Organization
PowerShares DB Base Metals Fund (the “Fund”; “Fund” may also
refer to the Fund and the Master Fund, collectively, as the context requires), a separate series of PowerShares DB Multi-Sector Commodity Trust (the “Trust”), a Delaware statutory trust organized in seven separate series and formed on
August 3, 2006, and its subsidiary, DB Base Metals Master Fund (the “Master Fund”), a separate series of DB Multi-Sector Commodity Master Trust (the “Master Trust”), a Delaware statutory trust organized in seven separate
series and formed on August 3, 2006. DB Commodity Services LLC, a Delaware limited liability company (“DBCS” or the “Managing Owner”), funded both the Fund and the Master Fund with a capital contribution of $1,000 in
exchange for 40 General Shares of each of the Fund and Master Fund. The fiscal year end of the Fund is December 31
st
.
The term of the Fund is perpetual (unless terminated earlier in certain circumstances) as provided for in the Amended and Restated
Declaration of Trust and Trust Agreement of each of the Trust and the Master Trust (the “Trust Agreements”).
The
Fund offers common units of beneficial interest (the “Limited Shares”) only to certain eligible financial institutions (“Authorized Participants”) in one or more blocks of 200,000 Limited Shares, called a Basket. The proceeds
from the offering of Limited Shares are invested in the Master Fund. The Fund and the Master Fund commenced investment operations on January 3, 2007 with the initial offering of 1,000,000 Limited Shares to Deutsche Bank Securities Inc. as
initial purchaser of the Fund in exchange for $25,000,000. The Fund commenced trading on the American Stock Exchange (the “Amex”) on January 5, 2007. After the initial offering of the Limited Shares, an additional 3,200,000 Limited
Shares were issued to certain Authorized Participants for $89,426,652 and 2,000,000 Limited Shares were redeemed for $47,212,300 during the period from January 3, 2007 (commencement of investment operations) to December 31, 2007. Limited
Shares may be purchased from the Fund only by Authorized Participants.
This report covers the three months ended
December 31, 2007 and the period from January 3, 2007 (commencement of investment operations) to December 31, 2007 (herein referred to as the “Period Ended December 31, 2007”). No investment operations occurred prior to
January 3, 2007 therefore the 2007 and 2006 operating results are not comparable.
Fund Investment Overview
The Master Fund invests with a view to tracking the changes, whether positive or negative, in the level of the Deutsche Bank Liquid
Commodity Index–Optimum Yield Industrial Metals Excess Return™ (DBLCI-OY Industrial Metals ER™, or “Index”) plus the excess, if any, of the Master Fund’s income from its holdings of United States Treasury Obligations
and other high credit quality short-term fixed income securities over the expenses of the Fund and the Master Fund.
The
Index is intended to reflect the change in market value of the base metals sector. The commodities comprising the Index, or the Index Commodities, are aluminum, zinc and copper—Grade A. The Index Commodities are currently trading on the London
Metals Exchange (“LME”). Although the LME does not currently impose position limits on the Index Commodities, the LME may in the future impose position limits on market participants trading in certain commodities included in the Index. The
Index is comprised of futures contracts on the Index Commodities that expire in a specific month and trade on a specific exchange (the “Index Contracts”). As disclosed in the Fund’s Prospectus, if the Managing Owner determines in its
commercially reasonable judgment that it has become impracticable or inefficient for any reason for the Master Fund to gain full or partial exposure to any Index Commodity by investing in a specific Index Contract, the Master Fund may invest in a
futures contract referencing the particular Index Commodity other than the Index Contract or, in the alternative, invest in other futures contracts not based on the particular Index Commodity if, in the commercially reasonable judgment of the
Managing Owner, such futures contracts tend to exhibit trading prices that correlate with such Index Commodity.
The Master
Fund also holds United States Treasury Obligations and other high credit quality short-term fixed income securities for deposit with the Master Fund’s commodities brokers as margin.
A description of the business of the Fund and related items is contained in the Prospectus under the sections captioned
“Summary,” “Organization Chart,” “Investment Objective,” “The Master-Feeder Structure,” “Description of the
1
Deutsche Bank Liquid Commodity Index-Optimum Yield Excess Return™,” “Information Barriers Between the Index Sponsor and the Managing
Owner,” “Charges,” “Conflicts of Interest” and “Description of the Shares and the Master Fund Units; Certain Material Terms of the Trust Declarations,” and such description is incorporated by reference herein by
reference from the Prospectus.
DBLCI™ and Deutsche Bank Liquid Commodity Index™ are trademarks of Deutsche Bank
AG London (the “Index Sponsor”). Trademark applications in the United States are pending with respect to both the Trust and aspects of the Index. Any use of these trademarks must be with the consent of or under license from the Index
Sponsor. The Fund, Master Fund and the Managing Owner have been licensed to use DBLCI™ and Deutsche Bank Liquid Commodity Index™. The Index Sponsor is an affiliate of the Trust, the Fund, the Master Trust, the Master Fund and the Managing
Owner.
The Index Sponsor obtains information for inclusion in, or for use in the calculation of, the Index from sources
the Index Sponsor considers reliable. None of the Index Sponsor, the Managing Owner, the Fund, the Master Fund or any of their respective affiliates accepts responsibility for or guarantees the accuracy and/or completeness of the Index or any data
included in the Index.
A patent application directed to the creation and operation of the Trust is pending at the United
States Patent and Trademark Office.
The Trustee
Under the Trust Agreements of each of the Fund and the Master Fund, Wilmington Trust Company, the Trustee of the Fund and the Master Fund has delegated to the Managing Owner the exclusive management and control of all
aspects of the business of the Fund and the Master Fund. The Trustee will have no duty or liability to supervise or monitor the performance of the Managing Owner, nor will the Trustee have any liability for the acts or omissions of the Managing
Owner. Pursuant to the Trust Agreements, the Trustee is compensated by the Fund or Master Fund, as appropriate. Under the Trust Agreements, the Managing Owner, from the assets of the Fund or the Master Fund, will indemnify the Trustee for any
liability or expense relating to the formation, operations and termination of the Funds incurred without gross negligence or willful misconduct of the Trustee.
The Managing Owner
The Managing Owner was formed on May 23, 2005. The Managing Owner is an indirect
wholly owned subsidiary of Deutsche Bank AG. The Managing Owner serves as the commodity pool operator and commodity trading advisor of the Fund and the Master Fund. The Managing Owner and its trading principals have limited experience in operating
commodity pools and managing futures trading accounts. The Managing Owner is registered as a commodity pool operator and commodity trading advisor with the Commodity Futures Trading Commission (the “CFTC”) and is a member of the National
Futures Association (the “NFA”). As a registered commodity pool operator and commodity trading advisor, with respect to both the Fund and the Master Fund, the Managing Owner must comply with various regulatory requirements under the
Commodity Exchange Act and the rules and regulations of the CFTC and the NFA, including investor protection requirements, antifraud prohibitions, disclosure requirements, and reporting and recordkeeping requirements. The Managing Owner is also
subject to periodic inspections and audits by the CFTC and NFA.
The Managing Owner’s main business offices are
located at 60 Wall Street, New York, New York 10005, telephone (212) 250-5122.
The Master Fund pays the Managing
Owner a management fee (the “Management Fee”) monthly in arrears, in an amount equal to 0.75% per annum of the daily net asset value of the Master Fund. No separate Management Fee is paid by the Fund. The Management Fee is paid in
consideration of the Managing Owner’s commodity futures trading advisory services.
Pursuant to the Trust Agreements,
the Fund and the Master Fund will indemnify the Managing Owner against any losses, judgments, liabilities, expenses and amounts paid in settlement of any claims sustained by it in connection with its activities on behalf of the Master Fund and the
Fund incurred without negligence or misconduct.
The Commodity Broker
Deutsche Bank Securities Inc., a Delaware corporation, serves as the Master Fund’s clearing broker (the “Commodity Broker”). The Commodity Broker is also an indirect wholly-owned
subsidiary of Deutsche Bank AG and an
2
affiliate of the Managing Owner. In its capacity as clearing broker, the Commodity Broker executes and clears each of the Master Fund’s futures
transactions and performs certain administrative services for the Master Fund.
A variety of executing brokers execute
futures transactions on behalf of the Master Fund. Such executing brokers “give-up”, or transfer for clearing, all such transactions to the Commodity Broker. The Commodity Broker is registered with the CFTC as a futures commission merchant
and is a member of the NFA in such capacity.
The Master Fund pays to the Commodity Broker all brokerage commissions,
including applicable exchange fees, NFA fees, give-up fees, pit brokerage fees and other transaction related fees and expenses charged in connection with trading activities. The Commodity Broker’s brokerage commissions and trading fees are
determined on a contract-by-contract basis. Brokerage commissions and fees in any future fiscal year or any part of any future fiscal year may be greater. On average, total charges paid to the Commodity Broker were approximately $7.00 per round-turn
trade for the period from January 3, 2007 (commencement of investment operations) to December 31, 2007.
A
round-turn trade is a completed transaction involving both a purchase and a liquidating sale, or a sale followed by a covering purchase.
The
Administrator
The Managing Owner, on behalf of the Fund and the Master Fund, has appointed The Bank of New York as the
administrator (the “Administrator”) of the Fund and the Master Fund and has entered into an Administration Agreement in connection therewith. The Bank of New York serves as custodian, or Custodian, of the Fund and has entered into a Global
Custody Agreement, or Custody Agreement, in connection therewith. The Bank of New York serves as the transfer agent, or Transfer Agent, of the Fund and has entered into a Transfer Agency and Service Agreement in connection therewith.
The Bank of New York, a banking corporation organized under the laws of the State
of New York with trust powers, has an office at 2 Hanson Place, 12
th
Floor, Brooklyn, New York 11217. The Bank of New York is subject to supervision
by the New York State Banking Department and the Board of Governors of the Federal Reserve System.
Pursuant to the
Administration Agreement, the Administrator performs or supervises the performance of services necessary for the operation and administration of the Fund and the Master Fund (other than making investment decisions), including receiving and
processing orders from Authorized Participants to create and redeem Baskets, net asset value calculations, accounting and other fund administrative services. The Administrator retains certain financial books and records, including: Basket creation
and redemption books and records, fund accounting records, ledgers with respect to assets, liabilities, capital, income and expenses, the registrar, transfer journals and related details and trading and related documents received from futures
commission merchants.
The Administration Agreement will continue in effect from the commencement of trading operations
unless terminated on at least 90 days’ prior written notice by either party to the other party. Notwithstanding the foregoing, the Administrator may terminate the Administration Agreement upon 30 days’ prior written notice if the Fund
and/or Master Fund has materially failed to perform its obligations under the Administration Agreement.
The Administration
Agreement provides for the exculpation and indemnification of the Administrator from and against any costs, expenses, damages, liabilities or claims (other than those resulting from the Administrator’s own bad faith, negligence or willful
misconduct) which may be imposed on, incurred by or asserted against the Administrator in performing its obligations or duties under the Administration Agreement.
The Administrator’s monthly fees are paid on behalf of the Fund and the Master Fund by the Managing Owner out of the Management Fee.
The Administrator and any of its affiliates may from time-to-time purchase or sell Limited Shares for their own account, as agent for
their customers and for accounts over which they exercise investment discretion.
The Administrator receives a transaction
processing fee in connection with orders from Authorized Participants to create or redeem Baskets in the amount of $500 per order. These transaction processing fees are paid indirectly by the Authorized Participants and not by the Fund or the Master
Fund.
3
The Distributor
ALPS Distributors (the “Distributor”) provides certain distribution services to the Fund. Pursuant to the Distribution Services Agreement between the Managing Owner, in its capacity as managing owner of the
Fund, the Fund and the Distributor, the Distributor assists the Managing Owner and the Administrator with certain functions and duties relating to the creation and redemption of Baskets.
The date of the Distribution Services Agreement is the effective date and such Agreement will continue until two years from such date and
thereafter will continue automatically for successive annual periods, provided that such continuance is specifically approved at least annually by the Fund’s Managing Owner or otherwise as provided under the Distribution Services Agreement. The
Distribution Services Agreement is terminable without penalty on sixty days’ written notice by the Managing Owner or by the Distributor. The Distribution Services Agreement will automatically terminate in the event of its assignment.
Pursuant to the Distribution Services Agreement, the Fund will indemnify and hold harmless the Distributor and each of its
directors and officers and each person, if any, who controls the Distributor within the meaning of Section 15 of the 1933 Act, against any loss, liability, claim, damages or expenses (including the reasonable cost of investigating or defending
any alleged loss, liability, claim, damages or expense and reasonable counsel fees incurred in connection therewith) arising by reason of any person acquiring any Limited Shares, based upon the ground that the registration statement, prospectus,
statement of additional information, shareholder reports or other information filed or made public by the Fund (as from time-to-time amended) included an untrue statement of a material fact or omitted to state a material fact required to be stated
or necessary in order to make the statements not misleading under the 1933 Act or any other statute or the common law.
A I M Distributors, Inc. and
PowerShares Capital Management, LLC
Certain marketing services are provided for the Fund by A I M Distributors, Inc.
or PowerShares Capital Management, LLC. This assistance includes the licensing of the PowerShares® registered service mark to the Managing Owner for use with the Fund. PowerShares® is a registered service mark of PowerShares Capital
Management LLC. PowerShares Capital Management LLC is not a sponsor or promoter of the Fund and has no responsibility for the performance of the Fund or the decisions made or actions taken by the Managing Owner.
Through a marketing agreement between the Managing Owner and A I M Distributors, Inc. (“AIM Distributors”) an affiliate of
PowerShares Capital Management LLC, or PowerShares, the Managing Owner, on behalf of the Fund and the Master Fund, has appointed AIM Distributors as a marketing agent. AIM Distributors assists the Managing Owner and the Administrator with certain
functions and duties such as providing various educational and marketing activities regarding the Fund, primarily in the secondary trading market, which activities include, but are not limited to, communicating the Fund’s name, characteristics,
uses, benefits, and risks, consistent with the prospectus. AIM Distributors will not open or maintain customer accounts or handle orders for the Fund. AIM Distributors engages in public seminars, road shows, conferences, media interviews, field
incoming telephone “800” number calls and distribute sales literature and other communications (including electronic media) regarding the Fund.
AIM Distributors is a subsidiary of Invesco, Ltd. Invesco, Ltd. is a leading independent global investment manager operating under the AIM, INVESCO, AIM Trimark, Invesco Perpetual and Atlantic Trust brands.
Tax Reporting
The
Fund has retained the services of PricewaterhouseCoopers LLP to assist with certain tax reporting requirements of the Fund and its Shareholders.
Regulation
Futures exchanges in the United States are subject to regulation under the Commodity Exchange
Act, or CEAct, by the CFTC, the governmental agency having responsibility for regulation of futures exchanges and trading on those exchanges. No governmental U.S. agency regulates the over-the-counter, or OTC, foreign exchange markets.
The CEAct and the CFTC also regulate the activities of “commodity trading advisors” and “commodity pool operators”
and the CFTC has adopted regulations with respect to certain of such persons’ activities. Pursuant to its authority, the CFTC requires a commodity pool operator (such as the Managing Owner) to keep accurate, current and orderly records with
respect to each pool it operates. The CFTC may suspend the registration of a commodity pool operator if the CFTC
4
finds that the operator has violated the CEAct or regulations thereunder and in certain other circumstances. Suspension, restriction or termination of the
Managing Owner’s registration as a commodity pool operator would prevent it, until such time (if any) as such registration were to be reinstated, from managing, and might result in the termination of, the Fund and the Master Fund. The CEAct
gives the CFTC similar authority with respect to the activities of commodity trading advisors, such as the Managing Owner. If the registration of a Managing Owner as a commodity trading advisor were to be terminated, restricted or suspended, the
Managing Owner would be unable, until such time (if any) as such registration were to be reinstated, to render trading advice to the Fund and the Master Fund. The Fund and the Master Fund themselves are not registered with the CFTC in any capacity.
The CEAct requires all “futures commission merchants,” such as the Commodity Broker, to meet and maintain
specified fitness and financial requirements, segregate customer funds from proprietary funds and account separately for all customers’ funds and positions, and to maintain specified book and records open to inspection by the staff of the CFTC.
The CEAct also gives the states certain powers to enforce its provisions and the regulations of the CFTC.
Shareholders are afforded certain rights for reparations under the CEAct. Shareholders may also be able to maintain a private right of
action for certain violations of the CEAct. The CFTC has adopted rules implementing the reparation provisions of the CEAct which provide that any person may file a complaint for a reparations award with the CFTC for violation of the CEAct against a
floor broker, futures commission merchant, introducing broker, commodity trading advisor, commodity pool operator, and their respective associated persons.
Pursuant to authority in the CEAct, the NFA has been formed and registered with the CFTC as a “registered futures association.” At the present time, the NFA is the only non-exchange
self-regulatory organization for commodities professionals. NFA members are subject to NFA standards relating to fair trade practices, financial condition, and consumer protection. As the self-regulatory body of the commodities industry, the NFA
promulgates rules governing the conduct of commodity professionals and disciplines those professionals who do not comply with such standards. The CFTC has delegated to the NFA responsibility for the registration of commodity trading advisors,
commodity pool operators, futures commission merchants, introducing brokers and their respective associated persons and floor brokers. The Commodity Broker and the Managing Owner are members of the NFA (the Fund and the Master Fund themselves are
not required to become members of the NFA).
The CFTC has no authority to regulate trading on foreign commodity exchanges
and markets.
Employees
The Fund and the Master Fund have no employees.
Available Information
The Fund files with or submits to the SEC annual, quarterly and current reports and other information meeting the informational
requirements of the Exchange Act. These reports are available on the Managing Owner’s website at
http://dbfunds.db.com
. Investors may also inspect and copy these reports, proxy statements and other information, and related exhibits and
schedules, at the Public Reference Room of the SEC at 100 F Street, NE, Washington, D.C. 20549. Investors may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an
Internet site that contains reports, proxy and information statements and other information filed electronically by us with the SEC which are available on the SEC’s Internet site at
http://www.sec.gov
.
The Fund also posts monthly performance reports and its annual report, as required by the Commodity Futures Trading Commission, on the
Managing Owner’s website at the address listed above.
An investment in the securities
of the Fund involves a high degree of risk. Investors should consider carefully all of the risks described below, together with the other information contained in this report and the Prospectus, before making a decision to invest in the securities
of the Fund. If any of the following risks occur, the business, financial condition and results of operations of the Fund may be adversely affected.
5
Investment and Trading Related Risks
The Value of the Limited Shares Relates Directly to the Value of the Futures Contracts and Other Assets Held by the Master Fund and Fluctuations in the Price of These Assets Could
Materially Adversely Affect an Investment in the Fund’s Limited Shares.
The Limited Shares are designed to
reflect as closely as possible the changes, whether positive or negative, in the level of the Index, over time, through the Master Fund’s portfolio of exchange traded futures contracts on its Index Commodities. The value of the Limited Shares
relates directly to the value of the portfolio of the Master Fund, less the liabilities (including estimated accrued but unpaid expenses) of the Fund and the Master Fund. The prices of the Index Commodities may fluctuate widely. Several factors may
affect the prices of the Index Commodities, including, but not limited to:
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Global supply and demand of the Index Commodities which may be influenced by such factors as forward selling by the various commodities producers, purchases made
by the commodities’ producers to unwind their hedge positions and production and cost levels in the major markets of the Index Commodities;
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•
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Domestic and foreign interest rates and investors’ expectations concerning interest rates;
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•
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Domestic and foreign inflation rates and investors’ expectations concerning inflation rates;
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•
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Investment and trading activities of mutual funds, hedge funds and commodity funds; and
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•
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Global or regional political, economic or financial events and situations.
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Net Asset Value May Not Always Correspond to Market Price and, as a Result, Baskets may be Created or Redeemed at a Value that Differs from the Market Price of the Limited Shares.
Net asset value may not always correspond to market price and, as a result, baskets may be created or redeemed at a value
that differs from the market price of the Limited Shares.
The net asset value per share of the Limited Shares will change
as fluctuations occur in the market value of the Master Fund’s portfolio. Investors should be aware that the public trading price of a Basket of Limited Shares may be different from the net asset value of a Basket of Limited Shares
(
i.e.
, 200,000 Limited Shares may trade at a premium over, or a discount to, net asset value of a Basket of Limited Shares) and similarly the public trading price per Limited Share may be different from its net asset value per Limited Share.
Consequently, an Authorized Participant may be able to create or redeem a Basket of Limited Shares at a discount or a premium to the public trading price per Limited Share. This price difference may be due, in large part, to the fact that supply and
demand forces at work in the secondary trading market for Limited Shares are closely related, but not identical, to the same forces influencing the prices of the Index Commodities comprising the Index, trading individually or in the aggregate at any
point in time. Investors also should note that the size of the Fund in terms of total assets held may change substantially over time and from time-to-time as Baskets are created and redeemed.
Authorized Participants or their clients or customers may have an opportunity to realize a riskless profit if they can purchase a Basket
at a discount to the public trading price of the Limited Shares or can redeem a Basket at a premium over the public trading price of the Limited Shares. The Managing Owner expects that the exploitation of such arbitrage opportunities by Authorized
Participants and their clients and customers will tend to cause the public trading price to track net asset value per Limited Share closely over time.
The value of a Limited Share may be influenced by non-concurrent trading hours between the Amex and the various futures exchanges on which the Index Commodities are traded. As a result, during periods when the Amex is
open and the futures exchanges on which the Index Commodities are traded is closed, trading spreads and the resulting premium or discount on the Limited Shares may widen and, therefore, increase the difference between the price of the Limited Shares
and the net asset value of the Limited Shares.
6
Regulatory and Exchange Position Limits and Other Rules May Restrict the Creation of Baskets of the
Fund and the Operation of the Master Fund.
Although the LME does not currently impose speculative positions
limits, the LME may from time-to-time impose speculative position limits on market participants, including the Master Fund, trading in certain commodities. These position limits prohibit any person from holding a position of more than a specific
number of such futures contracts.
It is possible that in the future, the LME may propose new rules with respect to
position limits in certain commodities for traders engaged in indexed-based trading, such as the trading engaged in by the Master Fund. Depending on the outcome of any future LME rulemaking, the rules concerning position limits may be amended in a
manner that is either detrimental or favorable to the Fund. For example, if the amended rules are detrimental to the Master Fund, the Fund’s ability to issue new Baskets, or the Master Fund’s ability to reinvest income in additional
futures contracts, may be limited to the extent these activities would cause the Master Fund to exceed the applicable position limits. Limiting the size of the Fund may affect the correlation between the price of the Limited Shares, as traded on the
Amex, and the net asset value of the Fund. That is, the inability to create additional Baskets could result in Shares in the Fund trading at a premium or discount to net asset value of the Fund.
If the LME imposed position limits and the Master Fund is approaching or has reached such position limits with respect to certain futures
contracts comprising the Index, the Master Fund may commence investing in other futures contracts based on commodities that comprise the Index and in futures contracts based on commodities other than commodities that comprise the Index that, in the
commercially reasonable judgment of the Managing Owner, tend to exhibit trading prices that correlate with a futures contract that comprises the Index.
The Fund’s Performance May Not Always Replicate Exactly the Changes in the Levels of the Index.
It is possible that the Fund’s performance may not fully replicate the changes in the levels of the Index due to disruptions in the markets for the Index Commodities, the imposition of speculative position limits
(as discussed in the above risk factor “Regulatory and Exchange Position Limits and Other Rules May Restrict the Creation of Baskets of the Fund and the Operation of the Master Fund”), or due to other extraordinary circumstances. In
addition, the Fund is not able to replicate exactly the changes in the levels of the Index because the total return generated by the Master Fund is reduced by expenses and transaction costs, including those incurred in connection with the Master
Fund’s trading activities, and increased by interest income from the Master Fund’s holdings of short-term high quality fixed income securities. Tracking the Index requires trading of the Master Fund’s portfolio with a view to tracking
the Index over time and is dependent upon the skills of the Managing Owner and its trading principals, among other factors.
The
Master Fund is Not Actively Managed and Tracks the Index During Periods in which the Index Is Flat or Declining as well as when the Index Is Rising.
The Master Fund is not actively managed by traditional methods. Therefore, if positions in any one or more of its Index Commodities are declining in value, the Master Fund will not close out such
positions, except in connection with a change in the composition or weighting of the Index. The Managing Owner seeks to cause the net asset value to track the Index during periods in which the Index is flat or declining as well as when the Index is
rising.
Amex May Halt Trading in the Limited Shares Which Would Adversely Impact Your Ability to Sell Limited Shares.
The Limited Shares are listed for trading on the Amex under the market symbol “DBB”. Trading in Limited
Shares may be halted due to market conditions or, in light of Amex rules and procedures, for reasons that, in the view of the Amex, make trading in Limited Shares inadvisable. In addition, trading is subject to trading halts caused by extraordinary
market volatility pursuant to “circuit breaker” rules that require trading to be halted for a specified period based on a specified market decline. There can be no assurance that the requirements necessary to maintain the listing of the
Limited Shares will continue to be met or will remain unchanged. The Fund and the Master Fund will be terminated if the Limited Shares are delisted.
The Lack of an Active Trading Market for the Limited Shares May Result in Losses on Your Investment in the Fund at the Time of Disposition of Your Limited Shares.
Although the Limited Shares are listed and traded on the Amex, there can be no guarantee that an active trading market for the Limited
Shares will be maintained. If you need to sell your Limited Shares at a time when no active market for
7
them exists, the price you receive for your Limited Shares, assuming that you are able to sell them, likely will be lower than the price you would receive if
an active market did exist.
The Limited Shares Are a New Securities Product and Their Value Could Decrease if Unanticipated
Operational or Trading Problems Arise.
The mechanisms and procedures governing the creation, redemption and
offering of the Limited Shares have been developed specifically for this securities product. Consequently, there may be unanticipated problems or issues with respect to the mechanics of the operations of the Fund and the Master Fund and the trading
of the Limited Shares that could have a material adverse effect on an investment in the Limited Shares. In addition, although the Master Fund is not actively “managed” by traditional methods, to the extent that unanticipated operational or
trading problems or issues arise, the Managing Owner’s past experience and qualifications may not be suitable for solving these problems or issues.
As the Managing Owner and its Principals have Only a Limited History of Operating Investment Vehicles like the Fund or the Master Fund, their Experience may be Inadequate or Unsuitable to Manage the Fund or the
Master Fund.
The Managing Owner was formed to be the managing owner of investment vehicles such as the Fund and
the Master Fund and has only a limited history of past performance. The past performances of the Managing Owner’s management of other commodity pools are no indication of its ability to manage an investment vehicle such as the Fund or the
Master Fund. If the experience of the Managing Owner and its principals is not adequate or suitable to manage an investment vehicle such as the Fund and the Master Fund, the operations of the Fund and the Master Fund may be adversely affected.
You May Not Rely on Past Performance or Index Results in Deciding Whether to Buy Limited Shares.
The Fund and the Master Fund have a limited performance history upon which to evaluate your investment in the Fund and the Master Fund.
Although past performance is not necessarily indicative of future results, if the Fund and the Master Fund had a longer performance history, such performance history might (or might not) provide you with more information on which to evaluate an
investment in the Fund and the Master Fund. Likewise, the Index has a limited history which may not be indicative of future Index results, or of the future performance of the Fund or the Master Fund. Therefore, you will have to make your decision to
invest in the Fund on the basis of limited information.
Fewer Representative Commodities May Result In Greater Index Volatility.
The Index is concentrated in terms of the number of commodities represented. The Fund is concentrated in 5 or
fewer commodities. You should be aware that other commodities indexes are more diversified in terms of both the number and variety of commodities included. Concentration in fewer commodities may result in a greater degree of volatility in an Index
and the net asset value of the Fund and Master Fund which track the Index under specific market conditions and over time.
Price
Volatility May Possibly Cause the Total Loss of Your Investment.
Futures contracts have a high degree of price
variability and are subject to occasional rapid and substantial changes. Consequently, you could lose all or substantially all of your investment in the Fund.
The following table* reflects various measures of volatility** of the history of the Index, as calculated on an excess return basis:
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Volatility Type
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Volatility
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Daily volatility over full history
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18.20
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%
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Average rolling 3 month daily volatility
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16.90
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%
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Monthly return volatility
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18.70
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%
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Average annual volatility
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16.67
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%
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The following table reflects the daily volatility on an annual basis of the Index:
8
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Year
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Daily
Volatility
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1997***
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11.99%
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1998
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14.38%
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1999
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14.07%
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2000
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11.78%
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2001
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12.57%
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2002
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13.12%
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2003
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13.80%
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2004
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20.85%
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2005
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18.18%
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2006
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32.26%
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2007*
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20.35%
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Past Index results are not necessarily indicative of future changes, positive or
negative, in the Index levels.
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*
|
As of December 31, 2007.
|
|
**
|
Volatility, for these purposes means the following:
|
Daily Volatility
: The relative rate at which the price of the Index moves up and down, found by calculating the annualized standard deviation of the daily change in price.
Monthly Return Volatility
: The relative rate at which the price of the Index moves up and down, found by calculating the
annualized standard deviation of the monthly change in price.
Average Annual Volatility
: The average of yearly
volatilities for a given sample period. The yearly volatility is the relative rate at which the price of the Index moves up and down, found by calculating the annualized standard deviation of the daily change in price for each business day in the
given year.
|
***
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As of September 3, 1997.
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Unusually Long Peak-to-Valley Drawdown Periods With Respect To the Index May Be Reflected in Equally Long Peak-to-Valley Drawdown Periods with Respect to the Performance of the Limited Shares.
Although past Index levels are not necessarily indicative of future Index levels, the peak-to-valley drawdown periods that the Index has
experienced has been unusually long and has lasted for multi-year drawdown periods.
Because it is expected that the
Fund’s performance will track the performance of the Index, the Fund would suffer a continuous drawdown during the period that the Index suffers such a drawdown period, and in turn, the value of your Limited Shares will also suffer.
Fees and Commissions are Charged Regardless of Profitability and May Result in Depletion of Assets.
The Fund is indirectly subject to the fees and expenses described herein which are payable irrespective of profitability. Such fees and
expenses include asset-based fees of 0.75% per annum. Additional charges include brokerage fees of not greater than 0.03% per annum in the aggregate in selling commissions. As of December 31, 2007, the Fund has earned interest income
at an annual rate of approximately 4.55% per annum. Consequently, it is expected that interest income will exceed fees (other than selling commissions), however, if interest rates fall below approximately 0.78%, the Fund will need to have
positive performance in order to break even net of fees and expenses. Consequently, depending upon the performance of the Fund and the interest rate environment, the expenses of the Master Fund could, over time, result in losses to your investment
therein. You may never achieve profits, significant or otherwise.
9
You Cannot Be Assured of the Managing Owner’s Continued Services, Which Discontinuance May Be
Detrimental to the Fund.
You cannot be assured that the Managing Owner will be willing or able to continue to
service the Fund and the Master Fund for any length of time. If the Managing Owner discontinues its activities on behalf of the Fund and the Master Fund, the Fund and the Master Fund may be adversely affected.
Possible Illiquid Markets May Exacerbate Losses.
Futures positions cannot always be liquidated at the desired price. It is difficult to execute a trade at a specific price when there is a relatively small volume of buy and sell orders in a
market. A market disruption, such as when foreign governments may take or be subject to political actions which disrupt the markets in their currency or major exports, can also make it difficult to liquidate a position.
There can be no assurance that market illiquidity will not cause losses for the Fund. The large size of the positions which the Master
Fund may acquire on behalf of the Fund increases the risk of illiquidity by both making its positions more difficult to liquidate and increasing the losses incurred while trying to do so.
You May Be Adversely Affected by Redemption Orders that Are Subject To Postponement, Suspension or Rejection Under Certain Circumstances.
The Fund may, in its discretion, suspend the right of redemption or postpone the redemption settlement date, (1) for any period
during which an emergency exists as a result of which the redemption distribution is not reasonably practicable, or (2) for such other period as the Managing Owner determines to be necessary for the protection of the Shareholders of the Fund.
In addition, the Fund will reject a redemption order if the order is not in proper form as described in the participant agreement among the Authorized Participant, the Managing Owner and the Managing Owner in its capacity as managing owner of the
Fund or if the fulfillment of the order, in the opinion of its counsel, might be unlawful. Any such postponement, suspension or rejection could adversely affect a redeeming Authorized Participant. For example, the resulting delay may adversely
affect the value of the Authorized Participant’s redemption proceeds if the net asset value of the Fund declines during the period of delay. The Fund disclaims any liability for any loss or damage that may result from any such suspension or
postponement.
Because the Futures Contracts Have No Intrinsic Value, the Positive Performance of Your Investment Is Wholly Dependent
Upon an Equal and Offsetting Loss.
Futures trading is a risk transfer economic activity. For every gain there is
an equal and offsetting loss rather than an opportunity to participate over time in general economic growth. Unlike most alternative investments, an investment in Limited Shares does not involve acquiring any asset with intrinsic value. Overall
stock and bond prices could rise significantly and the economy as a whole prosper while Limited Shares trade unprofitably.
Failure
of Commodity Futures Markets to Exhibit Low to Negative Correlation to General Financial Markets Will Reduce Benefits of Diversification and May Exacerbate Losses to Your Portfolio.
Historically, commodity futures’ returns have tended to exhibit low to negative correlation with the returns of other assets such as
stocks and bonds. Although commodity futures trading can provide a diversification benefit to investor portfolios because of its low to negative correlation with other financial assets, the fact that the Index is not 100% negatively correlated with
financial assets such as stocks and bonds means that the Fund cannot be expected to be automatically profitable during unfavorable periods for the stock or bond market, or vice-versa. If the Limited Shares perform in a manner that correlates with
the general financial markets or do not perform successfully, you will obtain no diversification benefits by investing in the Limited Shares and the Limited Shares may produce no gains to offset your losses from other investments.
Shareholders Do Not Have the Protections Associated With Ownership of Limited Shares in an Investment Company Registered Under the Investment
Company Act of 1940.
Neither the Fund nor the Master Fund is registered as an investment company under the
Investment Company Act of 1940 and is not required to register under such Act. Consequently, Shareholders do not have the regulatory protections provided to the investors in registered and regulated investment companies.
10
Various Actual and Potential Conflicts of Interest May Be Detrimental to Shareholders.
The Fund and the Master Fund are subject to actual and potential conflicts of interest involving the Managing Owner,
various commodity futures brokers and Authorized Participants. The Managing Owner and its principals, all of whom are engaged in other investment activities, are not required to devote substantially all of their time to the business of the Fund and
the Master Fund, which also presents the potential for numerous conflicts of interest with the Fund and the Master Fund. As a result of these and other relationships, parties involved with the Fund and the Master Fund have a financial incentive to
act in a manner other than in the best interests of the Fund, the Master Fund and the Shareholders. The Managing Owner has not established any formal procedure to resolve conflicts of interest. Consequently, investors are dependent on the good faith
of the respective parties subject to such conflicts to resolve them equitably. Although the Managing Owner attempts to monitor these conflicts, it is extremely difficult, if not impossible, for the Managing Owner to ensure that these conflicts do
not, in fact, result in adverse consequences to the Shareholders.
The Fund and the Master Fund may be subject to certain
conflicts with respect to the Commodity Broker, including, but not limited to, conflicts that result from receiving greater amounts of compensation from other clients, or purchasing opposite or competing positions on behalf of third party accounts
traded through the Commodity Broker.
Tax Related Risks
Shareholders of the Fund Will Be Subject to Taxation on Their Share of the Fund’s Taxable Income (Including the Fund’s Share of the Master Fund’s Taxable Income), Whether or Not They Receive Cash
Distributions.
Shareholders of the Fund will be subject to U.S. federal income taxation and, in some cases, state,
local, or foreign income taxation on their share of the Fund’s taxable income (including the Master Fund’s taxable income allocable to the Fund), whether or not they receive cash distributions from the Fund. Shareholders of the Fund may
not receive cash distributions equal to their share of the Fund’s taxable income (including the Master Fund’s taxable income) or even the tax liability that results from such income.
Items of Income, Gain, Loss, Deduction, and Credit with respect to Limited Shares could be Reallocated if the IRS does not Accept the Assumptions or Conventions Used by the Fund or the
Master Fund in Allocating Such Tax Items.
U.S. federal income tax rules applicable to partnerships are complex and
often difficult to apply to publicly traded partnerships. The Fund and the Master Fund will apply certain assumptions and conventions in an attempt to comply with the applicable rules and to report income, gain, deduction, loss and credit to
Shareholders of the Fund in a manner that reflects the Shareholders’ beneficial shares of partnership items, but these assumptions and conventions may not be in compliance with all aspects of applicable tax requirements. It is possible that the
IRS will successfully assert that the conventions and assumptions used by the Fund or the Master Fund do not satisfy the technical requirements of the Code and/or Treasury regulations and could require that items of income, gain, deduction, loss or
credit be adjusted or reallocated in a manner that adversely affects you.
The Current Treatment of Long Term Capital Gains Under
Current U.S. Federal Income Tax Law May Be Adversely Affected, Changed or Repealed in the Future.
Under current
law, long term capital gains are taxed to noncorporate investors at a maximum U.S. federal income tax rate of 15%. This tax treatment may be adversely affected, changed or repealed by future changes in tax laws at any time and is currently scheduled
to expire for tax years beginning after December 31, 2010.
PROSPECTIVE INVESTORS ARE STRONGLY URGED TO CONSULT
THEIR OWN TAX ADVISERS AND COUNSEL WITH RESPECT TO THE POSSIBLE TAX CONSEQUENCES TO THEM OF AN INVESTMENT IN THE LIMITED SHARES; SUCH TAX CONSEQUENCES MAY DIFFER IN RESPECT OF DIFFERENT INVESTORS.
11
Other Risks
Failure of Futures Commission Merchants or Commodity Brokers to Segregate Assets May Increase Losses; Despite Segregation of Assets, the Master Fund Remains at Risk of Significant Losses Because the Master Fund
May Only Receive a Pro-Rata Share of the Assets, or No Assets at All.
The CEAct requires a clearing broker to
segregate all funds received from customers from such broker’s proprietary assets. If the Commodity Broker fails to do so, the assets of the Master Fund might not be fully protected in the event of the Commodity Broker’s bankruptcy.
Furthermore, in the event of the Commodity Broker’s bankruptcy, the Master Fund Units could be limited to recovering either a pro rata share of all available funds segregated on behalf of the Commodity Broker’s combined customer accounts
or the Master Fund Units may not recover any assets at all, even though certain property specifically traceable to the Master Fund was held by the Commodity Broker. The Commodity Broker may, from time-to-time, have been the subject of certain
regulatory and private causes of action.
In the event of a bankruptcy or insolvency of any exchange or a clearing house,
the Master Fund could experience a loss of the funds deposited through its Commodity Broker as margin with the exchange or clearing house, a loss of any profits on its open positions on the exchange, and the loss of unrealized profits on its closed
positions on the exchange.
Regulatory Changes or Actions May Alter the Nature of an Investment in the Fund.
Considerable regulatory attention has been focused on non-traditional investment pools which are publicly distributed in the United
States.
There is a possibility of future regulatory changes altering, perhaps to a material extent, the nature of an investment in the Fund or the ability of the Fund to continue to implement its investment strategy
.
The futures markets are subject to comprehensive statutes, regulations, and margin requirements. In addition, the CFTC and the exchanges
are authorized to take extraordinary actions in the event of a market emergency, including, for example, the retroactive implementation of speculative position limits or higher margin requirements, the establishment of daily price limits and the
suspension of trading. The regulation of futures transactions in the United States is a rapidly changing area of law and is subject to modification by government and judicial action. The effect of any future regulatory change on the Fund is
impossible to predict, but could be substantial and adverse.
Lack of Independent Advisers Representing Investors.
The Managing Owner has consulted with counsel, accountants and other advisers regarding the formation and
operation of the Fund and the Master Fund. No counsel has been appointed to represent you in connection with the offering of the Limited Shares. Accordingly, you should consult your own legal, tax and financial advisers regarding the desirability of
an investment in the Limited Shares.
Possibility of Termination of the Fund or Master Fund May Adversely Affect Your Portfolio.
The Managing Owner may withdraw from the Fund upon 120 days’ notice, which would cause the Fund and the
Master Fund to terminate unless a substitute managing owner were obtained. Owners of 50% of the Limited Shares have the power to terminate the Fund. If it is so exercised, investors who may wish to continue to invest in the Fund’s Index through
a fund vehicle will have to find another vehicle, and may not be able to find another vehicle that offers the same features as the Fund. Such detrimental developments could cause you to liquidate your investments and upset the overall maturity and
timing of your investment portfolio. If the registrations with the CFTC or memberships in the NFA of the Managing Owner or the Commodity Broker were revoked or suspended, such entity would no longer be able to provide services to the Fund and the
Master Fund.
Shareholders Do Not Have the Rights Enjoyed by Investors in Certain Other Vehicles.
As interests in separate series of a Delaware statutory trust, the Limited Shares have none of the statutory rights normally associated
with the ownership of shares of a corporation (including, for example, the right to bring “oppression” or “derivative” actions). In addition, the Limited Shares have limited voting and distribution rights (for example,
Shareholders do not have the right to elect directors and the Fund is not required to pay regular distributions, although the Fund may pay distributions in the discretion of the Managing Owner).
12
An Investment in the Limited Shares May Be Adversely Affected by Competition From Other Methods of
Investing in Commodities.
The Fund and the Master Fund constitute a new, and thus untested, type of investment
vehicle. They compete with other financial vehicles, including other commodity pools, hedge funds, traditional debt and equity securities issued by companies in the commodities industry, other securities backed by or linked to such commodities, and
direct investments in the underlying commodities or commodity futures contracts. Market and financial conditions, and other conditions beyond the Managing Owner’s control, may make it more attractive to invest in other financial vehicles or to
invest in such commodities directly, which could limit the market for the Limited Shares and reduce the liquidity of the Limited Shares.
Competing Claims Over Ownership of Intellectual Property Rights Related to the Fund Could Adversely Affect the Fund and an Investment in the Limited Shares.
While the Managing Owner believes that all intellectual property rights needed to operate the Fund and the Master Fund are either owned
by or licensed to the Managing Owner or have been obtained, third parties may allege or assert ownership of intellectual property rights which may be related to the design, structure and operations of the Fund and the Master Fund. To the extent any
claims of such ownership are brought or any proceedings are instituted to assert such claims, the negotiation, litigation or settlement of such claims, or the ultimate disposition of such claims in a court of law if a suit is brought, may adversely
affect the Fund and the Master Fund and an investment in the Limited Shares, for example, resulting in expenses or damages or the termination of the Fund and the Master Fund.
The Value of the Limited Shares Will be Adversely Affected if the Fund or the Master Fund is Required to Indemnify the Trustee or the Managing Owner.
Under the Trust Agreements, the Trustee and the Managing Owner have the right to be indemnified for any liability or expense either
incurs without negligence or misconduct. That means the Managing Owner may require the assets of the Master Fund to be sold in order to cover losses or liability suffered by it or by the Trustee. Any sale of that kind would reduce the net asset
value of the Master Fund and the value of the Limited Shares.
The Net Asset Value Calculation of the Master Fund May Be Overstated
or Understated Due to the Valuation Method Employed When a Settlement Price is not Available on the Date of Net Asset Value Calculation.
Calculating the net asset value of the Master Fund (and, in turn, the Fund) includes, in part, any unrealized profits or losses on open commodity futures contracts. Under normal circumstances, the net asset value of
the Master Fund reflects the settlement price of open commodity futures contracts on the date when the net asset value is being calculated. However, if a commodity futures contract traded on an exchange (both U.S. and, to the extent it becomes
applicable, non-U.S. exchanges) could not be liquidated on such day (due to the operation of daily limits or other rules of the exchange or otherwise), the settlement price on the most recent day on which the position could have been liquidated will
be the basis for determining the market value of such position for such day. In such a situation, there is a risk that the calculation of the net asset value of the Master Fund on such day will not accurately reflect the realizable market value of
such commodity futures contract. For example, daily limits are generally triggered in the event of a significant change in market price of a commodity futures contract. Therefore, as a result of the daily limit, the current settlement price is
unavailable. Because the settlement price on the most recent day on which the position could have been liquidated would be used in lieu of the actual settlement price on the date of determination, there is a risk that the resulting calculation of
the net asset value of the Master Fund (and, in turn, the Fund) could be under or overstated, perhaps to a significant degree.
Although the Limited Shares are Limited Liability Investments, Certain Circumstances such as Bankruptcy of the Fund or Indemnification of the Fund by the Shareholders will Increase the Shareholders’ Liability.
The Limited Shares are limited liability investments; investors may not lose more than the amount that they invest plus any profits
recognized on their investment. However, Shareholders could be required, as a matter of bankruptcy law, to return to the estate of the Fund any distribution they received at a time when the Fund was in fact insolvent or in violation of its Trust
Agreement. In addition, although the Managing Owner is not aware of this provision ever having been invoked in the case of any public futures fund, Shareholders agree in the Trust Agreement that they will indemnify the Fund for any harm suffered by
it as a result of:
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•
|
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Shareholders’ actions unrelated to the business of the Fund, or
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13
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•
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Taxes imposed on the Limited Shares by the states or municipalities in which such investors reside.
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