H&Q HEALTHCARE INVESTORS
STATEMENT OF ADDITIONAL INFORMATION
H&Q Healthcare Investors (the "Trust") is a diversified, closed-end
management investment company registered under the Investment Company Act of
1940, as amended (the "Investment Company Act"). The Trust's investment
objective is to seek long-term capital appreciation by investing primarily in
securities of companies in the health services and medical technology
(healthcare) industries ("Healthcare Companies"). The Trust will invest
primarily in securities of companies that are believed by the Trust's investment
adviser to have significant potential for above-average, long-term growth in
revenues and earnings. The Trust emphasizes investment in securities of emerging
growth Healthcare Companies, most of which are expected to be traded in the
over-the-counter market. The Trust may also invest up to 40% of its net assets
in venture capital or other securities subject to legal or contractual
restrictions as to resale ("Restricted Securities"). Such securities may be
acquired in connection with venture capital opportunities, as well as in private
placements in public companies. No assurance can be given that the Trust will
achieve its investment objective. The Trust's investment adviser is Hambrecht &
Quist Capital Management Incorporated (the "Investment Adviser"), the President
and sole Director of which is Alan G. Carr, who is responsible for management of
the Trust's portfolio.
This Statement of Additional Information ("SAI") is not a prospectus, but
should be read in conjunction with the Prospectus for the Trust dated
February 7, 1997 (the "Prospectus"). This SAI does not include all information
that a prospective investor should consider before purchasing shares of
beneficial interest ("Shares") of the Trust, and investors should obtain and
read the Prospectus prior to purchasing Shares. A copy of the Prospectus may be
obtained without charge, by calling the Trust (617) 574-0567. This SAI
incorporates by reference the entire Prospectus.
TABLE OF CONTENTS
PAGE
Additional Information About Investments and Investment Techniques........ 2
Investment Restrictions................................................... 7
Trustees and Officers..................................................... 10
The Trust................................................................. 11
Investment Advisory Agreement............................................. 14
Net Asset Value........................................................... 17
Portfolio Transactions and Brokerage...................................... 18
Dividend Reinvestment Plan................................................ 21
Tax Matters............................................................... 22
Custodian, Transfer Agent, Dividend Disbursing Agent and Registrar........ 28
The Prospectus and this SAI omit certain of the information contained in
the registration statement filed with the Securities and Exchange Commission
(the "Commission"), Washington, D.C. The registration statement may be obtained
from the Commission upon payment of the fee prescribed, or inspected at the
Commission's office at no charge.
This SAI is dated February 7, 1997.
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ADDITIONAL INFORMATION ABOUT INVESTMENTS
AND INVESTMENT TECHNIQUES
Some of the different types of securities in which the Trust may invest,
subject to its investment objective, policies and restrictions, are described in
the Prospectus under "Investment Objectives and Policies" and "Appendix A -
Description of Risk Factors and Investment Techniques." Additional information
concerning certain of the Trust's investments and investment techniques is set
forth below.
When-Issued and Delayed Delivery Transactions
The Trust may purchase securities on a "when issued" basis or a "delayed
delivery" basis. "When-issued" securities are securities whose terms are
available and for which a market exists, but which are not available for
immediate delivery. "Delayed delivery" transactions are those in which the Trust
purchases a security but settlement of the transaction is to occur after the
customary settlement date. The Trust will enter into such transactions for the
purpose of acquiring securities that it wishes to purchase but that are not
currently available for purchase. The Trust may dispose of a commitment to
purchase prior to settlement. However, the Trust does not intend to make such
purchases for speculative purposes. When such transactions are negotiated, the
purchase price is fixed at the time the commitment is made, but delivery and
payment for the securities take place at a later date. During the period between
commitment and settlement, no payment is made for the securities purchased, and
no interest or dividends accrue to the Trust. However, the securities are
subject to market fluctuation, and the value at settlement may be less than the
purchase price. While awaiting settlement, the Trust will maintain with its
custodian a segregated account consisting of liquid securities, which may
include cash, obligations of the U.S. Government, its agencies or
instrumentalities ("U.S. Government Securities"), debt obligations or equity
securities having a value at least equal to its purchase commitments. The
commitment to purchase a security for which payment will be made on a future
date may be deemed a separate security and involves a risk of loss if the
security declines prior to the settlement date, which risk is in addition to the
risk of decline of the Trust's other assets.
Repurchase Agreements
A repurchase agreement is an agreement under which the Trust acquires a
security subject to the obligation of the seller to repurchase and the Trust to
resell such security at a fixed time and price (representing the Trust's cost
and interest). It is the Trust's present intention to enter into repurchase
agreements for a relatively short period (usually not more than one week) only
with commercial banks and registered broker-dealers and only with respect to
U.S. Government Securities and money market instruments. Repurchase agreements
may also be viewed as loans made by the Trust, which are collateralized by the
securities subject to repurchase. The Trust intends to take possession of
collateral, and the Investment Adviser will monitor repurchase
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transactions to ensure that the value of the underlying securities will at all
times be at least equal to the total amount of the repurchase obligation,
including the interest factor. If the seller defaults the Trust could realize a
loss on the sale of the underlying security to the extent that the proceeds of
sale, including accrued interest, are less than the resale price provided in the
agreement, including interest. In addition, if the seller should be involved in
bankruptcy or insolvency proceedings, the Trust may incur delay and costs in
selling the underlying security or may suffer a loss of principal and interest
if the Trust is treated as an unsecured creditor and required to return the
underlying collateral to the seller. The Trust may not enter into repurchase
agreements with respect to more than 10% of its net assets.
Loans of Portfolio Securities
In an attempt to make productive use of its assets, the Trust may lend its
portfolio securities, subject to the limitation that the Trust will not lend a
security if, as a result of such loan, all securities then subject to loans
would exceed 20% of the Trust's net assets. Under applicable regulatory
requirements (which are subject to change), the loan collateral must, on each
business day, be at least equal to the value of the loaned securities and must
consist of cash, bank letters of credit or U.S. Government Securities. To be
acceptable as collateral, letters of credit must obligate a bank to pay amounts
demanded by the Trust if the demand meets the terms of the letter. Such terms
and the issuing bank must be satisfactory to the Trust. When the Trust lends a
security, it continues to be entitled to receive any dividends or interest on
the loaned security and also receives one or more of: (i) a negotiated loan fee;
(ii) interest on securities used as collateral for the loan; or (iii) interest
on short-term debt securities purchased with the loan collateral. Either type of
interest may be shared with the borrower of the security. The Trust may also pay
reasonable finder's, custodian and administrative fees. The terms of the Trust's
loans of securities must meet certain requirements under the Internal Revenue
Code of 1986, as amended, (the "Code") such as providing that the Trust may
terminate the loan upon no more than five days' notice, and must permit the
Trust to reacquire loaned securities in time to vote on any important matter.
The Trust will make such loans only to banks and dealers with which it may enter
into repurchase agreements. If the borrower fails to return the loaned security,
the Trust's risks include: (1) any costs in disposing of the collateral; (2)
loss from a decline in value of the collateral to an amount less than 100% of
the securities loaned; (3) being unable to exercise its voting or consent rights
with respect to the security; (4) any loss arising from the Trust being unable
to settle a sale of such securities in a timely manner; and (5) the inability of
the Trust to reacquire the loaned securities.
Hedging
In order to hedge against changes in the value of its portfolio securities,
the Trust may from time to time engage in certain hedging strategies.
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The Trust will engage in hedging activities from time to time at the
Investment Adviser's discretion, and may not necessarily be engaging in such
activities when movements in the securities markets, foreign exchange rates, or
interest rates that could affect the value of the assets of the Trust occur. The
Trust's ability to pursue certain of these strategies may be limited by
applicable regulations of the Commodity Futures Trading Commission ("CFTC") and
the federal income tax requirements applicable to regulated investment
companies.
Although the Trust believes that use of such strategies will benefit the
Trust, if the Investment Adviser's judgment about the general direction of
securities market movements, foreign exchange rates or interest rates is
incorrect, the Trust's overall performance could be poorer than if it had not
pursued those strategies. Moreover, changes in the value of the instruments that
the Trust purchases to hedge its portfolio securities may not correlate
precisely with changes in the value of the portfolio securities the Trust is
attempting to hedge. In addition, in situations where the Trust has insufficient
cash, it may have to sell assets from its portfolio to meet margin requirements
at a time when it may be disadvantageous to do so. The Trust's hedging
activities may also result in a higher portfolio turnover rate and additional
brokerage costs.
Futures Contracts
Futures Contracts. The Trust may enter into contracts for the purchase or sale
for future delivery (a "futures contract") of baskets of securities, financial
indices, financial instruments or foreign currencies. The Trust may purchase
or sell futures contracts to attempt to protect the value of its securities from
market-wide price movements and fluctuations in interest or foreign exchange
rates without actually buying or selling securities or foreign currency.
A "sale" of a futures contract (or a "short" futures position) means the
assumption of a contractual obligation to deliver the securities or currency
underlying the contract at a specified price and at a specified future time. A
"purchase" of a futures contract (or a "long" futures position) means the
assumption of a contractual obligation to acquire the securities or currency
underlying the contract at a specified price and at a specified future time.
Margin Requirements. At the time a futures contract is purchased or sold, the
Trust must allocate cash or securities as a deposit payment ("initial margin").
It is expected that the initial margin on U.S. exchanges may range from
approximately 3% to approximately 15% of the value of the securities or
commodities underlying the contract. Under certain circumstances, however, such
as periods of high volatility, the Trust may be required by an exchange to
increase the level of its initial margin payment. Additionally, initial margin
requirements may be increased generally in the future by regulatory action. An
outstanding futures contract is valued daily and the payment in cash of
"variation margin" may be required, a process known as "mark to the market."
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Regulatory Limitations on the Use of Futures Contracts. Regulations of the CFTC
applicable to the Trust currently require that all of the Trust's futures
transactions constitute bona fide hedging transactions or be undertaken
incidental to the Trust's activities in the securities markets. In accordance
with CFTC regulations, the Trust may not purchase or sell futures contracts if
immediately thereafter the sum of the amounts of initial margin deposits on the
Trust's existing futures positions would exceed 5% of the fair market value of
the Trust's total assets. The Investment Adviser reserves the right to comply
with such different standards as may be established by CFTC rules and
regulations with respect to the purchase or sale of futures contracts.
Considerations Concerning Futures Contracts and Options on Futures Contracts.
Futures contracts entail special risks. The ordinary spreads between values in
the cash and futures markets, due to differences in the character of these
markets, are subject to distortions relating to (1) investor's obligations to
meet additional variation margin requirements, (2) decisions to make or take
delivery, rather than entering into offsetting transactions and (3) the
difference between margin requirements in the securities markets and margin
deposit requirements in the futures markets. The possibility of such distortion
means that a correct forecast of general market, foreign exchange rate or
interest rate trends by the Investment Adviser may still not result in a
successful transaction. The Trust's ability to establish and close out positions
in futures contracts and options on futures contracts will be subject to the
development and maintenance of a liquid market. Although the Trust generally
will purchase or sell only those futures contracts and options for which
there appears to be a liquid market, there is no assurance that a liquid market
on an exchange will exist for any particular futures contract or option
at any particular time.
Under certain circumstances, exchanges may establish daily limits in the
amount that the price of a futures contract may vary either up or down from the
previous day's settlement price. Once the daily limit has been reached in a
particular contract, no trades may be made that day at a price beyond that
limit.
Exchange Rate Risk
The Trust may enter into forward foreign currency exchange contracts
("forward contracts") and may purchase and sell foreign currency futures
contracts to protect against a decline in the U.S. Dollar equivalent value of
its foreign currency portfolio securities or the payments thereon that may
result from an adverse change in foreign currency exchange rates. The accurate
projection of short-term currency market movements is extremely difficult, and
the successful execution of a short-term hedging strategy is highly uncertain.
Forward Contracts. A forward contract obligates one party to purchase and the
other party to sell a definite amount of a given foreign currency at some
specified future date.
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In some circumstances the purchase or sale of appropriate forward contracts may
help offset declines in the U.S. Dollar equivalent value of the Trust's foreign
currency denominated assets and income available for distribution to the Trust's
shareholders of record that result from adverse changes in the exchange rate
between the U.S. Dollar and the various foreign currencies in which the Trust's
assets or income may be denominated. The U.S. Dollar equivalent value of the
principal of and rate of return on foreign currency denominated securities will
decline if the exchange rate of the U.S. Dollar rises in relation to that
currency. Such declines could be partially or completely offset by an increase
in the value of a forward contract on that foreign currency.
While the use of foreign currency forward contracts may protect the Trust
against declines in the U.S. Dollar equivalent value of its assets, their use
will reduce the possible gain from advantageous changes in the value of the U.S.
Dollar against particular currencies in which their assets are denominated.
Moreover, the use of foreign currency forward contracts will not eliminate
fluctuations in the underlying U.S. Dollar equivalent value of the prices of or
rates of return on the assets held in the portfolio and the use of such
techniques will subject the Trust to certain risks.
The foreign exchange markets can be highly volatile, subject to sharp price
fluctuations. In addition, trading forward contracts can involve a degree of
leverage. As a result, relatively small movements in the rates of exchange
between the currencies underlying a contract could result in immediate and
substantial losses to the Trust. Trading losses that are not offset by
corresponding gains in assets being hedged could sharply reduce the value of the
Trust's portfolio.
Futures Contracts on Foreign Currencies. Buyers and sellers of foreign currency
futures contracts are subject to the same risks that apply to the use of futures
generally. In addition, there are risks associated with foreign currency futures
contracts and their use as hedging devices similar to those associated with
options on foreign currencies described above. Further, settlement of a foreign
currency futures contract must occur within the country issuing the underlying
currency. Thus, the Trust must accept or make delivery of the underlying foreign
currency in accordance with any U.S. or foreign restrictions or regulations
regarding the maintenance of foreign banking arrangements by U.S. residents and
may be required to pay any fees, taxes or charges associated with such delivery
that are assessed in the country of the underlying currency.
Coverage Requirements
All futures and forward currency contracts purchased or sold by the Trust
are required to be covered. When the Trust purchases a futures or forward
currency contract, this means that the Trust will maintain with the Trust's
custodian in a segregated account an amount of liquid securities, including
cash, U.S. Government Securities, debt obligations or equity securities, so that
the amount so segregated, plus
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the amount of initial and variation margin held in the account of its broker, if
applicable, equals the market value of the futures or forward currency contract.
When the Trust sells a futures or forward currency contract, this means
that during the life of the futures or forward currency contract the Trust will
own or have the contractual right to acquire the securities or foreign currency
subject to the futures or forward currency contract, or will maintain with the
Trust's custodian in a segregated account liquid securities, including cash,
U.S. Government Securities, debt obligations or equity securities, in an amount
at least equal to the market value of the securities or foreign currency
underlying the futures or forward currency contract.
If the market value of the contract moves adversely to the Trust, or if
the value of the securities in the segregated account declines, the Trust will
be required to deposit additional cash or securities in the segregated account
at a time when it may be disadvantageous to do so.
INVESTMENT RESTRICTIONS
The Trust has adopted certain fundamental restrictions, which, like its
investment objective, may not be changed without the affirmative vote of the
holders of a majority of the Trust's outstanding Shares. As used in this SAI, a
"majority of the Trust's outstanding Shares" means the lesser of (i) 67% of the
Shares represented at a meeting at which more than 50% of the outstanding Shares
are represented or (ii) more than 50% of the outstanding Shares. The Trust may
not:
1. With respect to 75% of its total assets, invest in securities of
any one issuer if immediately after and as a result of such investment more
than 5% of the total assets of the Trust, taken at market value, would be
invested in the securities of such issuer. This restriction does not apply
to investments in U.S. Government Securities.
2. Purchase more than 10% of the outstanding voting securities of any
one issuer.
3. Purchase or sell commodities or commodities contracts. The
prohibition on the purchase or sale of commodities applies to the purchase
or sale of "physical" commodities.
4. Purchase or sell real estate; provided that the Trust may invest in
securities secured by real estate or interests therein or issued by
companies which invest in real estate or interests therein.
5. Purchase any securities on margin or make short sales of
securities, except for short-term credit necessary for the clearance of
portfolio transactions.
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6. Underwrite securities of other issuers, except to the extent that,
in connection with the disposition of its portfolio securities, the Trust
may be deemed an underwriter under federal or state securities law. See
"Portfolio Transactions and Brokerage."
7. Invest less than 25% of its net assets in securities of companies
in the healthcare industries.
8. Invest more than 40% of the Trust's net assets in venture capital
or other Restricted Securities.
9. Issue senior securities or borrow amounts in excess of 10% of its
net assets at the time of borrowing, and then only from banks as a
temporary measure for extraordinary or emergency purposes or for the
repurchase of its securities. The Trust will not repurchase its securities
during periods when it has outstanding borrowings in excess of 5% of its
net assets. The Trust will not borrow for investment purposes.
10. Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the Trust,
except as may be necessary in connection with permitted borrowings under 9.
above.
11. Make loans of money, except by the purchase of debt obligations in
which the Trust may invest consistent with its investment objective and
policies. The Trust reserves the authority to enter into repurchase
agreements and to make loans of its portfolio securities to qualified
institutional investors, brokers, dealers, banks or other financial
institutions, so long as the terms of the loans are not inconsistent with
the requirements of the Investment Company Act. Such loans may not exceed
an aggregate amount of 20% of the Trust's net assets. Repurchase agreements
are subject to the percentage limitation described in investment policy 5.
below. See also "Repurchase Agreement."
12. Purchase securities of other investment companies except in
connection with a merger, consolidation, acquisition or reorganization, if
(a) more than 10% of its total assets would be invested in securities of
other investment companies, (b) more than 5% of its total assets would be
invested in the securities of any one investment company, or (c) the Trust
would own more than 3% of any other investment company's securities.
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In addition, the Trust has adopted the following investment policies, which
may be changed by the action of the Board of Trustees (the "Board") without
shareholder approval:
1. The Trust, under normal circumstances, will have at least 80% of
its net assets invested in securities of companies in Healthcare Companies.
2. To the extent not invested in the Healthcare Company assets of the
Trust will be invested in cash, U.S. Government Securities, money market
instruments or money market mutual funds for liquidity. When, in the
opinion of the Investment Adviser, adverse market conditions or industry
expectations support such action, the Trust may temporarily take a
defensive position of up to 75% of net assets in such liquid investments.
The money market instruments in which the Trust may invest include
certificates of deposit and bankers' acceptances issued by domestic
branches of federally-insured U.S. banks and savings and loan associations
and commercial paper and high and upper medium grade corporate debt
securities rated, as of the date of purchase, among the highest rating
categories of Moody's Investors Service Inc. (Aaa, Aa or A for bonds;
MIG-1, MIG-2 or MIG-3 for notes; P-1 for commercial paper) or Standard &
Poor's Corporation (AAA, AA or A for bonds; SP-1+ to SP-2 for notes; A-1
for commercial paper). The Trust also may invest in shares of money market
mutual funds that invest in money market instruments and U.S. Government
Securities. Money market mutual funds are investment companies and the
Trust's investments in those companies are subject to the limitations set
forth in 12 under "Investment Restrictions." As a shareholder in money
market mutual funds, the Trust will bear its ratable share of such
companies' expenses, including investment adviser or management fees, and
will remain subject to payment of fees to the Investment Adviser.
3. Investments will not be made in any company with the objective of
exercising control over that company's management, and the Trust generally
will not provide managerial assistance to any such company as is normally
the case with venture capital funds. The Trust, however, may make
investments as a co-investor with other venture capital groups that may
provide issuers with significant managerial assistance.
4. The Trust may invest up to 5% of its net assets in warrants, valued
at market value. Warrants acquired in units or attached to other securities
are not subject to this restriction.
5. The Trust may not enter into repurchase agreements with respect to
more than 10% of its net assets. It is the Trust's present intention to
enter into repurchase agreements for a relatively short period (usually not
more than one week) only with commercial banks and registered
broker-dealers and only with
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respect to U.S. Government Securities and money market instruments. The
Trust does not intend to enter into repurchase agreements with Hambrecht &
Quist LLC ("H&Q"). Repurchase agreements may also be viewed as loans made
by the Trust which are collateralized by the securities subject to
repurchase. The Trust intends to take possession of collateral, and the
Investment Adviser will monitor repurchase transactions to ensure that the
value of the underlying securities will be at least equal at all times to
the total amount of the repurchase obligation, including the interest
factor. See also "Repurchase Agreements."
6. The Trust may not invest more than 20% of its net assets at the
time of purchase in securities of foreign issuers. Such issuers are
expected to be companies domiciled in Canada, Western Europe and Japan.
The Trust may buy and sell foreign currencies for the purpose of settlement
of transactions in foreign securities, but presently does not intend to
engage in hedging operations such as buying contracts for purchase in the
future of foreign currencies. Any such hedging operations would be limited
to 5% of net assets.
7. The Trust may not invest in put or call options.
Except as otherwise noted, all percentage limitations set forth above apply
immediately after a purchase and a subsequent change in the applicable
percentage resulting from market fluctuations does not require elimination of
any security from the portfolio.
TRUSTEES AND OFFICERS
Board of Trustees
For the names and addresses of the Trust's Trustees and Officers, a
description of their positions with the Trust and their principal occupations
during the last 5 years, see "Trustees and Officers" in the Trust's Prospectus.
Compensation of Trustees
The Trust pays each of the Trustees not affiliated with the Investment
Adviser a fee of $6,000 annually and $900 for each meeting of the Board
attended, together with such Trustee's actual out-of-pocket expenses relating to
attendance at meetings. For the fiscal years ended September 30, 1996 and
September 30, 1995 the Trust paid such fees and reimbursed such expenses
amounting to $56,663 and $49,109, respectively, in the aggregate.
The following table sets forth information regarding compensation of
Trustees by the Trust and other funds managed by the Investment Adviser for the
fiscal year ended
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September 30, 1996. Officers of the Trust and Trustees who are interested
persons of the Trust do not receive any compensation from the Trust or any other
funds managed by the Investment Adviser.
Compensation Table
For the Fiscal Year ended September 30, 1996
Aggregate Accrued Pension Total
Disinterested Compensation or Retirement Compensation
Trustee from the Trust Benefits from Fund Complex
(2 funds)
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Lawrence S. Lewin $9,600 None $19,200
Robert P. Mack, M.D. $9,600 None $19,200
Eric Oddleifson $9,600 None $19,200
Uwe E. Reinhardt, Ph.D. $9,600 None $19,200
Henri A. Termeer $8,700 None $17,400
To the knowledge of the Trust, as of January 2, 1997, there are no
control persons of the Trust. On January 2, 1997, the Trustees and
officers of the Trust owned as a group beneficially and of record less than 1%
of the Trust's outstanding Shares.
THE TRUST
The Trust's capitalization consists of an unlimited number of Shares, $.01
par value. Each Share represents an equal proportionate beneficial interest in
the Trust and, when issued and outstanding, will be fully paid and
non-assessable by the Trust. Upon any liquidation of the Trust, shareholders
will be entitled to share pro rata in the net assets of the Trust available for
distribution. The Trust will send annual and semi-annual financial statements to
shareholders and may also issue more abbreviated interim reports to update
shareholders on a quarterly basis. The Trust will hold annual meetings of its
shareholders in accordance with the provisions of the Trust's Declaration of
Trust and By-laws and the rules of the New York Stock Exchange ("NYSE").
Shareholders are entitled to one vote for each Share held. The Trust's
Shares do not have cumulative voting rights, which means that the holders of
more than 50% of the Shares of the Trust voting for the election of Trustees can
elect all of the Trustees, and, in such event, the holders of the remaining
Shares will not be able to elect any Trustees. The Trust has a staggered Board,
whereby one class of Trustees is elected each year.
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of such a trust under
certain circumstances may be determined to be personally liable as partners for
the Trust's obligations. However, the Trust's Declaration of Trust contains an
express disclaimer of shareholder
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liability for the acts or obligations of the Trust and provides for
indemnification and reimbursement of expenses out of the Trust's property for
any shareholder held personally liable for the obligations of the Trust. Thus,
the risk of a shareholder incurring financial loss on account of a Trust
liability is limited to circumstances in which the Trust is unable to meet its
obligations from the liquidation of its portfolio investments.
The overall management of the Trust is vested in the Board. The Board
approves all significant agreements between the Trust and persons or companies
furnishing services to it, including the Trust's agreements with its Investment
Adviser, Custodian, any foreign sub-custodians, Registrar and Transfer Agent.
The management of the day-to-day operations of the Trust is delegated to its
officers and to the Investment Adviser, subject always to the investment
objective and policies of the Trust and to general supervision by the Board.
In addition, the Declaration of Trust requires the affirmative vote or
consent of the holders of 75% of the Shares of the Trust to authorize certain
transactions with a person or entity that is directly, or indirectly through
affiliates, the beneficial owner of 5% or more of the outstanding Shares of the
Trust. These provisions will make it more difficult to change the management of
the Trust and could have the effect of depriving Shareholders of an opportunity
to sell their Shares at a premium over prevailing market prices by discouraging
a third party from seeking to obtain control of the Trust in a tender offer or
similar transaction. See "The Trust" in the Fund's Prospectus.
Repurchases of Shares and Tender Offers
The Trust is a closed-end management investment company and as such its
shareholders do not, and will not, have the right to redeem their Shares of the
Trust. The Trustees, however, intend to consider, from time to time, but not
less frequently than annually, the desirability of open market purchases or
tender offers. Any such repurchases will be made in accordance with the
applicable provisions of the Investment Company Act and Massachusetts law in
open market transactions. Shares repurchased by the Trust will be held in its
treasury. Although the Trust has no present intention of doing so, it reserves
the right to incur debt to finance such repurchases or tender offers, provided
that it will not repurchase securities during the periods when it has
outstanding borrowings in excess of 5% of its net assets. See "Investment
Restrictions." Interest on any borrowings to finance Share repurchase
transactions will increase the Trust's expenses and will reduce the Trust's net
income. There can be no assurance that Share repurchases, if any, will cause the
Shares to trade at a price equal to or in excess of their net asset value.
Nevertheless, the possibility that a portion of the Trust's outstanding Shares
may be the subject of repurchases may reduce the spread between market price and
net asset value that might otherwise exist. The Trust may not repurchase Shares
except (i) on a securities exchange and after notification to shareholders of
its intent to
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purchase Shares within the six months preceding the purchase, (ii) pursuant to a
tender offer to all shareholders or (iii) as otherwise permitted by the
Commission.
The Shares of the Trust will trade in the open market at a price which will
be a function of several factors, including their supply, demand, investment
performance and yield. The shares of closed-end investment companies generally
sell at market prices varying from their net asset value ("NAV") and such shares
frequently trade at a discount to NAV, but in some cases trade at a premium. The
market price of the Shares will be determined by factors including trading
volume of such Shares, general market and economic conditions and other factors
beyond the control of the Trust. Therefore, the Trust cannot predict whether its
Shares will trade at, below or above NAV. When the Trust repurchases its Shares
for a price below their NAV, the NAV of those Shares that remain outstanding
will be enhanced, but this does not necessarily mean that the market price of
those outstanding Shares will be affected, either positively or negatively.
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Conversion to Open-End Investment Company Status
The conversion of the Trust from a closed-end to an open-end investment
company would require an amendment to the Declaration of Trust. Such an
amendment would require the favorable vote of the holders of a majority of the
Shares of the Trust entitled to vote on the matter. Such a vote would also
satisfy a separate requirement in the Investment Company Act that the change be
approved by the Shareholders. The amendment would have to be approved by the
Board prior to its submission to Shareholders. The Board is required under the
Declaration of Trust to consider and vote annually upon the proposal to convert
to open-end status. A proposal to convert the Trust to an open-end company might
be supported or opposed by the Board depending on the Board's judgment as to its
advisability in light of circumstances prevailing at the time. Shareholders of
an open-end investment company may require the company to redeem their shares at
any time (except in certain circumstances as authorized by or under the
Investment Company Act) at their NAV, less such redemption charge, if any, as
might be in effect at the time of a redemption. Conversion to an open-end
investment company could require the disposal of illiquid investments to meet
current requirements of the Commission that no more than 15% of an open-end
investment company's assets consist of illiquid securities, and would likely
require involuntary liquidation of portfolio securities, and the inherent
realization of net long-term capital gains in connection therewith, to meet
periodic requests for redemption. Moreover, Shares of the Trust would no longer
be listed on the NYSE.
INVESTMENT ADVISORY AGREEMENT
The Investment Advisory Agreement between the Investment Adviser and the
Trust (the "Advisory Agreement") provides that, subject to the supervision and
direction of the Board, the Investment Adviser is responsible for the actual
management of the
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Trust's portfolio. The Investment Adviser is also obligated to supervise or
perform certain administrative and management services for the Trust and is
obligated to provide the office space, facilities, equipment and personnel
necessary to perform its duties under the Advisory Agreement. The responsibility
for making decisions to buy, sell or hold a particular security rests with the
Investment Adviser. However, the Investment Adviser may consider investment
analysis from various sources, including broker-dealers with which the Trust
does business. See "Portfolio Transactions and Brokerage."
For the services provided by the Investment Adviser under the Advisory
Agreement, the Trust will pay a fee, computed and payable monthly, equal when
annualized to (i) 2.5% of the average net assets for such month of its
Restricted Securities up to 25% of net assets; and (ii) 1.0% of the average net
assets for such month of all other assets. The aggregate monthly fee paid to the
Investment Adviser may not exceed when annualized 1.375% of the Trust's average
total net assets for such month (approximately .115% per month).
The Investment Adviser will not participate directly in the capital
appreciation of Restricted Securities or generally provide managerial assistance
to portfolio companies, as is normally the case with venture capital funds. For
purposes of calculation of the investment advisory fee, "average net assets" for
any month shall be equal to the average of the net asset value of such assets as
of the last business day of such month and the net asset value of the
appropriate assets as of the last business day of the preceding month. The
investment advisory fee paid by the Trust exceeds that paid by most registered
investment companies to their investment advisers. The Trust believes that the
fee is commensurate with the nature and quality of the services required for
identifying, evaluating and monitoring the Trust's Restricted Securities
investments.
The Advisory Agreement also provides that the Investment Adviser shall not
be liable for any error of judgment or for any loss suffered by the Trust in
connection with matters to which the Advisory Agreement relates, except a loss
resulting from a breach of fiduciary duty with respect to the receipt of
compensation for services or a loss resulting from wilful misfeasance, bad faith
or gross negligence on the part of the Investment Adviser in the performance of
its duties or from reckless disregard by the Investment Adviser of its
obligations and duties under the Advisory Agreement.
For the fiscal years ended September 30, 1996, September 30, 1995 and
September 30, 1994, the Trust paid the Adviser $1,961,266, $1,336,950 and
$1,348,897, respectively, in advisory fees.
The services of the Investment Adviser to the Trust are not deemed to be
exclusive, and nothing in the Advisory Agreement prevents the Investment
Adviser, or any affiliate thereof, from providing similar services to other
companies and other clients or from engaging in other activities.
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The Advisory Agreement obligates the Investment Adviser to pay all
compensation for officers and employees of the Trust connected with investment
and economic research, trading and investment management for the Trust. Under
the Advisory Agreement, the Trust is responsible for all other expenses incurred
in its organization and operation including, among other things, expenses
related to the offer of Shares, expenses for legal and auditing services; costs
of printing proxies, prospectuses, stock certificates and shareholder reports;
charges of the custodian, any sub-custodian and transfer agent; expenses in
connection with the Plan; Commission and National Association of Securities
Dealers, Inc. fees; fees and expenses of unaffiliated Trustees; accounting and
valuation costs; membership fees in trade associations; fidelity bond coverage
for the Trust's officers and employees; errors and omissions insurance coverage
for Trustees and officers; interest; brokerage costs; taxes; stock exchange
listing fees and expenses; expenses of qualifying the Trust's Shares for sale in
various states; expenses associated with personnel performing exclusively
shareholder servicing functions; litigation and other extraordinary or
non-recurring expenses and other expenses properly payable by the Trust. The
Trust may enter into arrangements to have third parties assume any expenses for
which it is responsible.
The Advisory Agreement was initially approved by the Trustees of the Trust,
including a majority of Trustees who are not parties to the agreement or
interested persons (as defined in the Investment Company Act) of any such party,
on April 21, 1987 and last approved by the Trustees of the Trust, including a
majority of the Trustees who are not parties to the Advisory Agreement or
interested persons of any such party, on February 12, 1996. Unless earlier
terminated as described below, the Advisory Agreement will remain in effect from
year to year if approved annually (i) by the Board or by the holders of a
majority of the Trust's outstanding Shares and (ii) by the majority of the
Trustees who are not parties to the Advisory Agreement or interested persons of
any such party. The Advisory Agreement may be terminated by (i) the Trust or the
Investment Adviser at any time without penalty upon not less than 30 and no more
than 60 days' written notice or (ii) a vote of the holders of a majority of the
Trust's outstanding Shares, and will automatically terminate in the event of its
assignment or any bankruptcy or similar proceeding involving any person who
controls the Investment Adviser.
The Advisory Agreement provides that the Trust may use "H&Q" or "Hambrecht
& Quist" as part of its name for so long as the Investment Adviser serves as
investment adviser to the Trust. The Trust has also acknowledged that the names
"H&Q" or "Hambrecht & Quist" are a property right of the Investment Adviser and
in the event that the investment advisory relationship terminates, the Trust
thereafter will not use such names. The Investment Adviser may at any time
permit others to use such names.
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NET ASSET VALUE
The net asset value per Share ("NAV") of the Trust's is computed based on
the value as discussed below of the securities held by the Trust and is
determined as of the close of the NYSE on the last business day of each month or
on a more frequent basis as required by the Trustees. NAV is calculated by
dividing the value of the securities held by the Trust plus any cash or other
assets minus all liabilities, including accrued expenses, by the total number of
Shares outstanding at such time.
Portfolio securities that are traded only on national securities exchanges
are valued at the last sale price or, lacking any sales, at the mean between
last bid and asked prices. Securities traded in the over-the-counter market
which are National Market System securities are valued at the last sale price.
Other over-the-counter securities are valued at the most recent bid prices as
obtained from one or more dealers that make markets in the securities. Portfolio
securities that are traded both in the over-the-counter market and on a national
securities exchange are valued according to the broadest and most representative
market, as determined by the Investment Adviser. Short-term investments that
mature in 60 days or less are valued at amortized cost, unless the Board
determines that such valuation does not constitute fair value.
Securities and assets for which market quotations are not readily available
are valued at fair value as determined in good faith by the Board in accordance
with the procedures hereinafter described. Such valuations and procedures will
be reviewed periodically by the Board. The fair value of investments for which
no market exists cannot be precisely determined. With respect to securities of a
company in its early stages of development, valuation will typically be based
upon their original cost to the Trust (the "cost method"). The cost method will
be utilized until significant developments affecting the portfolio company
provide a basis for use of an appraisal valuation (the "appraisal method"). The
appraisal method will be based upon such factors as earnings and net worth and
will also consider the market price for similar securities of comparable
publicly traded companies. In the case of unsuccessful operations, the appraisal
may be based upon liquidation value. Valuations based on the appraisal are
necessarily subjective. The Trust also will use third party transactions in the
portfolio company's securities as the basis of valuation (the "private market
method"). The private market method will be used only with respect to actual
transactions or actual firm offers by sophisticated, independent investors
unaffiliated with the Investment Adviser or Hambrecht & Quist Group ("Group").
Legal or contractual restrictions on the sale of portfolio securities by the
Trust will be considered in the valuation of such securities.
Other assets, which include cash, prepaid and accrued items, accounts
receivable and income on investments and from the sale of portfolio securities,
are carried in accordance with generally accepted accounting principles, as are
all liabilities. Liabilities
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primarily include accrued expenses, sums owed for securities purchased and
dividends payable.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to policies established by the Board, the Investment Adviser is
primarily responsible for the execution of the Trust's portfolio transactions
and the allocation of brokerage. In executing such transactions, the Investment
Adviser will seek to obtain the best price and execution for the Trust, taking
into account such factors as price, size of order, difficulty of execution,
operational facilities of the firm involved, the firm's risk in positioning a
block of securities, and research, market and statistical information provided
by such firm. While the Investment Adviser generally seeks reasonably
competitive commission rates, the Trust will not necessarily pay the lowest
commission available.
The Trust has no obligation to deal with any broker or group of brokers,
including H&Q, a wholly-owned subsidiary of Group, in executing transactions in
portfolio securities. Brokers, including H&Q, who provide supplemental research,
market and statistical information to the Investment Adviser may receive orders
for transactions by the Trust. The term "research, market and statistical
information" includes advice as to the value of securities, the advisability of
purchasing or selling securities and the availability of securities or
purchasers or sellers of securities, and furnishing analyses and reports
concerning issuers, industries, securities, economic factors and trends,
portfolio strategy and the performance of accounts. Information so received will
be in addition to and not in lieu of the services required to be performed by
the Investment Adviser under the Advisory Agreement and the expenses of the
Investment Adviser will not necessarily be reduced as a result of the receipt of
such supplemental information. Such information may be useful to the Investment
Adviser in providing services to clients other than the Trust, and not all such
information may be used by the Investment Adviser in connection with the Trust.
Conversely, such information provided to the Investment Adviser by brokers and
dealers through whom other clients of the Investment Adviser in the future may
effect securities transactions may be useful to the Investment Adviser in
providing services to the Trust. To the extent the Investment Adviser receives
valuable research, market and statistical information from a broker-dealer,
including H&Q, the Investment Adviser intends to direct orders for Trust
transactions to that broker-dealer, subject to the foregoing policies,
regulatory constraints and the ability of broker dealers, including H&Q, to
provide competitive prices and commission rates. For the fiscal year ended
September 30, 1996, the amount of transactions for which the Investment Adviser
directed brokerage because of research services aggregated $9,712,286 and the
related commissions aggregated $35,000.
The Investment Company Act restricts transactions involving the Trust and
its "affiliates", including among others, the Trust's Trustees, officers and
employees, the Investment Adviser and H&Q, and any "affiliates" of such
affiliates. Subject to any such restrictions, investment companies advised by
the Investment Adviser and venture capital funds managed by entities associated
with Group may concurrently invest with the Trust in Restricted Securities, and
the Trust may also invest in companies in which directors of
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the Investment Adviser or Trustees of the Trust have invested or for which they
serve as directors or executive officers. A substantial portion of the
securities in which the Trust may invest are traded in the over-the-counter
markets, and the Trust intends to deal directly with the dealers who make
markets in the securities involved, except as limited by applicable law and in
those circumstances where better prices and execution are available elsewhere.
Under the Investment Company Act, persons affiliated with the Trust are
generally prohibited from dealing as principal with the Trust in the purchase
and sale of securities. Under certain circumstances, affiliated persons of the
Trust are permitted to serve as its broker in over-the-counter transactions
conducted on an agency basis.
Subject to the foregoing policies of the Trust and provisions of law, the
Trust may use H&Q to execute portfolio transactions for the Trust on an agency
basis. The Trust's Board has adopted procedures in conformity with Rule 17e-1
under the Investment Company Act designed to ensure that all brokerage
commissions paid to H&Q are reasonable and fair as compared to the commissions
received by other brokers in connection with comparable transactions involving
similar securities being purchased or sold on securities exchanges during a
comparable period of time. In addition, pursuant to Section 11(a) of the
Securities Exchange Act of 1934 (the "Securities Act") and Rule 11a2-2(T)
thereunder, H&Q may not execute transactions for the Trust on the floor of any
national securities exchange, but may effect such transactions through
transmitting orders for execution, providing for clearance and settlement, and
arranging for the performance of such functions. As permitted by this Rule, the
Trust has entered into an agreement with H&Q that permits H&Q to retain
compensation for effecting transactions for the Trust on national securities
exchanges. The agreement provides, among other things, that H&Q must furnish the
Trust at least annually with a statement setting forth the total amount of all
compensation retained by H&Q under the agreement.
The Trust will not make venture capital investments in a company that has
retained H&Q to act as placement agent of such securities for a fee. It is
likely, however, that, subject to applicable law, the Trust may invest in
securities concurrently being purchased by other investment companies advised by
the Investment Adviser or by venture capital funds managed by entities
associated with Group. Such purchases would be made on terms no less favorable
than those under which such investment companies and venture capital funds would
be acquiring the Shares. In the case of concurrent purchases by the Trust and
another investment company or companies or accounts managed by the Investment
Adviser, such purchases would be made where the Investment Adviser has made an
independent decision on behalf of the Trust and such other company or companies
that the purchase is appropriate in light of the investment objectives,
policies, restrictions, current holdings, available cash and portfolio structure
of and other factors affecting each. Such investments will be allocated among
clients in a manner believed by the Investment Adviser to be equitable to each.
The Trust may also from time to time invest in securities of companies in which
affiliated persons of the
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Trust have invested, subject to the provisions of the Investment Company Act and
the rules and regulations promulgated thereunder.
The Trust's portfolio transactions in Restricted Securities are generally
subject to Rule 144 under the Securities Act. In general, under Rule 144 as
currently in effect, if the Trust has beneficially owned Restricted Securities
of a publicly held issuer for more than two but less than three years, it will
be entitled to sell in any three-month period that number of such securities
that will not exceed the greater of 1% of the then outstanding securities of
that class or the average weekly trading volume in securities of that class in
any national securities exchange and/or in the over-the-counter market during
the four calendar weeks immediately preceding the date on which notice of the
sale is filed with the Commission. These volume limitations also apply to sales
by the Trust of the securities of any issuer as to which it is deemed an
affiliate, regardless of whether securities of such issuer are publicly traded.
The above-described sales under Rule 144 are subject to certain requirements
relating to manner of sale, notice and availability of current public
information about the issuer. If the Trust is not deemed to have been an
affiliate of the issuer at any time during the 90 days immediately preceding the
sale and has beneficially owned Restricted Securities for at least three years,
it is entitled to sell such securities under Rule 144(k) without regard to
whether the issuer is publicly-held or to the volume limitations or other
requirements described above. When Restricted Securities are sold to the public
other than pursuant to Rule 144 or 144A, the Trust may be deemed an
"underwriter" with respect thereto for purposes of the Securities Act and
subject to liability as such thereunder.
Certain investments may be appropriate for the Trust and also for other
clients advised by the Investment Adviser. Investment decisions for the Trust
and for such other clients are made with a view to achieving their respective
investment objectives and after consideration of such factors as their current
holdings, availability of cash for investment and the size of their investments
generally. Frequently, a particular security may be bought or sold only for the
Trust or for another client or in different amounts and at different times for
more than one but less than all clients, including the Trust. Likewise, a
particular security may be bought for the Trust or one or more clients when one
or more other clients or the Trust are selling the security. In addition,
purchases or sales of the same security may be made for two or more clients,
including the Trust, on the same date. In such event, such transactions will be
allocated among the Trust and client(s) in a manner believed by the Investment
Adviser to be equitable to each. Purchase and sale orders for the Trust may be
combined with those of other clients of the Investment Adviser in the interest
of obtaining the most favorable net results to the Trust. In effecting
transactions, it may not always be possible, or consistent with the investment
objectives of the various persons described above and of the Trust, to take or
liquidate the same investment positions at the same time or at the same prices.
For the fiscal years ended September 30, 1996, September 30, 1995 and
September 30, 1994, $36,000, $16,100 and $21,000, respectively, of brokerage
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commissions were paid by the Trust. For the fiscal years ended September 30,
1996, September 30, 1995 and September 30, 1994, the Trust paid a total of $0,
$1,000 and $0, respectively in commissions to H&Q. For the fiscal years ended
September 30, 1996, September 30, 1995 and September 30, 1994, the percentage
of aggregate commissions paid for such fiscal years to H&Q Group was 0%, .62%,
and 0%, respectively.
For a description of the Trust's portfolio turnover policies and the
portfolio turnover rates for the last two fiscal years, see "Portfolio
Transactions and Brokerage" in the Trust's Prospectus.
DIVIDEND REINVESTMENT PLAN
Each shareholder holding Shares of the Trust will automatically be a
participant in the Trust's Dividend Reinvestment Plan (the "Plan"), unless the
shareholder elects not to participate in the Plan. Under the Plan, whenever the
Trust declares a distribution of dividends and capital gains payable in Shares
or cash, the distribution of dividends and capital gains will be automatically
reinvested by State Street Bank and Trust Company (the "Plan Agent"), in whole
or fractional Shares of the Trust, as the case may be, for the accounts of the
participating shareholders. Shareholders who specifically elect not to
participate in the Plan will receive all distributions of dividends and capital
gains in cash paid by check in U.S. dollars mailed directly to the shareholders
(or if the Shares are held in street or other nominee name, then to the nominee)
by the Custodian, as Dividend Disbursing Agent. Shareholders may receive more
detailed information regarding the Plan from the Trust or the Plan Agent.
Shareholders whose Shares are held in the name of a broker or nominee should
contact such broker or nominee to determine whether or how they may participate
in the Plan.
The Plan Agent serves as agent for the shareholders in administering the
Plan. Participants in the Plan will receive Shares valued on the valuation date,
generally at the lower of market price or NAV, except as specified below. The
valuation date will be the dividend or distribution payment date or, if that
date is not a trading day on the NYSE, the next trading day. Whenever the market
price per Share is equal to or exceeds NAV on the valuation date, participants
will be issued Shares at the greater of (i) NAV or (ii) 95% of the then current
market price of the Shares. If the NAV on the valuation date exceeds the market
price of the Shares at that time, participants will receive Shares from the
Trust valued at the market price.
Each shareholder may terminate his or her account under the Plan, or may
withdraw from the Plan upon written notice to the Plan Agent at the address
shown below received at least ten days prior to the record date for a dividend
or distribution, which notice will be effective for that and all subsequent
dividends or distributions. When a participant withdraws from the Plan or upon
termination of the Plan as provided below, certificates for whole Shares
credited to his or her account under the Plan will be issued and a cash payment
will be made for any fraction of a Share credited to such account. There is no
penalty for non-participation in or withdrawal from the Plan;
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Shareholders who have withdrawn from the Plan may rejoin it at any time by
furnishing to the Plan Agent an authorization in the required form.
The Plan Agent maintains each shareholder's account in the Plan and
furnishes written confirmations of all transactions in the accounts, including
information needed by shareholders for personal and tax records. Shares in the
account of each Plan participant will be held by the Plan Agent in
non-certificated form in the name of the participant, and each shareholder's
proxy will include those shares issued pursuant to the Plan.
In the case of shareholders such as banks, brokers or nominees that hold
Shares for others who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of Shares certified from time to time by the
record shareholder as representing the total amount registered in the record
shareholder's name and held for the account of beneficial owners who are
participants in the Plan. Brokers and nominees of banks and financial
institutions are advised to contact the Plan Agent to determine whether the
beneficial owners of Shares held in their names may participate in the Plan.
The Plan Agent's fees for the handling of the reinvestment of dividends and
distributions will be paid by the Trust.
The automatic reinvestment of dividends and distributions will not relieve
participants of any federal or other income tax that may be payable or required
to be withheld on such dividends or distributions.
Experience under the Plan may indicate that changes are desirable.
Accordingly, the terms and conditions of the Plan may be amended or supplemented
by the Plan Agent or the Trust at any time or times but, except when necessary
or appropriate to comply with applicable law or the rules or policies of the
Commission or any other regulatory authority, only by mailing to the
Shareholders appropriate written notice at least 90 days prior to the record
date for the dividend or distribution. All correspondence concerning the Plan
should be directed to the Plan Agent, State Street Bank and Trust Company, at
P.O. Box 8200, Boston, Massachusetts 02266-8200.
TAX MATTERS
The following is only a summary of certain U.S. federal income tax
considerations generally affecting the Trust and its shareholders. No attempt is
made to present a detailed explanation of the tax treatment of the Trust or its
shareholders, and the following discussion is not intended as a substitute for
careful tax planning. Shareholders should consult with their own tax advisers
regarding the specific federal, state, local, foreign and other tax consequences
of investing in the Trust.
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Taxation of the Trust
The Trust intends to qualify and elect to be treated each taxable year as a
regulated investment company under the Internal Revenue Code of 1986, as amended
(the "Code"). The principal federal income tax benefits of qualifying as a
regulated investment company ("RIC"), as compared to an ordinary taxable
corporation, are that a RIC generally is not itself subject to federal income
tax on ordinary investment income and net capital gains that are currently
distributed to its shareholders, and that the character of long-term capital
gains which are recognized and properly designated by a RIC flows through to its
shareholders, who receive (or are deemed to receive) distributions of such
income. However, the Trust would be subject to corporate income tax (currently
at a maximum marginal rate of 35%) on any undistributed income.
To qualify as a RIC, the Trust must, among other things, (a) derive in each
taxable year at least 90% of its gross income from dividends, interest, payments
with respect to securities loans, gains from the sale or other disposition of
stock, securities or foreign currencies, and other income derived with respect
to its business of investing in such stock, securities or currencies (the
"Qualifying Income Requirement"); (b) derive in each taxable year less than 30%
of its gross income from the sale or other disposition of certain assets
(namely, (i) stock or securities, (ii) options, futures, or forward contracts
(other than those on foreign currencies), or (iii) foreign currencies (including
options, futures, and forward contracts on such currencies) not directly related
to the Trust's principal business of investing in stocks or securities (or
options and futures with respect to stocks or securities)), held less than three
months (the "30% Limitation"); (c) diversify its holdings so that, at the end of
each quarter of the taxable year, (i) at least 50% of the market value of the
Trust's assets is represented by cash and cash items, U.S. Government
Securities, the securities of other RICs and other securities, with such other
securities of any one issuer limited for the purposes of this calculation to an
amount not greater than 5% of the value of the Trust's total 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 total assets is invested in the securities
of any one issuer (other than U.S. Government Securities or the securities of
other RICs); and (d) distribute at least 90% of its investment company taxable
income (which includes, among other items, dividends, interest and net
short-term capital gains in excess of net long-term capital losses) each taxable
year. The U.S. Treasury Department has authority to promulgate regulations
pursuant to which gains from foreign currency (and options, futures and forward
contracts on foreign currency) not directly related to a RIC's business of
investing in stocks and securities would not be treated as qualifying income for
purposes of the Qualifying Income Requirement. To date, such regulations have
not been promulgated.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax. To
avoid the excise tax, the Trust must distribute during each calendar year an
amount equal to the
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sum of (1) at least 98% of its ordinary income (not taking into account any
capital gains or losses) for the calendar year, (2) at least 98% of its capital
gains in excess of its capital losses (adjusted for certain ordinary losses) for
the one-year period ending on October 31 of the calendar year, and (3) all
ordinary income and capital gains for previous years that were not distributed
during such years. To avoid application of the excise tax, the Trust intends to
make its distributions in accordance with the calendar year distribution
requirement. A dividend will be treated as paid on December 31 of the calendar
year if it is declared by the Trust in October, November or December of the
year, payable to shareholders of record on a date in such a month and paid by
the Trust during January of the following year. Such dividends will be taxable
to shareholders as of December 31 of the calendar year in which the dividends
are declared, rather than during the calendar year in which the dividends are
received. If the Trust elects to retain net capital gains and treat such gains
as having been distributed, all or a portion of such gains may not be treated as
having been timely distributed for purposes of satisfying the excise tax
calendar year distribution requirement.
Distributions
Dividends paid from investment company taxable income will be taxable to
shareholders as ordinary income whether paid in cash or reinvested in the
Trust's Shares. The Trust intends to distribute to its shareholders
substantially all of its investment company taxable income, if any, for each
year. It is anticipated that the Trust's income distributions will be paid
annually in additional Shares unless the shareholder elects payment in cash.
Distributions of the excess, if any, of net long-term capital gains over
net short-term capital losses ("net capital gains") designated by the Trust as
capital gain dividends will be taxable to shareholders as long-term capital
gains, whether paid in cash or reinvested in the Trust's Shares, regardless of
how long the shareholders have held the Trust's Shares, and will not be eligible
for the dividends received deduction for corporations. The Trust may elect to
retain net capital gains. In such event, the Trust will be required to pay
federal income taxes on the undistributed net capital gains, but intends to
elect to treat such capital gains as having been distributed to shareholders. As
a result, such amounts will be included in the gross income of the shareholders
as long-term capital gains and shareholders will be able to claim their
proportionate share of federal income taxes paid by the Trust on such gains as a
credit against their own federal income tax liabilities, and will be entitled to
increase the adjusted tax basis of their Shares of the Trust by an amount equal
to 65% of the amount of the undistributed capital gains included in their gross
income. Organizations or persons not subject to federal income tax on such
capital gains (such as, generally, qualified pension and profit-sharing funds,
including Individual Retirement Accounts and Keogh plans, and certain trusts,
nonresident aliens and foreign corporations) will be entitled to a refund of
their pro rata share of such taxes paid by the Trust upon filing appropriate
returns or claims for refund with the Internal Revenue Service ("IRS"). Even if
the Trust makes such an
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election, it is possible that the Trust may incur an excise tax as a result of
not having distributed sufficient net capital gains.
If the value of the Trust's Shares is reduced below a Shareholder's cost as
a result of a distribution of investment company taxable income or net capital
gains by the Trust, such distribution will be taxable to the shareholder. The
price of Shares purchased at this time may reflect the amount of the forthcoming
distribution. Those purchasing just prior to a distribution of investment
company taxable income or net capital gains will receive a distribution which
will nevertheless be taxable to them.
Dividends (not including capital gain dividends) received by corporate
shareholders from the Trust qualify for the dividends received deduction for
corporate shareholders to the extent the Trust designates the amount distributed
as eligible for the deduction. The aggregate amount designated by the Trust
cannot exceed the aggregate amount of dividends received by the Trust from
domestic corporations for the taxable year, and the designation of dividend
income must generally be the same for all Shares. Thus, unless 100% of the
Trust's gross income constitutes qualified dividends, a portion of the dividends
paid to corporate shareholders will not qualify for the dividends received
deduction. The dividends received deduction for corporate shareholders may be
further reduced if the Shares with respect to which dividends are received are
treated as debt-financed or if either those Shares or the Shares of the Trust
are deemed to have been held by the Trust or its shareholders, respectively, for
less than 46 days.
In addition to furnishing any other required tax statements, the Trust
intends to send not later than 60 days after September 30 (the end of the tax
and fiscal year of the Trust) written notices to shareholders regarding the tax
status of all distributions made during such taxable year, the amount qualifying
for the dividends received deduction for corporations and the amount of
undistributed net capital gains and related tax credits.
Sale of Shares
Generally, gain or loss realized upon the sale or exchange of Shares will
be capital gain or loss if the Shares are capital assets in the shareholder's
hands and generally will be long-term or short-term, depending upon the
shareholder's holding period for the Shares. Investors should be aware that any
loss realized upon the sale or exchange of Shares held for six months or less
will be treated as a long-term capital loss to the extent of any distributions
or deemed distributions of long-term capital gain to the shareholder with
respect to such Shares. In addition, any loss realized on a sale or exchange of
Shares will be disallowed to the extent the Shares disposed of are replaced
within a period of 61 days beginning 30 days before and ending 30 days after the
Shares are disposed of, such as pursuant to the Plan. In such case, the basis of
Shares acquired will be adjusted to reflect the disallowed loss.
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Currency Fluctuations--"Section 988" Gains or Losses
Under the Code, the gains or losses attributable to fluctuations in
exchange rates which occur between the time the Trust accrues receivables or
liabilities denominated in a foreign currency and the time the Trust actually
collects such receivables or pays such liabilities generally are treated as
ordinary income or ordinary loss. Similarly, on disposition of foreign currency
or debt securities denominated in a foreign currency and on disposition of
certain futures and forward contracts, gains or losses attributable to
fluctuations in the value of foreign currency between the date of acquisition of
the currency, security or contract and the date of disposition also are treated
as ordinary gain or loss. These gains or losses, referred to under the Code as
"Section 988" gains or losses, may increase or decrease the amount of the
Trust's investment company taxable income to be distributed to its Shareholders
as ordinary income.
Certain futures and foreign currency contracts in which the Trust may
invest are "section 1256 contracts." While gains or losses on section 1256
contracts are considered 60% long-term and 40% short-term capital gains or
losses, certain foreign currency futures and foreign currency contracts may give
rise to ordinary income or loss, as described below. Also, section 1256
contracts held by the Trust at the end of each taxable year (and, generally, for
purposes if the 4% excise tax, on October 31 of each year) are
"marked-to-market" with the result that unrealized gains or losses are treated
as though they were realized.
Foreign Withholding Taxes
Income received by the Trust from non-U.S. sources may be subject to
withholding and other taxes imposed by other countries. Because it is not
expected that more than 50% of the value of the Trust's total assets at the
close of its taxable year will consist of stock and securities of non-U.S.
corporations, it is not expected that the Trust will be eligible to elect to
"pass-through" to the Trust's shareholders the amount of foreign income and
similar taxes paid by the Trust. In the absence of such an election, the foreign
taxes paid by the Trust will reduce its investment company taxable income, and
distributions of investment company taxable income received by the Trust from
non- U.S. sources will be treated as U.S. source income.
Backup Withholding
The Trust may be required to withhold U.S. federal income tax at the rate
of 31% of all taxable distributions payable to shareholders who fail to provide
the Trust 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. Backup withholding is not an additional tax. Any amounts
withheld may be credited against a shareholder's U.S. federal income tax
liability. Certain persons are exempt from the
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backup withholding requirements. Questions relating to backup withholding should
be directed to your tax adviser.
Foreign Shareholders
U.S. taxation of a shareholder who, as to the U.S., is a non-resident alien
individual, a foreign trust or estate, a foreign corporation or foreign
partnership ("foreign shareholder") depends on whether the income from the Trust
is "effectively connected" with a U.S. trade or business carried on by such
shareholder.
Income Not Effectively Connected. If the income from the Trust is not
"effectively connected" with a U.S. trade or business carried on by the foreign
shareholder, distributions of investment company taxable income will be subject
to a U.S. tax of 30% (or lower treaty rate), which tax is generally withheld
from such distributions.
Distributions of capital gain dividends and amounts retained by the Trust
which are designated as undistributed capital gains will not be subject to U.S.
tax at the rate of 30% (or lower treaty rate) unless the foreign shareholder is
a non-resident alien individual and is physically present in the U.S. for more
than 182 days during the taxable year and meets certain other requirements.
However, this 30% tax on capital gains of non-resident alien individuals who are
physically present in the U.S. for more than the 182-day period only applies in
exceptional cases, because any individual present in the U.S. for more than 182
days during the taxable year is generally treated as a resident for U.S. federal
income tax purposes; in that case, he or she would be subject to U.S. federal
income tax on his or her worldwide income at the graduated rates applicable to
U.S. citizens, rather than the 30% U.S. tax. In the case of a foreign
shareholder who is a non-resident alien individual, the Trust may be required to
withhold U.S. federal income tax at a rate of 31% of distributions of net
capital gains unless the foreign shareholder certifies his or her non-U.S status
under penalties of perjury or otherwise establishes an exemption. See "Backup
Withholding" above. If a foreign shareholder is a non-resident alien individual,
any gain such shareholder realizes upon the sale or exchange of such
shareholder's Shares of the Trust in the U.S. will ordinarily be exempt from
U.S. tax unless such shareholder is physically present in the U.S. for more than
182 days during the taxable year and meets certain other requirements.
Income Effectively Connected. If the income from the Trust is "effectively
connected" with a U.S. trade or business carried on by a foreign shareholder,
then distributions of investment company taxable income and capital gain
dividends, amounts retained by the Trust which are designated as undistributed
capital gains and any gains realized upon the sale or exchange of Shares of the
Trust will be subject to U.S. federal income tax at the graduated rates
applicable to U.S. citizens, residents and domestic
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corporations. Such foreign shareholders that are corporations may also be
subject to the branch profits tax imposed by the Code.
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 are advised to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in the
Trust.
Other Taxes
Distributions may also be subject to state, local and foreign taxes
depending on each shareholder's particular situation. Shareholders should
consult their own tax advisers with respect to their particular situation.
CUSTODIAN, TRANSFER AGENT, DIVIDEND
DISBURSING AGENT AND REGISTRAR
The Trust's securities and cash are held under a custodian contract by
State Street Bank and Trust Company (the "Custodian"), whose principal business
address is 225 Franklin Street, Boston, Massachusetts 02110. Rules adopted under
the Investment Company Act permit the Trust to maintain its securities and cash
in the custody of certain eligible banks and securities depositories. Pursuant
to those Rules, the Trust's portfolio of securities and cash, when invested in
Foreign Securities, will be held by sub-custodians who have been approved by the
Board in accordance with the Rules of the Commission following consideration of
a number of factors, including, but not limited to, the relationship of the
institution with the Custodian, the reliability and financial stability of the
institution, the ability of the institution to perform capably custodial
services for the Trust, the reputation of the institution in its national
market, the political and economic stability of the countries in which the
sub-custodians will be located and the risks of potential nationalization or
expropriation of Trust assets.
The Custodian also serves as Dividend Disbursing Agent, Transfer Agent and
Registrar for Shares of the Trust.
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