Management
Investment manager:
Legg Mason Partners Fund Advisor, LLC
Subadvisers:
Permal Asset Management LLC (Permal) and Legg Mason Global Asset Allocation, LLC
Portfolio managers:
Christopher Zuelhlsdorff, CFA, and Alexander Pillersdorf. Mr. Zuehlsdorff (Deputy Chief Investment Officer and Portfolio Manager of Permal) and Mr. Pillersdorf (Portfolio Manager of
Permal) have been portfolio managers for the fund since its inception.
Purchase and sale of fund shares
You may purchase, redeem or exchange shares of the fund each day the New York Stock Exchange is open, at the funds net asset value
determined after receipt of your request in good order, subject to any applicable sales charge.
The funds initial and
subsequent investment minimums generally are as follows:
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Investment minimum initial/additional investment ($)
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Class A
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Class C
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Class FI
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Class R
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Class I
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Class IS
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General
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1,000/50
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1,000/50
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N/A
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N/A
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1 million/None*
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N/A
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Uniform Gifts or Transfers to Minor Accounts
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1,000/50
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1,000/50
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N/A
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N/A
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1 million/None*
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N/A
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IRAs
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250/50
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250/50
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N/A
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N/A
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1 million/None*
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N/A
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SIMPLE IRAs
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None/None
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None/None
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N/A
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N/A
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1 million/None*
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N/A
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Systematic Investment Plans
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50/50
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50/50
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N/A
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N/A
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1 million/None*
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N/A
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Clients of Eligible Financial Intermediaries
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None/None
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N/A
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None/None
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N/A
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None/None
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N/A
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Eligible Investment Programs
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None/None
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N/A
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None/None
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None/None
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None/None
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N/A
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Retirement Plans with omnibus accounts held on the books of the fund and certain rollover IRAs
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None/None
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None/None
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None/None
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None/None
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None/None
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None/None
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Other Retirement Plans
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None/None
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None/None
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N/A
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N/A
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1 million/None*
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N/A
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Institutional Investors
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1,000/50
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1,000/50
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N/A
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N/A
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1 million/None
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1 million/None
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*
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Available to investors investing directly with the fund.
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Your financial intermediary may impose different investment minimums.
For more
information about how to purchase, redeem or exchange shares, and to learn which classes of shares are available to you, you should contact your financial intermediary, or, if you hold your shares or plan to purchase shares through the fund, you
should contact the fund by phone at 1-877-721-1926 or by mail at Legg Mason Funds, P.O. Box 55214, Boston, MA 02205-8504.
Tax information
The funds distributions are taxable as ordinary income or capital gain, except when your investment is through
an IRA, 401(k) or other tax-advantaged account.
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Payments to broker/dealers and other financial intermediaries
The funds related companies may pay broker/dealers or other
financial intermediaries (such as a bank or an insurance company) for the sale of fund shares and related services. These payments create a conflict of interest by influencing your broker/dealer or other intermediary or its employees or associated
persons to recommend the fund over another investment. Ask your financial adviser or salesperson or visit your financial intermediarys or salespersons website for more information.
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More on the funds investment strategies, investments and risks
The fund was named Legg Mason Permal Tactical
Allocation Fund prior to January 1, 2013 and was named Permal Tactical Allocation Fund prior to July 31, 2013.
* * *
The fund seeks
total return.
The fund is a fund of funds, which is a term used to describe a mutual fund that pursues its investment
objective by investing primarily in other investment companies (underlying funds).
In seeking to meet its investment objective, the fund
allocates assets in accordance with decisions made by Permal. The fund will seek to achieve its objective by allocating assets and primarily investing in mutual funds, closed-end funds, exchange-traded funds (ETFs) and indexed or other
performance-related instruments, including exchange-traded notes (ETNs), as identified by Permal. The fund may invest in affiliated and unaffiliated open-end funds and unaffiliated closed-end funds. Some of the underlying funds may not be registered
as investment companies under the Investment Company Act of 1940, as amended (the 1940 Act) and/or may not register their securities under the Securities Act of 1933, as amended (the 1933 Act), and are commonly known as
hedge funds. The fund may change the underlying fundswhether affiliated or unaffiliatedfrom time to time without notice to shareholders.
The fund may invest in underlying funds that employ any investment strategy or technique and may invest in any region or country. The fund also may invest directly in equity securities, fixed income
securities, derivatives and hedge fund strategies. The composition of the funds investment portfolio will vary over time based on Permals overall asset allocation decisions and top-down and bottom-up implementation. The fund will remain
flexible in its use of investment strategies and techniques and can seek both long and short exposure through passive and actively managed vehicles.
The fund typically will invest, directly or through underlying funds and ETNs, approximately
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50% to 100% of its total assets in alternative investments, including commodities, real estate assets, infrastructure assets, foreign currencies
and hedge fund strategies
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0% to 50% of its total assets in equity-related investments
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0% to 50% of its total assets in fixed income-related investments
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0% to 40% in cash and cash equivalents
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The fund may invest in hedge fund strategies directly and through underlying funds, including both hedge funds and registered investment companies that employ hedge fund strategies. Hedge fund
strategies may seek both long and short exposures to equities, fixed income, structured credit, currencies, commodities, real estate assets, infrastructure assets and other real assets. The fund will typically invest in multiple discrete styles of
hedge fund investing, including, but not limited to, macro strategies (including discretionary and systematic macro), managed futures, equity long-short, fixed income long-short, distressed debt and event-driven. The fund may also employ various
security, currency or commodity hedging strategies.
The fund may not invest more than 10% of its total assets in any one investment
considered by Permal to be an alternative investment. For purposes of this restriction, all investments in hedge funds will be considered alternative investments.
Permal seeks to allocate fund assets among underlying funds that, in its view, represent attractive investment opportunities that will assist the fund in achieving its investment objective. However,
Permal will consider periodically rebalancing the funds portfolio to maintain what it considers to be an appropriate mix of asset classes, given its prevailing market views. There is no guarantee that any given underlying fund will accept
additional investments from the fund at the time the fund wishes to make such an additional investment or at any time thereafter. Furthermore, any underlying fund may return the funds investment in whole or in part without the funds
consent (as a result of the underlying funds liquidation or other compulsory redemption).
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More on the funds investment strategies, investments and risks contd
Permal anticipates that the number and identity of underlying funds
and other investments will vary over time as a result of allocations and reallocations among new and existing underlying funds and the performance of each underlying fund as compared to the performance of other fund assets. In addition, to avoid
potential adverse regulatory consequences, the fund may need to hold its interest in an underlying fund in non-voting form or limit its voting rights to a certain percentage. Except for ETFs and other underlying funds that it has acquired in
reliance on an exemptive order from the Securities and Exchange Commission (the SEC), the fund generally does not intend to own 5% or more of the voting securities of any underlying unaffiliated fund. Such a limitation on voting rights
is intended to prevent an underlying unaffiliated fund from becoming an affiliated person of the fund for purposes of the 1940 Act. If the fund becomes an affiliated person of an underlying fund through ownership of its voting securities
or otherwise, the 1940 Act may limit the ability of the fund to transact with the underlying fund or its affiliates.
The fund may seek
to gain exposure to certain asset classes, such as ETFs that invest primarily in commodities or master limited partnerships (MLPs), through investments in its wholly-owned subsidiary, Alternative Core Fund Ltd., a Cayman Islands exempted company.
The subsidiary may invest without limit in these investments. The subsidiary has the same investment manager and subadvisers as the fund. The fund may invest up to 25% of its assets in the subsidiary.
The funds investment strategies may be changed without shareholder approval. The funds investment objective may be changed by the Board
of Trustees (the Board) without shareholder approval and on notice to shareholders.
Bank loans
The fund may invest (directly or through an underlying fund) in bank loans. Bank loans are fixed and floating rate loans arranged through private
negotiations between a company or a non-U.S. government and one or more financial institutions (lenders). The fund and the underlying funds may obtain interests in bank loans through participations or assignments. The purchaser of a participation
generally has no right to enforce compliance by the borrower with the terms of the loan agreement or any rights of set-off against the borrower. The purchaser of an assignment acquires direct rights against the borrower on the loan.
Borrowing
Certain underlying funds
may be authorized to borrow money, including for investment or cash management purposes. In addition, certain underlying funds may utilize investment techniques and invest in certain financial instruments, such as derivatives, that may result in
financial leverage.
Cash management
The fund and certain underlying funds may hold cash pending investment, and may invest in money market instruments for cash management purposes. The amount of assets the fund and the underlying
funds may hold for cash management purposes will depend on market conditions and the need to meet expected redemption requests.
Commodity-linked derivative instruments
The fund may invest (directly or through an underlying fund) in commodity-linked derivatives instruments such as commodity-linked notes, swap agreements, commodity options, futures and options on
futures that provide exposure to the investment returns of the commodities markets without investing directly in physical commodities.
Concentrated investments
The
funds investments (directly or through underlying funds) may be concentrated in a particular industry, group of industries, sector, geographic region, or asset class or in underlying funds that employ a particular strategy.
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Defensive investing
The fund and certain of the underlying funds may depart from their principal investment strategies in response to adverse market, economic or political conditions by taking temporary defensive
positions, including by investing without limit in any type of money market instruments, short-term debt securities, repurchase agreements or cash. Although a fund has the ability to take defensive positions, it may choose not to do so for a variety
of reasons, even during volatile market conditions.
Derivatives and hedging techniques
The fund and most of the underlying funds may, but need not, use derivative contracts. Derivatives are financial instruments whose value depends
upon, or is derived from, the value of an asset, such as one or more underlying investments, indexes or currencies. The fund and most of the underlying funds may engage in a variety of transactions using derivatives, such as futures and options on
U.S. and non-U.S. securities, securities indexes, interest rates or currencies, options on these futures and forward foreign currency contracts. Derivatives may be used by the fund and most of the underlying funds for any of the following purposes:
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As a hedging technique in an attempt to manage risk in an underlying funds portfolio
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As a substitute for buying or selling securities
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For certain underlying funds, as a means of enhancing returns
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As a cash flow management technique
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A derivative contract will obligate or entitle the fund or an underlying fund to deliver or receive an asset or cash payment based on the change in value of one or more investments, indexes or
currencies. When the fund or an underlying fund enters into derivatives transactions, it may be required to segregate assets or enter into offsetting positions, in accordance with applicable regulations. Such segregation is not a hedging technique
and will not limit the funds or the underlying funds exposure to loss. The fund or the underlying fund will, therefore, have investment risk with respect to both the derivative itself and the assets that have been segregated to offset
the funds or the underlying funds derivative exposure. If such segregated assets represent a large portion of the portfolio of the fund or the underlying fund, portfolio management may be affected as covered positions may have to be
reduced if it becomes necessary for the fund or the underlying fund to reduce the amount of segregated assets in order to meet redemptions or other obligations.
The fund and certain underlying funds will, in determining compliance with any percentage limitation or requirement regarding the use or investment of fund assets, take into account the market value
of its derivative positions that are intended to reduce or create exposure to the applicable category of investments. Other underlying funds are not subject to these requirements in their use of derivatives.
Diversified investments
The fund
is currently classified as a diversified fund under the 1940 Act. The underlying funds may be classified as diversified or non-diversified under the 1940 Act.
Equity investments
Subject to its investment policies, the fund may invest (directly
or through an underlying fund) in all types of equity securities. Equity securities include exchange-traded and over-the-counter (OTC) common and preferred stocks, warrants and rights, securities convertible into common stocks, and securities of
other investment companies and of real estate investment trusts.
Exchange-traded funds (ETFs)
The fund (directly or through an underlying fund) may invest in shares of open-end mutual funds or unit investment trusts that are traded on a stock
exchange, called exchange-traded funds. Typically, an ETF seeks to track (positively or negatively) the performance of an index by holding in its portfolio either the
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More on the funds investment strategies, investments and risks contd
same securities that comprise the index or a representative sample of the index. Investing in an ETF gives the fund exposure to the securities comprising the index on which the ETF is based and
the fund will gain or lose value depending on the performance of the index. Certain ETFs in which the fund may invest seek to track (positively or negatively) a multiple of index performance on any given day.
Exchange-traded notes (ETNs)
The
fund may invest (directly or through an underlying fund) in exchange-traded notes or ETNs, which are debt securities that combine certain aspects of ETFs and bonds. At maturity of the ETN, the issuer pays a return linked to the performance of a
market index, such as a commodity index, to which the ETN is linked, minus the issuers annual fee. Unlike regular bonds, ETNs have no periodic interest payments and principal is not protected. The price of ETNs in the secondary market is
determined by supply and demand, the current performance of the index underlying the ETN and the credit rating of the ETN issuer.
Fixed
income investments
Subject to its investment policies, the fund may invest (directly or through an underlying fund) in all types of
fixed income securities. Fixed income securities represent obligations of corporations, governments and other entities to repay money borrowed. Fixed income securities are commonly referred to as debt, debt obligations,
bonds or notes. The issuer of the fixed income security usually pays a fixed, variable or floating rate of interest, and repays the amount borrowed, usually at the maturity of the security. Some fixed income securities,
however, do not pay current interest but are sold at a discount from their face values. Other fixed income securities may make periodic payments of interest and/or principal. Some fixed income securities are partially or fully secured by collateral
supporting the payment of interest and principal.
Foreign investments
The fund may invest (directly or through an underlying fund) in securities of foreign issuers, either directly or through depositary receipts.
High yield, lower quality securities
The fund may invest (directly or through an underlying fund) a portion of its assets in debt securities rated below investment grade by a recognized
rating agency or unrated securities determined by the funds adviser to be of equivalent quality. These securities are commonly referred to as junk bonds.
Investments in hedge fund strategies
The fund may, directly or through the
underlying funds, employ a broad variety of hedge fund strategies, including but not limited to those set forth below. References to underlying funds should be read to include the fund when it is employing these strategies directly.
Global fixed income strategies.
Such strategies may include fundamental long-short credit, capital structure arbitrage, high yield debt and non-U.S. debt.
Fundamental long-short credit:
This strategy involves
performing intensive bottom up credit research on, among other factors, an issuers industry and company-specific fundamental drivers, its financial condition, sources of liquidity, access to capital markets and potential ratings changes by
credit agencies. Based on this analysis, underlying funds may decide to take a directional position, either long or short, in a companys debt securities. These funds typically identify specific catalysts in order to exploit these
situations (
e.g.
, exchange offers, workouts, financial reorganizations or other special credit event-related situations).
Capital structure arbitrage:
The portfolio managers of
these underlying funds perform the same intensive bottom up credit research on an issuer described above under Fundamental long-short credit. Based on this analysis, the portfolio managers look for inefficiencies in the
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relative pricing of securities within the same capital structure and may take a long position in a debt security, typically senior in the capital structure (
e.g.
, bank debt or senior bond)
and a parallel short position in another security, typically a subordinated bond, convertible bond, preferred stock or common stock.
High yield debt:
The high yield debt strategy involves
investing predominantly in the debt of financially troubled, or stressed, companies. These companies are generally experiencing financial difficulties that have either led to a default on their indebtedness or increased the likelihood of
default. The portfolio managers of high yield debt underlying funds will generally consider, among other factors, the price of the security, the prospects of the company, the companys history, management and current conditions when making
investment decisions.
Non-U.S.
debt:
Non-U.S. debt investing involves purchasing debt securities issued predominantly by non-U.S. corporations or non-U.S. governments or guaranteed by non-U.S. governments or
any agencies thereof. The strategy will generally consist of underlying funds investing in non-U.S. fixed income portfolios and/or emerging markets debt securities. Given the markets in which they invest, a significant portion of the portfolios
of non-U.S. debt underlying funds may be invested in restricted securities for which a market may not be readily available. Further, an investment in bonds issued by foreign governments or corporations may carry, among other things, significant
geopolitical risks, legal risks, currency risks (
e.g.,
significant devaluations) and liquidity risks (
e.g.,
lack of developed trading markets). To mitigate some of this risk, non-U.S. debt underlying funds may use certain hedging
tools, but there can be no assurance that any such hedging techniques will be successful.
Corporate event-driven strategies.
Event-driven strategies can include risk arbitrage, special situations, activist,
distressed/stressed debt and equity and private placements. Underlying funds employing such strategies maintain positions in companies currently or potentially involved in a wide variety of corporate transactions. Event-driven exposure can include a
combination of equity markets, credit markets and idiosyncratic, company-specific developments. The outcome of the investment is predicated on an event or catalyst.
Risk arbitrage.
Seeks to exploit the change in the price
of a firms securities as a result of a takeover or merger. Typically, an underlying fund will take long positions in the securities of the target firm and short positions in the securities of the acquiring firm.
Special situations.
Involves investing in securities of issuers that are engaged in, or expected to experience, certain special events such as restructurings, spin-offs, liquidations, privatizations, stock buybacks,
bond rating changes from credit agencies, and earnings surprises, all with the intention of profiting from the outcome of such events.
Activist strategies.
Relies on the ability to use a
significant economic stake in the instruments of a company to influence management and corporate decisions in such a way as to increase the value of the holdings (
e.g.,
seeking management changes, selling business units, securing special
dividends and influencing financial restructurings). Underlying funds using activist strategies may attempt to obtain representation on a companys board of directors to impact the firms policies or strategic direction. They can employ an
investment process primarily focused on opportunities in equity and equity-related instruments of companies that are currently or prospectively engaged in a corporate transaction or other catalyst-oriented situation.
Distressed/Stressed debt and equity.
This strategy focuses on investing in debt or equity securities of companies that are either experiencing financial distress or whose credit quality is poor but expected to improve. The objective
of an underlying fund employing this strategy is to obtain profits based upon the perceived material difference between the market value and intrinsic value of these securities, which is calculated based upon an analysis of the relevant assets and
liabilities along with a companys future projected cash flows.
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Private placements.
An underlying fund may invest in privately placed securities, such as structured discount
convertible securities. Normally, such securities are privately offered to an underlying fund by a company in need of timely financing. Portfolio managers generally will hedge with purchases of registered common stock until the registration becomes
effective and then liquidate the position gradually.
Long-equity
strategies:
Involve the purchase of equity and equity-linked instruments in global markets. An equity strategy may focus on a particular capitalization range (
e.g
., small cap
vs. large cap) or a particular industry sector (
e.g
., healthcare, technology or consumer products), may employ a specific investment style (
e.g
., value vs. growth) or may pursue a broad mandate, investing in securities without specific
regard for their issuers capitalization, sector or geography. Some equity strategies may use dynamic equity strategies to create long-biased holdings in potentially favorable positions, sectors or countries. In addition to long equity
investments, dynamic equity strategies generally hedge long positions and employ additional instruments, such as bonds, options, preferred securities and convertible securities.
An underlying fund pursuing an equity strategy typically seeks to capitalize on discrepancies between its advisers evaluation of the intrinsic value of an equity security and assessment of the
forward-looking prospects of the issuer of such security, on the one hand, and the consensus view reflected in the market price of such security, on the other hand. Some underlying funds pursuing this strategy also may seek to extract value by being
more trading-oriented or catalyst-driven.
Equity
long/short.
Equity long/short strategies may employ strategies similar to long-equity strategies, but combine long positions with short sales. Equity long/short strategies are among
the non-traditional absolute return strategies pursued by hedge funds. A distinguishing feature of absolute return strategies is their focus on absolute performance objectives as compared to measuring performance on a relative basis. Absolute return
strategies seek to generate returns that are uncorrelated with traditional performance benchmarks and seek to achieve positive returns even in declining market conditions.
Opportunistic equity.
Opportunistic equity investments
comprise underlying funds that predominantly invest in equity securities in all global markets, including U.S. domestic markets. Portfolio managers of these underlying funds will opportunistically allocate capital to those markets around the world
which present the best opportunities for profit based on either the portfolio managers fundamental company valuation analysis or perceived macroeconomic shifts.
Short sales.
Underlying funds may employ short selling.
A short sale involves the sale of a security that an underlying fund does not own with the expectation of purchasing the same security at a later date at a lower price. Portfolio managers employing this strategy sell short the stock of companies
whose fundamentals, liability profile or growth prospects do not support current public market valuations. Short selling relies on, among other things, fundamental analysis, in-depth knowledge of accounting, an understanding of public market pricing
and/or industry research.
Global macro strategies:
Seek to profit from changes in global financial markets and take positions to take advantage of changes in interest rates, exchange rates, liquidity and other macroeconomic factors. Investments may
be either long or short in securities, derivative contracts or options, and may be in equities, fixed income markets, currencies or commodities. This category is composed of three major management strategies: discretionary strategies,
systematic strategies and natural resources strategies.
Discretionary strategies:
An underlying fund may use discretionary global macro strategies to seek to profit by capturing market moves throughout a broad universe of investment opportunities. These opportunities include
financial markets, such as global equity, currency, and fixed income markets, as well as non-financial markets, such as the energy, agricultural and metals markets. An underlying fund may utilize a combination of fundamental market research and
information in conjunction with quantitative modeling to identify opportunities that exist within the markets. While the markets they invest in may be diverse, underlying funds
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using this strategy may hold more concentrated positions in a limited number of markets at any one time. Positions may be long and short in different markets, and an underlying fund may employ
leverage.
Systematic strategies:
An underlying fund uses systematic global macro strategies and employs proprietary or other models to identify opportunities that exist within a diverse group of financial and non-financial markets
and establish positions based on the models. While subjective investment decisions are made, such decisions are the result of a heavier reliance upon models than is the case with discretionary strategies and the vast majority of trading decisions
are executed without discretion. An underlying fund employing systematic strategies tends to hold positions in several markets at the same time, may be both long and short and tends to use leverage when establishing positions.
Natural resources trading
strategies:
An underlying fund may engage in commodity trading strategies to generally invest on a global basis in a portfolio of securities, commodities and derivative
instruments, which include but are not limited to energy, chemicals, agriculture, food, precious metals, industrial materials (and their related support industries, including oil service, mining equipment, forest products, building/construction
materials, ferrous and non-ferrous metals, petrochemicals and plastics) and related industries and manufacturing (
e.g.,
homebuilding, automobile manufacturing and auto parts, shipbuilding and construction and construction engineering).
Natural resources trading includes commodities and futures, forward, option and swap contracts in agricultural, metals and energy items, among other commodities, while equity investments include securities of companies that produce, process,
convert, transport and service such commodities.
In pursuit of macro strategies, the fund may also invest in underlying funds employing
the following strategies:
Momentum
investing or trend-following strategies:
An underlying fund may engage in momentum investing or trend-following to attempt to take
advantage of the observable tendency of the markets to trend and to tend to make exaggerated movements in both upward and downward directions. These exaggerated movements can be thought of as resulting from the influence of crowd psychology, or the
herd instinct, among market participants. An underlying fund may use this strategy to primarily trade futures, options and forward contracts, though it may take positions in cash, equity securities, investment companies and derivative securities. An
underlying fund may use leverage when establishing positions and hold positions in several markets at the same time.
Other quantitative strategies:
An underlying fund may engage in other quantitative strategies to seek to profit from discrepancies in the valuations of instruments and asset classes caused by differences in macroeconomic
fundamentals and technical factors, both across and within countries using a combination of fundamental, technical, macroeconomic data and linear and nonlinear forecasting models. An underlying fund may invest primarily in broad-based equity and
fixed income index futures and options, currency futures and options, commodity futures and options and swaps, and may also invest in stocks, bonds, currencies, commodities and other instruments, in an opportunistic model-driven fashion.
Relative value strategies:
Include volatility arbitrage and fixed income hedge strategies.
Volatility arbitrage:
Trades volatility as an asset class. Exposures may be long, short or neutral to the direction of implied volatility. Volatility arbitrage strategies may be either directional or relative value in
nature specifically, directional volatility arbitrage strategies seek to express a view on the likely trend of implied volatility across various asset classes including equities, foreign exchange, interest rates and commodities, whereas
relative value volatility arbitrage strategies seek to exploit mispricings between multiple options or instruments containing implied volatility. Volatility arbitrage managers typically invest in instruments including options and variance swaps.
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Fixed income hedge.
Fixed income hedge portfolio managers typically invest long and short primarily in corporate debt
instruments across the capital structure of companies, based on fundamental credit analysis. These portfolio managers run portfolios that have flexible mandates allowing them to invest in a large variety of corporate debt securities, enter short
positions, employ leverage, run concentrated portfolios and hedge credit and interest rate risk in their books. Although fixed income hedge portfolio managers invest a portion of their portfolios in investment grade debt, they typically focus on
high yield lower-rated corporate debt and distressed debt.
Fixed income arbitrage.
Attempts to capture mispricing within and across global fixed income markets and associated derivatives. Value may be added by taking advantage of advantageous tax provisions, yield curve anomalies,
volatility differences and arbitraging bond futures versus the underlying bonds (basis trading). Typically, a large amount of leverage is used to enhance returns.
Convertible arbitrage.
Seeks to profit from the
mispricing of the embedded option in a convertible bond. Frequently, this strategy is characterized by a long convertible position and corresponding short position in the underlying stock. Convertible arbitrage may use low or high levels of leverage
depending upon the specific securities held by an underlying fund.
Managed futures strategies
seek to generate positive total returns in rising or falling markets that are not directly correlated to broad market equity or fixed income returns. Managed futures strategies invest in a wide
variety of futures contracts and futures-related instruments across different asset classes, including commodities, currencies, fixed income and equities. Managed futures strategies can take long or short positions in any of these instruments and
seek to benefit if the price of the underlying instrument rises or falls.
Inflation-indexed securities
The fund may invest (directly or through an underlying fund) in inflation-indexed securities. Inflation-indexed securities are fixed income
securities whose principal value is periodically adjusted according to the rate of inflation. There are two common structures. The U.S. Treasury and some other issuers use a structure that accrues inflation into the principal value of the bond. Most
other issuers pay out the index-based accruals as part of a semiannual coupon. The underlying funds may invest in inflation-indexed securities issued in any country.
Lending of portfolio securities
Consistent with applicable regulatory requirements,
the fund and the underlying funds may lend portfolio securities to brokers, dealers and other financial organizations meeting capital and other credit requirements. Loans of portfolio securities will be collateralized by cash. The fund and the
underlying funds would typically invest cash collateral received in short-term investments. The fund and the underlying funds would generally lend portfolio securities to earn income. Loans will be made to firms deemed by Permal or the adviser of
the underlying fund to be of good standing and will not be made unless, in the judgment of Permal or the adviser of the underlying fund, the consideration to be earned from such loans would justify the risks.
Master limited partnerships (MLPs)
The fund may invest directly or through the underlying funds in MLP units. MLPs are limited partnerships whose interests (limited partnership units) are traded on securities exchanges like shares of
corporate stock. Currently, most MLPs operate in the energy, natural resources or real estate sectors. Due to their partnership structure, MLPs generally do not pay income taxes. Thus, unlike investors in corporate securities, direct MLP investors
are generally not subject to double taxation (i.e., corporate level tax and tax on corporate dividends). The amount of cash that any MLP has available to pay its unit holders in the form of distributions/dividends depends generally on the amount of
cash flow generated from such companys operations. Distributions from an MLP often exceed the MLPs taxable income, decreasing the tax basis of
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the MLPs units and increasing a holders taxable gain or decreasing a holders taxable loss at the time of disposal of such MLP units. Any such distributions that exceed the
remaining tax basis in the MLPs units will be taxable as capital gain immediately, assuming the units are held as capital assets. Certain MLP units have restrictions that limit or restrict the acquisition of such MLP units by regulated
investment companies such as the fund and certain underlying funds. Such limits or restrictions, if enforced, could limit the availability of such units to the fund or certain underlying funds or result in a forced sale at a below market price
and/or loss of rights to receive MLP distributions.
The fund may not invest directly more than 25% of the value of its total assets in
the securities of MLPs that are treated for U.S. federal income tax purposes as qualified publicly traded partnerships (QPTPs) (the 25% Limitation). A QPTP means a partnership (i) whose interests are traded on an
established securities market or readily tradable on a secondary market or the substantial equivalent thereof; (ii) that derives at least 90% of its annual income from (a) dividends, interest, payments with respect to securities loans, and
gains from the sale or other disposition of stock, securities or foreign currencies, or other income (including but not limited to gain from options, futures and forward contracts) derived with respect to its business of investing in such stock,
securities or foreign currencies, (b) real property rents, (c) gain from the sale or other disposition of real property, (d) the exploration, development, mining or production, processing, refining, transportation (including pipelines
transporting gas, oil, or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber), industrial source carbon dioxide, or the transportation or storage of certain fuels, and (e) in
the case of a partnership a principal activity of which is the buying and selling of commodities, income and gains from commodities or futures, forwards, and options with respect to commodities; and (iii) that derives less than 90% of its annual
income from the items listed in (a) above. The 25% Limitation generally does not apply to publicly traded partnerships that are not energy- or commodity focused, such as, for instance, asset management-related partnerships.
The fund may also invest in I-Shares issued by affiliates of MLPs, which represent an indirect ownership of MLP limited partnership
interests. Although I-Shares have similar features to MLP common units with respect to distributions, holders of I-Shares receive distributions in the form of additional I-Shares equal to the cash distributions received by the MLP common unit
holders. To the extent the issuers of I-Shares have elected to be treated as corporations for U.S. federal income tax purposes, the funds investments in I-Shares are not subject to the 25% Limitation.
Money market funds
The fund may
invest (directly or through an underlying fund) in money market funds.
Mortgage- and asset-backed securities
The fund may invest (directly or through an underlying fund) in mortgage- and asset-backed securities. Mortgage-backed securities represent direct
or indirect participations in, or are collateralized by and payable from, mortgage loans secured by real property. Asset-backed securities represent an interest in a pool of assets such as receivables from mortgages, credit card loans, automobile
loans and other trade receivables.
Non-publicly traded and illiquid securities
The fund may invest (directly or through an underlying fund) in non-publicly traded and illiquid securities, including securities subject to legal or contractual restrictions on resale or lacking
readily available markets.
Portfolio turnover
The fund and certain underlying funds may engage in active and frequent trading to achieve their principal investment strategies, resulting in high portfolio turnover.
Real estate investment trusts (REITs)
The fund may invest (directly or through an underlying fund) in REITs. REITs are pooled investment vehicles that invest primarily in income producing real estate or real estate related loans or
interests. REITs are generally classified as equity REITs, mortgage REITs or a combination of equity and mortgage REITs.
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Repurchase agreements
The fund may enter (directly or through an underlying fund) into repurchase agreements for cash management purposes. A repurchase agreement is a
transaction in which the seller of a security commits itself at the time of the sale to repurchase that security from the buyer at a mutually agreed upon time and price. The repurchase agreement determines the yield during the purchasers
holding period, while the sellers obligation to repurchase is secured by the value of the underlying security.
Royalty trusts
Royalty trusts are publicly traded investment vehicles that gather income on royalties and pay out almost all cash flows to stockholders
as distributions. Royalty trusts typically have no physical operations and no management or employees. Typically royalty trusts own the rights to royalties on the production and sales of a natural resource, including oil, gas, minerals and timber.
As these deplete, production and cash flows steadily decline, which may decrease distribution rates.
Reverse repurchase agreements
The fund may borrow (directly or through an underlying fund) by entering into reverse repurchase agreements or other borrowing
transactions. In a reverse repurchase agreement, the fund or an underlying fund sells securities to a counterparty in return for cash, and the fund or the underlying fund agrees to repurchase the security at a later date and for a higher price,
representing the cost to the fund or the underlying fund for the money borrowed. The fund or an underlying fund will use the proceeds of a reverse repurchase agreement to purchase other securities which either mature at a date simultaneous with or
prior to the expiration of the reverse repurchase agreement or which are held under an agreement to resell, maturing as of that time.
Short sales
Certain underlying
funds may sell securities short from time to time or engage in shorting strategies. In addition, the fund may invest in short ETFs or short ETNs. In seeking to meet their investment objectives, short ETFs and short ETNs may
engage to a significant extent in short sales. A short sale is a transaction in which an underlying fund, such as an ETF, or ETN sells securities it does not own in anticipation of a decline in the market price of the securities.
If Permal believes the fund may benefit from taking a direct short position in an asset class, it may do so by, among other means, causing the fund
to sell short shares of an ETF that invests in the subject asset class.
Small capitalization issuers
The fund may invest in, and certain of the underlying funds may focus on, investments in small capitalization companies.
Sovereign government and supranational debt
The fund may invest (directly or through an underlying fund) in sovereign debt, including emerging markets sovereign debt. Sovereign debt securities include fixed income securities issued or
guaranteed by governments, their agencies and instrumentalities, and debt securities issued by supranational entities such as the World Bank or the European Union.
U.S. government securities
The fund may invest (directly or through an underlying
fund) in U.S. government securities. U.S. government securities are obligations of, or guaranteed by, the U.S. government, its agencies or government-sponsored entities.
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When-issued securities and delayed-delivery transactions
To secure an advantageous price or yield, the fund may purchase (directly or through an underlying fund) certain securities on a when-issued basis
or purchase or sell securities for delayed delivery. Delivery of the securities in such cases occurs beyond the normal settlement periods, but no payment or delivery is made by the fund prior to the reciprocal delivery or payment by the other party
to the transaction.
Zero coupon securities
The fund may invest (directly or through an underlying fund) in zero coupon securities, which generally pay no cash interest (or dividends in the case of preferred stock) to their holders prior to
maturity.
Other investments
The fund may also use other strategies and invest (directly or through underlying funds) in other securities that are described, along with their risks, in the SAI. However, the fund might not use
all of the strategies and techniques or invest (directly or through underlying funds) in all of the types of securities described in this Prospectus or in the SAI.
Selection process
The composition of the funds investment portfolio will
vary over time, based on, among other things, quantitative and qualitative techniques and risk management guidelines that seek exposure to alternative investments, including commodities, real estate assets, infrastructure assets, foreign currencies,
hedge fund strategies, global equities, fixed income securities and cash and cash equivalents. The fund may employ an asset allocation strategy to exploit perceived inefficiencies or imbalances in equity, fixed income or other asset classes in
any region or country.
The fund will remain flexible in its use of investment strategies or techniques and investments and will be
managed from both a top-down and bottom-up perspective.
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From a top-down perspective, the allocation will reflect the views of the Permal Investment Committee, which considers various qualitative and quantitative
factors relating to the global economy and their impact on global equity, fixed income, currency and commodity markets. The factors used to develop a target asset allocation include, but are not limited to, current and forecasted economic
growth rates, interest rates and inflation trends for U.S. and foreign economies.
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Tactical allocation decisions are supported by various market specialists within Permal and take into consideration relative valuation differentials between
regions and asset classes and the potential return given the anticipated level of risk inherent in each asset class.
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From a bottom-up perspective, underlying fund allocation decisions take into consideration an underlying funds consistency, size, fees, risk/reward and
other investment statistics.
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Permal will cause the fund to invest in underlying funds, including hedge funds (to the
extent permitted under applicable regulatory requirements), ETFs and ETNs that have a range of investment styles and focuses. The underlying equity funds may include, among others, large capitalization funds, medium capitalization funds, small
capitalization funds, growth-oriented funds, value-oriented funds, international equity funds, emerging market equity funds and funds that invest in commodities and real estate-related securities (including REITs). The underlying fixed income funds
similarly have a range of investment focuses and include funds that invest primarily in investment grade fixed income securities or in junk bonds. The underlying funds may employ a wide variety of strategies.
Permal will allocate assets to various underlying funds and ETNs which, in its opinion, are consistent with its guidelines and invest in the markets
and strategies as identified by its asset allocation process. In allocating assets to underlying funds, Permal may consider, among other factors, the general type of strategy employed, depth of experience, fee levels, value, growth potential,
reputation in the industry, consistency, volatility, ability to perform in up and down markets and returns over time.
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The fund will purchase shares of the underlying open-end funds
(other than ETFs) that are offered only to institutional and other eligible investors at net asset value with no initial or contingent deferred sales charges or Rule 12b-1 fees and with generally lower expenses than other share classes.
More on risks of investing in the fund and the underlying funds
Allocation risk.
The funds ability to achieve its
investment goal depends upon the portfolio managers skill in determining the funds asset class allocation and in selecting the best mix of underlying funds. The value of your investment may decrease if the portfolio managers
judgment about the attractiveness, value or market trends affecting a particular asset class, investment style, underlying fund or other issuer is incorrect.
Bank loans risk.
The fund and the underlying funds will assume
the credit risk of both the borrower and the lender that is selling a participation in a bank loan. The fund or the underlying funds may have difficulty disposing of bank loans because, in certain cases, the market for such instruments is not highly
liquid. The lack of a highly liquid secondary market may have an adverse impact on the value of such instruments and on the funds and the underlying funds ability to dispose of the bank loan in response to a specific economic event, such
as deterioration in the creditworthiness of the borrower.
Borrowing
risk.
Certain borrowings may create an opportunity for increased return but, at the same time, create special risks. Borrowing may make the value of an investment in an underlying
fund more volatile and increase the underlying funds overall investment exposure. For example, borrowing may exaggerate changes in the net asset value of the underlying funds shares and in the return on the underlying funds
securities holdings. The underlying fund may be required to liquidate fund securities at a time when it would be disadvantageous to do so in order to make payments with respect to any borrowing. Interest on any borrowing will be a fund expense and
will reduce the value of the underlying funds shares.
Cash
management and defensive investing risk.
The value of the investments held by the fund or an underlying fund for cash management or defensive investing purposes may be affected by
changing interest rates and by changes in credit ratings of the investments. If the fund or an underlying fund holds cash uninvested it will be subject to the credit risk of the depository institution holding the cash. If a significant amount
of the fund or an underlying funds assets are used for cash management or defensive investing purposes, the fund or the underlying fund may not achieve its respective investment objective.
Closed-end investment company risk.
Investing in a closed-end investment company will give the fund exposure to the securities comprising the closed-end investment company and will expose the fund to risks similar to those of
investing directly in those securities. Shares of closed-end investment companies are traded on exchanges and may trade at either a premium or discount to net asset value. The fund will pay brokerage commissions in connection with the purchase and
sale of shares of closed-end investment companies.
Commodity-linked derivatives risk.
Investments by the fund (directly or through an underlying fund) in commodity-linked derivative instruments may subject the fund to greater volatility than investments in traditional securities.
The value of commodity-linked derivative instruments may be affected by changes in overall market movements, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease,
embargoes, tariffs and international economic, political and regulatory developments.
Concentration risk.
To the extent the funds or an underlying funds investments are concentrated, the fund may
present more risks than if it were broadly diversified over numerous industries, group of industries, sectors, geographic regions, asset classes, or underlying fund strategies. A downturn in any category in which the fund or an underlying fund may
be concentrated would have a larger negative impact on the fund than on a fund that does not concentrate its investments.
Credit risk.
If an obligor (such as the issuer itself or a party offering credit enhancement) for a security held by the fund
or an underlying fund fails to pay, otherwise defaults, is perceived to be less creditworthy,
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becomes insolvent or files for bankruptcy or a securitys credit rating is downgraded or the credit quality or value of any underlying assets declines, the value of your investment in the
fund could decline. If the fund or an underlying fund enters into financial contracts (such as certain derivatives, repurchase agreements, reverse repurchase agreements, and when-issued, delayed delivery and forward commitment transactions), the
fund will be subject to the credit risk presented by the counterparty. In addition, the fund or the underlying fund may incur expenses in an effort to protect the funds interest in securities experiencing these events. Credit risk is broadly
gauged by the credit ratings of the securities in which the fund or an underlying fund invests. However, ratings are only the opinions of the companies issuing them and are not guarantees as to quality. Securities rated in the lowest category of
investment grade (Baa/BBB) may possess certain speculative characteristics.
The fund or an underlying fund is subject to greater levels
of credit risk to the extent it holds below investment grade debt securities (that is, securities rated below Baa/BBB or unrated securities of comparable quality), or junk bonds. These securities have a higher risk of issuer default,
because, among other reasons, issuers of junk bonds often have more debt in relation to total capitalization than issuers of investment grade securities. These securities are considered speculative, tend to be less liquid and are more difficult to
value than higher rated securities and may involve major risk of exposure to adverse conditions and negative sentiments. These securities may be in default or in danger of default as to principal and interest. Unrated securities of comparable
quality share these risks.
The fund or an underlying fund may hold securities which are subordinated to more senior securities of the
issuer, or which represent interests in pools of such subordinated securities. The fund or an underlying fund is more likely to suffer a credit loss on subordinated securities than on non-subordinated securities of the same issuer. If there is a
default, bankruptcy or liquidation of the issuer, most subordinated securities are paid only if sufficient assets remain after payment of the issuers non-subordinated securities. In addition, any recovery of interest or principal may take more
time. As a result, even a perceived decline in creditworthiness of the issuer is likely to have a greater impact on subordinated securities.
Currency transactions risk.
The fund or an underlying fund may
not fully benefit from or may lose money on forward currency transactions if changes in currency exchange rates do not occur as anticipated or do not correspond accurately to changes in the value of the funds holdings.
The funds and an underlying funds ability to use forward foreign currency transactions successfully depends on a number of factors,
including the forward foreign currency transactions being available at prices that are not too costly, the availability of liquid markets and the ability of the portfolio managers to accurately predict the direction of changes in currency exchange
rates. Currency exchange rates may be volatile and may be affected by, among other factors, the general economics of a country, the actions of U.S. and foreign governments or central banks, the imposition of currency controls and speculation. A
security may be denominated in a currency that is different from the currency where the issuer is domiciled.
Currency transactions are
subject to counterparty risk, which is the risk that the other party in the transaction will not fulfill its contractual obligation.
Derivatives risk.
Using derivatives, especially for non-hedging purposes, may involve greater risks to the fund or an underlying fund than investing directly in securities, particularly as these instruments may be
very complex and may not behave in the manner anticipated. Certain derivatives transactions may have a leveraging effect on the fund or an underlying fund. Even a small investment in derivative contracts can have a significant impact on a
funds stock market, interest rate or currency exposure. Therefore, using derivatives can disproportionately increase losses and reduce opportunities for gains when stock prices, interest rates or currency rates are changing. The fund or an
underlying fund may not fully benefit from or may lose money on derivatives if changes in their value do not correspond as anticipated to changes in the value of the fund or an underlying funds holdings. Using derivatives may increase the
funds or an underlying funds volatility, which is the degree to which the funds share price may fluctuate within a short time period. Holdings of derivatives also can make the fund or an underlying fund less liquid and harder to
value, especially in declining markets. The fund or an underlying fund may incur additional costs related to derivatives, such as transaction costs and custody expenses, which can adversely affect the funds performance.
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Derivatives are subject to counterparty risk, which is the risk that
the other party in the transaction will not fulfill its contractual obligation.
Recent legislation calls for new regulation of the
derivatives markets. The extent and impact of the regulation are not yet fully known and may not be for some time. New regulation of derivatives may make them more costly, may limit their availability, or may otherwise adversely affect their value
or performance.
Risks associated with the use of derivatives are magnified to the extent that a large portion of the funds assets
are committed to derivatives in general or are invested in just one or a few types of derivatives.
Exchange-traded funds (ETFs) risk.
Investing in an ETF will give the fund (directly or through an underlying fund) exposure to
the securities comprising the index on which the ETF is based and will expose the fund to risks similar to those of investing directly in those securities. Unlike shares of typical mutual funds or unit investment trusts, shares of ETFs are traded on
an exchange and may trade throughout a trading day. ETFs are bought and sold based on market values and not at net asset value, and therefore may trade at either a premium or discount to net asset value. However, the trading prices of index-based
ETFs tend to closely track the actual net asset value of the underlying portfolios. The fund will generally gain or lose value on holdings of an ETF consistent with the performance of the index on which the ETF is based. The fund will pay brokerage
commissions in connection with the purchase and sale of shares of ETFs.
Exchange-traded notes (ETNs) risk.
ETNs are not structured as investment companies and thus are not regulated under the 1940 Act. ETNs may be traded on stock exchanges and generally track specified market indexes, and their value
depends on the performance of the underlying index and the credit rating of the issuer. ETNs may be held to maturity, but there are no periodic interest payments and principal is not protected. The fund (directly or through an underlying fund) could
lose some or the entire amount invested in an ETN.
Extension
risk.
When interest rates rise, repayments of fixed income securities, particularly asset- and mortgage-backed securities, may occur more slowly than anticipated, extending the
effective duration of these fixed income securities at below market interest rates and causing their market prices to decline. This may cause the funds or an underlying funds share price to be more volatile.
Foreign investments risk.
The fund or an underlying funds investments in securities of foreign issuers or issuers with significant exposure to foreign markets involve additional risk. Foreign countries in which the
fund or an underlying fund may invest may have markets that are less liquid, less regulated and more volatile than U.S. markets. The value of the funds or an underlying funds investments may decline because of factors affecting the
particular issuer as well as foreign markets and issuers generally, such as unfavorable government actions, and political or financial instability. Lack of information may also affect the value of these securities.
The value of the funds or an underlying funds foreign investments may also be affected by foreign tax laws, special U.S. tax
considerations and restrictions on receiving the investment proceeds from a foreign country. Dividends or interest on, or proceeds from the sale of, foreign securities may be subject to non-U.S. withholding taxes.
In some foreign countries, less information is available about issuers and markets because of less rigorous accounting and regulatory standards than
in the United States. It may be difficult for the fund or an underlying fund to pursue claims against a foreign issuer in the courts of a foreign country. Some securities issued by non-U.S. governments or their subdivisions, agencies and
instrumentalities may not be backed by the full faith and credit of such governments. Even where a security is backed by the full faith and credit of a government, it may be difficult for the fund or an underlying fund to pursue its rights against
the government. Some non-U.S. governments have defaulted on principal and interest payments, and more may do so.
The risks of investing
in foreign securities are heightened when investing in issuers in emerging market countries.
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Growth and value investing
risk.
Growth or value securities as a group may be out of favor and underperform the overall equity market while the market concentrates on other types of securities. Growth
securities typically are very sensitive to market movements because their market prices tend to reflect future expectations. When it appears those expectations will not be met, the prices of growth securities typically fall. Growth securities may
also be more volatile than other investments because they often do not pay dividends. The value approach to investing involves the risk that value stocks may remain undervalued.
Although the fund will not concentrate its investments in any one industry or industry group, it may, like many growth or value funds, weight its investments toward certain industries, thus
increasing its exposure to factors adversely affecting issuers within those industries. Certain underlying funds may also weight their investments toward certain industries or groups of industries.
Hedge funds risk.
The fund may invest in certain underlying funds that are not registered under the 1940 Act, and, therefore, the fund will not be entitled to the protections of the 1940 Act with respect to its
investments in these underlying funds. Some protections afforded by the 1940 Act to investors of registered investment companies include limitations applicable to the use of leverage and prohibitions on transactions with affiliated persons. The
shares of these funds are not registered under the 1933 Act, are not freely tradable and/or have substantial restrictions and have no active trading market.
Investments in unregistered funds generally will be illiquid and generally may not be transferred without the consent of the underlying fund. The fund may be unable to liquidate its investment in an
underlying unregistered fund when desired (and incur losses as a result), or may be required to sell such investment regardless of whether it desires to do so. Upon its withdrawal of all or a portion of its interest in an unregistered fund, the fund
may receive securities that are illiquid or difficult to value. In such a case, Permal would seek to cause the fund to dispose of these securities in a manner that is in the funds best interests. The fund may not be able to withdraw from an
underlying unregistered fund except at certain designated times, thereby limiting the ability of Permal to withdraw assets from an underlying unregistered fund that may have poor performance or for other reasons. The fees paid by unregistered funds
to their advisers and general partners or managing members often are significantly higher than those paid by registered funds and generally include a percentage of gains. The value of the funds interest in these unregistered funds will be
affected by these fees; the funds expense ratio will reflect an allocable portion of these fees and the funds expense limitation excludes such performance-based fees.
Hedge fund strategies risk.
The fund, both directly and through
the underlying funds, may employ investment strategies that involve greater risks than the strategies used by typical mutual funds, including increased use of short sales, leverage and derivative transactions and hedging strategies. The fund may
invest in underlying funds employing proprietary investment strategies that are not fully disclosed, which may involve risks that are not anticipated.
Hedging risk.
The decision as to whether and to what extent the
fund or an underlying fund will engage in hedging transactions to hedge against such risks as credit risk, currency risk and interest rate risk will depend on a number of factors, including prevailing market conditions, the composition of the fund
or the underlying fund and the availability of suitable transactions. Accordingly, there can be no assurance that the fund or an underlying fund will engage in hedging transactions at any given time or from time to time, even under volatile market
environments, or that any such strategies, if used, will be successful. Hedging transactions involve costs and may reduce gains or result in losses.
Inflation-indexed securities risk.
The value of
inflation-indexed fixed income securities generally fluctuates in response to changes in real interest rates, which are in turn tied to the relationship between nominal interest rates and the rate of inflation. Therefore, if inflation were to rise
at a faster rate than nominal interest rates, real interest rates might decline, leading to an increase in value of inflation-indexed securities. In contrast, if nominal interest rates increased at a faster rate than inflation, real interest rates
might rise, leading to a decrease in value of inflation-indexed securities. Although the principal value of inflation-indexed securities declines in periods of deflation, holders at maturity receive no less than the par value of the security.
However, if the fund or an underlying fund purchases inflation-indexed securities in the secondary market
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whose principal values have been adjusted upward due to inflation since issuance, it may experience a loss if there is a subsequent period of deflation. If inflation is lower than expected during
the period the fund or an underlying fund holds an inflation-indexed security, the fund (directly or through the underlying fund) may earn less on the security than on a conventional bond.
Any increase in principal value caused by an increase in the index to which the inflation-indexed securities are tied is taxable in the year the increase occurs, even though the fund or an
underlying fund will not receive cash representing the increase at that time. As a result, the fund or certain underlying funds could be required at times to liquidate other investments, including when it is not advantageous to do so, in order to
satisfy their distribution requirements as a regulated investment company under the Internal Revenue Code of 1986, as amended (the Code).
If real interest rates rise (
i.e.
, if interest rates rise for reasons other than inflation, for example, due to changes in currency exchange rates), the value of inflation-indexed securities
held by the fund or an underlying fund will decline. Moreover, because the principal amount of inflation-indexed securities would be adjusted downward during a period of deflation, the fund or an underlying fund will be subject to deflation risk
with respect to its investments in these securities. Inflation-indexed securities are tied to indexes that are calculated based on rates of inflation for prior periods. There can be no assurance that such indexes will accurately measure the actual
rate of inflation in the prices of goods and services.
Investing in a
fund of funds risk.
By investing in the fund, you will indirectly bear the fees and expenses charged by the underlying funds in which the fund invests in addition to the funds
direct fees and expenses. Your cost of investing in the fund, therefore, may be higher than the cost of investing in a mutual fund that only invests directly in individual securities. The underlying funds may change their investment objectives or
policies without the funds approval. If that were to occur, the fund might be forced to withdraw its investment from such underlying fund at a time that is unfavorable to the fund. Like any security that trades on an exchange, the price of an
underlying closed-end fund or ETF is based on supply and demand, as well as the underlying value of the closed-end funds or ETFs portfolio holdings. Closed-end funds and ETFs may not trade at their underlying net asset value.
Investing primarily in other funds presents special risks:
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One underlying fund may buy the same securities that another underlying fund sells. You would indirectly bear the costs of these trades without
accomplishing any investment purpose.
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The underlying funds invest principally in the securities constituting their asset class (
e.g.
, equity or fixed income). However, under
normal market conditions an underlying fund may vary the percentage of its assets in these securities (subject to any applicable regulatory requirements). Depending on Permals classification of an underlying fund as primarily investing in a
particular asset class (
e.g.
, equity or fixed income), the percentage of securities in a particular asset class held by the underlying funds at any given time and the percentage of the assets of the fund invested in various underlying funds,
the funds actual exposure to the securities in a particular asset class may vary substantially from its intended allocation for that asset class.
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An underlying fund may depart from its principal investment strategies in response to adverse market, economic or political conditions by taking
temporary defensive positions in any type of money market instruments and short-term debt securities or cash without regard to any percentage limitations. If an underlying fund takes a temporary defensive position, the fund may be unable to achieve
its investment objective.
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Issuer risk.
The value of a security can be more volatile than the market as a whole and can perform differently from the value of the market as a whole. The value of a companys securities may deteriorate
because of a variety of factors, including disappointing earnings reports by the issuer, unsuccessful products or services, loss of major customers, major litigation against the issuer or changes in government regulations affecting the issuer or the
competitive environment.
Large capitalization company
risk.
Large capitalization companies may fall out of favor with investors.
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Leverage risk.
An underlying fund may be exposed to leveraging risk by, among other things, engaging in derivative transactions or reverse repurchase agreements. When an underlying fund engages in transactions
that have a leveraging effect on its portfolio, the value of the underlying fund will be more volatile and all other risks tend to be heightened. This is because leverage will generally magnify the effect of any increase or decrease in the value of
the underlying funds underlying assets or create investment risk with respect to a larger pool of assets than the underlying fund would otherwise have. Engaging in such transactions may cause the underlying fund to liquidate positions when it
may not be advantageous to do so to satisfy its obligations.
Liquidity
risk.
Liquidity risk exists when particular investments are difficult to sell. Although most of the funds investments must be liquid at the time of investment, investments may
become illiquid after purchase by the fund, particularly during periods of market turmoil. When the fund or an underlying fund holds illiquid investments, the portfolio may be harder to value, especially in changing markets, and if a fund is forced
to sell these investments to meet redemption requests or for other cash needs, it may suffer a loss. In addition, when there is illiquidity in the market for certain investments, a fund, due to limitations on illiquid investments, may be unable to
achieve its desired level of exposure to a certain sector.
Master
limited partnership (MLP) investment risk.
An investment in MLP units involves certain risks which differ from an investment in the securities of a corporation. Holders of MLP units
have the rights typically afforded to limited partners in a limited partnership. Additionally, conflicts of interest may exist between common unit holders and the general partner of an MLP; for example, a conflict may arise as a result of incentive
distribution payments. The amount of cash that any MLP has available to pay its unit holders in the form of distributions/dividends depends on the amount of cash flow generated from such companys operations. Cash flow from operations will vary
from quarter to quarter and is largely dependent on factors affecting the MLPs operations and factors affecting the energy, natural resources or real estate sectors in general. Investing in MLPs involves certain risks related to investing in
the underlying assets of the MLPs. MLPs holding credit-related investments are subject to interest rate risk and the risk of default on payment obligations by debt issuers. In addition, MLPs are generally considered interest-rate sensitive
investments and during periods of interest rate volatility may not provide attractive returns. MLPs may be adversely affected by fluctuations in the prices of commodities and may be impacted by the levels of supply and demand for commodities. Much
of the benefit the fund derives from its direct or indirect investment in equity securities of MLPs is a result of MLPs generally being treated as partnerships for U.S. federal income tax purposes. A change in current tax law, or a change in
the business of a given MLP, could result in an MLP being treated as a corporation for U.S. federal income tax purposes and subject to corporate level tax on its income, and could reduce the amount of cash available for distribution by the MLP to
its unit holders, such as the fund or an underlying fund. If an MLP were classified as a corporation for federal income tax purposes, the MLP may incur significant federal and state tax liability, likely causing a reduction in the value of the
funds or an underlying funds shares.
Model
risk.
Permals investment models may not adequately take into account certain factors and may result in the fund having a lower return than if the fund were managed using
another technique or investment strategy. In addition, the investment models used by Permal to evaluate securities or securities markets are based on certain assumptions concerning the interplay of market factors. The markets or the prices of
individual securities may be affected by factors not foreseen in developing the models.
Money market funds risk.
The fund may invest in money market funds, which are registered open-end funds that generally seek to
maintain a stable $1.00 per share price. The fund may, however, lose money if shares of money market funds in which it invests fall below $1.00 per share.
Mortgage- and asset-backed securities risk.
The risks of
investing in mortgage- and asset-backed securities ultimately depend upon the payment of the loans by the individual borrowers. In its capacity as purchaser of a mortgage- or asset-backed security, the fund or an underlying fund would generally have
no recourse to the entity that originated the loans in the event of default by the borrower. Additionally, the loans
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underlying mortgage- and asset-backed securities are subject to prepayments, which may shorten the weighted average life of such securities and may lower their return. Changes in the
markets perception of the asset backing the security, the creditworthiness of the servicing agent for the loan pool, the originator of the loans or the financial institution providing any credit enhancement, will all affect the value of a
mortgage- or asset-backed security held by the fund or an underlying fund, as will the exhaustion of any credit enhancement.
Non-diversification risk.
To the extent an underlying fund invests its assets in a smaller number of issuers, the fund will be
more susceptible to negative events affecting those issuers.
Performance-based fee risk.
Portfolio managers of hedge funds typically charge asset-based management fees and are also entitled to receive performance-based fees or allocations. Investments by the fund in these funds would
be subject to these fees and allocations, which would reduce the investment returns of the fund, and are in addition to the funds management fee. The performance-based fees or allocations to portfolio managers of certain underlying funds may
create an incentive for those portfolio managers to make investments that are riskier or more speculative than those that might have been made in the absence of a performance-based fee or allocation. In addition, because a performance-based fee or
allocation will generally be calculated on a basis that includes unrealized appreciation of an underlying funds assets, the fee or allocation may be greater than if it were based solely on realized gains.
Portfolio turnover risk.
Active and frequent trading may lead to the realization and distribution to shareholders of higher short-term capital gains, which would increase their tax liability. Frequent trading also
increases transaction costs, which could detract from the fund or an underlying funds performance.
Prepayment or call risk.
Many fixed income securities give the issuer the option to repay or call the security prior to its
maturity date. Issuers often exercise this right when interest rates fall. Accordingly, if the fund or an underlying fund holds a fixed income security subject to prepayment or call risk, the fund may not benefit fully from the increase in value
that other fixed income securities generally experience when interest rates fall. Upon prepayment of the security, the fund or an underlying fund would also be forced to reinvest the proceeds at then current yields, which would be lower than the
yield of the security that was paid off. In addition, if the fund or an underlying fund purchases a fixed income security at a premium (at a price that exceeds its stated par or principal value), the fund may lose the amount of the premium paid in
the event of prepayment.
Real assets risk.
Investments in real assets directly or through an underlying fund involve a high degree of risk, including significant financial, operating, and competitive risks, and expose the fund to adverse
macroeconomic conditions, such as a rise in interest rates or an economic downturn in a country in which a real asset is located, elevating the risk of loss. Also, real asset investments involve exposure to business cycles, local economic conditions
and other factors that may not be present with other types of investments. These risks may be increased for investments in real assets located outside the United States.
REITs risk.
Investments in REITs expose the fund or underlying
fund to risks similar to investing directly in real estate. The value of these underlying investments may be affected by changes in the value of the underlying real estate, the quality of the property management, the creditworthiness of the issuer
of the investments, and changes in property taxes, interest rates and the real estate regulatory environment. Investments in REITs are also affected by general economic conditions.
Repurchase agreements risk.
Repurchase agreements could involve
certain risks in the event of default or insolvency of the seller, including losses and possible delays or restrictions upon the funds or the underlying funds ability to dispose of the underlying securities. To the extent that, in the
meantime, the value of the securities that the fund has purchased has decreased, the fund could experience a loss.
Reverse repurchase agreements risk.
Reverse repurchase agreements involve leverage, which may exaggerate the increase or
decrease of the value of a funds assets during the term of the agreement.
Risk of increase in expenses.
Your actual costs of investing in the fund may be higher than the expenses shown in Annual
fund operating expenses for a variety of reasons. For example, expense ratios may be higher than those shown if a fee limitation is changed or terminated or if average net assets decrease. Net assets are more likely to decrease and fund
expense ratios are more likely to increase when markets are volatile.
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Royalty trust risk.
The value of the equity securities of the royalty trusts in which the fund invests may fluctuate in accordance with changes in the financial condition of those royalty trusts, the condition of
equity markets generally, commodity prices and other factors. Distributions on royalty trusts in which the fund may invest will depend upon the declaration of distributions from the constituent royalty trusts, but there can be no assurance that
those royalty trusts will pay distributions on their securities.
Securities lending risk.
Lending securities involves the risk of possible delay in receiving additional collateral, delay in recovery of securities when the loan is called or possible loss of collateral should the borrower
fail financially. The fund could also lose money if its short-term investment of the cash collateral declines in value over the period of the loan.
Short sales risk.
A short sale of a security involves the risk
that instead of declining, the price of the security sold short will rise. If the price of the security sold short increases between the time of the short sale and the time the fund replaces the borrowed security, the fund will realize a loss. The
short sale of securities involves the possibility of a theoretically unlimited loss since there is a theoretically unlimited potential for the market price of the security sold short to increase.
Small and medium capitalization company risk.
The fund will be exposed to additional risks as a result of its investments (directly or through an underlying fund) in the securities of small and medium capitalization companies. Small and medium
capitalization companies may fall out of favor with investors; may have limited product lines, operating histories, markets or financial resources; or may be dependent upon a limited management group. The prices of securities of small and medium
capitalization companies generally are more volatile than those of large capitalization companies and are more likely to be adversely affected than large capitalization companies by changes in earnings results and investor expectations or poor
economic or market conditions, including those experienced during a recession. Securities of small and medium capitalization companies may underperform large capitalization companies, may be harder to sell at times and at prices the portfolio
managers believe appropriate and may offer greater potential for losses.
Sovereign debt risk.
Sovereign government and supranational debt involve many of the risks of foreign and emerging markets investments as well as the risk of debt moratorium, repudiation or renegotiation and the fund
or an underlying fund may be unable to enforce its rights against the issuers.
Market and interest rate risk.
The market prices of fixed income and other securities owned by the fund and the underlying
funds may go up or down, sometimes rapidly or unpredictably. If the market prices of the securities owned by the fund and the underlying funds fall, the value of your investment in the fund will decline. The value of a security may fall due to
general market conditions, such as real or perceived adverse economic or political conditions, inflation, changes in interest or currency rates, lack of liquidity in the bond markets or adverse investor sentiment. The equity and debt capital markets
in the United States and internationally have experienced unprecedented volatility. The financial crisis that began in 2008 has caused a significant decline in the value and liquidity of many securities; in particular, the values of some sovereign
debt and of securities of issuers that invest in sovereign debt and related investments have fallen, credit has become more scarce worldwide and there has been significant uncertainty in the markets. This environment could make identifying
investment risks and opportunities especially difficult for Permal and the advisers of the underlying funds. These market conditions may continue or get worse. In response to the crisis, the U.S. and other governments and the Federal Reserve and
certain foreign central banks have taken steps to support financial markets. The withdrawal of this support, failure of efforts in response to the crisis, or investor perception that such efforts are not succeeding could negatively affect financial
markets generally as well as the value and liquidity of certain securities. In addition, policy and legislative changes in the United States and in other countries are changing many aspects of financial regulation. The impact of these changes on the
markets, and the practical implications for market participants, may not be fully known for some time.
Subsidiary risk.
By investing in its subsidiary, the fund is indirectly exposed to the risks associated with the
subsidiarys investments. The investments held by the subsidiary are generally similar to those that are permitted to be held by the fund and are subject to the same risks that apply to similar investments if held directly by the fund. The
subsidiary is not registered under the 1940 Act and is not subject to all the
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requirements of the 1940 Act. The subsidiary is subject to the same investment restrictions and limitations as the fund and follows the funds compliance policies and procedures.
Changes in the laws of the United States and/or the Cayman Islands could result in the inability of the fund or its subsidiary to
operate as described in this Prospectus. For example, the Cayman Islands does not currently impose any income, corporate or capital gains tax, estate duty inheritance tax, gift tax or withholding tax on the subsidiary. If Cayman Islands law changes
such that the subsidiary must pay Cayman Islands taxes, fund shareholders could suffer decreased investment returns.
To receive
pass-through tax treatment as a regulated investment company under the Code, the fund must, among other things, derive at least 90% of its gross income for each taxable year from sources treated under the Code as qualifying income. The
Internal Revenue Service (the Service) has issued to the fund a private letter ruling stating that the income is treated as earnings from a wholly-owned subsidiary is such qualifying income. In July 2011, the Service
suspended the issuance of any further such rulings in order to re-examine the policy underlying them, and it is under some political pressure to change that policy, cease issuing any more such rulings, and even revoke the rulings it has previously
issued. The tax treatment of income from commodity-related investments and the funds income from the subsidiary may be adversely affected by future legislation, Treasury Regulations, and/or guidance issued by the Service that could affect the
character, timing, and/or amount of the funds taxable income or capital gains and distributions it makes. If the Service were to change that policy and revoke the funds ruling, such that the funds income from the subsidiary would
no longer be considered qualifying income, the fund may be unable to qualify as a regulated investment company for one or more taxable years.
Tax risk.
In order to qualify as a regulated investment company
under the Code, the fund must meet certain requirements regarding the source of its income, the diversification of its assets and the distribution of its income. Income that does not meet these requirements, including income from certain
commodity-linked investments, certain commodity-focused ETFs and ETNs and certain MLPs, must be limited to a maximum of 10% of a regulated investment companys gross income. If the fund were to fail to qualify as a regulated investment company,
the fund would be subject to U.S. federal income tax on its net income at regular corporate tax rates (without reduction for distributions to shareholders). When distributed, that income would also be taxable to shareholders as an ordinary dividend
to the extent attributable to the funds earnings and profits. If the fund were to fail to qualify as a regulated investment company and become subject to federal income tax, shareholders of the fund would be subject to diminished returns.
Tracking error risk.
The fund may hold long or short positions through investments in underlying funds and other instruments, such as ETNs, whose investment objectives are to track (positively or negatively) the
performance of a particular market or benchmark index. The performance of these instruments, however, may not match that of the indexes the instruments are designed to track, either on a daily or longer-term basis. Factors such as expenses,
imperfect correlation between an instruments investments and those of its underlying index, rounding of share prices, changes to the composition of the underlying index, regulatory policies, high portfolio turnover rate and the use of leverage
all contribute to tracking error.
Underlying fund rebalancing
risk.
From time to time, an underlying fund may experience relatively large redemptions or subscriptions due to a rebalancing of the assets of the fund or other funds of funds. In
such event, an underlying fund could be required to sell securities or to invest cash at a time when it is not advantageous to do so. An underlying fund may make distributions in-kind, or partly in cash and partly in-kind, to its shareholders,
including the fund. Securities that are distributed in-kind in connection with a redemption may be illiquid and the valuation of those securities will generally be determined according to procedures adopted by the underlying fund. The lack of a
liquid secondary market may have an adverse impact on the value of such instruments and on the funds ability to dispose of the security.
Rebalancings may increase brokerage and/or other transaction costs of an underlying fund, increase the funds expenses or result in the funds becoming too small to be economically viable.
Rebalancings could accelerate the realization of taxable capital gains in underlying funds subject to large redemptions if sales of securities result in capital gains.
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The impact of rebalancings is likely to be greater when the fund owns, redeems, or invests in a
substantial portion of an underlying fund. The effects of rebalancings could adversely affect an underlying funds performance and, therefore, the funds performance.
The adviser of the underlying fund may take such actions as it deems appropriate to minimize such adverse impact, considering the potential benefits of such investments to the underlying fund and
consistent with its obligations to the underlying fund. Permal will seek to cooperate with the adviser of an underlying fund in its efforts to minimize any such adverse impact on the underlying fund. Such actions may cause delay in the rebalancing
of the funds investments in the event of significant market or other events that may require more rapid action.
U.S. government securities risk.
Although the U.S. government guarantees principal and interest payments on securities issued
by the U.S. government and some of its agencies, such as securities issued by the Government National Mortgage Association, this guarantee does not apply to losses resulting from declines in the market value of these securities.
Valuation
risk.
Many factors may influence the price at which the fund could sell any particular portfolio investment. The sales price may well differhigher or lowerfrom the
funds last valuation, and such differences could be significant, particularly for illiquid securities and securities that trade in relatively thin markets and/or markets that experience extreme volatility. If market conditions make it
difficult to value some investments, the fund may value these investments using more subjective methods, such as fair value methodologies. The fund will rely primarily on information provided by underlying unregistered funds in valuing its
investments in such funds. Because these underlying funds generally provide net asset value information no more frequently than monthly, and may provide detailed information on their investment positions no more frequently than annually, the fund
generally fair values its investments in these underlying funds. Investors who purchase or redeem fund shares on days when the fund is holding fair-valued securities may receive fewer or more shares, or lower or higher redemption proceeds, than they
would have received if the fund had not fair-valued the security or had used a different valuation methodology. The value of foreign securities, certain fixed income securities and currencies, as applicable, may be materially affected by events
after the close of the market on which they are valued, but before the fund determines its net asset value. The fund generally will only be able to compare its fair valuation determinations of its investments in unregistered underlying funds with
their net asset values as of the end of each month, when these underlying funds generally provide net asset value information. Inaccurate valuations provided by unregistered underlying funds could adversely affect the value of the funds
shares.
When-issued securities and delayed-delivery transactions
risk.
In entering into a when-issued or delayed-delivery transaction, a fund will rely on the other party to consummate the transaction and may be disadvantaged if the other party
fails to do so.
Zero coupon securities risk.
Zero coupon securities usually are issued and traded at a deep discount from their face or par value and generally are subject to greater fluctuations of market value in response to changing
interest rates than securities of comparable maturities and credit quality that pay cash interest (or dividends in the case of preferred stock) on a current basis.
Please note that there are other factors that could adversely affect your investment and that could prevent the fund from achieving its investment objective. More information about risks appears in
the SAI. Before investing, you should carefully consider the risks that you will assume.
Portfolio holdings
A description of the funds policies and procedures with respect to the disclosure of its portfolio holdings is available in the
SAI. The fund posts its complete portfolio holdings at http://www.leggmason.com/individualinvestors/prospectuses (click on the name of the fund) on a quarterly basis. The fund intends to post its complete portfolio holdings 14 calendar days
following the quarter-end. The fund intends to post partial information concerning the funds portfolio holdings (such as top 10 holdings or sector breakdowns, for example) on the Legg Mason funds website on a monthly basis. The fund
intends to post this partial information 10 business days following each month-end. Such information will remain available until the next months or quarters holdings are posted.
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Legg Mason Partners Fund Advisor, LLC (LMPFA or the
manager) is the funds investment manager. LMPFA, with offices at 620 Eighth Avenue, New York, New York 10018, also serves as the investment manager of other Legg Mason-sponsored funds. LMPFA provides administrative and certain
oversight services to the fund. LMPFA was formed in April 2006 as a result of an internal reorganization to consolidate advisory services after Legg Mason, Inc. (Legg Mason) acquired substantially all of Citigroups asset management
business in December 2005. As of , 2013, LMPFAs total assets under management were approximately $
billion.
Permal Asset Management LLC (Permal) is an investment subadviser to the fund. Permal, with offices at 900 Third
Avenue, New York, New York 10022, with approximately $ billion in assets under management as of , 2013,
is a member of The Permal Group and is owned indirectly by Permal Group Ltd., a holding company of an international financial group of companies. Permal Group Ltd. is a subsidiary of Legg Mason. The Permal Group is one of the largest fund-of-funds
investment management firms in the world with approximately $ billion in assets under management as of
, 2013. Permal provides day-to-day portfolio management with respect to the funds assets, including the allocation among asset classes and the
determination of the funds allocation to particular underlying funds.
Legg Mason Global Asset Allocation, LLC (LMGAA)
is also an investment subadviser to the fund. LMGAA is responsible for implementing Permals portfolio investment decisions for the fund and provides certain compliance and portfolio execution services to the fund. LMGAA has offices at 620
Eighth Avenue, New York, New York 10018. As of , 2013, LMGAAs total assets under management were approximately
$ billion.
Western Asset Management Company (Western Asset) manages the
funds cash and short-term instruments. Western Asset, established in 1971, has offices at 385 East Colorado Boulevard., Pasadena, California 91101 and 620 Eighth Avenue, New York, New York 10018. Western Asset acts as investment adviser to
institutional accounts, such as corporate pension plans, mutual funds and endowment funds. As of , 2013, the total assets under management of Western
Asset and its supervised affiliates were approximately $ billion.
LMPFA, LMGAA and
Western Asset are wholly-owned subsidiaries of Legg Mason. Legg Mason, whose principal executive offices are at 100 International Drive, Baltimore, Maryland 21202, is a global asset management company. As of
, 2013, Legg Masons asset management operations had aggregate assets under management of approximately
$ billion.
Portfolio managers
Christopher Zuehlsdorff is Deputy Chief Investment Officer and Portfolio Manager with Permal. Mr. Zuehlsdorff manages the
Permal Hedge Strategies Fund, Permal Multi-Manager Funds (Lux) Natural Resources Fund, Legg Mason Permal Global Absolute Fund and Permal Tactical Allocation Fund. He joined The Permal Group as a Senior Financial Analyst in 2003, responsible for
discovering and screening both potential and existing investment managers. Prior to that time, Mr. Zuehlsdorff was an IT consultant at Computer Sciences Corporation. Mr. Zuehlsdorff holds an M.B.A. in Finance and Accounting from Carnegie Mellon
University (2003). He also holds a B.A. in Economics and Mathematics from Saint Olaf College (1998). He is a
CFA
®
Charterholder.
Alexander Pillersdorf is a Portfolio Manager with Permal. Mr. Pillersdorf is a Portfolio Manager of Permal Fixed Income Holdings N.V, Permal Emerging Markets Holdings N.V., Permal Tactical
Allocation Fund, Legg Mason Permal Global Absolute Fund and Permal Silk Road Fund Ltd. He joined The Permal Group in 2005 as a Financial Analyst. Prior to Permal, Mr. Pillersdorf was a Financial Analyst at Houlihan Lokey Howard & Zukin. Mr.
Pillersdorf graduated with distinction from the Goizueta Business School at Emory University with a B.B.A in Finance and Accounting (2003) and holds an M.B.A. from The Wharton School of the University of Pennsylvania (2010).
The Permal Investment Committee is also involved in advising with respect to the top-down allocation of investments of the fund. Its members are
listed below:
Isaac Souede, Director Permal Group Ltd., Chairman, Chief Executive Officer and Chief Investment Strategist, Permal
Asset Management LLC
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Mr. Souede has served as Director of Permal Group Inc. since September 1987 and he is also
Chairman, Chief Executive Officer and Chief Investment Strategist. In April 2003, Mr. Souede became the Chairman, Chief Executive Officer and Director of Permal and in July 2005 he became a Director of Permal Group Ltd. Mr. Souede serves
as a director of various Steinhardt Funds as well as other funds within the Permal Family of Funds. Mr. Souede holds an M.B.A. from the University of Michigan and is a Certified Public Accountant in the State of New York.
James R. Hodge, President and Chairman of the Investment Committee, Permal Asset Management LLC
Mr. Hodge joined The Permal Group in 1987. Mr. Hodge is Chairman of the Investment Committee, responsible for asset allocation as well as
performance monitoring and research and analysis of fund managers. In addition he is director, alternate director or on the advisory board of a number of independent offshore investment funds. Prior to joining The Permal Group, Mr. Hodge held a
number of positions culminating in Director of Cost Accounting during four years of employment with the NYSE. He was also the Controller of Biolectron, Inc., a privately held medical products company, for four years. Mr. Hodge has an M.B.A.
from Harvard Business School, a B.S. with highest distinction from Indiana University and is a Certified Public Accountant in the State of New Jersey.
Robert Kaplan, Chief Investment Officer, Executive Vice President, Permal Asset Management LLC
Mr. Kaplan joined The Permal Group in 1996 focusing on the discovery and identification of independent investment managers including the analysis of their styles and strategies. Mr. Kaplan
later became involved in and is currently responsible for ongoing asset allocation, performance monitoring and research. Prior to joining The Permal Group, Mr. Kaplan was an audit manager at Ernst & Young in its financial services
division. Mr. Kaplan has an M.B.A. with honors from Columbia University in New York and a B.S. in accounting from the State University of New York at Albany. Mr. Kaplan was a Certified Public Accountant in the State of New York.
Judy Tchou, Executive Vice President, Permal Asset Management LLC
Ms. Tchou joined The Permal Group in 1991. Her responsibilities include interviewing potential and existing money managers and analyzing and monitoring performance of existing fund managers,
including performing ongoing due diligence. Additionally, Ms. Tchou monitors fund cash flows and oversees the execution of investment transactions. Ms. Tchou has a B.S. in Finance from New York University.
The SAI provides information about the compensation of the portfolio managers, other accounts managed by the portfolio managers and any fund shares
held by the portfolio managers.
Management fee
The fund pays a management fee at an annual rate of 0.65% of its average daily net assets.
For the fiscal year ended December 31, 2012, the fund paid LMPFA an effective management fee of 0.37% of the funds average daily net assets for management services.
A discussion regarding the basis for the Boards approval of the funds management agreement and subadvisory agreements is available in
the funds Annual Report for the fiscal year ended December 31, 2012.
Expense limitation
The manager has agreed to waive fees and/or reimburse operating expenses (other than interest, brokerage (including brokerage commissions paid on
purchases and sales of shares of closed-end funds, ETFs, ETNs and other assets), taxes, incentive or performance-based fees of underlying funds and extraordinary expenses), so that total annual operating expenses are not expected to exceed 1.75% for
Class A shares, 2.50% for Class C shares, 1.75% for Class FI shares, 2.00% for Class R shares, 1.50% for Class I shares and 1.50% for Class IS shares, each subject to recapture as described below. Acquired fund fees and expenses are calculated
based on an average of the net expense ratio (as shown in the most recent prospectus or shareholder report for each underlying fund) of the class of shares of each underlying fund held by the fund, weighted in proportion to the funds
investment allocation among the underlying funds. Acquired fund fees
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and expenses are subject to these arrangements. These arrangements are expected to continue until December 31, 2014, may be terminated prior to that date by agreement of the manager and the
Board, and may be terminated at any time after that date by the manager. These arrangements, however, may be modified by the manager to decrease total annual operating expenses at any time. The manager is also permitted to recapture amounts waived
and/or reimbursed to a class during the same fiscal year if the class total annual operating expenses have fallen to a level below the limits described above. In no case will the manager recapture any amount that would result, on any
particular business day of the fund, in the class total annual operating expenses exceeding the applicable limits described above or any other lower limit then in effect.
Distribution
LMIS, a wholly-owned broker/dealer subsidiary of Legg Mason, serves as
the funds sole and exclusive distributor.
The fund has adopted a Rule 12b-1 shareholder services and distribution plan. Under the
plan, the fund pays distribution and/or service fees based on annualized percentages of average daily net assets, of up to 0.25% for Class A shares; up to 1.00% for Class C shares; up to 0.25% for Class FI shares; and up to 0.50% for Class R
shares. These fees are an ongoing expense and, over time, will increase the cost of your investment and may cost you more than other types of sales charges. Class I shares and Class IS shares are not subject to distribution and/or service fees under
the plan.
In addition, the distributor, the manager and/or their affiliates make payments for distribution, shareholder servicing,
marketing and promotional activities and related expenses out of their profits and other available sources, including profits from their relationships with the fund. These payments are not reflected as additional expenses in the fee table contained
in this Prospectus. The recipients of these payments may include the funds distributor and affiliates of the manager, as well as non-affiliated broker/dealers, insurance companies, financial institutions and other financial intermediaries
through which investors may purchase shares of the fund, including your financial intermediary. The total amount of these payments is substantial, may be substantial to any given recipient and may exceed the costs and expenses incurred by the
recipient for any fund-related marketing or shareholder servicing activities. The payments described in this paragraph are often referred to as revenue sharing payments. Revenue sharing arrangements are separately negotiated between the
distributor, the manager and/or their affiliates and the recipients of these payments.
Revenue sharing payments create an incentive for
an intermediary or its employees or associated persons to recommend or sell shares of the fund to you. Contact your financial intermediary for details about revenue sharing payments it receives or may receive. Revenue sharing payments, as well as
payments under the shareholder services and distribution plan (where applicable), also benefit the manager, the distributor and their affiliates to the extent the payments result in more assets being invested in the fund on which fees are being
charged.
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Choosing a class of shares to buy
Individual investors can generally invest in Class A and Class C
shares. Individual investors who invest directly with the fund and who meet the $1,000,000 minimum initial investment requirement may purchase Class I shares. Individual investors who held Class I shares prior to November 20, 2006 are permitted
to make additional investments in Class I shares.
Retirement Plan and Institutional Investors and Clients of Eligible Financial
Intermediaries should refer to Retirement and Institutional Investors eligible investors below for a description of the classes available to them. Each class has different sales charges and expenses, allowing you to choose a class
that may be appropriate for you.
When choosing which class of shares to buy, you should consider:
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How much you plan to invest
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How long you expect to own the shares
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The expenses paid by each class detailed in the fee table and example at the front of this Prospectus
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Whether you qualify for any reduction or waiver of sales charges
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Availability of share classes
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When choosing between Class A and Class C shares, you should be aware that, generally speaking, the larger the size of your investment and the longer your investment horizon, the more likely it will
be that Class C shares will not be as advantageous as Class A shares. The annual distribution and/or service fees on Class C shares may cost you more over the longer term than the front-end sales charge and service fees you would have paid for
larger purchases of Class A shares. If you are eligible to purchase Class I shares, you should be aware that Class I shares are not subject to a front-end sales charge and generally have lower annual expenses than Class A or Class C shares.
Each class of shares, except Class IS shares, is authorized to pay fees for recordkeeping services to Service Agents. As a result,
operating expenses of classes that incur new or additional recordkeeping fees may increase over time.
You may buy shares:
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Through banks, brokers, dealers, insurance companies, investment advisers, financial consultants or advisers, mutual fund supermarkets and other
financial intermediaries that have entered into an agreement with the distributor to sell shares of the fund (each called a Service Agent)
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Your Service Agent may provide shareholder services that differ from the services provided by other Service Agents. Services provided by your Service Agent may vary by class. You should ask your
Service Agent to explain the shareholder services it provides for each class and the compensation it receives in connection with each class. Remember that your Service Agent may receive different compensation depending on the share class in which
you invest.
Your Service Agent may not offer all classes of shares. You should contact your Service Agent for further information.
More information about the funds classes of shares is available through the Legg Mason funds website. Youll find
detailed information about sales charges and ways you can qualify for reduced or waived sales charges, including:
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The front-end sales charges that apply to the purchase of Class A shares
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The contingent deferred sales charges that apply to the redemption of Class C shares and certain Class A shares
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Who qualifies for lower sales charges on Class A shares
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Who qualifies for a sales load waiver
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To visit the website, go to http://www.leggmason.com/individualinvestors/products, and click on the name of the fund in the dropdown menu.
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Comparing the funds classes
The following table compares key features of the funds classes.
You should review the fee table and example at the front of this Prospectus carefully before choosing your share class. Your Service Agent can help you choose a class that may be appropriate for you. Please contact your Service Agent regarding the
availability of Class FI or Class R shares. You may be required to provide appropriate documentation confirming your eligibility to invest in Class FI or Class R shares. Your Service Agent may receive different compensation depending upon which
class you choose.
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Key features
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Initial sales charge
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Contingent deferred
sales charge
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Annual distribution and/
or service fees
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Exchange privilege
1
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Class
A
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Initial sales charge
You may qualify for
reduction or waiver of initial sales charge
Generally lower annual expenses than Class C
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Up to 5.75%; reduced or waived for large purchases and certain investors. No charge for purchases of $1 million or more
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1.00% on purchases of $1 million or more if you redeem 18 months of purchase (or within 12 months for shares purchased prior to August
1, 2012); waived for certain investors
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0.25% of average daily net assets
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Class A shares of funds sold by the distributor
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Class
C
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No initial sales charge
Contingent deferred sales charge for only 1 year
Does not convert to Class
A
Generally higher annual
expenses than Class A
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None
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1.00% if you redeem within 1 year of purchase; waived for certain investors
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1.00% of average daily net assets
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Class C shares of funds sold by the distributor
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Class
FI
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No initial or contingent deferred sales charge
Only offered to Clients of Eligible Financial Intermediaries and eligible Retirement
Plans
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None
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None
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0.25% of average daily net assets
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Class FI shares of funds sold by the distributor
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Class
R
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No initial or contingent deferred sales charge
Only offered to eligible Retirement Plans with omnibus accounts held on the books of the fund,
Clients of Eligible Financial Intermediaries and Eligible Investment Programs
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None
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None
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0.50% of average daily net assets
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Class R shares of funds sold by the distributor
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Class
I
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No initial or contingent deferred sales charge
Only offered to institutional and other eligible investors
Generally lower annual
expenses than all classes except Class IS
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None
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None
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None
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Class I shares of funds sold by the distributor
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Key features
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Initial sales charge
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Contingent deferred
sales charge
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Annual distribution and/
or service fees
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Exchange privilege
1
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Class
IS
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No initial or contingent deferred sales charge
Only offered to institutional and other eligible investors
Generally lower annual
expenses than the other classes
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None
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None
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None
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Class IS shares of funds sold by the distributor
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1
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Ask your Service Agent about the funds available for exchange.
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Sales charges
Class A shares
You buy Class A shares at the offering price, which is the net asset value plus a sales charge. You pay a lower rate as the size of your investment increases to certain levels called
breakpoints. You do not pay a sales charge on the funds distributions or dividends that you reinvest in additional Class A shares.
The table below shows the rate of sales charge you pay, depending on the amount you purchase. It also shows the amount of broker/dealer compensation that will be paid out of the sales charge if you
buy shares from a Service Agent. For Class A shares sold by the distributor, the distributor will receive the sales charge imposed on purchases of Class A shares (or any contingent deferred sales charge paid on redemptions) and will retain
the full amount of such sales charge. Service Agents will receive a distribution and/or service fee payable on Class A shares at an annual rate of up to 0.25% of the average daily net assets represented by the Class A shares serviced by
them.
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Amount of Investment
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Sales charge
as a % of
offering price
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Sales charge
as a % of net
amount
invested
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Broker/dealer
commission as a
% of
offering price
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Less than $25,000
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5.75
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6.10
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5.00
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$25,000 but less than $50,000
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5.00
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5.26
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4.25
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$50,000 but less than $100,000
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4.50
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4.71
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3.75
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$100,000 but less than $250,000
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3.50
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3.63
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2.75
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$250,000 but less than $500,000
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2.50
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2.56
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2.00
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$500,000 but less than $750,000
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2.00
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2.04
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1.60
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$750,000 but less than $1 million
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1.50
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1.52
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1.20
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$1 million or more
1
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-0-
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-0-
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up to 1.00
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1
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The distributor may pay a commission of up to 1.00% to a Service Agent for purchase amounts of $1 million or more. In such cases, starting in the
thirteenth month after purchase, the Service Agent will also receive an annual distribution and/or service fee of up to 0.25% of the average daily net assets represented by the Class A shares held by its clients. Prior to the thirteenth month,
the distributor will retain this fee. Where the Service Agent does not receive the payment of this commission, the Service Agent will instead receive the annual distribution and/or service fee starting immediately after purchase. Please contact your
Service Agent for more information.
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Investments of $1,000,000 or more
You do not pay an initial sales charge when you buy $1,000,000 or more of Class A shares. However, if you redeem these Class A shares
within 18 months of purchase (or within 12 months for shares purchased prior to August 1, 2012), you will pay a contingent deferred sales charge of 1.00%.
Qualifying for a reduced Class A sales charge
There are several ways you can
combine multiple purchases of Class A shares of funds sold by the distributor to take advantage of the breakpoints in the sales charge schedule. In order to take advantage of reductions in sales charges that may be available to you when you
purchase fund shares, you must inform your Service Agent or the fund if you are eligible for a letter of intent or a right of accumulation and if you own shares of other funds that are eligible to be aggregated with your purchases. Certain records,
such as account statements, may be necessary in order to verify your eligibility for a reduced sales charge.
Accumulation
Privilege
allows you to combine the current value of shares of the fund with other shares of funds sold by the distributor that are owned by:
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your spouse and children under the age of 21
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with the dollar amount of your next purchase of Class A shares for purposes of calculating the initial sales charges.
If you hold fund shares in accounts at two or more Service Agents, please contact your Service Agents to determine which shares may be combined.
Shares of money market funds sold by the distributor acquired by exchange from other funds offered with a sales charge may be combined. Shares of
money market funds sold by the distributor that were not
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acquired by exchange from other funds offered with a sales charge may not be combined. Please contact your Service Agent or the fund for additional information.
Certain trustees and other fiduciaries may be entitled to combine accounts in determining their sales charge.
Letter of Intent
allows you to purchase Class A shares of funds sold by the distributor over a 13-month period and pay the same
sales charge, if any, as if all shares had been purchased at once. At the time you enter into the letter of intent, you select your asset goal amount. Generally, purchases of shares of funds sold by the distributor that are purchased during the
13-month period by:
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your spouse, and children under the age of 21
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are eligible for inclusion under the letter of intent, based on the public offering price at the time of the purchase and any capital appreciation on those shares. In addition, you can include the
current value of any eligible holdings toward your asset goal amount.
If you hold shares of funds sold by the distributor in accounts at
two or more Service Agents, please contact your Service Agents to determine which shares may be credited toward your asset goal amount.
Shares of money market funds sold by the distributor acquired by exchange from other funds offered with a sales charge may be credited toward your
asset goal amount. Please contact your Service Agent for additional information.
If you do not meet your asset goal amount, shares in
the amount of any sales charges due, based on the amount of your actual purchases, will be redeemed from your account.
Waivers for
certain Class A investors
Class A initial sales charges are waived for certain types of investors, including:
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Employees of Service Agents
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Investors who redeemed Class A shares of a fund sold by the distributor in the past 60 days, if the investors Service Agent is
notified
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Directors and officers of any Legg Mason-sponsored fund
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Employees of Legg Mason and its subsidiaries
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Investors investing through certain Retirement Plans
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Investors who rollover fund shares from a qualified retirement plan into an individual retirement account administered on the same retirement
plan platform
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If you qualify for a waiver of the Class A initial sales charge, you must notify your Service Agent
or the fund at
1-877-721-1926 at the time of purchase and provide sufficient information at the time of purchase to permit verification that the purchase qualifies for the initial sales charge waiver.
If you want to learn about additional waivers of Class A initial sales charges, contact your Service Agent, consult the SAI or visit the Legg
Mason funds website, http://www.leggmason.com/individualinvestors/products, and click on the name of the fund in the dropdown menu.
Class C shares
You buy Class C
shares at net asset value with no initial sales charge. However, if you redeem your Class C shares within one year of purchase, you will pay a contingent deferred sales charge of 1.00%.
LMIS generally will pay Service Agents selling Class C shares a commission of up to 1.00% of the purchase price of the Class C shares they sell. LMIS will retain the contingent deferred sales
charges and an annual distribution and/or service fee of up to 1.00% of the average daily net assets represented by the Class C shares serviced by these Service Agents until the thirteenth month after purchase. Starting in the thirteenth month after
purchase, these Service Agents will receive an annual distribution and/or service fee of up to 1.00% of the average daily net assets represented by the Class C shares serviced by them.
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Sales charges contd
Class FI and Class R shares
You buy Class FI and Class R shares at net asset value with no initial sales charge and no contingent deferred sales charge when redeemed.
Service Agents receive an annual distribution and/or service fee of up to 0.25% of the average daily net assets represented by Class FI
shares serviced by them and up to 0.50% of the average daily net assets represented by Class R shares serviced by them.
Class I and
Class IS shares
You buy Class I and Class IS shares at net asset value with no initial sales charge and no contingent deferred sales
charge when redeemed. Class I and Class IS shares are not subject to any distribution and/or service fees.
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More about contingent deferred sales charges
The contingent deferred sales charge is based on the net asset value at
the time of purchase or redemption, whichever is less, and therefore you do not pay a sales charge on amounts representing appreciation or depreciation.
In addition, you do not pay a contingent deferred sales charge:
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When you exchange shares for shares of another fund sold by the distributor
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On shares representing reinvested distributions and dividends
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On shares no longer subject to the contingent deferred sales charge
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Each time you place a request to redeem shares, the fund will first redeem any shares in your account that are not subject to a contingent deferred sales charge and then redeem the shares in your
account that have been held the longest.
If you redeem shares of a fund sold by the distributor and pay a contingent deferred sales
charge, you may, under certain circumstances, reinvest all or part of the redemption proceeds within 60 days and receive pro rata credit for any contingent deferred sales charge imposed on the prior redemption. Please contact your Service Agent for
additional information.
The distributor receives contingent deferred sales charges as partial compensation for its expenses in selling
shares, including the payment of compensation to your Service Agent.
Contingent deferred sales charge waivers
The contingent deferred sales charge for each share class will generally be waived:
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On payments made through certain systematic withdrawal plans
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On certain distributions from a Retirement Plan
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For Retirement Plans with omnibus accounts held on the books of the fund
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For involuntary redemptions of small account balances
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For 12 months following the death or disability of a shareholder
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If you want to learn more about additional waivers of contingent deferred sales charges, contact your Service Agent, consult the SAI or visit the Legg Mason funds website,
http://www.leggmason.com/individualinvestors/products, and click on the name of the fund in the dropdown menu.
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Retirement and Institutional Investors
eligible investors
Retirement Plans
Retirement Plans include 401(k) plans, 457 plans, employer-sponsored 403(b) plans, profit-sharing plans, non-qualified deferred
compensation plans and other similar employer-sponsored retirement plans. Retirement Plans do not include individual retirement vehicles, such as traditional and Roth individual retirement accounts, Coverdell education savings accounts, individual
403(b)(7) custodial accounts, Keogh plans, SEPs, SARSEPs, SIMPLE IRAs or similar accounts.
Retirement Plans with omnibus accounts held
on the books of the fund can generally invest in Class A, Class C, Class FI, Class R, Class I and Class IS shares.
Investors who
rollover fund shares from a Retirement Plan into an individual retirement account administered on the same retirement plan platform may hold, purchase and exchange shares of the fund to the same extent as the applicable Retirement Plan.
Although Retirement Plans with omnibus accounts held on the books of the fund are not subject to minimum initial investment requirements for any of
these share classes, certain investment minimums may be imposed by a financial intermediary. The distributor may impose certain additional requirements. Please contact your Service Agent for more information.
Other Retirement Plans
Other
Retirement Plans include Retirement Plans investing through brokerage accounts and also include certain Retirement Plans with direct relationships to the fund that are neither Institutional Investors nor investing through omnibus accounts.
Other Retirement Plans and individual retirement vehicles, such as IRAs, are treated like individual investors for purposes of determining sales charges and any applicable sales charge reductions or waivers.
Other Retirement Plans do not include arrangements whereby an investor would rollover fund shares from a Retirement Plan into an
individual retirement account administered on the same retirement plan platform. Such arrangements are deemed to be Retirement Plans and are subject to the rights and privileges described under Retirement and Institutional
Investorseligible investorsRetirement Plans.
Other Retirement Plan investors can generally invest in Class A,
Class C and Class I shares. Individual retirement vehicles may also choose between these share classes.
Clients of Eligible Financial
Intermediaries
Clients of Eligible Financial Intermediaries are investors who invest in the fund through financial
intermediaries that (i) charge such investors an ongoing fee for advisory, investment, consulting or similar services, or (ii) have entered into an agreement with the distributor to offer Class A, Class FI, Class R or Class I shares
through a no-load network or platform (Eligible Investment Programs). Such investors may include pension and profit sharing plans, other employee benefit trusts, endowments, foundations and corporations. Eligible Investment Programs may
also include college savings vehicles such as Section 529 plans and direct retail investment platforms through mutual fund supermarkets, where the sponsor links its clients account (including IRA accounts on such platforms) to
a master account in the sponsors name. The financial intermediary may impose separate investment minimums.
Clients of Eligible
Financial Intermediaries may generally invest in Class A, Class FI, Class R or Class I shares. Class I shares are available for exchange from Class A or Class C shares of the fund by participants in the Eligible Investment Programs.
Institutional Investors
Institutional Investors may include corporations, banks, trust companies, insurance companies, investment companies, foundations,
endowments, defined benefit plans and other similar entities. The distributor or the financial intermediary may impose additional eligibility requirements or criteria to determine if an investor, including the types of investors listed above,
qualifies as an Institutional Investor.
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43
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Institutional Investors may invest in Class I or Class IS shares if they meet the $1,000,000 minimum
initial investment requirement. Institutional Investors may also invest in Class A and Class C shares, which have different investment minimums, fees and expenses.
Class A shares Retirement Plans
Retirement Plans may buy Class A shares. Under
certain programs for current and prospective Retirement Plan investors sponsored by financial intermediaries, the initial sales charge and contingent deferred sales charge for Class A shares are waived where:
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Such Retirement Plans recordkeeper offers only load-waived shares,
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Fund shares are held on the books of the fund through an omnibus account, and
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The Retirement Plan has more than 100 participants or has total assets exceeding $1 million.
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LMIS does not pay Service Agents selling Class A shares to Retirement Plans with a direct omnibus relationship with the fund a commission on
the purchase price of Class A shares sold by them. However, for certain Retirement Plans that are permitted to purchase shares at net asset value, LMIS may pay Service Agents commissions of up to 1.00% of the purchase price of the Class A
shares that are purchased with regular ongoing plan contributions. Please contact your Service Agent for more information.
Class C
shares Retirement Plans
Retirement Plans with omnibus accounts held on the books of the fund may buy Class C shares at net asset
value without paying a contingent deferred sales charge. LMIS does not pay Service Agents selling Class C shares to Retirement Plans with omnibus accounts held on the books of the fund a commission on the purchase price of Class C shares sold by
them. Instead, immediately after purchase, LMIS may pay these Service Agents an annual distribution and/or service fee of up to 1.00% of the average daily net assets represented by the Class C shares serviced by them.
Certain Retirement Plan programs with exchange features in effect prior to November 20, 2006, as approved by LMIS, will be eligible for
exchange from Class C shares to Class A shares in accordance with the program terms. Please see the SAI for more details.
Class FI
shares
Class FI shares are offered only to Clients of Eligible Financial Intermediaries and Retirement Plan programs.
Class R shares
Class R shares are
offered only to Retirement Plans with omnibus accounts held on the books of the fund (either at the plan level or at the level of the financial intermediary), to Clients of Eligible Financial Intermediaries and through Eligible Investment Programs.
Class I shares
Class I
shares are offered only to Institutional Investors and individual investors (investing directly with the fund) who meet the $1,000,000 minimum initial investment requirement, Retirement Plans with omnibus accounts held on the books of the fund and
certain rollover IRAs, Clients of Eligible Financial Intermediaries and other investors authorized by LMIS. Individual investors who held Class I shares prior to November 20, 2006 are permitted to make additional investments in Class I shares.
Certain waivers of these requirements for individuals associated with the fund, Legg Mason or its affiliates are discussed in the SAI.
Certain waivers of these requirements for individuals associated with the fund, Legg Mason or its affiliates are discussed in the SAI.
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Retirement and Institutional Investors
eligible investors
contd
Class IS shares
Class IS shares may be purchased only by Retirement Plans with omnibus accounts held on the books of the fund, certain rollover IRAs and
Institutional Investors, and other investors authorized by LMIS. In order to purchase Class IS shares, an investor must hold its shares in one account with the fund, which account is not subject to payment of recordkeeping or similar fees by the
fund to any intermediary.
Other considerations
Plan sponsors, plan fiduciaries and other financial intermediaries may choose to impose qualification requirements that differ from the funds share class eligibility standards. In certain
cases this could result in the selection of a share class with higher distribution and/or service fees than otherwise would have been charged. The fund is not responsible for, and has no control over, the decision of any plan sponsor, plan fiduciary
or financial intermediary to impose such differing requirements. Please consult with your plan sponsor, plan fiduciary or financial intermediary for more information about available share classes.
Your Service Agent may not offer all share classes. Please contact your Service Agent for additional details.
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Buying shares
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Generally
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You may buy shares at their net asset value next determined after receipt by your Service
Agent or the transfer agent of your purchase request in good order, plus any applicable sales charge.
You must provide the following information for your order to be processed:
Name of fund being
bought
Class of shares being bought
Dollar amount or number
of shares being bought
Account number (if existing account)
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Through a
Service Agent
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You should contact your Service Agent to open a brokerage account and make arrangements to
buy shares.
Your Service Agent may charge an annual account
maintenance fee.
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Through the fund
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Investors should contact the fund at 1-877-721-1926 to open an account and make
arrangements to buy shares.
For initial purchases, complete and send
your account application to the fund at the following address:
Legg Mason Funds
P.O. Box
55214
Boston, Massachusetts 02205-8504
Subsequent purchases should be sent to the same address. Enclose a check to pay for the shares.
For more information, please call the fund between 8:00 a.m. and 5:30 p.m. (Eastern time).
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Through a
systematic
investment plan
|
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You may authorize your Service Agent or the transfer agent to transfer funds automatically from (i) a regular bank account, (ii)
cash held in a brokerage account with a Service Agent or (iii) certain money market funds, in order to buy shares on a regular basis.
Amounts transferred must
meet the applicable minimums (see Purchase and sale of fund shares)
Amounts may be transferred monthly, every alternate month, quarterly, semi-annually or
annually
If you do not have sufficient funds in your account on a transfer date, you may be charged a fee
For more information, please contact your Service Agent or the fund or
consult the SAI.
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Exchanging shares
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Generally
|
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You may exchange shares of the fund for the same class of shares of other funds sold by
the distributor on any day that both the fund and the fund into which you are exchanging are open for business. For investors who qualify as Clients of Eligible Financial Intermediaries and participate in Eligible Investment Programs made available
through their financial intermediaries (such as investors in fee-based advisory or mutual fund wrap programs), an exchange may be made from Class A or Class C shares to Class I shares of the same fund under certain limited
circumstances. Please refer to the section of this prospectus titled Retirement and Institutional Investors eligible investors or contact your financial intermediary for more information.
An exchange of shares of one fund for shares of another fund is considered a
sale and generally results in a capital gain or loss for federal income tax purposes, unless you are investing through an IRA, 401(k) or other tax-advantaged account. An exchange of shares of one class directly for shares of another class of the
same fund normally should not be taxable for federal income tax purposes. You should talk to your tax advisor before making an exchange.
The exchange privilege is not intended as a vehicle for short-term trading. The fund may suspend or terminate your exchange privilege if you engage
in a pattern of excessive exchanges.
|
Legg Mason
offers a distinctive
family of funds
tailored
to help
meet the varying
needs of large and
small investors
|
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You may exchange shares at their net asset value next determined after receipt by your
Service Agent or the transfer agent of your exchange request in good order.
If you bought shares through a Service Agent, contact your Service Agent to learn which funds your
Service Agent makes available to you for exchanges
If you bought shares directly from the fund, contact the fund at 1-877-721-1926 to learn which
funds are available to you for exchanges
Exchanges may be made only between accounts that have identical registrations
Not all funds offer all classes
Some funds are offered
only in a limited number of states. Your Service Agent or the fund will provide information about the funds offered in your state
Always be sure to read the prospectus of the fund into which you are exchanging shares.
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Investment
minimums, sales
charges and other
requirements
|
|
In most instances, your shares will not be subject to an initial sales charge or a contingent deferred sales charge at the time of the exchange. You may be charged an
initial or contingent deferred sales charge if the shares being exchanged were not subject to a sales charge
Except as noted above,
your contingent deferred sales charge (if any) will continue to be measured from the date of your original purchase of shares subject to a contingent deferred sales charge, and you will be subject to the contingent deferred sales charge of the fund
that you originally purchased
You will generally be
required to meet the minimum investment requirement for the fund or share class into which your exchange is made (except in the case of systematic exchange plans)
Your exchange will also
be subject to any other requirements of the fund or share class into which you are exchanging shares
The fund may suspend or
terminate your exchange privilege if you engage in a pattern of excessive exchanges
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By telephone
|
|
Contact your Service Agent or, if you hold shares directly with the fund, call the fund at 1-877-721-1926 between 8:00 a.m. and 5:30 p.m. (Eastern time) for information.
Exchanges are priced at the net asset value next determined.
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By mail
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Contact your Service Agent or, if you hold shares directly with the fund, write to the
fund at the following address:
Legg Mason Funds
P.O. Box 55214
Boston,
Massachusetts 02205-8504
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Through a
systematic
exchange plan
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You may be permitted to schedule automatic exchanges of shares of the fund for shares of other funds available for exchange. All
requirements for exchanging shares described above apply to these exchanges. In addition:
Exchanges may be made
monthly, every alternate month, quarterly, semi-annually or annually
Each exchange must meet the applicable investment minimums for systematic investment plans (see
Purchase and sale of fund shares)
For more
information, please contact your Service Agent or the fund or consult the SAI.
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Redeeming shares
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Generally
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You may redeem shares at their net asset value next determined after receipt by your
Service Agent or the transfer agent of your redemption request in good order, less any applicable contingent deferred sales charge.
If the shares are held by a fiduciary or corporation, partnership or similar entity, other documents may be required.
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Redemption proceeds
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Your redemption proceeds normally will be sent within 3 business days after your request
is received in good order, but in any event within 7 days, except that your proceeds may be delayed for up to 10 days if your share purchase was made by check.
Your redemption proceeds may be delayed, or your right to receive redemption proceeds suspended, if the New York Stock Exchange (NYSE)
is closed (other than on weekends or holidays) or trading is restricted, if an emergency exists, or otherwise as permitted by order of the SEC.
If you have a brokerage account with a Service Agent, your redemption proceeds will be sent to your Service Agent. Your redemption proceeds can be
sent by check to your address of record or by wire or electronic transfer (ACH) to a bank account designated by you. To change the bank account designated to receive wire or electronic transfers, you will be required to deliver a new written
authorization and may be asked to provide other documents. You may be charged a fee on a wire or an electronic transfer (ACH).
In other cases, unless you direct otherwise, your proceeds will be paid by check mailed to your address of record.
The fund reserves the right to pay redemption proceeds by giving you shares of
underlying funds. The shares that you receive will be valued at the net asset value per share of the class of the underlying fund held by the fund on the day of the redemption. If you later decide to redeem the underlying fund shares, those shares
will be redeemed at the next-determined net asset value per share of the class of the underlying fund that you hold, which may be more or less than the value on the date of your redemption from the fund. You may pay transaction costs to dispose of
the fund shares.
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By mail
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Contact your Service Agent or, if you hold shares directly with the fund, write to the
fund at the following address:
Legg Mason Funds
P.O. Box 55214
Boston,
Massachusetts 02205-8504
Your written request must
provide the following:
The fund name, the class of shares being redeemed and your account number
The dollar amount or
number of shares being redeemed
Signature of each owner exactly as the account is registered
Signature guarantees, as applicable (see Other things to know about transactions)
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By telephone
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If your account application permits, you may be eligible to redeem shares by telephone. Contact your Service Agent or, if you hold
shares directly with the fund, call the fund at 1-877-721-1926 between 8:00 a.m. and 5:30 p.m. (Eastern time) for more information. Please have the following information ready when you call:
Name of fund being redeemed
Class of shares being
redeemed
Account number
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Automatic cash withdrawal plans
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You may be permitted to schedule automatic redemptions of a portion of your shares. To qualify, you must own shares of the fund
with a value of at least $10,000 ($5,000 for Retirement Plan accounts) and each automatic redemption must be at least $50.
The following conditions apply:
Redemptions may be made monthly, every alternate month, quarterly, semi-annually or
annually
If your shares are subject to a contingent deferred sales charge, the charge will be required to be paid upon redemption. However, the charge will be waived if your
automatic redemptions are equal to or less than 2% per month of your account balance on the date the redemptions commence, up to a maximum of 12% in one year
You must elect to have
all dividends and distributions reinvested
For more information,
please contact your Service Agent or the fund or consult the SAI.
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Other things to know about transactions
When you buy, exchange or redeem shares, your request must be in good
order. This means you have provided the following information, without which your request may not be processed:
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In the case of a purchase (including a purchase as part of an exchange transaction), the class of shares being bought
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In the case of an exchange or redemption, the class of shares being exchanged or redeemed (if you own more than one class)
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Dollar amount or number of shares being bought, exchanged or redeemed
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In certain circumstances, the signature of each owner exactly as the account is registered (see Redeeming shares)
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The fund generally will not permit non-resident aliens with non-U.S. addresses to establish accounts. U.S. citizens
with APO/FPO addresses or addresses in the United States (including its territories) and resident aliens with U.S. addresses are permitted to establish accounts with the fund. Subject to the requirements of local law, U.S. citizens residing in
foreign countries are permitted to establish accounts with the fund.
In certain circumstances, such as during periods of market
volatility, severe weather and emergencies, shareholders may experience difficulties placing exchange or redemption orders by telephone. In that case, shareholders should consider using the funds other exchange and redemption procedures
described under Exchanging shares and Redeeming shares.
The transfer agent or the fund will employ reasonable
procedures to confirm that any telephone exchange or redemption request is genuine, which may include recording calls, asking the caller to provide certain personal identification information, sending you a written confirmation or requiring other
confirmation procedures from time to time. If these procedures are followed, neither the fund nor its agents will bear any liability for these transactions.
The fund has the right to:
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Suspend the offering of shares
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Waive or change minimum initial and additional investment amounts
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Reject any purchase or exchange order
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Change, revoke or suspend the exchange privilege
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Suspend telephone transactions
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Suspend or postpone redemptions of shares on any day when trading on the NYSE is restricted or as otherwise permitted by the SEC
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Close your account after a period of inactivity, as determined by state law, and transfer your shares to the appropriate state
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For your protection, the fund or your Service Agent may request additional information in connection with large
redemptions, unusual activity in your account, or otherwise to ensure your redemption request is in good order. Please contact your Service Agent or the fund for more information.
Signature guarantees
To be in good order, your redemption request must include a
signature guarantee if you:
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Are redeeming shares and sending the proceeds to an address or bank not currently on file
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Changed your account registration or your address within 30 days
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Want the check paid to someone other than the account owner(s)
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Are transferring the redemption proceeds to an account with a different registration
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You can obtain a signature guarantee from most banks, dealers, brokers, credit unions and federal savings and loan institutions, but not from a
notary public.
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Anti-money laundering
Federal anti-money laundering regulations require all financial institutions to obtain, verify and record information that identifies each person who opens an account. When you sign your account
application, you may be asked to provide additional information in order for the fund to verify your identity in accordance with these regulations. Accounts may be restricted and/or closed, and the monies withheld, pending verification of this
information or as otherwise required under these and other federal regulations.
Small account balances/Mandatory redemptions
Small accounts may be subject to a small account fee or to mandatory redemption, as described below, depending on whether the account is
held directly with the fund or through a Service Agent.
Direct accounts
Direct accounts generally include accounts held in the name of the individual investor on the funds books and records. To offset the relatively higher impact on fund expenses of servicing
smaller direct accounts, if your shares are held in a direct account and the value of your account is below $1,000 (if applicable, $250 for retirement plans that are not employer-sponsored) for any reason (including declines in net asset value), the
fund may charge you a fee of $3.75 per account that is determined and assessed quarterly on the last business day of the quarter (with an annual maximum of $15.00 per account). The small account fee will be charged by redeeming shares in your
account. If the value of your account is $3.75 or less, the amount in the account may be exhausted to pay the small account fee. The small account fee will not be assessed on systematic investment plans until the end of the first quarter after the
account has been established for 15 months. Payment of the small account fee through a redemption of fund shares may result in tax consequences to you (see Taxes for more information).
The small account fee will not be charged on, if applicable: (i) Retirement Plans (but will be charged on other plans that are not
employer-sponsored such as traditional and Roth individual retirement accounts, Coverdell education savings accounts, individual 403(b)(7) custodial accounts, Keogh plans, SEPs, SARSEPs, SIMPLE IRAs or similar accounts); (ii) Legg Mason funds
that have been closed to subsequent purchases for all classes; (iii) accounts that do not have a valid address as evidenced by mail being returned to the fund or its agents; and (iv) Class FI, Class R, Class I and Class IS shares.
If your share class is no longer offered, you may not be able to bring your account up to the minimum investment amount (although you
may exchange into existing accounts of other Legg Mason funds in which you hold the same share class, to the extent otherwise permitted by those funds and subject to any applicable sales charges).
Non-direct accounts
Non-direct accounts include omnibus accounts and accounts jointly maintained by the Service Agent and the fund. Such accounts are not
subject to the small account fee that may be charged to direct accounts.
The fund reserves the right to ask you to bring your non-direct
account up to a minimum investment amount determined by your Service Agent if the aggregate value of the fund shares in your account is less than $500 for any reason (including solely due to declines in net asset value and/or failure to invest at
least $500 within a reasonable period). You will be notified in writing and will have 60 days to make an additional investment to bring your account value up to the required level. If you choose not to do so within this 60-day period, the fund may
close your account and send you the redemption proceeds. If your share class is no longer offered, you may not be able to bring your account up to the minimum investment amount. Some shareholders who hold accounts in multiple classes of the same
fund may have those accounts aggregated for the purposes of these calculations. If your account is closed, you will not be eligible to have your account reinstated without imposition of any sales charges that may apply to your new purchase. Please
contact your Service Agent for more information. Any redemption of fund shares may result in tax consequences to you (see Taxes for more information).
All accounts
The fund may, with prior notice, change the minimum size of
accounts subject to mandatory redemption, which may vary by class, implement fees for small non-direct accounts or change the amount of the fee for small direct accounts.
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Other things to know about transactions contd
Subject to applicable law, the fund may, with prior notice, adopt other
policies from time to time requiring mandatory redemption of shares in certain circumstances.
For more information, please contact
your Service Agent or the fund or consult the SAI.
Frequent trading of fund shares
Frequent purchases and redemptions of fund shares may interfere with the efficient management of the fund, increase fund transaction costs, and have
a negative effect on the funds long-term shareholders. For example, in order to handle large flows of cash into and out of the fund, the subadviser may need to allocate more assets to cash or other short-term investments or sell securities,
rather than maintaining full investment in securities selected to achieve the funds investment objective. Frequent trading may cause the fund to sell securities at less favorable prices. Transaction costs, such as brokerage commissions and
market spreads, can detract from the funds performance. In addition, the return received by long-term shareholders may be reduced when trades by other shareholders are made in an effort to take advantage of certain pricing discrepancies, when,
for example, it is believed that the funds share price, which is determined at the close of the NYSE on each trading day, does not accurately reflect the value of the funds investments. Funds investing in foreign securities have been
particularly susceptible to this form of arbitrage, but other funds could also be affected.
Because of the potential harm to funds sold
by the funds distributor and their long-term shareholders, the Board has approved policies and procedures that are intended to detect and discourage excessive trading and market timing abuses through the use of various surveillance techniques.
Under these policies and procedures, the fund may limit additional exchanges or purchases of fund shares by shareholders who are believed by the manager to be engaged in these abusive trading activities in the fund or in other funds sold by the
distributor. In the event that an exchange or purchase request is rejected, the shareholder may nonetheless redeem its shares. The intent of the policies and procedures is not to inhibit legitimate strategies, such as asset allocation, dollar cost
averaging, or similar activities that may nonetheless result in frequent trading of fund shares.
Under the funds policies and
procedures, the fund reserves the right to restrict or reject purchases of shares (including exchanges) without prior notice whenever a pattern of excessive trading by a shareholder is detected in funds sold by the distributor. A committee
established by the manager administers the policy. The policy provides that the committee may take action, which may include using its best efforts to restrict a shareholders trading privileges in funds sold by the distributor, if that
shareholder has engaged in one or more Round Trips across all funds sold by the distributor. However, the committee has the discretion to determine that action is not necessary if it is determined that the pattern of trading is not
abusive or harmful. In making such a determination, the committee will consider, among other things, the nature of the shareholders account, the reason for the frequent trading, the amount of trading and the particular funds in which the
trading has occurred. Additionally, the committee has the discretion to make inquiries or to take any action against a shareholder whose trading appears inconsistent with the frequent trading policy, regardless of the number of Round Trips. Examples
of the types of actions the committee may take include heightened surveillance of a shareholder account, providing a written warning letter to an account holder, restricting the shareholder from purchasing additional shares in the fund altogether or
imposing other restrictions (such as requiring purchase orders to be submitted by mail) that would deter the shareholder from trading frequently in the fund. The committee will generally follow a system of progressive deterrence, although it is not
required to do so.
A Round Trip is defined as a purchase (including subscriptions and exchanges) into a fund sold by the
distributor followed by a sale (including redemptions and exchanges) of the same or a similar number of shares out of that fund within 30 days of such purchase. Purchases and sales of the funds shares pursuant to an automatic investment plan
or similar program for periodic transactions are not considered in determining Round Trips. These policies and procedures do not apply to money market funds sold by the distributor.
The policies apply to any account, whether a direct account or accounts with financial intermediaries such as investment advisers, broker/dealers or retirement plan administrators, commonly called
omnibus accounts, where the intermediary holds fund shares for a number of its customers in one account. The
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funds ability to monitor trading in omnibus accounts may, however, be severely limited due to the lack of access to an individual investors trading activity when orders are placed
through these types of accounts. There may also be operational and technological limitations on the ability of the funds service providers to identify or terminate frequent trading activity within the various types of omnibus accounts. The
distributor has entered into agreements with intermediaries requiring the intermediaries to, among other things, help identify frequent trading activity and prohibit further purchases or exchanges by a shareholder identified as having engaged in
frequent trading.
The fund has also adopted policies and procedures to prevent the selective release of information about the
funds holdings, as such information may be used for market-timing and similar abusive practices.
The policies provide for ongoing
assessment of the effectiveness of current policies and surveillance tools, and the Board reserves the right to modify these or adopt additional policies and restrictions in the future. Shareholders should be aware, however, that any surveillance
techniques currently employed by the fund or other techniques that may be adopted in the future may not be effective, particularly where the trading takes place through certain types of omnibus accounts. Furthermore, the fund may not apply its
policies consistently or uniformly, resulting in the risk that some shareholders may be able to engage in frequent trading while others will bear the costs and effects of that trading.
Although the fund will attempt to monitor shareholder transactions for certain patterns of frequent trading activity, there can be no assurance that all such trading activity can be identified,
prevented or terminated. Monitoring of shareholder transactions may only occur for shareholder transactions that exceed a certain transaction amount threshold, which may change from time to time. The fund reserves the right to refuse any client or
reject any purchase order for shares (including exchanges) for any reason.
Record ownership
If you hold shares through a Service Agent, your Service Agent may establish and maintain your account and be the shareholder of record. In the
event that the fund holds a shareholder meeting, your Service Agent, as record holder, will be entitled to vote your shares and may seek voting instructions from you. If you do not give your Service Agent voting instructions, your Service Agent,
under certain circumstances, may nonetheless be entitled to vote your shares.
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Dividends, other distributions and taxes
Dividends and distributions
The fund generally pays dividends and distributes capital gain, if any, once in December and at such other times as are necessary. The fund may pay
additional distributions and dividends at other times if necessary for the fund to avoid a federal tax. Unless otherwise directed, dividends and capital gain distributions are reinvested in additional fund shares of the same class you hold. You do
not pay a sales charge on reinvested distributions or dividends. Alternatively, you can instruct your Service Agent or the fund to have your distributions and/or dividends paid in cash. You can change your choice at any time to be effective as of
the next distribution or dividend.
If you own Class A or Class C shares and hold your shares directly with the fund, you may
instruct the fund to have your distributions and/or dividends invested in Class A or Class C shares, respectively, of another fund sold by the distributor, subject to the following conditions:
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You have a minimum account balance of $10,000
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The fund is available for sale in your state
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To change your election to reinvest your dividends and distributions in shares of another fund, you must notify the fund at least three days before the next distribution is to be paid.
Please contact your Service Agent or the fund to discuss what options are available to you for receiving your dividends and distributions.
The Board reserves the right to revise the dividend policy or postpone the payment of dividends if warranted in the Boards
judgment due to unusual circumstances.
Taxes
The following discussion is very general, applies only to shareholders who are U.S. persons, and does not address shareholders subject to special rules, such as those who hold fund shares through an
IRA, 401(k) plan or other tax-advantaged account. Except as specifically noted, the discussion is limited to federal income tax matters, and does not address state, local, foreign or non-income taxes. Further information regarding taxes, including
certain federal income tax considerations relevant to non-U.S. persons, is included in the SAI. Because each shareholders circumstances are different and special tax rules may apply, you should consult your tax adviser about federal, state,
local and/or foreign tax considerations that may be relevant to your particular situation.
The fund may not invest more than 25% of
the value of its total assets in the securities of MLPs that are treated for U.S. federal income tax purposes as QPTPs (the 25% Limitation). A QPTP means a partnership (i) whose interests are traded on an established securities
market or readily tradable on a secondary market or the substantial equivalent thereof; (ii) that derives at least 90% of its annual income from (a) dividends, interest, payments with respect to securities loans, and gains from the sale or
other disposition of stock, securities or foreign currencies, or other income (including but not limited to gain from options, futures and forward contracts) derived with respect to its business of investing in such stock, securities or foreign
currencies, (b) real property rents, (c) gain from the sale or other disposition of real property, (d) the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas,
oil, or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber), industrial source carbon dioxide, or the transportation or storage of certain fuels, and (e) in the case of a
partnership a principal activity of which is the buying and selling of commodities, income and gains from commodities or futures, forwards, and options with respect to commodities; and (iii) that derives less than 90% of its annual income from
the items listed in (a) above. The 25% Limitation generally does not apply to publicly traded partnerships that are not energy- or commodity-focused, such as, for instance, asset management-related partnerships. An investment in a royalty trust
will be subject to the 25% Limitation if the royalty trust is treated for tax purposes as a QPTP.
In general, redeeming shares,
exchanging shares and receiving dividends and distributions (whether received in cash or reinvested in additional shares or shares of another fund) are all taxable events. An exchange between classes of shares of the same fund normally is not
taxable for federal income tax purposes, whether or not the shares are held in a taxable account.
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The following table summarizes the tax status to you of certain transactions related to the fund.
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Transaction
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Federal income tax status
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Redemption or exchange of shares
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Usually capital gain or loss; long-term only if shares owned more than one year
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Dividends of investment income and distributions of net short-term capital gain
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Ordinary income, or in certain cases qualified dividend income
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Distributions of net capital gain (excess of net long-term capital gain over net short-term capital loss)
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Long-term capital gain
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Distributions attributable to short-term capital gains are taxable to you as ordinary income. Distributions
attributable to qualified dividend income received by the fund, if any, may be eligible to be taxed to noncorporate shareholders at the reduced rates applicable to long-term capital gain if certain requirements are satisfied. Distributions of net
capital gain reported by the fund as capital gain dividends are taxable to you as long-term capital gain regardless of how long you have owned your shares. Noncorporate shareholders ordinarily pay tax at reduced rates on long-term capital gain. The
cash distributed to the fund from the MLPs may exceed the MLPs taxable income in some years. As the funds minimum distribution requirements are based upon taxable income, the fund may not distribute to shareholders all or any of the cash
received from MLP investments. To the extent that distributions exceed the funds earnings and profits, the excess will be tax-free for federal income tax purposes to the extent of your tax basis in your shares, which basis will be reduced;
that reduction will increase the amount of gain (or decrease the amount of loss) you will recognize on a subsequent redemption of your shares. If you have no remaining tax basis to offset, you must report the excess as capital gain, long-term
capital gain if you have held the shares for more than one year.
Beginning in 2013, a Medicare contribution tax will be imposed at
the rate of 3.8% on net investment income of U.S. individuals with income exceeding specified thresholds, and on undistributed net investment income of certain estates and trusts. Net investment income generally includes for this purpose dividends
and capital gain distributions paid by the fund and gain on the redemption or exchange of fund shares.
A dividend declared by the fund
in October, November or December and paid during January of the following year will, in certain circumstances, be treated as paid in December for tax purposes.
If the fund meets certain requirements with respect to its holdings, it may elect to pass through to shareholders foreign taxes that it pays, in which case each shareholder will include
the amount of such taxes in computing gross income, but will be eligible to claim a credit or deduction for such taxes, subject to generally applicable limitations on such deductions and credits. In addition, the funds investment in certain
foreign securities, foreign currencies or foreign currency derivatives may accelerate fund distributions to shareholders and increase the distributions taxed to shareholders as ordinary income.
After the end of each year, your Service Agent or the fund will provide you with information about the distributions and dividends you received and
any redemptions of shares during the previous year. Because each shareholders circumstances are different and special tax rules may apply, you should consult your tax adviser about your investment in the fund.
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Share price
You may buy, exchange or redeem shares at their net asset value next determined after receipt of your request in good
order, adjusted for any applicable sales charge. The funds net asset value per share is the value of its assets minus its liabilities divided by the number of shares outstanding. Net asset value is calculated separately for each class of
shares.
The fund calculates its net asset value every day the NYSE is open. The fund generally values its securities and other assets
and calculates its net asset value as of the close of regular trading on the NYSE, normally at 4:00 p.m. (Eastern time). If the NYSE closes at another time, the fund will calculate its net asset value as of the actual closing time. The NYSE is
closed on certain holidays listed in the SAI.
In order to buy, redeem or exchange shares at a certain days price, you must place
your order with your Service Agent or the transfer agent before the NYSE closes on that day. If the NYSE closes early on that day, you must place your order prior to the actual closing time. It is the responsibility of the Service Agent to transmit
all orders to buy, exchange or redeem shares to the transfer agent on a timely basis.
Investments in underlying funds (except for ETFs)
are valued at the net asset value per share of the class of the underlying fund held by the fund as determined on each business day. The prospectuses for the underlying funds or, in the case of underlying funds that are hedge funds, the offering
documents, describe how an underlying fund values its securities, the circumstances under which the underlying funds will use fair value pricing and the effects of fair value pricing.
The following generally describes how the fund and the underlying funds in the Legg Mason funds complex value their securities:
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Equity securities and certain derivative instruments that are traded on an exchange are valued at the closing price or, if that price is
unavailable or deemed by the manager not representative of market value, the last sale price. Where a security is traded on more than one exchange (as is often the case overseas), the security is generally valued at the price on the exchange
considered by the manager to be the primary exchange. In the case of securities not traded on an exchange, or if exchange prices are not otherwise available, the prices are typically determined by independent third party pricing services that use a
variety of techniques and methodologies.
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The valuations for fixed income securities and certain derivative instruments are typically the prices supplied by independent third party
pricing services, which may use market prices or broker/dealer quotations or a variety of fair valuation techniques and methodologies. Short-term fixed income securities that will mature in 60 days or less are valued at amortized cost, unless it is
determined that using this method would not reflect an investments fair value.
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The valuations of securities traded on foreign markets and certain fixed income securities will generally be based on prices determined as of the
earlier closing time of the markets on which they primarily trade, unless a significant event has occurred. When the fund holds securities or other assets that are denominated in a foreign currency, the fund will normally use the currency exchange
rates as of 4:00 p.m. (Eastern time). The fund uses a fair value model developed by an independent third party pricing service to value foreign equity securities on days when a certain percentage change in the value of a domestic equity
security index suggests that the closing prices on foreign exchanges may no longer represent the value of those securities at the time of closing of the NYSE. Foreign markets are open for trading on weekends and other days when the fund does not
price its shares. Therefore, the value of the funds shares may change on days when you will not be able to purchase or redeem the funds shares.
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For investments in ETFs, the market price is usually the closing sale or official closing price on that exchange.
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If independent third party pricing services are unable to supply prices for a portfolio investment, or if the prices supplied are deemed by the
manager to be unreliable, the market price may be determined by the manager using quotations from one or more broker/dealers. When such prices or quotations are not available, or when the manager believes that they are unreliable, the manager may
price securities using fair value procedures approved by the Board. These procedures permit, among other things, the use of a matrix, formula or other method that takes into consideration market indices, yield curves and other specific adjustments
to determine fair value. Fair value of a security is the amount, as determined
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by the manager in good faith, that the fund might reasonably expect to receive upon a current sale of the security. The fund may also use fair value procedures if the manager determines that a
significant event has occurred between the time at which a market price is determined and the time at which the funds net asset value is calculated.
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Many factors may influence the price at which the fund could sell any particular portfolio investment. The sales price may well differhigher or lowerfrom the funds last valuation,
and such differences could be significant, particularly for securities that trade in relatively thin markets and/or markets that experience extreme volatility. Moreover, valuing securities using fair value methodologies involves greater reliance on
judgment than valuing securities based on market quotations. A fund that uses fair value methodologies may value those securities higher or lower than another fund using market quotations or its own fair value methodologies to price the same
securities. There can be no assurance that the fund could obtain the value assigned to a security if it were to sell the security at approximately the time at which the fund determines its net asset value. Investors who purchase or redeem fund
shares on days when the fund is holding fair-valued securities may receive a greater or lesser number of shares, or higher or lower redemption proceeds, than they would have received if the fund had not fair-valued the security or had used a
different methodology.
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Financial highlights
The financial highlights tables are intended to help you understand
the performance of each class for the periods shown. No financial highlights are presented for Class R shares because no Class R shares were outstanding for the periods shown. The returns for Class R shares will differ from those of the other
classes to the extent that their expenses differ. Certain information reflects financial results for a single share. Total return represents the rate that a shareholder would have earned (or lost) on a fund share assuming reinvestment of all
dividends and distributions. The information in the following tables has been derived from the funds financial statements, which have been audited by
[ ], an independent registered public accounting firm, whose report, along with the funds financial statements, is included in the Annual Report
(available upon request).
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For a share of each class of beneficial interest outstanding throughout each year ended December 31, unless otherwise noted:
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Class A Shares
1
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2012
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2011
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2010
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2009
2
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Net asset value, beginning
of year
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$13.72
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|
|
$14.69
|
|
|
|
$13.66
|
|
|
|
$11.40
|
|
Income (loss) from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment
income
3
|
|
|
0.26
|
|
|
|
0.30
|
|
|
|
0.24
|
|
|
|
0.28
|
|
Net realized and unrealized gain (loss)
|
|
|
1.30
|
|
|
|
(0.97)
|
|
|
|
1.15
|
|
|
|
2.24
|
|
Total income (loss) from operations
|
|
|
1.56
|
|
|
|
(0.67)
|
|
|
|
1.39
|
|
|
|
2.52
|
|
Less distributions from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
(0.44)
|
|
|
|
(0.30)
|
|
|
|
(0.34)
|
|
|
|
(0.20)
|
|
Net realized gains
|
|
|
(0.05)
|
|
|
|
|
|
|
|
(0.02)
|
|
|
|
(0.06)
|
|
Total distributions
|
|
|
(0.49)
|
|
|
|
(0.30)
|
|
|
|
(0.36)
|
|
|
|
(0.26)
|
|
Net asset value, end of
year
|
|
|
$14.79
|
|
|
|
$13.72
|
|
|
|
$14.69
|
|
|
|
$13.66
|
|
Total
return
4
|
|
|
11.41
|
%
|
|
|
(4.58)
|
%
|
|
|
10.19
|
%
|
|
|
21.76
|
%
5
|
Net assets, end of year
(000s)
|
|
|
$17,164
|
|
|
|
$20,408
|
|
|
|
$16,492
|
|
|
|
$17,548
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
expenses
6
|
|
|
1.33
|
%
|
|
|
1.26
|
%
|
|
|
1.61
|
%
|
|
|
7.61
|
%
7
|
Net
expenses
6,8,9
|
|
|
1.02
|
|
|
|
1.05
|
|
|
|
1.13
|
|
|
|
1.16
|
7
|
Net investment income
|
|
|
1.80
|
|
|
|
2.06
|
|
|
|
1.71
|
|
|
|
2.89
|
7
|
Portfolio turnover
rate
|
|
|
72
|
%
|
|
|
99
|
%
|
|
|
112
|
%
|
|
|
76
|
%
|
1
|
Per share amounts have been calculated using the average shares method.
|
2
|
Information is provided for the period April 9, 2009, when the fund began investment operations, to December 31, 2009, except for the
funds total return, which is provided for the period April 13, 2009, when the fund began offering its shares to the public, to December 31, 2009. The per share impact of operations from April 9, 2009 to April 13, 2009 was
$0.03 of unrealized gains, which is reflected in the net realized and unrealized gain amount.
|
3
|
Net investment income per share includes short-term capital gain distributions from underlying funds.
|
4
|
Performance figures, exclusive of sales charges, may reflect compensating balance arrangements, fee waivers and/or expense reimbursements. In the
absence of compensating balance arrangements, fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results. Total returns for periods of less than one year are not annualized.
|
5
|
The total return is provided for the period from April 13, 2009, when the fund began offering its shares to the public, to December 31,
2009. The total return for the period April 9, 2009, when the fund began investment operations, to December 31, 2009 is 22.08%.
|
6
|
Does not include expenses of the underlying funds in which the fund invests.
|
8
|
As a result of an expense limitation arrangement, the ratio of expenses, other than interest, brokerage (including brokerage commissions paid on
purchases and sales of closed-end funds, exchange-traded funds, exchange-traded notes and other assets), taxes, incentive or performance-based fees of underlying funds and extraordinary expenses, to average net assets of Class A shares did not
exceed 1.75%. This expense limitation arrangement cannot be terminated prior to December 31, 2014 without the Board of Trustees consent. The expense limitation takes into account the underlying funds expense ratios.
|
9
|
Reflects fee waivers and/or expense reimbursements.
|
|
|
|
|
|
Permal Alternative Core Fund
|
|
|
59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For a share of each class of beneficial interest outstanding throughout each year ended December 31, unless otherwise noted:
|
|
Class C Shares
1
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
2
|
|
Net asset value, beginning
of year
|
|
|
$13.75
|
|
|
|
$14.71
|
|
|
|
$13.68
|
|
|
|
$11.40
|
|
Income (loss) from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment
income
3
|
|
|
0.17
|
|
|
|
0.21
|
|
|
|
0.18
|
|
|
|
0.28
|
|
Net realized and unrealized gain (loss)
|
|
|
1.27
|
|
|
|
(0.98)
|
|
|
|
1.10
|
|
|
|
2.15
|
|
Total income (loss) from operations
|
|
|
1.44
|
|
|
|
(0.77)
|
|
|
|
1.28
|
|
|
|
2.43
|
|
Less distributions from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
(0.31)
|
|
|
|
(0.19)
|
|
|
|
(0.23)
|
|
|
|
(0.09)
|
|
Net realized gains
|
|
|
(0.05)
|
|
|
|
|
|
|
|
(0.02)
|
|
|
|
(0.06)
|
|
Total distributions
|
|
|
(0.36)
|
|
|
|
(0.19)
|
|
|
|
(0.25)
|
|
|
|
(0.15)
|
|
Net asset value, end of
year
|
|
|
$14.83
|
|
|
|
$13.75
|
|
|
|
$14.71
|
|
|
|
$13.68
|
|
Total
return
4
|
|
|
10.63
|
%
|
|
|
(5.28)
|
%
|
|
|
9.36
|
%
|
|
|
21.03
|
%
5
|
Net assets, end of year
(000s)
|
|
|
$40,887
|
|
|
|
$45,602
|
|
|
|
$31,874
|
|
|
|
$8,452
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
expenses
6
|
|
|
2.05
|
%
|
|
|
2.02
|
%
|
|
|
2.27
|
%
|
|
|
5.49
|
%
7
|
Net
expenses
6,8,9
|
|
|
1.77
|
|
|
|
1.80
|
|
|
|
1.88
|
|
|
|
1.91
|
7
|
Net investment income
|
|
|
1.14
|
|
|
|
1.47
|
|
|
|
1.33
|
|
|
|
2.91
|
7
|
Portfolio turnover
rate
|
|
|
72
|
%
|
|
|
99
|
%
|
|
|
112
|
%
|
|
|
76
|
%
|
1
|
Per share amounts have been calculated using the average shares method.
|
2
|
Information is provided for the period April 9, 2009, when the fund began investment operations, to December 31, 2009, except for the
funds total return, which is provided for the period April 13, 2009, when the fund began offering its shares to the public, to December 31, 2009. The per share impact of operations from April 9, 2009 to April 13, 2009 was
$0.03 of unrealized gains, which is reflected in the net realized and unrealized gain amount.
|
3
|
Net investment income per share includes short-term capital gain distributions from underlying funds.
|
4
|
Performance figures, exclusive of contingent deferred sales charges, may reflect compensating balance arrangements, fee waivers and/or expense
reimbursements. In the absence of compensating balance arrangements, fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results. Total returns for periods of less than one
year are not annualized.
|
5
|
The total return is provided for the period from April 13, 2009, when the fund began offering its shares to the public, to December 31,
2009. The total return for the period April 9, 2009, when the fund began investment operations, to December 31, 2009 is 21.35%.
|
6
|
Does not include expenses of the underlying funds in which the fund invests.
|
8
|
As a result of an expense limitation arrangement, the ratio of expenses, other than interest, brokerage (including brokerage commissions paid on
purchases and sales of closed-end funds, exchange-traded funds, exchange-traded notes and other assets), taxes, incentive or performance-based fees of underlying funds and extraordinary expenses, to average net assets of Class C shares did not
exceed 2.50%. This expense limitation arrangement cannot be terminated prior to December 31, 2014 without the Board of Trustees consent. The expense limitation takes into account the underlying funds expense ratios.
|
9
|
Reflects fee waivers and/or expense reimbursements.
|
|
|
|
60
|
|
Permal Alternative Core Fund
|
Financial highlights contd
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For a share of each class of beneficial interest outstanding throughout each year ended December 31, unless otherwise noted:
|
|
Class FI Shares
1
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
2
|
|
Net asset value, beginning
of year
|
|
|
$13.71
|
|
|
|
$14.68
|
|
|
|
$13.65
|
|
|
|
$11.40
|
|
Income (loss) from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment
income
3
|
|
|
0.28
|
|
|
|
0.27
|
|
|
|
0.23
|
|
|
|
0.23
|
|
Net realized and unrealized gain (loss)
|
|
|
1.28
|
|
|
|
(0.94)
|
|
|
|
1.16
|
|
|
|
2.28
|
|
Total income (loss) from operations
|
|
|
1.56
|
|
|
|
(0.67)
|
|
|
|
1.39
|
|
|
|
2.51
|
|
Less distributions from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
(0.44)
|
|
|
|
(0.30)
|
|
|
|
(0.34)
|
|
|
|
(0.20)
|
|
Net realized gains
|
|
|
(0.05)
|
|
|
|
|
|
|
|
(0.02)
|
|
|
|
(0.06)
|
|
Total distributions
|
|
|
(0.49)
|
|
|
|
(0.30)
|
|
|
|
(0.36)
|
|
|
|
(0.26)
|
|
Net asset value, end of
year
|
|
|
$14.78
|
|
|
|
$13.71
|
|
|
|
$14.68
|
|
|
|
$13.65
|
|
Total
return
4
|
|
|
11.39
|
%
|
|
|
(4.58)
|
%
|
|
|
10.20
|
%
|
|
|
21.67
|
%
5
|
Net assets, end of year
(000s)
|
|
|
$96
|
|
|
|
$90
|
|
|
|
$134
|
|
|
|
$122
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
expenses
6
|
|
|
1.39
|
%
|
|
|
1.41
|
%
|
|
|
1.73
|
%
|
|
|
10.04
|
%
7
|
Net
expenses
6,8,9
|
|
|
1.02
|
|
|
|
1.06
|
|
|
|
1.13
|
|
|
|
1.15
|
7
|
Net investment income
|
|
|
1.90
|
|
|
|
1.86
|
|
|
|
1.67
|
|
|
|
2.39
|
7
|
Portfolio turnover
rate
|
|
|
72
|
%
|
|
|
99
|
%
|
|
|
112
|
%
|
|
|
76
|
%
|
1
|
Per share amounts have been calculated using the average shares method.
|
2
|
Information is provided for the period April 9, 2009, when the fund began investment operations, to December 31, 2009, except for the
funds total return, which is provided for the period April 13, 2009, when the fund began offering its shares to the public, to December 31, 2009. The per share impact of operations from April 9, 2009 to April 13, 2009 was
$0.03 of unrealized gains, which is reflected in the net realized and unrealized gain amount.
|
3
|
Net investment income per share includes short-term capital gain distributions from underlying funds.
|
4
|
Performance figures may reflect compensating balance arrangements, fee waivers and/or expense reimbursements. In the absence of compensating
balance arrangements, fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results. Total returns for periods of less than one year are not annualized.
|
5
|
The total return is provided for the period from April 13, 2009, when the fund began offering its shares to the public, to December 31,
2009. The total return for the period April 9, 2009, when the fund began investment operations, to December 31, 2009 is 21.99%.
|
6
|
Does not include expenses of the underlying funds in which the fund invests.
|
8
|
As a result of an expense limitation arrangement, the ratio of expenses, other than interest, brokerage (including brokerage commissions paid on
purchases and sales of closed-end funds, exchange-traded funds, exchange-traded notes and other assets), taxes, incentive or performance-based fees of underlying funds and extraordinary expenses, to average net assets of Class FI shares did not
exceed 1.75%. This expense limitation arrangement cannot be terminated prior to December 31, 2014 without the Board of Trustees consent. The expense limitation takes into account the underlying funds expense ratios.
|
9
|
Reflects fee waivers and/or expense reimbursements.
|
|
|
|
|
|
Permal Alternative Core Fund
|
|
|
61
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For a share of each class of beneficial interest outstanding throughout each year ended December 31, unless otherwise noted:
|
|
Class I Shares
1
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
2
|
|
Net asset value, beginning
of year
|
|
|
$13.70
|
|
|
|
$14.67
|
|
|
|
$13.64
|
|
|
|
$11.40
|
|
Income (loss) from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment
income
3
|
|
|
0.30
|
|
|
|
0.34
|
|
|
|
0.33
|
|
|
|
0.36
|
|
Net realized and unrealized gain (loss)
|
|
|
1.30
|
|
|
|
(0.98)
|
|
|
|
1.10
|
|
|
|
2.17
|
|
Total income (loss) from operations
|
|
|
1.60
|
|
|
|
(0.64)
|
|
|
|
1.43
|
|
|
|
2.53
|
|
Less distributions from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
(0.48)
|
|
|
|
(0.33)
|
|
|
|
(0.38)
|
|
|
|
(0.23)
|
|
Net realized gains
|
|
|
(0.05)
|
|
|
|
|
|
|
|
(0.02)
|
|
|
|
(0.06)
|
|
Total distributions
|
|
|
(0.53)
|
|
|
|
(0.33)
|
|
|
|
(0.40)
|
|
|
|
(0.29)
|
|
Net asset value, end of
year
|
|
|
$14.77
|
|
|
|
$13.70
|
|
|
|
$14.67
|
|
|
|
$13.64
|
|
Total
return
4
|
|
|
11.72
|
%
|
|
|
(4.35)
|
%
|
|
|
10.48
|
%
|
|
|
21.89
|
%
5
|
Net assets, end of year
(000s)
|
|
|
$39,583
|
|
|
|
$51,732
|
|
|
|
$44,012
|
|
|
|
$8,608
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
expenses
6
|
|
|
1.04
|
%
|
|
|
0.97
|
%
|
|
|
1.19
|
%
|
|
|
6.16
|
%
7
|
Net
expenses
6,8,9
|
|
|
0.77
|
|
|
|
0.80
|
|
|
|
0.88
|
|
|
|
0.91
|
7
|
Net investment income
|
|
|
2.02
|
|
|
|
2.30
|
|
|
|
2.36
|
|
|
|
3.75
|
7
|
Portfolio turnover
rate
|
|
|
72
|
%
|
|
|
99
|
%
|
|
|
112
|
%
|
|
|
76
|
%
|
1
|
Per share amounts have been calculated using the average shares method.
|
2
|
Information is provided for the period April 9, 2009, when the fund began investment operations, to December 31, 2009, except for the
funds total return, which is provided for the period April 13, 2009, when the fund began offering its shares to the public, to December 31, 2009. The per share impact of operations from April 9, 2009 to April 13, 2009 was
$0.03 of unrealized gains, which is reflected in the net realized and unrealized gain amount.
|
3
|
Net investment income per share includes short-term capital gain distributions from underlying funds.
|
4
|
Performance figures may reflect compensating balance arrangements, fee waivers and/or expense reimbursements. In the absence of compensating
balance arrangements, fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results. Total returns for periods of less than one year are not annualized.
|
5
|
The total return is provided for the period from April 13, 2009, when the fund began offering its shares to the public, to December 31,
2009. The total return for the period April 9, 2009, when the fund began investment operations, to December 31, 2009 is 22.21%.
|
6
|
Does not include expenses of the underlying funds in which the fund invests.
|
8
|
As a result of an expense limitation arrangement, the ratio of expenses, other than interest, brokerage (including brokerage commissions paid on
purchases and sales of closed-end funds, exchange-traded funds, exchange-traded notes and other assets), taxes, incentive or performance-based fees of underlying funds and extraordinary expenses, to average net assets of Class I shares did not
exceed 1.50%. This expense limitation arrangement cannot be terminated prior to December 31, 2014 without the Board of Trustees consent. The expense limitation takes into account the underlying funds expense ratios.
|
9
|
Reflects fee waivers and/or expense reimbursements.
|
|
|
|
62
|
|
Permal Alternative Core Fund
|
Financial highlights contd
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For a share of each class of beneficial interest outstanding throughout each year ended December 31, unless otherwise noted:
|
|
Class IS Shares
1
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
2009
2
|
|
Net asset value, beginning
of year
|
|
|
$13.70
|
|
|
|
$14.67
|
|
|
|
$13.64
|
|
|
|
$11.40
|
|
Income (loss) from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment
income
3
|
|
|
0.31
|
|
|
|
0.31
|
|
|
|
0.27
|
|
|
|
0.25
|
|
Net realized and unrealized gain (loss)
|
|
|
1.29
|
|
|
|
(0.95)
|
|
|
|
1.16
|
|
|
|
2.28
|
|
Total income (loss) from operations
|
|
|
1.60
|
|
|
|
(0.64)
|
|
|
|
1.43
|
|
|
|
2.53
|
|
Less distributions from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
(0.48)
|
|
|
|
(0.33)
|
|
|
|
(0.38)
|
|
|
|
(0.23)
|
|
Net realized gains
|
|
|
(0.05)
|
|
|
|
|
|
|
|
(0.02)
|
|
|
|
(0.06)
|
|
Total distributions
|
|
|
(0.53)
|
|
|
|
(0.33)
|
|
|
|
(0.40)
|
|
|
|
(0.29)
|
|
Net asset value, end of
year
|
|
|
$14.77
|
|
|
|
$13.70
|
|
|
|
$14.67
|
|
|
|
$13.64
|
|
Total
return
4
|
|
|
11.74
|
%
|
|
|
(4.35)
|
%
|
|
|
10.48
|
%
|
|
|
21.88
|
%
5
|
Net assets, end of year
(000s)
|
|
|
$93
|
|
|
|
$83
|
|
|
|
$135
|
|
|
|
$122
|
|
Ratios to average net assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
expenses
6
|
|
|
1.13
|
%
|
|
|
1.16
|
%
|
|
|
1.48
|
%
|
|
|
9.79
|
%
7
|
Net
expenses
6,8,9
|
|
|
0.77
|
|
|
|
0.81
|
|
|
|
0.88
|
|
|
|
0.90
|
7
|
Net investment income
|
|
|
2.15
|
|
|
|
2.08
|
|
|
|
1.92
|
|
|
|
2.63
|
7
|
Portfolio turnover
rate
|
|
|
72
|
%
|
|
|
99
|
%
|
|
|
112
|
%
|
|
|
76
|
%
|
1
|
Per share amounts have been calculated using the average shares method.
|
2
|
Information is provided for the period April 9, 2009, when the fund began investment operations, to December 31, 2009, except for the
funds total return, which is provided for the period April 13, 2009, when the fund began offering its shares to the public, to December 31, 2009. The per share impact of operations from April 9, 2009 to April 13, 2009 was
$0.03 of unrealized gains, which is reflected in the net realized and unrealized gain amount.
|
3
|
Net investment income per share includes short-term capital gain distributions from underlying funds.
|
4
|
Performance figures may reflect compensating balance arrangements, fee waivers and/or expense reimbursements. In the absence of compensating
balance arrangements, fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results. Total returns for periods of less than one year are not annualized.
|
5
|
The total return is provided for the period from April 13, 2009, when the fund began offering its shares to the public, to December 31,
2009. The total return for the period April 9, 2009, when the fund began investment operations, to December 31, 2009 is 22.21%.
|
6
|
Does not include expenses of the underlying funds in which the fund invests.
|
8
|
As a result of an expense limitation arrangement, the ratio of expenses, other than interest, brokerage (including brokerage commissions paid on
purchases and sales of closed-end funds, exchange-traded funds, exchange-traded notes and other assets), taxes, incentive or performance-based fees of underlying funds and extraordinary expenses, to average net assets of Class IS shares did not
exceed 1.50%. This expense limitation arrangement cannot be terminated prior to December 31, 2014 without the Board of Trustees consent. The expense limitation takes into account the underlying funds expense ratios.
|
9
|
Reflects fee waivers and/or expense reimbursements.
|
Legg Mason Funds Privacy and Security Notice
Your Privacy and the Security of Your Personal Information is Very Important to the Legg Mason Funds
This Privacy and Security Notice (the Privacy Notice) addresses the Legg Mason Funds privacy and data protection practices with
respect to nonpublic personal information the Funds receive. The Legg Mason Funds include any funds sold by the Funds distributor, Legg Mason Investor Services, LLC, as well as Legg Mason-sponsored closed-end funds and certain closed-end funds
managed or sub-advised by Legg Mason or its affiliates. The provisions of this Privacy Notice apply to your information both while you are a shareholder and after you are no longer invested with the Funds.
The Type of Nonpublic Personal Information the Funds Collect About You
The Funds collect and maintain nonpublic personal information about you in connection with your shareholder account. Such information may include, but is not limited to:
|
|
Personal information included on applications or other forms;
|
|
|
Account balances, transactions, and mutual fund holdings and positions;
|
|
|
Online account access user IDs, passwords, security challenge question responses; and
|
|
|
Information received from consumer reporting agencies regarding credit history and creditworthiness (such as the amount of an individuals
total debt, payment history, etc.).
|
How the Funds Use Nonpublic Personal Information About You
The Funds do not sell or share your nonpublic personal information with third parties or with affiliates for their marketing purposes, or with other
financial institutions or affiliates for joint marketing purposes, unless you have authorized the Funds to do so. The Funds do not disclose any nonpublic personal information about you except as may be required to perform transactions or services
you have authorized or as permitted or required by law. The Funds may disclose information about you to:
|
|
Employees, agents, and affiliates on a need to know basis to enable the Funds to conduct ordinary business or comply with obligations
to government regulators;
|
|
|
Service providers, including the Funds affiliates, who assist the Funds as part of the ordinary course of business (such as printing,
mailing services, or processing or servicing your account with us) or otherwise perform services on the Funds behalf, including companies that may perform marketing services solely for the Funds;
|
|
|
The Funds representatives such as legal counsel, accountants and auditors; and
|
|
|
Fiduciaries or representatives acting on your behalf, such as an IRA custodian or trustee of a grantor trust.
|
Except as otherwise permitted by applicable law, companies acting on the Funds behalf are contractually obligated to keep nonpublic personal
information the Funds provide to them confidential and to use the information the Funds share only to provide the services the Funds ask them to perform.
The Funds may disclose nonpublic personal information about you when necessary to enforce their rights or protect against fraud, or as permitted or required by applicable law, such as in connection
with a law enforcement or regulatory request, subpoena, or similar legal process. In the event of a corporate action or in the event a Fund service provider changes, the Funds may be required to disclose your nonpublic personal information to third
parties. While it is the Funds practice to obtain protections for disclosed information in these types of transactions, the Funds cannot guarantee their privacy policy will remain unchanged.
Keeping You Informed of the Funds Privacy and Security Practices
The Funds will notify you annually of their privacy policy as required by federal law. While the Funds reserve the right to modify this policy at any time they will notify you promptly if this
privacy policy changes.
Legg Mason Funds Privacy and Security Notice contd
The Funds Security Practices
The Funds maintain appropriate physical, electronic and procedural safeguards designed to guard your nonpublic personal information. The Funds
internal data security policies restrict access to your nonpublic personal information to authorized employees, who may use your nonpublic personal information for Fund business purposes only.
Although the Funds strive to protect your nonpublic personal information, they cannot ensure or warrant the security of any information you provide
or transmit to them, and you do so at your own risk. In the event of a breach of the confidentiality or security of your nonpublic personal information, the Funds will attempt to notify you as necessary so you can take appropriate protective steps.
If you have consented to the Funds using electronic communications or electronic delivery of statements, they may notify you under such circumstances using the most current email address you have on record with them.
In order for the Funds to provide effective service to you, keeping your account information accurate is very important. If you believe that your
account information is incomplete, not accurate or not current, or if you have questions about the Funds privacy practices, write the Funds using the contact information on your account statements, email the Funds by clicking on the Contact Us
section of the Funds website at www.leggmason.com, or contact the Funds at 1-877-721-1926.
Permal
Alternative Core Fund
You may visit the funds website, http://www.leggmason.com/individualinvestors/prospectuses, for a free copy of a Prospectus, Statement of
Additional Information (SAI) or an Annual or Semi-Annual Report.
Shareholder reports
Additional information about the funds investments is available in the funds Annual and
Semi-Annual Reports to shareholders. In the funds Annual Report, you will find a discussion of the market conditions and investment strategies that significantly affected the funds performance during its last fiscal year. The independent
registered public accounting firms report and financial statements in the funds Annual Report are incorporated by reference into (are legally part of) this Prospectus.
The fund sends only one report to a household if more than one account has the same last name and same address. Contact your Service Agent or the fund if you do not want this policy to apply to you.
Statement of additional information
The SAI provides more detailed information about the fund and is incorporated by reference into (is legally a part of) this Prospectus.
You can make inquiries about the fund or obtain shareholder reports or the SAI (without charge) by contacting your Service
Agent, by calling the fund at 1-877-721-1926, or by writing to the fund at 100 First Stamford Place, Attn.: Shareholder Services 5
th
Floor, Stamford, Connecticut 06902.
Information about the fund (including the SAI) can be reviewed and copied at the Securities and Exchange Commissions (the SEC) Public Reference Room in Washington, D.C. Information
on the operation of the Public Reference Room may be obtained by calling the SEC at 1-202-551-8090. Reports and other information about the fund are available on the EDGAR Database on the SECs Internet site at
http://www.sec.gov.
Copies of this information may be obtained for a duplicating fee by electronic request at the following
E-mail address:
publicinfo@sec.gov,
or by writing the SECs Public Reference Room, Washington, D.C.
20549-1520.
If someone makes a statement about the fund that is not in this Prospectus, you should not rely upon that information.
Neither the fund nor the distributor is offering to sell shares of the fund to any person to whom the fund may not lawfully sell its shares.
(Investment Company Act
file no. 811-06444)
FDXX011767ST 07/13
The information in this Statement of Additional Information is not complete and may be changed. We
may not sell securities until the registration statement filed with the Securities and Exchange Commission is effective. This Statement of Additional Information is not an offer to sell these securities and is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION,
MAY 24, 2013
July 31, 2013
LEGG MASON PARTNERS EQUITY TRUST
PERMAL ALTERNATIVE CORE FUND
Class A (LPTAX), Class C (LPTCX), Class FI (LPTFX),
Class R, Class I (LPTIX) and Class IS (LPTSX)
620 Eighth Avenue
New York, New York 10018
1-877-721-1926
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional
Information (the SAI) is not a prospectus and is meant to be read in conjunction with the current Prospectus of Permal Alternative Core Fund (the fund), dated July 31, 2013, as amended or supplemented from time to time,
and is incorporated by reference in its entirety into the Prospectus.
The fund is a series of Legg Mason Partners Equity
Trust (the Trust), a Maryland statutory trust. Prior to January 1, 2013, the fund was named Legg Mason Permal Tactical Allocation Fund and prior to July 31, 2013 was named Permal Tactical Allocation Fund.
Additional information about the funds investments is available in the funds annual and semi-annual
reports to shareholders. The annual report contains financial statements that are incorporated herein by reference. The funds Prospectus and copies of the annual and semi-annual reports may be obtained free of charge by contacting banks,
brokers, dealers, insurance companies, investment advisers, financial consultants or advisers, mutual fund supermarkets and other financial intermediaries that have entered into an agreement with the funds distributor to sell shares of the
fund (each called a Service Agent), by writing the Trust at 100 First Stamford Place, Attn: Shareholder Services 5
th
Floor, Stamford, Connecticut 06902, by calling the Trust at the telephone number set forth above, by sending an e-mail
request to prospectus@leggmason.com or by visiting the funds website at http://www.leggmason.com/individualinvestors. Legg Mason Investor Services, LLC (LMIS or the distributor), a wholly-owned broker/dealer subsidiary
of Legg Mason, Inc. (Legg Mason), serves as the funds sole and exclusive distributor.
TABLE OF CONTENTS
THIS SAI IS NOT A PROSPECTUS AND IS AUTHORIZED FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF
PRECEDED OR ACCOMPANIED BY AN EFFECTIVE PROSPECTUS.
No person has been authorized to give any information or to make any
representations not contained in the Prospectus or this SAI in connection with the offerings made by the Prospectus and, if given or made, such information or representations must not be relied upon as having been authorized by the fund or its
distributor. The Prospectus and this SAI do not constitute offerings by the fund or by the distributor in any jurisdiction in which such offerings may not lawfully be made.
2
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
The fund is registered under the Investment Company Act of 1940, as amended (the 1940 Act) as an open-end, diversified
management investment company.
The funds Prospectus discusses the funds investment objective and policies. The
following discussion supplements the description of the funds investment policies in its Prospectus.
Investment Objective and
Principal Investment Strategies
The fund seeks total return.
The fund is a fund of funds, which is a term used to describe a mutual fund that pursues its investment objective by
investing primarily in other investment companies (underlying funds).
In seeking to meet its investment objective, the fund
allocates assets in accordance with decisions made by Permal Asset Management LLC, one of the funds subadvisers (Permal or the subadviser). The fund will seek to achieve its objective by allocating assets and primarily
investing in mutual funds, closed-end funds, exchange-traded funds (ETFs) and indexed or other performance-related instruments, including exchange-traded notes (ETNs), as identified by Permal. The fund may invest in affiliated and unaffiliated
open-end funds and unaffiliated closed-end funds. Some of the underlying funds may not be registered as investment companies under the 1940 Act and/or may not register their securities under the Securities Act of 1933, as amended (the 1933
Act), and are commonly known as hedge funds. The fund may change the underlying fundswhether affiliated or unaffiliatedfrom time to time without notice to shareholders.
The fund may invest in underlying funds that employ any investment strategy or technique and may invest in any region or country. The
fund also may invest directly in equity securities, fixed income securities, derivatives and hedge fund strategies. The composition of the funds investment portfolio will vary over time based on Permals overall asset allocation decisions
and top-down and bottom-up implementation. The fund will remain flexible in its use of investment strategies and techniques and can seek both long and short exposure through passive and actively managed vehicles.
The fund typically will invest, directly or through underlying funds and ETNs, approximately
|
|
|
50% to 100% of its total assets in alternative investments, including commodities, real estate assets, infrastructure assets, foreign currencies and
hedge fund strategies
|
|
|
|
0% to 50% of its total assets in equity-related investments
|
|
|
|
0% to 50% of its total assets in fixed income-related investments
|
|
|
|
0% to 40% in cash and cash equivalents
|
The fund may invest in hedge fund strategies directly and through underlying funds, including both hedge funds and registered investment companies that employ hedge fund strategies. Hedge fund strategies
may seek both long and short exposures to equities, fixed income, structured credit, currencies, commodities, real estate assets, infrastructure assets and other real assets. The fund will typically invest in multiple discrete styles of hedge fund
investing, including, but not limited to, macro strategies (including discretionary and systematic macro), managed futures, equity long-short, fixed income long-short, distressed debt and event-driven. The fund may also employ various security,
currency or commodity hedging strategies.
The fund may not invest more than 10% of its total assets in any one investment
considered by Permal to be an alternative investment. For purposes of this restriction, all investments in hedge funds will be considered alternative investments.
3
Permal seeks to allocate fund assets among underlying funds that, in its view, represent
attractive investment opportunities that will assist the fund in achieving its investment objective. However, Permal will consider periodically rebalancing the funds portfolio to maintain what it considers to be an appropriate mix of asset
classes, given its prevailing market views. There is no guarantee that any given underlying fund will accept additional investments from the fund at the time the fund wishes to make such an additional investment or at any time thereafter.
Furthermore, any underlying fund may return the funds investment in whole or in part without the funds consent (as a result of the underlying funds liquidation or other compulsory redemption).
Permal anticipates that the number and identity of underlying funds and other investments will vary over time as a result of allocations
and reallocations among new and existing underlying funds and the performance of each underlying fund as compared to the performance of other fund assets. In addition, to avoid potential adverse regulatory consequences, the fund may need to hold its
interest in an underlying fund in non-voting form or limit its voting rights to a certain percentage. Except for ETFs and other underlying funds that it has acquired in reliance on an exemptive order from the Securities and Exchange Commission (the
SEC), the fund generally does not intend to own 5% or more of the voting securities of any underlying unaffiliated fund. Such a limitation on voting rights is intended to prevent an underlying unaffiliated fund from becoming an
affiliated person of the fund for purposes of the 1940 Act. If the fund becomes an affiliated person of an underlying fund through ownership of its voting securities or otherwise, the 1940 Act may limit the ability of the fund to
transact with the underlying fund or its affiliates.
The fund may seek to gain exposure to certain asset classes, such as
ETFs that invest primarily in commodities or master limited partnerships (MLPs), through investments in its wholly-owned subsidiary, Alternative Core Fund Ltd., a Cayman Islands exempted company. The subsidiary may invest without limit in these
investments. The subsidiary has the same investment manager and subadvisers as the fund. The fund may invest up to 25% of its assets in the subsidiary.
There is no guarantee that the fund will achieve its investment objective.
INVESTMENT PRACTICES AND RISK FACTORS
The funds principal investment strategies are described above. The
following provides additional information about these principal strategies and describes other investment strategies and practices that may be used by the underlying funds and the fund, which all involve risks of varying degrees.
Because the fund invests primarily in the underlying funds, rather than directly in securities or other instruments, the strategies and
risks below are described by reference to the underlying funds. However, each of the strategies and risks described below may not apply to all of the underlying funds. To the extent that the fund invests directly in securities and other instruments,
the strategies and risks described below are also directly applicable to the fund. In addition, certain of the regulatory requirements described in this SAI relating to, among other things, use of derivatives will apply only to the fund and those
underlying funds that are registered investment companies under the 1940 Act and qualify for treatment as regulated investment companies under the Internal Revenue Code of 1986, as amended (the Code). The underlying funds that are
neither registered nor regulated investment companies will not be subject to these requirements.
Equity Securities
General
. Equity securities are subject to the following risks: the risk that their prices generally fluctuate more than those of
other securities, such as debt or fixed income securities; the risk that prices of securities will go down because of the interplay of market forces, which may affect a single issuer, industry or sector of the economy, country or region, or may
affect the market as a whole; the risk that an adverse company-specific event, such as an unfavorable earnings report, may negatively affect the stock price of a company in which an underlying fund invests; and the risk that an underlying fund may
experience a substantial or complete loss on an individual stock.
4
Common Stocks
. Certain underlying funds may invest in common stocks. Common stocks
are shares of a corporation or other entity that entitle the holder to a pro rata share of the profits of the corporation, if any, without preference over any other shareholder or class of shareholders, including holders of the entitys
preferred stock and other senior equity securities. Common stock usually carries with it the right to vote and frequently an exclusive right to do so.
Preferred Stock
. Certain underlying funds may invest in preferred stocks which, like debt obligations, have characteristics similar to fixed income securities. Holders of preferred stocks normally
have the right to receive dividends at a fixed rate when and as declared by the issuers board of directors, but do not participate in other amounts available for distribution by the issuing corporation. Dividends on preferred stock may be
cumulative, and all cumulative dividends usually must be paid prior to common shareholders receiving any dividend. For that reason, preferred stocks generally entail less risk than common stocks. Upon liquidation, preferred stocks are entitled to a
specified liquidation preference, which is generally the same as the par or stated value, and are senior in right of payment to common stock. Preferred stocks are, however, equity securities in the sense that they do not represent a liability of the
issuer and, therefore, do not offer as great a degree of protection of capital or assurance of continued income as investments in corporate debt securities. In addition, preferred stocks are subordinated in right of payment to all debt obligations
and creditors of the issuer, and convertible preferred stocks may be subordinated to other preferred stock of the same issuer.
Foreign Securities
. Certain underlying funds may invest all or a portion of their assets in securities of non-U.S. issuers.
Foreign investments include non-U.S. dollar-denominated securities traded outside the United States and U.S. dollar-denominated securities traded in the United States (such as American Depositary Receipts (ADRs)).
The returns of the underlying fund may be adversely affected by fluctuations in value of one or more currencies relative to the U.S.
dollar. Investing in the securities of foreign companies involves special risks and considerations not typically associated with investing in U.S. companies. These include risks resulting from revaluation of currencies; future adverse political and
economic developments and the possible imposition of currency exchange blockages or other foreign governmental laws or restrictions; reduced availability of public information concerning issuers; differences in accounting, auditing and financial
reporting standards; generally higher commission rates on foreign portfolio transactions; the possibility of expropriation, nationalization or confiscatory taxation; possible withholding taxes and limitations on the use or removal of funds or other
assets, including the withholding of dividends; adverse changes in investment or exchange control regulations; political instability, which could affect U.S. investments in foreign countries; and potential restrictions on the flow of international
capital. Additionally, foreign securities often trade with less frequency and volume than domestic securities and, therefore, may exhibit greater price volatility and be less liquid. Many of the foreign securities held by an underlying fund will not
be registered with, nor will the issuers thereof be subject to the reporting requirements of, the SEC. Accordingly, there may be less publicly available information about the securities and about the foreign company issuing them than is available
about a U.S. company and its securities. Moreover, individual foreign economies may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rate of inflation, capital reinvestment, resource
self-sufficiency and balance of payment positions. The fund, through its investment in certain of the underlying funds or directly, may invest in securities of foreign governments (or agencies or subdivisions thereof), and, many, if not all, of the
foregoing considerations apply to such investments as well. These risks are intensified when investing in countries with developing economies and securities markets, also known as emerging markets.
The costs associated with investment in the securities of foreign issuers, including withholding taxes, brokerage commissions and
custodial fees, may be higher than those associated with investment in domestic issuers. In addition, foreign investment transactions may be subject to difficulties associated with the settlement of such transactions. Transactions in securities of
foreign issuers may be subject to less efficient settlement practices, including extended clearance and settlement periods. Delays in settlement could result in temporary periods when assets of the fund are uninvested and no return can be earned on
them. The inability of the fund to
5
make intended investments due to settlement problems could cause the fund to miss attractive investment opportunities. The inability to dispose of a portfolio security due to settlement problems
could result in losses to the fund due to subsequent declines in value of the portfolio security or, if the fund has entered into a contract to sell the security, could result in liability to the purchaser.
Since the underlying funds may invest in securities denominated in currencies other than the U.S. dollar and since the underlying funds
may hold foreign currencies, the underlying funds may be affected favorably or unfavorably by exchange control regulations or changes in exchange rates between such currencies and the U.S. dollar. Changes in currency exchange rates may influence the
value of an underlying funds shares, and also may affect the value of dividends and interest earned by an underlying fund and gains and losses realized by an underlying fund. Exchange rates are determined by the forces of supply and demand in
the foreign exchange markets. These forces are affected by the international balance of payments, other economic and financial conditions, government intervention, speculation and other factors.
Certain underlying funds may invest in the securities of foreign and domestic issuers in the form of ADRs and European Depositary
Receipts (EDRs). Generally, ADRs, in registered form, are denominated in U.S. dollars and are designed for use in the domestic market. Usually issued by a U.S. bank or trust company, ADRs are receipts that demonstrate ownership of
underlying foreign securities. ADRs may be sponsored or unsponsored; issuers of securities underlying unsponsored ADRs are not contractually obligated to disclose material information in the United States. Accordingly, there may be less information
available about such issuers than there is with respect to domestic companies and issuers of securities underlying sponsored ADRs. The underlying funds may also invest in GDRs, EDRs and other similar instruments, which are receipts that are often
denominated in U.S. dollars and are issued by either a U.S. or non-U.S. bank evidencing ownership of underlying foreign securities. Even where they are denominated in U.S. dollars, depositary receipts are subject to currency risk if the underlying
security is denominated in a foreign currency. EDRs are issued in bearer form and are designed for use in European securities markets. GDRs are tradable both in the United States and Europe and are designed for use throughout the world.
For purposes of the underlying funds investment policies, depositary receipts generally are deemed to have the same classifications
as the underlying securities they represent. Thus, a depositary receipt representing ownership of common stock will be treated as common stock.
Inflation and rapid fluctuations in inflation rates have had, and may continue to have, very negative effects on the economies and securities markets of certain emerging markets. Economies in emerging
markets generally are heavily dependent upon international trade and, accordingly, have been and may continue to be affected adversely by economic conditions, trade barriers, exchange controls, managed adjustments in relative currency values and
other protectionist measures imposed or negotiated by the countries with which they trade.
While some emerging market
countries have sought to develop a number of corrective mechanisms to reduce inflation or mitigate its effects, inflation may have significant effects both on emerging market economies and their securities markets. In addition, many of the
currencies of emerging market countries have experienced steady devaluations relative to the U.S. dollar, and major devaluations have occurred in certain countries.
Because of the high levels of foreign denominated debt owed by many emerging market countries, fluctuating exchange rates can significantly affect the debt service obligations of those countries. This
could, in turn, affect local interest rates, profit margins and exports, which are a major source of foreign exchange earnings.
To the extent an emerging market country faces a liquidity crisis with respect to its foreign exchange reserves, it may increase
restrictions on the outflow of any foreign exchange. Repatriation is ultimately dependent on the ability of a fund to liquidate its investments and convert the local currency proceeds obtained from such liquidation into U.S. dollars. Where this
conversion must be done through official channels (usually
6
the central bank or certain authorized commercial banks), the ability to obtain U.S. dollars is dependent on the availability of such U.S. dollars through those channels, and, if available, upon
the willingness of those channels to allocate those U.S. dollars to a fund. In such a case, a funds ability to obtain U.S. dollars may be adversely affected by any increased restrictions imposed on the outflow of foreign exchange. If a fund is
unable to repatriate any amounts due to exchange controls, it may be required to accept an obligation payable at some future date by the central bank or other governmental entity of the jurisdiction involved. If such conversion can legally be done
outside official channels, either directly or indirectly, a funds ability to obtain U.S. dollars may not be affected as much by any increased restrictions except to the extent of the price which may be required to be paid for the U.S. dollars.
Many emerging market countries have little experience with the corporate form of business organization and may not have
well-developed corporation and business laws or concepts of fiduciary duty in the business context.
The securities markets of
emerging markets are substantially smaller, less developed, less liquid and more volatile than the securities markets of the United States and other more developed countries. Disclosure and regulatory standards in many respects are less stringent
than in the United States and other major markets. There also may be a lower level of monitoring and regulation of emerging markets and the activities of investors in such markets; enforcement of existing regulations has been extremely limited.
Investing in the securities of companies in emerging markets may entail special risks relating to the potential political and economic instability and the risks of expropriation, nationalization, confiscation or the imposition of restrictions on
foreign investment, convertibility of currencies into U.S. dollars and on repatriation of capital invested. In the event of such expropriation, nationalization or other confiscation by any country, a fund could lose its entire investment in any such
country.
Some emerging markets have different settlement and clearance procedures. In certain markets there have been times
when settlements have been unable to keep pace with the volume of securities transactions, making it difficult to conduct such transactions. The inability of a fund to make intended securities purchases due to settlement problems could cause the
fund to miss attractive investment opportunities. Inability to dispose of a portfolio security caused by settlement problems could result either in losses to a fund due to subsequent declines in the value of the portfolio security or, if a fund has
entered into a contract to sell the security, in possible liability to the purchaser.
The risk also exists that an emergency
situation may arise in one or more emerging markets as a result of which trading of securities may cease or may be substantially curtailed and prices for the funds portfolio securities in such markets may not be readily available.
Section 22(e) of the 1940 Act permits a registered investment company to suspend redemption of its shares for any period during which an emergency exists, as determined by the SEC. Accordingly, if the fund believes that appropriate
circumstances warrant, it will promptly apply to the SEC for a determination that an emergency exists within the meaning of Section 22(a) of the 1940 Act. During the period commencing from the funds identification of such conditions until
the date of SEC action, the portfolio securities in the affected markets will be valued at fair value as determined in good faith by or under the direction of the Board.
Although it might be theoretically possible to hedge for anticipated income and gains, the ongoing and indeterminate nature of the risks associated with emerging market investing (and the costs associated
with hedging transactions) makes it very difficult to hedge effectively against such risks.
Economic, Political and Social
Factors.
Certain non-U.S. countries, including emerging markets, may be subject to a greater degree of economic, political and social instability. Such instability may result from, among other things: (i) authoritarian governments or military
involvement in political and economic decision making; (ii) popular unrest associated with demands for improved economic, political and social conditions; (iii) internal insurgencies; (iv) hostile relations with neighboring countries; and (v)
ethnic, religious and racial disaffection and conflict. Such economic, political and social instability could significantly disrupt the financial markets in
7
such countries and the ability of the issuers in such countries to repay their obligations. In addition, it may be difficult for the fund to pursue claims against a foreign issuer in the courts
of a foreign country. Investing in emerging countries also involves the risk of expropriation, nationalization, confiscation of assets and property or the imposition of restrictions on foreign investments and on repatriation of capital invested. In
the event of such expropriation, nationalization or other confiscation in any emerging country, the fund could lose its entire investment in that country. Certain emerging market countries restrict or control foreign investment in their securities
markets to varying degrees. These restrictions may limit the funds investment in those markets and may increase the expenses of the fund. In addition, the repatriation of both investment income and capital from certain markets in the region is
subject to restrictions such as the need for certain governmental consents. Even where there is no outright restriction on repatriation of capital, the mechanics of repatriation may affect certain aspects of the funds operation. Economies in
individual non-U.S. countries may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rates of inflation, currency valuation, capital reinvestment, resource self-sufficiency and balance of
payments positions. Many non-U.S. countries have experienced substantial, and in some cases extremely high, rates of inflation for many years. Inflation and rapid fluctuations in inflation rates have had, and may continue to have, very negative
effects on the economies and securities markets of certain emerging countries. Economies in emerging countries generally are dependent heavily upon international trade and, accordingly, have been and may continue to be affected adversely by trade
barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been, and may continue to be, affected adversely
and significantly by economic conditions in the countries with which they trade. Whether or not the fund invests in securities of issuers located in or with significant exposure to countries experiencing economic, financial and other difficulties,
the value and liquidity of the funds investments may be negatively affected by the conditions in the countries experiencing the difficulties.
Europe-Recent Events.
A number of countries in Europe have experienced severe economic and financial difficulties. Many non-governmental issuers, and even certain governments, have defaulted on, or
been forced to restructure, their debts; many other issuers have faced difficulties obtaining credit or refinancing existing obligations; financial institutions have in many cases required government or central bank support, have needed to raise
capital, and/or have been impaired in their ability to extend credit; and financial markets in Europe and elsewhere have experienced extreme volatility and declines in asset values and liquidity. These difficulties may continue, worsen or spread
within and without Europe. Responses to the financial problems by European governments, central banks and others, including austerity measures and reforms, may not work, may result in social unrest and may limit future growth and economic recovery
or have other unintended consequences. Further defaults or restructurings by governments and others of their debt could have additional adverse effects on economies, financial markets and asset valuations around the world. In addition, one or more
countries may abandon the euro, the common currency of the European Union, and/or withdraw from the European Union. The impact of these actions, especially if they occur in a disorderly fashion, is not clear but could be significant and
far-reaching. Whether or not the fund invests in securities of issuers located in Europe or with significant exposure to European issuers or countries, these events could negatively affect the value and liquidity of the funds investments.
Equity Linked Notes.
Equity linked notes, or ELNs, are securities that are valued based upon the performance of one or
more equity securities, such as a stock index, a group of stocks or a single stock. ELNs offer investors the opportunity to participate in the appreciation of the underlying local equity securities where an underlying fund may not have established
local access. Investors in ELNs are subject to risk of loss of principal investment.
Warrants
. A warrant entitles an
underlying fund to purchase common stock from the issuer at a specified price and time. Since a warrant does not carry with it the right to dividends or voting rights with respect to securities that the warrant holder is entitled to purchase, and
because it does not represent any rights to the assets of the issuer, a warrant may be considered more speculative than certain other types of investments. In addition, the value of a warrant does not necessarily change with the value of the
underlying securities and a warrant
8
ceases to have value if it is not exercised prior to its expiration date. Warrants acquired by an underlying fund in units or attached to securities may be deemed to be without value.
Model Risk
. The proprietary models that may be used by certain underlying funds advisers to evaluate securities or
securities markets are based on the advisers understanding of the interplay of market factors and do not assure successful investment. The markets or the prices of individual securities may be affected by factors not foreseen in developing the
models.
Style Risk
. The value approach to investing involves the risk that value stocks may remain undervalued. Value
investing seeks stocks having prices that are low in relation to their real worth or future prospects, with the expectation that the fund will realize appreciation in the value of its holdings when other investors realize the intrinsic value of the
stock. Value stocks as a group may be out of favor and underperform the overall equity market for a long period of time, while the market concentrates on growth stocks. Value funds often concentrate much of their investments in certain
industries, and thus will be more susceptible to factors adversely affecting issuers within that industry than would a more diversified portfolio of securities.
The market values of growth stocks may be more volatile than other types of investments and may lack dividends that can cushion share prices during market declines. The returns on growth securities may or
may not move in tandem with the returns of other styles of investing or the overall stock markets.
Capitalization
Risk
. Returns on investments in stocks of large capitalization companies could trail the returns on investments in stocks of small and medium capitalization companies. Returns on investments in medium capitalization companies could trail the
returns on investments in stocks of larger or smaller companies. Returns on investments in stocks of small companies could trail the returns on investments in stocks of larger companies. Investments in securities of companies with small and medium
market capitalizations are generally considered to offer greater opportunity for appreciation but involve special risks. The securities of those companies may be subject to more abrupt fluctuations in market price than larger, more established
companies. Small to medium capitalization companies may have limited product lines, markets or financial resources, or they may be dependent upon a limited management group. In addition to exhibiting greater volatility, small and medium
capitalization company stocks may, to a degree, fluctuate independently of larger company stocks,
i.e.
, small and medium capitalization company stocks may decline in price as the prices of large company stocks rise or vice versa. Micro cap
companies may be newly formed or in the early stages of development with limited product lines, markets or financial resources. Therefore, micro cap companies may be less financially secure than large, medium or small capitalization companies and
may be more vulnerable to key personnel losses due to reliance on a smaller number of management personnel. In addition, there may be less public information available about these companies. Micro cap stock prices may be more volatile than those of
large, medium and small capitalization companies. Such stocks may be more thinly traded and thus difficult for an underlying fund to buy and sell in the market.
Fixed Income Securities
General
. Fixed income securities may be
affected by general changes in interest rates, which will result in increases or decreases in the market value of the debt securities held by the underlying funds. The market value of the fixed income obligations in which the underlying funds may
invest can be expected to vary inversely in relation to the changes in prevailing interest rates and also may be affected by other market and credit factors.
Many fixed income securities, especially those issued at high interest rates and with longer maturities, provide that the issuer may repay them early. Issuers often exercise this right when prevailing
interest rates are lower than the interest rate of the security. Accordingly, holders of callable securities may not benefit fully from the increase in value that other fixed income securities experience when rates decline. Furthermore, the
underlying funds most likely would have to reinvest the proceeds of the payoff at current yields, which would be lower than those paid by the security that was paid off.
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Floating and variable rate income securities include securities whose rates vary inversely
with changes in market rates of interest. Such securities may also pay a rate of interest determined by applying a multiple to the variable rate. The extent of increases and decreases in the value of securities whose rates vary inversely with
changes in market rates of interest generally will be larger than comparable changes in the value of an equal principal amount of a fixed rate security having similar credit quality, redemption provisions and maturity.
Zero Coupon, Discount and Payment-in-Kind Securities
. Zero coupon securities generally pay no cash interest (or dividends in the
case of preferred stock) to their holders prior to maturity. Payment-in-kind securities allow the lender, at its option, to make current interest payments on such securities either in cash or in additional securities. Accordingly, such securities
usually are issued and traded at a deep discount from their face or par value and generally are subject to greater fluctuations of market value in response to changing interest rates than securities of comparable maturities and credit quality that
pay cash interest (or dividends in the case of preferred stock) on a current basis.
Premium Securities
. Premium
securities are income securities bearing coupon rates higher than prevailing market rates. Premium securities are typically purchased at prices greater than the principal amounts payable on maturity. If securities purchased by an underlying fund at
a premium are called or sold prior to maturity, a fund will recognize a capital loss to the extent the call or sale price is less than the purchase price. Additionally, the fund will recognize a capital loss if it holds such securities to maturity.
Sovereign Government and Supranational Debt.
Certain underlying funds may invest in all types of debt securities of
governmental issuers in all countries, including emerging markets. These sovereign debt securities may include: debt securities issued or guaranteed by governments, governmental agencies or instrumentalities and political subdivisions located in
emerging market countries; debt securities issued by government owned, controlled or sponsored entities located in emerging market countries; interests in entities organized and operated for the purpose of restructuring the investment
characteristics of instruments issued by any of the above issuers; Brady Bonds, which are debt securities issued under the framework of the Brady Plan as a means for debtor nations to restructure their outstanding external indebtedness;
participations in loans between emerging market governments and financial institutions; or debt securities issued by supranational entities such as the World Bank. A supranational entity is a bank, commission or company established or financially
supported by the national governments of one or more countries to promote reconstruction or development.
Sovereign debt is
subject to risks in addition to those relating to non-U.S. investments generally. As a sovereign entity, the issuing government may be immune from lawsuits in the event of its failure or refusal to pay the obligations when due. The debtors
willingness or ability to repay in a timely manner may be affected by, among other factors, its cash flow situation, the extent of its non-U.S. reserves, the availability of sufficient non-U.S. exchange on the date a payment is due, the relative
size of the debt service burden to the economy as a whole, the sovereign debtors policy toward principal international lenders and the political constraints to which the sovereign debtor may be subject. Sovereign debtors may also be dependent
on disbursements or assistance from foreign governments or multinational agencies, the countrys access to trade and other international credits, and the countrys balance of trade. Assistance may be dependent on a countrys
implementation of austerity measures and reforms, which measures may limit or be perceived to limit economic growth and recovery. Some sovereign debtors have rescheduled their debt payments, declared moratoria on payments or restructured their debt
to effectively eliminate portions of it, and similar occurrences may happen in the future. There is no bankruptcy proceeding by which sovereign debt on which governmental entities have defaulted may be collected in whole or in part.
Yankee Bonds
. Yankee bonds are U.S. dollar-denominated bonds sold in the United States by non-U.S. issuers. As compared with bonds
issued in the United States, such bond issues normally carry a higher interest rate but are less actively traded.
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Investment-Grade Securities
. Certain underlying funds may invest in high-quality,
high-grade or investment-grade securities. High-quality securities are those rated in the two highest categories by Moodys Investors Service, Inc. (Moodys) (Aaa or Aa) or Standard & Poors, a subsidiary of The
McGraw-Hill Companies, Inc. (S&P) (AAA or AA), or determined by the underlying funds adviser to be of comparable quality. High grade securities are those rated in the three highest categories by Moodys (Aaa, Aa or A) or
S&P (AAA, AA or A) or determined by the underlying funds adviser to be of comparable quality. Investment-grade securities are those rated in the four highest categories by Moodys (Aaa, Aa, A or Baa) or S&P (AAA, AA, A or BBB) or
determined by the underlying funds adviser to be of comparable quality. Securities rated Baa or BBB have speculative characteristics and changes in economic conditions or other circumstances are more likely to lead to a weakened capacity of
their issuer to make timely principal and interest payments than is the case with higher grade securities.
High Yield
Securities
. Certain of the underlying funds may invest in securities rated below investment grade; that is, rated below Baa by Moodys or BBB by S&P, or determined by the underlying funds adviser to be of comparable quality.
Securities rated below investment grade (and comparable unrated securities) are the equivalent of high yield, high risk bonds, commonly known as junk bonds. Such securities are regarded as predominantly speculative with respect to the
issuers capacity to pay interest and repay principal in accordance with the terms of the obligations and involve major risk exposure to adverse business, financial, economic or political conditions. The prices of debt securities fluctuate in
response to perceptions of the issuers creditworthiness and also tend to vary inversely with market interest rates. The value of such securities is likely to decline in times of rising interest rates. Conversely, when rates fall, the value of
these investments is likely to rise. The longer the time to maturity the greater are variations in value. The ratings of S&P and Moodys represent the opinions of those agencies. Such ratings are relative and subjective, and are not
absolute standards of quality.
Generally, high yield, below investment grade securities offer a higher return potential than
higher-rated securities but involve greater volatility of price and greater risk of loss of income and principal, including the possibility of default or bankruptcy of the issuers of such securities. Below investment grade securities and comparable
non-rated securities will likely have large uncertainties or major risk exposure to adverse conditions and are predominantly speculative with respect to the issuers capacity to pay interest and repay principal in accordance with the terms of
the obligation. The occurrence of adverse conditions and uncertainties would likely reduce the value of securities held by an underlying fund, with a commensurate effect on the value of the underlying funds shares.
The markets in which below investment grade securities or comparable non-rated securities are traded generally are more limited than
those in which higher-quality securities are traded. The existence of limited markets for these securities may restrict the availability of securities for an underlying fund to purchase and also may restrict the ability of an underlying fund to
obtain accurate market quotations for purposes of valuing securities and calculating NAV or to sell securities at their fair value. An economic downturn could adversely affect the ability of issuers of high yield securities to repay principal and
pay interest thereon.
While the market values of below investment grade securities and comparable non-rated securities tend
to react less to fluctuations in interest rate levels than do those of higher-quality securities, the market values of certain of these securities also tend to be more sensitive to individual corporate developments and changes in economic conditions
than higher-quality securities. In addition, below investment grade securities and comparable non-rated securities generally present a higher degree of credit risk. Issuers of below investment grade securities and comparable non-rated securities are
often highly leveraged and may not have more traditional methods of financing available to them so that their ability to service their debt obligations during an economic downturn or during sustained periods of rising interest rates may be impaired.
The risk of loss because of default by such issuers is significantly greater because below investment grade securities and comparable non-rated securities generally are unsecured and frequently are subordinated to the prior payment of senior
indebtedness. An underlying fund may incur additional expenses to the extent it is required to seek recovery upon a default in the payment of principal or interest on its portfolio holdings.
11
Convertible Securities
. A convertible security is a bond, debenture, note, preferred
stock or other security that may be converted into or exchanged for a prescribed amount of common stock of the same or a different issuer within a particular period of time at a specified price or formula. A convertible security entitles the holder
to receive interest paid or accrued on debt or the dividend paid on preferred stock until the convertible security matures or is redeemed, converted or exchanged. Before conversion or exchange, convertible securities ordinarily provide a stream of
income with generally higher yields than those of common stocks of the same or similar issuers, but lower than the yield of nonconvertible debt. Convertible securities are usually subordinated to comparable-tier nonconvertible securities but rank
senior to common stock in a corporations capital structure.
The value of a convertible security is a function of
(1) its yield in comparison with the yields of other securities of comparable maturity and quality that do not have a conversion privilege and (2) its worth, at market value, if converted or exchanged into the underlying common stock. A
convertible security may be subject to redemption at the option of the issuer at a price established in the convertible securitys governing instrument, which may be less than the ultimate conversion or exchange value.
Convertible securities are subject both to the stock market risk associated with equity securities and to the credit and interest rate
risks associated with fixed income securities. As the market price of the equity security underlying a convertible security falls, the convertible security tends to trade on the basis of its yield and other fixed income characteristics. As the
market price of such equity security rises, the convertible security tends to trade on the basis of its equity conversion features.
Synthetic convertible securities are created by combining non-convertible bonds or preferred stocks with warrants or stock call options. Synthetic convertible securities differ from convertible securities
in certain respects, including that each component of a synthetic convertible security has a separate market value and responds differently to market fluctuations. Investing in synthetic convertible securities involves the risks normally involved in
holding the securities comprising the synthetic convertible security.
Convertible securities generally are subordinated to
other similar but non-convertible securities of the same issuer, although convertible bonds, as corporate debt obligations, enjoy seniority in right of payment to all equity securities, and convertible preferred stock is senior to common stock of
the same issuer. Convertible securities typically have lower ratings than similar nonconvertible securities because of the subordination feature.
Money Market Instruments
. Most underlying funds may invest, for temporary defensive purposes, when opportunities for capital growth do not appear attractive or for other purposes in short-term
corporate and government money market instruments. Money market instruments include: U.S. government securities; certificates of deposit (CDs), time deposits (TDs) and bankers acceptances issued by domestic banks
(including their branches located outside the United States and subsidiaries located in Canada), domestic branches of foreign banks, savings and loan associations and similar institutions; commercial paper; and repurchase agreements with respect to
the foregoing types of instruments. The following is a more detailed description of such money market instruments.
CDs are
short-term negotiable obligations of commercial banks. TDs are non-negotiable deposits maintained in banking institutions for specified periods of time at stated interest rates. Bankers acceptances are time drafts drawn on commercial banks by
borrowers usually in connection with international transactions.
Recently enacted legislation will affect virtually every
area of banking and financial regulation. The impact of the regulation is not yet fully known and may not be for some time. In addition, new regulations to be promulgated pursuant to the legislation could adversely affect the funds and the
underlying funds investments in money market instruments.
Domestic commercial banks organized under federal law are
supervised and examined by the Comptroller of the Currency and are required to be members of the Federal Reserve System and to be insured by the Federal
12
Deposit Insurance Corporation (the FDIC). Domestic banks organized under state law are supervised and examined by state banking authorities but are members of the Federal Reserve
System only if they elect to join. Most state banks are insured by the FDIC (although such insurance may not be of material benefit to the fund, depending upon the principal amount of CDs of each bank held by the fund) and are subject to federal
examination and to a substantial body of federal law and regulation. As a result of governmental regulations, domestic branches of domestic banks are, among other things, generally required to maintain specified levels of reserves, and are subject
to other supervision and regulation designed to promote financial soundness.
Obligations of foreign branches of domestic
banks, such as CDs and TDs, may be general obligations of the parent bank in addition to the issuing branch, or may be limited by the terms of a specific obligation and government regulation. Such obligations are subject to different risks than are
those of domestic banks or domestic branches of foreign banks. These risks include foreign economic and political developments, foreign governmental restrictions that may adversely affect payment of principal and interest on the obligations, foreign
exchange controls and foreign withholding and other taxes on interest income. Foreign branches of domestic banks are not necessarily subject to the same or similar regulatory requirements that apply to domestic banks, such as mandatory reserve
requirements, loan limitations, and accounting, auditing and financial recordkeeping requirements. In addition, less information may be publicly available about a foreign branch of a domestic bank than about a domestic bank. CDs issued by wholly
owned Canadian subsidiaries of domestic banks are guaranteed as to repayment of principal and interest (but not as to sovereign risk) by the domestic parent bank.
Obligations of domestic branches of foreign banks may be general obligations of the parent bank in addition to the issuing branch, or may be limited by the terms of a specific obligation and by
governmental regulation as well as governmental action in the country in which the foreign bank has its head office. A domestic branch of a foreign bank with assets in excess of $1 billion may or may not be subject to reserve requirements imposed by
the Federal Reserve System or by the state in which the branch is located if the branch is licensed in that state. In addition, branches licensed by the Comptroller of the Currency and branches licensed by certain states (State Branches)
may or may not be required to: (a) pledge to the regulator by depositing assets with a designated bank within the state, an amount of its assets equal to 5% of its total liabilities; and (b) maintain assets within the state in an amount
equal to a specified percentage of the aggregate amount of liabilities of the foreign bank payable at or through all of its agencies or branches within the state. The deposits of State Branches may not necessarily be insured by the FDIC. In
addition, there may be less publicly available information about a domestic branch of a foreign bank than about a domestic bank.
In view of the foregoing factors associated with the purchase of CDs and TDs issued by foreign branches of domestic banks or by domestic branches of foreign banks, Western Asset Management Company
(Western Asset) and advisers of the underlying funds, as applicable, will carefully evaluate such investments on a case-by-case basis.
U.S. Government Securities
. U.S. government securities include (1) U.S. Treasury bills (maturity of one year or less), U.S. Treasury notes (maturity of one to ten years) and U.S. Treasury
bonds (maturities generally greater than ten years) and (2) obligations issued or guaranteed by U.S. government agencies or instrumentalities which are supported by any of the following: (a) the full faith and credit of the U.S. government
(such as Government National Mortgage Association (Ginnie Mae) certificates); (b) the right of the issuer to borrow an amount limited to specific line of credit from the U.S. government (such as obligations of the Federal Home Loan
Banks); (c) the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities (such as securities issued by Fannie Mae (formally known as the Federal National Mortgage Association)); or
(d) only the credit of the instrumentality (such as securities issued by Freddie Mac (formally known as the Federal Home Loan Mortgage Corporation)). In the case of obligations not backed by the full faith and credit of the United States, an
underlying fund must look principally to the agency or instrumentality issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the United States itself in the event the agency or instrumentality
does not meet its commitments. Neither the U.S. government nor any of its agencies or instrumentalities guarantees the market value of the securities they issue. Therefore, the market value of such securities will fluctuate in response to changes in
interest rates.
13
Ginnie Mae is a wholly owned U.S. government corporation within the Department of Housing
and Urban Development. The mortgage-backed securities guaranteed by Ginnie Mae are backed by the full faith and credit of the United States. Fannie Mae and Freddie Mac are stockholder-owned companies chartered by Congress. Fannie Mae and Freddie Mac
guarantee the securities they issue as to timely payment of principal and interest, but such guarantee is not backed by the full faith and credit of the United States.
Although the U.S. government has provided financial support to Fannie Mae and Freddie Mac, there can be no assurance that it will support these or other government-sponsored enterprises in the future.
Mortgage-Related Securities
. Mortgage-related securities provide capital for mortgage loans made to residential
homeowners and include securities which represent interests in pools of mortgage loans made by lenders such as savings and loan institutions, mortgage bankers, commercial banks and others. Pools of mortgage loans are assembled for sale to investors
(such as an underlying fund) by various governmental, government-related and private organizations, such as dealers. The market value of mortgage-related securities will fluctuate as a result of changes in interest rates and mortgage rates.
Interests in pools of mortgage loans generally 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 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 residential property, refinancing or foreclosure, net of fees or costs which may be incurred. Securities issued by Ginnie Mae and Fannie Mae are fully modified
pass-through securities,
i.e.
, the timely payment of principal and interest is guaranteed by the issuer. Freddie Mac securities are modified pass-through securities,
i.e.
, the timely payment of interest is guaranteed by Freddie Mac,
principal is passed through as collected but payment thereof is guaranteed not later than one year after it becomes payable.
Commercial banks, savings and loan institutions, private mortgage insurance companies, mortgage bankers and other secondary market
issuers, such as dealers, create pass-through pools of conventional residential mortgage loans. Such issuers also may be the originators 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 guarantees of payments with respect to such pools. However, timely payment of
interest and principal of these pools is supported by various forms of insurance or guarantees, including individual loan, title, pool and hazard insurance. There can be no assurance that the private insurers can meet their obligations under the
policies. The underlying funds may buy mortgage-related securities without insurance or guarantees if the adviser determines that the securities are an appropriate investment for the underlying fund.
Another type of security representing an interest in a pool of mortgage loans is known as a collateralized mortgage obligation
(CMO). CMOs represent interests in a short-term, intermediate-term or long-term portion of a mortgage pool. Each portion of the pool receives monthly interest payments, but the principal repayments pass through to the short-term CMO
first and to the long-term CMO last. A CMO permits an investor to more accurately predict the rate of principal repayments. CMOs are issued by private issuers, such as broker-dealers, and by government agencies, such as Fannie Mae and Freddie Mac.
Investments in CMOs are subject to the same risks as direct investments in the underlying mortgage-backed securities. In addition, in the event of a bankruptcy or other default of a broker that issued the CMO held by an underlying fund, such fund
could experience delays in liquidating both its position and losses. An underlying fund may invest in CMOs in any rating category of the recognized rating services and may invest in unrated CMOs. An underlying fund may also invest in
stripped CMOs, which represent only the income portion or the principal portion of the CMO. The values of stripped CMOs are very sensitive to interest rate changes; accordingly, these instruments present a greater risk of loss than
conventional mortgage-backed securities.
14
Governmental, government-related or private entities may create mortgage loan pools offering
pass-through investments in addition to those described above. The mortgages underlying these securities may be second mortgages or alternative mortgage instruments (for example, mortgage instruments whose principal or interest payments may vary or
whose terms to maturity may differ from customary long-term fixed rate mortgages). As new types of mortgage-related securities are developed and offered to investors, an underlying funds adviser may, consistent with the underlying funds
investment objective and policies, consider making investments in such new types of securities.
The average life of
securities representing interests in pools of mortgage loans is likely to be substantially less than the original maturity of the mortgage pools as a result of prepayments or foreclosures of such mortgages. Prepayments are passed through to the
registered holder with the regular monthly payments of principal and interest, and have the effect of reducing future payments. To the extent the mortgages underlying a security representing an interest in a pool of mortgages are prepaid, an
underlying fund may experience a loss (if the price at which the respective security was acquired by the fund was at a premium over par, which represents the price at which the security will be redeemed upon prepayment) or a gain (if the price at
which the respective security was acquired by the fund was at a discount from par). In addition, prepayments of such securities held by the fund will reduce the share price of the fund to the extent the market value of the securities at the time of
prepayment exceeds their par value, and will increase the share price of the fund to the extent the par value of the securities exceeds their market value at the time of prepayment. Prepayments may occur with greater frequency in periods of
declining mortgage rates because, among other reasons, it may be possible for mortgagors to refinance their outstanding mortgages at lower interest rates. When market interest rates increase, the market values of mortgage-backed securities decline.
At the same time, however, mortgage refinancing slows, which lengthens the effective maturities of these securities. As a result, the negative effect of the rate increase on the market value of mortgage securities is usually more pronounced than it
is for other types of fixed income securities.
Asset-Backed Securities
. Asset-backed securities are generally issued
as pass-through certificates, which represent undivided fractional ownership interests in the underlying pool of assets, or as debt instruments, which are generally issued as the debt of a special purpose entity organized solely for the purpose of
owning such assets and issuing such debt. The pool of assets generally represents the obligations of a number of different parties. Asset-backed securities frequently carry credit protection in the form of extra collateral, subordinated
certificates, cash reserve accounts, letters of credit or other enhancements. For example, payments of principal and interest may be guaranteed up to certain amounts and for a certain time period by a letter of credit or other enhancement issued by
a financial institution unaffiliated with the entities issuing the securities. Assets which have been used to back asset-backed securities include motor vehicle installment sales contracts or installment loans secured by motor vehicles, and
receivables from revolving credit (credit card) agreements.
Asset-backed securities present certain risks which are,
generally, related to limited interests, if any, in related collateral. Credit card receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such
debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. Most issuers of automobile receivables permit the servicers to retain possession of the underlying obligations. If the servicer were to sell
these obligations to another party, there is a risk that the purchaser would acquire an interest superior to that of the holders of the related automobile receivables. In addition, because of the large number of vehicles involved in a typical
issuance and technical requirements under state laws, the trustee for the holders of the automobile receivables may not have a proper security interest in all of the obligations backing such receivables. Therefore, there is the possibility that
recoveries on repossessed collateral may not, in some cases, be available to support payments on these securities. Other types of asset-backed securities will be subject to the risks associated with the underlying assets. If a letter of credit or
other form of credit enhancement is exhausted or otherwise unavailable, holders of asset-backed securities may also experience delays in payments or losses if the full amounts due on underlying assets are not realized.
15
Foreign Government Securities
. Among the foreign government securities in which
certain underlying funds may invest are those issued by countries with developing economies, which are countries in the initial stages of their industrialization cycles. Investing in securities of countries with developing economies involves
exposure to economic structures that are generally less diverse and less mature, and to political systems that can be expected to have less stability, than those of developed countries. The markets of countries with developing economies historically
have been more volatile than markets of the more mature economies of developed countries, but often have provided higher rates of return to investors.
Brady Bonds
. Certain underlying funds may invest in Brady Bonds, which are securities created through the exchange of existing commercial bank loans to sovereign entities for new obligations in
connection with debt restructurings under a debt restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the Brady Plan). Brady Plan debt restructurings have been implemented in a number of countries,
including: Argentina, Bolivia, Brazil, Bulgaria, Costa Rica, the Dominican Republic, Ecuador, Jordan, Mexico, Niger, Nigeria, Panama, Peru, the Philippines, Poland, Uruguay and Venezuela.
Brady Bonds may be collateralized or uncollateralized, are issued in various currencies (primarily the U.S. dollar) and are actively
traded in the over-the-counter (OTC) secondary market. The Brady Bonds that the underlying funds may purchase have no or limited collateralization, and an underlying fund will be relying for payment of interest and (except in the case of
principal collateralized Brady Bonds) principal primarily on the willingness and ability of the foreign government to make payment in accordance with the terms of the Brady Bonds. In the event of a default on collateralized Brady Bonds for which
obligations are accelerated, the collateral for the payment of principal will not be distributed to investors, nor will such obligations be sold and the proceeds distributed. In light of the residual risk of the Brady Bonds and, among other factors,
the history of default with respect to commercial bank loans by public and private entities of countries issuing Brady Bonds, investments in Brady Bonds are to be viewed as speculative. Brady Bonds are not considered to be U.S. government
securities. U.S. dollar-denominated, collateralized Brady Bonds, which may be fixed rate par bonds or floating rate discount bonds, are generally collateralized in full as to principal by U.S. Treasury zero coupon bonds having the same maturity as
the Brady Bonds. Interest payments on these Brady Bonds generally are collateralized on a one-year or longer rolling-forward basis by cash or securities in an amount that, in the case of fixed rate bonds, is equal to at least one year of interest
payments or, in the case of floating rate bonds, initially is equal to at least one years interest payments based on the applicable interest rate at that time and is adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to
value recovery payments in certain circumstances, which in effect constitute supplemental interest payments but generally are not collateralized. Brady Bonds are often viewed as having three or four valuation components: (i) the
collateralized repayment of principal at final maturity; (ii) the collateralized interest payments; (iii) the uncollateralized interest payments; and (iv) any uncollateralized repayment of principal at maturity (the uncollateralized
amounts constitute the residual risk).
Brady Bonds involve various risk factors, including residual risk and the
history of defaults with respect to commercial bank loans by public and private entities of countries issuing Brady Bonds. Sovereign obligors in developing and emerging market countries are among the worlds largest debtors to commercial banks,
other governments, international financial organizations and other financial institutions. These obligors have in the past experienced substantial difficulties in servicing their external debt obligations, which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring arrangements have included, among other things, reducing and rescheduling interest and principal payments by negotiating new or amended credit agreements or converting
outstanding principal and unpaid interest to Brady Bonds, and obtaining new credit to finance interest payments. Holders of certain foreign sovereign debt securities may be requested to participate in the restructuring of such obligations and to
extend further loans to their issuers. There can be no assurance that the Brady Bonds and other foreign sovereign debt securities in which the underlying funds may invest will not be subject to similar restructuring arrangements or to requests for
new credit which may adversely affect an underlying funds holdings. Furthermore, certain participants in the secondary market for such debt may be directly involved in negotiating the terms of these arrangements and may, therefore, have access
to information
16
not available to other market participants. There can be no assurance that Brady Bonds in which the underlying funds may invest will not be subject to restructuring arrangements or to requests
for new credit, which may cause the funds to suffer a loss of interest or principal on their holdings of Brady Bonds.
Bank
Obligations
. Domestic commercial banks organized under federal law are supervised and examined by the Comptroller of the Currency and are required to be members of the Federal Reserve System and to be insured by the Federal Deposit Insurance
Corporation (the FDIC). Domestic banks organized under state law are supervised and examined by state banking authorities but are members of the Federal Reserve System only if they elect to join. Most state banks are insured by the FDIC
(although such insurance may not be of material benefit to an underlying fund, depending upon the principal amount of CDs of each held by the fund) and are subject to federal examination and to a substantial body of federal law and regulation. As a
result of federal and state laws and regulations, domestic branches of domestic banks are, among other things, generally required to maintain specified levels of reserves, and are subject to other supervision and regulation designed to promote
financial soundness.
Obligations of foreign branches of U.S. banks, such as CDs and TDs, may be general obligations of the
parent bank in addition to the issuing branch, or may be limited by the terms of a specific obligation and governmental regulation. Obligations of foreign branches of U.S. banks and foreign banks are subject to different risks than are those of U.S.
banks or U.S. branches of foreign banks. These risks include foreign economic and political developments, foreign governmental restrictions that may adversely affect payment of principal and interest on the obligations, foreign exchange controls and
foreign withholding and other taxes on interest income. Foreign branches of U.S. banks are not necessarily subject to the same or similar regulatory requirements that apply to U.S. banks, such as mandatory reserve requirements, loan limitations and
accounting, auditing and financial recordkeeping requirements. In addition, less information may be publicly available about a foreign branch of a U.S. bank than about a U.S. bank. CDs issued by wholly-owned Canadian subsidiaries of U.S. banks are
guaranteed as to repayment of principal and interest, but not as to sovereign risk, by the U.S. parent bank.
Obligations of
U.S. branches of foreign banks may be general obligations of the parent bank in addition to the issuing branch, or may be limited by the terms of a specific obligation and by federal and state regulation as well as governmental action in the country
in which the foreign bank has its head office. An U.S. branch of a foreign bank with assets in excess of $1 billion may or may not be subject to reserve requirements imposed by the Federal Reserve System or by the state in which the branch is
located if the branch is licensed in that state. In addition, branches licensed by the Comptroller of the Currency and branches licensed by certain states (State Branches) may or may not be required to: (a) pledge to the regulator
by depositing assets with a designated bank within the state, an amount of its assets equal to 5% of its total liabilities; and (b) maintain assets within the state in an amount equal to a specified percentage of the aggregate amount of
liabilities of the foreign bank payable at or through all of its agencies or branches within the state. The deposits of State Branches may not necessarily be insured by the FDIC. In addition, there may be less publicly-available information about a
U.S. branch of a foreign bank than about a U.S. bank.
Bank Loans
. Certain underlying funds may invest in bank loans.
Bank loans are fixed and floating rate loans arranged through private negotiations between a company or a non-U.S. government and one or more financial institutions (lenders). In connection with purchasing participations, the underlying funds
generally will have no right to enforce compliance by the borrower with the terms of the loan agreement relating to the loan, nor any rights of set-off against the borrower, and an underlying fund may not benefit directly from any collateral
supporting the loan in which it has purchased the participation. As a result, the underlying funds will assume the credit risk of both the borrower and the lender that is selling the participation. When the underlying funds purchase assignments from
lenders, the underlying funds will acquire direct rights against the borrower on the loan. The underlying funds may have difficulty disposing of bank loans because, in certain cases, the market for such instruments is not highly liquid. The lack of
a highly liquid secondary market may have an adverse impact on the value of such instruments and on an underlying funds ability to dispose of the bank loan in response to a specific economic event, such as deterioration in the creditworthiness
of the borrower.
17
Exchange-Traded Notes (ETNs)
. Certain underlying funds may invest in ETNs. ETNs are
senior, unsecured, unsubordinated debt securities whose returns are linked to the performance of a particular market benchmark or strategy, minus applicable fees. ETNs are traded on an exchange (
e.g.
, the New York Stock Exchange (the
NYSE)) during normal trading hours. However, investors can also hold the ETN until maturity. At maturity, the issuer pays to the investor a cash amount equal to the principal amount, subject to the days market benchmark or strategy
factor.
ETNs do not make periodic coupon payments or provide principal protection. ETNs are subject to credit risk and the
value of the ETN may drop due to a downgrade in the issuers credit rating, despite the underlying market benchmark or strategy remaining unchanged. The value of an ETN may also be influenced by time to maturity, level of supply and demand for
the ETN, volatility and lack of liquidity in underlying assets, changes in applicable interest rates, changes in the issuers credit rating, and economic, legal, political, or geographic events that affect the referenced underlying asset. When
an underlying fund invests in ETNs, it will bear its proportionate share of any fees and expenses borne by the ETN. These fees and expenses generally reduce the return realized at maturity or upon redemption from an investment in an ETN; therefore,
the value of the index underlying the ETN must increase significantly in order for an investor in an ETN to receive at least the principal amount of the investment at maturity or upon redemption. An underlying funds decision to sell its ETN
holdings may be limited by the availability of a secondary market. ETNs are also subject to tax risk. The Internal Revenue Service (the IRS) and Congress have in the past considered proposals that would change the timing and character of
income and gains from ETNs. There may be times when an ETN share trades at a premium or discount to its net asset value (NAV).
Commercial Paper
. Commercial paper consists of short-term (usually from 1 to 270 days) unsecured promissory notes issued by corporations in order to finance their current operations. A variable
amount master demand note (which is a type of commercial paper) represents a direct borrowing arrangement involving periodically fluctuating rates of interest under a letter agreement between a commercial paper issuer and an institutional lender,
such as one of the underlying funds, pursuant to which the lender may determine to invest varying amounts. Transfer of such notes is usually restricted by the issuer, and there is no secondary trading market for such notes.
Real Estate Investment Trusts (REITs)
. Certain underlying funds may invest in pooled investment vehicles that invest primarily in
income-producing real estate or real estate-related loans or interests, called REITs. REITs are generally classified as equity REITs, mortgage REITs or a combination of equity and mortgage REITs. Equity REITs invest the majority of their assets
directly in real property and derive income primarily from the collection of rents. Equity REITs can also realize capital gains by selling properties that have appreciated in value. Mortgage REITs invest the majority of their assets in real estate
mortgages and derive income from the collection of interest payments. REITs are not taxed on income distributed to shareholders provided they comply with the applicable requirements of the Code. Debt securities issued by REITs, for the most part,
are general and unsecured obligations and are subject to risks associated with REITs. Like mutual funds, REITs have expenses, including advisory and administration fees paid by REIT shareholders and, as a result, a fund is subject to a duplicate
level of fees if the fund invests in REITs.
Investing in REITs involves certain unique risks in addition to those risks
associated with investing in the real estate industry in general. An equity REIT may be affected by changes in the value of the underlying properties owned by the REIT. A mortgage REIT may be affected by changes in interest rates and the ability of
the issuers of its portfolio mortgages to repay their obligations. REITs are dependent upon the skills of their managers and are not diversified. REITs are generally dependent upon maintaining cash flows to repay borrowings and to make distributions
to shareholders and are subject to the risk of default by lessees and borrowers. REITs whose underlying assets are concentrated in properties used by a particular industry, such as health care, are also subject to industry related risks.
18
REITs (especially mortgage REITs) are also subject to interest rate risks. When interest
rates decline, the value of a REITs investment in fixed income obligations can be expected to rise. Conversely, when interest rates rise, the value of a REITs investment in fixed rate obligations can be expected to decline. If the REIT
invests in adjustable rate mortgage loans the interest rates on which are reset periodically, yields on a REITs investments in such loans will gradually align themselves to reflect changes in market interest rates. This causes the value of
such investments to fluctuate less dramatically in response to interest rate fluctuations than would investments in fixed rate obligations. REITs may have limited financial resources, may trade less frequently and in a limited volume and may be
subject to more abrupt or erratic price movements than larger company securities. Historically, REITs have been more volatile in price than the larger capitalization stocks included in the S&P 500 Index.
Illiquidity of Investments in Underlying Funds
. The fund may invest in a combination of affiliated and unaffiliated funds, which
may or may not be registered under the 1940 Act. Investments in unregistered funds generally will be illiquid and generally may not be transferred without the consent of the underlying fund. The fund may be unable to liquidate its investment in an
underlying unregistered fund when desired (and incur losses as a result), or may be required to sell such investment regardless of whether it desires to do so. Upon its withdrawal of all or a portion of its interest in an unregistered fund, the fund
may receive securities that are illiquid or difficult to value. In such a case, Permal would seek to cause the fund to dispose of these securities in a manner that is in the funds best interests. The fund may not be able to withdraw from an
underlying unregistered fund except at certain designated times, thereby limiting the ability of Permal to withdraw assets from an underlying unregistered fund that may have poor performance or for other reasons. The fees paid by unregistered funds
to their advisers and general partners or managing members often are significantly higher than those paid by registered funds and generally include a percentage of gains. The value of the funds interest in these unregistered funds will be
affected by these fees; the funds expense ratio will reflect an allocable portion of these fees and the funds expense limitation excludes such performance-based fees.
Master Limited Partnerships (MLPs).
The fund may invest, both directly and through the underlying funds, in MLPs, which are
limited partnerships or limited liability companies usually taxable as partnerships. MLPs may derive income and gains from the exploration, development, mining or production, processing, refining, infrastructure related services, transportation
(including pipelines transporting gas, oil, or products thereof), storage or the marketing of mineral or natural resources, although they may also finance entertainment, research and development and other projects. Investments held by an MLP may be
relatively illiquid, limiting the MLPs ability to vary its portfolio promptly in response to changes in economic or other conditions. In addition, MLPs may have limited financial resources, their securities may trade infrequently and in
limited volume and they may be subject to more abrupt or erratic price movements than securities of larger or more broadly-based companies. Risks involved with investing in an MLP also include the risks associated with the specific industry or
industries in which the partnership invests, such as the risks of investing in real estate or oil and gas industries. The volatility and interrelationships of commodity prices can also indirectly affect certain MLPs due to the potential impact on
the volume of commodities transported, processed, stored or distributed. The funds investment in an MLP may be adversely affected by market perceptions that the performance and distributions or dividends of MLPs are directly tied to commodity
prices. In addition, MLPs are generally considered interest-rate sensitive investments and during periods of interest rate volatility may not provide attractive returns.
MLPs generally have two classes of owners, the general partner and limited partners. The general partner is typically owned by a major energy company, an investment fund, the direct management of the MLP
or is an entity owned by one or more of such parties. The general partner may be structured as a private or publicly traded corporation or other entity. The general partner typically controls the operations and management of the MLP through an
equity interest of up to 2% in the MLP plus, in many cases, ownership of common units and subordinated units. Limited partners own the remainder of the partnership, through ownership of common units, and have a limited role in the partnerships
operations and management.
MLPs are typically structured such that common units and general partner interests have first
priority to receive quarterly cash distributions up to an established minimum amount (minimum quarterly distributions or
19
MQD). Common and general partner interests also accrue arrearages in distributions to the extent the MQD is not paid. Once common and general partner interests have been paid,
subordinated units receive distributions of up to the MQD; however, subordinated units do not accrue arrearages. Distributable cash in excess of the MQD paid to both common and subordinated units is distributed to both common and subordinated units
generally on a pro rata basis. The general partner is also eligible to receive incentive distributions if the general partner operates the business in a manner which results in distributions paid per common unit surpassing specified target levels.
As the general partner increases cash distributions to the limited partners, the general partner receives an increasingly higher percentage of the incremental cash distributions. A common arrangement provides that the general partner can reach a
tier where it receives 50% of every incremental dollar paid to common and subordinated unit holders. These incentive distributions encourage the general partner to streamline costs, increase capital expenditures and acquire assets in order to
increase the partnerships cash flow and raise the quarterly cash distribution in order to reach higher tiers. Such results benefit all security holders of the MLP.
MLP common units represent a limited partnership interest in the MLP. Common units are listed and traded on U.S. securities exchanges, with their value fluctuating predominantly based on prevailing market
conditions and the success of the MLP. Unlike owners of common stock of a corporation, owners of common units have limited voting rights and have no ability annually to elect directors. In the event of liquidation, common units have preference over
subordinated units, but not over debt or preferred units, to the remaining assets of the MLP.
General partner interests of
MLPs are typically retained by the original sponsors of an MLP, such as its founders, corporate partners and entities that sell assets to the MLP. The holder of the general partner interest can be liable in certain circumstances for amounts greater
than the amount of the holders investment in the general partner. General partner interests often confer direct board participation rights in, and in many cases control over the operations of, the MLP. General partner interests can be
privately held or owned by publicly traded entities.
The fund may not invest more than 25% of the value of its total assets
in the securities of MLPs that are treated for U.S. federal income tax purposes as QPTPs (the 25% Limitation). A QPTP means a partnership (i) whose interests are traded on an established securities market or readily tradable on a
secondary market or the substantial equivalent thereof; (ii) that derives at least 90% of its annual income from (a) dividends, interest, payments with respect to securities loans, and gains from the sale or other disposition of stock, securities or
foreign currencies, or other income (including but not limited to gain from options, futures and forward contracts) derived with respect to its business of investing in such stock, securities or foreign currencies, (b) real property rents, (c) gain
from the sale or other disposition of real property, (d) the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil, or products thereof), or the marketing of any mineral or
natural resource (including fertilizer, geothermal energy, and timber), industrial source carbon dioxide, or the transportation or storage of certain fuels, and (e) in the case of a partnership a principal activity of which is the buying and selling
of commodities, income and gains from commodities or futures, forwards, and options with respect to commodities; and (iii) that derives less than 90% of its annual income from the items listed in (a) above. The 25% Limitation generally does not
apply to publicly traded partnerships that are not energy- or commodity-focused, such as, for instance, asset management-related partnerships.
The cash distributed to the fund from the MLPs is anticipated to exceed the MLPs taxable income in some years. As the funds minimum distribution requirements are based upon taxable income, the
fund may not distribute to shareholders all or any of the cash received from MLP investments. To the extent that distributions exceed the funds earnings and profits, the excess will be tax-free for federal income tax purposes to the extent of
your tax basis in your shares, which basis will be reduced; that reduction will increase the amount of gain (or decrease the amount of loss) you will recognize on a subsequent redemption of your shares. If you have no remaining tax basis to offset,
you must report the excess as capital gain, long-term capital gain if you have held the shares for more than one year.
Reinsurance Companies with Hedge Fund Strategies.
The fund may invest in reinsurance companies that
combine reinsurance underwriting with hedge fund strategies. Such companies engage hedge fund managers to
20
invest their surplus capital in order to obtain higher returns than may be obtained from a portfolio of fixed income investments. The fund may invest in both publicly traded and privately offered
reinsurance companies. These issuers will be considered to be alternative investments and subject to the limit of 10% in any one issuer. Investments in these issuers are subject to the risks of investments in insurance companies generally, such as
the risk of significant fluctuations in value due to changes in interest rates, catastrophic events causing insurance losses, price and marketing competition, the imposition of premium rate caps, or other changes in government regulation or tax law,
among other factors, as well as the risks of investments in hedge funds, which involve greater risks than the strategies used by typical mutual funds, including increased use of short sales, leverage and derivative transactions and hedging
strategies.
Royalty Trusts.
The fund and certain underlying funds may invest in royalty trusts. Royalty trusts
are publicly traded investment vehicles that control an underlying company whose business is the acquisition, exploitation, production and sale of oil and natural gas. Royalty trusts typically have no physical operations and no management or
employees. Royalty trusts generally pay out to unit holders the majority of the cash flow that they receive from the production and sale of underlying oil and natural gas reserves. The amount of distributions paid on royalty income trust units will
vary from time to time based on production levels, commodity prices, royalty rates and certain expenses, deductions and costs, as well as on the distribution payout ratio policies adopted. As a result of distributing the bulk of their cash flow to
unit holders, the ability of a royalty trust to finance internal growth through exploration is limited. Royalty trusts generally grow through acquisition of additional oil and gas properties or producing companies with proven reserves of oil and
gas, funded through the issuance of additional equity or, where the trust is able, additional debt. Royalty trusts are exposed to many of the same risks as energy and natural resources companies, such as commodity pricing risk, supply and demand
risk and depletion and exploration risk. Royalty trusts are, in some respects, similar to certain MLPs and include risks similar to those MLPs.
Ratings as Investment Criteria
. In general, the ratings of NRSROs represent the opinions of these agencies as to the quality of securities that they rate. Such ratings, however, are relative and
subjective, are not absolute standards of quality and do not evaluate the market value risk of the securities. These ratings may be used by the underlying funds as initial criteria for the selection of portfolio securities, but the underlying funds
also will rely upon the independent advice of their advisers to evaluate potential investments. Among the factors that may be considered are the long-term ability of the issuer to pay principal and interest and general economic trends. Appendix A to
this SAI contains further information concerning the rating categories of NRSROs and their significance.
Subsequent to its
purchase by an underlying fund, an issue of securities may cease to be rated or its rating may be reduced below the minimum required for purchase by the fund. In addition, it is possible that an NRSRO might not change its rating of a particular
issue to reflect subsequent events. None of these events may require sale of such securities by an underlying fund, but the adviser of an underlying fund may consider such events in its determination of whether such fund should continue to hold the
securities. In addition, to the extent that the ratings change as a result of changes in such organizations or their rating systems, or because of a corporate reorganization, an underlying fund may attempt to use comparable ratings as standards for
its investments in accordance with its investment objective and policies.
Derivative Transactions
General.
The fund and certain underlying funds may invest in certain derivative instruments (also called Financial
Instruments), discussed below, to attempt to enhance income or yield, to hedge investments, as a substitute for buying or selling securities or to enhance returns, among other things, as described in the Prospectus. The use of Financial
Instruments is subject to applicable regulations of the SEC, the several exchanges upon which they are traded and the Commodity Futures Trading Commission (the CFTC). In addition, the funds and an underlying funds ability to
use Financial Instruments may be limited by tax considerations. In addition to the instruments, strategies and risks described below, the funds and the underlying funds advisers expect that additional opportunities in connection with
Financial Instruments and other similar or related techniques may
21
become available. These new opportunities may become available as the funds and the underlying funds advisers develop new techniques, as regulatory authorities broaden the range of
permitted transactions and as new Financial Instruments or other techniques are developed. The funds and the underlying funds advisers may utilize these opportunities to the extent that they are consistent with a funds investment
objective and are permitted by its investment limitations and applicable regulatory authorities. The fund and the underlying funds might not use any of these strategies, and there can be no assurance that any strategy used will succeed.
Recent legislation calls for new regulation of the derivatives markets. The extent and impact of the regulations are not yet fully known
and may not be for some time. Any new regulations could adversely affect the value, availability and performance of Financial Instruments, may make them more costly, and may limit or restrict their use by the fund and underlying funds.
Hedging strategies can be broadly categorized as short hedges and long hedges. A short hedge is a purchase or
sale of a Financial Instrument intended partially or fully to offset potential declines in the value of one or more investments held in a funds portfolio. In a short hedge, the fund takes a position in a Financial Instrument whose price is
expected to move in the opposite direction of the price of the investment being hedged.
Conversely, a long hedge is a
purchase or sale of a Financial Instrument intended partially or fully to offset potential increases in the acquisition cost of one or more investments that the fund intends to acquire. In a long hedge, a fund takes a position in a Financial
Instrument whose price is expected to move in the same direction as the price of the prospective investment being hedged. A long hedge is sometimes referred to as an anticipatory hedge. In an anticipatory hedge transaction, a fund does not own a
corresponding security and, therefore, the transaction does not relate to a security the fund owns. Rather, it relates to a security that the fund intends to acquire. If the fund does not complete the hedge by purchasing the security as anticipated,
the effect on the funds portfolio is the same as if the transaction were entered into for speculative purposes.
Financial Instruments on securities may be used to attempt to hedge against price movements in one or more particular securities
positions that a fund owns or intends to acquire. Financial Instruments on indexes, in contrast, may be used to attempt to hedge against price movements in market sectors in which a fund has invested or expects to invest. Financial Instruments on
debt securities may be used to hedge either individual securities or broad debt market sectors.
Special Risks.
The use
of Financial Instruments involves special considerations and risks, certain of which are described below. In general, these techniques may increase the volatility of the fund or an underlying fund and may involve a small investment of cash relative
to the magnitude of the risk assumed.
(1)
|
Successful use of most Financial Instruments depends upon the advisers ability to predict movements of the overall securities, currency and interest rate markets,
which requires different skills than predicting changes in the prices of individual securities. There can be no assurance that any particular strategy will succeed, and use of Financial Instruments could result in a loss, regardless of whether the
intent was to enhance returns or manage risk.
|
(2)
|
When Financial Instruments are used for hedging purposes, the historical correlation between price movements of a Financial Instrument and price movements of the
investments being hedged might change so as to make the hedge less effective or unsuccessful. For example, if the value of a Financial Instrument used in a short hedge increased by less than the decline in value of the hedged investment, the hedge
would not be fully successful. Such a change in correlation might occur due to factors unrelated to the value of the investments being hedged, such as speculative or other pressures on the markets in which Financial Instruments are traded. The
effectiveness of hedges using Financial Instruments on indexes will depend on the degree to which correlation between price movements in the index and price movements in the securities being hedged can be accurately predicted.
|
Because there are a limited number of types of exchange-traded options and futures contracts, it is likely that
the standardized contracts available will not match a funds current or anticipated investments exactly.
22
A fund may invest in options and futures contracts based on securities with different issuers, maturities or other characteristics from the securities in which it typically invests, which
involves the risk that the options or futures position will not track the performance of the funds other investments.
Options and futures prices can also diverge from the prices of their underlying instruments, even if the underlying instruments match a
funds investments well. Options and futures prices are affected by factors that may not affect security prices the same way, such as current and anticipated short-term interest rates, changes in volatility of the underlying instrument and the
time remaining until expiration of the contract.
Imperfect correlation may also result from differing levels of demand in the
options and futures markets and the securities markets, from structural differences in how options and futures are traded as compared to securities or from the imposition of daily price fluctuation limits or trading halts. A fund may purchase or
sell options and futures contracts with a greater or lesser value than the securities it wishes to hedge or intends to purchase in order to attempt to compensate for differences in volatility between the contract and the securities, although this
may not be successful in all cases. If price changes in a funds options or futures positions have a low correlation with its other investments, the positions may fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.
(3)
|
If successful, the hedging strategies discussed above can reduce the risk of loss by wholly or partially offsetting the negative effect of unfavorable price movements.
However, such strategies can also reduce opportunity for gain by offsetting the positive effect of favorable price movements. For example, if a fund entered into a short hedge because its adviser projected a decline in the price of a security in the
funds portfolio, and the price of that security increased instead, the gain from that increase might be wholly or partially offset by a decline in the price of the Financial Instrument. Moreover, if the price of the Financial Instrument
declined by more than the increase in the price of the security, the fund could suffer a loss. In either such case, the fund would have been in a better position had it not attempted to hedge at all.
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(4)
|
A fund might be required to maintain segregated assets as cover or make margin payments when it takes positions in Financial Instruments involving
obligations to third parties (
i.e.
, Financial Instruments other than purchased options). If the fund were unable to close out its positions in such Financial Instruments, it might be required to continue to maintain such assets or accounts or
make such payments until the position expired or matured. These requirements might impair the funds ability to sell a portfolio security or make an investment at a time when it would otherwise be favorable to do so, or require that the fund
sell a portfolio security at a disadvantageous time.
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(5)
|
A fund may be subject to the risk that the other party to a Financial Instrument (the counterparty) will not be able to honor its financial obligation to
the fund.
|
(6)
|
Many Financial Instruments are traded in institutional markets rather than on an exchange. Nevertheless, many Financial Instruments are actively traded and can be
priced with as much accuracy as conventional securities. Financial Instruments that are custom designed to meet the specialized investment needs of a relatively narrow group of institutional investors such as the fund are not readily marketable and
are subject to the funds restrictions on illiquid investments.
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A funds ability to close out a
position in a Financial Instrument prior to expiration or maturity depends on the existence of a liquid secondary market or, in the absence of such a market, the ability and willingness of the counterparty to enter into a transaction closing out the
position. Therefore, there is no assurance that any position can be closed out at a time and price that is favorable to the fund.
The use of Financial Instruments involves certain investment risks and transaction costs to which a fund might not otherwise be subject. These risks include: dependence on the advisers ability to
predict movements in the prices of individual debt securities, fluctuations in the general fixed income markets and movements in interest rates and currency markets; imperfect correlation between movements in the price of currency, options, futures
contracts or options thereon and movements in the price of the currency or security hedged or used for cover; the fact that skills and techniques needed to trade options, futures contracts and options thereon or to use
23
forward currency contracts are different from those needed to select the securities in which the fund invests; the lack of assurance that a liquid market will exist for any particular option,
futures contract or options thereon at any particular time; and the possible need to defer or accelerate closing out certain options, futures contracts and options thereon in order for the underlying fund to continue to qualify for the beneficial
tax treatment afforded regulated investment companies under the Code.
The fund and certain underlying funds may
enter into stock index, interest rate and currency futures contracts (or options thereon), swaps, caps, collars and floors. The fund and certain underlying funds may also purchase and sell call and put options, futures and options contracts.
The fund and certain underlying funds may also enter into futures contracts on securities or related options on futures
contracts on securities that are traded on a domestic or foreign exchange or in the OTC market, and may also engage in transactions in options on securities, which may include the writing of covered put options and covered call options, the purchase
of put and call options and the entry into closing transactions.
Options on Securities
. The fund and certain
underlying funds may engage in transactions in options on securities, which, depending on the fund, may include the writing of covered put options and covered call options, the purchase of put and call options and the entry into closing
transactions.
The principal reason for writing covered call options on securities is to attempt to realize, through the
receipt of premiums, a greater return than would be realized on the securities alone. In return for a premium, the writer of a covered call option forfeits the right to any appreciation in the value of the underlying security above the strike price
for the life of the option (or until a closing purchase transaction can be effected). Nevertheless, the call writer retains the risk of a decline in the price of the underlying security. Similarly, the principal reason for writing covered put
options is to realize income in the form of premiums. The writer of a covered put option accepts the risk of a decline in the price of the underlying security. The size of the premiums a fund may receive may be adversely affected as new or existing
institutions engage in or increase their option-writing activities.
Options written by a fund will normally have expiration
dates between one and six months from the date written. The exercise price of the options may be below, equal to, or above the current market values of the underlying securities at the times the options are written. In the case of call options,
these exercise prices are referred to as in-the-money, at-the-money and out-of-the-money, respectively.
A fund may write (a) in-the-money call options when its adviser expects the price of the underlying security to remain flat or decline moderately during the option period, (b) at-the-money call
options when its adviser expects the price of the underlying security to remain flat or advance moderately during the option period and (c) out-of-the-money call options when its adviser expects that the price of the security may increase but
not above a price equal to the sum of the exercise price plus the premiums received from writing the call option. In any of the preceding situations, if the market price of the underlying security declines and the security is sold at this lower
price, the amount of any realized loss will be offset wholly or in part by the premium received. Writing out-of-the-money, at-the-money and in-the-money put options (the reverse of call options as to the relation of exercise price to market price)
may be utilized in the same market environments as such call options are used in equivalent transactions.
So long as the
obligation of a fund as the writer of an option continues, the fund may be assigned an exercise notice by the broker/dealer through which the option was sold, requiring it to deliver, in the case of a call, or take delivery of, in the case of a put,
the underlying security against payment of the exercise price. This obligation terminates when the option expires or the fund effects a closing purchase transaction. The fund can no longer effect a closing purchase transaction with respect to an
option once it has been assigned an exercise notice. To secure its obligation to deliver the underlying security when it writes a call option, or to pay for the underlying security when it writes a put option, the fund will be required to deposit in
escrow the underlying security or other assets in accordance with the rules of the Options Clearing Corporation (OCC) or similar clearing corporation and the securities exchange on which the option is written.
24
The fund and certain underlying funds may purchase and sell put, call and other types of
option securities that are traded on domestic or foreign exchanges or the OTC market including, but not limited to, spread options, knock-out options, knock-in options and average rate or
look-back options. Spread options are dependent upon the difference between the price of two securities or futures contracts, knock-out options are canceled if the price of the underlying asset reaches a trigger
level prior to expiration, knock-in options only have value if the price of the underlying asset reaches a trigger level and average rate or look-back options are options where, at expiration, the options
strike price is set based on either the average, maximum or minimum price of the asset over the period of the option.
An
option position may be closed out only where there exists a secondary market for an option of the same series on a recognized securities exchange or in the OTC market. The fund and the underlying funds expect to write options only on national
securities exchanges or in the OTC market. The fund and the underlying funds may purchase put options issued by the OCC or in the OTC market.
A fund may realize a profit or loss upon entering into a closing transaction. In cases in which the fund has written an option, it will realize a profit if the cost of the closing purchase transaction is
less than the premium received upon writing the original option and will incur a loss if the cost of the closing purchase transaction exceeds the premium received upon writing the original option. Similarly, when the fund has purchased an option and
engages in a closing sale transaction, whether it recognizes a profit or loss will depend upon whether the amount received in the closing sale transaction is more or less than the premium the fund initially paid for the original option plus the
related transaction costs.
Although the fund or an underlying fund generally will purchase or write only those options for
which its adviser believes there is an active secondary market so as to facilitate closing transactions, there is no assurance that sufficient trading interest to create a liquid secondary market on a securities exchange will exist for any
particular option or at any particular time, and for some options no such secondary market may exist or may cease to exist. In the past, for example, higher than anticipated trading activity or order flow, or other unforeseen events, have at times
rendered certain of the facilities of the OCC and national securities exchanges inadequate and resulted in the institution of special procedures, such as trading rotations, restrictions on certain types of orders or trading halts or suspensions in
one or more options. There can be no assurance that similar events, or events that may otherwise interfere with the timely execution of customers orders, will not recur. In such event, it might not be possible to effect closing transactions in
particular options. If, as a covered call option writer, a fund is unable to effect a closing purchase transaction in a secondary market, it will not be able to sell the underlying security until the option expires or it delivers the underlying
security upon exercise.
Securities exchanges generally have established limitations governing the maximum number of calls and
puts of each class which may be held or written, or exercised within certain periods, by an investor or group of investors acting in concert (regardless of whether the options are written on the same or different securities exchanges or are held,
written or exercised in one or more accounts or through one or more brokers). It is possible that the fund and other clients of the manager or Permal and certain of their affiliates may be considered to be such a group. A securities exchange may
order the liquidation of positions found to be in violation of these limits, and it may impose certain other sanctions.
A
call option written by the fund or an underlying fund is covered if the fund owns the securities or currency underlying the option or has an absolute and immediate right to acquire that security or currency without additional cash
consideration (or for additional cash consideration held in a segregated account by the funds custodian) upon conversion or exchange of other securities or currencies held in its portfolio. A written call option is also covered if the fund
holds on a share-for-share basis a purchased call on the same security or holds a call on the same currency as the call written where the exercise price of the call held is equal to less than the exercise price of the call written or greater than
the exercise price of the call written if the difference is maintained by the fund in cash or other liquid assets.
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In the case of options written by the fund or an underlying fund that are deemed covered by
virtue of the funds holding convertible or exchangeable preferred stock or debt securities, the time required to convert or exchange and obtain physical delivery of the underlying common stocks with respect to which the fund has written
options may exceed the time within which the fund must make delivery in accordance with an exercise notice. In these instances, the fund may purchase or temporarily borrow the underlying securities for purposes of physical delivery. By so doing, the
fund will not bear any market risk because the fund will have the absolute right to receive from the issuer of the underlying security an equal number of shares to replace the borrowed stock, but the fund may incur additional transaction costs or
interest expenses in connection with any such purchase or borrowing.
Additional risks exist with respect to certain of the
U.S. government securities for which the fund or an underlying fund may write covered call options. If the fund writes covered call options on mortgage-backed securities, the securities that it holds as cover may, because of scheduled amortization
or unscheduled prepayments, cease to be sufficient cover. The fund will compensate for the decline in the value of the cover by purchasing the appropriate additional amount of those securities.
Although Permal will attempt to take appropriate measures to minimize the risks relating to the funds writing of call options and
purchasing of put and call options, there can be no assurance that the funds use of options will succeed.
Stock
Index Options
. The fund and certain underlying funds may purchase and write put and call options on U.S. stock indexes listed on U.S. exchanges. A stock index fluctuates with changes in the market values of the stocks included in the index. Some
stock index options are based on a broad market index such as the NYSE Composite Index or the Canadian Market Portfolio Index, or a narrower market or industry index such as the S&P 100 Index, the NYSE Arca Oil Index or the NYSE Arca Computer
Technology Index.
Options on stock indexes are generally similar to options on stock except for the delivery requirements.
Instead of giving the right to take or make delivery of stock at a specified price, an option on a stock index gives the holder the right to receive a cash exercise settlement amount equal to (a) the amount, if any, by which the
fixed exercise price of the option exceeds (in the case of a put) or is less than (in the case of a call) the closing value of the underlying index on the date of exercise, multiplied by (b) a fixed index multiplier. Receipt of this
cash amount will depend upon the closing level of the stock index upon which the option is based being greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. The amount of cash received will be
equal to such difference between the closing price of the index and the exercise price of the option expressed in dollars or a foreign currency, as the case may be, times a specified multiple. The writer of the option is obligated, in return for the
premium received, to make delivery of this amount. The writer may offset its position in stock index options prior to expiration by entering into a closing transaction on an exchange or it may let the option expire unexercised.
The effectiveness of purchasing or writing stock index options as a hedging technique will depend upon the extent to which price
movements in the portion of the securities portfolio of the fund being hedged correlate with price movements of the stock index selected. Because the value of an index option depends upon movements in the level of the index rather than the price of
a particular stock, whether a fund will realize a gain or loss from the purchase or writing of options on an index depends upon movements in the level of stock prices in the stock market generally or, in the case of certain indexes, in an industry
or market segment, rather than movements in the price of a particular stock. Accordingly, successful use by the fund of options on stock indexes will be subject to its advisers ability to predict correctly movements in the direction of the
stock market generally or of a particular industry. This requires different skills and techniques than predicting changes in the price of individual stocks.
Currency Transactions
. The fund and certain underlying funds may enter into forward currency exchange transactions. A forward currency contract is an obligation to purchase or sell a currency
against another currency
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at a future date and price as agreed upon by the parties. A fund that enters into a forward currency contract may either accept or make delivery of the currency at the maturity of the forward
contract or, prior to maturity, enter into a closing transaction involving the purchase or sale of an offsetting contract. A fund may engage in forward currency transactions in anticipation of, or to protect itself against, fluctuations in exchange
rates.
A fund might sell a particular foreign currency forward, for example, when it holds bonds denominated in that currency
but anticipates, and seeks to be protected against, a decline in the currency against the U.S. dollar. Similarly, a fund may sell the U.S. dollar forward when it holds bonds denominated in U.S. dollars but anticipates, and seeks to be protected
against, a decline in the U.S. dollar relative to other currencies. Further, a fund may purchase a currency forward to lock in the price of securities denominated in that currency which it anticipates purchasing. Such contracts may
involve the purchase or sale of a foreign currency against the U.S. dollar or may involve two foreign currencies. A fund may enter into forward currency contracts either with respect to specific transactions or with respect to its portfolio
positions. For example, when a funds adviser anticipates recommending a purchase or sale of a security, it may cause the fund to enter into a forward currency contract in order to set the rate (either relative to the U.S. dollar or another
currency) at which the currency exchange transaction related to the purchase or sale will be made (transaction hedging). Further, when a funds adviser believes that a particular currency may decline compared to the U.S. dollar or
another currency, the fund may enter into a forward contract to sell the currency that the funds adviser expects to decline in an amount approximating the value of some or all of the funds securities denominated in that currency. When a
funds adviser believes that one currency may decline against a currency in which some or all of the portfolio securities held by the fund are denominated, it may enter into a forward contract to buy the currency expected to appreciate for a
fixed amount (position hedging). In this situation, the fund may, in the alternative, enter into a forward contract to sell a different currency for a fixed amount of the currency expected to decline where the adviser believes that the
value of the currency to be sold pursuant to the forward contract will fall whenever there is a decline in the value of the currency in which portfolio securities of the fund are denominated (cross hedging). If the fund is a registered
investment company, the funds custodian places cash or other liquid assets in a separate account of the fund having a value equal to the aggregate amount of the funds commitments under forward currency contracts entered into with respect
to position hedges and cross-hedges. If the value of the securities placed in a separate account declines, additional cash or assets are placed in the account on a daily basis so that the value of the amount will equal the amount of the funds
commitments with respect to such contracts.
At or before the maturity of a forward contract, a fund either may sell a
portfolio security and make delivery of the currency, or retain the security and offset its contractual obligation to deliver the currency by purchasing a second contract pursuant to which the fund will obtain, on the same maturity date, the same
amount of the currency which it is obligated to deliver. If a fund retains the portfolio security and engages in an offsetting transaction, the fund, at the time of execution of the offsetting transaction, will incur a gain or loss to the extent
movement has occurred in forward contract prices. Should forward prices decline during the period between the funds entering into a forward contract for the sale of a currency and the date that it enters into an offsetting contract for the
purchase of the currency, the fund will realize a gain to the extent that the price of the currency it has agreed to sell exceeds the price of the currency it has agreed to purchase. Should forward prices increase, the fund will suffer a loss to the
extent the price of the currency it has agreed to purchase exceeds the price of the currency it has agreed to sell.
The cost
to a fund of engaging in currency transactions varies with factors such as the currency involved, the length of the contract period and the market conditions then prevailing. Since transactions in currency exchanges are usually conducted on a
principal basis, no fees or commissions are involved. The use of forward currency contracts does not eliminate fluctuations in the underlying prices of the securities, but it does establish a rate of exchange that can be achieved in the future. In
addition, although forward currency contracts limit the risk of loss due to a decline in the value of the hedged currency, at the same time they limit any potential gain that might result should the value of the currency increase. If a devaluation
is generally anticipated a fund may not be able to contract to sell the currency at a price above the devaluation level it anticipates.
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Foreign Currency Options
. The fund and certain underlying funds may purchase or write
put and call options on foreign currencies for the purpose of hedging against changes in future currency exchange rates. Foreign currency options generally have three, six and nine month expiration cycles. Put options convey the right to sell the
underlying currency at a price which is anticipated to be higher than the spot price of the currency at the time the option expires. Call options convey the right to buy the underlying currency at a price which is expected to be lower than the spot
price of the currency at the time that the option expires.
A fund may use foreign currency options under the same
circumstances that it could use forward currency exchange transactions. A decline in the U.S. dollar value of a foreign currency in which the funds securities are denominated, for example, will reduce the U.S. dollar value of the securities,
even if their value in the foreign currency remains constant. In order to protect against such diminutions in the value of securities that it holds, the fund may purchase put options on the foreign currency. If the value of the currency does
decline, the fund will have the right to sell the currency for a fixed amount in U.S. dollars and will thereby offset, in whole or in part, the adverse effect on its securities that otherwise would have resulted. Conversely, if a rise in the U.S.
dollar value of a currency in which securities to be acquired are denominated is projected, thereby potentially increasing the cost of the securities, the fund may purchase call options on the particular currency. The purchase of these options could
offset, at least partially, the effects of the adverse movements in exchange rates. The benefit to the fund derived from purchases of foreign currency options, like the benefit derived from other types of options, will be reduced by the amount of
the premium and related transaction costs. In addition, if currency exchange rates do not move in the direction or to the extent anticipated, the fund could sustain losses on transactions in foreign currency options that would require it to forgo a
portion or all of the benefits of advantageous changes in the rates.
Futures Contracts
. The purpose of entering into a
futures contract is to protect a fund from fluctuations in the value of securities without actually buying or selling the securities. For example, in the case of stock index futures contracts, if the fund anticipates an increase in the price of
stocks that it intends to purchase at a later time, the fund could enter into contracts to purchase the stock index (known as taking a long position) as a temporary substitute for the purchase of stocks. If an increase in the market
occurs that influences the stock index as anticipated, the value of the futures contracts increases and thereby serves as a hedge against the funds not participating in a market advance. The fund then may close out the futures contracts by
entering into offsetting futures contracts to sell the stock index (known as taking a short position) as it purchases individual stocks. The fund can accomplish similar results by buying securities with long maturities and selling
securities with short maturities. But by using futures contracts as an investment tool to reduce risk, given the greater liquidity in the futures market, it may be possible to accomplish the same result more easily and more quickly.
The fund and certain underlying funds may enter into futures contracts or related options on futures contracts that are traded on a
domestic or foreign exchange or in the over-the-counter market. Generally, these investments may be made solely for the purpose of hedging against changes in the value of portfolio securities due to anticipated changes in interest rates, currency
values and/or market conditions when the transactions are economically appropriate to the reduction of risks inherent in the management of the fund and not for purposes of speculation, but the fund and some underlying funds may enter into futures
contracts for non-hedging purposes,
i.e.
, to increase total return. The ability of the fund and the underlying funds to trade in futures contracts may be limited by the requirements of the Code applicable to a regulated investment company.
No consideration will be paid or received by the fund upon the purchase or sale of a futures contract. Initially, the fund
will be required to deposit with the broker an amount of cash or cash equivalents equal to approximately 1% to 10% of the contract amount (this amount is subject to change by the exchange or board of trade on which the contract is traded and brokers
or members of such board of trade may charge a higher amount). This amount is known as initial margin and is in the nature of a performance bond or good faith deposit on the contract, which is returned to the fund upon termination of the
futures contract, assuming all contractual obligations have been satisfied. Subsequent payments, known as variation margin, to and from the broker, will be made daily as the price of the index or securities underlying the futures
contract fluctuates,
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making the long and short positions in the futures contract more or less valuable, a process known as marking-to-market. In addition, when the fund enters into a long position in a
futures contract or an option on a futures contract, it must maintain an amount of cash or cash equivalents equal to the total market value of the underlying futures contract, less amounts held in the funds commodity brokerage account at its
broker. At any time prior to the expiration of a futures contract, the fund may elect to close the position by taking an opposite position, which will operate to terminate the funds existing position in the contract.
Several risks are associated with the use of futures contracts as a hedging device. Successful use of futures contracts by a fund is
subject to the ability of its adviser to predict correctly movements in interest rates, stock or bond indices or foreign currency values. These predictions involve skills and techniques that may be different from those involved in the management of
the fund being hedged. In addition, there can be no assurance that there will be a correlation between movements in the price of the underlying securities, currency or index and movements in the price of the securities which are the subject of the
hedge. A decision of 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 trends in interest rates or currency values.
Positions in futures contracts may be closed out only on the exchange on which they were entered into (or through a linked
exchange) and no secondary market exists for those contracts. In addition, although the fund and the underlying funds normally enter into futures contracts only if there is an active market for the contracts, there is no assurance that an active
market will exist for the contracts at any particular time. Most futures exchanges and boards of trade limit the amount of fluctuation permitted in futures contract prices during a single trading day. Once the daily limit has been reached in a
particular contract, no trades may be made that day at a price beyond that limit. It is possible that futures contract prices could move to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt
liquidation of futures positions and subjecting some futures traders to substantial losses. In such event, and in the event of adverse price movements, a fund would be required to make daily cash payments of variation margin; in such circumstances,
an increase in the value of the portion of the portfolio being hedged, if any, may partially or completely offset losses on the futures contract. As described above, however, no assurance can be given that the price of the securities being hedged
will correlate with the price movements in a futures contract and thus provide an offset to losses on the futures contract.
If the fund or an underlying fund has hedged against the possibility of a change in interest rates or currency or market values adversely
affecting the value of securities held in its portfolio and rates or currency or market values move in a direction opposite to that which the fund has anticipated, the fund will lose part or all of the benefit of the increased value of securities
which it has hedged because it will have offsetting losses in its futures positions. In addition, in such situations, if the fund had insufficient cash, it may have to sell securities to meet daily variation margin requirements at a time when it may
be disadvantageous to do so. These sales of securities may, but will not necessarily, be at increased prices which reflect the change in interest rates or currency or market values, as the case may be.
Commodity Exchange Act Regulation.
Effective December 31, 2012, the fund is limited in its ability to use commodity futures
(which include futures on broad-based securities indexes and interest rate futures) (collectively, commodity interests) or options on commodity futures, engage in certain swaps transactions or make certain other investments (whether
directly or indirectly through investments in other investment vehicles) for purposes other than bona fide hedging, as defined in the rules of the CFTC. With respect to transactions other than for bona fide hedging purposes, either:
(1) the aggregate initial margin and premiums required to establish the funds positions in such investments may not exceed 5% of the liquidation value of the funds portfolio (after accounting for unrealized profits and unrealized
losses on any such investments); or (2) the aggregate net notional value of such instruments, determined at the time the most recent position was established, may not exceed 100% of the liquidation value of the funds portfolio (after
accounting for unrealized profits and unrealized losses on any such positions). In addition to meeting one of the foregoing trading limitations, the fund may not market itself as a commodity pool or otherwise as a vehicle for trading in the
futures, options or swaps markets.
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As noted above, the fund may be exposed to commodity interests indirectly in excess of the
limits described in the prior paragraph. Such exposure may result from the funds investment in other investment vehicles, including investment companies that are not managed by the funds manager or one of its affiliates, certain
securitized vehicles that may invest in commodity interests and/or non-equity REITs that may invest in commodity interests. These investment vehicles are referred to collectively as underlying funds. The manager may have limited or no
information as to what an underlying fund may be invested in at any given time, because they are not managed by the manager or persons affiliated with the manager and their holdings will likely change over time. To address this lack of transparency,
the CFTC staff has issued a no-action letter permitting the manager of a fund that invests in such underlying funds to register as a commodity pool operator (a CPO) or to claim the exclusion from the CPO definition until the later of
June 30, 2013 or six months from the date on which the CFTC issues additional guidance on the application of
de minimis
thresholds in the context of the CFTC exemptive rules. In order to rely on this no-action relief, the manager must
meet certain conditions (including certain compliance measures), and otherwise be able to rely on a claim of exclusion from the CPO definition. The funds manager has filed the required notice to claim this no-action relief.
Options on Futures Contracts
. An option on an interest rate futures contract, as contrasted with the direct investment in such a
contract, gives the purchaser the right, in return for the premium paid, to assume a position in the underlying futures contract at a specified exercise price at any time prior to the expiration date of the option. An option on a foreign currency
futures contract, as contrasted with the direct investment in such a contract, gives the purchaser the right, but not the obligation, to assume a long or short position in the relevant underlying foreign currency futures contract at a predetermined
exercise price at a time in the future. Upon exercise of an option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by delivery of the accumulated balance in the writers futures
margin account, which represents the amount by which the market price of the futures contract exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. The potential for loss
related to the purchase of an option on futures contracts is limited to the premium paid for the option (plus transaction costs). Since the value of the option is fixed at the point of sale, there are no daily cash payments to reflect changes in the
value of the underlying contract; however, the value of the option does change daily and that change would be reflected in the NAV of the fund investing in the options.
Several risks are associated with options on futures contracts. The ability to establish and close out positions on such options will be subject to the existence of a liquid market. In addition, the
purchase of put or call options on interest rate and foreign currency futures will be based upon predictions by a funds adviser as to anticipated trends in interest rates and currency values, as the case may be, which could prove to be
incorrect. Even if the expectations of an adviser are correct, there may be an imperfect correlation between the change in the value of the options and of the portfolio securities in the currencies being hedged.
Commodity-Linked Derivative Instruments
. Investments by the fund or an underlying fund in commodity-linked derivative instruments
may subject the fund to greater volatility than investments in traditional securities. The value of commodity-linked derivative instruments may be affected by changes in overall market movements; changes in interest rates or factors affecting a
particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes or tariffs; and international economic, political and regulatory developments. The means by which the fund or an underlying fund seeks exposure to
commodities, both directly and indirectly, including through derivatives, may be limited by the underlying funds intention to qualify as a regulated investment company under the Code.
Foreign Commodity Exchanges
. Unlike trading on domestic commodity exchanges, trading on foreign commodity exchanges is not
regulated by the CFTC and may be subject to greater risks than trading on domestic exchanges. For example, some foreign exchanges may be principal markets so that no common clearing facility exists and a trader may look only to the broker for
performance of the contract. In addition, unless a funds trading on a foreign commodity exchange hedges against fluctuations in the exchange rate between the U.S. dollar and the currencies in which trading is done on foreign exchanges, any
profits that the fund might realize in trading could be eliminated by adverse changes in the exchange rate, or the fund could incur losses as a result of those changes.
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Swap Agreements
. Among the hedging transactions into which the fund and certain
underlying funds may enter are interest rate swaps and the purchase or sale of interest rate caps and floors. Interest rate swaps involve the exchange by a fund with another party of their respective commitments to pay or receive interest,
e.g.
, an exchange of floating rate payments for fixed rate payments. The purchase of an interest rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a
notional principal amount from the party selling such interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payment of interest on
a notional principal amount from the party selling such interest rate floor.
The fund and certain underlying funds may enter
into interest rate swaps, caps and floors on either an asset-based or liability-based basis, depending on whether a fund is hedging its assets or its liabilities, and will usually enter into interest rate swaps on a net basis,
i.e.
, the two
payment streams are netted, with the fund receiving or paying, as the case may be, only the net amount of the two payments. Inasmuch as these hedging transactions are entered into for good faith hedging purposes, the funds adviser may believe
such obligations do not constitute senior securities and, accordingly, will not treat them as being subject to the funds borrowing restrictions. The net amount of the excess, if any, of a funds obligations over its entitlements with
respect to each interest rate swap will be accrued on a daily basis and an amount of cash or liquid assets having an aggregate NAV at least equal to the accrued excess will be maintained in a segregated account with its custodian. If there is a
default by the other party to such a transaction, a fund will have contractual remedies pursuant to the agreement related to the transaction.
Swap agreements will tend to shift a funds investment exposure from one type of investment to another. For example, if the fund agreed to exchange payments in U.S. dollars for payments in a foreign
currency, the swap agreement would tend to decrease the funds exposure to U.S. interest rates and increase its exposure to foreign currency and interest rates. Depending on how they are used, swap agreements may increase or decrease the
overall volatility of the funds investments and its share price and yield. Caps and floors have an effect similar to buying or writing options.
Swap agreements are sophisticated risk management instruments that typically require a small cash investment relative to the magnitude of risks assumed. As a result, swaps can be highly volatile and may
have a considerable impact on a funds performance. Swap agreements entail both interest rate risk and credit risk. There is a risk that, based on movements of interest rates in the future, the payments made by the fund under a swap agreement
will be greater than the payments it received. Swap agreements are subject to credit risks related to the counterpartys ability to perform, and may decline in value if the counterpartys creditworthiness deteriorates. The creditworthiness
of firms with which a fund enters into interest rate swaps, caps and floors will be monitored by the funds adviser. If a firms creditworthiness declines, the value of the agreement would be likely to decline, potentially resulting in
losses. If a default occurs by the other party to such transaction, the fund will have contractual remedies pursuant to the agreements related to the transaction. A fund may also suffer losses if it is unable to terminate outstanding swap agreements
or reduce its exposure through offsetting transactions. The fund will maintain in a segregated account cash or liquid assets equal to the net amount, if any, of the excess of the funds obligations over its entitlements with respect to a swap
transaction.
The swap market has grown substantially in recent years with a large number of banks and investment banking
firms acting both as principals and as agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid. Caps and floors are more recent innovations for which standardized documentation has not yet been
fully developed and, accordingly, they are less liquid than swaps.
Credit Default Swaps
. The fund and certain
underlying funds may from time to time sell protection on debt securities by entering into credit default swaps. In these transactions, the fund is generally required to pay the par (or other agreed-upon) value of a referenced debt security to the
counterparty in the event of a default on or downgrade of the debt security and/or a similar credit event. In return, the fund receives from the counterparty a periodic stream of payments over the term of the contract. If no default occurs, the fund
keeps the stream of
31
payments and has no payment obligations. As the seller, the fund would effectively add leverage to its portfolio because, in addition to its net assets, the fund would be subject to investment
exposure on the par (or other agreed upon) value it had undertaken to pay. Credit default swaps may also be structured based on an index or the debt of a basket of issuers, rather than a single issuer, and may be customized with respect to the
default event that triggers purchase or other factors (for example, a particular number of defaults within a basket, or defaults by a particular combination of issuers within the basket, may trigger a payment obligation).
Credit default swap contracts involve special risks and may result in losses to a fund. Credit default swaps may in some cases be
illiquid, and they increase credit risk since the fund has exposure to both the issuer of the referenced obligation and the counterparty to the credit default swap. The absence of a central exchange or market for swap transactions led, in some
instances, to difficulties in trading and valuation, especially in the event of market disruptions. Recent legislation, noted above, will require most swaps to be executed through a centralized exchange or regulated facility and be cleared through a
regulated clearinghouse. The swap market could be disrupted or limited as a result of this legislation, which could adversely affect the funds. Moreover, the establishment of a centralized exchange or market for swap transactions may not result in
swaps being easier to trade or value.
Investment Practices
In attempting to achieve its investment objectives, the fund and/or an underlying fund may employ, among others, the following investment strategies.
Borrowing
. Certain underlying funds may borrow in certain circumstances. Borrowing creates an opportunity for increased return,
but, at the same time, creates special risks. For example, borrowing may exaggerate changes in the NAV of the funds shares and in the return on the funds portfolio. Although the principal of any borrowing will be fixed, the funds
assets may change in value during the time the borrowing is outstanding. The fund may be required to liquidate portfolio securities at a time when it would be disadvantageous to do so in order to make payments with respect to any borrowing, which
could affect the advisers strategy and the funds ability to comply with certain provisions of the Code in order to provide pass-though tax treatment to shareholders. Interest on any borrowings will be a fund expense and will reduce the
value of the funds shares.
Repurchase Agreements
. The fund and certain underlying funds may enter into
repurchase agreements. Under the terms of a typical repurchase agreement, a fund would acquire an underlying debt obligation for a relatively short period (usually not more than one week) subject to an obligation of the seller to repurchase,
and the fund to resell, the obligation at an agreed-upon price and time, thereby determining the yield during the funds holding period. If the value of such securities were less than the repurchase price, plus interest, the other party to the
agreement would be required to provide additional collateral so that at all times the collateral is at least 102% of the repurchase price plus accrued interest. Repurchase agreements could involve certain risks in the event of default or insolvency
of the other party, including possible delays or restrictions upon the funds ability to dispose of the underlying securities, the risk of a possible decline in the value of the underlying securities during the period in which the fund seeks to
assert its right to them, the risk of incurring expenses associated with asserting those rights and the risk of losing all or part of the income from the agreement. With respect to the funds repurchase agreements, Western Asset, acting under
the supervision of the funds Board of Trustees (the Board), reviews on an ongoing basis the value of the collateral and creditworthiness of those banks and dealers with which the fund enters into repurchase agreements to evaluate
potential risks.
Pursuant to an exemptive order issued by the SEC, the fund, along with other affiliated entities managed by
the manager, may transfer uninvested cash balances into one or more joint repurchase accounts. These balances are invested in one or more repurchase agreements, secured by U.S. government securities. Securities that are collateral for repurchase
agreements are financial assets subject to the funds entitlement orders through its securities account at its custodian bank until the agreements mature. Each joint repurchase arrangement requires
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that the market value of the collateral be sufficient to cover payments of interest and principal; however, in the event of default by the other party to the agreement, retention or sale of the
collateral may be subject to legal proceedings.
Reverse Repurchase Agreements
. Certain underlying funds may enter into
reverse repurchase agreements, which involve the sale of fund securities with an agreement to repurchase the securities at an agreed-upon price, date and interest payment and have the characteristics of borrowings. Since the proceeds of borrowings
under reverse repurchase agreements are invested, this would introduce the speculative factor known as leverage. The securities purchased with the funds obtained from the agreement and securities collateralizing the agreement will have
maturity dates no later than the repayment date. Generally the effect of such a transaction is that a fund can recover all or most of the cash invested in the portfolio securities involved during the term of the reverse repurchase agreement, while
in many cases it will be able to keep some of the interest income associated with those securities. Such transactions are advantageous only if the fund has an opportunity to earn a greater rate of interest on the cash derived from the transaction
than the interest cost of obtaining that cash. Opportunities to realize earnings from the use of the proceeds equal to or greater than the interest required to be paid may not always be available. The use of reverse repurchase agreements may
exaggerate any interim increase or decrease in the value of a funds assets. If applicable, a funds custodian bank will maintain a separate account for the fund with cash or liquid assets having a value equal to or greater than such
commitment of the fund.
Western Asset also reviews on an ongoing basis the value of the collateral and creditworthiness of
the counterparties with which certain underlying funds enter into reverse repurchase agreements.
Reverse repurchase
agreements involve the risk that the market value of the securities sold by the fund may decline below the repurchase price of the securities. In the event the buyer of securities under a reverse repurchase agreement files for bankruptcy or becomes
insolvent, such buyer, or its trustee or receiver, may receive an extension of time to determine whether to enforce the funds obligation to repurchase the securities, and the funds use of the proceeds of the reverse repurchase agreement
may effectively be restricted pending such decision.
When-Issued Securities and Delayed-Delivery Transactions
. To
secure an advantageous price or yield, the fund, through its investment in certain of the underlying funds or directly, may purchase certain securities on a when-issued basis or purchase or sell securities for delayed delivery. Delivery of the
securities in such cases occurs beyond the normal settlement periods, but no payment or delivery is made by a fund prior to the reciprocal delivery or payment by the other party to the transaction. In entering into a when-issued or delayed-delivery
transaction, a fund will rely on the other party to consummate the transaction and may be disadvantaged if the other party fails to do so.
Fixed income securities normally are subject to changes in value based upon changes, real or anticipated, in the level of interest rates and the publics perception of the creditworthiness of the
issuers. In general, fixed income securities tend to appreciate when interest rates decline and depreciate when interest rates rise. Purchasing these securities on a when-issued or delayed-delivery basis, therefore, can involve the risk that the
yields available in the market when the delivery takes place may actually be higher than those obtained in the transaction itself. Similarly, the sale of fixed income securities for delayed delivery can involve the risk that the prices available in
the market when the delivery is made may actually be higher than those obtained in the transaction itself.
In the case of the
purchase by the fund or an underlying fund of securities on a when-issued or delayed-delivery basis, a segregated account in the name of the fund consisting of cash or liquid securities equal to the amount of the when-issued or delayed-delivery
commitments will be established. For the purpose of determining the adequacy of the securities in the accounts, the deposited securities will be valued at market or fair value. If the market or fair value of the securities declines, additional cash
or securities will be placed in the account daily so that the value of the account will equal the amount of such commitments by the fund involved. On the
33
settlement date, the fund will meet its obligations from then-available cash flow, the sale of securities held in the segregated account, the sale of other securities or, although it would not
normally expect to do so, from the sale of the securities purchased on a when-issued or delayed-delivery basis (which may have a value greater or less than the funds payment obligations).
Securities Lending
. Consistent with applicable regulatory requirements, the fund may lend portfolio securities to brokers, dealers
and other financial organizations meeting capital and other credit requirements or other criteria established by the Board. The fund will not lend portfolio securities to affiliates of Legg Mason unless it has applied for and received specific
authority to do so from the SEC. From time to time, the fund may pay to the borrower and/or a third party which is unaffiliated with the fund or Legg Mason and is acting as a finder a part of the interest earned from the investment of
collateral received for securities loaned. Although the borrower will generally be required to make payments to the fund in lieu of any dividends the fund would have otherwise received had it not loaned the shares to the borrower, such payments will
not be treated as qualified dividend income for purposes of determining what portion of the funds regular dividends (as defined below) received by individuals may be taxed at the rates generally applicable to long-term capital
gains (see Taxes below).
Requirements of the SEC, which may be subject to future modification, currently provide
that the following conditions must be met whenever the fund lends its portfolio securities: (a) the fund must receive at least 100% cash collateral or equivalent securities from the borrower; (b) the borrower must increase such collateral
whenever the market value of the securities rises above the level of such collateral; (c) the fund must be able to terminate the loan at any time; (d) the fund must receive reasonable interest on the loan, as well as any dividends,
interest or other distributions on the loaned securities, and any increase in market value; (e) the fund may pay only reasonable custodian fees in connection with the loan; and (f) voting rights on the loaned securities may pass to the
borrower. However, if a material event adversely affecting the investment in the loaned securities occurs, the fund must terminate the loan and regain the right to vote the securities.
The risks in lending portfolio securities, as with other extensions of secured credit, consist of possible delay in receiving additional
collateral or in the recovery of the securities or possible loss of rights in the collateral should the borrower fail financially. The fund could also lose money if its short-term investment of the cash collateral declines in value over the period
of the loan. Loans will be made to firms deemed by Permal to be of good standing and will not be made unless, in the judgment of Permal, the consideration to be earned from such loans would justify the risk.
Certain underlying funds may lend their portfolio securities subject to regulatory requirements.
Short Sales
. The fund, through its investment in certain underlying funds or directly, may engage in short sales. A short sale is
a transaction in which a fund sells a security it does not own in anticipation of a decline in the market price of that security. On occasions where Permal believes there is no suitable underlying fund through which the fund may gain a short
exposure to a particular asset class or market segment, it may cause the fund to engage in a short sale of an ETF that invests in the subject asset class or market segment. To effect a short sale, the fund or an underlying fund arranges through a
broker to borrow the security it does not own to be delivered to a buyer of such security. In borrowing the security to be delivered to the buyer, the fund will become obligated to replace the security borrowed at its market price at the time of
replacement, whatever that price may be. A short sale results in a gain when the price of the securities sold short declines between the date of the short sale and the date on which a security is purchased to replace the borrowed security.
Conversely, a short sale will result in a loss if the price of the security sold short increases. Short selling is a technique that may be considered speculative and involves risk beyond the amount of money used to secure each transaction.
When the fund or an underlying fund makes a short sale, the broker effecting the short sale typically holds the proceeds
as part of the collateral securing the funds obligation to cover the short position. The fund may use securities it owns to meet such collateral obligations. Generally, the fund may not keep, and must return to the
34
lender, any dividends or interest that accrue on the borrowed security during the period of the loan. Depending on the arrangements with a broker or the custodian, the fund may or may not receive
any payments (including interest) on collateral it designates as security for the broker.
In addition, until the fund or an
underlying fund that is a registered investment company closes its short position or replaces the borrowed security, the fund, pursuant to the 1940 Act, will designate liquid assets it owns (other than short sale proceeds) as segregated assets in an
amount equal to its obligation to purchase the securities sold short. The amount segregated in this manner will be increased or decreased each business day (called marked-to-market) in an amount equal to the changes in the market value of the
funds obligation to purchase the security sold short. This may limit the funds investment flexibility as well as its ability to meet redemption requests or other current obligations.
The fund will realize a gain if the price of a security declines between the date of the short sale and the date on which the fund
purchases a security to replace the borrowed security. On the other hand, the fund will incur a loss if the price of the security increases between those dates. The amount of any gain will be decreased and the amount of any loss increased by any
premium or interest that the fund may be required to pay in connection with a short sale. It should be noted that possible losses from short sales differ from those that could arise from a cash investment in a security in that losses from a short
sale may be limitless, while the losses from a cash investment in a security cannot exceed the total amount of the investment in the security.
There can be no assurance that the fund or an underlying fund will be able to close out a short position (
i.e
., purchase the same security) at any particular time or at an acceptable or
advantageous price.
When the fund or an underlying fund that is registered under the 1940 Act sells short, it must segregate
liquid assets held by its custodian as collateral to cover its obligation, and maintain the collateral in an amount at least equal to the market value of the short position. To the extent that the liquid assets segregated by the funds
custodian are subject to gain or loss, and the securities sold short are subject to the possibility of gain or loss, leverage is created. If the fund uses portfolio securities that are subject to gains or losses as collateral for short sales,
leverage will normally be created.
There is also a risk that a borrowed security will need to be returned to the
broker/dealer on short notice. If the request for the return of a security occurs at a time when other short sellers of the security are receiving similar requests, a short squeeze can occur, meaning that the fund might be compelled, at
the most disadvantageous time, to replace the borrowed security with a security purchased on the open market, possibly at prices significantly in excess of the proceeds received earlier.
A fund has a short position in the securities sold short until it delivers to the broker/dealer the securities sold, at which time the
fund receives the proceeds of the sale. The fund will normally close out a short position by purchasing on the open market and delivering to the broker/dealer an equal amount of the securities sold short.
As a hedging technique, a fund may purchase call options to buy securities sold short by the fund. Such options would lock in a future
price and protect the fund in case of an unanticipated increase in the price of a security sold short by the fund.
Short
Sales Against the Box
. The fund, through its investment in certain of the underlying funds, may be exposed to short sales against the box. An underlying fund may enter into a short sale of common stock such that when the short
position is open the fund owns an amount of preferred stocks or debt securities, convertible or exchangeable, without payment of further consideration, into an equal number of shares of the common stock sold short. This kind of short sale, which is
described as against the box, will be entered into by a fund for the purpose of receiving a portion of the interest earned by the executing broker from the proceeds of the sale. The proceeds of the sale will be held by the broker until
the settlement date, when the fund delivers the securities to
35
close out its short position. Although prior to delivery the fund will have to pay an amount equal to any dividends paid on the common stock sold short, the fund will receive the dividends from
the preferred stock or interest from the debt securities convertible into the stock sold short, plus a portion of the interest earned from the proceeds of the short sale. The fund will deposit, in a segregated account with its custodian, convertible
preferred stock or convertible debt securities in connection with short sales against the box.
Restricted and Illiquid
Securities
. The fund may invest up to 15% of its net assets in illiquid securities. The fund, through its investment in certain underlying funds and directly, may invest in securities (including shares of underlying funds) the disposition of
which is subject to legal or contractual restrictions. An illiquid security is any security which may not be sold or disposed of in the ordinary course of business within seven days at approximately the value at which the fund has valued the
security. Illiquid securities may include (a) repurchase agreements with maturities greater than seven days; (b) futures contracts and options thereon for which a liquid secondary market does not exist; (c) TDs maturing in more than
seven calendar days; (d) securities subject to contractual or other restrictions on resale and other instruments that lack readily available markets; and (e) securities of new and early stage companies whose securities are not publicly
traded.
Under SEC regulations, certain securities acquired through private placements can be traded freely among qualified
purchasers. The SEC has stated that an investment companys board of directors, or its investment adviser acting under authority delegated by the board, may determine that a security eligible for trading under these regulations is
liquid. Investing in these restricted securities could have the effect of increasing an underlying funds illiquidity if qualified purchasers become, for a time, uninterested in buying these securities.
Restricted securities are securities subject to legal or contractual restrictions on their resale, such as private placements. Such
restrictions might prevent the sale of restricted securities at a time when the sale would otherwise be desirable. Restricted securities may be sold only (1) pursuant to Rule 144A under the 1933 Act (such securities are referred to herein as
Rule 144A securities), or another exemption; (2) in privately negotiated transactions; or (3) in public offerings with respect to which a registration statement is in effect under the 1933 Act. Rule 144A securities, although
not registered in the United States, may be sold to qualified institutional buyers in accordance with Rule 144A under the 1933 Act. Where registration is required, a fund may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the time the fund is able to sell a security under an effective registration statement. If, during such a period, adverse market conditions were to develop, the fund might
obtain a less favorable price than expected when it decided to sell.
Illiquid securities may be difficult to value and
the fund or an underlying fund may have difficulty disposing of such securities promptly. Judgment plays a greater role in valuing illiquid investments than those securities for which a more active market exists. The fund or an underlying fund may
be forced to sell such securities at less than fair market value or may not be able to sell them when Permal or an underlying funds adviser believes it desirable to do so. Investments by the fund or an underlying fund in illiquid securities
are subject to the risk that should the fund or the underlying fund desire to sell any of these securities when a ready buyer is not available at a price that Permal or the funds adviser deems representative of its value, the value of the
funds or the underlying funds net assets could be adversely affected. The fund does not consider non-U.S. securities to be restricted if they can be freely sold in the principal markets in which they are traded, even if they are not
registered for sale in the United States.
To the extent required by applicable law and SEC guidance, no securities for which
there is not a readily available market will be acquired by the fund or an underlying fund that is a registered open-end investment company under the 1940 Act if such acquisition would cause the aggregate value of illiquid securities to exceed 15%
of the funds net assets.
Leveraging
. The fund, through its investment in certain underlying funds, may be
exposed to leverage (
i.e.,
the purchase of securities with borrowed money). A fund registered under the 1940 Act is required to maintain an
36
asset coverage of 300% of the amount of its borrowings, provided that in the event that the funds asset coverage falls below 300%, the fund is required to reduce the amount of its
borrowings so that it meets the 300% asset coverage threshold within three days (not including Sundays and holidays). If, as a result of market fluctuations or for any other reason, a funds asset coverage drops below 300%, the fund must reduce
its outstanding borrowings within three business days so as to restore its asset coverage to the 300% level. Certain of the underlying funds in which the fund may invest are not registered under the 1940 Act and thus are not subject to the 1940
Acts restrictions on the use of leverage.
Leverage creates an opportunity for increased returns to shareholders of an
underlying fund but, at the same time, creates special risk considerations. For example, leverage may exaggerate changes in the NAV of a funds shares and in a funds yield. Although the principal or stated value of such borrowings will be
fixed, a funds assets may change in value during the time the borrowing is outstanding. Leverage will create interest or dividend expenses for the fund that can exceed the income from the assets retained. To the extent the income or other gain
derived from securities purchased with borrowed funds exceeds the interest or dividends the fund will have to pay in respect thereof, the funds net income or other gain will be greater than if leverage had not been used. Conversely, if the
income or other gain from the incremental assets is not sufficient to cover the cost of leverage, the net income or other gain of the fund will be less than if leverage had not been used. If the amount of income for the incremental securities is
insufficient to cover the cost of borrowing, securities might have to be liquidated to obtain required funds. Depending on market or other conditions, such liquidations could be disadvantageous to the underlying fund.
Mortgage Dollar Rolls
. Certain underlying funds may enter into mortgage dollar rolls. A fund may enter into dollar rolls in which
the fund sells mortgage-backed securities for delivery in the current month, realizing a gain or loss, and simultaneously contracts to repurchase substantially similar (same type, coupon and maturity) securities to settle on a specified future date.
During the roll period, the fund forgoes interest paid on the securities. The fund is compensated by the interest earned on the cash proceeds of the initial sale and by the lower repurchase price at the specified future date. A fund registered under
the 1940 Act is required to maintain a segregated account, the dollar value of which is at least equal to its obligations with respect to dollar rolls.
The underlying funds generally execute mortgage dollar rolls in the to-be-announced (TBA) market, where a fund makes a forward commitment to purchase a security and, instead of accepting
delivery, the position is offset by a sale of the security with a simultaneous agreement to repurchase at a future date.
The
obligation to repurchase securities on a specified future date involves the risk that the market value of the securities a fund is obligated to repurchase under the agreement may decline below the repurchase price. In the event the buyer of
securities under a mortgage dollar roll files for bankruptcy, becomes insolvent or defaults on its obligations, a funds use of proceeds of the dollar roll may be restricted pending a determination by the other party, or its trustee or
receiver, whether to enforce the funds obligation to repurchase the securities. Dollar roll transactions may result in a form of leverage that increases the funds sensitivity to interest rate changes and may increase the overall risk of
investing in the fund.
Forward roll transactions are considered borrowings by a fund. Although investing the proceeds of
these borrowings in other instruments may provide an underlying fund with the opportunity for higher income, this leveraging practice will increase a funds exposure to capital risk and higher current expenses. Any income earned from the
securities purchased with the proceeds of these borrowings that exceeds the cost of the borrowings would cause a funds NAV per share to increase faster than would otherwise be the case; any decline in the value of the securities purchased
would cause a funds NAV per share to decrease faster than would otherwise be the case.
Investment in Other
Funds
. The investments of the fund are concentrated in underlying funds so the funds performance is directly related to the investment performance of the underlying funds held by it. The ability of the fund to meet its investment objective
is directly related to the ability of the underlying funds to meet their
37
objectives as well as the allocation among those underlying funds by Permal. There can be no assurance that the investment objective of the fund or any underlying fund will be achieved.
The underlying funds are subject to management risk. This is the risk that the underlying funds advisers security
selection process, which is subject to a number of constraints, may not produce the intended results.
The fund will invest
only in classes of shares of the underlying funds (except for ETFs) that are offered only to institutional and other eligible investors, such as the fund, at NAV and, accordingly, will not pay any sales loads or service or distribution (12b-1) fees
in connection with their investments in shares of the underlying funds. The fund, however, will indirectly bear its pro rata share of the fees and expenses incurred by the underlying funds that are applicable to institutional class shareholders,
including advisory fees. The investment returns of the fund, therefore, will be net of the expenses of the underlying funds in which it is invested. These expenses would be in addition to the advisory and other expenses that the fund bears directly
in connection with its own operations.
When the fund redeems shares from an underlying fund, the underlying fund, under
certain circumstances, may choose to pay the funds net redemption proceeds with an in-kind distribution of a portion of the underlying funds securities rather than in cash. If the fund does not want to invest in such securities, it will
liquidate such securities as soon as practicable. The liquidation of securities may cause the fund to incur brokerage or other transaction costs. In addition, there can be no assurance that when the fund sells these securities, it would receive the
value attributed to the securities by the underlying fund.
The fund will invest in securities of other investment companies
to the extent permitted under the 1940 Act, or pursuant to an order of the SEC. Generally, under the 1940 Act, the fund may hold securities of another investment company in amounts which (a) do not exceed 3% of the total outstanding voting
stock of such company, (b) do not exceed 5% of the value of the funds total assets and (c) when added to all other investment company securities held by the fund, do not exceed 10% of the value of the funds total assets.
However, a registered fund may invest in another registered fund that is in the same group of investment companies (as defined in the 1940 Act) subject to certain other conditions and in ETFs in amounts greater than those permitted under the 1940
Act if the fund enters into a participation agreement with the ETF and meets certain other conditions set forth in the exemptive order received by the ETF from the SEC. The exemptive order would permit the fund to, in the aggregate,
acquire up to 25% of the ETFs outstanding voting securities.
Business Development Companies.
Consistent with its investment objectives and policies and subject to the limitations of the 1940 Act, the fund may invest in business development companies (BDCs). BDCs are a type of closed-end investment company regulated by the
1940 Act and typically invest in and lend to small- and medium-sized private companies that may not have access to public equity markets for capital raising. BDCs invest in such diverse industries as healthcare, chemical and manufacturing,
technology and service companies. BDCs must invest at least 70% of the value of their total assets in certain asset types, which are typically the securities of private U.S. businesses, and must make available significant managerial assistance to
the issuers of such securities. BDCs, which are required to distribute substantially all of their income to investors in order to not be subject to entity-level taxation, often offer a yield advantage over other types of securities. Managers of BDCs
may be entitled to compensation based on the BDCs performance, which may result in a manager of a BDC making riskier or more speculative investments in an effort to maximize incentive compensation and higher fees.
Because BDCs typically invest in small and medium-sized companies, a BDCs portfolio is subject to the risks inherent in investing
in smaller companies, including that portfolio companies may be dependent on a small number of products or services and may be more adversely affected by poor economic or market conditions. Some BDCs invest substantially, or even exclusively, in one
sector or industry group and therefore the BDC may be susceptible to adverse conditions and economic or regulatory occurrences affecting the sector or industry group, which tends to increase the BDCs volatility and risk. Investments made by
BDCs are generally subject to legal and other restrictions on resale and are otherwise less liquid than publicly traded securities. The illiquidity
38
of these investments may make it difficult to sell such investments if the need arises, and if there is a need for a BDC in which the fund invests to liquidate its portfolio quickly, it may
realize a loss on its investment. BDCs also may have relatively concentrated investment portfolios, consisting of a relatively small number of holdings. A consequence of this limited number of investments is that the aggregate returns realized may
be disproportionately impacted by the poor performance of a small number of investments, or even a single investment, particularly if a BDC experiences the need to write down the value of an investment, which tends to increase the BDCs
volatility and risk.
Investments in BDCs are subject to management risk, including the ability of the BDCs management
to meet the BDCs investment objective, and the ability of the BDCs management to manage the BDCs portfolio when the underlying securities are redeemed or sold, during periods of market turmoil and as investors perceptions
regarding a BDC or its underlying investments change. BDC shares are not redeemable at the option of the BDC shareholder and, as with shares of other closed-end funds, they may trade in the secondary market at a discount to their net asset value.
Like an investment in other investment companies, the fund will indirectly bear its proportionate share of any management fees and other expenses charged by the BDCs in which it invests.
BDCs may employ the use of leverage through borrowings or the issuance of preferred stock. While leverage often serves to increase the
yield of a BDC, this leverage also subjects a BDC to increased risks, including the likelihood of increased volatility of the BDC and the possibility that the BDCs common share income will fall if the dividend rate of the preferred shares or
the interest rate on any borrowings rises.
Investments in Hedge Fund Strategies.
The fund may, directly or through the
underlying funds, employ a broad variety of hedge fund strategies, including but not limited to those set forth below. References to underlying funds should be read to include the fund when it is employing these strategies directly.
Global fixed income strategies.
Such strategies may include fundamental long-short credit, capital structure
arbitrage, high yield debt and non-U.S. debt.
Fundamental long-short credit
: This strategy
involves performing intensive bottom up credit research on an issuers industry and company-specific fundamental drivers, its financial condition, sources of liquidity and additional funding, access to capital markets, potential ratings changes
by credit agencies, covenant protection with respect to corporate debt securities, asset coverage, seniority in the capital structure, interest coverage and maturity of debt, among other fundamental factors that are important to assess an
issuers creditworthiness. Based on this analysis, assessment of supply and demand and technical factors of corporate debt securities traded in the market, underlying funds may decide to take a directional position, either long or short,
in a companys debt securities. These funds typically identify specific catalysts in order to exploit these situations (
e.g.
, exchange offers, workouts, financial reorganizations or other special credit event-related
situations). Typically, these funds run net long-biased books, but can hedge the interest rate or credit risk exposure embedded in the portfolios when deemed appropriate.
Capital structure arbitrage
: The portfolio managers of these underlying funds perform the same intensive
bottom up credit research on an issuer described above under Fundamental long-short credit. Based on this analysis, the portfolio managers look for inefficiencies in the relative pricing of securities within the same capital
structure and may take a long position in a debt security, typically senior in the capital structure (
e.g.
, bank debt or senior bond) and a parallel short position in another security, typically a subordinated bond, convertible bond,
preferred stock or common stock.
High yield debt
: The high yield debt strategy involves investing
predominantly in the debt of financially troubled, or stressed, companies. These companies are generally experiencing financial difficulties that have either led to a default on their indebtedness or increased the likelihood of default. A
default may be related to missing a payment of interest or principal when due (payment default), which is generally considered a major default, or more minor events of default, such as breaking a financial ratio
39
(
e.g.
, if the debt instrument requires a 2:1 cash flow to debt payment ratio, having a ratio of less than 2:1). These more minor events of default may be waived by the creditor (generally
the trustee of the bond issuance), but evidence an increased likelihood that the issuer will not be able to pay the indebtedness when due. The portfolio managers of high yield debt underlying funds will generally consider, among other factors,
the price of the security, the prospects of the company, the companys history, management and current conditions when making investment decisions.
High yield debt portfolio managers may deal in and with restricted or marketable securities and a significant portion of a high yield debt funds portfolio may be invested in restricted securities
that may not be registered under the 1933 Act and for which a market may not be readily available (
i.e.
, not freely traded). Investments may involve both U.S. and non-U.S. entities and may utilize leverage.
Non-U.S. debt
: Non-U.S. debt investing involves purchasing debt securities, including bonds, notes and
debentures issued predominantly by non-U.S. corporations; debt securities issued predominantly by non-U.S. governments; or debt securities guaranteed by non-U.S. governments or any agencies thereof. The strategy will generally consist of underlying
funds investing in non-U.S. fixed income portfolios and/or emerging markets debt securities. Given the markets in which they invest, a significant portion of the portfolio of non-U.S. debt underlying funds may be invested in restricted
securities that may not be registered and for which a market may not be readily available, and, therefore, a significant portion of the underlying fund may not be freely traded. Further, an investment in bonds issued by foreign governments or
corporations may carry, among other things, significant geopolitical risks, legal risks, currency risks (
e.g.,
significant devaluations) and liquidity risks (
e.g.,
lack of developed trading markets).
Given liquidity issues, currency risk, credit risk, interest rate risk and geopolitical risks, non-U.S. debt underlying
funds may experience significantly more volatility and risk than traditional fixed income funds. To mitigate some of this risk, non-U.S. debt underlying funds may use certain hedging tools, such as shorting securities in other
portions of the capital structure (
e.g.
, being long the non-U.S. debt position and short the issuers common stock) or buying protection for a decline in the native currency or the U.S. dollar in order to mitigate
the risk associated with an investment in a particular non-U.S. debt security. There can be no assurance that any such hedging techniques will be successful or that the hedging employed by the underlying fund will not have the negative effect of
lowering overall returns, or creating losses, in the underlying fund.
Corporate event-driven strategies.
Event-driven strategies can include risk arbitrage, special situations, activist, distressed/stressed debt and equity securities and private placements. Underlying funds employing such strategies maintain positions in companies currently or
potentially involved in a wide variety of corporate transactions. Event-driven exposure can include a combination of equity markets, credit markets and idiosyncratic, company-specific developments. The outcome of the investment is predicated on an
event or catalyst.
Risk arbitrage
. Risk arbitrage, sometimes called merger arbitrage, involves
investment in event-driven situations such as leveraged buy-outs, mergers and hostile takeovers. Normally, the security of an acquisition target appreciates while the acquiring companys securities decrease in value. Returns may be
obtained through use of this strategy by purchasing securities of the acquired company and in some instances selling short securities of the acquiring company. Certain underlying funds may use equity options as an alternative to the outright
purchase or sale of common stock. Most merger arbitrage underlying funds seek to hedge against market risk by utilizing derivative strategies, such as purchasing put options or put option spreads.
Special situations
. Involves investing in securities of issuers that are engaged in, or expected to experience,
certain special events such as restructurings, spin-offs, liquidations, privatizations, stock buybacks, bond rating changes from credit agencies, and earnings surprises, all with the intention of profiting from the outcome of such events.
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Activist strategies
. Rely on the ability to use a significant
economic stake in the instruments of a company to influence management and corporate decisions in such a way as to increase the value of the holdings (
e.g
., seeking management changes, selling business units, securing special dividends and
influencing financial restructurings). Underlying funds using activist strategies may attempt to obtain representation on a companys board of directors to impact the firms policies or strategic direction. They can employ an investment
process primarily focused on opportunities in equity and equity-related instruments of companies that are currently or prospectively engaged in a corporate transaction or other catalyst-oriented situation. Activist strategies are distinguished from
other event-driven strategies in that, over a given market cycle, activist strategies would expect to have greater than 50% of the portfolio in activist positions.
Distressed/Stressed debt and equity securities
. This strategy focuses on investing in debt or equity securities of
companies that are either experiencing financial distress or whose credit quality is poor but expected to improve. Other distressed/stressed security situations include companies that are either experiencing a liquidity crisis, defaulting on
their debt obligations or filing for Chapter 11 bankruptcy protection. Investments using this strategy are typically made in anticipation of a strengthening of the companys credit, a corporate event (
e.g.
, a recapitalization,
reorganization, liquidation or repayment) or refinancing, and may be made in securities such as bank debt, bonds or trade or vendor claims, as well as other contractual and legal obligations, such as defaulted swap claims or judgments. Certain
underlying funds may also invest in post-bankruptcy equity, typically received as part of a restructuring of defaulted debt into common stock. Additionally, portfolio managers of such underlying funds may often choose to participate by taking
an active role in a companys creditor and/or equity holder committees. By investing in the above-mentioned distressed or stressed securities, these funds seek to obtain profits based upon the perceived material difference between the
market value and intrinsic value of these securities, which is calculated based upon an analysis of the relevant assets and liabilities along with a companys future projected cash flows.
Private placements
. An underlying fund may invest in privately placed securities, such as structured discount
convertible securities. Normally, such securities are privately offered to an underlying fund by a company in need of timely financing. Portfolio managers generally will hedge with purchases of registered common stock until the registration becomes
effective and then liquidate the position gradually.
Long-equity strategies:
Involve the purchase of equity and
equity-linked instruments in global markets. An equity strategy may focus on a particular capitalization range (
e.g.
, small cap vs. large cap) or a particular industry sector (
e.g.
, healthcare, technology or consumer products), may
employ a specific investment style (
e.g
., value vs. growth) or may pursue a broad mandate, investing in securities without specific regard for their issuers capitalization, sector or geography. Some equity strategies may use dynamic
equity strategies to create long-biased holdings in potentially favorable positions, sectors or countries. In addition to long equity investments, dynamic equity strategies generally hedge long positions and employ additional instruments, such as
bonds, options, preferred securities and convertible securities.
An underlying fund pursuing an equity strategy typically
seeks to capitalize on discrepancies between its advisers evaluation of the intrinsic value of an equity security and assessment of the forward-looking prospects of the issuer of such security, on the one hand, and the consensus view reflected
in the market price of such security, on the other hand. Some underlying funds pursuing this strategy also may seek to extract value by being more trading-oriented or catalyst-driven.
Equity long/short.
Equity long/short strategies may employ strategies similar to long-equity strategies, but combine long
positions with short sales. Equity long/short strategies are among the non-traditional absolute return strategies pursued by hedge funds. A distinguishing feature of absolute return strategies is their focus on absolute performance objectives as
compared to measuring performance on a relative basis. Absolute return strategies seek to generate returns that are uncorrelated with traditional performance benchmarks and seek to achieve positive returns even in declining market conditions.
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Opportunistic equity
. Opportunistic equity investments comprise
underlying funds that predominantly invest in equity securities in all global markets, including U.S. domestic markets. Portfolio managers of these underlying funds will opportunistically allocate capital to those markets around the world which
present the best opportunities for profit based on either the portfolio managers fundamental company valuation analysis or perceived macroeconomic shifts.
Short sales
. Underlying funds may employ short selling. A short sale involves the sale of a security that an
underlying fund does not own with the expectation of purchasing the same security at a later date at a lower price. Portfolio managers employing this strategy sell short the stock of companies whose fundamentals, liability profile or growth
prospects do not support current public market valuations. Short selling relies on, among other things, fundamental analysis, in-depth knowledge of accounting, an understanding of public market pricing and/or industry research.
Global macro strategies:
Seek to profit from changes in global financial markets and take positions to take advantage of
changes in interest rates, exchange rates, liquidity and other macroeconomic factors. Investments may be either long or short in securities, derivative contracts or options, and may be in equities, fixed income markets, currencies or commodities.
This category is composed of three major management strategies: discretionary strategies, systematic strategies and natural resources strategies.
Discretionary strategies
: An underlying fund may use discretionary global macro strategies to seek to profit by capturing market moves throughout a broad universe of investment opportunities. These
opportunities include financial markets, such as global equity, currency, and fixed income markets, as well as non-financial markets, such as the energy, agricultural and metals markets. An underlying fund may utilize a combination of fundamental
market research and information in conjunction with quantitative modeling to identify opportunities that exist within the markets. While the markets they invest in may be diverse, underlying funds using these strategies may hold more concentrated
positions in a limited number of markets at any one time. Positions may be long and short in different markets, and an underlying fund may employ leverage.
Systematic strategies
: An underlying fund may use systematic global macro strategies and employ proprietary or other models to identify opportunities that exist within a diverse group of financial
and non-financial markets and establish positions based on the models. While subjective investment decisions are made, such decisions are the result of a heavier reliance upon models than is the case with discretionary strategies and the vast
majority of trading decisions are executed without discretion. An underlying fund employing systematic strategies tends to hold positions in several markets at the same time, may be both long and short and tends to use leverage when establishing
positions.
Natural resources trading strategies
: An underlying fund may engage in
commodity trading strategies to generally invest on a global basis in a portfolio of securities, commodities and derivative instruments, which include but are not limited to energy, chemicals, agriculture, food, precious metals, industrial materials
(and their related support industries, including oil service, mining equipment, forest products, building/construction materials, ferrous and non-ferrous metals, petrochemicals and plastics) and related industries and manufacturing (
e.g.
,
homebuilding, automobile manufacturing and auto parts, shipbuilding, and construction and construction engineering). Natural resources trading includes commodities and futures, forward, option and swap contracts in agricultural, metals and energy
items, among other commodities, while equity investments include securities of companies that produce, process, convert, transport and service such commodities.
In pursuit of macro strategies, the fund may also invest in underlying funds employing the following strategies:
Momentum investing or trend-following strategies
: An underlying fund may engage in momentum investing or trend-following to attempt to take advantage
of the observable tendency of the
42
markets to trend and to tend to make exaggerated movements in both upward and downward directions. These exaggerated movements can be thought of as resulting from the influence of crowd
psychology, or the herd instinct, among market participants. An underlying fund may use this strategy to primarily trade futures, options and forward contracts, though it may take positions in cash, equity securities, investment companies and
derivative securities. An underlying fund may use leverage when establishing positions and hold positions in several markets at the same time.
Other quantitative strategies
: An underlying fund may engage in other quantitative strategies to seek to profit from discrepancies in the valuations of instruments and asset classes caused by
differences in macroeconomic fundamentals and technical factors, both across and within countries using a combination of fundamental, technical, macroeconomic data and linear and nonlinear forecasting models. An underlying fund may invest primarily
in broad-based equity and fixed income index futures and options, currency futures and options, commodity futures and options and swaps, and may also invest in stocks, bonds, currencies, commodities and other instruments, in an opportunistic
model-driven fashion.
Relative value strategies:
Include volatility arbitrage and fixed income hedge
strategies.
Volatility arbitrage
: Trades volatility as an asset class. Exposures may be long, short or
neutral to the direction of implied volatility. Volatility arbitrage strategies may be either directional or relative value in nature specifically, directional volatility arbitrage strategies seek to express a view on the likely trend of
implied volatility across various asset classes including equities, foreign exchange, interest rates and commodities, whereas relative value volatility arbitrage strategies seek to exploit mispricings between multiple options or instruments
containing implied volatility. Volatility arbitrage managers typically invest in options and variance swaps.
Fixed Income Hedge
. Fixed income hedge underlying funds invest long and short primarily in corporate debt
instruments across the capital structure of companies, based on fundamental credit analysis. These portfolios have flexible mandates allowing them to invest in a large variety of corporate debt securities, enter short positions, employ leverage, run
concentrated portfolios and hedge credit and interest rate risk in their books.
Instruments traded by
fixed income hedge funds include bank debt, bonds, convertible bonds, preferred stock, convertible preferred stock and private placements, as well as common stock. Although fixed income hedge portfolio managers invest a portion of their
portfolios in investment grade debt, they typically focus on high yield, lower-rated corporate debt and distressed debt.
Fixed income arbitrage
. Attempts to capture mispricing within and across global fixed income markets and associated derivatives. Value may be added by taking advantage of advantageous tax
provisions, yield curve anomalies, volatility differences and arbitraging bond futures versus the underlying bonds (basis trading). Typically, a large amount of leverage is used to enhance returns.
Convertible arbitrage
. Seeks to profit from the mispricing of the embedded option in a convertible bond.
Frequently, this strategy is characterized by a long convertible position and corresponding short position in the underlying stock. Convertible arbitrage may use low or high levels of leverage depending upon the specific securities held by the
underlying fund.
Managed futures strategies
seek to generate positive total returns in rising or falling
markets that are not directly correlated to broad market equity or fixed income returns. Managed futures strategies invest in a wide variety of futures contracts and futures-related instruments across different asset classes, including commodities,
currencies, fixed income and equities. Managed futures strategies can take long or short positions in any of these instruments and seek to benefit if the price of the underlying instrument rises or falls.
43
Exchange-Traded Funds (ETFs).
The fund invests in shares of ETFs
whose shares are listed and traded on U.S. stock exchanges or otherwise traded in the OTC market. As with other investments in shares of mutual funds, the fund will bear its pro rata portion of the ETFs expenses, including advisory fees,
brokerage, shareholder servicing and other operational expenses. These expenses are in addition to the direct expenses of the funds own operations.
ETFs are ownership interests in investment companies, unit investment trusts, depositary receipts and other pooled investment vehicles that are traded on an exchange and that hold a portfolio of
securities or other financial instruments (the Underlying Assets). The Underlying Assets are typically selected to correspond to the securities that comprise a particular broad based, sector or international index, or to provide exposure
to a particular industry sector or asset class, including precious metals or other commodities. Many ETFs are not actively managed. Therefore, those ETFs may not sell a security because the securitys issuer was in financial
difficulty unless that security is removed from the relevant index. Such an ETF may not perform the same as its benchmark index due to tracking error. An ETFs return may not match the return of the benchmark index for a number of reasons. For
example, the ETF incurs a number of operating expenses not applicable to the benchmark index, and incurs costs in buying and selling securities, especially when rebalancing the ETFs securities holdings to reflect changes in the composition of
the benchmark index, or a representative sample of the benchmark index. The ETF may not be fully invested at times, either as a result of cash flows into the ETF or reserves of cash held by the ETF to meet redemptions and pay expenses. Since the ETF
may utilize a sampling approach and may hold futures or other derivative positions, its return may not correlate as well with the return on the benchmark index, as would be the case if the ETF purchased all of the stocks in the benchmark index. Such
an ETF would be subject to management risk, which is the risk that the ETFs advisers security selection process may not produce the intended results. Short ETFs seek a return similar to the inverse, or a multiple of the
inverse, of a reference index. Short ETFs carry additional risks because their Underlying Assets may include a variety of financial instruments, including futures and options on futures, options on securities and securities indexes, swap agreements
and forward contracts, and they may engage in short sales. An ETFs losses on short sales are potentially unlimited; however, the funds risk would be limited to the amount it invested in the ETF.
Unlike shares of typical mutual funds or unit investment trusts, shares of ETFs are designed to be traded throughout the trading day,
bought and sold based on market prices rather than NAV. Shares can trade at either a premium or discount to NAV. The portfolios held by ETFs are publicly disclosed on each trading day and an approximation of actual NAV is disseminated throughout the
trading day. Because of this transparency, the trading prices of ETFs tend to closely track the actual NAV of the Underlying Assets and the fund will generally gain or lose value depending on the performance of the Underlying Assets. In the future,
as new products become available, the fund may invest in ETFs that do not have this same level of transparency and, therefore, may be more likely to trade at a larger discount or premium to actual NAVs. Gains or losses on the funds investments
in ETFs will ultimately depend on the purchase and sale price of the ETF. An active trading market for an ETFs shares may not develop or be maintained and trading of an ETFs shares may be halted if the listing exchanges officials
deem such action appropriate, the shares are delisted from the exchange or the activation of market-wide circuit breakers (which are tied to large decreases in stock prices) halts stock trading generally.
An investment in an ETF involves risks similar to investing directly in the Underlying Assets, including the risk that the value of the
Underlying Assets may fluctuate in accordance with changes in the financial condition of their issuers, the value of securities and other financial instruments generally, and other market factors.
The performance of an ETF will be reduced by transaction and other expenses, including fees paid by the ETF to service providers.
Investors in ETFs are eligible to receive their portion of income, if any, accumulated on the securities held in the portfolio, less fees and expenses of the ETF.
ETFs that invest in commodities may be, or may become subject to, CFTC trading regulations that limit the amount of commodity contracts an ETF may hold. Such regulations could hurt the value of such
ETFs securities. Additionally, some commodity ETFs invest in commodity futures which can lose money even when commodity prices are rising (see Commodity-Linked Derivative Instruments above).
44
If an ETF is a registered investment company (as defined in the 1940 Act), the limitations
applicable to the funds ability to purchase securities issued by other investment companies apply. However, the SEC has granted orders for exemptive relief to certain ETFs that permit investments in those ETFs by other investment companies in
excess of these limits. The SEC has issued such exemptive orders to certain ETFs in which the fund may invest, which permits investment companies to invest in such ETFs beyond the limitations in the 1940 Act, subject to certain terms and conditions.
Under the orders, the fund generally may acquire up to 25% of the assets of an ETF. Some ETFs are not structured as investment companies and thus are not regulated under the 1940 Act.
Concentration Risk.
An underlying funds assets may be concentrated in an industry or group of industries. By concentrating
its assets in a single industry or group of industries, the underlying fund is subject to the risk that economic, political or other conditions that have a negative effect on that industry or group of industries will negatively impact the underlying
fund to a greater extent than if the underlying funds assets were invested in a wider variety of industries.
Trading
Frequency
. The fund or an underlying fund may engage in active and frequent trading, resulting in high portfolio turnover, in order to achieve its investment objective. This may lead to the realization and distribution to shareholders of higher
capital gains, increasing their tax liability. Frequent trading also increases transaction costs, which could detract from the funds performance.
Non-Diversified Portfolios
. Certain underlying funds are classified as non-diversified under the 1940 Act. Since a non-diversified fund is permitted to invest a greater proportion of its
assets in the securities of a smaller number of issuers, each such fund may be subject to greater risk with respect to its individual portfolio than a fund that is more broadly diversified.
Securities of Unseasoned Issuers
. Securities in which the fund, through its investment in certain underlying funds or directly,
may invest may have limited marketability and, therefore, may be subject to wide fluctuations in market value. In addition, certain securities may lack a significant operating history and be dependent on products or services without an established
market share.
Indexed Securities
. Certain underlying funds may invest in indexed securities, whose value is linked to
currencies, interest rates, commodities, indices or other financial indicators. Indexed securities may be positively or negatively indexed (
i.e.
, their value may increase or decrease if the underlying instrument appreciates), and may have
return characteristics similar to direct investments in the underlying instrument or to one or more options on the underlying instrument. Indexed securities may be more volatile than the underlying instrument itself.
Inflation-Indexed Securities
. Inflation-indexed bonds are fixed income securities whose principal value is periodically adjusted
according to the rate of inflation. Two structures are common. The U.S. Treasury and some other issuers use a structure that accrues inflation into the principal value of the bond. Most other issuers pay out the index-based accruals as part of a
semiannual coupon. An underlying fund may also invest in inflation-indexed securities with other structures or characteristics as such securities become available in the market.
U.S. Treasury Inflation Protected Securities (U.S. TIPS) are fixed income securities issued by the U.S. Department of the
Treasury, the principal amounts of which are adjusted daily based upon changes in the rate of inflation (currently represented by the non-seasonally adjusted Consumer Price Index for All Urban Consumers (CPI-U), calculated with a
three-month lag). The CPI-U is a measurement of changes in the cost of living, made up of components such as housing, food, transportation and energy. U.S. TIPS pay interest on a semi-annual basis, equal to a fixed percentage of the
inflation-adjusted principal amount. The interest rate on these bonds is fixed at issuance, but over the life of the bond this interest may be paid on an increasing or decreasing principal value that has been adjusted for inflation. The three-month
lag in calculating the CPI-U for purposes of adjusting the principal value of U.S. TIPS may give rise to risks under certain circumstances.
45
Repayment of the original bond principal upon maturity (as adjusted for inflation) is
guaranteed for U.S. TIPS, even during a period of deflation. However, because the principal amount of U.S. TIPS would be adjusted downward during a period of deflation, the underlying funds would be subject to deflation risk with respect to their
investments in these securities. In addition, the current market value of the bonds is not guaranteed and will fluctuate. If an underlying fund purchases U.S. TIPS in the secondary market whose principal values have been adjusted upward due to
inflation since issuance, the underlying fund may experience a loss if there is a subsequent period of deflation. The underlying funds may also invest in other inflation-related bonds which may or may not provide a guarantee of principal. If a
guarantee of principal is not provided, the adjusted principal value of the bond repaid at maturity may be less than the original principal amount.
The value of inflation-indexed bonds is expected to fluctuate in response to changes in real interest rates, which are in turn tied to the relationship between nominal interest rates and the rate of
inflation. Therefore, if inflation were to rise at a faster rate than nominal interest rates, real interest rates might decline, leading to an increase in value of inflation-indexed bonds. In contrast, if nominal interest rates increased at a faster
rate than inflation, real interest rates might rise, leading to a decrease in value of inflation-indexed bonds. Although the principal value of these securities declines in periods of deflation, holders at maturity receive no less than par. If
inflation is lower than expected during the period an underlying fund holds the security, the underlying fund may earn less on the security than on a conventional bond. Any increase in principal value is taxable to shareholders of regulated
investment companies in the year the increase occurs, even though such shareholders do not receive cash representing the increase at that time. As a result, an underlying fund investing in inflation-indexed securities could be required at times to
liquidate other investments, including when it is not advantageous to do so, in order to satisfy its distribution requirements as a regulated investment company and to eliminate any fund-level income tax liability under the Code.
While these securities are expected to be protected from long-term inflationary trends, short-term increases in inflation may lead to a
decline in value. If interest rates rise due to reasons other than inflation (
e.g.,
due to changes in currency exchange rates), investors in these securities may not be protected to the extent that the increase is not reflected in the
bonds inflation measure.
Certain underlying funds may invest in inflation-indexed securities issued in any country.
The periodic adjustment of U.S. TIPS is currently tied to the CPI-U, which is calculated by the U.S. Department of the
Treasury. Inflation-indexed bonds issued by a non-U.S. government are generally adjusted to reflect an inflation index calculated by that government. There can no assurance that the CPI-U or any non-U.S. inflation index will accurately measure the
real rate of inflation in the prices of goods and services. In addition, there can be no assurance that the rate of inflation in a non-U.S. country will be correlated to the rate of inflation in the United States.
INVESTMENT POLICIES
The fund has adopted the fundamental and non-fundamental investment policies below for the protection of shareholders. Fundamental investment policies of the fund may not be changed without the vote of a
majority of the outstanding shares of the fund, defined under the 1940 Act as the lesser of (a) 67% or more of the voting power of the fund present at a shareholder meeting, if the holders of more than 50% of the voting power of the fund are
present in person or represented by proxy, or (b) more than 50% of the voting power of the fund. The Board may change non-fundamental investment policies at any time.
If any percentage restriction described below is complied with at the time of an investment, a later increase or decrease in the percentage resulting from a change in values or assets will not constitute
a violation of such restriction.
46
Fundamental Investment Policies
The funds fundamental investment policies are as follows:
(1) The fund may not borrow money except as permitted by (i) the 1940 Act or interpretations or modifications
by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(2) The fund may not engage in the business of underwriting the securities of other issuers except as permitted by
(i) the 1940 Act or interpretations or modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(3) The fund may lend money or other assets to the extent permitted by (i) the 1940 Act or interpretations or
modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(4) The fund may not issue senior securities except as permitted by (i) the 1940 Act or interpretations or
modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(5) The fund may not purchase or sell real estate except as permitted by (i) the 1940 Act or interpretations or
modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
(6) The fund may purchase or sell commodities or contracts related to commodities to the extent permitted by
(i) the 1940 Act or interpretations or modifications by the SEC, SEC staff or other authority with appropriate jurisdiction, or (ii) exemptive or other relief or permission from the SEC, SEC staff or other authority.
With respect to the fundamental policy relating to borrowing money set forth in (1) above, the 1940 Act permits the fund to borrow
money in amounts of up to one-third of the funds total assets from banks for any purpose, and to borrow up to 5% of the funds total assets from banks or other lenders for temporary purposes. (The funds total assets include the
amounts being borrowed.) To limit the risks attendant to borrowing, the 1940 Act requires the fund to maintain an asset coverage of at least 300% of the amount of its borrowings, provided that in the event that the funds asset
coverage falls below 300%, the fund is required to reduce the amount of its borrowings so that it meets the 300% asset coverage threshold within three days (not including Sundays and holidays). Asset coverage means the ratio that the value of the
funds total assets (including amounts borrowed), minus liabilities other than borrowings, bears to the aggregate amount of all borrowings. Certain trading practices and investments, such as reverse repurchase agreements, may be considered to
be borrowings and thus subject to the 1940 Act restrictions. Borrowing money to increase portfolio holdings is known as leveraging. Borrowing, especially when used for leverage, may cause the value of the funds shares to be more
volatile than if the fund did not borrow. This is because borrowing tends to magnify the effect of any increase or decrease in the value of the funds portfolio holdings. Borrowed money thus creates an opportunity for greater gains, but also
greater losses. To repay borrowings, the fund may have to sell securities at a time and at a price that is unfavorable to the fund. There also are costs associated with borrowing money, and these costs would offset and could eliminate the
funds net investment income in any given period. Currently, the fund does not contemplate borrowing money for leverage but if the fund does so, it will not likely do so to a substantial degree. The policy in (1) above will be interpreted
to permit the fund to engage in trading practices and investments that may be considered to be borrowing to the extent permitted by the 1940 Act. Short-term credits necessary for the settlement of securities transactions and arrangements with
respect to securities lending will not be considered to be borrowings under the policy. Practices and investments that may involve leverage but are not considered to be borrowings are not subject to the policy.
47
With respect to the fundamental policy relating to underwriting set forth in (2) above,
the 1940 Act does not prohibit the fund from engaging in the underwriting business or from underwriting the securities of other issuers; in fact, the 1940 Act permits the fund to have underwriting commitments of up to 25% of its assets under certain
circumstances. Those circumstances currently are that the amount of the funds underwriting commitments, when added to the value of the funds investments in issuers where the fund owns more than 10% of the outstanding voting securities of
those issuers, cannot exceed the 25% cap. A fund engaging in transactions involving the acquisition or disposition of portfolio securities may be considered to be an underwriter under the 1933 Act. Under the 1933 Act, an underwriter may be liable
for material omissions or misstatements in an issuers registration statement or prospectus. Securities purchased from an issuer and not registered for sale under the 1933 Act are considered restricted securities. There may be a limited market
for these securities. If these securities are registered under the 1933 Act, they may then be eligible for sale but participating in the sale may subject the seller to underwriter liability. These risks could apply to a fund investing in restricted
securities. Although it is not believed that the application of the 1933 Act provisions described above would cause the fund to be engaged in the business of underwriting, the policy in (2) above will be interpreted not to prevent the fund from
engaging in transactions involving the acquisition or disposition of portfolio securities, regardless of whether the fund may be considered to be an underwriter under the 1933 Act.
With respect to the fundamental policy relating to lending set forth in (3) above, the 1940 Act does not prohibit the fund from
making loans; however, SEC staff interpretations currently prohibit funds from lending more than one-third of their total assets, except through the purchase of debt obligations or the use of repurchase agreements. (A repurchase agreement is an
agreement to purchase a security, coupled with an agreement to sell that security back to the original seller on an agreed-upon date at a price that reflects current interest rates. The SEC frequently treats repurchase agreements as loans.) While
lending securities may be a source of income to the fund, as with other extensions of credit there are risks of delay in recovery or even loss of rights in the underlying securities should the borrower fail financially. However, loans would be made
only when Permal believes the income justifies the attendant risks. The fund also will be permitted by this policy to make loans of money, including to other funds. The fund would have to obtain exemptive relief from the SEC to make loans to other
funds. The policy in (3) above will be interpreted not to prevent the fund from purchasing or investing in debt obligations and loans. In addition, collateral arrangements with respect to options, forward currency and futures transactions and
other derivative instruments, as well as delays in the settlement of securities transactions, will not be considered loans.
With respect to the fundamental policy relating to issuing senior securities set forth in (4) above, senior securities
are defined as fund obligations that have a priority over the funds shares with respect to the payment of dividends or the distribution of fund assets. The 1940 Act prohibits the fund from issuing senior securities, except that the fund may
borrow money in amounts of up to one-third of the funds total assets from banks for any purpose. The fund may also borrow up to 5% of the funds total assets from banks or other lenders for temporary purposes, and these borrowings are not
considered senior securities. The issuance of senior securities by the fund can increase the speculative character of the funds outstanding shares through leveraging. Leveraging of the funds portfolio through the issuance of senior
securities magnifies the potential for gain or loss on monies, because even though the funds net assets remain the same, the total risk to investors is increased to the extent of the funds gross assets. The policy in (4) above
will be interpreted not to prevent collateral arrangements with respect to swaps, options, forward or futures contracts or other derivatives, or the posting of initial or variation margin.
With respect to the fundamental policy relating to real estate set forth in (5) above, the 1940 Act does not prohibit the fund from
owning real estate; however, the fund is limited in the amount of illiquid assets it may purchase. Investing in real estate may involve risks, including that real estate is generally considered illiquid and may be difficult to value and sell. Owners
of real estate may be subject to various liabilities, including environmental liabilities. To the extent that investments in real estate are considered illiquid, the current SEC staff position generally limits the funds purchases of illiquid
securities to 15% of net assets. The policy in (5) above will be interpreted not to prevent the fund from investing in real estate-related companies, companies
48
whose businesses consist in whole or in part of investing in real estate, instruments (like mortgages) that are secured by real estate or interests therein, or REIT securities.
With respect to the fundamental policy relating to commodities set forth in (6) above, the 1940 Act does not prohibit the fund from
owning commodities, whether physical commodities and contracts related to physical commodities (such as oil or grains and related futures contracts), or financial commodities and contracts related to financial commodities (such as currencies and,
possibly, currency futures). However, the fund is limited in the amount of illiquid assets it may purchase. To the extent that investments in commodities are considered illiquid, the current SEC staff position generally limits the funds
purchases of illiquid securities to 15% of net assets. If the fund were to invest in a physical commodity or a physical commodity-related instrument, the fund would be subject to the additional risks of the particular physical commodity and its
related market. The value of commodities and commodity-related instruments may be extremely volatile and may be affected either directly or indirectly by a variety of factors. There may also be storage charges and risks of loss associated with
physical commodities. The policy in (6) above will be interpreted to permit investments in ETFs that invest in physical and/or financial commodities.
Due to its investment objective and policies, the fund will concentrate more than 25% of its assets in the mutual fund industry. In accordance with the funds investment program, the fund may invest
more than 25% of its assets in certain underlying funds.
The funds fundamental policies will be interpreted broadly.
For example, the policies will be interpreted to refer to the 1940 Act and the related rules as they are in effect from time to time, and to interpretations and modifications of or relating to the 1940 Act by the SEC and others as they are given
from time to time. When a policy provides that an investment practice may be conducted as permitted by the 1940 Act, the policy will be interpreted to mean either that the 1940 Act expressly permits the practice or that the 1940 Act does not
prohibit the practice.
Certain underlying funds in which the fund invests may have adopted investment restrictions that may
be less restrictive than those listed above, thereby permitting the fund to engage indirectly in investment strategies that are prohibited under its own investment restrictions. The investment restrictions of an underlying fund that is registered
under the 1940 Act are located in its statement of additional information.
Non-Fundamental Investment Policy
The funds non-fundamental investment policy is as follows:
(1) The fund may not purchase or otherwise acquire any security if, as a result, more than 15% of its net assets would be invested in securities that are illiquid.
Diversification
The
fund is currently classified as a diversified fund under the 1940 Act. This means that the fund may not purchase securities of an issuer (other than obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities and
securities of other investment companies) if, with respect to 75% of its total assets, (a) more than 5% of the funds total assets would be invested in securities of that issuer or (b) the fund would hold more than 10% of the
outstanding voting securities of that issuer. With respect to the remaining 25% of its total assets, the fund can invest more than 5% of its assets in one issuer. Under the 1940 Act, the fund cannot change its classification from diversified to
non-diversified without shareholder approval.
Portfolio Turnover
For reporting purposes, the funds portfolio turnover rate is calculated by dividing the lesser of purchases or sales of portfolio
securities for the fiscal year by the monthly average of the value of the portfolio securities
49
owned by the fund during the fiscal year. In determining such portfolio turnover, all securities whose maturities at the time of acquisition were one year or less are excluded. A 100% portfolio
turnover rate would occur, for example, if all of the securities in the funds investment portfolio (other than short-term money market securities) were replaced once during the fiscal year.
In the event that portfolio turnover increases, this increase necessarily results in correspondingly greater transaction costs which must
be paid by the fund. To the extent the portfolio trading results in realization of net short-term capital gains, shareholders will be taxed on such gains at ordinary tax rates (except shareholders who invest through individual retirement accounts
(IRAs), and other retirement plans which are not taxed currently on accumulations in their accounts).
Portfolio
turnover will not be a limiting factor should a subadviser or Western Asset deem it advisable to purchase or sell securities. The underlying funds do not limit their portfolio turnover rates should an adviser deem it advisable to purchase or sell
securities. Higher turnover rates may result in higher expenses being incurred by the underlying funds.
For the fiscal years
ended December 31, 2011 and 2012, the funds portfolio turnover rates were as follows:
50
MANAGEMENT
The business and affairs of the fund are conducted by management under the supervision and subject to the direction
of its Board. The business address of each Trustee is c/o Kenneth D. Fuller, 100 International Drive, Baltimore, Maryland 21202. Information pertaining to the Trustees and officers of the fund is set forth below.
|
|
|
|
|
|
|
|
|
|
|
Name and
Year of Birth
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5 Years
|
|
Number of
Funds
in Fund
Complex
Overseen
by Trustee
|
|
Other Board
Memberships Held
by
Trustee
|
INDEPENDENT TRUSTEES
#
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Paul R. Ades
Born
1940
|
|
Trustee
|
|
Since 1983
|
|
Paul R. Ades, PLLC (law firm) (since 2000)
|
|
52
|
|
None
|
|
|
|
|
|
|
Andrew L. Breech
Born 1952
|
|
Trustee
|
|
Since 1991
|
|
President, Dealer Operating Control Service, Inc. (automotive retail management) (since 1985)
|
|
52
|
|
None
|
|
|
|
|
|
|
Dwight B. Crane
Born
1937
|
|
Trustee
|
|
Since 1981
|
|
Professor Emeritus, Harvard Business School (since 2007); formerly, Professor, Harvard Business School (1969 to 2007); Independent Consultant (since 1969)
|
|
52
|
|
None
|
|
|
|
|
|
|
Frank G. Hubbard
Born
1937
|
|
Trustee
|
|
Since 1993
|
|
President, Avatar International Inc. (business development) (since 1998)
|
|
52
|
|
None
|
|
|
|
|
|
|
Howard J. Johnson
Born 1938
|
|
Chairman and Trustee
|
|
From 1981 to 1998 and since 2000 (Chairman since 2013)
|
|
Chief Executive Officer, Genesis Imaging LLC (technology company) (since 2003)
|
|
52
|
|
None
|
|
|
|
|
|
|
Jerome H. Miller
Born
1938
|
|
Trustee
|
|
Since 1995
|
|
Retired
|
|
52
|
|
None
|
|
|
|
|
|
|
Ken Miller
Born
1942
|
|
Trustee
|
|
Since 1983
|
|
Retired; formerly, President, Young Stuff Apparel Group, Inc. (apparel manufacturer), division of Li & Fung (1963 to 2012)
|
|
52
|
|
None
|
51
|
|
|
|
|
|
|
|
|
|
|
Name and
Year of Birth
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5 Years
|
|
Number of
Funds
in Fund
Complex
Overseen
by Trustee
|
|
Other Board
Memberships Held
by
Trustee
|
John J. Murphy Born 1944
|
|
Trustee
|
|
Since 2002
|
|
Founder and Senior Principal, Murphy Capital Management (investment management) (since 1983)
|
|
52
|
|
Trustee, UBS Funds (52 funds) (since 2008); Trustee, Consulting Group Capital Markets Funds (11 funds) (since 2002); formerly, Director, Nicholas Applegate Institutional Funds (12
funds) (2005 to 2010)
|
|
|
|
|
|
|
Thomas F. Schlafly
Born 1948
|
|
Trustee
|
|
Since 1983
|
|
Chairman, The Saint Louis Brewery, LLC (brewery) (since 2012); formerly, President, The Saint Louis Brewery, Inc. (1989 to 2012); Partner, Thompson Coburn LLP (law firm) (since
2009); formerly, Of Counsel, Husch Blackwell Sanders LLP (law firm) and its predecessor firms (1984 to 2009)
|
|
52
|
|
Director, Citizens National Bank of Greater St. Louis
(since 2006)
|
|
|
|
|
|
|
Jerry A. Viscione
Born 1944
|
|
Trustee
|
|
Since 1993
|
|
Retired
|
|
52
|
|
None
|
52
|
|
|
|
|
|
|
|
|
|
|
Name and
Year of Birth
|
|
Position(s)
with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5 Years
|
|
Number of
Funds
in Fund
Complex
Overseen
by Trustee
|
|
Other Board
Memberships Held
by
Trustee
|
INTERESTED TRUSTEE AND OFFICER:
|
|
|
|
|
|
|
|
|
|
|
Kenneth D. Fuller Born 1958
|
|
Trustee, President and Chief Executive Officer
|
|
Since 2013
|
|
Managing Director of Legg Mason & Co., LLC (Legg Mason & Co.) (since 2013); Officer and/or Trustee/Director of 162 funds associated with Legg Mason
Partners Fund Advisor, LLC (LMPFA) or its affiliates (since 2013); President and Chief Executive Officer of LMPFA (since 2013); President and Chief Executive Officer of LM Asset Services, LLC (formerly a registered investment adviser)
(since 2013); formerly, Senior Vice President of LMPFA (2012 to 2013); formerly, Director of Legg Mason & Co. (2012 to 2013); formerly, Vice President of Legg Mason & Co. (2009 to 2012); formerly, Vice PresidentEquity
Division of T. Rowe Price Associates (1993 to 2009), as well as formerly, Investment Analyst and Portfolio Manager for certain asset allocation accounts (2004 to 2009).
|
|
151
|
|
None
|
#
|
Trustees who are not interested persons of the fund within the meaning of Section 2(a)(19) of the 1940 Act.
|
*
|
Each Trustee serves until his respective successor has been duly elected and qualified or until his earlier death, resignation, retirement or removal.
|
**
|
Indicates the earliest year in which the Trustee became a board member for a fund in the Legg Mason fund complex.
|
|
Mr. Fuller is an interested person of the fund, as defined in the 1940 Act, because of his position with LMPFA and/or certain of its affiliates.
|
53
|
|
|
|
|
|
|
Name, Year of Birth
and Address
|
|
Position(s) with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5 Years
|
ADDITIONAL OFFICERS:
|
|
|
|
|
|
|
|
|
Ted P. Becker
Born 1951
Legg Mason
620 Eighth Avenue
49
th
Floor
New York, NY 10018
|
|
Chief Compliance Officer
|
|
Since 2007
|
|
Director of Global Compliance at Legg Mason (since 2006); Chief Compliance Officer of LMPFA (since 2006); Managing Director of Compliance of Legg Mason & Co. (since 2005); Chief
Compliance Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2006)
|
|
|
|
|
Vanessa Williams
Born 1979
Legg Mason
100 First Stamford Place
6
th
Floor
Stamford, CT 06902
|
|
Chief Anti-Money Laundering
Compliance Officer
Identity Theft Prevention Officer
|
|
Since 2011
Since 2011
|
|
Vice President of Legg Mason & Co. (since 2012); Identity Theft Prevention Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2011);
Chief Anti-Money Laundering Compliance Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2011); formerly, Senior Compliance Officer of Legg Mason & Co. (2008 to 2011); formerly, Compliance Analyst of
Legg Mason & Co. (2006 to 2008) and Legg Mason & Co. predecessors (prior to 2006)
|
|
|
|
|
Robert I. Frenkel
Born 1954
Legg Mason
100 First Stamford Place
6
th
Floor
Stamford, CT 06902
|
|
Secretary and Chief Legal Officer
|
|
Since 2007
|
|
Vice President and Deputy General Counsel of Legg Mason (since 2006); Managing Director and General Counsel of Global Mutual Funds for Legg Mason & Co. (since 2006) and Legg
Mason & Co. predecessors (since 1994); Secretary and Chief Legal Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2006) and Legg Mason & Co. predecessors (prior to
2006)
|
54
|
|
|
|
|
|
|
Name, Year of Birth
and Address
|
|
Position(s) with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5 Years
|
Thomas C. Mandia
Born 1962
Legg Mason
100 First Stamford Place
6
th
Floor
Stamford, CT 06902
|
|
Assistant Secretary
|
|
Since 2007
|
|
Managing Director and Deputy General Counsel of Legg Mason & Co. (since 2005) and Legg Mason & Co. predecessors (prior to 2005); Secretary of LMPFA (since 2006); Assistant
Secretary of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2006) and Legg Mason & Co. predecessors (prior to 2006); Secretary of LM Asset Services, LLC (since 2002)
|
|
|
|
|
Richard F. Sennett
Born 1970
Legg Mason
100 International Drive
5
th
Floor
Baltimore, MD 21202
|
|
Principal Financial Officer
|
|
Since 2011
|
|
Principal Financial Officer of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2011); Managing Director of Legg Mason & Co. and Senior Manager
of the Treasury Policy group for Legg Mason & Co.s Global Fiduciary Platform (since 2011); formerly, Chief Accountant within the SECs Division of Investment Management (2007 to 2011); formerly, Assistant Chief Accountant within the
SECs Division of Investment Management (2002 to 2007)
|
|
|
|
|
Albert Laskaj
Born 1977
Legg Mason
100 First Stamford Place
6
th
Floor
Stamford, CT 06902
|
|
Treasurer
|
|
Since 2010
|
|
Director of Legg Mason & Co. (since 2013); Vice President of Legg Mason & Co. (2008 to 2013); Treasurer of certain mutual funds associated with Legg Mason & Co. or its
affiliates (since 2010); formerly, Controller of certain mutual funds associated with Legg Mason & Co. or its affiliates (prior to 2010)
|
55
|
|
|
|
|
|
|
Name, Year of Birth
and Address
|
|
Position(s) with Trust
|
|
Term of Office*
and Length of
Time Served**
|
|
Principal Occupation(s)
During Past 5 Years
|
Jeanne M. Kelly
Born 1951
Legg Mason
620 Eighth Avenue
49
th
Floor
New York, NY 10018
|
|
Senior Vice
President
|
|
Since 2007
|
|
Senior Vice President of certain mutual funds associated with Legg Mason & Co. or its affiliates (since 2007); Senior Vice President of LMPFA (since 2006); Managing Director of
Legg Mason & Co. (since 2005) and Legg Mason & Co. predecessors (prior to 2005)
|
*
|
Each officer serves until his or her respective successor has been duly elected and qualified or until his or her earlier death, resignation, retirement or removal.
|
**
|
Indicates the earliest year in which the officer took such office for a fund in the Legg Mason fund complex.
|
Each Trustee, except for Mr. Fuller, previously served as a trustee or director of certain predecessor funds in the fund complex, and
each Trustee, except for Mr. Fuller, was thus initially selected by the board of the applicable predecessor funds. In connection with a restructuring of the fund complex completed in 2007, the Board was established to oversee mutual funds in the
fund complex that invest primarily in equity securities, including the fund, with a view to ensuring continuity of representation by board members of predecessor funds on the Board and in order to establish a Board with experience in and focused on
overseeing equity mutual funds, which experience would be further developed and enhanced over time.
In connection with the
restructuring, the Independent Trustees were selected to join the Board based upon the following as to each Trustee: character and integrity; service as a board member of predecessor funds; willingness to serve and willingness and ability to commit
the time necessary to perform the duties of a Trustee; the fact that service as a Trustee would be consistent with the requirements of the Trusts retirement policies; and the Trustees status as not being an interested person
of the fund, as defined in the 1940 Act. Mr. Fuller was selected to join the Board based upon the following: character and integrity; willingness to serve and willingness and ability to commit the time necessary to perform the duties of a
Trustee; the fact that service as a Trustee would be consistent with requirements of the Trusts retirement policies; and his status as a representative of Legg Mason. Independent Trustees constitute more than 75% of the Board and the Chairman
of the Board is an Independent Trustee. Mr. Fuller is an interested person of the fund.
The Board believes that
each Trustees experience, qualifications, attributes or skills on an individual basis and in combination with those of the other Trustees lead to the conclusion that the Board possesses the requisite attributes and skills. The Board believes
that the Trustees ability to review critically, evaluate, question and discuss information provided to them, to interact effectively with the manager, the subadvisers and Western Asset, other service providers, counsel and the independent
registered public accounting firm, and to exercise effective business judgment in the performance of their duties support this conclusion. In addition, the following specific experience, qualifications, attributes and/or skills apply to each
Trustee.
Each Trustee, except for Mr. Fuller, has served as a board member of the fund and other funds (or predecessor
funds) in the fund complex for at least eight years. Mr. Ades has substantial experience practicing law and advising clients with respect to various business transactions. Mr. Breech has substantial experience as the chief executive of a
private corporation. Mr. Crane has substantial experience as an economist, academic and business consultant. Mr. Hubbard has substantial experience in business development and was a senior executive of an operating company.
Mr. Johnson has substantial experience as the chief executive of an operating company and in the financial services industry, including as an actuary and pension consultant. Mr. Jerome Miller had
56
substantial experience as an executive in the asset management group of a major broker/dealer. Mr. Ken Miller has substantial experience as a senior executive of an operating company.
Mr. Murphy has substantial experience in the asset management business and has current and prior service on the boards of other mutual funds and corporations. Mr. Schlafly has substantial experience practicing law and also serves as the
president of a private corporation and as director of a bank. Mr. Viscione has substantial experience as an academic and senior executive of a major university. Mr. Fuller has been the Chief Executive Officer of the Trust and other funds
in the fund complex since 2013 and has substantial investment management and risk oversight experience as an executive and portfolio manager and in leadership roles with Legg Mason and affiliated entities and another investment advisory firm.
References to the experience, qualifications, attributes and skills of Trustees are pursuant to requirements of the SEC, do not constitute holding out of the Board or any Trustee as having any special expertise, and shall not impose any greater
responsibility or liability on any such person or on the Board.
The Board has five standing Committees: the Audit Committee,
the Contract Committee, the Performance Committee, the Governance Committee, and the Compensation and Nominating Committee (which is a sub-committee of the Governance Committee). Each Committee is chaired by an Independent Trustee. The Audit
Committee and the Governance Committee are composed of all of the Independent Trustees. The Contract Committee is composed of four Independent Trustees. The Performance Committee is composed of three Independent Trustees and the Chief Executive
Officer of the Trust. The Compensation and Nominating Committee is composed of four Independent Trustees. The Chairman of the Board serves as the Chair of the Governance Committee. Where deemed appropriate, the Board may constitute
ad hoc
committees.
The Chairman of the Board and the chairs of the Audit and Performance Committees work with the Chief Executive
Officer of the Trust to set the agendas for Board and committee meetings. The Chairman of the Board also serves as a key point person for interaction between management and the other Independent Trustees. Through the committees the Independent
Trustees consider and address important matters involving the fund, including those presenting conflicts or potential conflicts of interest for management. The Independent Trustees also regularly meet outside the presence of management and are
advised by independent legal counsel. The Board has determined that its committees help ensure that the fund has effective and independent governance and oversight. The Board also has determined that its leadership structure, in which the Chairman
of the Board is not affiliated with Legg Mason, is appropriate. The Board also believes that its leadership structure facilitates the orderly and efficient flow of information between the Independent Trustees and management, including the
funds subadvisers and Western Asset.
The Audit Committee oversees the scope of the funds audit, the
funds accounting and financial reporting policies and practices and its internal controls. The Audit Committee assists the Board in fulfilling its responsibility for oversight of the integrity of the funds accounting, auditing and
financial reporting practices, the qualifications and independence of the funds independent registered public accounting firm and the funds compliance with legal and regulatory requirements. The Audit Committee approves, and recommends
to the Board for ratification, the selection, appointment, retention or termination of the funds independent registered public accounting firm and approves the compensation of the independent registered public accounting firm. The Audit
Committee also approves all audit and permissible non-audit services provided to the fund by the independent registered public accounting firm and all permissible non-audit services provided by the funds independent registered public
accounting firm to its manager and any affiliated service providers if the engagement relates directly to the funds operations and financial reporting. The Audit Committee also assists the Board in fulfilling its responsibility for the review
and negotiation of the funds investment management and subadvisory arrangements.
The Contract Committee is charged with
assisting the Board in requesting and evaluating such information from the manager, the subadvisers and Western Asset as may reasonably be necessary to evaluate the terms of the funds investment management agreement, subadvisory arrangements
and distribution arrangements.
57
The Performance Committee is charged with assisting the Board in carrying out its oversight
responsibilities over the fund and fund management with respect to investment management, objectives, strategies, policies and procedures, performance and performance benchmarks, and the applicable risk management process.
The Governance Committee is charged with overseeing Board governance and related Trustee practices, including selecting and nominating
persons for election or appointment by the Board as Trustees of the Trust. The Governance Committee has formed the Compensation and Nominating Committee, the function of which is to recommend to the Board the appropriate compensation for serving as
a Trustee on the Board. In addition, the Compensation and Nominating Committee is responsible for, among other things, selecting and recommending candidates to fill vacancies on the Board. The Committee may consider nominees recommended by a
shareholder. In evaluating potential nominees, including any nominees recommended by shareholders, the Committee takes into consideration various factors, including, among any others it may deem relevant, character and integrity, business and
professional experience, and whether the committee believes the person has the ability to apply sound and independent business judgment and would act in the interest of the fund and its shareholders. Shareholders who wish to recommend a nominee
should send recommendations to the Trusts Secretary that include all information relating to such person that is required to be disclosed in solicitations of proxies for the election of Trustees. A recommendation must be accompanied by a
written consent of the individual to stand for election if nominated by the Board and to serve if elected by the shareholders.
Service providers to the fund, primarily the funds manager, the funds subadvisers and Western Asset and, as appropriate,
their affiliates, have responsibility for the day-to-day management of the fund, which includes responsibility for risk management. As an integral part of its responsibility for oversight of the fund, the Board oversees risk management of the
funds investment program and business affairs. Oversight of the risk management process is part of the Boards general oversight of the fund and its service providers. The Board has emphasized to the funds manager, the funds
subadvisers and Western Asset the importance of maintaining vigorous risk management. The Board exercises oversight of the risk management process primarily through the Audit Committee and the Performance Committee, and through oversight by the
Board itself.
The fund is subject to a number of risks, including investment risk, counterparty risk, valuation risk,
reputational risk, risk of operational failure or lack of business continuity, and legal, compliance and regulatory risk. Risk management seeks to identify and address risks,
i.e.
, events or circumstances that could have material adverse
effects on the business, operations, shareholder services, investment performance or reputation of the fund. The funds manager, the subadvisers and Western Asset, the affiliates of the manager, the subadvisers and Western Asset, or various
service providers to the fund employ a variety of processes, procedures and controls to identify various of those possible events or circumstances, to lessen the probability of their occurrence and/or to mitigate the effects of such events or
circumstances if they do occur. Different processes, procedures and controls are employed with respect to different types of risks. Various personnel, including the funds and the managers Chief Compliance Officer and the managers
chief risk officer, as well as personnel of the subadvisers and Western Asset and other service providers, such as the funds independent registered public accounting firm, make periodic reports to the Audit Committee, the Performance Committee
or to the Board with respect to various aspects of risk management, as well as events and circumstances that have arisen and responses thereto. The Board recognizes that not all risks that may affect the fund can be identified, that it may not be
practical or cost-effective to eliminate or mitigate certain risks, that it may be necessary to bear certain risks (such as investment-related risks) to achieve the funds goals, and that the processes, procedures and controls employed to
address certain risks may be limited in their effectiveness. Moreover, reports received by the Trustees as to risk management matters are typically summaries of the relevant information. As a result of the foregoing and other factors, the
Boards risk management oversight is subject to inherent limitations.
The Board met 4 times during the fiscal year ended
December 31, 2012. The Audit Committee, the Contract Committee, the Performance Committee, the Governance and Nominating Committee and the Compensation Committee met 4, 1, 4, 4 and 1 time(s), respectively, during the fiscal year ended December 31,
2012.
58
The following table shows the amount of equity securities owned by the Trustees in the
fund and other investment companies in the fund complex overseen by the Trustees as of December 31, 2012, except for Mr. Fuller, for whom the information is shown as of March 31, 2013.
|
|
|
|
|
Name of Trustee
|
|
Dollar
Range
of Equity
Securities in
the Fund
($)
|
|
Aggregate Dollar Range
of Equity Securities
In
Registered
Investment Companies
Overseen by Trustee ($)
|
Independent Trustees
|
|
|
|
|
Paul R. Ades
|
|
None
|
|
Over 100,000
|
Andrew L. Breech
|
|
None
|
|
Over 100,000
|
Dwight B. Crane
|
|
None
|
|
Over 100,000
|
Frank G. Hubbard
|
|
None
|
|
Over 100,000
|
Howard J. Johnson
|
|
None
|
|
Over 100,000
|
Jerome H. Miller
|
|
None
|
|
Over 100,000
|
Ken Miller
|
|
None
|
|
Over 100,000
|
John J. Murphy
|
|
None
|
|
Over 100,000
|
Thomas F. Schlafly
|
|
None
|
|
Over 100,000
|
Jerry A. Viscione
|
|
None
|
|
Over 100,000
|
Interested Trustee
|
|
|
|
|
Kenneth D. Fuller
|
|
None
|
|
Over 100,000
|
As of December 31, 2012, none of the Independent Trustees or their immediate family members owned
beneficially or of record any securities of the manager, subadvisers, Western Asset or distributor of the fund, or of a person (other than a registered investment company) directly or indirectly controlling, controlled by or under common control
with the manager, subadvisers, Western Asset or distributor of the fund.
The Independent Trustees receive a fee for each
meeting of the Board and committee meetings attended and are reimbursed for all out-of-pocket expenses relating to attendance at such meetings. Mr. Fuller, an interested person of the fund, as defined in the 1940 Act, does not
receive compensation from the fund for his service as Trustee, but may be reimbursed for all out-of-pocket expenses relating to attendance at such meetings.
The fund pays a
pro rata
share of the Trustees fees based upon asset size. The fund currently pays each of the Independent Trustees its
pro rata
share of: an annual fee of $120,000,
plus $20,000 for each regularly scheduled Board meeting attended in person, and $1,000 for each telephonic Board meeting in which that Trustee participates. The Chairman of the Board receives an additional $25,000 per year, the Chair of the Audit
Committee receives an additional $15,000 per year and the Chairs of the Contract Committee, the Performance Committee, and the Compensation and Nominating Committee receive an additional $12,500 per year. Other members of the Contract Committee, the
Performance Committee, and the Compensation and Nominating Committee receive an additional $10,000 per year. Effective January 1, 2013, the Trustee designated as the funds audit committee financial expert (as defined in the instructions to
Item 3 of Form N-CSR) receives an additional $10,000 per year.
Officers of the Trust receive no compensation from the
fund, although they may be reimbursed by the fund for reasonable out-of-pocket travel expenses for attending Board meetings.
59
Information regarding compensation paid to the Trustees is shown below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Name of Trustee
|
|
Aggregate
Compensation
from the
Fund
(2)
($)
|
|
|
Total Pension
or Retirement
Benefits Paid
as Part of
Fund
Expenses
(4)
($)
|
|
|
Total
Compensation
from Fund
Complex Paid
to Trustee
(3)
($)
|
|
|
Number of
Portfolios in
Fund
Complex
Overseen by
Trustee
(2)
|
|
Independent Trustees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paul R. Ades
|
|
|
880
|
|
|
|
0
|
|
|
|
210,000
|
|
|
|
52
|
|
Andrew L. Breech
|
|
|
890
|
|
|
|
0
|
|
|
|
212,500
|
|
|
|
52
|
|
Dwight B. Crane
|
|
|
985
|
|
|
|
0
|
|
|
|
235,000
|
|
|
|
52
|
|
Frank G. Hubbard
|
|
|
880
|
|
|
|
0
|
|
|
|
210,000
|
|
|
|
52
|
|
Howard J. Johnson
|
|
|
943
|
|
|
|
0
|
|
|
|
225,000
|
|
|
|
52
|
|
Jerome H. Miller
|
|
|
880
|
|
|
|
0
|
|
|
|
210,000
|
|
|
|
52
|
|
Ken Miller
|
|
|
880
|
|
|
|
0
|
|
|
|
210,000
|
|
|
|
52
|
|
John J. Murphy
|
|
|
880
|
|
|
|
0
|
|
|
|
210,000
|
|
|
|
52
|
|
Thomas F. Schafly
|
|
|
890
|
|
|
|
0
|
|
|
|
212,500
|
|
|
|
52
|
|
Jerry A. Viscione
|
|
|
890
|
|
|
|
0
|
|
|
|
212,500
|
|
|
|
52
|
|
Interested Trustee:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
R. Jay Gerken
(
1
)
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
161
|
|
Kenneth D. Fuller
(1)
|
|
|
None
|
|
|
|
None
|
|
|
|
None
|
|
|
|
151
|
|
(1)
|
Mr. Gerken retired as a Trustee effective May 31, 2013, and Mr. Fuller became a Trustee effective June 1, 2013. Mr. Gerken was not compensated
for his services as a Trustee, and Mr. Fuller will not be compensated for such services, because of their affiliations with the manager.
|
(2)
|
Information is for the fiscal year ended December 31, 2012.
|
(3)
|
Information is for the calendar year ended December 31, 2012.
|
(4)
|
Pursuant to prior retirement plans, the fund made payments of $0 to former Trustees for the fiscal year ended December 31, 2012.
|
As of , 2013, the Trustees and officers
of the Trust, as a group, owned less than 1% of the outstanding shares of the fund.
To the knowledge of the fund, as of
, 2013, the following shareholders owned or held of record 5% or more, as indicated, of the outstanding shares of the following classes of the fund:
|
|
|
|
|
Class
|
|
Name and Address
|
|
Percent of
Shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
60
INVESTMENT MANAGEMENT AND OTHER SERVICES
Manager
LMPFA serves
as investment manager to the fund pursuant to an investment management agreement (the Management Agreement). LMPFA provides administrative and certain oversight services to the fund. LMPFA, with offices at 620 Eighth Avenue, New York,
New York 10018, also serves as the investment manager of other Legg Mason-sponsored funds. As of [ ], 2013, LMPFAs total
assets under management were approximately $ billion. LMPFA is a wholly-owned subsidiary of Legg Mason. Legg Mason, whose principal executive offices are at 100 International
Drive, Baltimore, Maryland 21202, is a global asset management company. As of [ ], 2013, Legg Masons asset management
operations had aggregate assets under management of approximately $ billion.
The manager has agreed, under the Management Agreement, subject to the supervision of the funds Board, to provide the fund with investment research, advice, management and supervision; furnish a
continuous investment program for the funds portfolio of securities and other investments consistent with the funds investment objective, policies and restrictions; and place orders pursuant to its investment determinations. The manager
is permitted to enter into contracts with subadvisers or subadministrators, subject to the Boards approval. The manager has entered into subadvisory arrangements, as described below.
The manager performs administrative and management services as reasonably requested by the fund necessary for the operation of the fund,
such as (i) supervising the overall administration of the fund, including negotiation of contracts and fees with and the monitoring of performance and billings of the funds transfer agent, shareholder servicing agents, custodian and other
independent contractors or agents; (ii) providing certain compliance, fund accounting, regulatory reporting and tax reporting services; (iii) preparing or participating in the preparation of Board materials, registration statements, proxy
statements and reports and other communications to shareholders; (iv) maintaining the funds existence; and (v) maintaining the registration and qualification of the funds shares under federal and state laws.
The Management Agreement will continue in effect for its initial term and thereafter from year to year, provided such continuance is
specifically approved at least annually (a) by the Board or by a majority of the outstanding voting securities of the fund (as defined in the 1940 Act), and (b) in either event, by a majority of the Independent Trustees with such
Independent Trustees casting votes in person at a meeting called for such purpose.
The Management Agreement provides that the
manager may render services to others. The Management Agreement is terminable without penalty on not more than 60 days nor less than 30 days written notice by the fund when authorized either by a vote of holders of shares representing a
majority of the voting power of the outstanding voting securities of the fund (as defined in the 1940 Act) or by a vote of a majority of the Trustees, or by the manager on not less than 90 days written notice, and will automatically terminate
in the event of its assignment (as defined in the 1940 Act). The Management Agreement is not assignable by the Trust except with the consent of the manager. The Management Agreement provides that neither the manager nor its personnel shall be liable
for any error of judgment or mistake of law or for any loss arising out of any investment or for any act or omission in the execution of security transactions for the fund, except for willful misfeasance, bad faith or gross negligence or reckless
disregard of its or their obligations and duties.
For its services under the Management Agreement, LMPFA receives an
investment management fee of 0.65% of the funds average daily net assets (including assets invested in its subsidiary), from which it compensates the funds subadvisers.
61
For the fiscal years ended December 31, 2012, 2011 and 2010, the fund paid management fees
to LMPFA as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
For the fiscal years ended December 31
|
|
Gross
Management
Fees ($)
|
|
|
Management Fees
Waived/Expense
Reimbursements ($)
|
|
|
Net Management
Fees (After Waivers/
Expense
Reimbursements) ($)
|
|
2012
|
|
|
708,218
|
|
|
|
305,924
|
|
|
|
402,294
|
|
2011
|
|
|
752,149
|
|
|
|
224,227
|
|
|
|
527,922
|
|
2010
|
|
|
435,347
|
|
|
|
251,001
|
|
|
|
184,346
|
|
Subadvisory Arrangements
Permal serves as a subadviser to the fund pursuant to a subadvisory agreement between the manager and Permal with respect to the fund (the Permal Subadvisory Agreement). Permal, with offices
at 900 Third Avenue, New York, New York 10022, with approximately $ billion in assets under management as of
[ ], 2013, is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940, as amended (the
Advisers Act). Permal is a member of The Permal Group and is owned indirectly by Permal Group Ltd., a holding company of an international financial group of companies. Permal Group Ltd. is a subsidiary of Legg Mason. The Permal
Group is one of the largest fund-of-funds investment management firms in the world with approximately $ billion in assets under management as of
[ ], 2013.
LMGAA also serves as a subadviser to the fund pursuant to a subadvisory agreement (the LMGAA Subadvisory Agreement) between the manager and LMGAA with respect to the fund. LMGAA is responsible
for coordinating portfolio investment decisions for the fund and provides certain compliance and portfolio execution services to the fund. LMGAA, with offices at 620 Eighth Avenue, New York, New York 10018, is registered with the SEC as an
investment adviser under the Advisers Act. As of [ ], 2013, LMGAAs total assets under management were approximately
$ billion. LMGAA is a wholly-owned subsidiary of Legg Mason.
Western Asset manages the funds cash and short-term instruments pursuant to an agreement between the manager and Western Asset (the Western Asset Agreement). Western Asset, established
in 1971, has offices at 385 East Colorado Boulevard, Pasadena, California 91101 and 620 Eighth Avenue, New York, New York 10018. Western Asset acts as investment adviser to institutional accounts, such as corporate pension plans, mutual funds and
endowment funds. As of [ ], 2013, the total assets under management of Western Asset and its supervised affiliates were
approximately $ billion.
Under the Permal
Subadvisory Agreement and subject to the supervision and direction of the Board and the manager, Permal provides day-to-day portfolio management with respect to the funds assets, including the allocation among asset classes and the
determination of the funds allocation to particular underlying funds. Under the LMGAA Subadvisory Agreement and subject to the supervision and direction of the Board and the manager, LMGAA is responsible for implementing Permals
portfolio investment decisions for the fund and provides certain compliance and portfolio execution services to the fund. Under the Western Asset Agreement, Western Asset manages the funds cash and short-term instruments.
Each Subadvisory Agreement and the Western Asset Agreement will continue in effect for its initial term and thereafter from year to year
provided such continuance is specifically approved at least annually (a) by the Board or by a majority of the outstanding voting securities of the fund (as defined in the 1940 Act), and (b) in either event, by a majority of the Independent
Trustees with such Independent Trustees casting votes in person at a meeting called for such purpose. The Board or a majority of the outstanding voting securities of the fund (as defined in the 1940 Act) may terminate a Subadvisory Agreement or the
Western Asset Agreement without penalty, in each case on not more than 60 days nor less than 30 days written notice to the subadviser. Either subadviser or Western Asset may terminate its Subadvisory Agreement or the Western Asset
Agreement,
62
respectively, on 90 days written notice to the fund and the manager. The manager or either subadviser or the manager and Western Asset may terminate the applicable Subadvisory Agreement or
the Western Asset Agreement, respectively, upon their mutual written consent. Each Subadvisory Agreement will terminate automatically in the event of assignment by Permal, LMGAA or Western Asset, as applicable, and shall not be assignable by the
manager without the consent of such subadviser.
LMPFA provides administrative and certain oversight services to the fund.
LMPFA delegates to the subadvisers and Western Asset the day-to-day portfolio management of the fund. For its services, LMPFA pays Permal and Western Asset an aggregate subadvisory fee, calculated daily and paid monthly, in accordance with the
following breakpoint schedule:
|
|
|
|
|
Average Daily Net Assets
|
|
Annual Rate (%)
|
|
Up to and including $250 million
|
|
|
0.450
|
|
Over $250 million and up to and including $750 million
|
|
|
0.400
|
|
Over $750 million
|
|
|
0.350
|
|
For its services, LMPFA pays LMGAA an annual rate of 0.05% of the funds average daily net assets.
Portfolio Managers
The following tables set forth certain additional information with respect to the portfolio managers for the fund. Unless noted otherwise, all information is provided as of December 31, 2012.
Other Accounts Managed by the Portfolio Managers
The table below identifies the portfolio managers, the number of accounts (other than the fund) for which each portfolio manager has day-to-day management responsibilities and the total assets in such
accounts, within each of the following categories: registered investment companies, other pooled investment vehicles, other accounts and, if applicable, the number of accounts and total assets in the accounts where fees are based on performance.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Type of
Account
|
|
Number of
Accounts
Managed
|
|
|
Total Assets
Managed ($)
|
|
|
Number of
Accounts
Managed
for
which
Advisory Fee is
Performance-
Based
|
|
|
Assets
Managed for
which
Advisory Fee is
Performance-
Based
($)
|
|
Christopher Zuehlsdorff
|
|
Registered
investment
companies
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
Other
pooled
investment
vehicles
|
|
|
3
|
|
|
|
291 million
|
|
|
|
2
|
|
|
|
253 million
|
|
|
|
|
|
|
|
|
|
Other
accounts
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
|
|
0
|
|
63
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Type of
Account
|
|
|
Number of
Accounts
Managed
|
|
|
Total Assets
Managed ($)
|
|
|
Number of
Accounts
Managed
for
which
Advisory Fee is
Performance-
Based
|
|
|
Assets
Managed for
which
Advisory Fee is
Performance-
Based
($)
|
|
Alexander Pillersdorf
|
|
|
Registered
investment
companies
|
|
|
|
1
|
|
|
|
21.3 million
|
|
|
|
0
|
|
|
|
0
|
|
|
|
|
|
|
|
|
|
|
Other
pooled
investment
vehicles
|
|
|
|
6
|
|
|
|
4.46 billion
|
|
|
|
5
|
|
|
|
4.42 billion
|
|
|
|
|
|
|
|
|
|
|
Other
accounts
|
|
|
|
3
|
|
|
|
448 million
|
|
|
|
0
|
|
|
|
0
|
|
Portfolio Manager CompensationPermal
Permal portfolio managers earn from Permal a base salary, with an opportunity to earn a bonus, which varies depending on job level and is set at the sole discretion of Permals compensation
committee. No Permal portfolio managers are compensated on the basis of assets raised. Wage and salary increases are based on merit and business conditions. Length of service and cost of living may also be considered. Permal conducts compensation
reviews periodically, often following a performance review.
Permal also encourages ongoing education and provides time and
monetary support for employees taking additional classes related to their job functions to improve their skills and knowledge base. In addition, Permal provides employees with a 401(k) plan and has a matching contribution program in connection
with the 401(k) plan.
Portfolio Manager CompensationLMGAA
LMGAA investment professionals receive base salary and other employee benefits and are eligible to receive incentive compensation. Base salary is fixed and typically determined based on market factors and
the skill and experience of individual investment personnel.
The level of incentive compensation is determined by the senior
management of Legg Mason and is awarded on a discretionary basis. A formula-based scheme directly linking compensation to investment performance as measured against a benchmark is not currently in place nor is one planned; however, senior management
considers a number of factors when determining compensation, including (but not limited to) the performance of LMGAAs funds relative to their benchmarks and to their relevant peer groups over a 1, 3 and 5-year period.
Up to 20% of an LMGAA investment professionals annual incentive compensation is subject to deferral. Of that principal deferred
award amount, 50% will accrue a return based on the hypothetical returns of the investment fund or product that is the primary focus of the investment professionals business activities with LMGAA and 50% may be received in the form of Legg
Mason restricted stock shares.
Potential Conflicts of Interest
The Manager, the Subadvisers and their Affiliates
The investment activities of
the manager, the subadvisers, the investment advisers of the underlying funds and their respective affiliates, and their directors, trustees, managers, members, partners, officers, and employees (collectively, the Related Parties), for
their own accounts and other accounts they manage, may give rise to
64
conflicts of interest that could disadvantage the fund and its shareholders. The Related Parties provide other investment management services to other funds and discretionary managed
accounts that follow an investment program certain aspects of which are similar to certain aspects of the funds investment program. The Related Parties are involved with a broad spectrum of financial services and asset management
activities, and may, for example, engage in the ordinary course of business in activities in which their interests or the interests of their clients may conflict with those of the fund. The trading activities of the Related Parties are carried
out without reference to positions held directly or indirectly by the fund. In addition, and more significantly, the Related Parties may be involved with other investment programs, investment partnerships or separate accounts that use
underlying funds that are either already a part of the funds portfolio or that may be appropriate for investment by the fund. In some cases, these underlying funds may be capacity constrained. The Related Parties are under no
obligation to provide the fund with capacity with respect to these underlying funds and, accordingly, the fund may not have exposure or may have reduced exposure with respect to these underlying funds. The funds operations may give rise
to other conflicts of interest that could disadvantage the fund.
Certain Related Parties participate in the fixed income,
equity and other markets in which the fund directly or indirectly invests. In addition, certain Related Parties are actively engaged as investors, advisers and/or market makers, agents and principals in relation to certain of the same
securities, issuers, currencies and other instruments in which the assets of the fund (directly or through the underlying funds) may be invested, and these activities may have a negative effect on the fund.
Certain Related Parties may give advice and take action with respect to any of their clients or proprietary or other accounts that may
conflict with the advice given to the fund, or may involve a different timing or nature of action taken than with respect to the fund. Such transactions, whether with respect to proprietary accounts, customer accounts other than those advised
by the manager or the subadvisers, or certain other accounts that are advised by the manager or the subadvisers, may affect the prices and availability of the securities, currencies and other instruments in which the fund (directly or indirectly
through the underlying funds) may invest. In addition, accounts or funds managed by the Related Parties may compete with the fund (directly or indirectly through the underlying funds) for investment opportunities. As a result, transactions
for the fund (directly or indirectly through the underlying funds) may be effected at prices or rates that may be less favorable than would have been the case absent such conflicts, and the fund may be negatively affected. The results of the
investment activities of the fund may differ significantly from the results achieved by Related Parties for other accounts managed by them. This may have a negative effect on the fund.
Subject to applicable regulatory requirements, the fund may invest (directly or indirectly through the underlying funds) in securities of
companies affiliated with the Related Parties or in which certain of the Related Parties have an equity or participation interest. The purchase, holding and sale of such investments by the fund (directly or indirectly through the underlying
funds) may enhance the profitability of the Related Parties own investments in such companies.
Certain Related Parties
may buy and sell securities or other investments for their own accounts, including interests in the underlying funds, and conduct other activities that may cause the same types of conflicts as those conflicts described herein applicable to the
proprietary, management, advisory and other activities of Related Parties. As a result of differing trading and investment strategies or constraints, positions may be taken by directors, officers and employees and affiliates of the investment
manager or the subadvisers that are the same, different from or made at different times than positions taken for the fund or an underlying fund in which the fund participates. In connection with the above, each of the fund, the manager and the
subadvisers have adopted codes of ethics in compliance with Rule 17j-1 under the 1940 Act and Rule 204A-1 under the Advisers Act that restrict securities trading in the personal accounts of investment professionals and others who normally
come into possession of information regarding the funds portfolio transactions.
Accounts or underlying funds managed or
advised by Related Parties (including those managed by the manager and subadvisers) may have investment objectives that are similar to those of the fund and/or may
65
engage in transactions in the same types of securities, currencies and instruments as the fund, and from which the manager, the subadvisers or other Related Parties may receive more or less
compensation for its services than the manager and subadvisers receive from the fund. As a result, Related Parties and accounts or funds which Related Parties may manage or advise (including, without limitation, those funds discussed in greater
detail below), or in which Related Parties and their personnel may have a proprietary interest, may compete with the fund for appropriate investment opportunities. For example, investment advisers of the underlying funds may limit the number of
investors in or size of an underlying fund or the amount of assets and accounts that they will manage. The allocation of such opportunities among Related Parties funds and accounts may present conflicts, as may the potentially different
investment objectives of different investors. In determining such allocations, a number of factors may be considered, which may include the relative sizes of the applicable funds and accounts and their expected future sizes, the expected future
capacity of the applicable underlying funds, the funds available for allocation at any given time and the investment objectives of the fund and such other funds and accounts. Allocation of investment opportunities among the fund and other funds
and accounts will be made by the subadvisers or by Related Parties in their capacities as the managers of such funds and accounts in a reasonable and equitable manner, as determined by them in their sole discretion. The disposition of any such
investments is subject to the same conditions.
Subject to applicable regulatory requirements, Related Parties from time to
time may invest proprietary or client capital with investment advisers, including investment advisers of the underlying funds selected by the fund, and may also invest in underlying funds in which the fund invests on terms different from the
interests held by the fund. In addition, Related Parties may have other business relationships with such investment advisers. Related Parties may perform or seek to perform investment banking and other financial services for, and will
receive compensation from, underlying funds, the sponsors of underlying funds, companies in which underlying funds invest or other parties in connection with transactions related to those investments or otherwise. This compensation could
include financial advisory fees, as well as underwriting or placement fees, financing or commitment fees or other types of compensation. Compensation for investment banking and other financial services will not be shared with the fund and may be
received before the fund realizes a return on its investment. Related Parties may also provide brokerage services to underlying funds or act as a prime broker for underlying funds in compliance with applicable law, including, without
limitation, the 1940 Act. In connection with such brokerage services, Related Parties may provide research products and services to the underlying funds. Due to such relationships, the subadvisers may face a conflict in evaluating the
applicable investment advisers of the underlying funds or underlying funds. Moreover, as a result of certain of such relationships, Related Parties may take actions with respect to an underlying fund, such as making a margin call, that may
materially adversely affect such underlying fund and, therefore, the fund.
Related Parties may, from time to time, purchase
shares of the fund. Any redemption of shares held by the Related Parties will be effected pursuant to the funds redemption policies. Such redemptions may have an adverse effect on the funds investment strategies, the breadth of
their allocation of investments and on the fees, expenses and costs incurred by the fund.
To the extent permitted by
applicable law, including, without limitation, the 1940 Act, an underlying fund may enter into transactions and invest in futures, securities, currencies, swaps, options, forward contracts or other instruments in which one of the Related Parties,
acting as principal or on a proprietary basis for its customers, serves as the counterparty. The manager, the subadvisers and other Related Parties will not, directly or indirectly, purchase securities or other property from, or sell securities
or other property to, the fund except in accordance with applicable law. However, subject to compliance with applicable law, including without limitation, the 1940 Act, the fund may engage in transactions with accounts that are affiliated with
the fund because they are advised by Related Parties or because they have common officers, directors or managers. Such transactions would be made in circumstances where a subadviser has determined that it would be appropriate for the fund to
purchase and a subadviser or another client of the Related Parties to sell, or the fund to sell and another client of the Related Parties to purchase, the same security or instrument on the same day.
66
To the extent permitted by applicable law (including, without limitation, the 1940 Act), the
fund (directly or indirectly through underlying funds) may purchase investments that are issued, or the subject of an underwriting or other distribution, by Related Parties. It is anticipated that the commissions, mark-ups and mark-downs
charged by Related Parties will be, in their view, commercially reasonable, although Related Parties will have an interest in obtaining commission rates, mark-ups and mark-downs that are favorable to such Related Parties.
Purchases or sales of securities for the account of the fund may be bunched or aggregated with orders for other accounts of the Related
Parties, including other investment partnerships (including those in which the Related Parties or their employees have a beneficial interest). In the event that it is not possible to receive the same price or execution on the entire volume of
securities purchased or sold, the various prices would be averaged, and the fund will be charged or credited with the average price. Thus, the effect of the aggregation may be disadvantageous to the fund on some occasions. In addition,
under certain circumstances, the fund may not be charged the same commission or commission equivalent rates in connection with a bunched or aggregated order. It is expected that the underlying funds generally will follow the same practice, but
there is no guarantee that they will do so. The manager or a subadviser may invest the funds assets in underlying funds or managed accounts managed by investment advisers affiliated with the Related Parties.
The manager or a subadviser may advise certain accounts with respect to which the advisory fee is based entirely or partially on
performance. Performance fee arrangements may create a conflict of interest in that the manager or a subadviser may have an incentive to allocate the investment opportunities that it believes might be the most profitable to such other accounts
instead of allocating them to the fund.
Conflicts of Interest of Underlying Fund Investments
The subadvisers anticipate that each investment adviser of an underlying fund will consider participation by the applicable underlying
fund in all appropriate investment opportunities that are also under consideration for investment by the investment advisers of the underlying funds for other funds and accounts managed by the investment adviser (Underlying Adviser
Accounts) that pursue investment programs similar to that of the applicable underlying funds or the fund. However, there can be no guarantee or assurance that investment advisers of the underlying funds will follow such practices or that
an investment adviser will adhere to, and comply with, its stated practices, if any. In addition, circumstances may arise under which an investment adviser of an underlying fund will cause its Underlying Adviser Accounts to commit a larger
percentage of their assets to an investment opportunity than to which the investment adviser of the underlying fund will commit assets of the underlying fund. Circumstances may also arise under which an investment adviser of the underlying fund
will consider participation by its Underlying Adviser Accounts in investment opportunities in which the investment adviser intends not to invest on behalf of the underlying fund, or vice versa.
Situations may occur where the fund could be disadvantaged by investment activities conducted by the investment adviser of an underlying
fund for the Underlying Adviser Accounts. These situations may arise as a result of, among other things: (1) legal restrictions on the combined size of positions that may be taken for an underlying fund in which the fund and/or
Underlying Adviser Accounts participate (collectively, Co-Investors and, individually, a Co-Investor), limiting the size of underlying funds position; (2) legal prohibitions on the Co-Investors participating
in the same instruments; (3) the difficulty of liquidating an investment for a Co-Investor when the market cannot absorb the sale of the combined positions; and (4) the determination that a particular investment is warranted only if hedged
with an option or other instrument and the availability of those options or other instrument is limited.
A investment adviser
of an underlying fund may from time to time cause an underlying fund to effect certain principal transactions in securities with one or more Underlying Adviser Accounts, subject to certain conditions. For example, these transactions may be made
in circumstances in which the portfolio managers determine it is appropriate for the underlying fund to purchase and an Underlying Adviser Account to sell, or the
67
underlying fund to sell and the Underlying Adviser Account to purchase, the same security or instrument on the same day.
Each investment adviser of an underlying fund and its affiliates, and their directors, officers and employees, may buy and sell securities or other investments for their own accounts, including shares in
underlying funds, and may have conflicts of interest with respect to investments made on behalf of an underlying fund in which the fund participates. As a result of differing trading and investment strategies or constraints, positions may be
taken by directors, officers, employees and affiliates of the underlying fund for their own accounts that are the same as, different from or made at different times than positions taken for the underlying fund. Future investment activities of
the investment adviser of the underlying funds, or their affiliates, and the principals, members, directors, officers or employees of the foregoing, may give rise to additional conflicts of interest that could disadvantage the fund.
Investment advisers of the underlying funds or their affiliates may from time to time provide investment advisory or other services to
underlying funds and other entities or accounts managed by the investment advisers or their affiliates. In addition, investment advisers of the underlying funds or their affiliates may from time to time receive research products and services in
connection with the brokerage services that brokers (including, without limitation, affiliates of the investment adviser) may provide to one or more Underlying Adviser Accounts.
Portfolio Manager Securities Ownership
The table below identifies
ownership of the funds securities by the portfolio managers as of December 31, 2012.
|
|
|
Portfolio Manager
|
|
Dollar Range of
Ownership of
Securities ($)
|
Christopher Zuehlsdorff
|
|
100,001 - 500,000
|
Alexander Pillersdorf
|
|
50,001 - 100,000
|
Expenses
In addition to amounts payable under the Management Agreement and the 12b-1 Plan (as discussed below), the fund is responsible for its own expenses, including, among other things: interest; taxes;
governmental fees; voluntary assessments and other expenses incurred in connection with membership in investment company organizations; organization costs of the fund; the cost (including brokerage commissions, transaction fees or charges, if any)
in connection with the purchase or sale of the funds securities and other investments and any losses in connection therewith; fees and expenses of custodians, transfer agents, registrars, independent pricing vendors or other agents; legal
expenses; loan commitment fees; expenses relating to the issuance and redemption or repurchase of the funds shares and servicing shareholder accounts; expenses of registering and qualifying the funds shares for sale under applicable
federal and state law; expenses of preparing, setting in print, printing and distributing prospectuses and statements of additional information and any supplements thereto, reports, proxy statements, notices and dividends to the funds
shareholders; costs of stationery; website costs; costs of meetings of the Board or any committee thereof, meetings of shareholders and other meetings of the fund; Board fees; audit fees; travel expenses of officers, Trustees and employees of the
fund, if any; the funds pro rata portion of premiums on any fidelity bond and other insurance covering the fund and its officers, Trustees and employees; and litigation expenses and any non-recurring or extraordinary expenses as may arise,
including, without limitation, those relating to actions, suits or proceedings to which the fund is a party and any legal obligation which the fund may have to indemnify the funds Trustees and officers with respect thereto.
Management may agree to implement an expense cap, waive fees and/or reimburse operating expenses for one or more classes of shares. Any
such waived fees and/or reimbursed expenses are described in the funds
68
Prospectus. The expense caps and waived fees and/or reimbursed expenses do not cover extraordinary expenses, such as (a) any expenses or charges related to litigation, derivative actions,
demand related to litigation, regulatory or other government investigations and proceedings, for cause regulatory inspections and indemnification or advancement of related expenses or costs, to the extent any such expenses are considered
extraordinary expenses for the purposes of fee disclosure in Form N-1A as the same may be amended from time to time; (b) transaction costs (such as brokerage commissions and dealer and underwriter spreads) and taxes; and (c) other
extraordinary expenses as determined for the purposes of fee disclosure in Form N-1A, as the same may be amended from time to time. Without limiting the foregoing, extraordinary expenses are generally those that are unusual or expected to recur only
infrequently, and may include such expenses, by way of illustration, as (i) expenses of the reorganization, restructuring, redomiciling or merger of the fund or class or the acquisition of all or substantially all of the assets of another fund
or class; (ii) expenses of holding, and soliciting proxies for, a meeting of shareholders of the fund or class (except to the extent relating to routine items such as the election of Trustees or the approval of the independent registered public
accounting firm); and (iii) expenses of converting to a new custodian, transfer agent or other service provider, in each case to the extent any such expenses are considered extraordinary expenses for the purposes of fee disclosure in Form N-1A
as the same may be amended from time to time.
In order to implement an expense cap, the manager will, as necessary, waive
management fees or reimburse operating expenses. However, the manager is permitted to recapture amounts previously waived or reimbursed by the manager to the fund during the same fiscal year if the funds total annual operating expenses have
fallen to a level below the expense cap shown in the funds Prospectus. In no case will the manager recapture any amount that would result, on any particular fund business day, in the funds total annual operating expenses exceeding the
expense cap.
Distributor
LMIS, a wholly-owned broker/dealer subsidiary of Legg Mason, located at 100 International Drive, Baltimore, Maryland 21202, serves as the funds sole and exclusive distributor pursuant to a written
agreement dated August 5, 2010 (the distribution agreement).
LMIS may be deemed to be an underwriter for purposes
of the 1933 Act. The distributors obligation is an agency or best efforts arrangement under which the distributor is required to take and pay only for such shares of the fund as may be sold to the public. The distributor is not
obligated to sell any stated number of shares.
The distribution agreement is renewable from year to year if approved
(a) by the Trustees or by a vote of a majority of the funds outstanding voting securities, and (b) by the affirmative vote of a majority of Independent Trustees who are not parties to such agreement or interested persons of any such
party by votes cast in person at a meeting called for such purpose. The distribution agreement provides that it will terminate if assigned, and that it may be terminated without penalty by either party on 60 days written notice.
LMPFA, LMIS, their affiliates and their personnel have interests in promoting sales of the Legg Mason Funds, including remuneration,
fees and profitability relating to services to and sales of the funds. Employees of LMPFA, LMIS or their affiliates (including wholesalers registered with LMIS) may receive additional compensation related to the sale of individual Legg Mason Funds
or categories of Legg Mason Funds. LMPFA, the subadvisers, and their advisory or other personnel may also benefit from increased amounts of assets under management.
Financial intermediaries, including broker/dealers, investment advisers, financial consultants or advisers, mutual fund supermarkets, insurance companies, financial institutions and other financial
intermediaries through which investors may purchase shares of the fund, also may benefit from the sales of shares of the Legg Mason Funds. For example, in connection with such sales, financial intermediaries may receive compensation from the fund
(with respect to the fund as a whole or a particular class of shares) and/or from LMPFA, LMIS, and/or their
69
affiliates, as further described below. The structure of these compensation arrangements, as well as the amounts paid under such arrangements, vary and may change from time to time. In addition,
new compensation arrangements may be negotiated at any time. The compensation arrangements described in this section are not mutually exclusive, and a single financial intermediary may receive multiple types of compensation.
LMIS has agreements in place with financial intermediaries defining how much each firm will be paid for the sale of a particular mutual
fund from sales charges, if any, paid by fund shareholders and from Rule 12b-1 Plan fees paid to LMIS by the fund. These financial intermediaries then pay their employees or associated persons who sell fund shares from the sales charges and/or fees
they receive. The financial intermediary, and/or its employees or associated persons may receive a payment when a sale is made and will, in most cases, continue to receive ongoing payments while you are invested in the fund. In other cases, LMIS may
retain all or a portion of such fees and sales charges.
In addition, LMIS, LMPFA and/or certain of their affiliates may make
additional payments (which are often referred to as revenue sharing payments) to the financial intermediaries from their past profits and other available sources, including profits from their relationships with the fund. Revenue sharing
payments are a form of compensation paid to a financial intermediary in addition to the sales charges paid by fund shareholders or Rule 12b-1 Plan fees paid by the fund. LMPFA, LMIS and/or certain of its affiliates may revise the terms of any
existing revenue sharing arrangement, and may enter into additional revenue sharing arrangements with other financial services firms.
Revenue sharing arrangements are intended, among other things, to foster the sale of fund shares and/or to compensate financial services firms for assisting in marketing or promotional activities in
connection with the sale of fund shares. In exchange for revenue sharing payments, LMPFA and LMIS generally expect to receive the opportunity for the fund to be sold through the financial intermediaries sales forces or to have access to
third-party platforms or other marketing programs, including but not limited to mutual fund supermarket platforms or other sales programs. To the extent that financial intermediaries receiving revenue sharing payments sell more shares of
the fund, LMPFA and LMIS and/or their affiliates benefit from the increase in fund assets as a result of the fees they receive from the fund.
Revenue sharing payments are usually calculated based on a percentage of fund sales and/or fund assets attributable to a particular financial intermediary. Payments may also be based on other criteria or
factors such as, for example, a fee per each transaction. Specific payment formulas are negotiated based on a number of factors, including, but not limited to, reputation in the industry, ability to attract and retain assets, target markets,
customer relationships and scope and quality of services provided. In addition, LMIS, LMPFA and/or certain of their affiliates may pay flat fees on a one-time or irregular basis for the initial set-up of the fund on a financial intermediarys
systems, participation or attendance at a financial intermediarys meetings, or for other reasons. In addition, LMIS, LMPFA and/or certain of their affiliates may pay certain education and training costs of financial intermediaries (including,
in some cases, travel expenses) to train and educate the personnel of the financial intermediaries. It is likely that financial intermediaries that execute portfolio transactions for the fund will include those firms with which LMPFA, LMIS and/or
certain of their affiliates have entered into revenue sharing arrangements.
The fund generally pays the transfer agent for
certain recordkeeping and administrative services. In addition, the fund may pay financial intermediaries for certain recordkeeping, administrative, sub-accounting and networking services. These services include maintenance of shareholder accounts
by the firms, such as recordkeeping and other activities that otherwise would be performed by a funds transfer agent. Administrative fees may be paid to a firm that undertakes, for example, shareholder communications on behalf of the fund.
Networking services are services undertaken to support the electronic transmission of shareholder purchase and redemption orders through the National Securities Clearing Corporation (NSCC). These payments are generally based on either
(1) a percentage of the average daily net assets of fund shareholders serviced by a financial
70
intermediary or (2) a fixed dollar amount for each account serviced by a financial intermediary. LMIS, LMPFA and/or their affiliates may make all or a portion of these payments.
In addition, the fund reimburses LMIS for NSCC fees that are invoiced to LMIS as the party to the agreement with NSCC for the
administrative services provided by NSCC to the fund and its shareholders. These services include transaction processing and settlement through Fund/SERV, electronic networking services to support the transmission of shareholder purchase and
redemption orders to and from financial intermediaries, and related recordkeeping provided by NSCC to the fund and its shareholders.
If your fund shares are purchased through a retirement plan, LMIS, LMPFA or certain of their affiliates may also make similar payments to those described in this section to the plans recordkeeper or
an affiliate.
Revenue sharing payments, as well as the other types of compensation arrangements described in this section,
may provide an incentive for financial intermediaries and their employees or associated persons to recommend or sell shares of the fund to customers and in doing so may create conflicts of interest between the firms financial interests and the
interests of their customers. Please contact your financial intermediary for details about any payments it (and its employees) may receive from the fund and/or from LMIS, LMPFA and/or their affiliates. You should review your financial
intermediarys disclosure and/or talk to your broker/dealer or financial intermediary to obtain more information on how this compensation may have influenced your broker/dealers or financial intermediarys recommendation of the fund.
Initial Sales Charge
The aggregate dollar amounts of initial sales charge on Class A shares received by LMIS were as follows:
Class A Shares
For the fiscal year ended December 31:
|
|
|
|
|
|
|
LMIS ($)
|
|
2012
|
|
|
6,251
|
|
2011
|
|
|
27,402
|
|
2010
|
|
|
38,878
|
|
Contingent Deferred Sales Charges
The aggregate dollar amounts of contingent deferred sales charges on Class A and Class C shares received and retained by LMIS were as follows:
Class A Shares
For the fiscal year ended December 31:
|
|
|
|
|
|
|
LMIS ($)
|
|
2012
|
|
|
0
|
|
2011
|
|
|
250
|
|
2010
|
|
|
1
|
|
71
Class C Shares
For the fiscal year ended December 31:
|
|
|
|
|
|
|
LMIS ($)
|
|
2012
|
|
|
10,739
|
|
2011
|
|
|
11,235
|
|
2010
|
|
|
9,468
|
|
Shareholder Services and Distribution Plan
The Trust, on behalf of the fund, has adopted an amended shareholder services and distribution plan (the 12b-1 Plan) pursuant
to Rule 12b-1 under the 1940 Act with respect to its Class A, Class C, Class FI and Class R shares. Under the 12b-1 Plan, the fund pays distribution fees to LMIS for the services it provides and expenses it bears with respect to the
distribution of Class C and Class R shares and service fees for Class A, Class C, Class FI and Class R shares. The distributor will provide the Board with periodic reports of amounts expended under the 12b-1 Plan and the purposes for which such
expenditures were made. The fund pays service fees, accrued daily and payable monthly, calculated at the annual rate of 0.25% of the value of the funds average daily net assets attributable to the funds Class A, Class C, Class FI
and Class R shares. In addition, the fund pays distribution fees with respect to the Class C shares at the annual rate of 0.75% of the funds average daily net assets attributable to each such class and with respect to the Class R shares
at the annual rate of 0.25% of the funds average daily net assets attributable to such class.
Fees under the 12b-1 Plan
may be used to make payments to the distributor for distribution services, Service Agents and other parties in respect of the sale of shares of the fund, and to make payments for advertising, marketing or other promotional activity, and payments for
preparation, printing, and distribution of prospectuses, statements of additional information and reports for recipients other than regulators and existing shareholders. The fund may also make payments to the distributor, Service Agents and others
for providing personal service or the maintenance of shareholder accounts. The amounts paid to each recipient may vary based upon certain factors, including, among other things, the levels of sales of fund shares and/or shareholder services
provided.
The 12b-1 Plan also provides that the distributor and Service Agents may receive all or a portion of the sales
charges paid by Class A and Class C investors.
The 12b-1 Plan permits the fund to pay fees to the distributor, Service
Agents and others as compensation for their services, not as reimbursement for specific expenses incurred. Thus, even if their expenses exceed the fees provided for by the 12b-1 Plan, the fund will not be obligated to pay more than those fees and,
if their expenses are less than the fees paid to them, they will realize a profit. The fund may pay the fees to the distributor and others until the 12b-1 Plan or distribution agreement is terminated or not renewed. In that event, the
distributors or other recipients expenses in excess of fees received or accrued through the termination date will be the distributors or other recipients sole responsibility and not obligations of the fund. In their annual
consideration of the continuation of the 12b-1 Plan for the fund, the Trustees will review the 12b-1 Plan and the expenses for each class within the fund separately.
The 12b-1 Plan also recognizes that various service providers to the fund, such as the manager, may make payments for distribution-related expenses out of their own resources, including past profits, or
payments received from the fund for other purposes, such as management fees, and that the funds distributor or Service Agents may from time to time use their own resources for distribution-related services, in addition to the fees paid under
the 12b-1 Plan. The 12b-1 Plan specifically provides that, to the extent that such payments might be deemed to be indirect financing of any activity primarily intended to result in the sale of shares of the fund within the context of Rule 12b-1,
then the payments are deemed to be authorized by the 12b-1 Plan, if permitted under applicable law.
72
The 12b-1 Plan continues in effect if such continuance is specifically approved at least
annually by a vote of both a majority of the Trustees and a majority of the Independent Trustees of the Trust who have no direct or indirect financial interest in the operation of the 12b-1 Plan or in any agreement related to the 12b-1 Plan (for
purposes of this paragraph Qualified Trustees). The Qualified Trustees, in the exercise of their business judgment in the best interests of the shareholders of the fund and each class, have approved the continuation of the 12b-1 Plan.
The 12b-1 Plan requires that the fund and the distributor provide to the Board and the Board review, at least quarterly, a written report of the amounts expended (and the purposes therefor) under the 12b-1 Plan. The 12b-1 Plan further provides that
the selection and nomination of the Qualified Trustees is committed to the discretion of the Qualified Trustees then in office. The 12b-1 Plan may be terminated with respect to any class of the fund at any time by a vote of a majority of the
funds Qualified Trustees or by a vote of a majority of the outstanding voting securities of that class. The 12b-1 Plan may not be amended to increase materially the amount of permitted expenses of the class thereunder without the approval of a
majority of the outstanding securities of that class and may not be materially amended in any case without a vote of a majority of both the Trustees and Qualified Trustees. The fund will preserve copies of any plan, agreement or report made pursuant
to the 12b-1 Plan for a period of not less than six years, and for the first two years the fund will preserve such copies in an easily accessible place.
As contemplated by the 12b-1 Plan, the distributor acts as an agent of the fund in connection with the offering of shares of the fund pursuant to the distribution agreement.
Dealer reallowances, if any, are described in the funds Prospectus.
The following service and distribution fees were incurred by the fund pursuant to the 12b-1 Plan during the fiscal year ended December
31, 2012:
|
|
|
|
|
Class A
|
|
$
|
46,276
|
|
Class C
|
|
$
|
446,878
|
|
Class FI
|
|
$
|
232
|
|
Distribution expenses incurred by LMIS during the fiscal year ended December 31, 2012 for
compensation to Service Agents, printing costs of prospectuses and marketing materials are expressed in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class
|
|
Third Party
Fees ($)
|
|
|
Financial
Consultants
Compensation
(Amortized) ($)
|
|
|
Marketing ($)
|
|
|
Printing ($)
|
|
|
Total
Current
Expenses ($)
|
|
A
|
|
|
46,276
|
|
|
|
0
|
|
|
|
33,641
|
|
|
|
788
|
|
|
|
80,705
|
|
C
|
|
|
290,806
|
|
|
|
65,258
|
|
|
|
74,768
|
|
|
|
1,537
|
|
|
|
432,369
|
|
FI
|
|
|
232
|
|
|
|
0
|
|
|
|
101
|
|
|
|
4
|
|
|
|
337
|
|
No information is presented for Class R shares because no shares of that class were outstanding during
the fiscal year ended December 31, 2012.
Custodian and Transfer Agent
State Street Bank and Trust Company (State Street), One Lincoln Street, Boston, Massachusetts 02111, serves as the custodian
of the fund. State Street, among other things, maintains a custody account or accounts in the name of the fund, receives and delivers all assets for the fund upon purchase and upon sale or maturity, collects and receives all income and other
payments and distributions on account of the assets of the fund and makes disbursements on behalf of the fund. State Street neither determines the funds investment policies, nor decides which securities the fund will buy or sell. For its
services, State Street receives a monthly fee based upon the daily average market value of securities held in custody and also receives securities transaction charges, including out-of-pocket expenses. The fund may also periodically enter into
arrangements with other qualified
73
custodians with respect to certain types of securities or other transactions such as repurchase agreements or derivatives transactions. State Street may also act as the funds securities
lending agent and in that case would receive a share of the income generated by such activities.
Boston Financial Data
Services, Inc. (the transfer agent), located at 2000 Crown Colony Drive, Quincy, Massachusetts 02169, serves as the funds transfer agent. Under the transfer agency agreement, the transfer agent maintains the shareholder
account records for the fund, handles certain communications between shareholders and the fund and distributes dividends and distributions payable by the fund. For these services, the transfer agent receives a monthly fee computed on the basis of
the number of shareholder accounts it maintains for the fund during the month and is reimbursed for out-of-pocket expenses.
Counsel
Willkie Farr & Gallagher LLP, 787 Seventh Avenue, New York, New York 10019, serves as counsel to the Trust and
the fund.
Stroock & Stroock & Lavan LLP, 180 Maiden Lane, New York, New York 10038, serves as counsel to
the Independent Trustees.
Independent Registered Public Accounting Firm
, an independent registered public accounting firm, located at
, , has been selected to audit and report upon the
funds financial statements and financial highlights for the fiscal year ending December 31, 2013.
Code of Ethics
Pursuant to Rule 17j-1 under the 1940 Act, the fund, the manager, the subadvisers, Western Asset and the distributor have
adopted codes of ethics that permit personnel to invest in securities for their own accounts, including securities that may be purchased or held by the fund. All personnel must place the interests of clients first and avoid activities, interests and
relationships that might interfere with the duty to make decisions in the best interests of the clients. All personal securities transactions by employees must adhere to the requirements of the codes and must be conducted in such a manner as to
avoid any actual or potential conflict of interest, the appearance of such a conflict or the abuse of an employees position of trust and responsibility.
Copies of the codes of ethics of the fund, the manager, the subadvisers, Western Asset and the distributor are on file with the SEC.
Proxy Voting Guidelines and Procedures
Although individual Trustees may
not agree with particular policies or votes by the manager, the Board has delegated proxy voting discretion to the manager, believing that the manager should be responsible for voting because it is a matter relating to the investment decision making
process.
LMPFA delegates the responsibility for voting proxies for the fund to the subadvisers through its contracts with the
subadvisers. Permal will use its own proxy voting policies and procedures to vote proxies and LMGAA will implement such voting policies and procedures. Accordingly, LMPFA does not expect to have proxy-voting responsibility for the fund. Should LMPFA
become responsible for voting proxies for any reason, such as the inability of the subadvisers to provide investment advisory services, LMPFA shall utilize the proxy voting guidelines established by Permal to vote proxies until a new subadviser is
retained. In the case of a material conflict between the interests of LMPFA (or its affiliates if such conflict is known to persons responsible for voting at LMPFA) and the fund, the Board of Directors of LMPFA shall consider how to address the
conflict
74
and/or how to vote the proxies. LMPFA shall maintain records of all proxy votes in accordance with applicable securities laws and regulations, to the extent that LMPFA votes proxies. LMPFA shall
be responsible for gathering relevant documents and records related to proxy voting from the subadvisers and providing them to the fund as required for the fund to comply with applicable rules under the 1940 Act.
Permals proxy voting policies and procedures govern in determining how proxies relating to the funds portfolio securities are
voted, a copy of which is attached as Appendix B to this SAI. Information regarding how the fund voted proxies (if any) relating to portfolio securities during the most recent 12-month period ended June 30 is available without charge
(1) by calling 1-877-721-1926, (2) on the funds website at http://www.leggmason.com/individualinvestors and (3) on the SECs website at http://www.sec.gov.
PURCHASE OF SHARES
General
Investors may purchase shares from a Service Agent. In addition,
certain investors, including retirement plans purchasing through certain Service Agents, may purchase shares directly from the fund. When purchasing shares of the fund, investors must specify whether the purchase is for Class A, Class C, Class
FI, Class R, Class I or Class IS shares. Service Agents may charge their customers an annual account maintenance fee in connection with a brokerage account through which an investor purchases or holds shares. Accounts held directly at the transfer
agent are not subject to a maintenance fee.
See the funds Prospectus for a discussion of which classes of shares of the
fund are available for purchase and who is eligible to purchase shares of each class.
There are minimum investment
requirements of $1,000 for initial investments and $50 for subsequent investments for purchases of Class A shares by: (i) current and retired board members of Legg Mason, (ii) current and retired board members of any fund advised by
LMPFA or its affiliates (such board members, together with board members of Legg Mason, are referred to herein as Board Members), (iii) current employees of Legg Mason and its affiliates, (iv) the immediate families
of such persons (immediate families are such persons spouse, including the surviving spouse of a deceased Board Member, and children under the age of 21) and (v) a pension, profit-sharing or other benefit plan for the benefit
of such persons. The fund reserves the right to waive or change minimums, to decline any order to purchase its shares and to suspend the offering of shares from time to time.
Purchase orders received by the fund prior to the close of regular trading on the NYSE, on any day the fund calculates its NAV, are priced according to the NAV determined on that day (the trade
date). Orders received by a Service Agent prior to the close of regular trading on the NYSE on any day the fund calculates its NAV are priced according to the NAV determined on that day, provided the order is transmitted by the Service Agent
to the funds transfer agent in accordance with their agreed-upon procedures. Payment must be made with the purchase order.
Class I Shares
. The following persons are eligible to purchase Class I shares of the fund: (i) current employees of the funds manager and its affiliates; (ii) current and former board members
of investment companies managed by affiliates of Legg Mason; (iii) current and former board members of Legg Mason; and (iv) the immediate families of such persons. Immediate families are such persons spouse, including the surviving spouse of a
deceased board member, and children under the age of 21. For such investors, the minimum initial investment is $1,000 and the minimum for each purchase of additional shares is $50. Current employees may purchase additional Class I shares through a
systematic investment plan.
75
Under certain circumstances, an investor who purchases fund shares pursuant to a fee-based
advisory account program of an Eligible Financial Intermediary as authorized by LMIS may be afforded an opportunity to make a conversion between one or more share classes owned by the investor in the same fund to Class I shares of that fund. Such a
conversion in these particular circumstances does not cause the investor to realize taxable gain or loss.
Class IS
Shares
. Class IS shares may be purchased only by Retirement Plans with omnibus accounts held on the books of the fund, certain rollover IRAs and Institutional Investors, and other investors authorized by LMIS. In order to purchase Class IS
shares, an investor must hold its shares in one account with the fund, which account is not subject to payment of recordkeeping or similar fees by the fund to any intermediary.
Systematic Investment Plan
. Shareholders may make additions to their accounts at any time by purchasing shares through a service
known as the Systematic Investment Plan. Under the Systematic Investment Plan, the distributor or the transfer agent is authorized through preauthorized transfers of at least $50 on a monthly, quarterly, every alternate month, semi-annual or annual
basis to charge the shareholders account held with a bank or other financial institution as indicated by the shareholder, to provide for systematic additions to the shareholders fund account. A shareholder who has insufficient funds to
complete the transfer will be charged a fee of up to $25 by the distributor or the transfer agent. The Systematic Investment Plan authorizes the distributor to apply cash held in the shareholders brokerage account to make additions to the
account. Additional information is available from the fund or a Service Agent.
Sales Charge Alternatives
The following classes of shares are available for purchase. See the Prospectus for a discussion of who is eligible to purchase certain
classes and of factors to consider in selecting which class of shares to purchase.
Class A Shares
. Class A
shares are sold to investors at the public offering price, which is the NAV plus an initial sales charge, as described in the funds Prospectus.
Members of the selling group may receive a portion of the sales charge as described in the Prospectus and may be deemed to be underwriters of the fund as defined in the 1933 Act. Sales charges are
calculated based on the aggregate of purchases of Class A shares of the fund made at one time by any person, which includes an individual and his or her spouse and children under the age of 21, or a trustee or other fiduciary of a
single trust estate or single fiduciary account. For additional information regarding sales charge reductions, see Sales Charge Waivers and Reductions below.
You do not pay an initial sales charge when you buy $1,000,000 or more of Class A shares. However, if you redeem these Class A shares within 18 months of purchase (or within 12 months for shares purchased
prior to August 1, 2012), you will pay a contingent deferred sales charge at 1.00%.
Class C Shares
. Class C shares are
sold without an initial sales charge but are subject to a contingent deferred sales charge payable upon certain redemptions. See Contingent Deferred Sales Charge Provisions below.
Class FI, Class R, Class I and Class IS Shares
. Class FI, Class R, Class I and Class IS shares are sold at NAV with no initial
sales charge and no contingent deferred sales charge upon redemption.
Sales Charge Waivers and Reductions
Initial Sales Charge Waivers
. Purchases of Class A shares may be made at NAV without an initial sales charge in the following
circumstances:
76
(a) sales to (i) current and retired Board Members, (ii) current employees of Legg
Mason and its subsidiaries, (iii) the immediate families of such persons (immediate families are such persons spouse, including the surviving spouse of a deceased Board Member, and children under the age of 21) and
(iv) a pension, profit-sharing or other benefit plan for the benefit of such persons;
(b) sales to any employees of
Service Agents having dealer, service or other selling agreements with the funds distributor or otherwise having an arrangement with any such Service Agent with respect to sales of fund shares, and by the immediate families of such persons or
by a pension, profit-sharing or other benefit plan for the benefit of such persons (providing the purchase is made for investment purposes and such securities will not be resold except through redemption or repurchase);
(c) offers of Class A shares to any other investment company to effect the combination of such company with the fund by merger,
acquisition of assets or otherwise;
(d) purchases by shareholders who have redeemed Class A shares in the fund (or
Class A shares of another fund sold by the distributor that is offered with a sales charge) and who wish to reinvest their redemption proceeds in the fund, provided the reinvestment is made within 60 calendar days of the redemption;
(e) purchases by certain separate accounts used to fund unregistered variable annuity contracts;
(f) purchases by investors participating in wrap fee or asset allocation programs or other fee-based arrangements sponsored by
broker/dealers and other financial institutions that have entered into agreements with LMIS; and
(g) purchases by direct
retail investment platforms through mutual fund supermarkets, where the sponsor links its clients account (including IRA accounts on such platforms) to a master account in the sponsors name.
In order to obtain such discounts, the purchaser must provide sufficient information at the time of purchase to permit verification that
the purchase qualifies for the elimination of the sales charge.
All existing retirement plan shareholders who purchased
Class A shares at NAV prior to November 20, 2006, are permitted to purchase additional Class A shares at NAV. Certain existing programs for current and prospective retirement plan investors sponsored by financial intermediaries
approved by LMIS prior to November 20, 2006 will also remain eligible to purchase Class A shares at NAV.
There are
several ways you can combine multiple purchases of Class A shares of funds sold by the distributor to take advantage of the breakpoints in the sales charge schedule. In order to take advantage of reductions in sales charges that may be available to
you when you purchase fund shares, you must inform your Service Agent or the fund if you are eligible for a letter of intent or a right of accumulation and if you own shares of other funds that are eligible to be aggregated with your purchases.
Certain records, such as account statements, may be necessary in order to verify your eligibility for a reduced sales charge.
Accumulation Privilege
allows you to combine the current value of shares of the fund with other shares of funds sold by the
distributor that are owned by:
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your spouse and children under the age of 21 with the dollar amount of your next purchase of Class A shares for purposes of calculating the initial
sales charge.
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If you hold fund shares in accounts at two or more Service Agents, please contact your
Service Agents to determine which shares may be combined.
Shares of money market funds sold by the distributor acquired by
exchange from other funds offered with a sales charge may be combined. Shares of money market funds sold by the distributor that were not acquired by
77
exchange from other funds offered with a sales charge may not be combined. Please contact your Service Agent for additional information.
Certain trustees and other fiduciaries may be entitled to combine accounts in determining their sales charge.
Letter of Intent
Helps you take advantage of breakpoints in Class A sales charges. You may purchase Class A shares
of funds sold by the distributor over a 13-month period and pay the same sales charge, if any, as if all shares had been purchased at once. You have a choice of seven Asset Level Goal amounts, as follows:
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(1) $25,000
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(5) $500,000
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(2) $50,000
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(6) $750,000
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(3) $100,000
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(7) $1,000,000
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(4) $250,000
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Each time you make a Class A purchase under a Letter of Intent, you will be entitled to pay the
sales charge that is applicable to the amount of your Asset Level Goal. For example, if your Asset Level Goal is $100,000, any Class A investments you make under a Letter of Intent would be subject to the sales charge of the specific fund you
are investing in for purchases of $100,000. Sales charges and breakpoints vary among the funds sold by the distributor.
When
you enter into a Letter of Intent, you agree to purchase in Eligible Accounts over a thirteen (13) month period Eligible Fund Purchases in an amount equal to the Asset Level Goal you have selected, less any Eligible Prior Purchases. For this
purpose, shares are valued at the public offering price (including any sales charge paid) calculated as of the date of purchase, plus any appreciation in the value of the shares as of the date of calculation, except for Eligible Prior Purchases,
which are valued at current value as of the date of calculation. Your commitment will be met if at any time during the 13-month period the value, as so determined, of eligible holdings is at least equal to your Asset Level Goal. All reinvested
dividends and distributions on shares acquired under the Letter will be credited towards your Asset Level Goal. You may include any Eligible Fund Purchases towards the Letter, including shares of classes other than Class A shares. However, a
Letter of Intent will not entitle you to a reduction in the sales charge payable on any shares other than Class A shares, and if the shares are subject to a contingent deferred sales charge, you will still be subject to that contingent deferred
sales charge with respect to those shares. You must make reference to the Letter of Intent each time you make a purchase under the Letter.
Eligible Fund Purchases.
Generally, any shares of a fund sold by the distributor may be credited towards your Asset Level Goal. Shares of money market funds sold by the distributor acquired by
exchange from other funds offered with a sales charge may be credited toward your Asset Level Goal.
The eligible funds may
change from time to time. Investors should check with their Service Agent to see which funds may be eligible.
Eligible
Accounts
. Purchases may be made through any account in your name, or in the name of your spouse or your children under the age of 21. You may need to provide certain records, such as account statements, in order to verify your eligibility for
reduced sales charges. Contact your Service Agent to see which accounts may be credited toward your Asset Level Goal.
Eligible Prior Purchases
. You may also credit towards your Asset Level Goal any Eligible Fund Purchases made in Eligible Accounts
at any time prior to entering into the Letter of Intent that have not been sold or redeemed, based on the current price of those shares as of the date of calculation.
Increasing the Amount of the Letter of Intent
. You may at any time increase your Asset Level Goal. You must, however, contact your Service Agent, or if you purchase your shares directly through the
transfer agent,
78
contact the transfer agent, prior to making any purchases in an amount in excess of your current Asset Level Goal. Upon such an increase, you will be credited by way of additional shares at the
then-current offering price for the difference between: (a) the aggregate sales charges actually paid for shares already purchased under the Letter of Intent and (b) the aggregate applicable sales charges for the increased Asset Level
Goal. The 13-month period during which the Asset Level Goal must be achieved will remain unchanged.
Sales and
Exchanges
. Shares acquired pursuant to a Letter of Intent, other than Escrowed Shares as defined below, may be redeemed or exchanged at any time, although any shares that are redeemed prior to meeting your Asset Level Goal will no longer count
towards meeting your Asset Level Goal. However, complete liquidation of purchases made under a Letter of Intent prior to meeting the Asset Level Goal will result in the cancellation of the Letter. See Failure to Meet Asset Level Goal
below. Exchanges in accordance with the funds Prospectus are permitted, and shares so exchanged will continue to count towards your Asset Level Goal, as long as the exchange results in an Eligible Fund Purchase.
Cancellation of Letter of Intent
. You may cancel a Letter of Intent by notifying your Service Agent in writing, or if you purchase
your shares directly through the transfer agent, by notifying the transfer agent in writing. The Letter will be automatically cancelled if all shares are sold or redeemed as set forth above. See Failure to Meet Asset Level Goal below.
Escrowed Shares
. Shares equal in value to five percent (5%) of your Asset Level Goal as of the date your Letter
of Intent (or the date of any increase in the amount of the Letter) is accepted will be held in escrow during the term of your Letter. The Escrowed Shares will be included in the total shares owned as reflected in your account statement and any
dividends and capital gains distributions applicable to the Escrowed Shares will be credited to your account and counted towards your Asset Level Goal or paid in cash upon request. The Escrowed Shares will be released from escrow if all the terms of
your Letter are met.
Failure to Meet Asset Level Goal
. If the total assets under your Letter of Intent within its
13-month term are less than your Asset Level Goal whether because you made insufficient Eligible Fund Purchases, redeemed all of your holdings or cancelled the Letter before reaching your Asset Level Goal, you will be liable for the difference
between: (a) the sales charge actually paid and (b) the sales charge that would have applied if you had not entered into the Letter. You may, however, be entitled to any breakpoints that would have been available to you under the
accumulation privilege. An appropriate number of shares in your account will be redeemed to realize the amount due. For these purposes, by entering into a Letter of Intent, you irrevocably appoint your Service Agent, or if you purchase your shares
directly through the transfer agent, the transfer agent, as your attorney-in-fact for the purposes of holding the Escrowed Shares and surrendering shares in your account for redemption. If there are insufficient assets in your account, you will be
liable for the difference. Any Escrowed Shares remaining after such redemption will be released to your account.
Contingent Deferred Sales
Charge Provisions
Contingent deferred sales charge shares are: (a) Class C shares and
(b) Class A shares that were purchased without an initial sales charge but are subject to a contingent deferred sales charge. A contingent deferred sales charge may be imposed on certain redemptions of these shares.
Any applicable contingent deferred sales charge will be assessed on the NAV at the time of purchase or redemption, whichever is less.
Class A shares that are contingent deferred sales charge shares are subject to a 1.00% contingent deferred sales charge
if redeemed within 18 months of purchase (or within 12 months for shares purchased prior to August 1, 2012). Class C shares that are contingent deferred sales charge shares are subject to a 1.00% contingent deferred sales charge if redeemed within
12 months of purchase.
79
In determining the applicability of any contingent deferred sales charge, it will be assumed
that a redemption is made first of shares representing capital appreciation, next of shares representing the reinvestment of dividends and capital gain distributions, next of shares that are not subject to the contingent deferred sales charge and
finally of other shares held by the shareholder for the longest period of time. The length of time that contingent deferred sales charge shares acquired through an exchange have been held will be calculated from the date the shares exchanged were
initially acquired in one of the other funds sold by the distributor. For federal income tax purposes, the amount of the contingent deferred sales charge will reduce the gain or increase the loss, as the case may be, on the amount realized on
redemption. The funds distributor receives contingent deferred sales charges in partial consideration for its expenses in selling shares.
Waivers of Contingent Deferred Sales Charge
The contingent deferred sales charge will be waived on: (a) exchanges (see Exchange Privilege); (b) automatic cash withdrawals in amounts equal to or less than 2.00% per month
of the shareholders account balance at the time the withdrawals commence, up to a maximum of 12.00% in one year (see Automatic Cash Withdrawal Plan); (c) redemptions of shares within 12 months following the death or disability
(as defined in the Code) of the shareholder; (d) mandatory post-retirement distributions from retirement plans or IRAs commencing on or after attainment of age
70
1
/
2
(except that shareholders who purchased shares subject to a contingent deferred sales charge prior to May 23, 2005 will be grandfathered and will be eligible to obtain the waiver at age
59
1
/
2
by demonstrating such eligibility at the time of redemption); (e) involuntary redemptions; (f) redemptions of shares to effect a combination of the fund with any investment company by merger,
acquisition of assets or otherwise; (g) tax-free returns of an excess contribution to any retirement plan; and (h) certain redemptions of shares of the fund in connection with lump-sum or other distributions made by eligible retirement
plans or redemption of shares by participants in certain wrap fee or asset allocation programs sponsored by broker-dealers and other financial institutions that have entered into agreements with the distributor or the manager.
The contingent deferred sales charge is waived on Class C shares purchased by retirement plan omnibus accounts
held on the books of the fund.
A shareholder who has redeemed shares from other funds sold by the distributor may, under
certain circumstances, reinvest all or part of the redemption proceeds within 60 days and receive pro rata credit for any contingent deferred sales charge imposed on the prior redemption.
Contingent deferred sales charge waivers will be granted subject to confirmation by the distributor or the transfer agent of the
shareholders status or holdings, as the case may be.
Grandfathered Retirement Program with Exchange Features
Certain retirement plan programs with exchange features in effect prior to November 20, 2006 (collectively, the Grandfathered
Retirement Program), that are authorized by the distributor to offer eligible retirement plan investors the opportunity to exchange all of their Class C shares for Class A shares of an applicable fund sold by the distributor, are
permitted to maintain such share class exchange feature for current and prospective retirement plan investors. Under the Grandfathered Retirement Program, Class C shares of the fund may be purchased by plans investing less than $3 million. Class C
shares are eligible for exchange into Class A shares not later than eight years after the plan joins the program. They are eligible for exchange in the following circumstances:
If a participating plans total Class C holdings in all non-money market funds sold by the distributor equal at least $3,000,000 at
the end of the fifth year after the date the participating plan enrolled in the Grandfathered Retirement Program, the participating plan will be offered the opportunity to exchange all of its Class C shares for Class A shares of the fund. Such
participating plans will be notified of the pending exchange in writing within 30 days after the fifth anniversary of the enrollment date and, unless the exchange offer has been rejected in
80
writing, the exchange will occur on or about the 90th day after the fifth anniversary date. If the participating plan does not qualify for the five-year exchange to Class A shares, a review
of the participating plans holdings will be performed each quarter until either the participating plan qualifies or the end of the eighth year.
Any participating plan that has not previously qualified for an exchange into Class A shares will be offered the opportunity to exchange all of its Class C shares for Class A shares of the same
fund regardless of asset size at the end of the eighth year after the date the participating plan enrolled in the Grandfathered Retirement Program. Such plans will be notified of the pending exchange in writing approximately 60 days before the
eighth anniversary of the enrollment date and, unless the exchange has been rejected in writing, the exchange will occur on or about the eighth anniversary date. Once an exchange has occurred, a participating plan will not be eligible to acquire
additional Class C shares, but instead may acquire Class A shares of the same fund. Any Class C shares not converted will continue to be subject to the distribution fee.
For further information regarding this Program, contact your Service Agent or the transfer agent. Participating plans that enrolled in the Grandfathered Retirement Program prior to June 2, 2003
should contact the transfer agent for information regarding Class C exchange privileges applicable to their plan.
Determination of Public
Offering Price
The fund offers its shares on a continuous basis. The public offering price for each class of shares of the
fund is equal to the NAV per share at the time of purchase, plus for Class A shares an initial sales charge based on the aggregate amount of the investment. The public offering price for Class C, Class FI, Class R, Class I and Class IS shares
(and Class A share purchases, including applicable rights of accumulation, equaling or exceeding $1,000,000) is equal to the NAV per share at the time of purchase and no sales charge is imposed at the time of purchase. A contingent deferred
sales charge, however, is imposed on certain redemptions of Class C shares and on Class A shares when purchased in amounts equaling or exceeding $1,000,000.
Set forth below is an example of the method of computing the offering price of the Class A shares of the fund based on the NAV of a Class A share of the fund as of December 31, 2012.
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Class A (based on a NAV of $14.79 and a maximum initial sales charge of 5.75%):
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$
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15.69
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REDEMPTION OF SHARES
The right of redemption may be suspended or the date of payment postponed (a) for any period during which the NYSE is closed (other
than for customary weekend and holiday closings), (b) when trading in the markets the fund normally utilizes is restricted, or an emergency exists, as determined by the SEC, so that disposal of the funds investments or determination of
NAV is not reasonably practicable or (c) for such other periods as the SEC by order may permit for protection of the funds shareholders.
If the shares to be redeemed were issued in certificate form, the certificates must be endorsed for transfer (or be accompanied by an endorsed stock power) and must be submitted to the transfer agent
together with the redemption request.
Redemption proceeds will be mailed to an investors address of record. The
transfer agent may require additional supporting documents for redemptions made by corporations, executors, administrators, trustees or guardians. A redemption request will not be deemed properly received until the transfer agent receives all
required documents in proper form.
If a shareholder holds shares in more than one class, any request for redemption must
specify the class being redeemed. In the event of a failure to specify which class, or if the investor owns fewer shares of the class than
81
specified, the redemption request will be delayed until the transfer agent receives further instructions. The redemption proceeds will be remitted on or before the seventh business day following
receipt of proper tender, except on any days on which the NYSE is closed or as permitted under the 1940 Act, in extraordinary circumstances. Redemption proceeds for shares purchased by check, other than a certified or official bank check, will be
remitted upon clearance of the check, which may take up to ten days. Each Service Agent is responsible for transmitting promptly orders for its customers.
The Service Agent may charge you a fee for executing your order. The amount and applicability of such a fee is determined and disclosed to its customers by each Service Agent.
Additional Information Regarding Telephone Redemption and Exchange Program
. Neither the fund nor its agents will be liable for
following instructions communicated by telephone that are reasonably believed to be genuine. The fund and its agents will employ procedures designed to verify the identity of the caller and legitimacy of instructions (for example, a
shareholders name and account number will be required and phone calls may be recorded). The fund reserves the right to suspend, modify or discontinue the telephone redemption and exchange program or to impose a charge for this service at any
time following at least seven (7) days prior notice to shareholders.
Automatic Cash Withdrawal Plan
An automatic cash withdrawal plan (the Withdrawal Plan) is available to shareholders as described in the Prospectus. To the
extent withdrawals under the Withdrawal Plan exceed dividends, distributions and appreciation of a shareholders investment in the fund, there will be a reduction in the value of the shareholders investment, and continued withdrawal
payments may reduce the shareholders investment and ultimately exhaust it. Withdrawal payments should not be considered as income from investment in the fund. The Withdrawal Plan will be carried over on exchanges between funds sold by the
distributor or classes of the fund. All dividends and distributions on shares in the Withdrawal Plan are reinvested automatically at NAV in additional shares of the fund.
For additional information, shareholders should contact their Service Agent. A shareholder who purchases shares directly through the transfer agent may continue to do so and applications for participation
in the Withdrawal Plan should be sent to the transfer agent. Withdrawals may be scheduled on any day of the month; however, if the shareholder does not specify a day, the transfer agent will schedule the withdrawal on the 25th day (or the next
business day if the 25th day is a weekend or holiday) of the month.
Legg Mason Institutional Funds Systematic Withdrawal Plan
Certain shareholders of Class FI, Class I or Class IS shares with an initial NAV of $1,000,000 or more may be eligible to
participate in the Legg Mason Institutional Funds Systematic Withdrawal Plan. Receipt of payment of proceeds of redemptions made through the Systematic Withdrawal Plan will be wired through ACH to your checking or savings accountredemptions of
fund shares may occur on any business day of the month and the checking or savings account will be credited with the proceeds in approximately two business days. Requests must be made in writing to the fund or a Service Agent to participate in,
change or discontinue the Systematic Withdrawal Plan. You may change the monthly amount to be paid to you or terminate the Systematic Withdrawal Plan at any time, without charge or penalty, by notifying the fund or a Service Agent. The fund, its
transfer agent and the distributor also reserve the right to modify or terminate the Systematic Withdrawal Plan at any time.
Redemptions
in Kind
If the funds manager determines that it would not be in the best interests of the funds remaining
shareholders to make a redemption payment wholly in cash, the fund may honor a redemption request by delivering portfolio securities to a shareholder to pay all or a portion of the redemption proceeds. However, the
82
fund will not use securities to satisfy any request for redemption, or combination of requests from the same shareholder in any 90-day period, if the total redemption amount does not exceed
$250,000 or 1% of the net assets of the fund, whichever is less. When a redemption is paid in kind, the securities distributed to the redeeming shareholder will be valued in accordance with the procedures described under Share
price in the funds Prospectus. Because a redemption in-kind may be used during times when the markets experience increased illiquidity, these valuation methods may include fair value estimations and a shareholder may have difficulty
selling those securities at the valuation price. A shareholder receiving securities from the fund may incur costs in holding and when subsequently selling those securities, and the market price of those securities will be subject to fluctuation
until they are sold. The fund will not use securities to pay redemptions by LMIS or other affiliated persons of the fund, except as permitted by law, SEC rules or orders, or interpretive guidance from the SEC staff or other proper authorities.
EXCHANGE PRIVILEGE
The exchange privilege enables shareholders to acquire shares of the same class in another fund sold by the distributor. This privilege is available to shareholders residing in any state in which the fund
shares being acquired may legally be sold. Prior to any exchange, the shareholder should obtain and review a copy of the current prospectus of each fund into which an exchange is being considered. Prospectuses may be obtained from a Service Agent.
Upon receipt of proper instructions and all necessary supporting documents, shares submitted for exchange are redeemed at the
then-current NAV, and the proceeds are immediately invested in shares of the fund being acquired at that funds then current NAV. The distributor reserves the right to reject any exchange request. The exchange privilege may be modified or
terminated at any time after written notice to shareholders.
Class A, Class FI, Class R, Class I and Class IS
Exchanges
. Class A, Class FI, Class R, Class I and Class IS shareholders of the fund who wish to exchange all or a portion of their shares for shares of the respective class in another fund may do so without imposition of any charge.
Class C Exchanges
. Class C shares of the fund may be exchanged for other Class C shares without a contingent deferred
sales charge. Upon an exchange, the new Class C shares will be deemed to have been purchased on the same date as the Class C shares of the fund that have been exchanged.
Additional Information Regarding the Exchange Privilege
The fund is not
designed to provide investors with a means of speculation on short-term market movements. A pattern of frequent exchanges by investors can be disruptive to efficient portfolio management and, consequently, can be detrimental to the fund and its
shareholders. See Frequent trading of fund shares in the Prospectus.
During times of drastic economic or market
conditions, the fund may suspend the exchange privilege temporarily without notice and treat exchange requests based on their separate componentsredemption orders with a simultaneous request to purchase the other funds shares. In such a
case, the redemption request would be processed at the funds next determined NAV but the purchase order would be effective only at the NAV next determined after the fund being purchased formally accepts the order, which may result in the
purchase being delayed.
Certain shareholders may be able to exchange shares by telephone. See the funds Prospectus for
additional information. Exchanges will be processed at the NAV next determined. Redemption procedures discussed above are also applicable for exchanging shares, and exchanges will be made upon receipt of all supporting documents
83
in proper form. If the account registration of the shares of the fund being acquired is identical to the registration of the shares of the fund exchanged, no signature guarantee is required.
This exchange privilege may be modified or terminated at any time, and is available only in those jurisdictions where such
exchanges legally may be made. Before making any exchange, shareholders should contact the transfer agent or, if they hold fund shares through a Service Agent, their Service Agent, to obtain more information and prospectuses of the funds to be
acquired through the exchange. An exchange is treated as a sale of the shares exchanged and could result in taxable gain or loss to the shareholder making the exchange.
VALUATION OF SHARES
The NAV per share of each
class is calculated on each day, Monday through Friday, except days on which the NYSE is closed. As of the date of this SAI, the NYSE is normally open for trading every weekday except in the event of an emergency or for the following holidays (or
the days on which they are observed): New Years Day, Martin Luther King, Jr. Day, Presidents Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Because of the differences in distribution fees
and class-specific expenses, the per share NAV of each class will differ. Please see the Prospectus for a description of the procedures used by the fund in valuing its assets.
PORTFOLIO TRANSACTIONS
Subject to such
policies as may be established by the Board from time to time, Permal is primarily responsible for the funds portfolio decisions. LMGAA is responsible for placing the funds portfolio transactions. Western Asset manages the cash and
short-term instruments of the fund.
The cost of securities purchased from underwriters includes an underwriting commission,
concession or a net price. Debt securities purchased and sold by the fund generally are traded on a net basis (i.e., without a commission) through dealers acting for their own account and not as brokers, or otherwise involve transactions directly
with the issuer of the instrument. This means that a dealer makes a market for securities by offering to buy at one price and selling the security at a slightly higher price. The difference between the prices is known as a spread. Other
portfolio transactions may be executed through brokers acting as agents. The fund will pay a spread or commission in connection with such transactions. Commissions are negotiated with brokers on such transactions. The aggregate brokerage commissions
paid by the fund for the three most recent fiscal years are set forth below under Aggregate Brokerage Commissions Paid.
Pursuant to the LMGAA Subadvisory Agreement, LMGAA is authorized to place orders pursuant to investment determinations for the fund either directly with the issuer or with any broker or dealer, foreign
currency dealer, futures commission merchant or others selected by it. The general policy of LMGAA in selecting brokers and dealers is to obtain the best results achievable in the context of a number of factors which are considered both in relation
to individual trades and broader trading patterns, including the reliability of the broker/dealer, the competitiveness of the price and the commission, the research services received and whether the broker/dealer commits its own capital.
In connection with the selection of such brokers or dealers and the placing of such orders, subject to applicable law, brokers or dealers
may be selected who also provide brokerage and research services (as those terms are defined in Section 28(e) of the 1934 Act) to the fund and/or the other accounts over which the subadvisers or their affiliates exercise investment discretion.
LMGAA is authorized to pay a broker or dealer who provides such brokerage and research services a commission for executing a portfolio transaction for the fund which is in excess of the amount of commission another broker or dealer would have
charged for effecting that transaction if LMGAA determines in good faith that such amount of commission is reasonable in relation to
84
the value of the brokerage and research services provided by such broker or dealer. Investment research services include information and analysis on particular companies and industries as well as
market or economic trends and portfolio strategy, market quotations for portfolio evaluations, analytical software and similar products and services. If a research service also assists LMGAA in a non-research capacity (such as bookkeeping or other
administrative functions), then only the percentage or component that provides assistance to LMGAA in the investment decision making process may be paid in commission dollars. This determination may be viewed in terms of either that particular
transaction or the overall responsibilities that LMGAA and its affiliates have with respect to accounts over which they exercise investment discretion. LMGAA may also have arrangements with brokers pursuant to which such brokers provide research
services to LMGAA in exchange for a certain volume of brokerage transactions to be executed by such brokers. While the payment of higher commissions increases the funds costs, LMGAA does not believe that the receipt of such brokerage and
research services significantly reduces its expenses as a subadviser. Arrangements for the receipt of research services from brokers may create conflicts of interest.
Research services furnished to LMGAA by brokers that effect securities transactions for the fund may be used by LMGAA in servicing other investment companies and accounts which it manages. Similarly,
research services furnished to LMGAA by brokers who effect securities transactions for other investment companies and accounts which LMGAA manages may be used by LMGAA in servicing the fund. Not all of these research services are used by LMGAA in
managing any particular account, including the fund.
For the fiscal year ended December 31, 2012, the fund paid no
commissions to brokers that provided research services.
The fund contemplates that, consistent with the policy of obtaining
the best net results, brokerage transactions may be conducted through affiliated broker/dealers, as defined in the 1940 Act. The funds Board has adopted procedures in accordance with Rule 17e-1 under the 1940 Act to ensure that all
brokerage commissions paid to such affiliates are reasonable and fair in the context of the market in which such affiliates operate.
Aggregate Brokerage Commissions Paid
For the fiscal years shown below, the fund paid aggregate brokerage commissions as set forth in the table below.
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Fiscal Year Ended:
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Aggregate Brokerage
Commissions Paid ($)
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December 31, 2012
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81,712
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December 31, 2011
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93,769
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December 31, 2010
|
|
|
31,048
|
|
For the fiscal years ended December 31, 2012, 2011 and 2010, the fund did not pay any brokerage
commissions to LMIS or its affiliates.
In certain instances there may be securities that are suitable as an investment for
the fund as well as for one or more of the other clients of the subadvisers. Investment decisions for the fund and for the subadvisers other clients are made with a view to achieving their respective investment objectives. It may develop that
a particular security is bought or sold for only one client even though it might be held by, or bought or sold for, other clients. Likewise, a particular security may be bought for one or more clients when one or more clients are selling the same
security. Some simultaneous transactions are inevitable when several clients receive investment advice from the same investment adviser, particularly when the same security is suitable for the investment objectives of more than one client. When two
or more clients are simultaneously engaged in the purchase or sale of the same security, the securities are allocated among clients in a manner believed to be equitable to each. It is recognized
85
that in some cases this system could adversely affect the price of or the size of the position obtainable in a security for the fund. When purchases or sales of the same security for the fund and
for other portfolios managed by the subadvisers occur contemporaneously, the purchase or sale orders may be aggregated in order to obtain any price advantages available to large volume purchases or sales.
At December 31, 2012, the fund did not hold any securities issued by its regular broker/dealers.
DISCLOSURE OF PORTFOLIO HOLDINGS
The funds Board has adopted policies and procedures (the policy) developed by the manager with respect to the
disclosure of a funds portfolio securities and any ongoing arrangements to make available information about the funds portfolio securities. The manager believes the policy is in the best interests of each fund and its shareholders and
that it strikes an appropriate balance between the desire of investors for information about fund portfolio holdings and the need to protect funds from potentially harmful disclosures.
General rules/Website disclosure
The policy provides that information
regarding a funds portfolio holdings may be shared at any time with employees of the manager, a funds subadviser and other affiliated parties involved in the management, administration or operations of the fund (referred to as
fund-affiliated personnel). With respect to non-money market funds, a funds complete list of holdings (including the size of each position) may be made available to investors, potential investors, third parties and Legg Mason personnel that
are not fund-affiliated personnel (i) upon the filing of Form N-Q or Form N-CSR in accordance with SEC rules, provided that such filings are not made until 15 calendar days following the end of the period covered by the Form N-Q or Form N-CSR
or (ii) no sooner than 15 days after month end, provided that such information has been made available through public disclosure at least one day previously. Typically, public disclosure is achieved by required filings with the SEC and/or
posting the information to Legg Masons or the funds Internet site that is accessible by the public, or through public release by a third party vendor.
The fund currently discloses its complete portfolio holdings 14 calendar days after quarter-end on Legg Masons website: http://www.leggmason.com/individualinvestors/prospectuses (click on the name
of the fund).
Ongoing arrangements
Under the policy, a fund may release portfolio holdings information on a regular basis to a custodian, sub-custodian, fund accounting agent, proxy voting provider, rating agency or other vendor or service
provider for a legitimate business purpose, where the party receiving the information is under a duty of confidentiality, including a duty to prohibit the sharing of non-public information with unauthorized sources and trading upon non-public
information. A fund may enter into other ongoing arrangements for the release of portfolio holdings information, but only if such arrangements serve a legitimate business purpose and are with a party who is subject to a confidentiality agreement and
restrictions on trading upon non-public information. None of the funds, Legg Mason or any other affiliated party may receive compensation or any other consideration in connection with such arrangements. Ongoing arrangements to make available
information about a funds portfolio securities will be reviewed at least annually by the funds board.
86
Set forth below is a list, as of March 31, 2013, of those parties with whom the
manager, on behalf of each fund, has authorized ongoing arrangements that include the release of portfolio holdings information in accordance with the policy, as well as the frequency of the release under such arrangements, and the length of the
lag, if any, between the date of the information and the date on which the information is disclosed. The parties identified below as recipients are service providers, fund rating agencies, consultants and analysts.
|
|
|
|
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Recipient
|
|
Frequency
|
|
Delay Before Dissemination
|
State Street Bank and Trust Company
(Fund Custodian and Accounting Agent)
|
|
Daily
|
|
None
|
|
|
|
A.S.A.P. Advisor Services, Inc.
|
|
Quarterly
|
|
8-10 Days after Quarter-End
|
|
|
|
Bloomberg L.P.
|
|
Quarterly
|
|
Sent 6 Business Days after Quarter-End
|
|
|
|
Lipper Analytical Services Corp.
|
|
Quarterly
|
|
Sent 6 Business Days after Quarter-End
|
|
|
|
Morningstar
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
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|
|
|
Institutional Shareholder Services
(Proxy Voting Services)
|
|
As necessary
|
|
None
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|
|
|
Thomson/Vestek
|
|
Daily
|
|
None
|
|
|
|
FactSet
|
|
Daily
|
|
None
|
|
|
|
The Bank of New York Mellon
|
|
Daily
|
|
None
|
|
|
|
Thomson
|
|
Semi-annually
|
|
None
|
|
|
|
SunGard/Protegent (formerly Dataware)
|
|
Daily
|
|
None
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|
|
|
ITG
|
|
Daily
|
|
None
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|
|
|
The Northern Trust Company
|
|
Daily
|
|
None
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|
|
|
Middle Office Solutions, LLC
|
|
Daily
|
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None
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|
|
|
NaviSite, Inc.
|
|
Daily
|
|
None
|
Portfolio holdings information for a fund may also be released from time to time pursuant to ongoing
arrangements with the following parties:
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|
|
|
|
Recipient
|
|
Frequency
|
|
Delay Before Dissemination
|
Baseline
|
|
Daily
|
|
None
|
|
|
|
Frank Russell
|
|
Monthly
|
|
1 Day
|
|
|
|
Callan Associates
|
|
Quarterly
|
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Sent 8-10 Days after Quarter-End
|
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|
|
Mercer LLC
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|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
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|
|
|
eVestment Alliance
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
|
|
|
Rogerscasey
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
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|
|
|
Cambridge Associates LLC
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|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
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|
Wilshire Associates Inc.
|
|
Quarterly
|
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Sent 8-10 Days after Quarter-End
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|
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|
Informa Investment Solutions
|
|
Quarterly
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Sent 8-10 Days after Quarter-End
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|
|
Prima Capital
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Quarterly
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Sent 8-10 Days after Quarter-End
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|
|
|
Investor Tools
|
|
Daily
|
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None
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87
|
|
|
|
|
Recipient
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|
Frequency
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|
Delay Before Dissemination
|
Advent
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Daily
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|
None
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|
|
|
BARRA
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Daily
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|
None
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|
|
|
Plexus
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|
Quarterly (Calendar)
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|
Sent 1-3 Business Days after Quarter-End
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|
|
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Elkins/McSherry
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|
Quarterly (Calendar)
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Sent 1-3 Business Days after Quarter-End
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|
|
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Quantitative Services Group
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Daily
|
|
None
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|
|
|
Deutsche Bank
|
|
Monthly
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|
6-8 Business Days
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|
|
|
Fitch
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|
Monthly
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|
6-8 Business Days
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|
|
|
Liberty Hampshire
|
|
Weekly and Month End
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|
None
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|
|
|
SunTrust
|
|
Weekly and Month End
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|
None
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|
|
|
S&P (Rating Agency)
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|
Weekly Tuesday Night
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1 Business Day
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|
|
|
Electra Information Systems
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|
Daily
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|
None
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|
|
|
Cabot Research
|
|
Weekly
|
|
None
|
|
|
|
Goldman Sachs
|
|
Daily
|
|
None
|
|
|
|
Chicago Mercantile Exchange
|
|
Daily
|
|
None
|
|
|
|
Canterbury Consulting
|
|
Quarterly
|
|
Sent 8-10 Days after Quarter-End
|
|
|
|
Broadridge
|
|
Daily
|
|
None
|
|
|
|
DST Global Solutions Limited
|
|
Monthly
|
|
Sent 6 Business Days after Month-End
|
|
|
|
Interactive Data Corp.
|
|
Daily
|
|
None
|
|
|
|
Citigroup Global Markets Inc.
|
|
Daily
|
|
None
|
|
|
|
Glass Lewis & Co.
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|
Daily
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|
None
|
|
|
|
Fidelity
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|
Quarterly
|
|
5 Business Days
|
Excluded from the lists of ongoing arrangements set forth above are ongoing arrangements where either
(i) the disclosure of portfolio holdings information occurs concurrently with or after the time at which the portfolio holdings information is included in a public filing with the SEC that is required to include the information, or (ii) a
funds portfolio holdings information is made available no earlier than the day next following the day on which the fund makes the information available on its website, as disclosed in the funds prospectus. The approval of the funds
Chief Compliance Officer, or designee, must be obtained before entering into any new ongoing arrangement or altering any existing ongoing arrangement to make available portfolio holdings information, or with respect to any exceptions from the
policy.
Release of limited portfolio holdings information
In addition to the ongoing arrangements described above, a funds complete or partial list of holdings (including size of positions) may be released to another party on a one-time basis, provided the
party receiving the information has executed a non-disclosure and confidentiality agreement and provided that the specific release of information has been approved by the funds Chief Compliance Officer or designee as consistent with the
policy. By way of illustration and not of limitation, release of non-public information about a funds portfolio holdings may be made (i) to a proposed or potential adviser or subadviser or other investment manager asked to provide
investment management services to the fund, or (ii) to a third party in connection with a program or similar trade.
88
In addition, the policy permits the release to investors, potential investors, third parties
and Legg Mason personnel that are not fund-affiliated personnel of limited portfolio holdings information in other circumstances, including:
|
1.
|
A funds top ten securities, current as of month-end, and the individual size of each such security position may be released at any time following month-end with
simultaneous public disclosure.
|
|
2.
|
A funds top ten securities positions (including the aggregate but not individual size of such positions) may be released at any time with simultaneous public
disclosure.
|
|
3.
|
A list of securities (that may include fund holdings together with other securities) followed by an investment professional (without position sizes or identification of
particular funds) may be disclosed to sell-side brokers at any time for the purpose of obtaining research and/or market information from such brokers.
|
|
4.
|
A trade in process may be discussed only with counterparties, potential counterparties and others involved in the transaction (
i.e
., brokers and custodians).
|
|
5.
|
A funds sector weightings, yield and duration (for fixed income and money market funds), performance attribution (
e.g
., analysis of the funds
out-performance or underperformance of its benchmark based on its portfolio holdings) and other summary and statistical information that does not include identification of specific portfolio holdings may be released, even if non-public, if such
release is otherwise in accordance with the policys general principles.
|
|
6.
|
A small number of a funds portfolio holdings (including information that the fund no longer holds a particular holding) may be released, but only if the release
of the information could not reasonably be seen to interfere with current or future purchase or sales activities of the fund and is not contrary to law.
|
|
7.
|
A funds portfolio holdings may be released on an as-needed basis to its legal counsel, counsel to its independent trustees and its independent public accounting
firm, in required regulatory filings or otherwise to governmental agencies and authorities.
|
Exceptions to the policy
A funds Chief Compliance Officer, or designee, may, as is deemed appropriate, approve exceptions from the policy.
Exceptions are granted only after a thorough examination and consultation with the managers legal department, as necessary. Exceptions from the policy are reported annually to each funds board.
Limitations of policy
The funds portfolio holdings policy is designed to prevent sharing of portfolio information with third parties that have no
legitimate business purpose for accessing the information. The policy may not be effective to limit access to portfolio holdings information in all circumstances, however. For example, the manager or a subadviser may manage accounts other than a
fund that have investment objectives and strategies similar to those of the fund. Because these accounts, including a fund, may be similarly managed, portfolio holdings may be similar across the accounts. In that case, an investor in another account
managed by the manager or a subadviser may be able to infer the portfolio holdings of the fund from the portfolio holdings in that investors account.
THE TRUST
The fund is a series of Legg Mason
Partners Equity Trust (referred to in this section as the trust), a Maryland statutory trust. The certificate of trust to establish the trust was filed with the State of Maryland on October 4, 2006.
89
A Maryland statutory trust is an unincorporated business association that is established
under, and governed by, Maryland law. Maryland law provides a statutory framework for the powers, duties, rights and obligations of the Board (referred to in this section as the trustees) and shareholders of a trust, while the more
specific powers, duties, rights and obligations of the trustees and the shareholders are determined by the trustees as set forth in a trusts declaration of trust (referred to in this section as the declaration). Some of the more
significant provisions of the declaration are described below.
Shareholder Voting
The declaration provides for shareholder voting as required by the 1940 Act or other applicable laws but otherwise permits, consistent
with Maryland law, actions by the trustees without seeking the consent of shareholders. The trustees may, without shareholder approval, amend the declaration or authorize the merger or consolidation of the trust into another trust or entity,
reorganize the trust, or any series or class into another trust or entity or a series or class of another entity, sell all or substantially all of the assets of the trust or any series or class to another entity, or a series or class of another
entity, or terminate the trust or any series or class.
The fund is not required to hold an annual meeting of shareholders,
but the fund will call special meetings of shareholders whenever required by the 1940 Act or by the terms of the declaration. The declaration provides for dollar-weighted voting which means that a shareholders voting power is
determined, not by the number of shares he or she owns, but by the dollar value of those shares determined on the record date. All shareholders of record of all series and classes of the trust vote together, except where required by the 1940 Act to
vote separately by series or by class, or when the trustees have determined that a matter affects only the interests of one or more series or classes of shares.
Election and Removal of Trustees
The declaration provides that the
trustees may establish the number of trustees and that vacancies on the Board may be filled by the remaining trustees, except when election of trustees by the shareholders is required under the 1940 Act. Trustees are then elected by a plurality of
votes cast by shareholders at a meeting at which a quorum is present. The declaration also provides that a mandatory retirement age may be set by action of two-thirds of the trustees and that trustees may be removed, with or without cause, by a vote
of shareholders holding two-thirds of the voting power of the trust, or by a vote of two-thirds of the remaining trustees. The provisions of the declaration relating to the election and removal of trustees may not be amended without the approval of
two-thirds of the trustees.
Amendments to the Declaration
The trustees are authorized to amend the declaration without the vote of shareholders, but no amendment may be made that impairs the exemption from personal liability granted in the declaration to persons
who are or have been shareholders, trustees, officers or employees of the trust, or that limits the rights to indemnification or insurance provided in the declaration with respect to actions or omissions of persons entitled to indemnification under
the declaration prior to the amendment.
Issuance and Redemption of Shares
The fund may issue an unlimited number of shares for such consideration and on such terms as the trustees may determine. Shareholders are
not entitled to any appraisal, preemptive, conversion, exchange or similar rights, except as the trustees may determine. The fund may involuntarily redeem a shareholders shares upon certain conditions as may be determined by the trustees,
including, for example, if the shareholder fails to provide the fund with identification required by law, or if the fund is unable to verify the information received from the shareholder. Additionally, as discussed below, shares may be redeemed in
connection with the closing of small accounts.
90
Disclosure of Shareholder Holdings
The declaration specifically requires shareholders, upon demand, to disclose to the fund information with respect to the direct and
indirect ownership of shares in order to comply with various laws or regulations, and the fund may disclose such ownership if required by law or regulation or as the trustees otherwise decide.
Small Accounts
The
declaration provides that the fund may close out a shareholders account by redeeming all of the shares in the account if the account falls below a minimum account size (which may vary by class) that may be set by the trustees from time to
time. Alternately, the declaration permits the fund to assess a fee for small accounts (which may vary by class) and redeem shares in the account to cover such fees, or convert the shares into another share class that is geared to smaller accounts.
Series and Classes
The declaration provides that the trustees may establish series and classes in addition to those currently established and to determine the rights and preferences, limitations and restrictions, including
qualifications for ownership, conversion and exchange features, minimum purchase and account size, expenses and charges, and other features of the series and classes. The trustees may change any of those features, terminate any series or class,
combine series with other series in the trust, combine one or more classes of a series with another class in that series or convert the shares of one class into shares of another class.
Each share of the fund, as a series of the trust, represents an interest in the fund only and not in the assets of any other series of
the trust.
Shareholder, Trustee and Officer Liability
The declaration provides that shareholders are not personally liable for the obligations of the fund and requires the fund to indemnify a shareholder against any loss or expense arising from any such
liability. The fund will assume the defense of any claim against a shareholder for personal liability at the request of the shareholder. The declaration further provides that a trustee acting in his or her capacity of trustee is not personally
liable to any person, other than the trust or its shareholders, in connection with the affairs of the trust. Each trustee is required to perform his or her duties in good faith and in a manner he or she believes to be in the best interests of the
trust. All actions and omissions of trustees are presumed to be in accordance with the foregoing standard of performance, and any person alleging the contrary has the burden of proving that allegation.
The declaration limits a trustees liability to the trust or any shareholder to the full extent permitted under current Maryland law
by providing that a trustee is liable to the trust or its shareholders for monetary damages only (a) to the extent that it is proved that he or she actually received an improper benefit or profit in money, property or services or (b) to
the extent that a judgment or other final adjudication adverse to the trustee is entered in a proceeding based on a finding in the proceeding that the trustees action, or failure to act, was the result of active and deliberate dishonesty and
was material to the cause of action adjudicated in the proceeding. The declaration requires the trust to indemnify any persons who are or who have been trustees, officers or employees of the trust to the fullest extent permitted by law against
liability and expenses in connection with any claim or proceeding in which he or she is involved by virtue of having been a trustee, officer or employee. In making any determination as to whether any person is entitled to the advancement of expenses
in connection with a claim for which indemnification is sought, such person is entitled to a rebuttable presumption that he or she did not engage in conduct for which indemnification is not available.
The declaration provides that any trustee who serves as chair of the Board or of a committee of the Board, lead independent trustee or
audit committee financial expert, or in any other similar capacity will not be subject to any greater standard of care or liability because of such position.
91
Derivative Actions
The declaration provides a detailed process for the bringing of derivative actions by shareholders in order to permit legitimate inquiries and claims while avoiding the time, expense, distraction and
other harm that can be caused to the fund or its shareholders as a result of spurious shareholder demands and derivative actions. Prior to bringing a derivative action, a demand by three unrelated shareholders must be made on the trustees. The
declaration details information, certifications, undertakings and acknowledgements that must be included in the demand. The trustees are not required to consider a demand that is not submitted in accordance with the requirements contained in the
declaration. The declaration also requires that in order to bring a derivative action, the complaining shareholders must be joined in the action by shareholders owning, at the time of the alleged wrongdoing, at the time of demand, and at the time
the action is commenced, shares representing at least 5% of the voting power of the affected funds. The trustees have a period of 90 days, which may be extended by an additional 60 days, to consider the demand. If a majority of the trustees who are
considered independent for the purposes of considering the demand determine that a suit should be maintained, then the trust will commence the suit and the suit will proceed directly and not derivatively. If a majority of the independent trustees
determines that maintaining the suit would not be in the best interests of the fund, the trustees are required to reject the demand and the complaining shareholders may not proceed with the derivative action unless the shareholders are able to
sustain the burden of proof to a court that the decision of the trustees not to pursue the requested action was not consistent with the standard of performance required of the trustees in performing their duties. If a demand is rejected, the
complaining shareholders will be responsible for the costs and expenses (including attorneys fees) incurred by the trust in connection with the consideration of the demand if, in the judgment of the independent trustees, the demand was made
without reasonable cause or for an improper purpose. If a derivative action is brought in violation of the declaration, the shareholders bringing the action may be responsible for the funds costs, including attorneys fees.
The declaration further provides that the fund shall be responsible for payment of attorneys fees and legal expenses incurred by a
complaining shareholder only if required by law, and any attorneys fees that the fund is obligated to pay shall be calculated using reasonable hourly rates. The declaration also requires that actions by shareholders against the fund be brought
only in federal court in Baltimore, Maryland, or if not permitted to be brought in federal court, then in state court in Baltimore, Maryland, and that the right to jury trial be waived to the full extent permitted by law.
TAXES
The following is a summary of certain material U.S. federal income tax considerations regarding the purchase, ownership and disposition of shares of the fund. This summary does not address all of the
potential U.S. federal income tax consequences that may be applicable to the fund or to all categories of investors, some of which may be subject to special tax rules. Current and prospective shareholders are urged to consult their own tax advisers
with respect to the specific federal, state, local and foreign tax consequences of investing in the fund. The summary is based on the laws in effect on the date of this SAI and existing judicial and administrative interpretations thereof, all of
which are subject to change, possibly with retroactive effect.
The Fund and Its Investments
The fund intends to continue to qualify to be treated as a regulated investment company each taxable year under the Code. To so qualify,
the fund must, among other things: (a) derive at least 90% of its gross income in each taxable year from dividends, interest, payments with respect to securities loans and gains from the sale or other disposition of stock or securities, or
foreign currencies, or other income (including, but not limited to, gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies and net income derived from interests in
qualified publicly traded partnerships (
i.e.
, partnerships, including certain ETFs, that are traded on an established securities market or tradable on a
92
secondary market, other than partnerships that derive 90% of their income from interest, dividends, capital gains, and other traditionally permitted mutual fund income); and (b) diversify
its holdings so that, at the end of each quarter of the funds taxable year, (i) at least 50% of the market value of the funds assets is represented by cash, securities of other regulated investment companies, U.S. government
securities and other securities, with such other securities limited, in respect of any one issuer, to an amount not greater than 5% of the funds assets and not greater than 10% of the outstanding voting securities of such issuer and
(ii) not more than 25% of the value of its assets is invested in the securities (other than U.S. government securities or securities of other regulated investment companies) of any one issuer, any two or more issuers of which 20% or more of the
voting securities are held by a fund and that are determined to be engaged in the same or similar trades or businesses or related trades or businesses or in the securities of one or more qualified publicly traded partnerships. Income from commodity
derivatives, including certain ETNs, is not considered qualifying income to the fund. Any income the fund derives from direct investments in commodity derivatives must be limited to a maximum of 10% of the funds gross income.
Although in general the passive loss rules of the Code do not apply to regulated investment companies, such rules do apply to a regulated
investment company with respect to items attributable to an interest in QPTPs. Fund or underlying fund investments in partnerships, including in QPTPs, may result in such fund being subject to state, local or foreign income, franchise or withholding
tax liabilities.
As a regulated investment company, the fund will not be subject to U.S. federal income tax on the
portion of its taxable investment income and capital gains that it distributes to its shareholders, provided such fund satisfies a minimum distribution requirement. To satisfy the minimum distribution requirement, the fund must distribute to its
shareholders at least the sum of (i) 90% of its investment company taxable income (
i.e
., generally, the taxable income of a RIC other than its realized long term capital gain over its net realized short term capital loss plus
or minus certain adjustments) and (ii) 90% of its net tax-exempt income for the taxable year. The fund will be subject to income tax at regular corporation tax rates on any taxable income or gains that it does not distribute to its
shareholders.
Fund losses realized upon redemptions from underlying funds may be deferred indefinitely as investments made
into the same underlying funds within thirty days before or after the redemptions may trigger wash sale tax rules, which defer the recognition of losses. Except with respect to its subsidiary, all redemptions that the fund makes from the
underlying funds will be recognized as exchanges for tax purposes.
Distributions received by the fund from an underlying fund
attributable to the underlying funds investment company taxable income including short-term capital gains are taxable as dividend income to the fund. Distributions received by the fund from an underlying fund attributable to the excess of the
underlying funds net long-term capital gain over its net short-term capital loss and that are properly designated as capital gain dividends are taxable as long-term capital gain to the fund, regardless of how long the fund has held
the underlying funds shares. Upon the sale or other disposition by a fund of shares of any underlying fund, the fund generally will realize a capital gain or loss which will be long-term or short-term, generally depending upon the funds
holding period for the shares.
On December 31, 2012, the unused capital loss carryforward of the fund was $0.
For taxable years beginning in 2011 or later, capital losses will not be subject to expiration.
The Code imposes a 4% nondeductible excise tax on a fund to the extent it does not distribute by the end of any calendar year at
least the sum of (i) 98% of its ordinary income for that year and (ii) 98.2% of its capital gain net income (both long-term and short-term and including capital gain dividends received from the underlying funds) for the one-year period
ending, as a general rule, on October 31 of that year. For this purpose, however, any ordinary income or capital gain net income retained by the fund that is subject to corporate income
93
tax will be considered to have been distributed by year-end. In addition, the minimum amounts that must be distributed in any year to avoid the excise tax will be increased or decreased to
reflect any underdistribution or overdistribution, as the case may be, from the previous year. The fund anticipates that it will pay such dividends and will make such distributions as are necessary in order to avoid the application of this excise
tax. Unexpected or unpredictable distributions from lower-tier funds may impede the funds ability to avoid application of this excise tax.
If, in any taxable year, the fund failed to qualify as a regulated investment company under the Code or failed to meet the distribution requirement, it would be taxed in the same manner as an ordinary
corporation and distributions to its shareholders would not be deductible by the fund in computing its taxable income. In addition, in the event of a failure to qualify, the funds distributions, to the extent derived from the funds
current or accumulated earnings and profits, including any distributions of net long-term capital gains, would be taxable to shareholders as ordinary dividend income for federal income tax purposes to the extent of the funds earnings and
profits. However, such dividends would be eligible (i) to be treated as qualified dividend income in the case of shareholders taxed as individuals and (ii) for the dividends received deduction in the case of corporate shareholders.
Moreover, if the fund fails to qualify as a regulated investment company in any year, it must pay out its earnings and profits accumulated in that year in order to qualify again as a regulated investment company. If the fund failed to qualify as a
regulated investment company for a period greater than two taxable years, the fund may be required to recognize any net built-in gains with respect to certain of its assets (
i.e
., the excess of the aggregate gains, including items of income,
over aggregate losses that would have been realized with respect to such assets if the fund had been liquidated) if it qualifies as a regulated investment company in a subsequent year.
In certain situations, the fund may, for a taxable year, defer all or a portion of its capital losses realized after October and its
late-year ordinary losses (defined as the excess of post-October foreign currency and PFIC losses and other post-December ordinary losses over post-October foreign currency and PFIC gains and other post-December ordinary income) realized after
December until the next taxable year in computing its investment company taxable income and net capital gain, which will defer the recognition of such realized losses. Such deferrals and other rules regarding gains and losses realized after October
(and December) may affect the tax character of shareholder distributions.
Tax Treatment of the Underlying Funds
Each underlying fund intends to continue to qualify annually to be treated as a regulated investment company under Subchapter M of the
Code. In any year in which an underlying fund qualifies as a regulated investment company and timely distributes all of its taxable income, the underlying fund generally will not pay any U.S. federal income or excise tax. The underlying funds are
subject to the same asset diversification and income distribution requirements applicable to the fund.
An underlying
funds transactions in zero coupon securities, foreign currencies, forward contracts, options and futures contracts (including options and futures contracts on foreign currencies) will be subject to special provisions of the Code (including
provisions relating to hedging transactions and straddles) that, among other things, may affect the character of gains and losses realized by such underlying fund (
i.e
., may affect whether gains or losses are ordinary
or capital), accelerate recognition of income to the underlying fund and defer underlying fund losses. These rules could therefore affect the character, amount and timing of distributions to the fund and thus to the shareholders. These provisions
also (a) will require an underlying fund to mark-to-market certain types of the positions in its portfolio (
i.e.,
treat them as if they were closed out at the end of each year) and (b) may cause the underlying fund to
recognize income prior to the receipt of cash with which to pay dividends or make distributions in amounts necessary to satisfy the distribution requirements for avoiding income and excise taxes. In order to distribute this income and avoid a tax on
the applicable underlying fund, that underlying fund might be required to liquidate portfolio securities that it might otherwise have continued to hold, potentially resulting in additional taxable gain or loss. Each underlying fund will monitor its
transactions, will
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make the appropriate tax elections and will make the appropriate entries in its books and records when it acquires any foreign currency, forward contract, option, futures contract or hedged
investment in order to mitigate the effect of these rules and prevent disqualification of the underlying fund as a regulated investment company.
An underlying funds investments in so-called section 1256 contracts, such as regulated futures contracts, most foreign currency forward contracts traded in the interbank market and
options on most stock indices, are subject to special tax rules. All section 1256 contracts held by an underlying fund at the end of its taxable year are required to be marked to their market value, and any unrealized gain or loss on those positions
will be included in the underlying funds income as if each position had been sold for its fair market value at the end of the taxable year. The resulting gain or loss will be combined with any gain or loss realized by the underlying fund from
positions in section 1256 contracts closed during the taxable year. Provided such positions were held as capital assets and were not part of a hedging transaction nor part of a straddle, 60% of the resulting net gain or loss
will be treated as long-term capital gain or loss, and 40% of such net gain or loss will be treated as short-term capital gain or loss, regardless of the period of time the positions were actually held by the underlying fund.
As a result of entering into swap contracts, an underlying fund may make or receive periodic net payments. An underlying fund may also
make or receive a payment when a swap is terminated prior to maturity through an assignment of the swap or other closing transaction. Periodic net payments will generally constitute ordinary income or deductions, while termination of a swap will
generally result in capital gain or loss (which will be a long-term capital gain or loss if the fund has been a party to the swap for more than one year). With respect to certain types of swaps, an underlying fund may be required to currently
recognize income or loss with respect to future payments on such swaps or may elect under certain circumstances to mark such swaps to market annually for tax purposes as ordinary income or loss.
An underlying fund may be required to treat amounts as taxable income or gain, subject to the distribution requirements referred to
above, even though no corresponding amounts of cash are received concurrently, as a result of (1) mark-to-market or constructive sale rules or rules applicable to PFICs (as defined below), partnerships, trusts in which the underlying fund
invests, certain options, futures or forward contracts, or appreciated financial positions, or (2) the inability to obtain cash distributions or other amounts due to currency controls or restrictions on repatriation imposed by a
foreign country with respect to the underlying funds investments (including through depositary receipts) in issuers in such country or (3) tax rules applicable to debt obligations acquired with original issue discount,
including zero-coupon or deferred payment bonds and pay-in-kind debt obligations, or to market discount if an election is made with respect to such market discount. An underlying fund may therefore be required to obtain cash to be used to satisfy
these distribution requirements by selling securities at times that it might not otherwise be desirable to do so or borrowing the necessary cash, thereby incurring interest expenses. In certain situations, an underlying fund may, for a taxable year,
defer all or a portion of its capital losses realized after October and its late-year ordinary losses (defined as the excess of post-October foreign currency and PFIC losses and other post-December ordinary losses over post-October foreign currency
and PFIC gains and other post-December ordinary income) realized after December until the next taxable year in computing its investment company taxable income and net capital gain, which will defer the recognition of such realized losses. Such
deferrals and other rules regarding gains and losses realized after October (and December) may affect the tax character of shareholder distributions.
In general, gain or loss on a short sale is recognized when an underlying fund closes the sale by delivering the borrowed property to the lender, not when the borrowed property is sold. Gain or loss from
a short sale is generally considered as capital gain or loss to the extent that the property used to close the short sale constitutes a capital asset in an underlying funds hands. Except with respect to certain situations where the property
used by an underlying fund to close a short sale has a long-term holding period on the date of the short sale, special rules would generally treat the gains on short sales as short-term capital gains. These rules may also terminate the running of
the holding period of substantially identical property held by an underlying fund. Moreover, a loss on a short sale will be treated as a long-term capital loss if, on the date of the short sale, substantially identical
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property has been held by an underlying fund for more than one year. In general, an underlying fund will not be permitted to deduct payments made to reimburse the lender of securities for
dividends paid on borrowed stock if the short sale is closed on or before the 45th day after the short sale is entered into. Furthermore, certain transactions (including options, futures contracts, notional principal contracts, short sales and short
sales against the box) with respect to an appreciated financial position in certain financial instruments may be deemed a constructive sale of the appreciated position, requiring the immediate recognition of gain as if the appreciated
position were sold. For this purpose, an appreciated financial position is defined generally to mean any position (defined as any interest, including a futures or forward contract, short sale or option) with respect to stocks, debt instruments, or
partnership interests where there would be gain if such position is sold, assigned or otherwise terminated at its fair market value. The term appreciated financial position, however, does not apply generally to a position with respect to certain
debt instruments or a position which is marked to market.
The Code contains a provision codifying the judicial economic
substance doctrine, which has traditionally been used by courts to deny tax benefits for transactions that lack economic substance; a strict liability penalty is imposed for an understatement of tax liability due to a transactions lack of
economic substance.
Foreign Investments
. Dividends or other income (including, in some cases, capital gains) received
by an underlying fund from investments in foreign securities may be subject to withholding and other taxes imposed by foreign countries. Tax conventions between certain countries and the United States may reduce or eliminate such taxes in some
cases. Foreign taxes paid by an underlying fund will reduce the return from the underlying funds investments.
If more
than 50% of the value of an underlying funds assets at the close of its taxable year consists of stocks or securities of foreign corporations, that underlying fund may elect for U.S. federal income tax purposes to treat certain foreign taxes
paid by it as paid by its shareholders (including the fund) that own its shares. The fund would then be required to include its proportionate share of the electing funds foreign income and related foreign taxes in income even if the fund does
not receive the amount representing foreign taxes. The fund may invest in some underlying funds that expect to be eligible to make the above-described election. If so, the fund may, in turn, if permitted to do so, make a corresponding election to
treat the foreign taxes as paid by its shareholders. Maximum holding period requirements apply. Accordingly, the shareholders of the fund may have an option of claiming a foreign tax credit or deduction for foreign taxes paid by the underlying
funds.
The fund may be subject to non-U.S. income taxes withheld at the source. The fund, if permitted to do so, may elect to
pass through to its investors the amount of non-U.S. income taxes paid by the fund provided that the fund held the security on the dividend settlement date and for at least 15 additional days immediately before and/or thereafter, with
the result that each investor with respect to shares of the fund held for a minimum 16-day holding period at the time of the deemed distribution will (i) include in gross income, even though not actually received, the investors pro rata
share of the funds non-U.S. income taxes, and (ii) either deduct (in calculating U.S. federal income tax, but only for investors who itemize their deductions on their personal tax returns) or credit (in calculating U.S. federal income
tax) the investors pro rata share of the funds non-U.S. income taxes. A non-U.S. person invested in the fund in a year that the fund elects to pass through its non-U.S. taxes may be treated as receiving additional dividend
income subject to U.S. withholding tax. A non-U.S. tax credit may not exceed the investors U.S. federal income tax otherwise payable with respect to the investors non-U.S. source income. For this purpose, shareholders must treat as
non-U.S. source gross income (i) their proportionate shares of non-U.S. taxes paid by the fund and (ii) the portion of any dividend paid by the fund that represents income derived from non-U.S. sources; the funds gain from the sale
of securities will generally be treated as U.S.-source income. Certain limitations will be imposed to the extent to which the non-U.S. tax credit may be claimed.
Under Section 988 of the Code, gains or losses attributable to fluctuations in exchange rates between the time an underlying fund accrues income or receivables or expenses or other liabilities
denominated in a foreign currency and the time the underlying fund actually collects such income or pays such liabilities are generally treated as ordinary income or ordinary loss. In general, gains (and losses) realized on debt instruments will be
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treated as Section 988 gain (or loss) to the extent attributable to changes in exchange rates between the U.S. dollar and the currencies in which the instruments are denominated.
Similarly, gains or losses on foreign currency, foreign currency forward contracts, certain foreign currency options or futures contracts and the disposition of debt securities denominated in foreign currency, to the extent attributable to
fluctuations in exchange rates between the acquisition and disposition dates, are also treated as ordinary income or loss unless the underlying fund were to elect otherwise.
Passive Foreign Investment Companies
. If an underlying fund purchases shares in certain foreign investment entities, called passive foreign investment companies (PFICs), it
may be subject to U.S. federal income tax on a portion of any excess distribution or gain from the disposition of such shares even if such income is distributed as a taxable dividend by the underlying fund to its shareholders. Additional
charges in the nature of interest may be imposed on the underlying fund in respect of deferred taxes arising from such distributions or gains.
Tax Credit Bonds
. If the fund holds (directly or indirectly) one or more tax credit bonds (defined below) on one or more specified dates during the funds taxable year, and the
fund satisfies the minimum distribution requirement, the fund may elect for U.S. federal income tax purposes to pass through to shareholders tax credits otherwise allowable to the fund for that year with respect to such bonds. A tax credit bond is
defined in the Code as a qualified tax credit bond (which includes a qualified forestry conservation bond, a new clean renewable energy bond, a qualified energy conservation bond, or a qualified zone academy bond, each of which must meet
certain requirements specified in the Code), a build America bond or certain other specified bonds. If the fund were to make an election, a shareholder of the fund would be required to include in income and would be entitled to claim as
a tax credit an amount equal to a proportionate share of such credits. Certain limitations may apply on the extent to which the credit may be claimed.
If an underlying fund were to invest in a PFIC and elect to treat the PFIC as a qualified electing fund under the Code, in lieu of the foregoing requirements, such underlying fund might be
required to include in income each year a portion of the ordinary earnings and net capital gains of the qualified electing fund, even if not distributed to the underlying fund, and such amounts would be subject to the 90% and excise tax distribution
requirements described above. In order to distribute this income and avoid a tax on the applicable underlying fund, that underlying fund might be required to liquidate portfolio securities that it might otherwise have continued to hold, potentially
resulting in additional taxable gain or loss. In order to make the qualified electing fund election, the underlying fund would be required to obtain certain annual information from the PFICs in which it invests, which may be difficult or
impossible to obtain.
Alternatively, an underlying fund may make a mark-to-market election that will result in the underlying
fund being treated as if it had sold and repurchased all of the PFIC stock at the end of each year. In such case, the underlying fund would report any such gains as ordinary income and would deduct any such losses as ordinary losses to the extent of
previously recognized gains. The election must be made separately for each PFIC owned by the underlying fund and, once made, would be effective for all subsequent taxable years of the underlying fund, unless revoked with the consent of the Internal
Revenue Service (the IRS). By making the election, such underlying fund could potentially ameliorate the adverse tax consequences with respect to its ownership of shares in a PFIC, but in any particular year may be required to recognize
income in excess of the distributions it receives from PFICs and its proceeds from dispositions of PFIC stock. The underlying fund may have to distribute this phantom income and gain to satisfy the 90% distribution requirement and to
avoid imposition of the 4% excise tax. In order to distribute this income and avoid a tax on the applicable underlying fund, that underlying fund might be required to liquidate portfolio securities that it might otherwise have continued to hold,
potentially resulting in additional taxable gain or loss.
Each underlying fund will make the appropriate tax elections, if
possible, and take any additional steps that are necessary to mitigate the effect of these rules.
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Taxation of U.S. Shareholders
Dividends and Distributions
. Dividends and other distributions by the fund are generally treated under the Code as received by the
shareholders at the time the dividend or distribution is made. However, any dividend or distribution declared by the fund in October, November or December of any calendar year and payable to shareholders of record on a specified date in such a month
shall be deemed to have been received by each shareholder on December 31 of such calendar year and to have been paid by the fund not later than such December 31, provided such dividend is actually paid by the fund during January of the
following calendar year.
The fund intends to distribute annually to its shareholders substantially all of its investment
company taxable income, and any net realized long-term capital gains in excess of net realized short-term capital losses (including any capital loss carryovers). However, if the fund retains for investment an amount equal to all or a portion of its
net long-term capital gains in excess of its net short-term capital losses (including any capital loss carryovers), it will be subject to a corporate tax (at a maximum rate of 35%) on the amount retained. In that event, the fund will report
such retained amounts as undistributed capital gains in a notice to its shareholders who (a) will be required to include in income for U.S. federal income tax purposes, as long-term capital gains, their proportionate shares of the undistributed
amount, (b) will be entitled to credit their proportionate shares of the 35% tax paid by the fund on the undistributed amount against their U.S. federal income tax liabilities, if any, and to claim refunds to the extent their credits exceed
their liabilities, if any, and (c) will be entitled to increase their tax basis, for U.S. federal income tax purposes, in their shares by an amount equal to 65% of the amount of undistributed capital gains included in the shareholders
income. Organizations or persons not subject to U.S. federal income tax on such capital gains will be entitled to a refund of their pro rata share of such taxes paid by the fund upon timely filing appropriate returns or claims for refund with the
IRS.
Distributions of net realized long-term capital gains, if any, that the fund reports as capital gains dividends are
taxable as long-term capital gains, whether paid in cash or in shares and regardless of how long a shareholder has held shares of the fund. Long-term capital gains are taxed for individuals at 15% for those with incomes below $400,000 ($450,000 if
married filing jointly), 20% for those with any income above those amounts that is net long-term capital gain or qualified dividend income (discussed below) and 0% at certain income levels. The above income thresholds will be adjusted annually for
inflation. Such distributions will not be eligible for the dividends-received deduction. All other dividends (including dividends from short-term capital gains) of the fund from its current and accumulated earnings and profits (regular
dividends) are generally subject to tax as ordinary income.
Special rules apply, however, to regular dividends paid to
individuals. Such dividends may be subject to tax at the rates generally applicable to long-term capital gains for individuals, provided that the individual receiving the dividend satisfies certain holding period and other requirements. Dividends
subject to these special rules are not actually treated as capital gains, however, and thus are not included in the computation of an individuals net capital gain and generally cannot be used to offset capital losses. The long-term capital
gains rates will apply to: (i) 100% of the regular dividends paid by the fund to an individual in a particular taxable year if 95% or more of the funds gross income (ignoring gains attributable to the sale of stocks and securities except
to the extent net short-term capital gain from such sales exceeds net long-term capital loss from such sales) in that taxable year is attributable to qualified dividend income received by the fund; or (ii) the portion of the regular dividends
paid by the fund to an individual in a particular taxable year that is attributable to qualified dividend income received by the fund in that taxable year if such qualified dividend income accounts for less than 95% of the funds gross income
(ignoring gains attributable to the sale of stocks and securities except to the extent net short-term capital gain from such sales exceeds net long-term capital loss from such sales) for that taxable year. For this purpose, qualified dividend
income generally means income from dividends received by the fund from U.S. corporations and qualified foreign corporations, provided that the fund satisfies certain holding period requirements in respect of the stock of such corporations and
has not hedged its position in the stock in certain ways. However, qualified dividend income does not include any dividends received from tax-exempt corporations. Also, dividends received by the fund from a REIT or another regulated investment
company (such
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as an underlying fund) generally are qualified dividend income only to the extent the dividend distributions are made out of qualified dividend income received by such REIT or other regulated
investment company. In the case of securities lending transactions, payments in lieu of dividends are not qualified dividend income. If a shareholder elects to treat fund dividends as investment income for purposes of the limitation on the
deductibility of investment interest, such dividends would not be a qualified dividend income.
The fund in which you are a
shareholder or your Service Agent will send you information after the end of each year setting forth the amount of dividends paid by the fund that are eligible for the reduced rates.
If an individual receives a regular dividend qualifying for the long-term capital gains rates and such dividend constitutes an
extraordinary dividend and the individual subsequently recognizes a loss on the sale or exchange of stock in respect of which the extraordinary dividend was paid, then the loss will be long-term capital loss to the extent of such
extraordinary dividend. An extraordinary dividend on common stock for this purpose is generally a dividend (i) in an amount greater than or equal to 10% of the taxpayers tax basis (or trading value) in a share of stock, aggregating
dividends with ex-dividend dates within an 85-day period or (ii) in an amount greater than 20% of the taxpayers tax basis (or trading value) in a share of stock, aggregating dividends with ex-dividend dates within a 365-day period.
If an underlying fund derives dividends from domestic corporations, a portion of the income distributions of the fund that
invests in that underlying fund may be eligible for the 70% deduction for dividends received by corporations. Shareholders will be informed of the portion of dividends that so qualify. The dividends received deduction is reduced to the extent the
shares of the corporation paying the dividend, the shares of the underlying fund or the shares of the fund receiving the dividends are treated as debt-financed under U.S. federal income tax law and is eliminated if either the shares of the
corporation paying the dividend, the shares of the underlying fund or the shares of the fund receiving the dividends are deemed to have been held by the underlying fund, the fund or the shareholders, as the case may be, for less than a minimum
period, generally 46 days, during a prescribed period with respect to each dividend.
Distributions in excess of the
funds current and accumulated earnings and profits will, as to each shareholder, be treated as a tax-free return of capital to the extent of a shareholders basis in his shares of the fund, and as a capital gain thereafter (if the
shareholder holds his shares of the fund as capital assets). Shareholders receiving dividends or distributions in the form of additional shares should be treated for U.S. federal income tax purposes as receiving a distribution in an amount equal to
the amount of money that the shareholders receiving cash dividends or distributions will receive and should have a cost basis in the shares received equal to such amount.
Investors considering buying shares just prior to a dividend or capital gain distribution should be aware that, although the price of shares just purchased at that time may reflect the amount of the
forthcoming distribution, such dividend or distribution may nevertheless be taxable to them. If the fund is the holder of record of any stock on the record date for any dividends payable with respect to such stock, such dividends are included in the
funds gross income not as of the date received but as of the later of (a) the date such stock became ex-dividend with respect to such dividends (
i.e.,
the date on which a buyer of the stock would not be entitled to receive the
declared, but unpaid, dividends) or (b) the date the fund acquired such stock. Accordingly, in order to satisfy its income distribution requirements, the fund may be required to pay dividends based on anticipated earnings, and shareholders may
receive dividends in an earlier year than would otherwise be the case.
Sales of Shares
. Upon the sale or exchange of
his shares, a shareholder will realize a taxable gain or loss equal to the difference between the amount realized and his basis in his shares. Such gain or loss will be treated as capital gain or loss if the shares are capital assets in the
shareholders hands, and will be long-term capital gain or loss if the shares are held for more than one year and short-term capital gain or loss if the shares are held for one year or less. Any loss realized on a sale or exchange will be
disallowed to the extent the shares disposed of are replaced, including replacement through the reinvesting of dividends and capital gains distributions in the
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fund, within a 61-day period beginning 30 days before and ending 30 days after the disposition of the shares. In such a case, the basis of the shares acquired will be increased to reflect the
disallowed loss. Any loss realized by a shareholder on the sale of the fund share held by the shareholder for six months or less will be disallowed to the extent of any exempt-interest dividends received by the shareholder with respect to such
shares and, to the extent not disallowed, will be treated for U.S. federal income tax purposes as a long-term capital loss to the extent of any distributions or deemed distributions of long-term capital gains received by the shareholder (or amounts
credited to the shareholder as an undistributed capital gain) with respect to such shares. If a shareholder incurs a sales charge in acquiring shares of the fund, disposes of those shares within 90 days and then by January 31 of the calendar year
following the year of disposition acquires shares in a mutual fund for which the otherwise applicable sales charge is reduced by reason of a reinvestment right (
e.g.
, an exchange privilege), the original sales charge will not be taken into
account in computing gain/loss on the original shares to the extent the subsequent sales charge is reduced. Instead, the disregarded portion of the original sales charge will be added to the tax basis of the newly acquired shares. Furthermore, the
same rule also applies to a disposition of the newly acquired shares made within 90 days of the second acquisition. This provision prevents a shareholder from immediately deducting the sales charge by shifting his or her investment within a family
of mutual funds.
Under current law, the fund serves to block unrelated business taxable income (UBTI) from being
realized by its tax-exempt shareholders. Notwithstanding the foregoing, a tax-exempt shareholder could realize UBTI by virtue of its investment in the fund if shares in the fund constitute debt-financed property in the hands of the tax-exempt
shareholder within the meaning of Code Section 514(b). Certain types of income received by the fund from REITs, real estate mortgage investment conduits (REMICs), taxable mortgage pools or other investments may cause the fund to
designate some or all of its distributions as excess inclusion income. To the funds shareholders such excess inclusion income may (1) constitute taxable income, as UBTI for those shareholders who would otherwise be tax-exempt
such as IRAs, 401(k) accounts, Keogh plans, pension plans and certain charitable entities; (2) not be offset against otherwise allowable deductions for tax purposes; (3) not be eligible for reduced U.S. withholding for non-U.S.
shareholders even from tax treaty countries; and (4) cause the fund to be subject to tax if certain disqualified organizations, as defined by the Code, are fund shareholders. If a charitable remainder annuity trust or charitable
remainder unitrust (each as defined by Code Section 664) has UBTI for a tax year, a 100% excise tax on the UBTI is imposed on the trust.
Excise Tax
. Beginning in 2013, a new 3.8% Medicare contribution tax is imposed on net investment income, including interest, dividends, and capital gain, of U.S. individuals with income exceeding
$200,000 (or $250,000 if married filing jointly), and of estates and trusts.
Losses realized upon redemptions of interests in
the underlying funds may result in wash sales and deferral, perhaps indefinitely, of realized losses to the fund.
The fund, or, if you hold your shares through a Service Agent, your Service Agent will report to the IRS the amount of proceeds that a
shareholder receives from a redemption or exchange of fund shares. For redemptions or exchanges of shares acquired on or after January 1, 2012, the fund will also report the shareholders basis in those shares and the character of any gain
or loss that the shareholder realizes on the redemption or exchange (
i.e.
, short-term or long-term), and certain related tax information. If a shareholder has a different basis for different shares of the fund in the same account
(
e.g.
, if a shareholder purchased fund shares held in the same account when the shares were at different prices), the fund will by default report the basis of the shares redeemed or exchanged using the average basis method, under which the
basis per share is the average of the bases of all the shareholders fund shares in the account. (For these purposes, shares acquired prior to January 1, 2012 and shares acquired on or after January 1, 2012 will be treated as held in
separate accounts.)
A shareholder may instruct the fund to use a method other than average basis for an account. If
redemptions, including in connection with payment of an account fee, or exchanges have occurred in an account to which the average basis method applied, the basis of the fund shares remaining in the account will continue to reflect the average basis
notwithstanding the shareholders subsequent election of a different method. For further assistance,
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shareholders who hold their shares directly with the fund may call the fund at 1-877-721-1926 Monday through Friday between 8:00 a.m. and 5:30 p.m. (Eastern time). Shareholders who hold shares
through a Service Agent should contact the Service Agent for further assistance or for information regarding the Service Agents default method for calculating basis and procedures for electing to use an alternative method. Shareholders should
consult their tax advisers concerning the tax consequences of applying the average basis method or electing another method of basis calculation, and should consider electing such other method prior to making redemptions or exchanges in their
account.
Backup Withholding
. The fund may be required to withhold, for U.S. federal income tax purposes, 28% of the
dividends, distributions and redemption proceeds payable to shareholders who fail to provide the fund with their correct taxpayer identification number or to make required certifications, or who have been notified by the IRS that they are subject to
backup withholding. Certain shareholders are exempt from backup withholding. Backup withholding is not an additional tax and any amount withheld may be credited against a shareholders U.S. federal income tax liability.
Notices; Other Taxes
Notices
. Shareholders will receive, if appropriate, various written notices after the close of the funds taxable year
regarding the U.S. federal income tax status of certain dividends, distributions and deemed distributions that were paid (or that are treated as having been paid) by the fund to its shareholders during the preceding taxable year.
Other Taxes
. Dividends, distributions and redemption proceeds may also be subject to additional state, local and foreign taxes
depending on each shareholders particular situation.
If a shareholder recognizes a loss with respect to the funds
shares of $2 million or more for an individual shareholder or $10 million or more for a corporate shareholder, the shareholder must file with the IRS a disclosure statement on Form 8886. Direct shareholders of stocks or securities are in many cases
excepted from this reporting requirement, but under current guidance, shareholders of a regulated investment company are not excepted. The fact that a loss is reportable under these regulations does not affect the legal determination of whether the
taxpayers treatment of the loss is proper. Shareholders should consult their tax advisors to determine the applicability of these regulations in light of their individual circumstances.
Taxation of Non-U.S. Shareholders.
Dividends and Distributions.
Dividends paid by the fund to non-U.S. shareholders are generally subject to withholding tax at a 30% rate (or such lower rate as may be determined in accordance with any applicable treaty). 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 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, U.S. 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, exempt-interest dividends, or upon the
sale or other disposition of shares of the fund.
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For taxable years beginning before January 1, 2014, distributions that the fund reports
as short-term capital gain dividends or long-term capital gain dividends will not be treated as such to a recipient foreign shareholder if the distribution is attributable to gain received from the sale or exchange of U.S.
real property or an interest in a U.S. real property holding corporation and the funds direct or indirect interests in U.S. real property exceeded certain levels. Instead, if the foreign shareholder has not owned more than 5% of the
outstanding shares of the fund at any time during the one year period ending on the date of distribution, such distributions will be subject to 30% withholding by the fund and will be treated as ordinary dividends to the foreign shareholder; if the
foreign shareholder owned more than 5% of the outstanding shares of the fund at any time during the one year period ending on the date of the distribution, such distribution will be treated as real property gain subject to 35% withholding tax and
could subject the foreign shareholder to U.S. filing requirements. Additionally, if the funds direct or indirect interests in U.S. real property were to exceed certain levels, a foreign shareholder realizing gains upon redemption from the fund
on or before December 31, 2013 could be subject to the 35% withholding tax and U.S. filing requirements unless more than 50% of the funds shares were owned by U.S. persons at such time or unless the foreign person had not held more than
5% of the funds outstanding shares throughout either such persons holding period for the redeemed shares or, if shorter, the previous five years.
In addition, the same rules apply with respect to distributions to a foreign shareholder from the fund and redemptions of a foreign shareholders interest in the fund attributable to a REITs
distribution to the fund of gain from the sale or exchange of U.S. real property or an interest in a U.S. real property holding corporation, if the funds direct or indirect interests in U.S. real property were to exceed certain levels. The
rule with respect to distributions and redemptions attributable to a REITs distribution to the fund will not expire for taxable years beginning on or after January 1, 2014.
The rules laid out in the previous two paragraphs, other than the withholding rules, will apply notwithstanding the funds
participation in a wash sale transaction or its payment of a substitute dividend.
For taxable years beginning before January
1, 2014, properly-reported dividends were generally exempt from U.S. federal withholding tax where they (i) are paid in respect of the funds qualified net interest income (generally, the funds U.S. source interest income,
other than certain contingent interest and interest from obligations of a corporation or partnership in which the fund is at least a 10% shareholder, reduced by expenses that are allocable to such income) or (ii) are paid in respect of the
funds qualified short-term capital gains (generally, the excess of the funds net short-term capital gain over the funds long-term capital loss for such taxable year). However, depending on its circumstances, the fund
could report all, some or none of its potentially eligible dividends as such qualified net interest income or as qualified short-term capital gains and/or treat such dividends, in whole or in part, as ineligible for this exemption from withholding.
In order to qualify for this exemption from withholding, a non-U.S. shareholder would need to comply with applicable certification requirements relating to its non-U.S. status (including, in general, furnishing an IRS Form W-8BEN or substitute
Form). In the case of shares held through an intermediary, the intermediary could withhold even if the fund report the payment as qualified net interest income or qualified short-term capital gain. Non-U.S. shareholders should contact their
intermediaries with respect to the application of these rules to their accounts.
Beginning in 2014, the Code will
impose a U.S. withholding tax of 30% on payments (including, beginning in 2017, payments of gross proceeds) that are attributable to certain U.S. investments and made to a non-U.S. financial institution, including a non-U.S. investment fund.
The fund will withhold at this rate on certain of its distributions unless any non-U.S. financial institution shareholder complies with certain reporting requirements to the IRS in respect of its direct and indirect U.S. investors. Non-U.S.
financial institution shareholders should consult their own tax advisers regarding the possible implications of these requirements on their investment in the fund.
102
The tax consequences to a foreign shareholder entitled to claim the benefits of an
applicable tax treaty may be different from those described herein. Foreign shareholders should consult their own tax advisers with respect to the particular tax consequences to them of an investment in the fund, including the applicability of
foreign taxes.
In the event that the fund were to experience an ownership change as defined under the Code, the funds
capital loss carryforwards, if any, may be subject to limitation.
The foregoing is only a summary of certain material
U.S. federal income tax consequences (and, where noted, state and local tax consequences) affecting the fund and its shareholders. Current and prospective shareholders are advised to consult their own tax advisers with respect to the particular tax
consequences to them of an investment in the fund.
FINANCIAL STATEMENTS
The audited financial statements of the fund (Consolidated Statement of Assets and Liabilities as of December 31, 2012, Consolidated
Schedule of Investments as of December 31, 2012, Consolidated Statement of Operations for the year ended December 31, 2012, Consolidated Statement of Changes in Net Assets for each of the years in the two-year period ended December 31, 2012,
Consolidated Financial Highlights for each of the years in the three-year period ended December 31, 2012, and the period from April 9, 2009 (commencement of operations) to December 31, 2009, and Notes to Financial Statements, along with the Report
of Independent Registered Public Accounting Firm, each of which is included in the Annual Report to Shareholders of the fund), are incorporated by reference into this SAI (filed on February 27, 2013; Accession Number 0001193125-13-079507).
103
APPENDIX A
DESCRIPTION OF RATINGS
The ratings of Moodys, Standard & Poors and Fitch Ratings represent their opinions as to the quality of various debt obligations. It should be emphasized, however, that ratings are
not absolute standards of quality. Consequently, debt obligations with the same maturity, coupon and rating may have different yields while debt obligations of the same maturity and coupon with different ratings may have the same yield. As described
by the rating agencies, ratings are generally given to securities at the time of issuances. While the rating agencies may from time to time revise such ratings, they undertake no obligation to do so.
Description of Moodys Long-Term 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 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.
Description of Moodys US Municipal and Tax Exempt Ratings:
Municipal
Ratings are opinions of the investment quality of issuers and issues in the US municipal and tax-exempt markets. As such, these ratings incorporate Moodys assessment of the default probability and loss severity of these issuers and issues. The
default and loss content for Moodys municipal long-term rating scale differs from Moodys general long-term rating scale.
Municipal Ratings are based upon the analysis of four primary factors relating to municipal finance: economy, debt, finances, and administration/management strategies. Each of the factors is evaluated
individually and for its effect on the other factors in the context of the municipalitys ability to repay its debt.
Municipal Long-Term Rating Definitions:
Aaa
Issuers or issues rated Aaa demonstrate the strongest creditworthiness relative to other US municipal or tax-exempt
issuers or issues.
Aa
Issuers or issues rated Aa demonstrate very strong creditworthiness relative to other US
municipal or tax-exempt issuers or issues.
A
Issuers or issues rated A present above-average creditworthiness
relative to other US municipal or tax-exempt issuers or issues.
Baa
Issuers or issues rated Baa represent average
creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Ba
Issuers or issues rated Ba
demonstrate below-average creditworthiness relative to other US municipal or tax-exempt issuers or issues.
B
Issuers or issues rated B demonstrate weak creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Caa
Issuers or issues rated Caa demonstrate very weak creditworthiness relative to other US municipal or
tax-exempt issuers or issues.
Ca
Issuers or issues rated Ca demonstrate extremely weak creditworthiness relative
to other US municipal or tax-exempt issuers or issues.
C
Issuers or issues rated C demonstrate the weakest
creditworthiness relative to other US municipal or tax-exempt issuers or issues.
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.
Description of Moodys US Municipal Short-Term Debt And Demand Obligation Ratings:
There are three rating categories for short-term municipal obligations that are considered investment grade. These ratings are designated as Municipal Investment Grade (MIG) and are divided
into three levels-MIG 1 through MIG 3. In addition, those short-term obligations that are of speculative quality are designated SG, or speculative grade. MIG ratings expire at the maturity of the obligation.
MIG 1
This designation denotes superior credit quality. Excellent protection is afforded by established cash
flows, highly reliable liquidity support, or demonstrated broad-based access to the market for refinancing.
MIG
2
This designation denotes strong credit quality. Margins of protection are ample, although not as large as in the preceding group.
MIG 3
This designation denotes acceptable credit quality. Liquidity and cash-flow protection may be narrow, and market access for refinancing is likely to be less well-established.
SG
This designation denotes speculative-grade credit quality. Debt instruments in this category may lack sufficient margins
of protection.
A-2
Description of Moodys Demand Obligation Ratings:
In the case of variable rate demand obligations (VRDOs), a two-component rating is assigned; a long or short-term debt rating
and a demand obligation rating. The first element represents Moodys evaluation of the degree of risk associated with scheduled principal and interest payments. The second element represents Moodys evaluation of the degree of risk
associated with the ability to receive purchase price upon demand (demand feature), using a variation of the MIG rating scale, the Variable Municipal Investment Grade or VMIG rating. When either the long-or short-term aspect of a VRDO is
not rated, that piece is designated NR,
e.g.
, Aaa/NR or NR/VMIG 1. VMIG rating expirations are a function of each issues specific structural or credit features.
VMIG 1
This designation denotes superior credit quality. Excellent protection is afforded by the superior short-term credit strength of the liquidity provider and structural and legal
protections that ensure the timely payment of purchase price upon demand.
VMIG 2
This designation denotes strong
credit quality. Good protection is afforded by the strong short-term credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of purchase price upon demand.
VMIG 3
This designation denotes acceptable credit quality. Adequate protection is afforded by the satisfactory short-term
credit strength of the liquidity provider and structural and legal protections that ensure the timely payment of purchase price upon demand.
SG
This designation denotes speculative-grade credit quality. Demand features rated in this category may be supported by a liquidity provider that does not have an investment grade short-term
rating or may lack the structural and/or legal protections necessary to ensure the timely payment of purchase price upon demand.
Description of Moodys Short-Term Prime Ratings:
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.
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.
Description of Standard & Poors Long-Term Issue Credit
Ratings:
Issue credit ratings are based, in varying degrees, on the following considerations: (1) likelihood of
paymentcapacity and willingness of the obligor to meet its financial commitment on an obligation in
A-3
accordance with the terms of the obligation; (2) nature of and provisions of the obligation; and (3) protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy and other laws affecting creditors rights.
The issue rating definitions are expressed in terms of default risk. As such, they pertain to senior obligations of an entity. Junior
obligations are typically rated lower than senior obligations, to reflect the lower priority in bankruptcy, as noted above. (Such differentiation applies when an entity has both senior and subordinated obligations, secured and unsecured obligations,
or operating company and holding company obligations.) Accordingly, in the case of junior debt, the rating may not conform exactly with the category definition.
AAA
An obligation rated AAA has the highest rating assigned by Standard & Poors. The obligors capacity to meet its financial commitments on the obligation is
extremely strong.
AA
An obligation rated AA differs from the highest-rated obligations only to a
small degree. The obligors capacity to meet its financial obligations 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.
BB, B, CCC, CC, and C
Obligations rated BB, B, CCC, CC, and C are
regarded as having significant speculative characteristics. BB indicates the least degree of speculation and C the highest. While such obligations will likely have some quality and protective characteristics, these may be
outweighed by large uncertainties or major 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. 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 subordinated debt or preferred stock obligation
rated C is currently highly vulnerable to nonpayment. The C rating may be used to cover a situation where a bankruptcy petition has been filed or similar action taken, but payments on this obligation are being continued. A
C also will be assigned to a preferred stock issue in arrears on dividends or sinking fund payments, but that is currently paying.
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 &
A-4
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.
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.
N.R.: 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.
Active Qualifiers (Currently applied and/or outstanding)
i: This subscript is used for issues in which the credit factors, terms, or both, that determine the likelihood of receipt of payment of
interest are different from the credit factors, terms or both that determine the likelihood of receipt of principal on the obligation. The i subscript indicates that the rating addresses the interest portion of the obligation only. The
i subscript will always be used in conjunction with the p subscript, which addresses likelihood of receipt of principal. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that the
principal portion is rated AAA and the interest portion of the obligation is not rated.
L: Ratings qualified with
L apply only to amounts invested up to federal deposit insurance limits.
p: This subscript is used for issues in
which the credit factors, the terms, or both, that determine the likelihood of receipt of payment of principal are different from the credit factors, terms or both that determine the likelihood of receipt of interest on the obligation. The
p subscript indicates that the rating addresses the principal portion of the obligation only. The p subscript will always be used in conjunction with the i subscript, which addresses likelihood of receipt of
interest. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that the principal portion is rated AAA and the interest portion of the obligation is not rated.
pi: Ratings with a pi subscript are based on an analysis of an issuers published financial information, as well as
additional information in the public domain. They do not, however, reflect in-depth meetings with an issuers management and are therefore based on less comprehensive information than ratings without a pi subscript. Ratings with a
pi subscript are reviewed annually based on a new years financial statements, but may be reviewed on an interim basis if a major event occurs that may affect the issuers credit quality.
pr: The letters pr indicate that the rating is provisional. A provisional rating assumes the successful completion of the
project financed by the debt being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful, timely completion of the project. This rating, however, while addressing credit quality subsequent
to completion of the project, makes no comment on the likelihood of or the risk of default upon failure of such completion. The investor should exercise his own judgment with respect to such likelihood and risk.
preliminary: Preliminary ratings are assigned to issues, including financial programs, in the following circumstances. Preliminary
ratings may be assigned to obligations, most commonly structured and project finance issues, pending receipt of final documentation and legal opinions. Assignment of a final rating is conditional on the receipt and approval by Standard &
Poors of appropriate documentation. Changes in the information provided to Standard & Poors could result in the assignment of a different rating. In addition, Standard & Poors reserves the right not to issue a
final rating. Preliminary ratings are assigned to Rule 415 Shelf Registrations. As specific issues, with defined terms, are offered from the master registration, a final rating may be assigned to them in accordance with Standard &
Poors policies. The final rating may differ from the preliminary rating.
t: This symbol indicates termination
structures that are designed to honor their contracts to full maturity or, should certain events occur, to terminate and cash settle all their contracts before their final maturity date.
A-5
Local Currency and Foreign Currency Risks: Country risk considerations are a standard part
of Standard & Poors analysis for credit ratings on any issuer or issue. Currency of repayment is a key factor in this analysis. An obligors capacity to repay foreign currency obligations may be lower than its capacity to repay
obligations in its local currency due to the sovereign governments own relatively lower capacity to repay external versus domestic debt. These sovereign risk considerations are incorporated in the debt ratings assigned to specific issues.
Foreign currency issuer ratings are also distinguished from local currency issuer ratings to identify those instances where sovereign risks make them different for the same issuer.
Description of Standard & Poors Ratings of Notes:
A
Standard & Poors U.S. municipal note rating reflects the liquidity factors and market access risks unique to notes. Notes due in three years or less will likely receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria will be used in making that assessment:
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|
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Amortization schedulethe larger the final maturity relative to other maturities, the more likely it will be treated as a note; and
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Source of paymentthe more dependent the issue is on the market for its refinancing, the more likely it will be treated as a note.
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Note rating symbols are as follows:
SP-1
Strong capacity to pay principal and interest. An issue determined to possess a very strong capacity to pay debt service
is given a plus (+) designation.
SP-2
Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the notes.
SP-3
Speculative capacity to
pay principal and interest.
Description of Standard & Poors Short-Term Issue Credit Ratings:
A-1
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 commitments is
extremely strong.
A-2
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
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.
A-6
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.
Active Qualifiers (Currently applied and/or outstanding)
i: This subscript is
used for issues in which the credit factors, terms, or both, that determine the likelihood of receipt of payment of interest are different from the credit factors, terms or both that determine the likelihood of receipt of principal on the
obligation. The i subscript indicates that the rating addresses the interest portion of the obligation only. The i subscript will always be used in conjunction with the p subscript, which addresses likelihood of
receipt of principal. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that the principal portion is rated AAA and the interest portion of the obligation is not rated.
L: Ratings qualified with L apply only to amounts invested up to federal deposit insurance limits.
p: This subscript is used for issues in which the credit factors, the terms, or both, that determine the likelihood of receipt of payment
of principal are different from the credit factors, terms or both that determine the likelihood of receipt of interest on the obligation. The p subscript indicates that the rating addresses the principal portion of the obligation only.
The p subscript will always be used in conjunction with the i subscript, which addresses likelihood of receipt of interest. For example, a rated obligation could be assigned ratings of AAAp NRi indicating that the
principal portion is rated AAA and the interest portion of the obligation is not rated.
pi: Ratings with a
pi subscript are based on an analysis of an issuers published financial information, as well as additional information in the public domain. They do not, however, reflect in-depth meetings with an issuers management and are
therefore based on less comprehensive information than ratings without a pi subscript. Ratings with a pi subscript are reviewed annually based on a new years financial statements, but may be reviewed on an interim basis
if a major event occurs that may affect the issuers credit quality.
pr: The letters pr indicate that the
rating is provisional. A provisional rating assumes the successful completion of the project financed by the debt being rated and indicates that payment of debt service requirements is largely or entirely dependent upon the successful, timely
completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood of or the risk of default upon failure of such completion. The investor should exercise his
own judgment with respect to such likelihood and risk.
preliminary: Preliminary ratings are assigned to issues, including
financial programs, in the following circumstances. Preliminary ratings may be assigned to obligations, most commonly structured and project
A-7
finance issues, pending receipt of final documentation and legal opinions. Assignment of a final rating is conditional on the receipt and approval by Standard & Poors of
appropriate documentation. Changes in the information provided to Standard & Poors could result in the assignment of a different rating. In addition, Standard & Poors reserves the right not to issue a final rating.
Preliminary ratings are assigned to Rule 415 Shelf Registrations. As specific issues, with defined terms, are offered from the master registration, a final rating may be assigned to them in accordance with Standard & Poors policies.
The final rating may differ from the preliminary rating.
t: This symbol indicates termination structures that are designed to
honor their contracts to full maturity or, should certain events occur, to terminate and cash settle all their contracts before their final maturity date. Local Currency and Foreign Currency Risks: Country risk considerations are a standard part of
Standard & Poors analysis for credit ratings on any issuer or issue. Currency of repayment is a key factor in this analysis. An obligors capacity to repay foreign currency obligations may be lower than its capacity to repay
obligations in its local currency due to the sovereign governments own relatively lower capacity to repay external versus domestic debt. These sovereign risk considerations are incorporated in the debt ratings assigned to specific issues.
Foreign currency issuer ratings are also distinguished from local currency issuer ratings to identify those instances where sovereign risks make them different for the same issuer.
Description of Standard & Poors Ratings of Commercial Paper:
A Standard & Poors commercial paper rating is a current assessment of the likelihood of timely payment of debt having an
original maturity of no more than 365 days. Ratings are graded into several categories, ranging from A for the highest-quality obligations to D for the lowest. These categories are as follows:
A-1
This designation indicates that the degree of safety regarding timely payment is strong. Those issues determined to
possess extremely strong safety characteristics are denoted with a plus sign (+) designation.
A-2
Capacity
for timely payment on issues with this designation is satisfactory. However, the relative degree of safety is not as high as for issues designated A-1.
A-3
Issues carrying this designation have an adequate capacity for timely payment. They are, however, more vulnerable to the adverse effects of changes in circumstances than obligations
carrying the higher designations.
B
Issues rated B are regarded as having only speculative capacity
for timely payment.
C
This rating is assigned to short-term debt obligations with a doubtful capacity for
payment.
D
Debt rated D is in payment default. The D rating category is used when
interest payments of principal payments are not made on the date due, even if the applicable grace period has not expired, unless Standard & Poors believes such payments will be made during such grace period.
Description of Standard & Poors 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 debt rating symbols are used for bonds to denote the long-term maturity and the commercial paper rating symbols for the put option (for example, AAA/A-1+). With short-term demand debt, Standard &
Poors note rating symbols are used with the commercial paper rating symbols (for example, SP-1+/A-1+).
A-8
Description of Fitch Ratings 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.
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 is 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. For issuers and performing obligations, 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. For individual obligations,
B ratings may indicate distressed or defaulted obligations with potential for extremely high recoveries. Such obligations would possess a Recovery Rating of R1 (outstanding).
CCC
For issuers and performing obligations, default is a real possibility. Capacity for meeting financial commitments is
solely reliant upon sustained, favorable business or economic conditions. For individual obligations, may indicate distressed or defaulted obligations with potential for average to superior levels of recovery. Differences in credit quality may be
denoted by plus/minus distinctions. Such obligations typically would possess a Recovery Rating of R2 (superior), or R3 (good) or R4 (average).
CC
For issuers and performing obligations, default of some kind appears probable. For individual obligations, may indicate
distressed or defaulted obligations with a Recovery Rating of R4 (average) or R5 (below average).
C
For issuers and performing obligations, default is imminent. For individual obligations, may indicate distressed or
defaulted obligations with potential for below-average to poor recoveries. Such obligations would possess a Recovery Rating of R6 (poor).
A-9
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: (i) failure of an obligor to make timely
payment of principal and/or interest under the contractual terms of any financial obligation; (ii) the bankruptcy filings, administration, receivership, liquidation or other winding-up or cessation of business of an obligor; or (iii) 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.
Description of Fitch Ratings International Short-Term Credit Ratings:
International Short-Term Credit Ratings may also be referred to as Short-Term Ratings. 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 U.S. public finance, in line with industry standards, to reflect unique characteristics of
bond, tax, and revenue anticipation notes that are commonly issued with terms up to three years. Short-term ratings thus places 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 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
Default. Indicates an entity or sovereign that has
defaulted on all of its financial obligations.
A-10
Notes to Fitch Ratings International Long-Term and Short-Term Credit Ratings:
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.)
Rating Watch: Ratings are placed on Rating Watch to notify
investors that there is a reasonable probability of a rating change and the likely direction of such change. These are designated as Positive, indicating a potential upgrade, Negative, for a potential downgrade, or
Evolving, if ratings may be raised, lowered or maintained. Rating Watch is typically resolved over a relatively short period.
Rating Outlook: An Outlook indicates the direction a rating is likely to move over a one to two-year period. Outlooks may be positive, stable or negative. A positive or negative Rating Outlook does not
imply a rating change is inevitable. Similarly, ratings for which outlooks are stable could be upgraded or downgraded before an outlook moves to positive or negative if circumstances warrant such an action. Occasionally, Fitch Ratings
may be unable to identify the fundamental trend. In these cases, the Rating Outlook may be described as evolving.
Program
ratings (such as the those assigned to MTN shelf registrations) relate only to standard issues made under the program concerned; it should not be assumed that these ratings apply to every issue made under the program. In particular, in the case of
non-standard issues,
i.e.
, those that are linked to the credit of a third party or linked to the performance of an index, ratings of these issues may deviate from the applicable program rating.
Variable rate demand obligations and other securities which contain a short-term put or other similar demand feature will
have a dual rating, such as AAA/F1+. The first rating reflects the ability to meet long-term principal and interest payments, whereas the second rating reflects the ability to honor the demand feature in full and on time.
Interest Only: Interest Only ratings are assigned to interest strips. These ratings do not address the possibility that a security holder
might fail to recover some or all of its initial investment due to voluntary or involuntary principal repayments.
Principal
Only: Principal Only ratings address the likelihood that a security holder will receive their initial principal investment either before or by the scheduled maturity date.
Rate of Return: Ratings also may be assigned to gauge the likelihood of an investor receiving a certain predetermined internal rate of return without regard to the precise timing of any cash flows.
PIF: Paid-in-Full; denotes a security that is paid-in-full, matured, called, or refinanced.
NR indicates that Fitch Ratings does not rate the issuer or issue in question.
Withdrawn: A rating is withdrawn when Fitch Ratings deems the amount of information available to be inadequate for rating
purposes, or when an obligation matures, is called, or refinanced, or for any other reason Fitch Ratings deems sufficient.
A-11