions by McDonnell are
implemented for the ETFs portfolio. All
questions as to the composition of the In-Kind Creation Basket and the
validity, form, eligibility, and acceptance for deposit of any securities shall
be determined by the ETF, and the ETFs determination shall be final and
binding. In addition, each ETF reserves
the right to accept a nonconforming or custom In-Kind Creation Basket.
Balancing Amount and Cash Component.
In addition to the In-Kind Creation Basket, a
purchaser will typically pay to the ETF a Balancing Amount equal to the
difference between the NAV of a Creation Unit and the value of the securities
in the In-Kind Creation Basket. The
Balancing Amount ensures that the consideration paid by an investor for a
Creation Unit is exactly equal to the value of the Creation Unit. BNY Mellon, through the NSCC, makes available
on each Business Day, the estimated Balancing Amount, effective through and
including the previous Business Day.
With respect to Fund Deposits of an In-Kind Creation Basket, the
Balancing Amount and the Transaction Fee may be referred to collectively as the
Cash Component.
In-Kind/Cash
Basket.
In lieu of depositing the
In-Kind Creation Basket and Balancing Amount, the purchaser of a Creation Unit
may make a Fund Deposit of an In-Kind/Cash Basket. The cash portion of such a Fund Deposit is
known as the Partial Cash Value and will be subject to a variable charge, as
explained below. With respect to Fund
Deposits of In-Kind/Cash Baskets, the Partial Cash Value and the Transaction
Fee may be referred to collectively as the Cash Component.
Cash
Value
. In lieu of depositing the
In-Kind Creation Basket and Balancing Amount or an In-Kind/Cash Basket, Fund
Deposits may consist solely of cash in an amount equal to the NAV of the
Creation Units, which amount is referred to as the Cash Value and will be
subject to a variable charge, as explained below. BNY Mellon will publish, on a daily basis,
information about the Cash Value of a Creation Unit. With respect to any Fund Deposit of a Cash
Value, the Cash Value and Transaction Fee may be referred to collectively as
the Cash Component.
Order
Cut-Off Time.
For an order
involving a Creation Unit to be effectuated at the ETFs NAV on a particular
day, it must be received by the Distributor by or before the deadline for such
order (Order Cut-Off Time). The Order
Cut-Off Time for creation and redemption orders for the ETFs are generally
expected to be as follows:
ETF
|
|
In-Kind
Creation or
Redemption Basket
|
|
In-Kind/Cash
Basket
|
|
Cash
Value
|
|
Grail McDonnell
Intermediate Municipal Bond ETF
|
|
4:00 p.m. ET
|
|
2:00 p.m. ET
|
|
2:00 p.m. ET
|
|
Grail McDonnell Core
Taxable Bond ETF
|
|
4:00 p.m. ET
|
|
2:00 p.m. ET
|
|
2:00 p.m. ET
|
|
In-Kind
Creation and Redemption Baskets are expected to be accepted until the close of
regular trading on the Exchange on each Business Day, which is usually 4:00 p.m.
Eastern time. On days when the Exchange
or bond markets close earlier than normal (such as the day before a
51
holiday),
the Order Cut-Off Time is expected to track the Exchange closing and be
similarly earlier than normal. Persons
placing or effectuating custom orders and/or orders involving an In-Kind/Cash
Basket or Cash Value should be mindful of time deadlines imposed by
intermediaries, such as DTC and/or the Federal Reserve Bank wire system, which
may impact the successful processing of such orders to ensure that cash and
securities are transferred by the Settlement Date, which is generally the
Business Day immediately following the Transmittal Date for cash and the third
Business Day following the Transmittal Date for securities.
Placement of Creation Orders
All
purchase orders must be placed by or through an Authorized Participant. In-kind (portions of) purchase orders will be
processed through the Clearing Process when it is available. The Clearing Process is an enhanced clearing
process that is available only for certain securities and only to DTC
participants that are also participants in the Continuous Net Settlement System
of the NSCC. In-kind (portions of)
purchase orders not subject to the Clearing Process will go through a manual
clearing process run by DTC. Fund
Deposits that include government securities must be delivered through the
Federal Reserve Bank wire transfer system.
Fund Deposits that include cash may be delivered through the Clearing
Process or the Federal Reserve Bank wire transfer system.
Orders Using the Clearing Process
. Orders to purchase Creation Units of the
Grail McDonnell Intermediate Municipal Bond ETF may use NSCCs Clearing
Process. In connection with such orders
the Distributor transmits, on behalf of the Authorized Participant, such trade
instructions as are necessary to effect the creation order. Pursuant to such trade instructions, the
Authorized Participant agrees to deliver the requisite In-Kind Creation Basket
(whether standard or custom) to the Trust, together with such additional
information as may be required by the Distributor, and the Cash Component. An order to create Creation Units through the
Clearing Process is deemed received by the Distributor on the Business Day the
order is placed (Transmittal Date) if (i) such order is received by the
Distributor by the Order Cut-Off Time on such Transmittal Date and (ii) all
other procedures set forth in the Participant Agreement are properly
followed. The Cash Component will be
delivered using either the Clearing Process or the Federal Reserve System, as
described below.
Orders Outside the Clearing Process
. All in-kind orders for the Grail McDonnell
Taxable Bond ETF will be made outside the Clearing Process and certain orders
for the Grail McDonnell Intermediate Municipal Bond ETF will be made outside
the Clearing Process. In-kind deposits
of securities for such orders must be delivered through the Federal Reserve
System (for government securities) or through DTC (for corporate
securities). Fund Deposits made outside
the Clearing Process must state that the DTC Participant is not using the
Clearing Process. The Fund Deposit
transfer must be ordered by the DTC Participant on the Transmittal Date in a
timely fashion so as to ensure the delivery of the requisite number of
securities in the In-Kind Creation Basket (whether standard or custom) through
the Federal Reserve System or DTC, as applicable, to the relevant Trust
account. The delivery of (corporate)
securities through DTC must occur by 3:00 p.m., Eastern time, (the DTC
Cut-Off Time) on the Settlement Date.
The delivery of (government) securities through the Federal Reserve
System must occur by 3:00 p.m., Eastern time, on the Settlement Date. An order to create Creation Units outside the
Clearing Process is deemed received by the Distributor on the Transmittal Date
if (i) such order is received by the Distributor by the Order Cut-Off Time
on such Transmittal Date and (ii) all
52
other
procedures set forth in the Participant Agreement are properly followed. If the Custodian does not receive the in-kind
securities and Cash Component by the appointed time(s), such order may be
canceled. Upon written notice to the
Distributor, a canceled order may be resubmitted the following Business Day
using a Fund Deposit as newly constituted to reflect the then-current In-Kind
Creation Basket and Cash Component. The
delivery of Creation Units so created will occur no later than the third
(3rd) Business Day following the day on which the order is deemed received
by the Distributor.
Federal
Reserve System.
The amount of
cash equal to the Cash Component must be transferred directly to the Custodian
through the Federal Reserve Bank wire transfer system. The Cash Component must be transferred in a
timely manner so as to be received by the Custodian no later than 12:00 p.m.,
Eastern time, on the Settlement Date.
Creation
Units may be created in advance of receipt by the Trust of all or a portion of
the applicable In-Kind Creation Basket, provided the purchaser tenders an
initial deposit consisting of any available securities in the In-Kind Creation
Basket and cash equal to the sum of the Cash Component and at least equal of
105% of the market value of the In-Kind Creation Basket securities not
delivered (Additional Cash Deposit). Such
initial deposit will have a value greater than the NAV of the Creation Unit on
the date the order is placed. The order
shall be deemed to be received on the Transmittal Date provided that it is
placed in proper form prior to 4:00 p.m., Eastern time, on such date, and
federal funds in the appropriate amount are deposited with the Custodian by the
DTC Cut-Off Time the following Business Day.
If the order is not placed in proper form by 4:00 p.m. or federal
funds in the appropriate amount are not received by the DTC Cut-Off Time the
next Business Day, then the order will be canceled or deemed unreceived and the
Authorized Participant effectuating such transaction will be liable to the ETF
for any losses resulting therefrom.
To
the extent securities in the In-Kind Creation Basket remain undelivered,
pending delivery of such securities additional cash will be required to be
deposited with the Trust as necessary to maintain an Additional Cash Deposit at
least equal to 105% of the daily marked to market value of the missing
securities. To the extent that either
such securities are still not received by 1:00 p.m., Eastern time, on the
third Business Day following the day on which the purchase order is deemed
received by the Distributor or a marked-to-market payment is not made within
one Business Day following notification to the purchaser and/or Authorized
Participant that such a payment is required, the Trust may use the cash on
deposit to purchase the missing securities, and the Authorized Participant effectuating
such transaction will be liable to the ETF for any costs incurred therein or
losses resulting therefrom, including any Transaction Fee, any amount by which
the actual purchase price of the missing securities exceeds the Additional Cash
Deposit or the market value of such securities on the day the purchase order
was deemed received by the Distributor, as well as brokerage and related
transaction costs. The Trust will return
any unused portion of the Additional Cash Deposit once all of the missing securities
have been received by the Trust. The
delivery of Creation Units so created will occur no later than the third
Business Day following the day on which the purchase order is deemed received
by the Distributor.
Acceptance
of Orders for Creation Units
. The Trust reserves the absolute right to
reject a creation order transmitted to it by the Transfer Agent in respect of
an ETF if: (i) the order is not in proper form; (ii) the investor(s),
upon obtaining the Shares, would own 80% or more of the currently outstanding
Shares of an ETF; (iii) the securities delivered do not conform to the In-
53
Kind Creation Basket for the
relevant date; (iv) acceptance of the In-Kind Creation Basket would have
adverse tax consequences to the ETF; (v) acceptance of the Fund Deposit
would, in the opinion of counsel, be unlawful; (vi) acceptance of the Fund
Deposit would otherwise in the discretion of the Trust or the Manager have an
adverse effect on the Trust or the rights of beneficial owners; or (vii) in
the event that circumstances that are outside the control of the Trust,
Custodian, Distributor and Manager make it practically impossible to process
creation orders. Examples of such
circumstances include acts of God, public service or utility problems such as
fires, floods, extreme weather conditions and power outages resulting in
telephone, telecopy and computer failures; market conditions or activities
causing trading halts; systems failures involving computer or other information
systems affecting the Trust, the Manager, the Distributor, DTC, NSCC, the
Custodian or sub-custodian or any other participant in the creation process,
and similar extraordinary events.
Creation
and Redemption Transaction Fees
To
compensate the Trust for costs incurred in connection with creation and
redemption transactions, investors will be required to pay to the Trust a
Transaction Fee as follows:
|
|
Transaction Fees
|
|
ETF
|
|
Standard
Transaction Fee
|
|
Variable
Charge
|
|
Grail McDonnell Intermediate
Municipal Bond ETF
|
|
$
|
500
|
*
|
Up to 3.0%
|
|
Grail McDonnell Core
Taxable Bond ETF
|
|
$
|
500
|
|
Up to 3.0%
|
|
* The Transaction Fee may be higher for
transactions outside the Clearing Process.
Grail
McDonnell Intermediate Municipal Bond ETF.
The Standard Transaction Fee (of $500) applies to in-kind purchases of
the ETF effected through the Clearing Process on any business day, regardless
of the number of Creation Units purchased or redeemed that day (assuming, in
the case of multiple orders on the same day, that the orders are received at or
near the same time). A higher
Transaction Fee may apply to creation and redemption transactions that occur
outside the Clearing Process, regardless of the number of Creation Units
purchased or redeemed that day (assuming, in the case of multiple orders on the
same day, that the orders are received at or near the same time). In each instance the Transaction Fee will be
determined without regard to whether the in-kind securities tendered (or
received) consist of those in the In-Kind Creation (or Redemption) Basket. If a transaction involves an In-Kind/Cash
Basket, the Transaction Fee will also include a Partial Cash Value, which will
be subject to a variable charge of up to 3.0% of its value. Similarly, Fund Deposits consisting of a Cash
Value will be subject to a variable charge of up to 3.0% of its value in
addition to the standard Transaction Fee.
With cash received from the variable charge, the Manager or McDonnell
will purchase the necessary securities for the ETFs portfolio and return any
unused portion thereof to the investor.
Grail
McDonnell Taxable Bond ETF.
The standard
Transaction Fee (of $500) applies to in-kind purchases of the ETF effected
through or outside the Clearing Process on any business day, regardless of
the number of Creation Units purchased or redeemed that day (assuming, in the
case of multiple orders on the same day, that the orders are received at or
near the same time). If a transaction
involves an In-Kind/Cash Basket, it will include a Partial Cash Value, and
54
the
Transaction Fee will also include a variable charge of up to 3.0% of the
Partial Cash Value. Similarly, Fund
Deposits consisting of a Cash Value will be subject to a variable charge of up
to 3.0% of the Cash Value in addition to the standard Transaction Fee. With cash received from the variable charge,
the Manager or McDonnell will purchase the necessary securities for the ETFs
portfolio and return any unused portion thereof to the investor.
The
Manager, subject to the approval of the Board, may adjust the Transaction Fee
from time to time. Investors will also be responsible for the costs associated
with transferring the securities in the In-Kind Creation (and Redemption)
Baskets (and from) the account of the Trust.
Further, investors who, directly or indirectly, use the services of a
broker or other intermediary to compose a Creation Unit in addition to an
Authorized Participant to effect a transaction in Creation Units may be charged
an additional fee for such services.
Redeeming Creation Units
Fund
Redemptions
. ETF Shares
may be redeemed only in Creation Units at their NAV next determined after
receipt of a redemption request in proper form by an ETF through the Transfer
Agent and only on a Business Day.
Creation Units generally may be redeemed in exchange for a Fund
Redemption. A Fund Redemption consists
of (i) a basket of securities known as the
In-Kind
Redemption Basket
and
Balancing Amount,
(ii) a basket of in-kind securities and Partial Cash Value or (iii) a
Cash Value, in all instances equal to the value of a Creation Unit.
In-Kind Redemption Basket.
If different from the In-Kind Creation
Basket, the composition of the In-Kind Redemption Basket will be available on
the NSCC bulletin board; otherwise, the In-Kind Creation Basket posted on NSCC
may be assumed to be the In-Kind Redemption Basket, too. BNY Mellon, in a portfolio composition file
sent via the NSCC, makes available prior to the opening of business on the
Exchange (currently 9:30 a.m., Eastern time) on each Business Day, the
identity of the portfolio securities in the current In-Kind Redemption Basket
(subject to possible amendment or correction).
An ETF may honor a redemption request with a nonconforming or custom
In-Kind Redemption Basket.
Balancing Amount and Cash Component.
Depending on whether the NAV of a Creation
Unit is higher (or lower) than the value of the securities in the In-Kind
Redemption Basket, a redeeming investor will receive from (or pay to) the ETF a
Balancing Amount in cash, which may be referred to as the Cash Redemption
Amount. If due to receive a Balancing
Amount, the amount actually received will be reduced by the amount of the
applicable Transaction Fee. The
Balancing Amount and the Transaction Fee may be referred to collectively as the
Cash Component.
In-Kind/Cash
Basket.
In lieu of receiving the
In-Kind Redemption Basket and Balancing Amount as a Fund Redemption, the
redeemer of a Creation Unit may instead elect to receive an In-Kind/Cash
Basket. The cash portion is known as the
Partial Cash Value and will be subject to a variable charge, as explained
above. With respect to Fund Redemptions
consisting of an In-Kind/Cash Basket, the Partial Cash Value and Transaction
Fee may be referred to collectively as the Cash Component.
55
Cash
Value
. In lieu of In-Kind Redemption
Basket and Balancing Amount or an In-Kind/Cash Basket, Creation Units may be
redeemed for a Fund Redemption consisting solely of cash in an amount equal to
the NAV of a Creation Unit, which amount is referred to as the Cash Value. Such redemptions will be subject to a
variable charge, as explained above. BNY
Mellon will publish, on a daily basis, information about the Cash Value of a Creation
Unit. With respect to any Fund
Redemption consisting of a Cash Value, the Cash Value and Transaction Fee may
be referred to collectively as the Cash Component.
There
can be no assurance that there will be sufficient liquidity in Shares in the
secondary market to permit assembly of a Creation Unit. In addition, investors may incur brokerage
and other costs in connection with assembling a Creation Unit.
The right of redemption may
be suspended or the date of payment postponed: (i) for any period during
which the NYSE is closed (other than customary weekend and holiday closings); (ii) for
any period during which trading on the NYSE is suspended or restricted; (iii) for
any period during which an emergency exists as a result of which disposal of
the Shares or determination of the ETFs NAV is not reasonably practicable; or (iv) in
such other circumstances as permitted by the SEC, including as described below.
Placement
of Redemption Orders
Redemptions
must be placed to the Transfer Agent through an Authorized Participant. In addition, redemption orders must be
processed either through the DTC process or the Clearing Process.
Orders
Using the Clearing Process
. Orders to redeem Creation Units of the Grail
McDonnell Intermediate Municipal Bond ETF may use the Clearing Process. Orders to redeem Creation Units through the Clearing
Process are deemed received by the Trust on the Transmittal Date if (i) such
order is received by the Transfer Agent not later than the Order Cut-Off Time
on such Transmittal Date, and (ii) all other procedures set forth in the
Participant Agreement are properly followed.
Orders deemed received will be effectuated based on the NAV of the ETF
as next determined. An order to redeem
Creation Units using the Clearing Process made in proper form but received by
the Trust after the Order Cut-Off Time will be deemed received on the next
Business Day and will be effected at the NAV next determined on such next
Business Day. The applicable In-Kind
Redemption Basket and the Cash Component will be transferred to the investor by
the third NSCC business day following the date on which such request for
redemption is deemed received.
Placement
of Redemption Orders Outside Clearing Process
. All in-kind orders for the Grail McDonnell
Taxable Bond ETF and certain orders for the Grail McDonnell Intermediate Municipal
Bond ETF will be made outside the Clearing Process. Orders to redeem Creation Units must be
delivered through an Authorized Participant with the ability to transact
through the Federal Reserve System. Such
orders are deemed received by the Trust on the Transmittal Date if: (i) such
order is received by the Transfer Agent not later than the Order Cut-Off Time
on the Transmittal Date; (ii) such order is accompanied or followed by the
delivery of both (a) the Creation Unit(s), which delivery must be made
through DTC to the Custodian no later than the DTC Cut-Off Time on the Business
Day immediately following the Transmittal Date and (b) the Cash Component
by 3:00 p.m., Eastern time on the Business Day immediately following the
56
Transmittal
Date; and (iii) all other procedures set forth in the Participant
Agreement are properly followed. After
the Trust has deemed such an order received, the Trust will initiate procedures
to transfer, and expect to deliver, the requisite Fund Redemption to the
redeeming party by the third Business Day following the Transmittal Date on
which such redemption order is deemed received by the Trust.
In
the event that the Authorized Participant has submitted a redemption request in
proper form but is unable to transfer all or part of the Creation Units to be
redeemed to the Transfer Agent, the Distributor will nonetheless accept the
redemption request in reliance on the undertaking by the Authorized Participant
to deliver the missing Shares as soon as possible. Such undertaking shall be secured by the
Authorized Participants delivery and maintenance of collateral consisting of
cash having a value (marked-to-market daily) at least equal to 105% of the
value of the missing Shares, which the Manager may change from time to time.
The
current procedures for collateralization of missing Shares require, among other
things, that any cash collateral shall be in the form of U.S. dollars in
immediately-available funds and shall be held by the Custodian and
marked-to-market daily, and that the fees of the Custodian and any relevant
sub-custodians in respect of the delivery, maintenance and redelivery of the
cash collateral shall be payable by the Authorized Participant. The Authorized Participants agreement will
permit the Trust, on behalf of the relevant ETF, to purchase the missing Shares
at any time and will subject the Authorized Participant to liability for any
shortfall between the cost to the Trust of purchasing such Shares and the value
of the collateral.
The calculation of the value
of the In-Kind Redemption Basket and the Cash Redemption Amount to be
delivered/received upon redemption will be made by the Custodian computed on
the Business Day on which a redemption order is deemed received by the
Trust. Therefore, if a redemption order
in proper form is submitted to the Transfer Agent by a DTC Participant or an
Authorized Participant with the ability to transact through the Federal Reserve
System, as applicable, not later than Closing Time on the Transmittal Date, and
the requisite number of Shares of the ETF are delivered to the Custodian prior
to the DTC Cut-Off-Time, then the value of the In-Kind Redemption Basket and
the Cash Redemption Amount to be delivered/received will be determined by the
Custodian on such Transmittal Date. If,
however, either: (i) the requisite number of Shares of the relevant ETF
are not delivered by the DTC Cut-Off-Time, as described above, or (ii) the
redemption order is not submitted in proper form, then the redemption order
will not be deemed received as of the Transmittal Date. In such case, the value of the In-Kind
Redemption Basket and the Cash Redemption Amount to be delivered/received will
be computed on the Business Day following the Transmittal Date provided that
the ETF Shares of the relevant ETF are delivered through DTC to the Custodian
by 11:00 a.m. the following Business Day pursuant to a properly submitted
redemption order.
If
it is not possible to effect deliveries of the securities in the In-Kind
Redemption Basket, the investor may request and/or the Trust may opt to redeem
Shares wholly or partially in cash.
Redemptions effected partially in cash are treated as In-Kind/Cash
Baskets and redemptions effected entirely in cash are considered to be for the
Cash Value. In connection with such
redemptions, the investor will receive, respectively, securities and a cash
payment or a cash payment equal in value to the NAV of the Shares being redeemed,
based on the relevant ETFs
57
NAV
next determined after the redemption request is received in proper form (minus
a Transaction Fee (including variable charge) as described above.
Redemptions
of Shares for the In-Kind Redemption Basket or In-Kind/Cash Basket will be
subject to compliance with applicable federal and state securities laws and the
ETF (whether or not it otherwise permits cash redemptions) reserves the right
to redeem Creation Units for cash to the extent that the Trust could not
lawfully deliver specific securities in a basket upon redemptions or could not
do so without first registering such securities under relevant laws. In this regard, among other things, an
Authorized Participant or an investor for which it is acting subject to a legal
restriction with respect to a particular security included in the In-Kind
Redemption Basket or In-Kind/Cash Basket applicable to the redemption of a
Creation Unit may be paid an equivalent amount of cash. The Authorized Participant may request the
redeeming beneficial owner of the Shares to complete an order form or to enter
into agreements with respect to such matters as compensating cash payment,
beneficial ownership of shares or delivery instructions.
DETERMINATION OF NET ASSET VALUE
The
net asset value, or NAV, of Shares is calculated each business day as of the
close of regular trading on the NYSE, generally 4:00 p.m. Eastern time,
though U.S. fixed income assets may be valued as of the announced closing time
for trading in fixed income instruments on any day that an early closing time
is announced. An ETFs NAV per Share is
computed by dividing the net assets by the number of Shares outstanding.
TAXATION
The following supplements
the tax information contained in the Prospectus.
For federal income tax
purposes, each ETF is treated as a separate corporate entity and will elect
and intends to continue to qualify as a regulated
investment company under Subchapter M of the Code. Such qualification generally relieves each
ETF of liability for federal income taxes to the extent its earnings are
distributed in accordance with applicable requirements. If, for any reason, an ETF does not qualify
for a taxable year for the special federal tax treatment afforded regulated
investment companies, the ETF would be subject to federal tax on all of its
taxable income at regular corporate rates, without any deduction for dividends
to shareholders. In such event, dividend
distributions would be taxable as ordinary income to shareholders to the extent
of such ETFs current and accumulated earnings and profits and would be
eligible for taxation at reduced rates through 2010 for non-corporate
shareholders and for the dividends received deduction available in some
circumstances to corporate shareholders.
Moreover, if an ETF were to fail to make sufficient distributions in a
year, the ETF would be subject to corporate income taxes and/or excise taxes in
respect of the shortfall or, if the shortfall is large enough, the ETF could be
disqualified as a regulated investment company.
A 4% non-deductible excise tax is imposed on
regulated investment companies that fail to distribute currently an amount
equal to specified percentages of their ordinary taxable income and capital
gain net income (excess of capital gains over capital losses), if any. Each ETF intends to make sufficient
distributions or deemed distributions of its ordinary taxable income
58
and any capital gain net income prior to the end of
each calendar year to avoid liability for this excise tax.
Any market discount
recognized by the ETFs on a bond is taxable as ordinary income. A market discount bond is a bond acquired in
the secondary market at a price below redemption value or adjusted issue price
if issued with original issue discount.
Absent an election by the ETF to include the market discount in income
as it accrues, gain on the ETFs disposition of such an obligation will be
treated as ordinary income rather than capital gain to the extent of the
accrued market discount.
The tax principles applicable to transactions in
financial instruments and futures contacts and options that may be engaged in
by the ETF and investments in passive foreign investment companies (PFICs)
are complex and, in some cases, uncertain.
Such transactions and investments may cause the ETF to recognize taxable
income prior to the receipt of cash, thereby requiring the ETF to liquidate
other positions or to borrow money so as to make sufficient distributions to
shareholders to avoid corporate-level tax.
Moreover, some or all of the taxable income recognized may be ordinary
income or short-term capital gain, so that the distributions may be taxable to
shareholders as ordinary income. In
addition, in the case of any shares of a PFIC in which the ETF invests, the ETF
may be liable for corporate-level tax on any ultimate gain or distributions on
the shares if the ETF fails to make an election to recognize income annually
during the period of its ownership of the PFIC shares.
Special rules govern the federal income tax
treatment of certain transactions denominated in a currency other than the U.S.
dollar or determined by reference to the value of one or more currencies other
than the U.S. dollar. The types of transactions
covered by the special rules include the following: (1) the
acquisition of, or becoming the obligor under, a bond or other debt instrument
(including, to the extent provided in Treasury regulations, preferred stock); (2) the
accruing of certain trade receivables and payables; and (3) the entering
into or acquisition of any forward contract, futures contract, option, or
similar financial instrument if such instrument is not marked to market. The disposition of a currency other than the
U.S. dollar by a taxpayer whose functional currency is the U.S. dollar is also
treated as a transaction subject to the special currency rules. However, foreign currency-related regulated
futures contracts and non-equity options are generally not subject to the special
currency rules if they are or would be treated as sold for their fair
market value at year-end under the marking-to-market rules applicable to
other futures contracts unless an election is made to have such currency rules apply. With respect to transactions covered by the
special rules, foreign currency gain or loss is calculated separately from any
gain or loss on the underlying transaction and is normally taxable as ordinary
income or loss. A taxpayer may elect to
treat as capital gain or loss foreign currency gain or loss arising from
certain identified forward contracts, futures contracts, and options that are
capital assets in the hands of the taxpayer and which are not part of a
straddle. The Treasury Department issued
regulations under which certain transactions subject to the special currency rules that
are part of a Section 988 hedging transaction will be integrated and
treated as a single transaction or otherwise treated consistently for purposes
of the Code. Any gain or loss
attributable to the foreign currency component of a transaction engaged in by
the ETF which is not subject to the special currency rules (such as
foreign equity investments other than certain preferred stocks) will be treated
as capital gain or loss and will not be segregated from the gain or loss on the
underlying transaction.
59
Distributions from an ETFs
net investment income, including any net short-term capital gains, if any, and
distributions of income from securities lending, are taxable as ordinary
income. Distributions reinvested in additional Shares of the ETFs through the
means of a dividend reinvestment service will be taxable dividends to
shareholders acquiring such additional Shares to the same extent as if such
dividends had been received in cash.
Distributions of net long-term capital gains, if any, in excess of net
short-term capital losses are taxable as long-term capital gains, regardless of
how long shareholders have held the Shares.
If at the end of each
quarter of the taxable year of an ETF, 50% or more of the assets, by value, of
the ETF are state, municipal and other bonds that pay interest that is exempt
from federal income tax, the ETF may designate a portion of its dividends as
exempt-interest dividends. The Grail
McDonnell Intermediate Municipal Bond ETF expects to be eligible to make such
designations with respect to a substantial amount of the income it
receives. The portion of the dividends
that are designated as being exempt-interest dividends generally will be exempt
from federal income tax and may be exempt from state and local taxation. Depending on a shareholders state of
residence, exempt-interest dividends paid by the ETF from interest earned on
municipal securities of that state, or its political subdivision, may be exempt
in the hands of such shareholder from income tax in that state and its
localities. However, income from
municipal securities of states other than the shareholders state of residence
generally will not qualify for this treatment.
A shareholder may lose the
ability to treat dividends paid by Grail McDonnell Intermediate Municipal Bond
ETF as exempt-interest dividends while those shares are subject to securities
lending or similar arrangements. In
addition, interest on indebtedness incurred by a shareholder to purchase or
carry shares of the Grail McDonnell Intermediate Bond ETF will not be
deductible for U.S. federal income tax purposes.
If a shareholder receives
exempt-interest dividends with respect to any share of the Grail McDonnell
Intermediate Municipal Bond ETF and if the share is held by the shareholder for
six months or less, then any loss on the sale or exchange of the share may, to
the extent of the exempt-interest dividends, be disallowed. In addition, the IRS may require a
shareholder in the ETF that receives exempt-interest dividends to treat as
taxable income a portion of certain otherwise non-taxable social security and
railroad retirement benefit payments.
Furthermore, a portion of any exempt-interest dividend paid by the ETF
that unexpectedly represents income derived from certain revenue or private
activity bonds held by the ETF may not retain its tax-exempt status in the
hands of a shareholder who is a substantial user of a facility financed by
such bonds, or a related person thereof.
If, for any calendar year,
the total distributions made exceed an ETFs current and accumulated earnings
and profits, the excess will, for federal income tax purposes, be treated as a
tax-free return of capital to each shareholder up to the amount of the
shareholders basis in his or her shares, and thereafter as gain from the sale
of shares. The amount treated as a tax
free return of capital will reduce the shareholders adjusted basis in his or
her shares, thereby increasing his or her potential gain or reducing his or her
potential loss on the subsequent sale of his or her shares.
Dividends declared in
October, November or December of any year payable to shareholders of
record on a specified date in such months will be deemed to have been received
by shareholders and paid by the ETF on December 31 of such year if such
dividends are actually paid during January of the following year.
60
The sale, exchange or
redemption of 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 Shares will be
treated as short-term capital gain or loss. A loss realized on a sale or
exchange of Shares of an ETF may be disallowed if other substantially identical
Shares are acquired (whether through the automatic reinvestment of dividends or
otherwise) within a sixty-one (61) day period beginning thirty (30) days before
and ending thirty (30) days after the date that the Shares are disposed of. In
such a case, the basis of the Shares acquired must be adjusted to reflect the
disallowed loss. Any loss upon the sale or exchange of Shares held for six (6) months
or less is treated as long-term capital loss to the extent of any capital gain
dividends received by the shareholders. Distribution of ordinary income and capital
gains may also be subject to state and local taxes.
Long-term capital gains of
non-corporate taxpayers generally are taxed at a maximum rate of 15% for
taxable years beginning before January 1, 2011. Without future
congressional action, the maximum rate of long-term capital gains will return
to 20% for taxable years beginning on or after January 1, 2011. Each ETF
will report to shareholders annually the amounts of dividends received from
ordinary income, tax-exempt income, the amount of distributions received from
capital gains and the portion of dividends, if any, which may qualify for the
dividends received deduction.
Dividends and interest received by an ETF may give
rise to withholding and other taxes imposed by foreign countries. Tax conventions between certain countries and
the United States may reduce or eliminate such taxes.
The ETF will be required in certain cases to impose backup
withholding on taxable dividends or gross proceeds realized upon sale paid to
shareholders who have failed to provide a correct tax identification number in
the manner required, who are subject to withholding by the Internal Revenue
Service for failure properly to include on their return payments of taxable
interest or dividends, or who have failed to certify to the ETF when required
to do so either that they are not subject to backup withholding or that they
are exempt recipients. Backup
withholding is not an additional tax and any amounts withheld may be credited
against a shareholders ultimate federal income tax liability if proper
documentation is provided.
As a result of tax requirements, the Trust on behalf
of each ETF has the right to reject an order to purchase Shares if the
purchaser (or group of purchasers) would, upon obtaining the Shares so ordered,
own 80% or more of the outstanding Shares of the ETF and if, pursuant to
section 351 of the Code, the ETF would have a basis in the transferred
securities different from the market value of such securities on the date of
deposit. The Trust also has the right to
require information necessary to determine beneficial Share ownership for
purposes of the 80% determination.
Except as described below,
dividends paid by an ETF to non-U.S. Shareholders are generally subject to
withholding tax at a 30% rate or a reduced rate specified by an applicable
income tax treaty to the extent derived from investment income and short-term
capital gains. In order to obtain a
reduced rate of withholding, a non-U.S. Shareholder will be required to provide
an IRS Form W-8BEN certifying its entitlement to benefits under a
treaty. The withholding tax does not
apply to regular dividends paid to a non-U.S. Shareholder who provides a Form W-8ECI,
certifying that the dividends are effectively connected with the non-U.S.
Shareholders conduct
61
of a trade or business
within the United States. Instead, the
effectively connected dividends will be subject to regular U.S. income tax as
if the non-U.S. Shareholder were a U.S. Shareholder. A non-U.S. corporation receiving effectively
connected dividends may also be subject to additional branch profits tax
imposed at a rate of 30% (or lower treaty rate). A non-U.S. Shareholder who fails to provide
an IRS Form W-8BEN or other applicable form may be subject to backup
withholding at the appropriate rate.
In general, United States
federal withholding tax will not apply to any gain or income realized by a
non-U.S. Shareholder in respect of any distributions of net long-term capital
gains over net short-term capital losses, or, through December 31, 2009
(or possibly later if legislation is enacted extending these provisions),
interest-related dividends and short-term capital gain dividends, or upon the
sale or other disposition of shares of an ETF.
Properly designated exempt-interest dividends paid by the Grail
McDonnell Intermediate Municipal Bond ETF to non-U.S. Shareholders will also
generally not be subject to United States federal withholding tax.
The foregoing discussion is
based on federal tax laws and regulations which are in effect on the date of
this SAI; such laws and regulations may be changed by legislative or
administrative action. Shareholders are
advised to consult their tax advisers concerning their specific situations and
the application of state, local and foreign taxes.
62
Appendix A
Proxy Voting
Policies and Procedures for the Trust
GRAIL
ADVISORS ETF TRUST
Proxy
Voting Policies and Procedures
Grail
Advisors ETF Trust (the Trust) has adopted these Proxy Voting Policies and
Procedures (the Trust Policy), as set forth below, in recognition of the fact
that proxy voting is an important component of investment management and must
be performed in a dutiful and purposeful fashion in order to advance the best
interests of shareholders of the series of the Trust (Funds).
The
Funds are managed by Grail Advisors, LLC (Manager). The Manager may retain a proxy voting service
(Proxy Voting Service) to provide assistance regarding the objective review
and voting of proxies on any assets held by the Funds that invest primarily in
the securities of domestic issuers consistent with these Policies.
Shareholders
of the Funds expect the Trust to vote proxies received from issuers whose
voting securities are held by a Fund.
The Trust exercises its voting responsibilities as a fiduciary, with the
goal of maximizing the value of the Trusts and its shareholders
investments. For all of the Funds, the
Manager seeks to ensure that proxies are voted in the best interests of the
Trust, Fund and Fund shareholders.
I. Delegation of Proxy Voting to Subadvisers
Each
of the Funds whose portfolio is managed by a sub-adviser (Sub-Adviser) shall
vote all proxies relating to securities held by the Fund and, in that
connection subject to any further policies and procedures contained herein, shall
use proxy voting policies and procedures adopted by the Sub-Adviser in
conformance with Rule 206(4)-6 under the Investment Advisers Act of 1940,
as amended (Advisers Act). For
securities in the portfolio of a Fund that is managed by more than one Sub-Adviser,
each Sub-Adviser shall make voting decisions pursuant to their own proxy voting
policies and procedures, as adopted in conformance with the Advisers Act for
their respective portions of the Funds portfolio,
except
that,
to the extent such a Fund has a primary Sub-Adviser (Primary Sub-Adviser, and
with respect to each Fund a subset of the Funds Sub-Advisers), the securities
of the Fund may be voted pursuant to the policies and procedures adopted by the
Primary Sub-Adviser in conformance with the Advisers Act or, with respect to
the various Sub-Advisers portions of the Funds portfolio, pursuant to each
Sub-Advisers proxy voting policies and procedures, as adopted in conformance
with the Advisers Act.
Except
as noted below, the Trust Policy with respect to a Fund shall be the same as
that adopted by the Primary Sub-Adviser or Sub-Adviser, as applicable, with
respect to voting proxies held by its clients (the Sub-Adviser Policy). Each Sub-Adviser Policy, as it may be amended
from time to time, is hereby incorporated by reference into the Trust Policy.
A-1
II.
Material
Conflicts of Interest
If
(i) a Sub-Adviser knows that a vote presents a material conflict between
the interests of: (a) shareholders of the Fund and (b) the Funds
investment advisers (including Sub-Advisers), principal underwriter, or any of
their affiliated persons, and (ii) the Sub-Adviser does not propose to
vote on the particular issue in the manner prescribed by its Sub-Adviser
Policy, then the Sub-Adviser will follow the material conflict of interest
procedures set forth in its Sub-Adviser Policy when voting such proxies.
If
a Sub-Adviser Policy provides that in the case of a material conflict of
interest between Fund shareholders and another party, the Sub-Adviser will ask
the Board of Trustees of the Trust (Board) to provide voting instructions,
the Sub-Adviser, in its discretion, shall vote the proxies as recommended by an
independent third party or according to its own proxy voting policy, or the
Sub-Adviser shall abstain from voting the proxies altogether.
III.
Securities
Lending Program
Certain
of the Funds may participate in a securities lending program through a lending
agent. When a Funds securities are out
on loan, they are transferred into the borrowers name and are voted by the
borrower, in its discretion. Where a
Sub-Adviser determines, however, that a proxy vote may be material to the Fund
or Trust, the Sub-Adviser should request that the Trust recall the security for
the purposes of the Sub-Adviser voting the security.
IV.
Disclosure
of Proxy Voting Policies and Procedures in the Trusts Statement of Additional
Information (SAI)
The
Trust shall include in its SAI a summary of the Trust Policy and of each
Sub-Adviser Policy. In lieu of including
a summary of policy, the Trust may include the policies in full.
V.
Disclosure
of Proxy Voting Policies and Procedures in
Annual and
Semi-Annual Shareholder Reports
The
Trust shall disclose in its annual and semi-annual shareholder reports that a
description of the Trust Policy and the Trusts proxy voting record for the
most recent 12 months ended June 30 are available on the Securities and
Exchange Commissions (SEC) website, and without charge, upon request, by
calling a specified toll-free telephone number.
The Trust will send the foregoing documents within three business days
of receipt of a request, by first-class mail or other means designed to ensure
equally prompt delivery.
VI.
Filing
of Proxy Voting Record on Form N-PX
The
Trust will annually file its complete proxy voting record with the SEC on Form N-PX. The Form N-PX shall be filed for the
twelve months ended June 30 no later than August 31 of that year.
A-2
VII. Manager, Sub-Adviser and Trust CCO
Responsibilities
The
Trust has delegated proxy voting authority with respect to Fund portfolio
securities to the Funds Sub-Adviser(s), as set forth above. Consistent with this delegation, each Sub-Adviser
is responsible for the following:
1)
Implementing written
policies and procedures, in compliance with Rule 206(4)-6 under the
Advisers Act, reasonably designed to ensure that the Sub-Adviser votes
portfolio securities in the best interest of shareholders of the Fund owning
the portfolio securities voted.
2)
Providing the Manager,
through a Primary Sub-Adviser, as applicable, with a quarterly certification
indicating that the Sub-Adviser did vote proxies of the Fund in a manner
consistent with the Sub-Adviser Policy.
If the Sub-Adviser voted any proxies in a manner inconsistent with the
Sub-Adviser Policy, the Sub-Adviser will promptly provide the Manager with a
report detailing the exceptions prior to the end of the quarter in which the
exceptions occurred.
3)
Providing the Manager,
through a Primary Sub-Adviser, as applicable, with a copy and description of
the Sub-Adviser Policy prior to being approved by the Board as a Sub-Adviser
for the Fund, accompanied by a certification that represents that the
Sub-Adviser Policy has been adopted in conformity with Rule 206(4)-6 under
the Advisers Act. Thereafter, providing
the Manager with notice of any amendment or revision to the Sub-Adviser Policy
or with a description thereof.
4)
The Manager is required to
report all material changes to a Sub-Adviser Policy quarterly to the Board.
5)
The annual written
compliance report of the Trusts Chief Compliance Officer (CCO) to the Board
will contain a summary of the material changes to each Sub-Adviser Policy
during the period covered by the report.
VIII.
Review
Responsibilities
The
Trust may retain a proxy voting service (Proxy Voting Service) to coordinate,
collect, and maintain all proxy-related information, and to prepare and file
the Trusts reports on Form N-PX with the SEC.
The
Manager or, where applicable, a Primary Sub-Adviser will review the Funds
voting records maintained by the Proxy Voting Service in accordance with the
following procedures:
1)
Receive a file with the
proxy voting information directly from the Sub-Adviser, as applicable, on a
quarterly basis.
2)
Select a sample of proxy
votes from the files submitted and examine them against the Proxy Voting
Service files for accuracy of the votes.
A-3
To
the extent that a Primary Sub-Adviser takes responsibility for reviewing a Funds
voting records pursuant to this paragraph, the Primary Sub-Adviser will report
the results of its review to the Manager.
The Trust will deliver instructions to shareholders on how to access
proxy voting information in the Trusts semi-annual and annual shareholder
reports.
IX. Proxy Voting Service Responsibilities
Aggregation of Votes:
The Proxy Voting Services
proxy disclosure system will collect Fund-specific voting records, including
votes cast by multiple Sub-Advisers or third party voting services.
Reporting:
The Proxy Voting Services
proxy disclosure system will provide the following reporting features:
1)
multiple report
export options;
2)
report
customization by Fund, account, portfolio manager, security, etc.; and
3)
account details
available for vote auditing.
X. Form N-PX Preparation and Filing
Fund
Administrator will be responsible for oversight and completion of the filing of
the Trusts reports on Form N-PX with the SEC. The Proxy Voting Service will prepare the
EDGAR version of Form N-PX and will submit it to Fund Administrator for
review and approval prior to filing with the SEC; the Fund Administrator in
turn will submit it to the Trust for review and approval prior to filing with
the SEC. Upon the approval of the Trust
and Fund Administrator, the Proxy Voting Service will file Form N-PX for
each twelve-month period ended June 30.
The filing for each year will be made with the SEC on or before August 31
of that year.
XI. Recordkeeping
Records
of all votes will be maintained by Proxy Voting Service. Documentation of all votes for the Trust will
be maintained by the Manager and/or the Proxy Voting Service. Such
documentation will include the recommendations of the Sub-Advisers along with
pertinent supporting comments and letters, the Trust Policy, any additional
information gathered by the Manager, minutes from any meeting at which the
Board considered a proxy voting matter, the conclusion of the Board and the
Trusts final vote.
Adopted:
March 18, 2009
A-4
Appendix B
Proxy Voting
Policies and Procedures for McDonnell
Summary of Proxy Voting Policy
McDonnell Investment Management, as a matter of
policy and as a fiduciary to its clients, recognizes that it is responsible for
voting proxies for all client securities for which it has been granted
authority in a manner that is consistent with the clients best economic
interests and without regard to any benefit to the Adviser.
McDonnell (or
Adviser) is primarily a fixed income manager and, accordingly, does not as a
practical matter exercise discretion over proxy voting for fixed income
securities as proxy solicitations do not occur. For those accounts that we
manage that include securities for which proxy voting is applicable, the
Adviser seeks to delegate the responsibility for proxy voting to the client
and, with respect to accounts subject to ERISA, to ensure that the
responsibility for proxy voting has been delegated by the client to another
qualified plan fiduciary. However, while
the Adviser does not typically vote proxies for its clients, it has adopted
this proxy voting policy in advance of possibly finding itself in such a
position in the future.
Examples of ways that McDonnell could become
responsible for voting securities include: receiving equity securities as part
of a workout of an issuer whose bonds are owned by a client; inheriting
legacy
securities from a client; purposely buying the equity
securities of a distressed bond issuer in order to salvage value for clients
who hold the bonds.
As mentioned previously, McDonnell declines to take
responsibility for voting client proxies except where it is specifically
authorized and agrees to do so in its advisory contracts or comparable
documents with clients. For clients for whom the Adviser does not vote
proxies, the relevant custodian banks or brokers are instructed to mail proxy
material directly to clients.
McDonnell has adopted proxy voting guidelines that
are designed to provide guidance with respect to certain types of voting
proposals that may arise. The guidelines
have been developed in part on the belief that the quality of management is
critical to the investment success of any portfolio company. Hence, the Adviser tends to vote most routine
matters in accordance with management recommendations, provided there is no
conflict with shareholder value. At the
same time, when the Adviser believes that the position of the management of a
portfolio company is not in the best interests of shareholders, it will vote
against managements recommendation.
In instances where a potential conflict of interest
exists, McDonnell will provide the client with sufficient information regarding
the shareholder vote and the Advisers potential conflict so that the client
can make an informed decision regarding whether or not to consent.
B-1
Appendix C
Description
Of Securities Ratings
A.
Long-Term Ratings
1.
Moodys Investors Service Long-Term Corporate Obligation Ratings
Moodys
long-term obligation ratings are opinions of the relative credit risk of
fixed-income obligations with an original maturity of one year or more. They
address the possibility that a financial obligation will not be honored as
promised. Such ratings use Moodys Global Scale and reflect both the likelihood
of default and any financial loss suffered in the event of default.
Aaa
Obligations
rated Aaa are judged to be of the highest quality, with minimal credit risk.
Aa
Obligations
rated Aa are judged to be of high quality and are subject to very low credit
risk.
A
Obligations
rated A are considered upper-medium grade and are subject to low credit risk.
Baa
Obligations
rated Baa are subject to moderate credit risk. They are considered medium grade
and as such may possess certain speculative characteristics.
Ba
Obligations
rated Ba are judged to have speculative elements and are subject to substantial
credit risk.
B
Obligations
rated B are considered speculative and are subject to high credit risk.
Caa
Obligations
rated Caa are judged to be of poor standing and are subject to very high credit
risk.
Ca
Obligations rated
Ca are highly speculative and are likely in, or very near, default, with some
prospect of recovery of principal and interest.
C
Obligations
rated C are the lowest rated class of bonds and are typically in default, with
little prospect for recovery of principal or interest.
Note
Moodys appends
numerical modifiers 1, 2, and 3 to each generic rating classification from Aa
through Caa. The modifier 1 indicates that the obligation ranks in the higher
end of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates a ranking in the lower end of that
generic rating category.
C-1
2.
Standard and Poors Long-Term Issue Credit Ratings (including Preferred
Stock)
Issue
credit ratings are based, in varying degrees, on the following considerations:
·
Likelihood of paymentcapacity 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.
Issue
ratings are an assessment of default risk, but may incorporate an assessment of
relative seniority or ultimate recovery in the event of default. Junior
obligations are typically rated lower than senior obligations, to reflect the
lower priority in bankruptcy, as noted above. (Such differentiation may apply
when an entity has both senior and subordinated obligations, secured and
unsecured obligations, or operating company and holding company obligations.)
AAA
An obligation rated AAA
has the highest rating assigned by Standard & Poors. The obligors
capacity to meet its financial commitment on the obligation is extremely
strong.
AA
An obligation
rated AA differs from the highest-rated obligations only to a small degree.
The obligors 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 obligors 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.
Note
Obligations
rated BB, B, CCC, CC, and C are regarded as having significant
speculative characteristics. BB indicates the least degree of speculation and
C the highest. While such obligations will likely have some quality and
protective characteristics, these may be outweighed by large uncertainties or
major 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 obligors 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.
C-2
Adverse business, financial, or economic conditions will likely impair
the obligors capacity or willingness to meet its financial commitment on the
obligation.
CCC
An obligation rated CCC is
currently vulnerable to nonpayment, and is dependent upon favorable business,
financial, and economic conditions for the obligor to meet its financial
commitment on the obligation. In the event of adverse business, financial, or
economic conditions, the obligor is not likely to have the capacity to meet its
financial commitment on the obligation.
CC
An obligation
rated CC is currently highly vulnerable to nonpayment.
C
A C rating is
assigned to obligations that are currently highly vulnerable to nonpayment,
obligations that have payment arrearages allowed by the terms of the documents,
or obligations of an issuer that is the subject of a bankruptcy petition or
similar action which have not experienced a payment default. Among others, the
C rating may be assigned to subordinated debt, preferred stock or other
obligations on which cash payments have been suspended in accordance with the
instruments terms.
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 & Poors 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.
Note
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.
NR
This indicates
that no rating has been requested, that there is insufficient information on
which to base a rating, or that Standard & Poors does not rate a
particular obligation as a matter of policy.
3.
Fitch International Long-Term Credit Ratings
International
Long-Term Credit Ratings (LTCR) may also be referred to as Long-Term Ratings.
When assigned to most issuers, it is used as a benchmark measure of probability
of default and is formally described as an Issuer Default Rating (IDR). The
major exception is within Public Finance, where IDRs will not be assigned as
market convention has always focused on timeliness and does not draw analytical
distinctions between issuers and their underlying obligations. When applied to
issues or securities, the LTCR may be higher or lower than the issuer rating
(IDR) to reflect relative differences in recovery expectations.
The
following rating scale applies to foreign currency and local currency ratings:
C-3
Investment Grade
AAA
Highest credit quality.
AAA ratings denote the lowest expectation of credit risk. They are assigned
only in case of exceptionally strong capacity for payment of financial
commitments. This capacity is highly unlikely to be adversely affected by
foreseeable events.
AA
Very high
credit quality. AA ratings denote expectations of very low credit risk. They
indicate very strong capacity for payment of financial commitments. This
capacity is not significantly vulnerable to foreseeable events.
A
High credit
quality. A ratings denote expectations of low credit risk. The capacity for
payment of financial commitments is considered strong. This capacity may,
nevertheless, be more vulnerable to changes in circumstances or in economic
conditions than is the case for higher ratings.
BBB
Good credit quality. BBB
ratings indicate that there are currently expectations of low credit risk. The
capacity for payment of financial commitments is considered adequate but
adverse changes in circumstances and economic conditions are more likely to
impair this capacity. This is the lowest investment grade category.
Speculative Grade
BB
Speculative.
BB ratings indicate that there is a possibility of credit risk developing,
particularly as the result of adverse economic change over time; however,
business or financial alternatives may be available to allow financial
commitments to be met. Securities rated in this category are not investment
grade.
B
Highly
speculative. B ratings indicate that
significant credit risk is present, but a limited margin of safety remains.
Financial commitments are currently being met; however, capacity for continued
payment is contingent upon a sustained, favorable business and economic
environment.
CCC
Default is a real
possibility. Capacity for meeting financial commitments is solely reliant upon
sustained, favorable business or economic conditions.
CC
Default of some
kind appears probable.
C
Default is
imminent.
RD
Indicates an
entity that has failed to make due payments (within the applicable grace
period) on some but not all material financial obligations, but continues to
honor other classes of obligations.
D
Indicates an
entity or sovereign that has defaulted on all of its financial obligations.
Default generally is defined as one of the following:
C-4
·
Failure of an
obligor to make timely payment of principal and/or interest under the
contractual terms of any financial obligation;
·
The bankruptcy
filings, administration, receivership, liquidation or other winding-up or
cessation of business of an obligor;
·
The distressed
or other coercive exchange of an obligation, where creditors were offered
securities with diminished structural or economic terms compared with the
existing obligation.
Default
ratings are not assigned prospectively; within this context, non-payment on an
instrument that contains a deferral feature or grace period will not be
considered a default until after the expiration of the deferral or grace
period.
Issuers
will be rated D upon a default. Defaulted and distressed obligations
typically are rated along the continuum of C to B ratings categories,
depending upon their recovery prospects and other relevant characteristics.
Additionally, in structured finance transactions, where analysis indicates that
an instrument is irrevocably impaired such that it is not expected to meet pay
interest and/or principal in full in accordance with the terms of the
obligations documentation during the life of the transaction, but where no
payment default in accordance with the terms of the documentation is imminent,
the obligation may be rated in the B or CCC-C categories.
Default
is determined by reference to the terms of the obligations documentation.
Fitch will assign default ratings where it has reasonably determined that
payment has not been made on a material obligation in accordance with the
requirements of the obligations documentation, or where it believes that
default ratings consistent with Fitchs published definition of default are the
most appropriate ratings to assign.
Note
The modifiers
+ or - may be appended to a rating to denote relative status within major
rating categories. Such suffixes are not added to the AAA Long-term rating
category, to categories below CCC, or to Short-term ratings other than F1.
(The +/- modifiers are only used to denote issues within the CCC category,
whereas issuers are only rated CCC without the use of modifiers.)
B.
Preferred Stock Ratings
1.
Moodys Investors Service
aaa
An issue which
is rated aaa is considered to be a top-quality preferred stock. This rating
indicates good asset protection and the least risk of dividend impairment
within the universe of preferred stocks.
aa
An issue which
is rated aa is considered a high-grade preferred stock. This rating indicates
that there is a reasonable assurance the earnings and asset protection will
remain relatively well-maintained in the foreseeable future.
C-5
a
An issue which
is rated a is considered to be an upper-medium grade preferred stock. While
risks are judged to be somewhat greater than in the aaa and aa
classification, earnings and asset protection are, nevertheless, expected to be
maintained at adequate levels.
baa
An issue which
is rated baa is considered to be a medium-grade preferred stock, neither
highly protected nor poorly secured. Earnings and asset protection appear
adequate at present but may be questionable over any great length of time.
ba
An issue which
is rated ba is considered to have speculative elements and its future cannot
be considered well assured. Earnings and asset protection may be very moderate
and not well safeguarded during adverse periods. Uncertainty of position
characterizes preferred stocks in this class.
b
An issue which
is rated b generally lacks the characteristics of a desirable investment.
Assurance of dividend payments and maintenance of other terms of the issue over
any long period of time may be small.
caa
An issue which
is rated caa is likely to be in arrears on dividend payments. This rating
designation does not purport to indicate the future status of payments.
ca
An issue which
is rated ca is speculative in a high degree and is likely to be in arrears on
dividends with little likelihood of eventual payments.
c
This is the
lowest rated class of preferred or preference stock. Issues so rated can be
regarded as having extremely poor prospects of ever attaining any real
investment standing.
Note
Moodys applies
numerical modifiers 1, 2, and 3 in each rating classification; 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.
C.
Short Term Ratings
1.
Moodys Investors Service
Moodys short-term ratings are opinions of the ability of issuers to
honor short-term financial obligations. Ratings may be assigned to issuers,
short-term programs or to individual short-term debt instruments. Such
obligations generally have an original maturity not exceeding thirteen months,
unless explicitly noted.
C-6
Moodys employs the following designations to indicate the relative
repayment ability of rated issuers:
P-1
Issuers (or
supporting institutions) rated Prime-1 have a superior ability to repay
short-term debt obligations.
P-2
Issuers (or
supporting institutions) rated Prime-2 have a strong ability to repay
short-term debt obligations.
P-3
Issuers (or
supporting institutions) rated Prime-3 have an acceptable ability to repay
short-term obligations.
NP
Issuers (or
supporting institutions) rated Not Prime do not fall within any of the Prime
rating categories.
Note
Canadian
issuers rated P-1 or P-2 have their short-term ratings
enhanced by the senior-most long-term rating of the issuer, its guarantor or
support-provider.
2.
Standard and Poors
A-1
A short-term
obligation rated A-1 is rated in the highest category by Standard &
Poors. The obligors 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 obligors 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 obligors 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. Ratings of B-1, B-2, and B-3 may be
assigned to indicate finer distinctions within the B category. 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 obligors
inadequate capacity to meet its financial commitment on the obligation.
B-1
A short-term
obligation rated B-1 is regarded as having significant speculative
characteristics, but the obligor has a relatively stronger capacity to meet its
financial commitments over the short-term compared to other speculative-grade
obligors.
C-7
B-2
A short-term
obligation rated B-2 is regarded as having significant speculative
characteristics, and the obligor has an average speculative-grade capacity to
meet its financial commitments over the short-term compared to other
speculative-grade obligors.
B-3
A short-term
obligation rated B-3 is regarded as having significant speculative
characteristics, and the obligor has a relatively weaker capacity to meet its
financial commitments over the short-term compared to other speculative-grade
obligors.
C
A short-term
obligation rated C is currently vulnerable to nonpayment and is dependent
upon favorable business, financial, and economic conditions for the obligor to
meet its financial commitment on the obligation.
D
A short-term
obligation rated D is in payment default. The D rating category is used
when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poors
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.
Note
Dual
Ratings. Standard & Poors
assigns dual ratings to all debt issues that have a put option or demand
feature as part of their structure. The first rating addresses the likelihood
of repayment of principal and interest as due, and the second rating addresses
only the demand feature. The long-term rating symbols are used for bonds to
denote the long-term maturity and the short-term rating symbols for the put
option (for example, AAA/A-1+). With U.S. municipal short-term demand debt,
note rating symbols are used with the short-term issue credit rating symbols
(for example, SP-1+/A-1+).
3.
Fitch
The following ratings scale applies to foreign currency and local
currency ratings. A Short-term rating has a time horizon of less than 13 months
for most obligations, or up to three years for US public finance, in line with
industry standards, to reflect unique risk characteristics of bond, tax, and
revenue anticipation notes that are commonly issued with terms up to three
years. Short-term ratings thus place greater emphasis on the liquidity necessary
to meet financial commitments in a timely manner.
F1
Highest credit
quality. Indicates the strongest capacity for timely payment of financial
commitments; may have an added + to denote any exceptionally strong credit
feature.
F2
Good credit
quality. A satisfactory capacity for timely payment of financial commitments,
but the margin of safety is not as great as in the case of the higher ratings.
F3
Fair credit
quality. The capacity for timely payment of financial commitments is adequate;
however, near term adverse changes could result in a reduction to non
investment grade.
B
Speculative.
Minimal capacity for timely payment of financial commitments, plus
C-8
vulnerability
to near term adverse changes in financial and economic conditions.
C
High default
risk. Default is a real possibility. Capacity for meeting financial commitments
is solely reliant upon a sustained, favorable business and economic
environment.
D
Indicates an
entity or sovereign that has defaulted on all of its financial obligations.
Note
The modifiers
+ or - may be appended to a rating to denote relative status within major
rating categories. Such suffixes are not added to the AAA Long-term rating
category, to categories below CCC, or to Short-term ratings other than F1.
(The +/- modifiers are only used to denote issues within the CCC category,
whereas issuers are only rated CCC without the use of modifiers.)
C-9
PART C
OTHER
INFORMATION
Item 28. Exhibits
(a)
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(1) Certificate of Trust dated
December 7, 2007 is incorporated by reference from Registrants initial
registration statement filed on December 14, 2007
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(2) Certificate of Amendment to
Certificate of Trust dated March 25, 2008 is incorporated by reference
from Pre-Effective Amendment No. 2 to Registrants registration
statement filed on April 8, 2009
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(3) Certificate of Amendment to
Certificate of Trust dated January 12, 2009 is incorporated by reference
from Pre-Effective Amendment No. 2 to Registrants registration
statement filed on April 8, 2009
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(4) Trust Instrument is incorporated by
reference from Pre-Effective Amendment No. 2 to Registrants
registration statement filed on April 8, 2009
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(b)
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By-laws of Registrant
is incorporated by reference from Pre-Effective Amendment No. 2 to
Registrants registration statement filed on April 8, 2009
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(c)
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Not applicable
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(d)
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(1) Form of Investment Management
Agreement between Registrant and Grail Advisors, LLC with respect to the
Large Cap Value ETF and International Equity ETF is incorporated by reference
from Pre-Effective Amendment No. 3 to Registrants registration
statement filed on April 29, 2009
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(2) Form of Primary Investment
Sub-Advisory Agreement between Grail Advisors, LLC and American Beacon
Advisors, Inc. with respect to the Large Cap Value ETF and International
Equity ETF is incorporated by reference from Pre-Effective Amendment
No. 3 to Registrants registration statement filed on April 29,
2009
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(3) Form of Investment
Sub-Advisory Agreement by and among Grail Advisors, LLC, American Beacon
Advisors, Inc. and Brandywine Global Investment Management, LLC with
respect to the Large Cap Value ETF is incorporated by reference from
Pre-Effective Amendment No. 3 to Registrants registration statement
filed on April 29, 2009
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(4) Form of Investment
Sub-Advisory Agreement by and among Grail Advisors, LLC, American Beacon
Advisors, Inc. and Hotchkis and Wiley Capital Management, LLC with
respect to the Large Cap Value ETF is incorporated by reference from
Pre-Effective Amendment No. 3 to Registrants registration statement
filed on April 29, 2009
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(5) Form of Investment
Sub-Advisory Agreement by and among Grail Advisors, LLC, American Beacon
Advisors, Inc. and Metropolitan West Capital Management, LLC with
respect to the Large Cap Value ETF is incorporated by reference from
Pre-Effective Amendment No. 3 to Registrants registration statement
filed on April 29, 2009
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(6) Form of Investment Sub-Advisory
Agreement by and among Grail Advisors, LLC, American Beacon
Advisors, Inc. and Lazard Asset Management LLC with respect to the
International Equity ETF is incorporated by reference from Pre-Effective
Amendment No. 3 to Registrants registration statement filed on
April 29, 2009
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(7) Form of Investment
Sub-Advisory Agreement by and among Grail Advisors, LLC, American Beacon
Advisors, Inc. and Templeton Investment Counsel, LLC with respect to the
International Equity ETF is incorporated by reference from Pre-Effective
Amendment No. 3 to Registrants registration statement filed on
April 29, 2009
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(8) Form of Investment
Sub-Advisory Agreement by and among Grail Advisors, LLC, American Beacon
Advisors, Inc. and The Boston Company Asset Management with respect to
the International Equity ETF is incorporated by reference from Pre-Effective
Amendment No. 3 to Registrants registration statement filed on
April 29, 2009
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(9) Form of Investment Management
Agreement between Registrant and Grail Advisors, LLC with respect to the RP
Growth ETF, RP Focused Large Cap Growth ETF, RP Technology ETF and RP
Financials ETF is incorporated by reference from Post-Effective Amendment
No. 2 to Registrants registration statement filed on August 28,
2009
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(10) Form of Primary Investment
Sub-Advisory Agreement between Grail Advisors, LLC and RiverPark Advisors,
LLC with respect to the RP Focused Large Cap Growth ETF is incorporated by
reference from Post-Effective Amendment No. 2 to Registrants
registration statement filed on August 28, 2009
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(11) Form of Investment Sub-Advisory
Agreement between Grail Advisors, LLC and RiverPark Advisors, LLC with
respect to the RP Growth ETF, RP Technology ETF and RP Financials ETF is
incorporated by reference from Post-Effective Amendment No. 2 to
Registrants registration statement filed on August 28, 2009
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(12) Form of Investment Sub-Advisory
Agreement by and among Grail Advisors, LLC, RiverPark Advisors, LLC and
Wedgewood Partners, Inc. with respect to the RP Focused Large Cap Growth
ETF is incorporated by reference from Post-Effective Amendment No. 2 to
Registrants registration statement filed on August 28, 2009
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(13) Form of Investment Management
Agreement between Registrant and Grail Advisors, LLC with respect to the
Grail McDonnell Intermediate Municipal Bond ETF and Grail McDonnell Core
Taxable Bond ETF*
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(14) Form of Investment Sub-Advisory
Agreement between Grail Advisors, LLC and McDonnell Investment Management,
LLC with respect to the Grail McDonnell Intermediate Municipal Bond ETF and
Grail McDonnell Core Taxable Bond ETF*
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(e)
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(1) Form of Distribution Agreement
between Registrant and ALPS Distributors, Inc. is incorporated by
reference from Pre-Effective Amendment No. 2 to Registrants
registration statement filed on April 8, 2009
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(2) Form of Amendment No. 1
to Distribution Agreement between Registrant and ALPS Distributors, Inc.
is incorporated by reference from Post-Effective Amendment No. 3 to
Registrants registration statement filed on October 5, 2009.
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(3) Form of Amendment No. 2
to Distribution Agreement between Registrant and ALPS Distributors, Inc.
*
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(f)
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Not applicable
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(g)
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(1) Form of Custody Agreement
between Registrant and The Bank of New York Mellon Corporation is
incorporated by reference from Pre-Effective Amendment No. 2 to
Registrants registration statement filed on April 8, 2009
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(2) Form of Amended and Restated
Schedule II to the Custody Agreement adding RP Growth ETF, RP Focused Large
Cap Growth ETF, RP Technology ETF and RP Financials ETF is incorporated by
reference from Post-Effective Amendment No. 4 to Registrants
registration statement filed on October 7, 2009.
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(3) Form of Amended and Restated
Schedule II to the Custody Agreement adding Grail McDonnell Intermediate
Municipal Bond ETF and Grail McDonnell Core Taxable Bond ETF*
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(h)
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(1) Form of Fund Administration
and Accounting Agreement between Registrant and The Bank of New York Mellon
Corporation is incorporated by reference from Pre-Effective Amendment
No. 2 to Registrants registration statement filed on April 8, 2009
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(2) Form of Transfer Agency and
Service Agreement between Registrant and The Bank of New York Mellon
Corporation is incorporated by reference from Pre-Effective Amendment
No. 2 to Registrants registration statement filed on April 8, 2009
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(3) Fee Schedule for Custody,
Accounting, Administration and Transfer Agency Agreements is incorporated by
reference from Pre-Effective Amendment No. 2 to Registrants
registration statement filed on April 8, 2009
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(4) Form of Participant Agreement
is incorporated by reference from Pre-Effective Amendment No. 2 to
Registrants registration statement filed on April 8, 2009
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(5) Expense Limit Agreement for Large
Cap Growth ETF and International Equity ETF is incorporated by reference from
Pre-Effective Amendment No. 2 to Registrants registration statement
filed on April 8, 2009
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2
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(6) Expense Limit Agreement for RP
Growth ETF, RP Focused Large Cap Growth ETF, RP Technology ETF and RP
Financials ETF is incorporated by reference from Post-Effective Amendment
No. 2 to Registrants registration statement filed on August 28,
2009
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(7) Form of Amendment to Fund
Administration and Accounting Agreement adding RP Growth ETF, RP Focused Large
Cap Growth ETF, RP Technology ETF and RP Financials ETF is incorporated by
reference from Post-Effective Amendment No. 4 to Registrants
registration statement filed on October 7, 2009.
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(8) Form of Amended and Restated
Appendix 1 to the Transfer Agency and Service Agreement adding RP Growth ETF,
RP Focused Large Cap Growth ETF, RP Technology ETF and RP Financials ETF is
incorporated by reference from Post-Effective Amendment No. 4 to
Registrants registration statement filed on October 7, 2009.
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(9) Expense Limit Agreement for Grail
McDonnell Intermediate Municipal Bond ETF and Grail McDonnell Core Taxable
Bond ETF*
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(10) Form of Amendment to Fund
Administration and Accounting Agreement adding Grail McDonnell Intermediate
Municipal Bond ETF and Grail McDonnell Core Taxable Bond ETF *
|
|
(11) Form of Amended and Restated
Appendix 1 to the Transfer Agency and Service Agreement adding Grail
McDonnell Intermediate Municipal Bond ETF and Grail McDonnell Core Taxable
Bond ETF*
|
|
(12) Form of Participant Agreement
for fixed income ETFs.*
|
|
|
(i)
|
Opinion and consent of
K&L Gates LLP*
|
|
|
(j)
|
Consent of Independent
Registered Public Accounting Firm not applicable
|
|
|
(k)
|
Not applicable
|
|
|
(l)
|
Form of Initial
Capital Agreement is incorporated by reference from Pre-Effective Amendment
No. 3 to Registrants registration statement filed on April 29,
2009
|
|
|
(m)
|
Form of
Distribution and Service Plan is incorporated by reference from Pre-Effective
Amendment No. 2 to Registrants registration statement filed on April 8,
2009
|
|
|
(n)
|
Not applicable
|
|
|
(o)
|
Not applicable
|
|
|
(p)
|
(1) Amended Code of Ethics of
Registrant is incorporated by reference from Post-Effective Amendment
No. 2 to Registrants registration statement filed on August 28,
2009
|
|
(2) Code of Ethics of Grail Advisors,
LLC is incorporated by reference from Pre-Effective Amendment No. 2 to
Registrants registration statement filed on April 8, 2009
|
|
(3) Code of Ethics of American Beacon
Advisors, Inc. is incorporated by reference from Pre-Effective Amendment
No. 2 to Registrants registration statement filed on April 8, 2009
|
|
(4) Code of Ethics of Distributor is
incorporated by reference from Pre-Effective Amendment No. 2 to
Registrants registration statement filed on April 8, 2009
|
|
(5) Code of Ethics of Brandywine Global
Investment Management, LLC is incorporated by reference from Pre-Effective
Amendment No. 2 to Registrants registration statement filed on
April 8, 2009
|
|
(6) Code of Ethics of Hotchkis and
Wiley Capital Management, LLC is incorporated by reference from Pre-Effective
Amendment No. 2 to Registrants registration statement filed on
April 8, 2009
|
|
(7) Code of Ethics of Metropolitan West
Capital Management, LLC is incorporated by reference from Pre-Effective
Amendment No. 2 to Registrants registration statement filed on
April 8, 2009
|
|
(8) Code of Ethics of Lazard Asset
Management LLC is incorporated by reference from Pre-Effective Amendment
No. 2 to Registrants registration statement filed on April 8, 2009
|
|
(9) Code of Ethics of Templeton
Investment Counsel, LLC is incorporated by reference from Pre-Effective
Amendment No. 2 to Registrants registration statement filed on
April 8, 2009
|
|
(10) Code of Ethics of The Boston Company
Asset Management, LLC is incorporated by reference from Pre-Effective
Amendment No. 2 to Registrants registration statement filed on
April 8, 2009
|
3
|
(11) Code of Ethics of RiverPark Advisors,
LLC is incorporated by reference from Post-Effective Amendment No. 2 to
Registrants registration statement filed on August 28, 2009
|
|
(12) Code of Ethics of Wedgewood
Partners, Inc. is incorporated by reference from Post-Effective
Amendment No. 2 to Registrants registration statement filed on
August 28, 2009
|
|
(13) Code of Ethics of McDonnell
Investment Management, LLC*
|
*
Filed herewith.
Item 29. Persons Controlled by or Under Common Control
with the Fund
None.
Item
30. Indemnification
Article IX of the
Registrants Trust Instrument provides for indemnification of certain persons
acting on behalf of the Registrant. Article IX,
Section 2 provides as follows:
(a) Subject to the exceptions and limitations contained in subsection (b) below:
(i) every person who is, or has been,
a Trustee or an officer, employee or agent of the Trust, including persons who
act at the request of the Trust as directors, trustees, officers, employees or
agents of another organization in which the Trust has an interest as a
shareholder, creditor or otherwise (Covered Person) shall be indemnified by
the Trust or the appropriate Series to the fullest extent permitted by law
against liability and against all expenses reasonably incurred or paid by him
or her in connection with any claim, action, suit or proceeding in which he or
she becomes involved as a party or otherwise by virtue of his or her being or
having been a Covered Person
and against amounts paid or incurred by him or her in the settlement thereof.
(ii) as used herein, the words claim, action,
suit or proceeding shall apply to all claims, actions, suits or proceedings
(whether civil, criminal or administrative proceedings, regulatory
investigations, or other proceedings, including appeals), actual or threatened,
and the words liability and expenses
shall include, without limitation, counsel fees, costs, judgments, amounts paid
in settlement, fines, penalties and other liabilities.
(b) No indemnification shall be provided
hereunder to a Covered Person:
(i) who shall have been adjudicated by
a court or body before which the proceeding was brought (A) to be liable
to the Trust or its Shareholders by reason
of willful misfeasance, bad faith, gross negligence or reckless disregard of
the duties involved in the conduct of his or her office or (B) not to have
acted in good faith in the reasonable belief that his or her action was in the
best interest of the Trust; or
(ii) in the event of a settlement, if
there has been a determination that such Covered Person engaged in willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his or her office:
(A) by the court or other body approving the settlement; (B) by
at least a majority of those Trustees who are neither Interested Persons of the
Trust nor are parties to the matter based upon a review of readily available
facts (as opposed to a full trial-type inquiry); or (C) by written opinion
of independent legal counsel based upon a review of readily available facts (as
opposed to a full trial-type inquiry).
(c) The rights of indemnification
herein provided may be insured against by policies maintained by the Trust,
shall be severable, shall not be exclusive of or affect any other rights to
which any Covered Person may now or hereafter be entitled and shall inure to
the benefit of the heirs, executors and administrators of a Covered
Person. Nothing contained herein shall
affect any rights to indemnification to which Trust personnel other than
Covered Persons may be entitled by contract or otherwise under law.
(d) To the maximum extent permitted by
applicable law, expenses in connection with the preparation and presentation of
a defense to any claim, action, suit or proceeding of the character described
in
4
subsection (a) of
this Section shall be paid by the Trust or applicable Series from
time to time prior to final disposition thereof upon receipt of an undertaking
by or on behalf of such Covered Person that such amount will be paid over by
him or her to the Trust or applicable Series if it is ultimately
determined that he or she is not entitled to indemnification under this
Section.
(e) Any repeal or modification of this Article IX
by the Shareholders, or adoption or modification of any other provision of this
Trust Instrument or the By-laws inconsistent with this Article, shall be
prospective only, to the extent that such, repeal or modification would, if
applied retrospectively, adversely affect any limitation on the liability of
any Covered Person or indemnification available to any Covered Person with
respect to any act or omission which occurred prior to such repeal,
modification or adoption.
Numbered
Paragraph 6.A. of the Management Agreements with Grail Advisors, LLC provide
that:
Manager.
Manager will exercise its best judgment in rendering its services to the
Trust, and the Trust agrees, as an inducement to Managers undertaking to do
so, that Manager will not be liable for any error of judgment or mistake of law
or for any loss suffered by the Trust in connection with the matters to which
this Agreement relates, but will be liable only for willful misconduct, bad
faith, gross negligence or reckless disregard of its duties or obligations in
rendering its services to the Trust as specified in this Agreement. Any person, even though an officer, director,
employee or agent of Manager, who may be or become an officer, Trustee,
employee or agent of the Trust, shall be deemed, when rendering services to the
Trust or when acting on any business of the Trust, to be rendering such
services to or to be acting solely for the Trust and not as an officer,
director, employee or agent, or one under the control or direction of Manager,
even though paid by it.
Numbered
Paragraph 6 of the Primary Investment Sub-Advisory Agreements and the
Investment Sub-Advisory Agreements with each Sub-Adviser provides substantially
to the effect that:
A.
Sub-Adviser.
Sub-Adviser will exercise its best judgment
in rendering its services to the Trust, and the Trust agrees, as an inducement
to Sub-Advisers undertaking to do so that, except as may otherwise be provided
by the Investment Company Act or any other federal securities law, neither
Sub-Adviser nor any of its officers, members or employees (its Affiliates)
shall be liable for any losses, claims, damages, liabilities or litigation
(including legal and other expenses) incurred or suffered by the Manager or the
Trust as a result of any error of judgment or mistake of law by Sub-Adviser or
its Affiliates with respect to the Fund, except that nothing in this Agreement
shall operate or purport to operate in any way to exculpate, waive or limit the
liability of Sub-Adviser or its Affiliates for, and Sub-Adviser shall indemnify
and hold harmless the Trust, the Manager, all affiliated persons thereof (within
the meaning of Section 2(a)(3) of the Investment Company Act) and all
controlling persons (as described in Section 15 of the Securities Act of
1933, as amended (1933 Act))
(collectively, Manager Indemnitees) against any and
all losses, claims, damages, liabilities or litigation (including reasonable
legal and other expenses) to which any of the Manager Indemnitees may become
subject under the 1933 Act, the Investment Company Act, the Advisers Act, or
under any other statute, or common law or otherwise arising out of or based on (i) any willful misconduct, bad faith,
reckless disregard or gross negligence of Sub-Adviser in the performance of any
of its duties or obligations hereunder or (ii) any untrue statement of a
material fact contained in the Prospectus and SAI, proxy materials,
reports, advertisements, sales literature, or other materials pertaining to the
Fund or the omission to state therein a material
fact known to Sub-Adviser which was required to be stated therein or necessary
to make the statements therein not misleading, if such statement or omission
was made in reliance upon information furnished to the Manager or the Trust by
Sub-Adviser Indemnitees (as defined below) for use therein.
The
assets of the Fund will be maintained in the custody of a custodian (who shall
be identified by the Manager in writing).
Sub-Adviser will not have custody of any securities, cash or other
assets of the Fund and will not be liable for any loss resulting from any act
or omission of the custodian other than acts or omissions arising in reliance
on instructions of Sub-Adviser.
B.
Manager and Trust.
Except as may otherwise be provided by
the Investment Company Act or any other federal securities law, the Manager and
the Trust shall not be liable for any losses, claims, damages, liabilities or
litigation (including legal and other expenses) incurred or suffered by
Sub-Adviser as a result of any error of judgment or mistake of law by the
Manager with respect to the Fund, except that nothing in this Agreement shall
operate or purport to operate in any way to exculpate, waive or limit the
liability of the Manager for, and the
5
Manager
shall indemnify and hold harmless Sub-Adviser, all affiliated persons thereof
(within the meaning of Section 2(a)(3) of the Investment Company Act)
and all controlling persons (as described in Section 15 of the 1933 Act)
(collectively, Sub-Adviser Indemnitees)
against any and all losses, claims, damages, liabilities or litigation
(including reasonable legal and other expenses) to which any of the Sub-Adviser
Indemnitees may become subject under the 1933 Act, the Investment Company Act,
the Advisers Act, or under any other statute, at common law or otherwise arising out of or based on (i) any willful
misconduct, bad faith, reckless disregard or gross negligence of the Manager in
the performance of any of its duties or obligations hereunder or (ii) any
untrue statement of a material fact contained in the Prospectus and SAI, proxy
materials, reports, advertisements, sales literature, or other materials
pertaining to the Fund or the omission to state
therein a material fact known to the Manager that was required to be stated
therein or necessary to make the statements therein not misleading, unless such
statement or omission was made in reliance upon information furnished to the
Manager or the Trust.
Insofar as indemnification for liability arising under the Securities Act of 1933 may be permitted to trustees, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a trustee, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such trustee, officer or controlling person in connection with the securities being registered, the Registrant may, 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.
Item
31. Business and Other Connections of
the Investment Adviser
Grail Advisors, LLC
serves as investment manager to the ETFs and provides investment supervisory
services. Information as to the officers and directors of Grail Advisors, LLC
is included in its Form ADV last filed with the Securities and Exchange
Commission (SEC File No 801-69967) and is incorporated herein by reference.
American Beacon Advisors, Inc.
serves as primary subadviser to the Large Cap Value and International Equity
ETFs and provides investment supervisory services. Information as to the officers and directors
of American Beacon Advisors, Inc. is included in its Form ADV last
filed with the Securities and Exchange Commission (SEC File No. 801-29198)
and is incorporated herein by reference.
RiverPark Advisors, LLC
serves as primary subadviser to the RP Focused Large Cap Growth ETF and
subadviser to the RP Growth ETF, RP Technology ETF and RP Financials ETF. Information as to the officers and directors
of RiverPark Advisors, LLC is included in its Form ADV last filed with the
Securities and Exchange Commission and is incorporated herein by reference.
McDonnell Investment
Management, LLC serves as subadviser to the Grail McDonnell Intermediate
Municipal Bond ETF and Grail McDonnell Core Taxbale Bond ETF. Information as to the officers and directors
of McDonnell Investment Management, LLC is included in its Form ADV last
filed with the Securities and Exchange Commission and is incorporated herein by
reference.
The sub-advisers listed
below also provide investment advisory services to the ETFs:
Brandywine Global
Investment Management, LLC, 2929 Arch Street, 8th Floor, Philadelphia,
Pennsylvania 19104
Hotchkis and Wiley
Capital Management, LLC, 725 South Figueroa Street, 39
th
Floor, Los
Angeles, California 90017.
Metropolitan West Capital
Management, LLC, 610 Newport Center Drive, Suite 1000, Newport Beach,
California 92660
Lazard Asset Management
LLC, 30 Rockefeller Plaza, New York, New York 10112
Templeton Investment
Counsel, LLC, 500 East Broward Boulevard, Suite 2100, Ft. Lauderdale,
Florida 33394
The Boston Company Asset
Management, LLC, One Boston Place, Boston, Massachusetts 02108
Wedgewood Partners, Inc.,
9909 Clayton Road, Suite 103, St. Louis, Missouri 63124.
Information as to the
officers and directors of each of the above sub-advisers is included in that
advisers current Form ADV filed with the SEC and is incorporated by
reference herein.
6
Item
32. Principal Underwriters
(a) ALPS Distributors, Inc. acts as the
distributor for the Registrant and the following investment companies: AARP
Funds, ALPS ETF Trust, ALPS Variable
Insurance Trust, Ameristock Mutual Fund, Inc., AQR Funds, BLDRS Index Fund
Trust, Caldwell & Orkin Funds, Inc., Campbell Multi-Strategy
Trust, Cook & Bynum Funds Trust, CornerCap Group of Funds, Cullen
Funds, DIAMONDS Trust, EGA Global Shares Trust , Financial Investors Trust,
Financial Investors Variable Insurance Trust, Firsthand Funds, Forward Funds,
Heartland Group, Inc., Henssler Funds, Inc., Holland Balanced Fund,
IndexIQ Trust, Index IQ ETF Trust,
Laudus Trust, Milestone Funds, MTB Group of Funds, OOK, Inc., Pax
World Funds, PowerShares QQQ 100 Trust Series 1, SPDR Trust, MidCap SPDR
Trust, Select Sector SPDR Trust, Stonebridge Funds, Inc., Stone Harbor
Investment Funds, TDX Independence Funds, Inc., TXF Funds, Inc.,
Wasatch Funds, WesMark Funds, Westcore Trust, Williams Capital Liquid Assets
Fund, and WisdomTree Trust.
(b) To the best of Registrants knowledge, the
directors and executive officers of ALPS Distributors, Inc., are as
follows:
Name and Principal
Business Address*
|
|
Positions and Offices with
Underwriter
|
|
Positions and Offices with
Registrant
|
|
|
|
|
|
Edmund J. Burke
|
|
Director
|
|
None
|
|
|
|
|
|
Spencer Hoffman
|
|
Director
|
|
None
|
|
|
|
|
|
Thomas A. Carter
|
|
President, Director
|
|
None
|
|
|
|
|
|
Jeremy O. May
|
|
Executive Vice
President, Director
|
|
None
|
|
|
|
|
|
Richard Hetzer
|
|
Executive Vice
President
|
|
None
|
|
|
|
|
|
John C. Donaldson
|
|
Executive Vice
President, Chief Financial Officer
|
|
None
|
|
|
|
|
|
Robert Szydlowski
|
|
Senior Vice President,
Chief Technology Officer
|
|
None
|
|
|
|
|
|
Tané T. Tyler
|
|
Senior Vice President,
General Counsel, Secretary
|
|
None
|
|
|
|
|
|
Diana M. Adams
|
|
Senior Vice President,
Controller, Treasurer
|
|
None
|
|
|
|
|
|
Bradley J. Swenson
|
|
Senior Vice President,
Chief Compliance Officer
|
|
None
|
|
|
|
|
|
Kevin J. Ireland
|
|
Senior Vice President,
Director of Institutional Sales
|
|
None
|
|
|
|
|
|
Mark R. Kiniry
|
|
Senior Vice President,
National Sales Director - Investments
|
|
None
|
|
|
|
|
|
Erin Douglas
|
|
Vice President, Senior
Associate Counsel
|
|
None
|
|
|
|
|
|
JoEllen Legg
|
|
Vice President,
Associate Counsel
|
|
None
|
|
|
|
|
|
Steven Price
|
|
Vice President, Deputy
Chief Compliance Officer
|
|
None
|
* The principal business address for each of the above
directors and executive officers is 1290 Broadway, Suite 1100, Denver,
Colorado 80203.
7
Item
33. Location of Accounts and Records
All accounts, books, and
other documents required to be maintained by Section 31(a) of the
Investment Company Act of 1940, as amended, and the rules promulgated
thereunder are maintained at the offices of the: (a) Registrant; (b)
Manager; (c) Primary Subadvisers; (d) Investment Sub-Advisers; (e) Principal
Underwriter; (f) Administrator/ Fund Accountant/ Transfer Agent and (g) Custodian.
The address of each is as follows:
(a)
Registrant
c/o Grail Advisors, LLC
One Ferry Building, Suite 255
San Francisco, CA 94111
(b)
Manager
Grail Advisors, LLC
One Ferry Building, Suite 255
San Francisco, CA 94111
(c)
Primary Subadvisers
American Beacon Advisors, Inc.
4151 Amon Carter
Boulevard
Fort Worth, TX 76155
RiverPark Advisors, LLC
156 West 56
th
Street, 17
th
Floor
New York, NY 10019
McDonnell Investment
Management, LLC
1515 W. 22
nd
Street, 11
th
Floor
Oak Brook, IL 60523
(d)
Investment Sub-advisers
see the addresses listed
in Item 31 above.
(e)
Principal Underwriter
ALPS Distributors, Inc.
1290 Broadway, Suite 1100
Denver, CO 80203
(f)
Custodian
The Bank of New York
Mellon
One Wall Street
New York, New York 10286
Item
34. Management Services
Not Applicable.
Item
35. Undertakings
None.
8
SIGNATURES
Pursuant to the
requirements of the Securities Act of 1933 and the Investment Company Act of
1940, the Registrant certifies that it meets all of the requirement for
effectiveness of this registration statement under Rule 485(b) under
the Securities Act and has duly caused this Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of San
Francisco, and State of California, on the 31st day of December 2009.
|
Grail Advisors ETF
Trust
|
|
|
|
|
By:
|
/s/ William M. Thomas
|
|
|
William M. Thomas
Trustee and
Principal Executive Officer
|
Pursuant to the
requirements of the Securities Act of 1933, the Registration Statement has been
signed below by the following person(s) in the capacities and on the date(s) indicated.
/s/
William M. Thomas
|
|
Trustee and Principal
Executive Officer
|
December 31, 2009
|
|
|
|
|
William
M. Thomas
|
|
|
|
|
|
|
|
/s/
Bryan M. Hiser
|
|
Principal Financial
Officer
|
December 31, 2009
|
|
|
|
|
Bryan
M. Hiser
|
|
|
|
|
|
|
|
/s/
Bradford K. Gallagher*
|
|
Trustee
|
December 31, 2009
|
|
|
|
|
Bradford
K. Gallagher
|
|
|
|
|
|
|
|
/s/
Charles H. Salisbury*
|
|
Trustee
|
December 31, 2009
|
|
|
|
|
Charles
H. Salisbury
|
|
|
|
|
|
|
|
/s/
Dennis G. Schmal*
|
|
Trustee
|
December 31, 2009
|
|
|
|
|
Dennis
G. Schmal
|
|
|
|
|
|
|
|
|
|
|
|
*
By:
|
/s/ Kurt
J. Decko
|
|
|
|
|
|
|
|
Pursuant
to Power of Attorney
|
|
|
|
|
|
|
|
|
9
Index to Exhibits
(d)(13)
|
Form of Investment
Management Agreement between Registrant and Grail Advisors, LLC with respect
to the Grail McDonnell Intermediate Municipal Bond ETF and Grail McDonnell
Core Taxable Bond ETF
|
(d)(14)
|
Form of Investment
Sub-Advisory Agreement between Grail Advisors, LLC and McDonnell Investment
Management, LLC with respect to the Grail McDonnell Intermediate Municipal
Bond ETF and Grail McDonnell Core Taxable Bond ETF
|
(e)(3)
|
Amendment No. 2 to
Distribution Agreement between Registrant and ALPS Distributors, Inc.
|
(g)(3)
|
Form of Amended
and Restated Schedule II to the Custody Agreement adding Grail McDonnell
Intermediate Municipal Bond ETF and Grail McDonnell Core Taxable Bond ETF
|
(h)(9)
|
Expense Limit Agreement
for Grail McDonnell Intermediate Municipal Bond ETF and Grail McDonnell Core
Taxable Bond ETF
|
(h)(10)
|
Form of Amendment
to Fund Administration and Accounting Agreement adding Grail McDonnell
Intermediate Municipal Bond ETF and Grail McDonnell Core Taxable Bond ETF
|
(h)(11)
|
Form of Amended
and Restated Appendix 1 to the Transfer Agency and Service Agreement adding
Grail McDonnell Intermediate Municipal Bond ETF and Grail McDonnell Core
Taxable Bond ETF
|
(h)(12)
|
Form of
Participant Agreement for fixed income ETFs
|
(i)
|
Opinion and consent of
K&L Gates LLP
|
(p)(13)
|
Code of Ethics of
McDonnell Investment Management, LLC
|
10
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