Dated June 25, 2003,
as supplemented
June 30, 2003
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
STATEMENT OF ADDITIONAL INFORMATION
Nuveen Preferred and Convertible Income Fund 2 (the "Fund") is a newly
organized, diversified, closed-end management investment company.
This Statement of Additional Information relating to common shares of the
Fund ("Common Shares") does not constitute a prospectus, but should be read in
conjunction with the Fund's Prospectus relating thereto dated June 25, 2003,
(the "Prospectus"). This Statement of Additional Information does not include
all information that a prospective investor should consider before purchasing
Common Shares. Investors should obtain and read the Fund's Prospectus prior to
purchasing such shares. A copy of the Fund's Prospectus may be obtained without
charge by calling (800) 257-8787. You may also obtain a copy of the Fund's
Prospectus on the Securities and Exchange Commission's web site
(http://www.sec.gov). Capitalized terms used but not defined in this Statement
of Additional Information have the meanings ascribed to them in the Prospectus.
TABLE OF CONTENTS
Page
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Use of Proceeds.............................................................. 3
Investment Objectives.........................................................3
Investment Restrictions ......................................................3
Investment Policies and Techniques............................................6
Investment Philosophy and Process ............................................6
Other Investment Policies and Techniques......................................9
Management of the Fund.......................................................15
Investment Advisers..........................................................20
Portfolio Transactions and Brokerage.........................................24
Distributions ...............................................................26
Description of Shares........................................................26
Certain Provisions in the Declaration of Trust...............................30
Repurchase of Fund Shares; Conversion to Open-End Fund.......................32
Tax Matters..................................................................34
Performance Related and Comparative Information..............................38
Experts......................................................................41
Custodian and Transfer Agent.................................................41
Additional Information.......................................................41
Report of Independent Auditors...............................................42
Financial Statements.........................................................43
Ratings of Investments (Appendix A)........................................ A-1
Performance Related and Comparative Information (Appendix B)............... B-1
This Statement of Additional Information is dated June 25, 2003.
2
USE OF PROCEEDS
The net proceeds of the offering of Common Shares of the Fund will be
approximately: $1,929,825,000 ($2,085,640,500 if the Underwriters exercise the
over-allotment option in full) after payment of organization and offering costs.
For the Fund, Nuveen has agreed to pay (i) all organizational expenses and
(ii) offering costs (other than sales load) that exceed $0.03 per Common Share.
Pending investment in preferred, convertible and other debt instruments
that meet the Fund's investment objectives and policies, the net proceeds of the
offering will be invested in short-term or long-term U.S. government securities
or high quality, short-term money market instruments.
INVESTMENT OBJECTIVES
The Fund's primary objective is high current income. The Fund's secondary
objective is total return. There can be no assurance that the Fund's investment
objectives will be achieved.
The Fund cannot change its investment objectives without the approval of
the holders of a "majority of the outstanding" Common Shares and FundPreferred
shares voting together as a single class, and of the holders of a "majority of
the outstanding" FundPreferred shares voting as a separate class. When used with
respect to particular shares of the Fund, a "majority of the outstanding" shares
means (i) 67% or more of the shares present at a meeting, if the holders of more
than 50% of the shares are present or represented by proxy, or (ii) more than
50% of the shares, whichever is less. See "Description of Shares--FundPreferred
Shares--Voting Rights" in the Fund's Prospectus and "Description of
Shares--FundPreferred Shares--Voting Rights" in this Statement of Additional
Information for additional information with respect to the voting rights of
holders of FundPreferred shares.
INVESTMENT RESTRICTIONS
Except as described below, the Fund, as a fundamental policy, may not,
without the approval of the holders of a majority of the outstanding Common
Shares and, if issued, FundPreferred shares voting together as a single class,
and of the holders of a majority of the outstanding FundPreferred shares voting
as a separate class:
(1) Issue senior securities, as defined in the Investment Company Act
of 1940, other than (i) preferred shares which immediately after issuance
will have asset coverage of at least 200%, (ii) indebtedness which
immediately after issuance will have asset coverage of at least 300%, or
(iii) the borrowings permitted by investment restriction (2) set forth
below;
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(2) Borrow money, except as permitted by the Investment
Company Act of 1940 and exemptive orders granted under the Investment
Company Act of 1940;
(3) Act as underwriter of another issuer's securities, except
to the extent that the Fund may be deemed to be an underwriter within
the meaning of the Securities Act of 1933 in connection with the
purchase and sale of portfolio securities or acting as an agent or one
of a group of co-agents in originating corporate loans;
(4) Invest more than 25% of its total assets in securities of
issuers in any one industry other than the financial services industry;
provided, however, that such limitation shall not apply to obligations
issued or guaranteed by the United States Government or by its agencies
or instrumentalities, and provided further that for purposes of this
limitation, the term "issuer" shall not include a lender selling a
participation to the Fund together with any other person
interpositioned between such lender and the Fund with respect to a
participation;
(5) Purchase or sell real estate, except pursuant to the
exercise by the Fund of its rights under loan agreements and except to
the extent that interests in corporate loans the Fund may invest in are
considered to be interests in real estate, and this shall not prevent
the Fund from investing in securities of companies that deal in real
estate or are engaged in the real estate business, including real
estate investment trusts, and securities secured by real estate or
interests therein and the Fund may hold and sell real estate or
mortgages on real estate acquired through default, liquidation, or
other distributions of an interest in real estate as a result of the
Fund's ownership of such securities;
(6) Purchase or sell physical commodities unless acquired as a
result of ownership of securities or other instruments except pursuant
to the exercise by the Fund of its rights under loan agreements and
except to the extent that interests in corporate loans the Fund may
invest in are considered to be interests in commodities and this shall
not prevent the Fund from purchasing or selling options, futures
contracts, derivative instruments or from investing in securities or
other instruments backed by physical commodities;
(7) Make loans except as permitted by the Investment Company
Act of 1940 and exemptive orders granted under the Investment Company
Act of 1940; and
(8) With respect to 75% of the value of the Fund's total
assets, purchase any securities (other than obligations issued or
guaranteed by the United States Government or by its agencies or
instrumentalities), if as a result more than 5% of the Fund's total
assets would then be invested in securities of a single issuer or if as
a result the Fund would hold more than 10% of the outstanding voting
securities of any single issuer, and provided further that for purposes
of this restriction, the term "issuer" includes both the borrower under
a loan agreement and the lender selling a participation to the Fund
together with any other persons interpositioned between such lender and
the Fund with respect to a participation.
For purposes of the foregoing and "Description of Shares--
FundPreferred Shares--Voting Rights" below, "majority of the outstanding," when
used with respect to particular shares of the Fund, means (i) 67% or more of the
shares present at a meeting, if the holders of more than 50% of the shares are
present or represented by proxy, or (ii) more than 50% of the shares, whichever
is less.
For the purpose of applying the limitation set forth in subparagraph
(8) above, an issuer shall be deemed the single issuer of a security when its
assets and revenues are separate from other governmental entities and its
securities are backed only by its assets and revenues. Similarly, in the case of
a non-governmental issuer, such as an industrial corporation or a privately
owned or operated hospital, if the security is backed only by the assets and
revenues of the non-governmental issuer, then such non-governmental issuer would
be deemed to be the single issuer. Where a security is also backed by the
enforceable obligation of a superior or unrelated governmental or other entity
(other than a bond insurer), it shall also be included in the
4
computation of securities owned that are issued by such governmental or other
entity. Where a security is guaranteed by a governmental entity or some other
facility, such as a bank guarantee or letter of credit, such a guarantee or
letter of credit would be considered a separate security and would be treated as
an issue of such government, other entity or bank. When a municipal bond is
insured by bond insurance, it shall not be considered a security that is issued
or guaranteed by the insurer; instead, the issuer of such municipal bond will be
determined in accordance with the principles set forth above.
Under the Investment Company Act of 1940, the Fund may invest only up
to 10% of its Managed Assets in the aggregate in shares of other investment
companies and only up to 5% of its Managed Assets in any one investment company,
provided the investment does not represent more than 3% of the voting stock of
the acquired investment company at the time such shares are purchased. As a
stockholder in any investment company, the Fund will bear its ratable share of
that investment company's expenses, and will remain subject to payment of the
Fund's management, advisory and administrative fees with respect to assets so
invested. Holders of Common Shares would therefore be subject to duplicative
expenses to the extent the Fund invests in other investment companies. In
addition, the securities of other investment companies may also be leveraged and
will therefore be subject to the same leverage risks described herein. As
described in the Prospectus in the section entitled "Risks," the net asset value
and market value of leveraged shares will be more volatile and the yield to
shareholders will tend to fluctuate more than the yield generated by unleveraged
shares.
In addition to the foregoing fundamental investment policies, the Fund
is also subject to the following non-fundamental restrictions and policies,
which may be changed by the Board of Trustees. The Fund may not:
(1) Sell securities short, except that the Fund may make short
sales of securities if, at all times when a short position is open, the
Fund owns at least an equal amount of such securities or securities
convertible into or exchangeable for, without payment of any further
consideration, securities of the same issuer as, and equal in amount
to, the securities sold short, and provided that transactions in
options, futures contracts, options on futures contracts, or other
derivative instruments are not deemed to constitute selling securities
short.
(2) Purchase securities of open-end or closed-end investment
companies except in compliance with the Investment Company Act of 1940
or any exemptive relief obtained thereunder. The Fund will rely on
representations of borrowers in loan agreements in determining whether
such borrowers are investment companies.
(3) Purchase securities of companies for the purpose of
exercising control, except to the extent that exercise by the Fund of
its rights under loan agreements would be deemed to constitute
exercising control.
The restrictions and other limitations set forth above will apply only
at the time of purchase of securities and will not be considered violated unless
an excess or deficiency occurs or exists immediately after and as a result of an
acquisition of securities.
The Fund intends to apply for ratings for its FundPreferred shares
from a nationally recognized statistical rating organization ("NRSRO")
(typically, Moody's, S&P or Fitch). In order to obtain and maintain the required
ratings, the Fund may be required to comply with investment quality,
diversification and other guidelines established by the NRSRO. Such guidelines
will likely be more restrictive than the restrictions set forth above. The Fund
may also be subject to certain restrictions and guidelines imposed by
5
lenders if the Fund engages in Borrowings. The Fund does not anticipate that
such guidelines would have a material adverse effect on its Common Shareholders
or the Fund's ability to achieve its investment objectives. The Fund presently
anticipates that any FundPreferred shares that it intends to issue initially
would be given at least a AA/Aa rating by such NRSRO -- Moody's ("Aa"), S&P
("AA") or Fitch ("AA") -- but no assurance can be given that such ratings will
be obtained. NRSROs receive fees in connection with their ratings issuances.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objectives, policies, and techniques that are described in the Fund's
Prospectus.
The Fund's primary investment objective is high current income. The Fund's
secondary objective is total return. There can be no assurance that the Fund's
investment objectives will be achieved.
Under normal circumstances, the Fund:
. will invest at least 80% of its Managed Assets in preferred
securities, convertible securities and related instruments. The Fund
intends that most or all of the preferred securities in which it
invests will be fully taxable and will not be eligible for the
dividends received deduction; and
. may invest up to 20% of its Managed Assets in other securities,
including debt instruments and common stocks acquired upon conversion
of a convertible security (such common stocks not normally to exceed
5% of the Fund's Managed Assets).
NIAC will be responsible for determining the Fund's overall investment
strategy, including allocating the portion of the Fund's assets to be invested
in preferred securities, convertible securities and other debt instruments. The
Fund's assets allocated to preferred securities will be managed by Spectrum. The
Fund's assets allocated to convertible securities will be managed by Froley,
Revy. The Fund's assets allocated to other debt instruments will be managed by
NIAC. Initially, NIAC will allocate approximately 60%, 30% and 10% of the Fund's
Managed Assets to preferred securities, convertible securities and other debt
instruments, respectively. Thereafter, the portion of the Fund's Managed Assets
invested in preferred securities, convertible securities and other debt
instruments will vary from time to time consistent with the Fund's investment
objectives, although the Fund will normally invest at least 50% of its Managed
Assets in preferred securities and at least 20% of its Managed Assets in
convertible securities (so long as the combined total equals at least 80% of the
Fund's Managed Assets). Convertible preferred securities will be regarded as
convertible securities for purposes of these limits. In making allocation
decisions, NIAC will consider factors such as interest rate levels, conditions
and developing trends in the bond and equity markets, analysis of relative
valuations for preferred, convertible and other debt instruments, and other
economic and market factors, including the overall outlook for the economy and
inflation.
The Fund will invest at least 65% of its Managed Assets in securities that,
at the time of investment, are investment grade quality. Investment grade
quality securities are those securities that, at the time of investment, are (i)
rated by at least one of the NRSROs within the four highest grades (Baa or BBB
or better by Moody's, S&P or Fitch) or (ii) unrated but judged to be of
comparable quality by the Adviser responsible for the investment. Split-rated
securities are considered to be investment grade quality securities, except that
to the extent the Fund owns split-rated securities that exceed 10% of its
Managed Assets, the excess over 10% will not be considered to be investment
grade quality. Initially, the Fund intends to invest approximately 75% of its
Managed Assets in investment grade quality securities. The Fund may invest up to
35% of its Managed Assets in securities that, at the time of investment, are not
investment grade quality. The Fund will only invest in securities that, at the
time of investment, are rated B or higher by at least one NRSRO or that are
unrated but judged to be of comparable quality by the Adviser responsible for
the investment, except, however, the Fund may invest up to 5% of its Managed
Assets in securities with a highest rating of CCC or that are unrated but judged
to be of comparable quality by the Adviser responsible for the investment.
The Fund may invest up to 10% of its Managed Assets in securities that, at
the time of investment, are illiquid (i.e., securities that are not readily
marketable). All securities and other instruments in which the Fund invests will
be subject to this 10% limitation to the extent they are deemed to be illiquid.
Initially, the Fund does not intend to invest more than 5% of its Managed Assets
in illiquid securities. In addition, the Fund may invest up to 35% of its
Managed Assets in securities of non-U.S. issuers. Subject to this 35%
limitation, up to 10% of the Fund's Managed Assets may be invested in securities
that are denominated in Japanese yen, Canadian dollars, British pounds or Euros
and which may be offered, traded or listed in markets other than U.S. markets.
The remainder of the Fund's Managed Assets that may be invested in securities of
non-U.S. issuers will be invested in U.S. dollar denominated securities offered,
traded or listed in U.S. markets. Initially, the Fund does not intend to invest
more than 20% of its Managed Assets in securities of non-U.S. issuers and does
not currently intend to invest in the non-U.S. dollar denominated securities
described above.
INVESTMENT PHILOSOPHY AND PROCESS
Nuveen Institutional Advisory Corp. (NIAC)
Asset Allocation Philosophy. NIAC is responsible for the overall strategy
and asset allocation decisions among the three primary asset classes in which
the Fund invests - preferred securities, convertible securities and other debt
instruments. The goal of the allocation decision is to effectively capture the
diversification benefits provided by the low-correlation across these asset
classes and provide the potential for high income generation, an opportunity to
participate in rising equity markets and some protection against risks
associated with rising interest rates. NIAC believes that the opportunity will
exist from time to time to potentially enhance the Fund's total return by
over-weighting or under-weighting these asset classes as the relative
attractiveness of the asset classes changes.
Asset Allocation Process. In determining the Fund's asset allocation, NIAC
will periodically consult with the Fund's Subadvisers and other investment
manager affiliates of NIAC. NIAC will consider factors such as interest rate
levels, conditions and developing trends in the bond and equity markets,
analysis of relative valuations for preferred, convertible and other debt
instruments, and other economic and market factors, including the overall
outlook for the economy and inflation.
Investment Philosophy. NIAC is responsible for managing the other debt
instruments in which the Fund may invest. NIAC believes that managing risk,
particularly in a volatile asset class such as high yield debt, is of paramount
importance. NIAC believes that a combination of fundamental credit analysis and
valuation information that is available from the equity markets provide a means
of identifying what it believes to be superior investment candidates.
Additionally, NIAC focuses on liquid securities to ensure that exit strategies
remain viable throughout market cycles.
Investment Process. NIAC begins with a quantitative screening of the
universe to identify investment candidates with favorable capital structures,
factor valuation and other equity market indicators. NIAC screens this universe
of securities for liquidity constraints and relative value opportunities to
determine investment candidates. Subsequently, the investment team performs
rigorous fundamental analysis to ensure sound industry fundamentals, cash flow
sufficiency and asset quality. The final portfolio is constructed using
proprietary risk factor and monitoring systems to ensure proper diversification.
Spectrum Asset Management, Inc. (Spectrum)
Investment Philosophy. Spectrum's investment philosophy with respect to
preferred securities is centered on several underlying themes:
.. High levels of current income are the primary return contributor to the
total return potential of preferred securities.
.. Investing in the subordinated preferred securities of stronger,
highly-rated issuers is potentially more advantageous than owing the
senior debt of weaker, potentially deteriorating issuers.
.. Investment grade quality preferred securities, over time, present a very
attractive risk/return opportunity.
.. Diversifying across a large number of different industries and issuers
helps insulate an overall portfolio of preferred securities from events
that affect any particular company or sector.
.. Inefficiencies in the preferred securities market, particularly in the
pricing and trading of securities, can create opportunities to enhance
portfolio value.
Investment Process. Spectrum's investment process begins with macroeconomic
and fundamental credit analysis to identify sectors, industries and companies
that are potential investments. In its fundamental analysis, Spectrum employs a
value-oriented style that considers the relative attractiveness of the security
to other preferred securities and to the same issuer's senior debt. In addition,
Spectrum evaluates the structural features of each security as well as its
liquidity. In its investment decision, Spectrum also considers the contribution
of sectors and individual securities to the overall goal of achieving a
well-diversified portfolio.
Froley, Revy Investment Co., Inc. (Froley, Revy)
Investment Philosophy. Froley, Revy's investment philosophy with respect to
convertible securities is centered on the belief that convertible securities are
a total return vehicle that afford the opportunity to earn equity-like returns
with substantially reduced risk relative to equities, while providing some
current income. The firm believes that focusing on the mid-market sector of the
convertibles market while investing opportunistically in the bond-like and
equity-like areas of the convertible securities market may enhance total return
potential. In addition, the firm believes that because of the hybrid nature of
the asset class, research that emphasizes both fundamental credit analysis and
equity valuation analysis can help identify investment opportunities with the
greatest potential for enhancing a portfolio's overall total return.
Investment Process. Froley, Revy's investment process begins with screening
the universe of convertible securities on certain valuation and structural
parameters, including price, yield, premium, calls, equity sensitivity and other
factors. On this pool of potential investments, Froley, Revy then conducts
credit (bond) analysis and valuation (equity) analysis to identify what it
believes to be the most attractive candidates within the universe. Additional
inputs into the sector and security selection decision are top down,
macroeconomic analysis of economic, interest rate and other trends and the
analysis of the structural characteristics of the individual securities.
Froley, Revy monitors all securities and sectors on an on-going basis to
identify those that fall outside the intended investment range. Positions in
securities that have increased in value and equity sensitivity may be reduced to
normal position weights or sold entirely based on the fundamental outlook for
the underlying equity. In addition, Froley, Revy considers significant declines
from the purchase prices of securities in determining whether to purchase or
sell a particular security.
6
PORTFOLIO COMPOSITION
Under normal circumstances, the Fund will invest at least 80% of its
Managed Assets in preferred securities, convertible securities and related
instruments. The Fund will notify shareholders at least 60 days prior to any
change in the 80% policy.
Preferred Securities. The Fund intends that most or all of the preferred
securities in which it invests will be fully taxable and will not generate
dividends that qualify for treatment as "qualified dividend income" or the
Dividends Received Deduction. Preferred securities generally pay fixed or
adjustable rate dividends to investors, and have a "preference" over common
stock in the payment of dividends and the liquidation of a company's assets.
This means that a company must pay dividends on preferred stock before paying
any dividends on its common stock. In order to be payable, distributions on
preferred securities must be declared by the issuer's board of directors. Income
payments on typical preferred securities currently outstanding are cumulative,
causing dividends and distributions to accrue even if not declared by the board
of directors or otherwise made payable. There is no assurance that dividends or
distributions on the preferred securities in which the Fund invests will be
declared or otherwise made payable.
Preferred stockholders usually have no right to vote for corporate
directors or on other matters.
Shares of preferred securities have a liquidation value that generally
equals the original purchase price at the date of issuance. The market value of
preferred securities may be affected by favorable and unfavorable changes
impacting companies in the utilities and financial services sectors, which are
prominent issuers of preferred securities, and by actual and anticipated changes
in tax laws, such as changes in corporate income tax rates, income tax rates
applicable to capital gains and dividend income, and in the Dividends Received
Deduction.
Because the claim on an issuer's earnings represented by preferred
securities may become onerous when interest rates fall below the rate payable on
such securities, the issuer may redeem the securities. Thus, in declining
interest rate environments in particular, the Fund's holdings of higher
rate-paying fixed rate preferred securities may be reduced and the Fund would be
unable to acquire securities paying comparable rates with the redemption
proceeds.
The Fund intends that all of the preferred securities in which it will
invest will be investment grade quality at the time of investment. The average
call protection of the Fund's portfolio allocated to preferred securities is
expected to be approximately three to four years.
Taxable preferred securities are treated in a similar fashion to
traditional preferred securities by several regulatory agencies, including the
Federal Reserve Bank, and by credit rating agencies, for various purposes, such
as the assignment of minimum capital ratios, over-collateralization rates and
diversification limits.
Additional Information on Taxable Preferred Securities. See "The Fund's
Investments - Portfolio Composition - Taxable Preferred Securities" in the
Fund's Prospectus for a general description of taxable preferred securities.
Convertible Securities. Convertible securities are bonds, debentures,
notes, preferred securities or other securities that may be converted or
exchanged (by the holder or the issuer) into shares of the underlying common
stock (or cash or securities of equivalent value) at a stated exchange ratio or
predetermined price (the "conversion price"). Convertible securities have
general characteristics similar to both debt securities and common stocks. The
interest paid on convertible securities may be fixed or floating rate. Floating
rate convertible securities also may be issued in zero coupon form with an
original issue discount. See "Other Investment Policies and Techniques-Zero
Coupon and Payment-In-Kind Securities." Although to a lesser extent than with
debt securities, the market value of convertible securities tends to decline as
interest rates increase and, conversely, tends to increase as interest rates
decline. In addition, because of the conversion feature, the market value of
convertible securities tends to vary with fluctuations in the market value of
the underlying common stocks and, therefore, will also react to the variations
in the general market for common stocks. Depending upon the relationship of the
conversion price to the market value of the underlying common stock, a
convertible security may trade more like a common stock than a debt instrument.
Mandatory convertible securities are distinguished as a subset of
convertible securities because they may be called for conversion by the issuer
after a particular date and under certain circumstances (including at a
specified price) established upon its issuance. If a mandatory convertible
security is called for conversion, the Fund will be required to either convert
it into the underlying common stock or sell it to a third party, which may have
an adverse effect on the Fund's ability to achieve its investment objective.
A convertible security generally entitles the holder to receive interest
paid or accrued until the convertible security matures or is redeemed, converted
or exchanged. Convertible securities rank senior to common stock in a
corporation's capital structure and, therefore, generally entail less risk than
the corporation's common stock, although the extent to which such risk is
reduced depends in large measure upon the degree to which the convertible
security sells above its value as a debt obligation. Before conversion,
convertible securities have characteristics similar to non-convertible debt
obligations and can provide for a stable stream of income with generally higher
yields than common stocks. However, convertible securities fall below debt
obligations of the same issuer in order of preference or priority in the event
of a liquidation, and are typically unrated or rated lower than such debt
obligations. In addition, contingent payment convertible securities allow the
issuer to claim deductions based on its nonconvertible cost of debt which
generally will result in deductions in excess of the actual cash payments made
on the securities (and accordingly, holders will recognize income in amounts in
excess of the cash payments received). There can be no assurance of current
income because the issuers of the convertible securities may default on their
obligations. The convertible securities in which the Fund may invest may be
below investment grade quality. See "--High Yield Securities" below.
Convertible securities generally offer lower interest or dividend yields
than non-convertible securities of similar credit quality because of the
potential for capital appreciation. A convertible security, in addition to
providing current income, offers the potential for capital appreciation through
the conversion feature, which enables the holder to benefit from any increases
in the market price of the underlying common stock. The common stock underlying
convertible securities may be issued by a different entity than the issuer of
the convertible securities.
The value of convertible securities is influenced by both the yield of
non-convertible securities of comparable issuers and by the value of the
underlying common stock. The value of a convertible security viewed without
regard to its conversion feature (i.e., strictly on the basis of its yield) is
sometimes referred to as its "investment value." The investment value of the
convertible security typically will fluctuate based on the credit quality of the
issuer and will fluctuate inversely with changes in prevailing interest rates.
However, at the same time, the convertible security will be influenced by its
"conversion value," which is the market value of the underlying common stock
that would be obtained if the convertible security were converted. Conversion
value fluctuates directly with the price of the underlying common stock, and
will therefore be subject to risks relating to the activities of the issuer
and/or general market and economic conditions. Depending upon the relationship
of the conversion price to the market value of the underlying security, a
convertible security may trade more like an equity security than a debt
instrument.
If, because of a low price of the common stock, the conversion value is
substantially below the investment value of the convertible security, the price
of the convertible security is governed principally by its investment value. If
the conversion value of a convertible security increases to a point that
approximates or exceeds its investment value, the value of the security will be
principally influenced by its conversion value. A convertible security will sell
at a premium over its conversion value to the extent investors place value on
the right to acquire the underlying common stock while holding a fixed-income
security.
Mandatory convertible securities are distinguished as a subset of
convertible securities because the conversion is not optional and the conversion
price at maturity (or redemption) is based solely upon the market price of the
underlying common stock, which may be significantly less than par or the price
(above or below par) paid. For these reasons, the risks associated with the
investing in mandatory convertible securities most closely resemble the risks
inherent in common stocks. Mandatory convertible securities customarily pay a
higher coupon yield to compensate for the potential risk of additional price
volatility and loss upon redemption. Since the correlation of common stock risk
increases as the security approaches its redemption date, there can be no
assurance that the higher coupon will compensate for the potential loss.
Synthetic Convertible Securities. Although the Fund does not currently
intend to invest in synthetic convertible securities, the Fund may invest up to
10% of its Managed Assets in such securities. Synthetic convertible securities
possess the two principal characteristics of a true convertible security, i.e.,
a fixed-income security ("fixed-income component") and the right to acquire an
equity security ("convertible component"). If the Fund invests in synthetic
convertible securities, it is expected that the Fund will invest in such
synthetic convertible securities that are created by third parties, typically
investment banks or other financial institutions. Synthetic convertible
securities created by third parties typically trade as a single security with a
unitary value, similar to a true convertible security. The Fund may also invest
in synthetic convertible securities by acquiring separate securities, one
possessing a fixed-income component and the other possessing an equity
component. The fixed-income component is achieved by investing in
non-convertible, fixed-income securities such as bonds, debentures, notes,
preferred stocks and money market instruments. The equity component is achieved
by investing in warrants or options to buy common stock at a certain exercise
price, or options on a common stock index. Unlike a true convertible security or
a synthetic convertible security created by third parties, each of which is a
single security having a unitary market value, a synthetic convertible security
that is comprised of two or more separate securities will have a "market value"
that is the sum of the values of its fixed-income component and its equity
component. For this reason, the value of a synthetic convertible security that
is comprised of separate securities may respond differently to market
fluctuations than would a true convertible security or synthetic convertible
security created by a third party. More flexibility is possible in the assembly
of a synthetic convertible security than in the purchase of a convertible
security. Although synthetic convertible securities may be selected where the
two components are issued by a single issuer, thus making the synthetic
convertible security similar to the true convertible security, the character of
a synthetic convertible security allows the combination of components
representing distinct issuers, when an Adviser believes that such a combination
would better promote the Fund's investment objective. A synthetic convertible
security also is a more flexible investment in that its two components may be
purchased separately. For example, the Fund may purchase a warrant for inclusion
in a synthetic convertible security but temporarily hold short-term investments
while postponing the purchase of a corresponding bond pending development of
more favorable market conditions.
A holder of a synthetic convertible security faces the risk of a decline in
the price of the security or the level of the index involved in the equity
component, causing a decline in the value of the call option or warrant
purchased to create the synthetic convertible security. Should the price of the
stock fall below the exercise price and remain there throughout the exercise
period, the entire amount paid for the call option or warrant would be lost.
Because a synthetic convertible security includes the fixed-income component as
well, the holder of a synthetic convertible security also faces the risk that
interest rates will rise, causing a decline in the value of the fixed-income
instrument. Convertible structured notes are fixed-income debentures linked to
equity, which have the attributes of a convertible security; however, the
investment bank that issued the convertible note, rather than the issuer of the
underlying common stock into which the note is convertible, assumes the credit
risk associated with the investment. The Fund's holdings of synthetic
convertible securities, including those created by third parties, are considered
convertible securities for purposes of the Fund's policy to invest at least 80%
of its Managed Assets in preferred securities and convertible securities.
Warrants to Purchase Securities
The Fund may invest in warrants to purchase debt securities or equity
securities in connection with its investments in synthetic convertible
securities. A warrant to purchase equity securities is a right to purchase
common stock at a specific price (usually at a premium above the market value of
the underlying common stock at time of issuance) during a specified period of
time. Such a warrant may have a life ranging from less than a year to twenty
years or longer, but the warrant becomes worthless unless it is exercised or
sole before expiration. In addition, if the market price of the common stock
does not exceed an equity security warrant's exercise price during the life of
the warrant, the warrant will expire worthless. Equity security warrants have no
voting rights, pay no dividends and have no rights with respect to the assets of
the corporation issuing them. The percentage increase or decrease in the value
of an equity security warrant may be greater than the percentage increase or
decrease in the value of the underlying common stock.
Debt obligations with warrants attached to purchase equity securities have
many characteristics of convertible securities and their prices may, to some
degree, reflect the performance of the underlying stock. Debt obligations also
may be issued with warrants attached to purchase additional debt securities at
the same coupon rate. A decline in interest rates would permit the Fund to buy
additional bonds at the favorable rate or to sell such warrants at a profit. If
interest rates rise, these warrants would generally expire with no value.
Options on Securities and Indexes
In connection with its investments in synthetic convertible securities, the
Fund may purchase call options on common stocks and call options on common stock
indexes. The Fund may purchase call options on common stocks or common stock
indexes in standardized contracts traded on domestic or other securities
exchanges, boards of trade, or similar entities, or quoted on NASDAQ or on an
over-the-counter market.
A call option on a security (or an index) is a contract that gives the
holder of the option, in return for a premium, the right to buy from the writer
of the option the security underlying the option (or the cash value of the
common stock index) at a specified exercise price at any time during the term of
the option. The writer of an option on a security has the obligation upon
exercise of the option to deliver the underlying security upon payment of the
exercise price. Upon exercise, the writer of an option on an index is obligated
to pay the difference between the cash value of the index and the exercise price
multiplied by the specified multiplier for the index option. (An index is
designed to reflect features of a particular securities market, a specific group
of financial instruments or securities, or certain economic indicators.)
If an option purchased by the Fund expires unexercised, the Fund realizes a
capital loss equal to the premium paid. Prior to the earlier of exercise or
expiration, an exchange-traded option may be closed out by an offsetting
purchase or sale of an option of the same series (type, exchange, underlying
security or index, exercise price, and expiration). There can be no assurance,
however, that a closing purchase or sale transaction can be effected when the
Fund desires.
The Fund may sell call options it has previously purchased, which could
result in a net gain or loss depending on whether the amount realized on the
sale is more or less than the premium and other transaction costs paid on the
call option which is sold. The principal factors affecting the market value of a
call option include supply and demand, interest rates, the current market price
of the underlying security or index in relation to the exercise price of the
option, the volatility of the underlying security or index, and the time
remaining until the expiration date.
The premium paid for a call option purchased by the Fund is an asset of the
Fund. The value of an option purchased is marked to market daily and is valued
at the closing price on the exchange on which it is traded or, if not traded on
an exchange or no closing price is available, at the mean between the last bid
and asked prices.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
If a call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security remains less than or
equal to the exercise price, the Fund will lose its entire investment in the
option.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it has purchased.
Short-Term/Long-Term Debt Securities; Defensive Position; Invest-Up Period.
Upon an Adviser's recommendation and for temporary defensive purposes or to keep
cash on hand fully invested, including the period during which the net proceeds
of the offering are being invested, the Fund may invest up to 100% of its
Managed Assets in cash equivalents and investment grade fixed-income securities.
In such a case, the Fund may not pursue or achieve its investment objectives.
These investments are defined to include, without limitation, the following:
7
(1) U.S. government securities, including bills, notes and
bonds differing as to maturity and rates of interest that are either
issued or guaranteed by the U.S. Treasury or by U.S. government
agencies or instrumentalities. U.S. government agency securities
include securities issued by (a) the Federal Housing Administration,
Farmers Home Administration, Export-Import Bank of the United States,
Small Business Administration, and the Government National Mortgage
Association, whose securities are supported by the full faith and
credit of the United States; (b) the Federal Home Loan Banks, Federal
Intermediate Credit Banks, and the Tennessee Valley Authority, whose
securities are supported by the right of the agency to borrow from the
U.S. Treasury; (c) the Federal National Mortgage Association, whose
securities are supported by the discretionary authority of the U.S.
government to purchase certain obligations of the agency or
instrumentality; and (d) the Student Loan Marketing Association, whose
securities are supported only by its credit. While the U.S. government
provides financial support to such U.S. government-sponsored agencies
or instrumentalities, no assurance can be given that it always will do
so since it is not so obligated by law. The U.S. government, its
agencies, and instrumentalities do not guarantee the market value of
their securities. Consequently, the value of such securities may
fluctuate.
(2) Certificates of Deposit issued against funds deposited in
a bank or a savings and loan association. Such certificates are for a
definite period of time, earn a specified rate of return, and are
normally negotiable. The issuer of a certificate of deposit agrees to
pay the amount deposited plus interest to the bearer of the certificate
on the date specified thereon. Under current FDIC regulations, the
maximum insurance payable as to any one certificate of deposit is
$100,000; therefore, certificates of deposit purchased by the Fund may
not be fully insured.
(3) Repurchase agreements, which involve purchases of debt
securities. At the time the Fund purchases securities pursuant to a
repurchase agreement, it simultaneously agrees to resell and redeliver
such securities to the seller, who also simultaneously agrees to buy
back the securities at a fixed price and time. This assures a
predetermined yield for the Fund during its holding period, since the
resale price is always greater than the purchase price and reflects an
agreed-upon market rate. Such actions afford an opportunity for the
Fund to invest temporarily available cash. The Fund may enter into
repurchase agreements only with respect to obligations of the U.S.
government, its agencies or instrumentalities; certificates of deposit;
or bankers' acceptances in which the Fund may invest. Repurchase
agreements may be considered loans to the seller, collateralized by the
underlying securities. The risk to the Fund is limited to the ability
of the seller to pay the agreed-upon sum on the repurchase date; in the
event of default, the repurchase agreement provides that the Fund is
entitled to sell the underlying collateral. If the seller defaults
under a repurchase agreement when the value of the underlying
collateral is less than the repurchase price, the Fund could incur a
loss of both principal and interest. The Fund's investment adviser
monitors the value of the collateral at the time the action is entered
into and at all times during the term of the repurchase agreement. The
investment adviser does so in an effort to determine that the value of
the collateral always equals or exceeds the agreed-upon repurchase
price to be paid to the Fund. If the seller were to be subject to a
federal bankruptcy proceeding, the ability of
8
the Fund to liquidate the collateral could be delayed or impaired
because of certain provisions of the bankruptcy laws.
(4) Commercial paper, which consists of short-term unsecured
promissory notes, including variable rate master demand notes issued by
corporations to finance their current operations. Master demand notes
are direct lending arrangements between the Fund and a corporation.
There is no secondary market for such notes. However, they are
redeemable by the Fund at any time. An Adviser will consider the
financial condition of the corporation (e.g., earning power, cash flow,
and other liquidity measures) and will continuously monitor the
corporation's ability to meet all of its financial obligations, because
the Fund's liquidity might be impaired if the corporation were unable
to pay principal and interest on demand. Investments in commercial
paper will be limited to commercial paper rated in the highest
categories by a NRSRO and which mature within one year of the date of
purchase or carry a variable or floating rate of interest.
OTHER INVESTMENT POLICIES AND TECHNIQUES
NON-U.S. SECURITIES
The Fund may invest up to 35% of its Managed Assets in securities of
non-U.S. issuers. Subject to this 35% limitation, up to 10% of the Fund's
Managed Assets may be invested in securities that are denominated in Japanese
yen, Canadian dollars, British pounds or Euros and which may be offered, traded
or listed in markets other than U.S. markets. The remainder of the Fund's
Managed Assets that may be invested in securities of non-U.S. issuers will be
invested in U.S. dollar denominated securities offered, traded or listed in U.S.
markets. Initially, the Fund does not intend to invest more than 20% of its
Managed Assets in securities of non-U.S. issuers, and does not currently intend
to invest in the non-U.S. dollar denominated securities described above. For
this purpose, securities of non-U.S. issuers include American Depository
Receipts (ADRs), Global Depositary Receipts (GDRs) or other securities
representing underlying shares of non-U.S. issuers. Positions in those
securities are not necessarily denominated in the same currency as the common
stocks into which they may be converted. ADRs are receipts typically issued by
an American bank or trust company evidencing ownership of the underlying
securities. GDRs are U.S. dollar-denominated receipts evidencing ownership of
non-U.S. securities. Generally, ADRs, in registered form, are designed for the
U.S. securities markets and GDRs, in bearer form, are designed for use in
non-U.S. securities markets. The Fund may invest in sponsored or unsponsored
ADRs. In the case of an unsponsored ADR, the Fund is likely to bear its
proportionate share of the expenses of the depository and it may have greater
difficulty in receiving shareholder communications than it would have with a
sponsored ADR.
Investors should understand and consider carefully the risks involved in
investing in securities of non-U.S. issuers. Investing in securities of non-U.S.
issuers involves certain considerations comprising both risks and opportunities
not typically associated with investing in securities of U.S. issuers. These
considerations include: (i) less publicly available information about non-U.S.
issuers or markets due to less rigorous disclosure or accounting standards or
regulatory practices; (ii) many non-U.S. markets are smaller, less liquid and
more volatile meaning that in a changing market, an Adviser may not be able to
sell the Fund's portfolio securities at times, in amounts and at prices it
considers reasonable; (iii) potential adverse effects of fluctuations in
currency exchange rates or controls on the value of the Fund's investments; (iv)
the economies of non-U.S. countries may grow at slower rates than expected or
may experience a downturn or recession; (v) the impact of economic, political,
social or diplomatic developments may adversely affect the securities markets;
(vi) withholding and other non-U.S. taxes may decrease the Fund's return; (vii)
certain non-U.S. countries may impose restrictions on the ability of non-U.S.
issuers to make payments of principal and/or interest to investors located
outside the U.S., due to blockage of foreign currency exchanges or otherwise;
and (viii) possible seizure, expropriation or nationalization of the company or
its assets. These risks are more pronounced to the extent that the Fund invests
a significant amount of its investments in issuers located in one region.
Although an Adviser may hedge the Fund's exposure to certain of these risks,
including the foreign currency exchange rate risk, there can be no assurance
that the Fund will enter into hedging transactions at any time or at times or
under circumstances in which it might be advisable to do so.
Although the Fund intends to invest in companies and government
securities of countries having stable political environments, there is the
possibility of expropriation or confiscatory taxation, seizure or
nationalization of non-U.S. bank deposits or other assets,
9
establishment of exchange controls, the adoption of non-U.S. government
restrictions, or other adverse political, social or diplomatic developments that
could affect investment in non-U.S. issuers.
Debt Obligations of Non-U.S. Governments. An investment in debt obligations
of non-U.S. governments and their political subdivisions (sovereign debt)
involves special risks that are not present in corporate debt obligations. The
non-U.S. issuer of the sovereign debt or the non-U.S. governmental authorities
that control the repayment of the debt may be unable or unwilling to repay
principal or interest when due, and the Fund may have limited recourse in the
event of a default. During periods of economic uncertainty, the market prices of
sovereign debt may be more volatile than prices of debt obligations of U.S.
issuers. In the past, certain non-U.S. countries have encountered difficulties
in servicing their debt obligations, withheld payments of principal and interest
and declared moratoria on the payment of principal and interest on their
sovereign debt.
A sovereign debtor's willingness or ability to repay principal and pay
interest in a timely manner may be affected by, among other factors, its cash
flow situation, the extent of its non-U.S. currency reserves, the availability
of sufficient non-U.S. currency, the relative size of the debt service burden,
the sovereign debtor's policy toward its principal international lenders and
local political constraints. Sovereign debtors may also be dependent on expected
disbursements from non-U.S. governments, multilateral agencies and other
entities to reduce principal and interest arrearages on their debt. The failure
of a sovereign debtor to implement economic reforms, achieve specified levels of
economic performance or repay principal or interest when due may result in the
cancellation of third-party commitments to lend funds to the sovereign debtor,
which may further impair such debtor's ability or willingness to service its
debts.
Eurodollar Instruments and Yankee Bonds. The Fund may invest in Eurodollar
instruments and Yankee bonds. Yankee bonds are U.S. dollar denominated bonds
typically issued in the U.S. by non-U.S. governments and their agencies and
non-U.S. banks and corporations. These investments involve risks that are
different from investments in securities issued by U.S. issuers, including
potential unfavorable political and economic developments, non-U.S. withholding
or other taxes, seizure of non-U.S. deposits, currency controls, interest
limitations or other governmental restrictions which might affect payment of
principal or interest.
BONDS
The Fund may invest in a wide variety of bonds and related debt obligations
of varying maturities issued by U.S. and foreign corporations (including banks)
and other business entities, as well as governments and other issuers to borrow
money from investors. Bonds are fixed or variable rate debt obligations,
including bills, notes, debentures, money market instruments and similar
instruments and securities. Bonds generally are used by corporations,
governments and other issuers to borrow money from investors. The issuer pays
the investor a fixed or variable rate of interest and normally must repay the
amount borrowed on or before maturity. Certain bonds are "perpetual" in that
they have no maturity date. The Fund may invest up to 35% of its Managed Assets
in securities of foreign issuers, including corporate debt securities of foreign
issuers in accordance with the Fund's investment objective and policies as
described in the Prospectus. See "Non-U.S. Securities" above.
The Fund may also invest in corporate bonds that are generally used by
corporations as well as governments and other issuers to borrow money from
investors. The issuer pays the investor a fixed or variable rate of interest and
normally must repay the amount borrowed on or before maturity. The Fund may also
invest in corporate bonds that are below investment grade quality. See "--High
Yield Securities" below.
The Fund's investments in bonds are subject to a number of risks described
in the Prospectus and elaborated upon elsewhere in this section of the Statement
of Additional Information, including interest rate risk, credit risk, high yield
risk, issuer risk, foreign (non-U.S.) investment risk, inflation risk, liquidity
risk, smaller company risk and management risk.
STRUCTURED NOTES
The Fund may use structured notes, which are privately negotiated debt
obligations where the principal and/or interest is determined by reference to
the performance of a benchmark asset, market or interest rate (an "embedded
index"), such as selected securities, an index of securities or specified
interest rates, or the differential performance of two assets or markets.
Structured notes may be issued by corporations, including banks, as well as by
governmental agencies. Structured notes frequently are assembled in the form of
medium-term notes, but a variety of forms are available and may be used in
particular circumstances. The terms of such structured notes normally provide
that their principal and/or interest payments are to be adjusted upwards or
downwards (but ordinarily not below zero) to reflect changes in the embedded
index while the structured notes are outstanding. As a result, the interest
and/or principal payments that may be made on a structured product may vary
widely, depending on a variety of factors, including the volatility of the
embedded index and the effect of changes in the embedded index on principal
and/or interest payments. The rate of return on structured notes may be
determined by applying a multiplier to the performance or differential
performance of the referenced index(es) or other asset(s). Application of a
multiplier involves leverage that will serve to magnify the potential for gain
and the risk of loss.
An Adviser may utilize structured notes for investment purposes and also
for risk management purposes, such as to reduce the duration and interest rate
sensitivity of the Fund's portfolio. While structured notes may offer the
potential for a favorable rate of return from time to time, they also entail
certain risks. Structured notes may be less liquid than other debt securities,
and the price of structured notes may be more volatile. In some cases, depending
on the terms of the embedded index, a structured note may provide that the
principal and/or interest payments may be adjusted below zero. Structured notes
also may involve significant credit risk and risk of default by the
counterparty. Although structured notes are not necessarily illiquid, NIAC
believes that currently most structured notes are illiquid. Like other
sophisticated strategies, the Fund's use of structured notes may not work as
intended. If the value of the embedded index changes in a manner other than that
expected by an Adviser, principal and/or interest payments received on the
structured notes may be substantially less than expected. Also, if an Adviser
uses structured notes to reduce the duration of the Fund's portfolio, this may
limit the Fund's return when having a longer duration would be beneficial (for
instance, when interest rates decline)
NO INVERSE FLOATING RATE SECURITIES
The Fund will not invest in inverse floating rate securities, which are
securities that pay interest at rates that vary inversely with changes in
prevailing interest rates and which represent a leveraged investment in an
underlying security.
HIGH YIELD SECURITIES
Non-investment grade quality securities are sometimes referred to as "high
yield" securities or "junk bonds." See also "--Split-Rated Securities."
Investments in high yield securities generally provide greater income and
increased opportunity for capital appreciation than investments in higher
quality securities, but they also typically entail greater price volatility and
principal and income risk, including the possibility of issuer default and
bankruptcy. High yield securities are regarded as predominantly speculative with
respect to the issuer's continuing ability to meet principal and interest
payments. Issuers of high yield securities may be highly leveraged and may not
have available to them more traditional methods of financing. Securities in the
lowest investment grade category also may be considered to possess some
speculative characteristics by certain rating agencies. In addition, analysis of
the creditworthiness of issuers of high yield securities may be more complex
than for issuers of higher quality securities.
High yield securities may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade securities. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a decline in high yield security prices because the advent
of a recession could lessen the ability of an issuer to make principal and
interest payments on its debt obligations. If an issuer of high yield securities
defaults, in addition to risking payment of all or a portion of interest and
principal, the Fund may incur additional expenses to seek recovery. In the case
of high yield securities structured as zero-coupon or payment-in-kind
securities, their market prices will normally be affected to a greater extent by
interest rate changes, and therefore tend to be more volatile than securities
which pay interest currently and in cash. Each Adviser seeks to reduce these
risks through diversification, credit analysis and attention to current
developments and trends in both the economy and financial markets.
The secondary market for high yield securities may not be as liquid as the
secondary market for more highly rated securities, a factor which may have an
adverse effect on the Fund's ability to dispose of a particular security. There
are fewer dealers in the market for high yield securities than for investment
grade obligations. The prices quoted by different dealers may vary significantly
and the spread between the bid and ask price is generally much larger than for
higher quality instruments. Under adverse market or economic conditions, the
secondary market for high yield securities could contract further, independent
of any specific adverse changes in the condition of a particular issuer, and
these instruments may become illiquid. As a result, the Fund could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower rated or unrated securities, under these circumstances,
may be less than the prices used in calculating the Fund's net asset value.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of high yield
securities, especially in a thinly traded market. When secondary markets for
high yield securities are less liquid than the market for investment grade
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is less reliable, objective data available.
During periods of thin trading in these markets, the spread between bid and
asked prices is likely to increase significantly and the Fund may have greater
difficulty selling its portfolio securities. The Fund will be more dependent on
an Adviser's research and analysis when investing in high yield securities. Each
Adviser seeks to minimize the risks of investing in all securities through
in-depth credit analysis and attention to current developments in interest rates
and market conditions.
A general description of the ratings of securities by Moody's and S&P is
set forth in Appendix A to this Statement of Additional Information. The ratings
of Moody's and S&P represent their opinions as to the quality of the securities
they rate. It should be emphasized, however, that ratings are general and are
not absolute standards of quality. Consequently, in the case of debt
obligations, certain debt obligations with the same maturity, coupon and rating
may have different yields while debt obligations with the same maturity and
coupon with different ratings may have the same yield. For these reasons, the
use of credit ratings as the sole method of evaluating high yield securities can
involve certain risks. For example, credit ratings evaluate the safety of
principal and interest payments, not the market value risk of high yield
securities. Also, credit rating agencies may fail to change credit ratings in a
timely fashion to reflect events since the security was last rated. The Advisers
do not rely solely on credit ratings when selecting securities for the Fund, and
develop their own independent analysis of issuer credit quality.
The Fund's credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or an Adviser downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, an Adviser may consider such factors as an Adviser's assessment
of the credit quality of the issuer of such security, the price at which such
security could be sold and the rating, if any, assigned to such security by
other rating agencies. However, analysis of the creditworthiness of issuers of
high yield securities may be more complex than for issuers of higher quality
debt securities.
COMMON STOCK
The Fund does not intend to purchase common stock as part of its investment
strategy. The Fund will have exposure to common stock risks by virtue of the
equity component of the convertible securities in which the Fund invests. The
Fund may hold common stocks in its portfolio upon conversion of a convertible
security, such holdings not normally to exceed 5% of the Fund's Managed Assets.
In addition, in keeping with the income focus of the Fund, the Fund expects to
sell any common stock holdings as soon as practicable after conversion of a
convertible security. Common stock generally represents an ownership interest in
an issuer. Although common stocks historically have generated higher average
returns than debt securities, common stocks also have experienced significantly
more volatility in those returns. An adverse event, such as an unfavorable
earnings report, may depress the value of a particular common stock held by the
Fund or to which it has exposure. Also, prices of common stocks are sensitive to
general movements in the stock market. A drop in the stock market may depress
the prices of common stocks held by the Fund or to which it has exposure.
SPLIT-RATED SECURITIES
Split-rated securities are those securities that, at the time of
investment, are rated below investment grade by Moody's, S&P or Fitch, so long
as at least one NRSRO rates such securities within the four highest grades
(i.e., investment grade quality). This means that a split-rated security may be
regarded by one NRSRO (but by definition not by all NRSROs or by an Adviser) as
having predominately speculative characteristics with respect to the issuer's
capacity to pay interest and repay principal, and accordingly subject to a
greater risk of default. The prices of split-rated securities, in the view of
one but not all NRSROs, may be more sensitive to negative developments, such as
a decline in the issuer's revenues or a general economic downturn, than
securities without a split-rating.
CORPORATE LOANS
The Fund may invest up to 20% of its Managed Assets in other debt
instruments including corporate loans. Corporate loans, as with the other types
of securities in which the Fund may invest, are counted for purposes of various
other limitations described in this Statement of Additional Information,
including the limitation on investing no more than 10% of the Fund's Managed
Assets in illiquid securities, to the extent such corporate loans are deemed to
be illiquid.
Corporate loans, like most other debt obligations, are subject to the risk
of default. Default in the payment of interest or principal on a corporate loan
results in a reduction in income to the Fund, a reduction in the value of the
corporate loan and a decrease in the Fund's net asset value. This decrease in
the Fund's net asset value would be magnified by the Fund's use of leverage. The
risk of default increases in the event of an economic downturn or a substantial
increase in interest rates. An increased risk of default could result in a
decline in the value of corporate loans and in the Fund's net asset value.
The Fund may acquire corporate loans of borrowers that are experiencing, or
are more likely to experience, financial difficulty, including corporate loans
of borrowers that have filed for bankruptcy protection. Borrowers may have
corporate loans or other outstanding debt obligations that are rated below
investment grade or that are unrated but of comparable quality to such
securities. Debt securities rated below investment grade are viewed by the
rating agencies as speculative and are commonly known as junk bonds.
Corporate loans may not be rated at the time that the Fund purchases them.
If a corporate loan is rated at the time of purchase, the Adviser responsible
for the investment may consider the rating when evaluating the corporate loan
but the Adviser responsible for the investment may not view ratings as a
determinative factor in investment decisions. As a result, the Fund is more
dependent on an Adviser's credit analysis abilities. Because of the protective
terms of most corporate loans, it is possible that the Fund is more likely to
recover more of its investment in a defaulted corporate loan than would be the
case for most other types of defaulted debt securities. The values of corporate
loans of borrowers that have filed for bankruptcy protection or that are
experiencing payment difficulty will reflect, among other things, the assessment
of the Adviser responsible for the investment of the likelihood that the Fund
ultimately will receive repayment of the principal amount of such corporate
loans, the likely duration, if any, of a lapse in the scheduled payment of
interest and repayment of principal and prevailing interest rates.
In the case of collateralized corporate loans, there is no assurance that
sale of the collateral would raise enough cash to satisfy the borrower's payment
obligation or that the collateral can or will be liquidated. In the event of
bankruptcy, liquidation may not occur and the court may not give lenders the
full benefit of their senior positions. If the terms of a corporate loan do not
require the borrower to pledge additional collateral in the event of a decline
in the value of the original collateral, the Fund will be exposed to the risk
that the value of the collateral will not at all times equal or exceed the
amount of the borrower's obligations under the corporate loan. To the extent
that a corporate loan is collateralized by stock in the borrower or its
subsidiaries, such stock may lose all of its value in the event of bankruptcy of
the borrower. Uncollateralized corporate loans involve a greater risk of loss.
Some corporate loans in which the Fund may invest are subject to the risk that a
court, pursuant to fraudulent conveyance or other similar laws, could
subordinate such corporate loans to presently existing or future indebtedness of
the borrower or take other action detrimental to the holders of corporate loans,
such as the Fund, including, under certain circumstances, invalidating such
corporate loans. Lenders commonly have certain obligations pursuant to the loan
agreement, which may include the obligation to make additional loans or release
collateral in certain circumstances.
Information about most corporate loans is less readily available and
reliable than is the case for many other types of securities. In addition, there
is no minimum rating or other independent evaluation of a borrower or its
securities limiting the Fund's investments. The Adviser responsible for the
investment may rely exclusively or primarily on its own evaluation of borrower
credit quality in selecting corporate loans for purchase. As a result, the Fund
is particularly dependent on the analytical abilities of the Adviser responsible
for the investment.
No active trading market currently exists for many corporate loans.
Corporate loans are thus relatively illiquid. Liquidity relates to the ability
of the Fund to sell an investment in a timely manner at a price approximately
equal to its value on the Fund's books. The illiquidity of corporate loans may
impair the Fund's ability to realize the full value of its assets in the event
of a voluntary or involuntary liquidation of such assets. Because of the lack of
an active trading market, illiquid securities are also difficult to value and
prices provided by external pricing services may not reflect the true fair value
of the securities. However, many corporate loans are of a large principal amount
and are held by a large number of financial institutions. It is possible that
this should enhance their liquidity. In addition, in recent years the number of
institutional investors purchasing corporate loans has increased. The risks of
illiquidity are particularly important when the Fund's operations require cash,
and may in certain circumstances require that the Fund borrow to meet short-term
cash requirements. To the extent that a secondary market does exist for certain
corporate loans, the market may be subject to irregular trading activity, wide
bid/ask spreads and extended trade settlement periods. The market for corporate
loans could be disrupted in the event of an economic downturn or a substantial
increase or decrease in interest rates. This could result in increased
volatility in the market and in the Fund's net asset value and market price per
share.
If legislation or state or federal regulators impose additional
requirements or restrictions on the ability of financial institutions to make
loans that are considered highly leveraged transactions, the availability of
corporate loans for investment by the Fund may be adversely affected. In
addition, such requirements or restrictions could reduce or eliminate sources of
financing for certain borrowers. This would increase the risk of default. If
legislation or federal or state regulators require financial institutions to
dispose of corporate loans that are considered highly leveraged transactions or
subject such corporate loans to increased regulatory scrutiny, financial
institutions may determine to sell such corporate loans. Such sales could result
in prices that, in the opinion of the Adviser, do not represent fair value. If
the Fund attempts to sell a corporate loan at a time when a financial
institution is engaging in such a sale, the price the Fund could get for the
corporate loan may be adversely affected.
Some corporate loans are subject to the risk that a court, pursuant to
fraudulent conveyance or other similar laws, could subordinate the corporate
loans to presently existing or future indebtedness of the borrower or take other
action detrimental to lenders. Such court action could under certain
circumstances include invalidation of corporate loans. Any lender, which could
include the Fund, is subject to the risk that a court could find the lender
liable for damages in a claim by a borrower arising under the common laws of
tort or contracts or anti-fraud provisions of certain securities laws for
actions taken or omitted to be taken by the lenders under the relevant terms of
a loan agreement or in connection with actions with respect to the collateral
underlying in the corporate loan.
The Fund may purchase participations in corporate loans. By purchasing a
participation interest in a loan, the Fund acquires some or all of the interest
of a bank or other financial institution in a loan to a corporate borrower.
Under a participation, the Fund generally will have rights that are more limited
than the rights of lenders or of persons who acquire a corporate loan by
assignment. In a participation, the Fund typically has a contractual
relationship with the lender selling the participation, but not with the
borrower. As a result, the Fund assumes the credit risk of the lender selling
the participation in addition to the credit risk of the borrower. In the event
of insolvency of the lender selling the participation, the Fund may be treated
as a general creditor of the lender and may not have a senior claim to the
lenders' interest in the corporate loan. A lender selling a participation and
other persons interpositioned between the lender and the Fund with respect to
participations will likely conduct their principal business activities in the
banking, finance and financial services industries.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS
The Fund may buy and sell securities on a when-issued or delayed delivery
basis, making payment or taking delivery at a later date, normally within 15-45
days of the trade date. On such transactions the payment obligation and the
interest rate are fixed at the time the buyer enters into the commitment.
Beginning on the date the Fund enters into a commitment to purchase securities
on a when-issued or delayed delivery basis, the Fund is required under rules of
the Commission to maintain in a separate account liquid assets, consisting of
cash, cash equivalents or liquid securities having a market value at all times
of at least equal to the amount of the commitment. Income generated by any such
assets which provide taxable income for federal income tax purposes is
includable in the taxable income of the Fund. The Fund may enter into contracts
to purchase securities on a forward basis (i.e., where settlement will occur
more than 60 days from the date of the transaction) only to the extent that the
Fund specifically collateralizes such obligations with a security that is
expected to be called or mature within sixty days before or after the settlement
date of the forward transaction. The commitment to purchase securities on a
when-issued, delayed delivery or forward basis may involve an element of risk
because no interest accrues on the bonds prior to settlement and at the time of
delivery the market value may be less than cost.
REPURCHASE AGREEMENTS
As temporary investments, the Fund may invest in repurchase agreements. A
repurchase agreement is a contractual agreement whereby the seller of securities
(U.S. Government securities or municipal bonds) agrees to repurchase the same
security at a specified price on a future date agreed upon by the parties. The
agreed-upon repurchase price determines the yield during the Fund's holding
period. Repurchase agreements are considered to be loans collateralized by the
underlying security that is the subject of the repurchase contract. Income
generated from transactions in repurchase agreements will be taxable. See "Tax
Matters" for information relating to the allocation of taxable income between
Common Shares and FundPreferred shares, if any. The Fund will only enter into
repurchase agreements with registered securities dealers or domestic banks that,
in the opinion of an Adviser, present minimal credit risk. The risk to the Fund
is limited to the ability of the issuer to pay the agreed-upon repurchase price
on the delivery date; however, although the value of the underlying collateral
at the time the transaction is entered into always equals or exceeds the
agreed-upon repurchase price, if the value of the collateral declines there is a
risk of loss of both principal and interest. In the event of default, the
collateral may be sold but the Fund might incur a loss if the value of the
collateral declines, and might incur disposition costs or experience delays in
connection with liquidating the collateral. In addition, if bankruptcy
proceedings are commenced with respect to the seller of the security,
realization upon the collateral by the Fund may be delayed or limited. The
Adviser responsible for the investment will monitor the value of the collateral
at the time the transaction is entered into and at all times subsequent during
the term of the repurchase agreement in an effort to determine that such value
always equals or exceeds the agreed-upon repurchase price. In the event the
value of the collateral declines below the repurchase price, Spectrum will
demand additional collateral from the issuer to increase the value of the
collateral to at least that of the repurchase price, including interest.
ZERO COUPON BONDS AND PAYMENT-IN-KIND SECURITIES
Zero-coupon securities are debt obligations that do not entitle the holder to
any periodic payments of interest either for the entire life of the obligation
or for an initial period after the issuance of the obligation. When held to its
maturity, its return comes from the difference between the purchase price and
its maturity value. Payment-in-kind securities ("PIKs") pay dividends or
interest in the form of additional securities of the issuer, rather than in
cash. Each of these instruments is typically issued and traded at a deep
discount from its face amount. The amount of the discount varies depending on
such factors as the time remaining until maturity of the securities, prevailing
interest rates, the liquidity of the security and the perceived credit quality
of the issuer. The market prices of zero-coupon bonds and PIKs generally are
more volatile than the market prices of debt instruments that pay interest
currently and in cash and are likely to respond to changes in interest rates to
a greater degree than do other types of securities having similar maturities and
credit quality. In order to satisfy a requirement for qualification as a
"regulated investment company" under the Internal Revenue Code of 1986, as
amended (the "Code"), an investment company, such as the Fund, must distribute
each year at least 90% of its net investment income, including the original
issue discount accrued on zero-coupon bonds and PIKs. Because the Fund will not
on a current basis receive cash payments from the issuer of these securities in
respect of any accrued original issue discount, in some years the Fund may have
to distribute cash obtained from selling other portfolio holdings of the Fund in
order to avoid unfavorable tax consequences. In some circumstances, such sales
might be necessary in order to satisfy cash distribution requirements even
though investment considerations might otherwise make it undesirable for the
Fund to sell securities at such time. Under many market conditions, investments
in zero-coupon bonds and PIKs may be illiquid, making it difficult for the Fund
to dispose of them or determine their current value.
LENDING OF PORTFOLIO SECURITIES
The Fund may lend its portfolio securities to broker-dealers and banks. Any
such loan must be continuously secured by collateral in cash or cash equivalents
maintained on a current basis in an amount at least equal to the market value of
the securities loaned by the Fund. The Fund would continue to receive the
equivalent of the interest or dividends paid by the issuer on the securities
loaned, and would also receive an additional return that may be in the form of a
fixed fee or a percentage of the collateral. The Fund may pay reasonable fees to
persons unaffiliated with the Fund for services in arranging these loans. The
Fund would have the right to call the loan and obtain the securities loaned at
any time on notice of not more than five business days. The Fund would not have
the right to vote the securities during the existence of the loan but would call
the loan to permit voting of the securities, if, in an Adviser's judgment, a
material event requiring a shareholder vote would otherwise occur before the
loan was repaid. In the event of bankruptcy or other default of the borrower,
the Fund could experience both delays in liquidating the loan collateral or
recovering the loaned securities and losses, including (a) possible decline in
the value of the collateral or in the value of the securities loaned during the
period while the Fund seeks to enforce its rights thereto, (b) possible
subnormal levels of income and lack of access to income during this period, and
(c) expenses of enforcing its rights.
PORTFOLIO TRADING AND TURNOVER RATE
Portfolio trading may be undertaken to accomplish the investment objectives
of the Fund in relation to actual and anticipated movements in interest rates.
In addition, a security may be sold and another of comparable quality purchased
at approximately the same time to take advantage of what an Adviser believes to
be a temporary price disparity between the two securities. Temporary price
disparities between two comparable securities may result from supply and demand
imbalances where, for example, a temporary oversupply of certain securities may
cause a temporarily low price for such securities, as compared with other
securities of like quality and characteristics.
The Fund may also engage to a limited extent in short-term trading
consistent with its investment objectives. Securities may be sold in
anticipation of a market decline (a rise in interest rates) or purchased in
anticipation of a market rise (a decline in interest rates) and later sold, but
the Fund will not engage in trading solely to recognize a gain. Subject to the
foregoing, the Fund will attempt to achieve its investment objectives by prudent
selection of preferred securities with a view to holding them for investment.
While there can be no assurance thereof, the Fund anticipates that its annual
portfolio turnover rate will generally not exceed 75%. However, the rate of
turnover will not be a limiting factor when the Fund deems it desirable to sell
or purchase securities. Therefore, depending upon market conditions, the annual
portfolio turnover rate of the Fund may exceed 75% in particular years. A higher
portfolio turnover rate results in correspondingly greater brokerage commissions
and other transactional expenses that are borne by the Fund. High portfolio
turnover may result in the realization of net short-term capital gains by the
Fund which, when distributed to shareholders, will be taxable as ordinary
income.
HEDGING TRANSACTIONS
As a non-fundamental policy that can be changed by the Board of Trustees,
the use of derivatives and other transactions for purposes of hedging the
portfolio will be restricted to reducing the portfolio's exposure to the risk of
increases in interest rates, common stock risk, high yield credit risk and
foreign currency exchange risk. The specific derivative instruments to be used,
or other transactions to be entered into, for hedging purposes may include (i)
options and futures contracts, including options on common stock, stock indexes,
bonds and bond indexes, stock index futures, bond index futures and related
instruments, (ii) short sales of securities that the Fund owns or has the right
to acquire through the conversion of securities, (iii) structured notes and
similar instruments, (iv) credit derivative instruments, and (v) currency
exchange transactions. Some, but not all, of the derivative instruments may be
traded and listed on an exchange. The positions in derivatives will be
marked-to-market daily at the closing price established on the relevant exchange
or at a fair value. Except for investing in synthetic convertible securities,
the Fund will use derivatives or other transactions described in this paragraph
solely for purposes of hedging the Fund's portfolio risks.
10
There may be an imperfect correlation between changes in the value of
the Fund's portfolio holdings and hedging positions entered into by the Fund,
which may prevent the Fund from achieving the intended hedge or expose the Fund
to risk of loss. In addition, the Fund's success in using hedging instruments is
subject to an Adviser's ability to predict correctly changes in the
relationships of such hedge instruments to the Fund's portfolio holdings or
other factors, and there can be no assurance that an Adviser's judgment in this
respect will be correct. Consequently, the use of hedging transactions might
result in a poorer overall performance for the Fund, whether or not adjusted for
risk, than if the Fund had not hedged its portfolio holdings. In addition, there
can be no assurance that the Fund will enter into hedging or other transactions
at times or under circumstances in which it would be advisable to do so. See
"Risks--Hedging Risks."
Options on Securities. In order to hedge against adverse market shifts,
the Fund may purchase put and call options on stock, bonds or other securities.
In addition, the Fund may seek to hedge a portion of its portfolio investments
through writing (i.e., selling) covered put and call options. A put option
embodies the right of its purchaser to compel the writer of the option to
purchase from the option holder an underlying security or its equivalent at a
specified price at any time during the option period. In contrast, a call option
gives the purchaser the right to buy the underlying security covered by the
option or its equivalent from the writer of the option at the stated exercise
price at any time during the option period.
As a holder of a put option, the Fund will have the right to sell the
securities underlying the option and as the holder of a call option, the Fund
will have the right to purchase the securities underlying the option, in each
case at their exercise price at any time prior to the option's expiration date.
The Fund may choose to exercise the options it holds, permit them to expire or
terminate them prior to their expiration by entering into closing sale or
purchase transactions. In entering into a closing sale or purchase transaction,
the Fund would sell an option of the same series as the one it has purchased.
The ability of the Fund to enter into a closing sale transaction with respect to
options purchased and to enter into a closing purchase transaction with respect
to options sold depends on the existence of a liquid secondary market. There can
be no assurance that a closing purchase or sale transaction can be effected when
the Fund so desires. The Fund's ability to terminate option positions
established in the over-the-counter market may be more limited than in the case
of exchange-traded options and may also involve the risk that securities dealers
participating in such transactions would fail to meet their obligations to the
Fund.
In purchasing a put option, the Fund will seek to benefit from a
decline in the market price of the underlying security, while in purchasing a
call option, the Fund will seek to benefit from an increase in the market price
of the underlying security. If an option purchased is not sold or exercised when
it has remaining value, or if the market price of the underlying security
remains equal to or greater than the exercise price, in the case of a put, or
remains equal to or below the exercise price, in the case of a call, during the
life of the option, the option will expire worthless. For the purchase of an
option to be profitable, the market price of the underlying security must
decline sufficiently below the exercise price, in the case of a put, and must
increase sufficiently above the exercise price, in the case of a call, to cover
the premium and transaction costs. Because option premiums paid by the Fund are
small in relation to the market value of the instruments underlying the options,
buying options can result in additional amounts of leverage to the Fund. The
leverage caused by trading in options could cause the Fund's net asset value to
be subject to more frequent and wider fluctuation than would be the case if the
Fund did not invest in options.
The Fund will receive a premium when it writes put and call options,
which increases the Fund's return on the underlying security in the event the
option expires unexercised or is closed out at a profit. By writing a call, the
Fund will limit its opportunity to profit from an increase in the market value
of the underlying security above the exercise price of the option for as long as
the Fund's obligation as the writer of the option continues. Upon the exercise
of a put option written by the Fund, the Fund may suffer an economic loss equal
to the difference between the price at which the Fund is required to purchase
the underlying security and its market value at the time of the option exercise,
less the premium received for writing the option. Upon the exercise of a call
option written by the Fund, the Fund may suffer an economic loss equal to an
amount not less than the excess of the security's market value at the time of
the option exercise over the Fund's acquisition cost of the security, less the
sum of the premium received for writing the option and the difference, if any,
between the call price paid to the Fund and the Fund's acquisition cost of the
security. Thus, in some periods the Fund might receive less total return and in
other periods greater total return from its hedged positions than it would have
received from its underlying securities unhedged.
Options on Stock and Bond Indexes. The Fund may purchase put and call
options on stock and bond indexes to hedge against risks of market-wide price
movements affecting its assets. In addition, the Fund may write covered put and
call options on stock and bond indexes. A stock or bond index measures the
movement of a certain group of stocks or bonds by assigning relative values to
the stocks or bonds included in the index. Options on a stock or bond index are
similar to options on securities. Because no underlying security can be
delivered, however, the option represents the holder's right to obtain from the
writer, in cash, a fixed multiple of the amount by which the exercise price
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 exercise date. The advisability of
using stock or bond index options to hedge against the risk of market-wide
movements will depend on the extent of diversification of the Fund's investments
and the sensitivity of its investments to factors influencing the underlying
index. The effectiveness of purchasing or writing stock or bond index options as
a hedging technique will depend upon the extent to which price movements in the
Fund's investments correlate with price movements in the stock or bond index
selected. In addition, successful use by the Fund of options on stock or bond
indexes will be subject to the ability of an Adviser to predict correctly
changes in the relationship of the underlying index to the Fund's portfolio
holdings. No assurance can be given that the Adviser's judgment in this respect
will be correct.
When the Fund writes an option on a stock or bond index, it will
establish a segregated account with its custodian in which the Fund will deposit
liquid securities in an amount equal to the market value of the option, and will
maintain the account while the option is open.
Stock and Bond Index Futures Contracts. The Fund may purchase and sell
stock index futures as a hedge against movements in the equity markets. Stock
and bond index futures contracts are agreements in which one party agrees to
deliver to the other an amount of cash equal to a specific dollar amount times
the difference between the value of a specific stock or bond index at the close
of the last trading day of the contract and the price at which the agreement is
made. No physical delivery of securities is made.
For example, if an Adviser expects general stock or bond market prices
to decline, it might sell a futures contract on a particular stock or bond
index. If that index does in fact decline, the value of some or all of the
securities in the fund's portfolio may also be expected to decline, but that
decrease would be offset in part by the increase in the value of the Fund's
position in such futures contract. If, on the other hand, an Adviser expects
general stock or bond market prices to rise, it might purchase a stock or bond
index futures contract as a hedge against an increase in prices of particular
securities it wants ultimately to buy. If in fact the stock or bond index does
rise, the price of the particular securities intended to be purchased may also
increase, but that increase would be offset in part by the increase in the value
of the Fund's futures contract resulting from the increase in the index. The
Fund may purchase futures contracts on a stock or bond index to enable an
Adviser to gain immediate exposure to the underlying securities market pending
the investment in individual securities of the portion of the Fund's portfolio
allocated to that Adviser.
Under regulations of the Commodity Futures Trading Commission ("CFTC")
currently in effect, which may change from time to time, with respect to futures
contracts purchased by the Fund, the Fund will set aside in a segregated account
liquid securities with a value at least equal to the value of instruments
underlying such futures contracts less the amount of initial margin on deposit
for such contracts. The current view of the staff of the Securities and Exchange
Commission is that the Fund's long and short positions in futures contracts must
be collateralized with cash or certain liquid assets held in a segregated
account or "covered" in order to counter the impact of any potential leveraging.
Parties to a futures contract must make "initial margin" deposits to
secure performance of the contract. There are also requirements to make
"variation margin" deposits from time to time as the value of the futures
contract fluctuates. The Fund is not a commodity pool and, in compliance with
CFTC regulations currently in effect, may enter into any futures contracts and
related options for "bona fide hedging" purposes and, in addition, for other
purposes, provided that aggregate initial margin and premiums required to
establish positions other than those considered by the CFTC to be "bona fide
hedging" will not exceed 0.5% of the Fund's Managed Assets, after taking into
account unrealized profits and unrealized losses on any such contracts. The Fund
reserves the right to engage in transactions involving futures and options
thereon to the extent allowed by CFTC regulations in effect from time to time
and in accordance with the Fund's policies. In addition, certain provisions of
the Code may limit the extent to which the Fund may enter into futures contracts
or engage in options transactions. See "Tax Matters."
11
The potential loss related to the purchase of an option on a futures
contract is limited to the premium paid for the option (plus transaction costs).
With respect to options purchased by the Fund, there are no daily cash
payments made by the Fund 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 net asset value of the Fund.
Risks Associated with Futures Contracts and Options on Futures
Contracts. Futures prices are affected by many factors, 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. A purchase
or sale of a futures contract may result in losses in excess of the amount
invested in the futures contract. While the Fund may enter into futures
contracts and options on futures contracts for hedging purposes, the use of
futures contracts and options on futures contracts might result in a poorer
overall performance for the Fund than if it had not engaged in any such
transactions. If, for example, the Fund had insufficient cash, it might have to
sell a portion of its underlying portfolio of securities in order to meet daily
variation margin requirements on its futures contracts or options on futures
contracts at a time when it might be disadvantageous to do so. There may be an
imperfect correlation between the Fund's portfolio holdings and futures
contracts or options on futures contracts entered into by the Fund, which may
prevent the Fund from achieving the intended hedge or expose the Fund to risk of
loss. The degree of imperfection of correlation depends on circumstances such
as: variations in speculative market demand for futures, futures options and the
related securities, including technical influences in futures and futures
options trading and differences between the securities markets and the
securities underlying the standard contracts available for trading. Futures
prices are affected by many factors, such as current and anticipated short-term
interest rates, changes in volatility of the underlying instrument and the time
remaining until the expiration of the contract. Further, the Fund's use of
futures contracts and options on futures contracts to reduce risk involves costs
and will be subject to an Adviser's ability to predict correctly changes in
interest rate relationships or other factors. A decision as to whether, when and
how to use futures contracts involves the exercise of skill and judgment, and
even a well-conceived transaction may be unsuccessful to some degree because of
market behavior or unexpected stock price or interest rate trends. No assurance
can be given that Spectrum's judgment in this respect will be correct.
Futures exchanges may limit the amount of fluctuation permitted in
certain futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of the
current trading session. Once the daily limit has been reached in a futures
contract subject to the limit, no more trades may be made on that day at a price
beyond that limit. The daily limit governs only price movements during a
particular trading day and therefore does not limit potential losses because the
limit may work to prevent the liquidation of unfavorable positions. For example,
futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses. Stock index futures contracts are not normally subject to
such daily price change limitations.
The Fund may invest in other options. An option is an instrument that
gives the holder of the instrument the right, but not the obligation, to buy or
sell a predetermined number of specific securities (i.e. preferred stocks,
common stocks or bonds) at a stated price within the expiration period of the
instrument, which is generally less than 12 months from its issuance. If the
right is not exercised after a specified period but prior to the expiration, the
option expires. Both put and call options may be used by the Fund.
Short Sales. The Fund may make short sales of securities if, at all
times when a short position is open, the Fund owns at least an equal amount of
such securities or securities convertible into or exchangeable for, without
payment of any further consideration, securities of the same issue as, and equal
in amount to, the securities sold short. This technique is called selling short
"against the box."
In a short sale against the box, the Fund will not deliver from its
portfolio the securities sold and will not receive immediately the proceeds from
the short sale. Instead, the Fund will borrow the securities sold short from a
broker-dealer through which the short sale is executed and the broker-dealer
will deliver such securities, on behalf of the Fund, to the purchaser of such
securities. Such broker-dealer will be entitled to retain the proceeds from the
short sale until the Fund delivers to such broker-dealer the securities sold
short. In addition, the Fund will be required to pay the broker-dealer the
amount of any dividends paid on shares sold short. Finally, to secure its
obligation to deliver to such broker-dealer the securities sold short, the Fund
must deposit and continuously maintain in a separate account with its custodian
an equivalent amount of the securities sold short or securities convertible into
or exchangeable for such securities without the payment of additional
consideration. The Fund is said to have a short position in the securities sold
until it delivers to the broker-dealer the securities sold, at which time the
Fund will receive the proceeds of the sale. Because the Fund ordinarily will
want to continue to hold securities in its portfolio that are sold short, 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, rather than by delivering portfolio securities.
Short sales may protect the Fund against the risk of losses in the
value of its portfolio securities because any unrealized losses with respect to
such portfolio securities should be wholly or partially offset by a
corresponding gain in the short position. However, any potential gain in such
portfolio securities should be wholly or partially offset by a corresponding
loss in the short position. The extent to which such gains or losses are offset
will depend upon the amount of securities sold short relative to the amount the
Fund owns, either directly or indirectly, and, in the case where the Fund owns
convertible securities, changes in the conversion premium. The Fund will incur
transaction costs in connection with short sales.
In addition to enabling the Fund to hedge against market risk, short
sales may afford the Fund an opportunity to earn additional current income to
the extent the Fund is able to enter into arrangements with broker-dealers
through which the short sales are executed to receive income with respect to the
proceeds of the short sales during the period the Fund's short positions remain
open.
The Code imposes constructive sale treatment for federal income tax
purposes on certain hedging strategies with respect to appreciated financial
positions. Under these rules, taxpayers will recognize gain, but not loss, with
respect to securities if they enter into short sales or "offsetting notional
principal contracts" (as defined by the Code) with respect to, or futures or
forward contracts to deliver, the same or substantially identical property, or
if they enter into such transactions and then acquire the same or substantially
identical property. The Secretary of the Treasury is authorized to promulgate
regulations that will treat as constructive sales certain transactions that have
substantially the same effect as these transactions. See "Tax Matters."
Structured Notes. The Fund may use structured notes and similar
instruments for hedging purposes. Structured notes are privately negotiated debt
obligations where the principal and/or interest is determined by reference to
the performance of a benchmark asset, market or interest rate (an "embedded
index"), such as selected securities, an index of securities or specified
interest rates or the differential performance of two assets or markets. The
terms of such structured instruments normally provide that their principal
and/or interest payments are to be adjusted upwards or downwards (but not
ordinarily below zero) to reflect changes in the embedded index while the
structured instruments are outstanding. As a result, the interest and/or
principal payments that may be made on a structured product may vary widely,
depending on a variety of factors, including the volatility of the embedded
index and the effect of changes in the embedded index on principal and/or
interest payments. The rate of return on structured notes may be determined by
applying a multiplier to the performance or differential performance of the
referenced index(es) or other asset(s). Application of a multiplier involves
leverage that will serve to magnify the potential for gain and the risk of loss.
Credit Derivative Instruments. The Fund may purchase credit derivative
instruments for purposes of hedging the Fund's credit risk exposure to certain
issuers of securities that the Fund owns. For example, the Fund may enter into
credit swap default contracts for hedging purposes where the Fund would be the
buyer of such a default contract. The Fund would be entitled to receive the par
(or other agreed-upon) value of a referenced debt obligation from the
counterparty to the contract in the event of a default by a third party, such as
a U.S. or foreign corporate issuer, on the debt obligation. In return, the Fund
would pay to the counterparty a periodic stream of payments over the term of the
contract provided that no event of default has occurred. If no default occurs,
the Fund would have spent the stream of payments and received no benefit from
the contract.
Currency Exchange Transactions. The Fund may enter into currency
exchange transactions to hedge the Fund's exposure to foreign currency exchange
rate risk in the event the Fund invests in non-U.S. dollar denominated
securities of non-U.S. issuers as described in this Statement of Additional
Information. The Fund's currency transactions will be limited to portfolio
hedging involving portfolio positions. Portfolio hedging is the use of a forward
contract with respect to a portfolio security position denominated or quoted in
a particular currency. A forward contract is an agreement to purchase or sell a
specified currency at a specified future date (or within a specified time
period) and price set at the time of the contract. Forward contracts are usually
entered into with banks, foreign exchange dealers or broker-dealers, are not
exchange-traded, and are usually for less than one year, but may be renewed.
At the maturity of a forward contract to deliver a particular currency,
the Fund may either sell the portfolio security related to such contract and
make delivery of the currency, or it may retain the security and either acquire
the currency on the spot market or terminate its contractual obligation to
deliver the currency by purchasing an offsetting contract with the same currency
trader obligating it to purchase on the same maturity date the same amount of
the currency.
It is impossible to forecast with absolute precision the market value
of portfolio securities at the expiration of a forward contract. Accordingly, it
may be necessary for the Fund to purchase additional currency on the spot market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of currency that the Fund is obligated to deliver and if a
decision is made to sell the security and make delivery of the currency.
Conversely, it may be necessary to sell on the spot market some of the currency
received upon the sale of the portfolio security if its market value exceeds the
amount of currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
currency. Should forward prices decline during the period between the Fund's
entering into a forward contract for the sale of a currency and the date it
enters into an offsetting contract for the purchase of the currency, the Fund
will realize a gain to the extent 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. A default on the contract would deprive the Fund of unrealized
profits or force the Fund to cover its commitments for purchase or sale of
currency, if any, at the current market price.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the currency
at a price above the devaluation level it anticipates. The cost to the Fund of
engaging in currency exchange transactions varies with such factors as the
currency involved, the length of the contract period, and prevailing market
conditions. Since currency exchange transactions are usually conducted on a
principal basis, no fees or commissions are involved.
12
The Fund may invest in relatively new instruments without a significant
trading history for purposes of hedging the Fund's portfolio risks. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist.
INTEREST RATE TRANSACTIONS
In connection with the Fund's likely use of leverage through its sale
of FundPreferred shares or Borrowings, the Fund, if market conditions are deemed
favorable, likely will enter into interest rate swap or cap transactions to
attempt to protect itself from increasing dividend or interest expenses on its
FundPreferred shares or Borrowings. Interest rate swaps involve the Fund's
agreement with the swap counterparty to pay a fixed rate payment in exchange for
the counterparty agreeing to pay the Fund a payment at a variable rate that is
expected to approximate the rate on the Fund's variable rate payment obligation
on FundPreferred shares or any variable rate Borrowings. The payment obligations
would be based on the notional amount of the swap. The Fund may use an interest
rate cap, which would require it to pay a premium to the cap counterparty and
would entitle it, to the extent that a specified variable rate index exceeds a
predetermined fixed rate, to receive from the counterparty payment of the
difference based on the notional amount. The Fund would use interest rate swaps
or caps only with the intent to reduce or eliminate the risk that an increase in
short-term interest rates could have on Common Share net earnings as a result of
leverage.
The Fund will usually enter into swaps or caps on a net basis; that is,
the two payment streams will be netted out in a cash settlement on the payment
date or dates specified in the instrument, with the Fund receiving or paying, as
the case may be, only the net amount of the two payments. The Fund intends to
maintain in a segregated account with its custodian cash or liquid securities
having a value at least equal to the Fund's net payment obligations under any
swap transaction, marked-to-market daily.
The use of interest rate swaps and caps is a highly specialized
activity that involves investment techniques and risks different from those
associated with ordinary portfolio security transactions. Depending on the state
of interest rates in general, the Fund's use of interest rate swaps or caps
could enhance or harm the overall performance on the Common Shares. To the
extent there is a decline in interest rates, the value of the interest rate swap
or cap could decline, and could result in a decline in the net asset value of
the Common Shares. In addition, if short-term interest rates are lower than the
Fund's fixed rate of payment on the interest rate swap, the swap will reduce
Common Share net earnings. If, on the other hand, short-term interest rates are
higher than the fixed rate of payment on the interest rate swap, the swap will
enhance Common Share net earnings. Buying interest rate caps could enhance the
performance of the Common Shares by providing a maximum leverage expense. Buying
interest rate caps could also decrease the net earnings of the Common Shares in
the event that the premium paid by the Fund to the counterparty exceeds the
additional amount the Fund would have been required to pay had it not entered
into the cap agreement. The Fund has no current intention of selling an interest
rate swap or cap. The Fund will not enter into interest rate swap or cap
transactions in an aggregate notional amount that exceeds the outstanding amount
of the Fund's leverage.
Interest rate swaps and caps do not involve the delivery of securities
or other underlying assets or principal. Accordingly, the risk of loss with
respect to interest rate swaps is limited to
13
the net amount of interest payments that the Fund is contractually obligated to
make. If the counterparty defaults, the Fund would not be able to use the
anticipated net receipts under the swap or cap to offset the dividend payments
on the FundPreferred shares or interest payments on Borrowings. Depending on
whether the Fund would be entitled to receive net payments from the counterparty
on the swap or cap, which in turn would depend on the general state of
short-term interest rates at that point in time, such a default could negatively
impact the performance of the Common Shares.
Although this will not guarantee that the counterparty does not
default, the Fund will not enter into an interest rate swap or cap transaction
with any counter-party that NIAC believes does not have the financial resources
to honor its obligation under the interest rate swap or cap transaction.
Further, NIAC will continually monitor the financial stability of a counterparty
to an interest rate swap or cap transaction in an effort to proactively protect
the Fund's investments.
In addition, at the time the interest rate swap or cap transaction
reaches its scheduled termination date, there is a risk that the Fund would not
be able to obtain a replacement transaction or that the terms of the replacement
would not be as favorable as on the expiring transaction. If this occurs, it
could have a negative impact on the performance of the Fund's Common Shares.
The Fund may choose or be required to redeem some or all of the
FundPreferred shares or prepay any Borrowings. This redemption would likely
result in the Fund seeking to terminate early all or a portion of any swap or
cap transaction. Such early termination of a swap could result in termination
payment by or to the Fund. An early termination of a cap could result in a
termination payment to the Fund.
14
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The management of the Fund, including general supervision of the duties
performed for the Fund under the Management Agreement, is the responsibility of
the Board of Trustees of the Fund. The number of trustees of the Fund is
currently set at 12. None of the trustees who are not "interested persons" of
the Fund has ever been a director or employee of, or consultant to, Nuveen,
Spectrum or Froley, Revy or their affiliates. The Trustees serve annual terms
until the next annual shareholder meeting. The names and business addresses of
the trustees and officers of the Fund, their principal occupations and other
affiliations during the past five years, the number of portfolios each oversees
and other directorships they hold are set forth below.
Positions and Offices Principal Occupations, Including Number of Portfolios
with the Fund and Year First Other Directorships Held, During in Fund Complex
Name and Address Birthdate Elected or Appointed Past Five Years Overseen by Trustee
---------------- --------- -------------------- --------------- -------------------
Trustee who is an "interested person" of the Fund:
Timothy R. Schwertfeger* 03/28/49 Chairman of the Board Chairman and Director (since 1996) 142
333 West Wacker Drive and Trustee, 2003 of Nuveen Investments, Inc.,
Chicago, IL 60606 Nuveen Investments, LLC, Nuveen
Advisory Corp. and Nuveen Institutional
Advisory Corp.
_______________________________
* Mr. Schwertfeger is an "interested person" of the Fund, as defined in the
Investment Company Act of 1940, because he is an officer and director of
Nuveen Investments, Inc., Nuveen Investments, LLC and NIAC.
15
Positions and Offices Principal Occupations, Including Number of Portfolios
with the Fund and Year First Other Directorships Held, During in Fund Complex
Name and Address Birthdate Elected or Appointed Past Five Years Overseen by Trustee
---------------- --------- -------------------- --------------- -------------------
Chairman and Director (since 1997)
of Nuveen Asset Management, Inc.;
Director (since 1996) of Institutional
Capital Corporation; Chairman and
Director (since 1999) of Rittenhouse
Asset Management, Inc.; Chairman of
Nuveen Investments Advisers Inc. (since
2002).
Trustees who are not "interested persons" of the Fund:
William E. Bennett 10/16/46 Trustee, 2003 Private Investor; previously, 20
333 West Wacker Drive President and Chief Executive
Chicago, IL 60606 Officer, Draper & Kramer, Inc.,
a private company that handles
mortgage banking, real estate
development, pension advisory
and real estate management
(1995 - 1998).
Robert P. Bremner 8/22/40 Trustee, 2003 Private Investor and Management Consultant. 122
333 West Wacker Drive
Chicago, Il 60606
Lawrence H. Brown 7/29/34 Trustee, 2003 Retired (since 1989) as Senior Vice President 122
333 West Wacker Drive of The Northern Trust Company; Director of the
Chicago, Il 60606 United Way of Highland Park-Highwood (since
2002).
Jack B. Evans** 10/22/48 Trustee, 2003 President, The Hall-Perrine 20
333 West Wacker Drive Foundation, a private philanthropic
Chicago, IL 60606 corporation (since 1996); Director,
Alliant Energy; Director and Vice
Chairman, United Fire & Casualty
Company; Director, Federal Reserve
Bank of Chicago; formerly, President and
Chief Operating Officer, SCI
Financial Group, Inc., a regional
financial services firm.
Anne E. Impellizzeri 1/26/33 Trustee, 2003 Retired, formerly Executive Director (1998- 122
333 West Wacker Drive 2001) of Manitoga (Center for Russel Wright's
Chicago, IL 60606 Design with Nature); formerly, President and
Executive Officer of Blanton-Peale Institutes
Chief of Religion and Health (since 1990);
prior thereto, Vice President, Metropolitan
Life Insurance Co.
William L. Kissick 7/29/32 Trustee, 2003 Professor Emeritus, School of Medicine 20
333 West Wacker Drive and the Wharton School of Management and
Chicago, IL 60606 former Chairman, Leonard Davis
Institute of Health Economics,
University of Pennsylvania; Adjunct Professor,
Health Policy and Management, Yale University.
Thomas E. Leafstrand 11/11/31 Trustee, 2003 Retired; previously, Vice President 20
333 West Wacker Drive in charge of Municipal Underwriting
Chicago, IL 60606 and Dealer Sales at The Northern
Trust Company.
Peter R. Sawers 4/3/33 Trustee, 2003 Adjunct Professor of Business and Economics, 122
333 West Wacker Drive University of Dubuque, Iowa; formerly (1991-
Chicago, IL 60606 2000) Adjunct Professor, Lake Forest Graduate
School of Management, Lake Forest, Illinois;
prior thereto, Executive Director, Towers
Perrin Australia, a management consulting firm;
Chartered Financial Analyst; Director, Executive
Service Corps of Chicago, a not-for-profit
organization; Certified Management Consultant.
William J. Schneider*** 9/24/44 Trustee, 2003 Senior Partner and Chief Operating Officer, 122
333 West Wacker Drive Miller-Valentine Group, Vice President,
Chicago, IL 60606 Miller-Valentine Realty, a development and
contract company; Chair, Miami Valley Hospital;
Chair, Miami Valley Economic Development
Coalition; formerly Member, Community Advisory
Board, National City Bank, Dayton, Ohio and
Business Advisory Council, Cleveland Federal
Reserve Bank.
Judith M. Stockdale*** 12/29/47 Trustee, 2003 Executive Director, Gaylord and Dorothy 122
333 West Wacker Drive Donnelley Foundation (since 1994); prior
Chicago, IL 60606 thereto, Executive Director, Great Lakes
Protection Fund (from 1990 to 1994)
Sheila W. Wellington 2/24/32 Trustee, 2003 President (since 1993) of Catalyst (a 20
333 West Wacker Drive not-for-profit organization focusing
Chicago, IL 60606 on women's leadership development in
business and the professions).
** As a result of his ownership of securities issued by Wells Fargo & Co., the
parent company of Wells Fargo Securities, LLC, one of the principal underwriters
of the Fund, the Fund believes that Mr. Evans may be deemed to be an interested
person for as long as Wells Fargo Securities, LLC serves as principal
underwriter to the Fund and, therefore, for purposes of this offering he is
being treated as an interested person. Mr. Evans owns less than 1% of such
securities outstanding and has abstained from voting on any items involving the
appointment of Wells Fargo Securities, LLC as principal underwriter to the Fund.
*** As a result of his ownership of securities issued by PNC Financial Services
Group, the parent company of J.J.B. Hilliard, W.L. Lyons, Inc., one of the
principal underwriters of the Fund, the Fund believes that Mr. Schneider may be
deemed to be an interested person for as long as J.J.B. Hilliard, W.L. Lyons,
Inc. serves as principal underwriter to the Fund and, therefore, for purposes of
this offering he is being treated as an interested person. Mr. Schneider owns
less than 1% of such securities outstanding and has obstained from voting on any
items involving the appointment of J.J.B. Hilliard, W.L. Lyons, Inc. as
principal underwriter to the Fund.
16
Positions and Offices Principal Occupations, Including Number of Portfolios
with the Fund and Year First Directorships Held, During in Fund Complex
Name and Address Birthdate Elected or Appointed Past Five Years Overseen by Officer
---------------- --------- -------------------- --------------- -------------------
Officers of the Fund:
Gifford R. Zimmerman 9/9/56 Chief Administrative Managing Director (since 2002), Assistant 142
333 West Wacker Drive Officer, 2003 Secretary and Associate General Counsel,
Chicago, IL 60606 formerly, Vice President and Assistant General
Counsel of Nuveen Investments, LLC; Managing
Director (since 2002), General Counsel
and Assistant Secretary, formerly, Vice
President of Nuveen Advisory Corp. and Nuveen
Institutional Advisory Corp.; Managing
Director (since 2002), Assistant Secretary and
Associate General Counsel, formerly, Vice President
(since 2000), of Nuveen Asset Management, Inc.;
Assistant Secretary of Nuveen Investments, Inc.
(since 1994); Assistant Secretary of NWQ
Investment Management Company, LLC. (since 2002);
Vice President and Assistant Secretary of Nuveen
Investments Advisers Inc. (since 2002); Managing
Director, Associate General Counsel and Assistant
Secretary of Rittenhouse Asset Management, Inc.
(since May 2003); Chartered Financial Analyst.
Michael T. Atkinson 2/3/66 Vice President and Vice President (since January 2002), 142
333 West Wacker Drive Assistant Secretary, formerly Assistant Vice President
Chicago, IL 60606 2003 (since 2000), previously, Associate
of Nuveen Investments, LLC.
Peter H. D'Arrigo 11/28/67 Vice President and Vice President of Nuveen Investments, LLC 142
333 West Wacker Drive Treasurer, 2003 (since 1999), prior thereto, Assistant
Chicago, IL 60606 Vice President (from 1997); Vice
President and Treasurer (since 1999)
of Nuveen Investments, Inc.; Vice President
and Treasurer (since 1999) of Nuveen Advisory
Corp. and Nuveen Institutional Advisory Corp.;
Vice President and Treasurer of Nuveen Asset
Management, Inc. (since 2002) and of Nuveen
Investments Advisers Inc.; Assistant Treasurer
of NWQ Investment Management Company, LLC.
(since 2002); Chartered Financial Analyst.
Susan M. DeSanto 9/8/54 Vice President, 2003 Vice President of Nuveen Advisory 142
333 West Wacker Drive Corp. (since 2001); previously, Vice
Chicago, IL 60606 President of Van Kampen Investment
Advisory Corp. (since 1998); prior
thereto, Assistant Vice President of
Van Kampen Investment Advisory Corp.
(since 1994).
Jessica R. Droeger 9/24/64 Vice President and Vice President (since 2002) 142
333 West Wacker Drive Secretary, 2003 and Assistant General Counsel (since
Chicago, IL 60606 1998); formerly, Assistant Vice
President (since 1998), of Nuveen Investments,
LLC; Vice President (since 2002) and
Assistant Secretary (since 1998), formerly
Assistant Vice President, of Nuveen Advisory
Corp. and Nuveen Institutional Advisory Corp.
Lorna C. Ferguson 10/24/45 Vice President, 2003 Vice President of Nuveen Investments, LLC; 142
333 West Wacker Drive Vice President (since 1998) of Nuveen Advisory
Chicago, IL 60606 Corp. and Nuveen Institutional Advisory Corp.
William M. Fitzgerald 3/2/64 Vice President, 2003 Managing Director (since 2002) of Nuveen 142
333 West Wacker Drive Investments, LLC; Managing Director (since
Chicago, IL 60606 2001), formerly, Vice President of Nuveen
Advisory Corp. and Nuveen Institutional
Advisory Corp. (since 1995); Managing
Director of Nuveen Asset Management, Inc.
(since 2001); Vice President of Nuveen
Investments Advisers Inc. (since 2002);
Chartered Financial Analyst.
Stephen D. Foy 5/31/54 Vice President and Vice President (since 1993) and Funds 142
333 West Wacker Drive Controller, 2003 Controller (since 1998) of Nuveen Investments,
Chicago, IL 60606 LLC; Vice President and Funds Controller
(since 1998) of Nuveen Investments, Inc.;
Certified Public Accountant.
David J. Lamb 3/22/63 Vice President, 2003 Vice President (since 2000) of 142
333 West Wacker Drive Nuveen Investments, LLC, previously
Chicago, IL 60606 Assistant Vice President (since
1999); prior thereto, Associate
of Nuveen Investments, LLC; Certified
Public Accountant.
Tina M. Lazar 8/27/61 Vice President, 2003 Vice President (since 1999), previously 142
333 West Wacker Drive Assistant Vice President (since 1993)
Chicago, IL 60606 of Nuveen Investments, LLC.
Larry W. Martin 7/27/51 Vice President and Vice President, Assistant Secretary 142
333 West Wacker Drive Assistant Secretary, and Assistant General Counsel of
Chicago, IL 60606 2003 Nuveen Investments, LLC; Vice President and
Assistant Secretary of Nuveen Advisory
Corp. and Nuveen Institutional Advisory Corp.;
17
Positions and Offices Principal Occupations, Including Number of Portfolios
with the Fund and Year First Directorships Held, During in Fund Complex
Name and Address Birthdate Elected or Appointed Past Five Years Overseen by Officer
---------------- --------- -------------------- --------------- -------------------
Assistant Secretary of Nuveen Investments,
Inc. and (since 1997) of Nuveen Asset
Management, Inc.; Vice President (since
2000), Assistant Secretary and Assistant
General Counsel (since 1998) of Rittenhouse
Asset Management, Inc.; Vice President and
Assistant Secretary of Nuveen Investments
Advisers Inc. (since 2002); Assistant
Secretary of NWQ Investment Management
Company, LLC. (since 2002).
Edward F. Neild, IV 7/7/65 Vice President, 2003 Managing Director (since 2002) 142
333 W. Wacker Drive of Nuveen Investments, LLC;
Chicago, IL 60606 Managing Director (since 1997), formerly
Vice President (since 1996) of Nuveen
Advisory Corp. and Nuveen Institutional
Advisory Corp.; Managing Director of Nuveen
Asset Management, Inc. (since 1999); Chartered
Financial Analyst.
The Board of Trustees has five standing committees: the executive
committee, the audit committee, the nominating and governance committee, the
dividend committee and the valuation and risk committee. Because the Fund is
newly organized, none of the committees have met during the Fund's last fiscal
year. The executive committee met once prior to the commencement of the Fund's
operations.
Robert P. Bremner, Anne E. Impellizzeri and Timothy R. Schwertfeger,
Chair, serve as members of the executive committee of the Board of Trustees of
the Fund. The executive committee, which meets between regular meetings of the
Board of Trustees, is authorized to exercise all of the powers of the Board of
Trustees.
The audit committee monitors the accounting and reporting policies and
practices of the Funds, the quality and integrity of the financial statements of
the Funds, compliance by the Funds with legal and regulatory requirements and
the independence and performance of the external and internal auditors. The
members of the audit committee are William E. Bennett, Robert P. Bremner,
Lawrence H. Brown, Jack B. Evans, Thomas E. Leafstrand, William J. Schneider,
Chair, and Peter R. Sawers.
The nominating and governance committee is responsible for Board
selection and tenure; selection and review of committees; and Board education
and operations. In addition, the committee monitors performance of legal counsel
and other service providers; periodically reviews and makes recommendations
about any appropriate changes to trustee compensation; and has the resources and
authority to discharge its responsibilities--including retaining special counsel
and other experts or consultants at the expense of the Fund. In the event of a
vacancy on the Board, the nominating and governance committee receives
suggestions from various sources (including shareholders) as to suitable
candidates. Suggestions should be sent in writing to Lorna Ferguson, Vice
President for Board Relations, Nuveen Investments, LLC, 333 West Wacker Drive,
Chicago, IL 60606. The nominating and governance committee sets appropriate
standards and requirements for nominations for new trustees and reserves the
right to interview all candidates and to make
18
the final selection of any new trustees. The members of the nominating and
governance committee are William E. Bennett, Robert P. Bremner, Chair, Lawrence
H. Brown, Jack B. Evans, Anne E. Impellizzeri, William L. Kissick, Thomas E.
Leafstrand, Peter R. Sawers, William J. Schneider, Judith M. Stockdale and
Sheila W. Wellington.
The dividend committee is authorized to declare distributions on the
Fund's shares including, but not limited to, regular and special dividends,
capital gains and ordinary income distributions. The members of the dividend
committee are Timothy R. Schwertfeger, Chair, Lawrence H. Brown, Jack B. Evans
and Thomas E. Leafstrand.
The valuation committee oversees the Fund's pricing procedures
including, but not limited to, the review and approval of fair value pricing
determinations made by Nuveen's Valuation Group. The members of the valuation
committee are William E. Bennett, Chair, Lawrence H. Brown, Thomas E.
Leafstrand, and Judith M. Stockdale.
Trustees Bennett, Evans, Kissick, Leafstrand and Wellington are also
trustees of 8 Nuveen open-end funds and 12 Nuveen closed-end funds managed by
NIAC. Trustees Bremner, Brown, Impellizzeri, Sawers, Schneider and Stockdale are
also directors or trustees, as the case may be, of 30 open-end and 92 closed-end
funds managed by Nuveen Advisory Corp. Mr. Schwertfeger is also a director or
trustee, as the case may be, of 38 Nuveen open-end funds and 104 closed-end
funds managed by NIAC or Nuveen Advisory Corp. None of the independent trustees,
nor any of their immediate family members, has ever been a director, officer, or
employee of, or a consultant to, NIAC, Nuveen or their affiliates. In addition,
none of the independent trustees owns beneficially or of record, any security of
NIAC, Nuveen or any person (other than a registered investment company) directly
or indirectly controlling, controlled by or under common control with NIAC or
Nuveen.
The Common Shareholders of the Fund will elect trustees at the next
annual meeting of Common Shareholders, unless any FundPreferred shares are
outstanding at that time, in which event holders of FundPreferred shares,
voting as a separate class, will elect two trustees, and the remaining trustees
shall be elected by Common Shareholders and holders of FundPreferred shares,
voting together as a single class. Holders of FundPreferred shares will be
entitled to elect a majority of the Fund's trustees under certain circumstances.
See "Description of Shares - FundPreferred Shares - Voting Rights." The
following table sets forth the dollar range of equity securities beneficially
owned by each trustee as of December 31, 2002:
Aggregate Dollar Range of Equity Securities in All
Dollar Range of Equity Securities Registered Investment Companies Overseen by Trustee
Name of Trustee in the Fund in Family of Investment Companies
--------------- ----------- ---------------------------------
Timothy R. Schwertfeger $0 Over $100,000
William E. Bennett $0 $50,001 - $100,000
Robert P. Bremner $0 $10,001 - $50,000
Lawrence H. Brown $0 $50,001 - $100,000
Jack B. Evans $0 Over $100,000
Anne E. Impellizzeri $0 $10,001 - $50,000
William L. Kissick $0 $50,001 - $100,000
Thomas E. Leafstrand $0 Over $100,000
Peter R. Sawers $0 Over $100,000
William S. Schneider $0 Over $100,000
Judith M. Stockdale $0 $10,001 - $50,000
Sheila W. Wellington $0 Over $100,000
No trustee who is not an interested person of the Fund owns
beneficially or of record, any security of NIAC, Nuveen, Spectrum, Froley, Revy,
Citigroup Global Markets Inc. or any person (other than a registered investment
company) directly or indirectly controlling, controlled by or under common
control with NIAC, Nuveen, Spectrum, Froley, Revy or Citigroup Global Markets
Inc.
The following table sets forth estimated compensation to be paid by the
Fund projected during the Fund's first full fiscal year after commencement of
operation. The Fund does not have a retirement or pension plan. The officers and
trustees affiliated with Nuveen serve without any compensation from the Fund.
The Fund has a deferred compensation plan (the "Plan") that
19
permits any trustee who is not an "interested person" of the Fund to elect to
defer receipt of all or a portion of his or her compensation as a trustee. The
deferred compensation of a participating trustee is credited to a book reserve
account of the Fund when the compensation would otherwise have been paid to the
trustee. The value of the trustee's deferral account at any time is equal to the
value that the account would have had if contributions to the account had been
invested and reinvested in shares of one or more of the eligible Nuveen funds.
At the time for commencing distributions from a trustee's deferral account, the
trustee may elect to receive distributions in a lump sum or over a period of
five years. The Fund will not be liable for any other fund's obligations to make
distributions under the Plan.
Estimated Aggregate Total Compensation from Amount of Total Compensation
Name of Trustee Compensation from Fund* Fund and Fund Complex** That Has Been Deferred
--------------- ----------------------- ----------------------- ----------------------------
Timothy R. Schwertfeger $ 0 $ 0 $ 0
William E. Bennett 501 53,050 41,564
Robert P. Bremner 501 77,500 8,780
Lawrence H. Brown 521 82,000 0
Jack B. Evans 521 49,100 19,357
Anne E. Impellizzeri 480 77,500 58,535
William L. Kissick 480 49,000 18,000
Thomas E. Leafstrand 521 52,300 20,542
Peter R. Sawers 501 79,250 58,785
William S. Schneider 516 77,500 58,535
Judith M. Stockdale 480 77,750 14,690
Sheila W. Wellington 480 47,600 37,403
____________________________
* Based on the estimated compensation to be earned by the independent trustees
for the 12-month period ending 7/31/2004, representing the Fund's first full
fiscal year, for services to the Fund.
**Based on the compensation paid to the trustees for the one year period ending
12/31/02 for services to the Nuveen open-end and closed-end funds.
The Fund has no employees. Its officers are compensated by Nuveen
Investments, Inc. or its affiliates.
Nuveen Investments, Inc. maintains charitable contributions programs
to encourage the active support and involvement of individuals in the civic
activities of their community. These programs include a matching contributions
program and a direct contributions program. The Independent Board Members of the
funds managed by NIAC are eligible to participate in the charitable
contributions program of Nuveen Investments, Inc. Under the matching program,
Nuveen Investments, Inc. will match the personal contributions of a Board Member
to Section 501(c)(3) organizations up to an aggregate maximum amount of $10,000
during any calendar year. Under its direct (non-matching) program, Nuveen
Investments, Inc. makes contributions to qualifying Section 501(c)(3)
organizations, as approved by the Corporate Contributions Committee of Nuveen
Investments, Inc. The Independent Board Members are also eligible to submit
proposals to the committee requesting that contributions be made under this
program to Section 501(c)(3) organizations identified by the Board Member,
in an aggregate amount not to exceed $5,000 during any calendar year. Any
contribution made by Nuveen Investments, Inc. under the direct program is made
solely at the discretion of the Corporate Contributions Committee.
INVESTMENT ADVISERS
NIAC, 333 West Wacker Drive, Chicago, Illinois 60606, will be
responsible for determining the Fund's overall investment strategy, including
portfolio allocations, and the use of leverage, hedging and interest rate
transactions. NIAC also is responsible for selection of the Fund's Subadvisers
and ongoing monitoring of the Subadvisers, managing the Fund's business affairs
and providing day-to-day administrative services to the Fund. For additional
information regarding the management services performed by NIAC, see "Management
of the Fund" in the Fund's Prospectus.
NIAC serves as the investment adviser to the Fund and is responsible
for managing the portion of the Fund's assets allocated to other debt
instruments.
NIAC, a registered investment adviser, is a wholly owned subsidiary of
Nuveen Investments, Inc. According to data from Thomson Wealth Management,
Nuveen Investments, Inc. is the leading sponsor of exchange-traded funds as
measured by number of funds 103 and fund assets under
20
management (approximately $42 billion) as of April 30, 2003. Founded in 1898,
Nuveen Investments, Inc. and its affiliates had approximately $83 billion in
assets under management as of April 30, 2003. Nuveen Investments, Inc. is a
publicly-traded company that is approximately 79% owned by The St. Paul
Companies, Inc. ("St. Paul"). St. Paul is a publicly-traded company located in
St. Paul, Minnesota, and is principally engaged in providing property-liability
insurance through subsidiaries.
Gunther Stein and Lenny Mason are the portfolio managers for NIAC
responsible for investing the Fund's assets allocated to other debt instruments.
Mr. Stein is a Vice President of NIAC. He also has been lead portfolio manager
for high yield strategies at Symphony Asset Management, LLC ("Symphony"), a
wholly owned subsidiary of Nuveen Investments, Inc., since 1999. Prior to
joining Symphony in 1999, Mr. Stein was a high yield portfolio manager at Wells
Fargo. Mr. Mason is a Vice President of NIAC. He also is a high yield portfolio
manager at Symphony. Prior to joining Symphony in 2001, Mr. Mason was a Managing
Director in FleetBoston's Technology and Communications Group.
Nuveen Investments, Inc. provides investment services to financial
advisors serving high-net-worth clients and institutional clients. Nuveen
Investments today markets its capabilities--which include tax-free investing,
separately-managed accounts and market-neutral alternative investment
portfolios--under four distinct brands: Nuveen, NWQ, Rittenhouse and Symphony.
Nuveen Investments, Inc. is listed on The New York Stock Exchange and trades
under the symbol "JNC."
Spectrum, 4 High Ridge Park, Stamford, Connecticut 06905, is a
Subadviser to the Fund and is responsible for managing the portion of the Fund's
assets allocated to preferred securities. As one of the leading managers of
preferred securities in the U.S., Spectrum specializes in the management of
diversified preferred security portfolios for institutional investors, including
Fortune 500 companies, pension funds, insurance companies and foundations.
Spectrum also serves as a sub-adviser for a large offshore fund. Spectrum, a
registered investment adviser, commenced operations in 1987 and had
approximately $8 billion in assets under management as of April 30, 2003.
Spectrum is an independently managed wholly owned subsidiary of
Principal Global Investors, LLC, which is part of Principal Financial Group
Inc., a publicly traded, diversified, insurance and financial services company.
Collectively, subsidiaries and affiliates of Principal Global Investors, LLC
managed over $98 billion in combined assets worldwide as of April 30, 2003.
As a subsidiary of Principal Global Investors, LLC, Spectrum also can take
advantage of Principal's extensive staff of internal credit analysts.
A team of Spectrum professionals led by Mark A. Lieb, Bernard M.
Sussman and L. Phillip Jacoby, IV is responsible for investing the portion of
the Fund's assets allocated to preferred securities.
Mr. Lieb is an Executive Director and the Chief Financial Officer of
Spectrum. Mr. Lieb is responsible for business development of Spectrum. Prior to
founding Spectrum in 1987, Mr. Lieb was a founder, director and partner of DBL
Preferred Management, Inc., a wholly owned corporate cash management subsidiary
of Drexel Burnham Lambert, Inc. Mr. Lieb was instrumental in the formation and
continual development of all aspects of DBL Preferred Management, Inc.,
including the daily management of preferred stock portfolio for institutional
clients, general hedging strategies, and market strategies employed by the firm.
Mr. Lieb's prior employment included the development of the preferred stock
trading desk at Mosley Hallgarten & Estabrook. Mr. Lieb has a B.A. in economics
from Central Connecticut State College and an M.B.A. in finance from the
University of Hartford.
Mr. Sussman is an Executive Director and the Chief Investment Officer
of Spectrum and is Chairman of Spectrum's Investment Committee. Prior to joining
Spectrum in 1995, Mr. Sussman was employed by Goldman Sachs & Co. for nearly 18
years. A general partner and head of the Preferred Stock Department, he was in
charge of sales, trading and underwriting for all preferred products and was
instrumental in the development of the hybrid (MIPS) market. Mr. Sussman was a
limited partner at Goldman Sachs from December 1994 through November 1996. He
has a B.S. in industrial relations and an M.B.A. in finance from Cornell
University.
Mr. Jacoby is a Senior Vice President of Spectrum. He joined Spectrum
in 1995 as a Portfolio Manager. Previously, Mr. Jacoby worked as a senior
investment officer at USL Capital Corporation (a subsidiary of Ford Motor
Corporation) and was a co-manager of a $600 million preferred stock portfolio.
Mr. Jacoby has a B.S. in finance from Boston University.
Froley, Revy, 10900 Wilshire Boulevard, Suite 900, Los Angeles,
California 90024, is a Subadviser to the Fund and is responsible for managing
the portion of the Fund's assets allocated to convertible securities. Froley,
Revy specializes in the management of convertible securities. Froley, Revy
commenced operations in 1975 and had approximately $2.5 billion in assets under
management as of April 30, 2003.
Froley, Revy is an independently managed wholly owned subsidiary of
First Republic Bank, which is a publicly-traded commercial bank and wealth
management firm. Collectively, subsidiaries and affiliates of First Republic
Bank, including Froley, Revy, managed approximately $7 billion in combined
assets as of April 30, 2003.
Andrea Revy O'Connell and Michael Revy are the portfolio managers at
Froley, Revy responsible for investing the portion of the Fund's assets
allocated to convertible securities. Ms. O'Connell is President and Chief
Executive Officer of Froley, Revy and has been Managing Director and a Principal
of Froley, Revy since 1994. Mr. Revy is a Senior Vice President, Senior
Portfolio Manager and a Managing Director of Froley, Revy and is responsible for
the development and co-management of Froley, Revy's convertible arbitrage
product. Before joining Froley, Revy in 2002, Mr. Revy was a private banker at
Wechsler & Co., Inc. since 1998, and prior thereto worked for Lehman Brothers
for six years in that firm's convertible bond group.
21
Pursuant to an investment management agreement between NIAC and the
Fund, the Fund has agreed to pay an annual management fee for the services and
facilities provided by NIAC, payable on a monthly basis, according to the
following schedule:
Average Daily Managed Assets Management
Fee
---
Up to $500 million.................................................. .9000%
$500 million to $1 billion.......................................... .8750%
$1 billion to $1.5 billion.......................................... .8500%
$1.5 billion to $2.0 billion........................................ .8250%
Over $2.0 billion................................................... .8000%
If the Fund utilizes leverage through the issuance of FundPreferred
shares in an amount equal to 33 1/3% of the Fund's total assets (including the
amount obtained from leverage), the management fee calculated as a percentage of
net assets attributable to Common Shares would be as follows:
Net Assets Attributable to Common Shares Management
---------------------------------------- Fee
---
Up to $500 million ....................................................1.3500%
$500 million to $1 billion ............................................1.3125%
$1 billion to $1.5 billion ............................................1.2750%
$1.5 billion to $2.0 billion ..........................................1.2375%
Over $2.0 billion .....................................................1.2000%
Pursuant to investment subadvisory agreements between NIAC and each of
the Subadvisers, each Subadviser will receive from NIAC a management fee equal
to 40% of the management fee payable by the Fund to NIAC (net of the
reimbursements described below) with respect to the Subadviser's allocation of
Managed Assets up to the first $500 million of the average daily Managed Assets
of the Fund allocated to that Subadviser and 35% thereafter.
In addition to the fee of NIAC, the Fund pays all other costs and
expenses of its operations, including compensation of its trustees (other than
those affiliated with NIAC), custodian, transfer agency and dividend disbursing
expenses, legal fees, expenses of independent auditors, expenses of repurchasing
shares, expenses of issuing any FundPreferred shares, expenses of preparing,
printing and distributing shareholder reports, notices, proxy statements and
reports to governmental agencies, and taxes, if any. All fees and expenses are
accrued daily and deducted before payment of dividends to investors.
For the first eight full years of the Fund's operation, the Advisers
have contractually agreed to reimburse the Fund for fees and expenses
in the amounts, and for the time periods, set forth below:
Percentage Percentage
Reimbursed Reimbursed
(as a percentage (as a percentage
Year Ending of Managed Year Ending of Managed
June 30 Assets) June 30 Assets)
------------ ------------ ------------ ------------
2003(1) .32% 2008 .32%
2004 .32% 2009 .24%
2005 .32% 2010 .16%
2006 .32% 2011 .08%
2007 .32%
22
_______________
(1) From the commencement of operations.
Reducing Fund expenses in this manner will tend to increase the amount
of income available for the Common Shareholders. The Advisers have not agreed to
reimburse the Fund for any portion of its fees and expenses beyond June 30,
2011.
Unless earlier terminated as described below, the Fund's investment
management agreement with NIAC and the Fund's investment sub-advisory agreements
(the "management agreements") will remain in effect until August 1, 2004. The
management agreements continue in effect from year to year so long as such
continuation is approved at least annually by (1) the Board of Trustees or the
vote of a majority of the outstanding voting securities of the Fund, and (2) a
majority of the trustees who are not interested persons of any party to the
investment management agreement, cast in person at a meeting called for the
purpose of voting on such approval. The investment management agreement may be
terminated at any time, without penalty, by either the Fund or NIAC upon 60 days
written notice, and is automatically terminated in the event of its assignment
as defined in the 1940 Act. Each investment sub-advisory agreement may be
terminated at any time, without penalty, by the Fund, NIAC or the Subadviser
party thereto upon 60 days written notice, and is automatically terminated in
the event of its assignment as defined in the 1940 Act.
The management agreements have been approved by a majority of the
independent trustees of the Fund and the sole shareholder of the Fund. The
independent trustees have determined that the terms of the Fund's management
agreements are fair and reasonable and that the agreements are in the Fund's
best interests. The independent trustees believe that the management agreements
will enable the Fund to obtain high quality investment management services at a
cost that they deem appropriate, reasonable, and in the best interests of the
Fund and its shareholders. In making such determination, the independent
trustees met independently from the interested trustee of the Fund and any
officers of NIAC, Spectrum, Froley, Revy and their affiliates. The independent
trustees also relied upon the assistance of counsel to the independent trustees.
In evaluating the investment management agreement between the Fund and
NIAC, the independent trustees reviewed materials furnished by NIAC at the
annual advisory contract renewal meeting held in May 2003, including information
regarding NIAC, its affiliates and its personnel, operations and financial
condition. In evaluating the investment sub-advisory agreements, the independent
trustees reviewed materials furnished by Spectrum in May, 2003, including
information regarding Spectrum, its affiliates and its personnel, operations and
financial condition. The independent trustees also reviewed materials previously
furnished by Froley, Revy, including information regarding Froley, Revy, its
affiliates and its personnel, operations and financial condition. The
independent trustees also reviewed, among other things, the nature and quality
of services to be provided by NIAC, Spectrum and Froley, Revy, the proposed fees
to be charged by NIAC, Spectrum and Froley, Revy for investment management
services, the profitability to NIAC, Spectrum and Froley, Revy of their
relationships with the Fund, fall-out benefits to NIAC, Spectrum and Froley,
Revy from that relationship, economies of scale achieved by NIAC, Spectrum and
Froley, Revy, the experience of the investment advisory and other personnel
providing services to the Fund, the historical quality of the services provided
by NIAC, Spectrum and Froley, Revy and comparative fees and expense ratios of
investment companies with similar objectives and strategies managed by other
investment advisers, and other factors that the independent trustees deemed
relevant. The independent trustees, at various times, discussed with
representatives of NIAC, Spectrum and Froley, Revy the Fund's operations and
each of NIAC's, Spectrum's and Froley, Revy's ability to provide advisory and
other services to the Fund.
23
The Fund, NIAC, Nuveen, Spectrum, Froley, Revy, Citigroup Global
Markets Inc. and other related entities have adopted codes of ethics which
essentially prohibit certain of their personnel, including the Fund's portfolio
managers, from engaging in personal investments which compete or interfere with,
or attempt to take advantage of a client's, including the Fund's, anticipated or
actual portfolio transactions, and are designed to assure that the interests of
clients, including Fund shareholders, are placed before the interests of
personnel in connection with personal investment transactions. Text-only
versions of the codes of ethics of the Fund, NIAC, Nuveen, Spectrum, and Froley,
Revy can be viewed online or downloaded from the EDGAR Database on the SEC's
internet web site at www.sec.gov. You may also review and copy those documents
by visiting the SEC's Public Reference Room in Washington, DC. Information on
the operation of the Public Reference Room may be obtained by calling the SEC at
202-942-8090. In addition, copies of those codes of ethics may be obtained,
after mailing the appropriate duplicating fee, by writing to the SEC's Public
Reference Section, 450 5th Street, N.W., Washington, DC 20549-0102 or by e-mail
request at publicinfo@sec.gov.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the supervision of the Board of Trustees, each Adviser,
with respect to the securities for which it is responsible, is responsible for
decisions to buy and sell securities for the Fund and the negotiation of
brokerage commissions to be paid. Transactions on stock exchanges involve the
payment by the Fund of brokerage commissions. There generally is no stated
commission in the case of securities traded in the over-the-counter market but
the price paid by the Fund usually includes an undisclosed dealer commission or
mark-up. In certain instances, the Fund may make purchases of underwritten
issues at prices which include underwriting fees.
NIAC
NIAC, with respect to the securities for which it is responsible, is
responsible for decisions to buy and sell securities for the Fund and for the
placement of the Fund's securities business, the negotiation of the prices to be
paid for principal trades and the allocation of its transactions among various
dealer firms. Portfolio securities will normally be purchased directly from an
underwriter or in the over-the-counter market from the principal dealers in such
securities, unless it appears that a better price or execution may be obtained
through other means. Portfolio securities will not be purchased from Nuveen or
its affiliates except in compliance with the 1940 Act.
With respect to interests in corporate loans, the Fund generally will
engage in privately negotiated transactions for purchase or sale in which NIAC
will negotiate on behalf of the Fund, although a more developed market may exist
for certain corporate loans. The Fund may be required to pay fees, or forgo a
portion of interest and any fees payable to the Fund, to the lender selling
participations or assignments to the Fund. NIAC will determine the lenders from
whom the Fund will purchase assignments and participations by considering their
professional ability, level of service, relationship with the borrower,
financial condition, credit standards and quality of management. Although the
Fund intends generally to hold interests in corporate loans until maturity or
prepayment of the corporate loan, the illiquidity of many corporate loans may
restrict the ability of NIAC to locate in a timely manner persons willing to
purchase the Fund's interests in corporate loans at a fair price should the Fund
desire to sell such interests. See "Risks" in the Prospectus.
The Fund expects that substantially all other portfolio transactions
will be effected on a principal (as opposed to an agency) basis and,
accordingly, does not expect to pay any brokerage commissions. Purchases from
underwriters will include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers will include the spread between the bid
and ask price. It is the policy of NIAC to seek the best execution under the
circumstances of each trade. NIAC evaluates price as the primary consideration,
with the financial condition, reputation and responsiveness of the dealer
considered secondary in determining best execution. Given the best execution
obtainable, it will be NIAC's practice to select dealers which, in addition,
furnish research information (primarily credit analyses of issuers and general
economic reports) and statistical and other services to NIAC. It is not possible
to place a dollar value on information and statistical and other services
received from dealers. Since it is only supplementary to NIAC's own research
efforts, the receipt of research information is not expected to reduce
significantly NIAC's expenses. While NIAC will be primarily responsible for the
placement of the business of the Fund, the policies and practices of NIAC in
this regard must be consistent with the foregoing and will, at all times, be
subject to review by the Board of Trustees of the Fund.
NIAC may manage other investment accounts and investment companies for
other clients which have investment objectives similar to those of the Fund.
Subject to applicable laws and regulations, NIAC seeks to allocate portfolio
transactions equitably whenever concurrent decisions are made to purchase or
sell assets or securities by the Fund and another advisory account. In making
such allocations the main factors to be considered will be the respective
investment objectives, the relative size of portfolio holdings of the same or
comparable securities, the availability of cash for investment and the size of
investment commitments generally held. While this procedure could have a
detrimental effect on the price or amount of the securities available to the
Fund from time to time, it is the opinion of the Board of Trustees that the
benefits available from NIAC's organization will outweigh any disadvantage that
may arise from exposure to simultaneous transactions.
Spectrum
In selecting a broker to execute each particular transaction for which
it is responsible, Spectrum will take the following into consideration: the best
net price available; the reliability, integrity and financial condition of the
broker; the size and difficulty in executing the order; and the value of the
expected contribution of the broker to the investment performance of a Fund on a
continuing basis.
Spectrum may act as broker for the Fund in connection with the purchase
or sale of securities by or to the Fund if and to the extent permitted by
procedures adopted from time to time by the Board of Trustees of the Fund. The
Board of Trustees, including a majority of the trustees who are not "interested"
trustees, has determined that portfolio transactions for the Fund may be
executed through Spectrum if, in the judgment of NIAC and Spectrum, the use of
Spectrum is likely to result in prices and execution at least as favorable to
the Fund as would be available from other qualified brokers and if, in such
transactions, Spectrum charges the Fund commission rates at least as favorable
to the Fund as those charged by Spectrum to comparable unaffiliated customers in
similar transactions. The Board of Trustees also has adopted procedures that are
reasonably designed to provide that any commission, fee or other remuneration
paid to Spectrum is consistent with the foregoing standard. The Fund will not
effect principal transactions with Spectrum. In executing transactions through
Spectrum, the
24
Fund will be subject to, and intends to comply with, Section 17(e) of the 1940
Act and the rules thereunder.
The cost of the brokerage commissions to the Fund in any transaction
(other than those effected by Spectrum) may be greater than that available from
other brokers if the difference is reasonably justified by other aspects of the
portfolio execution services offered. Subject to such policies and procedures as
the trustees may determine, Spectrum shall not be deemed to have acted
unlawfully or to have breached any duty solely by reason of having caused the
Fund to pay a broker (other than Spectrum) that provides research services an
amount of commission for effecting a portfolio investment transaction in excess
of the amount of commission another broker would have charged for effecting that
transaction if Spectrum determines in good faith that such amount of commission
was reasonable in relation to the value of the research service provided by such
broker viewed in terms of either that particular transaction or Spectrum's
ongoing responsibilities with respect to the Fund. Research and investment
information may be provided by these and other brokers at no cost to Spectrum
and is available for the benefit of other accounts advised by Spectrum and its
affiliates, and not all of the information will be used in connection with the
Fund. Although this information may be useful in varying degrees and may tend to
reduce Spectrum's expenses, it is not possible to estimate its value and in the
opinion of Spectrum it does not reduce expenses in a determinable amount. The
extent to which Spectrum makes use of statistical, research and other services
furnished by brokers is considered by Spectrum in the allocation of brokerage
business but there is no formula by which such business is allocated. Spectrum
does so in accordance with its judgement of the best interests of the Fund and
its shareholders. Spectrum may also take into account payments made by brokers
effecting transactions for the Fund to other persons on behalf of the Fund for
services provided to them for which they would be obligated to pay (such as
custodial and professional fees). In addition, consistent with the Conduct Rules
of the National Association of Securities Dealers, Inc., and subject to seeking
best price and execution, Spectrum may consider sales of shares of the Fund as a
fact in the selection of brokers and dealers to enter into portfolio
transactions with the Fund.
Certain other clients of Spectrum may have investment objectives and
policies similar to those of the Fund. Spectrum may, from time to time, make
recommendations that result in the purchase or sale of a particular security by
their other clients simultaneously with the Fund. If transactions on behalf of
more than one client during the same period increase the demand for securities
being sold, there may be an adverse effect on the price of such securities. It
is the policy of Spectrum to allocate advisory recommendations and the placing
of orders in a manner that each deems equitable to the accounts involved,
including the Fund. When two or more of the clients of Spectrum (including the
Fund) are purchasing or selling the same security on a given day through the
same broker-dealer, such transactions may be averaged as to price.
Froley, Revy
It is the policy of Froley, Revy to secure the execution of orders on its
portfolio transactions in an effective manner at the most favorable price.
Pursuant to its agreement with the Fund, Froley, Revy determines, subject to the
general supervision of the Board of Trustees and in accordance with the Fund's
investment objectives, policies and restrictions, which securities are to be
purchased and sold and which brokers are to be eligible to execute its portfolio
transactions. It is not the policy of Froley, Revy to deal solely with one
broker, but it is Froley, Revy's intention to place portfolio transactions with
those brokers which provide the most favorable combination of price, execution
and services to the Fund. Research services are a factor in selection of
brokers, but payment in excess of brokerage commissions charged by other brokers
is made in recognition of research services. The reasonableness of brokerage
commissions is evaluated by comparison to fees charged by other brokers where
the execution and services are comparable.
25
DISTRIBUTIONS
Level Rate Dividend Policy
Subject to the determination of the Board of Trustees to implement a
Managed Dividend Policy, as discussed below, commencing with the Fund's first
dividend, the Fund intends to make regular monthly cash distributions to Common
Shareholders at a level rate based on the projected performance of the Fund,
which rate may be adjusted from time to time. The Fund's ability to maintain a
Level Rate Dividend Policy will depend on a number of factors, including the
stability of income received from its investments and dividends payable on Fund
Preferred Shares, if any, and interest and required principal payments on
Borrowings, if any. The net investment income of the Fund consists of all income
(other than net capital gain) less all expenses of the Fund. Expenses of the
Fund are accrued each day. Over time, all the net investment income of the Fund
will be distributed. At least annually, the Fund intends to distribute all of
its net capital gain and ordinary taxable income, if any, after paying any
accrued dividends or making any redemption or liquidation payments to
FundPreferred shareholders, or making interest and required principal payments
on Borrowings, if any. Initial distributions to Common Shareholders are expected
to be declared approximately 45 days, and paid approximately 60 to 90 days, from
the commencement of this offering, depending upon market conditions. Although it
does not now intend to do so, the Board of Trustees may change the Fund's
dividend policy and the amount or timing of the distributions, based on a number
of factors, including the amount of the Fund's undistributed net investment
income and historical and projected net investment income and the amount of the
expenses and dividend rates on the outstanding FundPreferred shares.
To permit the Fund to maintain a more stable monthly distribution, the
Fund will initially distribute less than the entire amount of net investment
income earned in a particular period. The undistributed net investment income
would be available to supplement future distributions. As a result, the
distributions paid by the Fund for any particular monthly period may be more or
less than the amount of net investment income actually earned by the Fund during
the period. Undistributed net investment income will be added to the Fund's net
asset value and, correspondingly, distributions from undistributed net
investment income will be deducted from the Fund's net asset value.
Managed Dividend Policy
In June 2002, NIAC, on behalf of itself and certain funds, filed an
exemptive application with the Securities and Exchange Commission seeking an
order under the 1940 Act facilitating the implementation of the Managed Dividend
Policy. The application will be amended to include the Fund as a party. If, and
when, NIAC, on behalf of itself and other parties, receives the requested
relief, the Fund may, subject to the determination of its Board of Trustees,
implement a Managed Dividend Policy.
Under a Managed Dividend Policy, the Fund would intend to distribute a
monthly fixed amount to Common Shareholders. As with the Level Dividend Rate
Policy, distributions would be made only after paying any accrued dividends or
making any redemption or liquidation payments with respect to FundPreferred
Shares, if any, and interest and required principal payments on Borrowings, if
any. Under a Managed Dividend Policy, if for any monthly distribution, net
investment income and net realized capital gain were less than the amount of the
distribution, the difference would be distributed from the Fund's assets. In
addition, in order to make such distributions, the Fund might have to sell a
portion of its investment portfolio at a time when independent investment
judgment might not dictate such action. The Fund's final distribution for each
calendar year would include any remaining net investment income undistributed
during the year, as well as all net capital gain realized during the year.
If, for any calendar year, the Fund's total distributions exceeded net
investment income and net realized capital gain (the "Excess"), the Excess,
distributed from the Fund's assets, would generally be treated as a tax-free
return of capital up to the amount of the Common Shareholder's tax basis in
Common Shares, with any amounts exceeding such basis treated as gain from the
sale of Common Shares. The Excess, however, would be treated as ordinary
dividend income to the extent of the Fund's current and accumulated earnings and
profits. Pursuant to the requirements of the 1940 Act and other applicable laws,
a notice would accompany each monthly distribution with respect to the estimated
source of the distribution made.
There is no guarantee that the Fund will receive an exemptive order
facilitating the implementation of a Managed Dividend Policy or, if received,
that the Board of Trustees will determine to implement a Managed Dividend
Policy. The Board of Trustees reserves the right to change the dividend policy
from time to time.
In the event the Fund distributed the Excess, such distribution would
decrease the Fund's total assets and, therefore, have the likely effect of
increasing the Fund's expense ratio. There is a risk that the Fund would not
eventually realize capital gains in an amount corresponding to a distribution of
the Excess.
For tax purposes, the Fund is currently required to allocate net
capital gain and other taxable income, if any, between Common Shares and
FundPreferred shares in proportion to total dividends paid to each class for the
year in which such net capital gain or other taxable income is realized. For
information relating to the impact of the issuance of FundPreferred shares on
the distributions made by a Fund to Common Shareholders, see the Fund's
Prospectus under "Use of Leverage."
While any FundPreferred shares are outstanding, the Fund may not
declare any cash dividend or other distribution on its Common Shares unless at
the time of such declaration (1) all accumulated dividends on the FundPreferred
shares have been paid and (2) the net asset value of the Fund's portfolio
(determined after deducting the amount of such dividend or other distribution)
is at least 200% of the liquidation value of any outstanding FundPreferred
shares. This latter limitation on the Fund's ability to make distributions on
its Common Shares could under certain circumstances impair the ability of the
Fund to maintain its qualification for taxation as a regulated investment
company. See "Tax Matters."
DESCRIPTION OF SHARES
COMMON SHARES
The Fund's Declaration of Trust (the "Declaration") authorizes the
issuance of an unlimited number of Common Shares. The Common Shares being
offered have a par value of $0.01 per share and, subject to the rights of
holders of FundPreferred shares if issued, have equal rights as to the payment
of dividends and the distribution of assets upon liquidation of the Fund. The
Common Shares being offered will, when issued, be fully paid and, subject to
matters discussed in "Certain Provisions in the Declaration of Trust,"
non-assessable, and will have no pre-emptive or conversion rights or rights to
cumulative voting. At any time when the Fund's FundPreferred
26
shares are outstanding, Common Shareholders will not be entitled to receive any
cash distributions from the Fund unless all accrued dividends on FundPreferred
shares have been paid, and unless asset coverage (as defined in the 1940 Act)
with respect to FundPreferred shares would be at least 200% after giving effect
to such distributions. See "FundPreferred Shares" below.
The Common Shares have been approved for listing on the New York Stock
Exchange, subject to notice of issuance. The Fund intends to hold annual
meetings of shareholders so long as the Common Shares are listed on a national
securities exchange and such meetings are required as a condition to such
listing.
Shares of closed-end investment companies may frequently trade at
prices lower than net asset value. Shares of closed-end investment companies
like the Fund have during some periods traded at prices higher than net asset
value and during other periods have traded at prices lower than net asset value.
Because the market value of the Common Shares may be influenced by such factors
as dividend levels (which are in turn affected by expenses), call protection,
dividend stability, portfolio credit quality, net asset value, relative demand
for and supply of such shares in the market, general market and economic
conditions, and other factors beyond the control of the Fund, the Fund cannot
assure you that Common Shares will trade at a price equal to or higher than net
asset value in the future. The Fund's net asset value per share generally
increases when interest rates decline, and decreases when interest rates rise,
and these changes are likely to be greater because the Fund, if market
conditions are deemed favorable, likely will have a leveraged capital structure.
Net asset value will be reduced immediately following the offering after payment
of the sales load and organization and offering expenses. Nuveen has agreed to
pay (i) all organizational expenses and (ii) offering costs (other than sales
load) that exceed $0.03 per Common Share. See "Use of Proceeds." Whether
investors will realize gains or losses upon the sale of Common Shares will not
depend upon a Fund's net asset value but will depend entirely upon whether the
market price of the Common Shares at the time of sale is above or below the
original purchase price for the shares. Since the market price of the Fund's
Common Shares will be determined by factors beyond the control of the Fund, the
Fund cannot predict whether the Common Shares will trade at, below, or above net
asset value or at, below or above the initial public offering price.
Accordingly, the Common Shares are designed primarily for long-term investors,
and investors in the Common Shares should not view the Fund as a vehicle for
trading purposes. See "Repurchase of Fund Shares; Conversion to Open-End Fund"
and the Fund's Prospectus under "Use of Leverage" and "The Fund's Investments."
FUNDPREFERRED SHARES
The Declaration authorizes the issuance of an unlimited number of
FundPreferred shares in one or more classes or series, with rights as determined
by the Board of Trustees of the Fund, by action of the Board of Trustees without
the approval of the Common Shareholders.
The Fund's Board of Trustees has authorized an offering of
FundPreferred shares (representing approximately 33 1/3% of the Fund's capital
immediately after the time the FundPreferred shares are issued) that the Fund
expects will likely be issued within approximately one and one-half to two
months after completion of the offering of Common Shares. Any such decision is
subject to market conditions and to the Board's continuing belief that
leveraging the Fund's capital structure through the issuance of FundPreferred
shares is likely to achieve the benefits to the Common Shareholders described in
this Statement of Additional Information. The Board has stated that the initial
series of FundPreferred shares would likely pay cumulative dividends at
relatively shorter-term periods (such as 7 days); by providing for the periodic
redetermination of the
27
dividend rate through an auction or remarketing procedure. The Board of Trustees
of the Fund has indicated that the liquidation preference, preference on
distribution, voting rights and redemption provisions of the FundPreferred
shares will be as stated below.
Limited Issuance of FundPreferred Shares. Under the 1940 Act, the Fund
could issue FundPreferred shares with an aggregate liquidation value of up to
one-half of the value of the Fund's total net assets, measured immediately after
issuance of the FundPreferred shares. "Liquidation value" means the original
purchase price of the shares being liquidated plus any accrued and unpaid
dividends. In addition, the Fund is not permitted to declare any cash dividend
or other distribution on its Common Shares unless the liquidation value of the
FundPreferred shares is less than one-half of the value of the Fund's total net
assets (determined after deducting the amount of such dividend or distribution)
immediately after the distribution. If the Fund sells all the Common Shares and
FundPreferred shares discussed in this Prospectus, the liquidation value of the
FundPreferred shares is expected to be approximately 33 1/3% of the value of the
Fund's total net assets. The Fund intends to purchase or redeem FundPreferred
shares, if necessary, to keep that fraction below one-half.
Distribution Preference. The FundPreferred shares have complete
priority over the Common Shares as to distribution of assets.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the Fund, holders of
FundPreferred shares will be entitled to receive a preferential liquidating
distribution (expected to equal the original purchase price per share plus
accumulated and unpaid dividends thereon, whether or not earned or declared)
before any distribution of assets is made to holders of Common Shares. After
payment of the full amount of the liquidating distribution to which they are
entitled, holders of FundPreferred shares will not be entitled to any further
participation in any distribution of assets by the Fund. A consolidation or
merger of the Fund with or into any Massachusetts business trust or corporation
or a sale of all or substantially all of the assets of the Fund shall not be
deemed to be a liquidation, dissolution or winding up of the Fund.
Voting Rights. In connection with any issuance of FundPreferred
shares, the Fund must comply with Section 18(i) of the 1940 Act, which requires,
among other things, that FundPreferred shares be voting shares and have equal
voting rights with Common Shares. Except as otherwise indicated in this
Statement of Additional Information and except as otherwise required by
applicable law, holders of FundPreferred shares will vote together with Common
Shareholders as a single class.
In connection with the election of the Fund's trustees, holders of
FundPreferred shares, voting as a separate class, will be entitled to elect two
of the Fund's trustees, and the remaining trustees shall be elected by Common
Shareholders and holders of FundPreferred shares, voting together as a single
class. In addition, if at any time dividends on the Fund's outstanding
FundPreferred shares shall be unpaid in an amount equal to two full years'
dividends thereon, the holders of all outstanding FundPreferred shares, voting
as a separate class, will be entitled to elect a majority of the Fund's trustees
until all dividends in arrears have been paid or declared and set apart for
payment.
28
The affirmative vote of the holders of a majority of the Fund's
outstanding FundPreferred shares of any class or series, as the case may be,
voting as a separate class, will be required to, among other things, (1) take
certain actions which would affect the preferences, rights, or powers of such
class or series or (2) authorize or issue any class or series ranking prior to
the FundPreferred shares. Except as may otherwise be required by law, (1) the
affirmative vote of the holders of at least two-thirds of the Fund's
FundPreferred shares outstanding at the time, voting as a separate class, will
be required to approve any conversion of the Fund from a closed-end to an
open-end investment company and (2) the affirmative vote of the holders of at
least two-thirds of the outstanding FundPreferred shares, voting as a separate
class, shall be required to approve any plan of reorganization (as such term is
used in the 1940 Act) adversely affecting such shares, provided however, that
such separate class vote shall be a majority vote if the action in question has
previously been approved, adopted or authorized by the affirmative vote of
two-thirds of the total number of trustees fixed in accordance with the
Declaration or the By-laws. The affirmative vote of the holders of a majority of
the outstanding FundPreferred shares, voting as a separate class, shall be
required to approve any action not described in the preceding sentence requiring
a vote of security holders under Section 13(a) of the 1940 Act including, among
other things, changes in a Fund's investment objectives or changes in the
investment restrictions described as fundamental policies under "Investment
Objectives and Policies--Investment Restrictions." The class or series vote of
holders of FundPreferred shares described above shall in each case be in
addition to any separate vote of the requisite percentage of Common Shares and
FundPreferred shares necessary to authorize the action in question.
The foregoing voting provisions will not apply with respect to the
Fund's FundPreferred shares if, at or prior to the time when a vote is
required, such shares shall have been (1) redeemed or (2) called for redemption
and sufficient funds shall have been deposited in trust to effect such
redemption.
Redemption, Purchase and Sale of FundPreferred Shares. The terms of the
FundPreferred shares may provide that they are redeemable by the Fund at certain
times, in whole or in part, at the original purchase price per share plus
accumulated dividends, that the Fund may tender for or purchase FundPreferred
shares and that the Fund may subsequently resell any shares so tendered for or
purchased. Any redemption or purchase of FundPreferred shares by the Fund will
reduce the leverage applicable to Common Shares, while any resale of shares by
the Fund will increase such leverage.
The discussion above describes the Board of Trustees' present intention
with respect to a possible offering of the FundPreferred shares. The terms of
the FundPreferred shares may be the same as, or different from, the terms
described above, subject to applicable law and the Fund's Declaration.
BORROWINGS
The Declaration authorizes the Fund, without prior approval of the
Common Shareholders, to borrow money. In this connection, the Fund may issue
notes or other evidence of indebtedness (including bank borrowings or commercial
paper) ("Borrowings") and may secure any such borrowings by mortgaging, pledging
or otherwise subjecting as security the Fund's assets. In connection with such
borrowing, the Fund may be required to maintain average balances with the lender
or to pay a commitment or other fee to maintain a line of credit. Any such
requirements will increase the cost of borrowing over the stated interest rate.
Limitations on Borrowings. Under the requirements of the 1940 Act, the
Fund, immediately after any Borrowings, must have an asset coverage of at least
300%. With respect
29
to any Borrowings, asset coverage means the ratio which the value of the total
assets of the Fund, less all liabilities and indebtedness not represented by
senior securities (as defined in the 1940 Act), bears to the aggregate amount of
such Borrowings represented by senior securities issued by the Fund. Certain
types of Borrowings may result in the Fund being subject to covenants in credit
agreements relating to asset coverages or portfolio composition or otherwise. In
addition, the Fund may be subject to certain restrictions imposed by guidelines
of one or more NRSROs which may issue ratings for commercial paper or notes
issued by the Fund. Such restrictions may be more stringent than those imposed
by the 1940 Act.
Distribution Preference. The rights of lenders to the Fund to receive
interest on and repayment of principal of any such Borrowings will be senior to
those of the Common Shareholders, and the terms of any such Borrowings may
contain provisions which limit certain activities of the Fund, including the
payment of dividends to Common Shareholders in certain circumstances.
Voting Rights. The 1940 Act does (in certain circumstances) grant to
the lenders to the Fund certain voting rights in the event of default in the
payment of interest on or repayment of principal. In the event that such
provisions would impair the Fund's status as a regulated investment company
under the Code, the Fund, subject to its ability to liquidate its relatively
illiquid portfolio, intends to repay the Borrowings. Any Borrowings will likely
be ranked senior or equal to all other existing and future borrowings of the
Fund.
The discussion above describes the Fund's Board of Trustees' present
intention with respect to an offering of FundPreferred shares or Borrowings.
The terms of the FundPreferred shares and, if authorized by the Board of
Trustees, the terms of any Borrowings may be the same as, or different from,
the terms described above, subject to applicable law and the Fund's Declaration.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Fund.
However, the Declaration contains an express disclaimer of shareholder
liability for debts or obligations of the Fund and requires that notice of such
limited liability be given in each agreement, obligation or instrument entered
into or executed by the Fund or the trustees. The Declaration further provides
for indemnification out of the assets and property of the Fund for all loss and
expense of any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the Fund would be
unable to meet its obligations. The Fund believes that the likelihood of such
circumstances is remote.
The Declaration includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to convert the Fund to
open-end status. Specifically, the Declaration requires a vote by holders of at
least two-thirds of the Common Shares and FundPreferred shares, voting together
as a single class, except as described below, to authorize (1) a conversion of
the Fund from a closed-end to an open-end investment company, (2) a merger or
consolidation of the Fund, or a series or class of the Fund, with any
corporation, association, trust or other organization or a reorganization of the
Fund, or a series or class of the Fund, (3) a sale, lease or transfer of all or
substantially all of the Fund's assets (other than in the
30
regular course of the Fund's investment activities), (4) in certain
circumstances, a termination of the Fund, or a series or class of the Fund or
(5) removal of trustees by shareholders, and then only for cause, unless, with
respect to (1) through (4), such transaction has already been authorized by the
affirmative vote of two-thirds of the total number of trustees fixed in
accordance with the Declaration or the By-laws, in which case the affirmative
vote of the holders of at least a majority of the Fund's Common Shares and
FundPreferred shares outstanding at the time, voting together as a single class,
is required, provided, however, that where only a particular class or series is
affected (or, in the case of removing a trustee, when the trustee has been
elected by only one class), the required vote by only the applicable class or
series will be required. Approval of shareholders is not required, however, for
any transaction, whether deemed a merger, consolidation, reorganization or
otherwise whereby the Fund issues shares in connection with the acquisition of
assets (including those subject to liabilities) from any other investment
company or similar entity. None of the foregoing provisions may be amended
except by the vote of at least two-thirds of the Common Shares and FundPreferred
shares, voting together as a single class. In the case of the conversion of the
Fund to an open-end investment company, or in the case of any of the foregoing
transactions constituting a plan of reorganization which adversely affects the
holders of FundPreferred shares, the action in question will also require the
affirmative vote of the holders of at least two-thirds of the Fund's
FundPreferred shares outstanding at the time, voting as a separate class, or, if
such action has been authorized by the affirmative vote of two-thirds of the
total number of trustees fixed in accordance with the Declaration or the Bylaws,
the affirmative vote of the holders of at least a majority of the Fund's
FundPreferred shares outstanding at the time, voting as a separate class. The
votes required to approve the conversion of the Fund from a closed-end to an
open-end investment company or to approve transactions constituting a plan of
reorganization which adversely affects the holders of FundPreferred shares are
higher than those required by the 1940 Act. The Board of Trustees believes that
the provisions of the Declaration relating to such higher votes are in the best
interest of the Fund and its shareholders.
The provisions of the Declaration described above could have the
effect of depriving the Common Shareholders of opportunities to sell their
Common Shares at a premium over market value by discouraging a third party from
seeking to obtain control of the Fund in a tender offer or similar transaction.
The overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control by a third party. They
provide, however, the advantage of potentially requiring persons seeking
control of the Fund to negotiate with its management regarding the price to be
paid and facilitating the continuity of the Fund's investment objectives and
policies. The Board of Trustees of the Fund has considered the foregoing
anti-takeover provisions and concluded that they are in the best interests of
the Fund and its Common Shareholders.
Reference should be made to the Declaration on file with the
Commission for the full text of these provisions.
The Declaration provides that the obligations of the Fund are not
binding upon the trustees of the Fund individually, but only upon the assets
and property of the Fund, and that the trustees shall not be liable for errors
of judgment or mistakes of fact or law. Nothing in the Declaration, however,
protects a trustee against any liability to which he would otherwise be
31
subject by reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his office.
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its
shareholders will not have the right to cause the Fund to redeem their shares.
Instead, the Fund's Common Shares will trade in the open market at a price that
will be a function of several factors, including dividend levels (which are in
turn affected by expenses), net asset value, call protection, price, dividend
stability, relative demand for and supply of such shares in the market, general
market and economic conditions and other factors. Because shares of a
closed-end investment company may frequently trade at prices lower than net
asset value, the Fund's Board of Trustees has currently determined that, at
least annually, it will consider action that might be taken to reduce or
eliminate any material discount from net asset value in respect of Common
Shares, which may include the repurchase of such shares in the open market or
in private transactions, the making of a tender offer for such shares at net
asset value, or the conversion of the Fund to an open-end investment company.
There can be no assurance, however, that the Board of Trustees will decide to
take any of these actions, or that share repurchases or tender offers, if
undertaken, will reduce market discount.
Notwithstanding the foregoing, at any time when the Fund's
FundPreferred shares are outstanding, the Fund may not purchase, redeem or
otherwise acquire any of its Common Shares unless (1) all accrued
FundPreferred shares dividends have been paid and (2) at the time of such
purchase, redemption or acquisition, the net asset value of the Fund's portfolio
(determined after deducting the acquisition price of the Common Shares) is at
least 200% of the liquidation value of the outstanding FundPreferred shares
(expected to equal the original purchase price per share plus any accrued and
unpaid dividends thereon). The staff of the Commission currently requires that
any tender offer made by a closed-end investment company for its shares must be
at a price equal to the net asset value of such shares on the close of business
on the last day of the tender offer. Any service fees incurred in connection
with any tender offer made by the Fund will be borne by the Fund and will not
reduce the stated consideration to be paid to tendering shareholders.
Subject to its investment limitations, the Fund may borrow to finance
the repurchase of shares or to make a tender offer. Interest on any borrowings
to finance share repurchase transactions or the accumulation of cash by the
Fund in anticipation of share repurchases or tenders will reduce the Fund's net
income. Any share repurchase, tender offer or borrowing that might be approved
by the Board of Trustees would have to comply with the Securities Exchange Act
of 1934, as amended, and the 1940 Act and the rules and regulations thereunder.
Although the decision to take action in response to a discount from
net asset value will be made by the Board of the Fund at the time it considers
such issue, it is the Board's present policy, which may be changed by the
Board, not to authorize repurchases of Common Shares or a tender offer for such
shares if (1) such transactions, if consummated, would (a) result in the
delisting of the Common Shares from the New York Stock Exchange, or (b) impair
the Fund's status as a regulated investment company under the Code (which would
make the Fund a taxable entity, causing the Fund's income to be taxed at the
corporate level in addition to the taxation of
32
shareholders who receive dividends from the Fund) or as a registered closed-end
investment company under the 1940 Act; (2) the Fund would not be able to
liquidate portfolio securities in an orderly manner and consistent with the
Fund's investment objectives and policies in order to repurchase shares; or (3)
there is, in the Board's judgment, any (a) material legal action or proceeding
instituted or threatened challenging such transactions or otherwise materially
adversely affecting the Fund, (b) general suspension of or limitation on prices
for trading securities on the New York Stock Exchange, (c) declaration of a
banking moratorium by Federal or state authorities or any suspension of payment
by United States or state banks in which the Fund invests, (d) material
limitation affecting the Fund or the issuers of its portfolio securities by
Federal or state authorities on the extension of credit by lending institutions
or on the exchange of non-U.S. currency, (e) commencement of war, armed
hostilities or other international or national calamity directly or indirectly
involving the United States, or (f) other event or condition which would have a
material adverse effect (including any adverse tax effect) on the Fund or its
shareholders if shares were repurchased. The Board of Trustees of the Fund may
in the future modify these conditions in light of experience.
Conversion to an open-end company would require the approval of the
holders of at least two-thirds of the Fund's Common Shares and FundPreferred
shares outstanding at the time, voting together as a single class, and of the
holders of at least two-thirds of the Fund's FundPreferred shares outstanding
at the time, voting as a separate class, provided however, that such separate
class vote shall be a majority vote if the action in question has previously
been approved, adopted or authorized by the affirmative vote of two-thirds of
the total number of trustees fixed in accordance with the Declaration or
By-laws. See the Prospectus under "Certain Provisions in the Declaration of
Trust" for a discussion of voting requirements applicable to conversion of the
Fund to an open-end company. If the Fund converted to an open-end company, it
would be required to redeem all FundPreferred shares then outstanding, and the
Fund's Common Shares would no longer be listed on the New York Stock Exchange.
Shareholders of an open-end investment company may require the company to
redeem their shares on any business day (except in certain circumstances as
authorized by or under the 1940 Act) at their net asset value, less such
redemption charge, if any, as might be in effect at the time of redemption. In
order to avoid maintaining large cash positions or liquidating favorable
investments to meet redemptions, open-end companies typically engage in a
continuous offering of their shares. Open-end companies are thus subject to
periodic asset in-flows and out-flows that can complicate portfolio management.
The Board of Trustees of the Fund may at any time propose conversion of the
Fund to an open-end company depending upon their judgment as to the
advisability of such action in light of circumstances then prevailing.
The repurchase by the Fund of its shares at prices below net asset
value will result in an increase in the net asset value of those shares that
remain outstanding. However, there can be no assurance that share repurchases
or tenders at or below net asset value will result in the Fund's shares trading
at a price equal to their net asset value. Nevertheless, the fact that the
Fund's shares may be the subject of repurchase or tender offers at net asset
value from time to time, or that the Fund may be converted to an open-end
company, may reduce any spread between market price and net asset value that
might otherwise exist.
In addition, a purchase by the Fund of its Common Shares will decrease
the Fund's total assets which would likely have the effect of increasing the
Fund's expense ratio. Any purchase
33
by the Fund of its Common Shares at a time when FundPreferred shares are
outstanding will increase the leverage applicable to the outstanding Common
Shares then remaining. See the Fund's Prospectus under "Risks--Concentration
Risk" and "Risks--Leverage Risk."
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of the Fund would consider all relevant
factors, including the extent and duration of the discount, the liquidity of
the Fund's portfolio, the impact of any action that might be taken on the Fund
or its shareholders and market considerations. Based on these considerations,
even if the Fund's shares should trade at a discount, the Board of Trustees may
determine that, in the interest of the Fund and its shareholders, no action
should be taken.
TAX MATTERS
FEDERAL INCOME TAX MATTERS
The following discussion of federal income tax matters is based upon
the advice of Bell, Boyd & Lloyd LLC, special counsel to the Fund.
Set forth below is a discussion of certain U.S. federal income tax
issues concerning the Fund and the purchase, ownership and disposition of Fund
shares. This discussion does not purport to be complete or to deal with all
aspects of federal income taxation that may be relevant to shareholders in
light of their particular circumstances. Unless otherwise noted, this
discussion assumes you are a U.S. shareholder and that you hold your shares as
a capital asset. This discussion is based upon present provisions of the Code,
the regulations promulgated thereunder, and judicial and administrative ruling
authorities, all of which are subject to change, which change may be
retroactive. Prospective investors should consult their own tax advisors with
regard to the federal tax consequences of the purchase, ownership, or
disposition of Fund shares, as well as the tax consequences arising under the
laws of any state, non-U.S. country, or other taxing jurisdiction.
The Fund intends to elect to be treated and to qualify annually as a
regulated investment company under the Code.
To qualify for the favorable U.S. federal income tax treatment
generally accorded to regulated investment companies, the Fund 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 and gains
from the sale or other disposition of stock, securities or foreign currencies
or other income derived with respect to its business of investing in such
stock, securities or currencies; (b) 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 Fund's assets is represented by cash and cash items (including
receivables), U.S. Government securities, the securities of other regulated
investment companies 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 Fund'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 (other than
U.S. Government securities or the securities of other regulated investment
companies) of a single issuer, or two or more issuers which the Fund controls
and are engaged in the same, similar or
34
related trades or businesses; and (c) distribute at least 90% of its investment
company taxable income (as that term is defined in the Code, but without regard
to the deduction for dividends paid).
As a regulated investment company, the Fund generally will not be subject
to U.S. federal income tax on its investment company taxable income and net
capital gain (the excess of net long-term capital gain over net short-term
capital loss), if any, that it distributes to shareholders. The Fund may retain
for investment its net capital gain. However, if the Fund retains any net
capital gain or any investment company taxable income, it will be subject to tax
at regular corporate rates on the amount retained. If the Fund retains any net
capital gain, it may designate the retained amount as undistributed capital
gains in a notice to its shareholders who, if subject to federal income tax on
long-term capital gains, (i) will be required to include in income for federal
income tax purposes, as long-term capital gain, their share of such
undistributed amount, and (ii) will be entitled to credit their proportionate
shares of the tax paid by the Fund on such undistributed amount against their
federal income tax liabilities, if any, and to claim refunds to the extent the
credit exceeds such liabilities. For federal income tax purposes, the tax basis
of shares owned by a shareholder of the Fund will be increased by an amount
equal under current law to the difference between the amount of undistributed
capital gains included in the shareholder's gross income and the tax deemed paid
by the shareholder under clause (ii) of the preceding sentence. The Fund intends
to distribute to its shareholders, at least annually, substantially all of its
investment company taxable income and net capital gain.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax. To
prevent imposition of the excise tax, the Fund must distribute during each
calendar year an amount equal to the 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 October 31
of the calendar year, and (3) any ordinary income and capital gains for previous
years that were not distributed during those years and on which the Fund paid no
federal income tax. To prevent application of the excise tax, the Fund intends
to make its distributions in accordance with the calendar year distribution
requirement. A distribution will be treated as paid on December 31 of the
current calendar year if it is declared by the Fund in October, November or
December with a record date in such a month and paid by the Fund during January
of the following calendar year. Such distributions will be taxable to
shareholders in the calendar year in which the distributions are declared,
rather than the calendar year in which the distributions are received.
If the Fund failed to qualify as a regulated investment company or
failed to satisfy the 90% distribution requirement in any taxable year, the
Fund would be taxed as an ordinary corporation on its taxable income (even if
such income were distributed to its shareholders) and all distributions out of
earnings and profits would be taxed to shareholders as ordinary income. Such
distributions generally would be eligible (i) to be treated as "qualified
dividend income" in the case of noncorporate shareholders and (ii) for the
Dividend Received Deduction in the case of corporate shareholders.
DISTRIBUTIONS
Dividends paid out of the Fund's investment company taxable income
will be taxable to a shareholder as ordinary income to the extent of the Fund's
earnings and profits, whether paid in cash or reinvested in additional shares.
Because Spectrum does not intend to invest with a view to maximizing the portion
of the Fund's distributions qualifying for the Dividends Received Deduction or
treatment as "qualified dividend income," any shareholder who otherwise
would qualify for the reduced tax rates on "qualified dividend income" or the
Dividends Received Deduction should assume that dividends paid to it out of the
Fund generally will not qualify for the reduced tax rates on "qualified
dividend income" or the Dividends Received deduction.
Distributions of net capital gain (the excess of net long-term capital
gain over net short-term capital loss), if any, designated as capital gain
dividends are taxable to a shareholder as long-term capital gains, regardless
of how long the shareholder has held Fund shares. Shareholders receiving
distributions in the form of additional shares, rather than cash, generally
will have a cost basis in each such share equal to the net asset value of a
share of the Fund on the reinvestment date. A distribution of an amount in
excess of the Fund's current and accumulated earnings and profits will be
treated by a shareholder as a return of capital which is applied against and
reduces the shareholder's basis in his or her shares. To the extent that the
amount of
35
any such distribution exceeds the shareholder's basis in his or her shares, the
excess will be treated by the shareholder as gain from a sale or exchange of the
shares.
The Internal Revenue Service's position in a published revenue ruling
indicates that the Fund is required to designate distributions paid with
respect to its Common Shares and its FundPreferred Shares as consisting of a
portion of each type of income distributed by the Fund. The portion of each
type of income deemed received by the holders of each class of shares will be
equal to the portion of total Fund dividends received by such class. Thus, the
Fund will designate dividends paid as capital gain dividends in a manner that
allocates such dividends between the holders of the Common Shares and the
holders of FundPreferred Shares, in proportion to the total dividends paid to
each such class during or with respect to the taxable year, or otherwise as
required by applicable law.
Shareholders will be notified annually as to the U.S. federal tax
status of distributions, and shareholders receiving distributions in the form
of additional shares will receive a report as to the net asset value of those
shares.
SALE OR EXCHANGE OF FUND SHARES
Upon the sale or other disposition of shares of the Fund, which a
shareholder holds as a capital asset, such a shareholder may realize a capital
gain or loss which will be long-term or short-term, depending upon the
shareholder's holding period for the shares. Generally, a shareholder's gain or
loss will be a long-term gain or loss if the shares have been held for more
than one year.
Any loss realized on a sale or exchange will be disallowed to the
extent that shares disposed of are replaced (including through reinvestment of
dividends) within a period of 61 days beginning 30 days before and ending 30
days after disposition of shares. In such a case, the basis of the shares
acquired will be adjusted to reflect the disallowed loss. Any loss realized by
a shareholder on a disposition of Fund shares held by the shareholder for six
months or less will be treated as a long-term capital loss to the extent of any
distributions of net capital gain received by the shareholder with respect to
such shares.
NATURE OF FUND'S INVESTMENTS
Certain of the Fund's investment practices are subject to special and
complex federal income tax provisions that may, among other things, (i)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (ii) convert lower taxed long-term capital gain into higher taxed
short-term capital or ordinary income, (iii) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited), (iv)
cause the Fund to recognize income or gain without a corresponding receipt of
cash, (v) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur and (vi) adversely alter the characterization of
certain complex financial transactions. The Fund may make certain tax elections
in order to mitigate the effect of these provisions.
FUTURES CONTRACTS AND OPTIONS
The Fund's transactions in futures contracts and options will be
subject to special provisions of the Code that, among other things, may affect
the character of gains and losses realized by the Fund (i.e., may affect
whether gains or losses are ordinary or capital), may accelerate recognition of
income to the Fund and may defer Fund losses. These rules could, therefore,
affect the character, amount and timing of distributions to shareholders. These
provisions also (a) will require the Fund to mark-to-market certain types of
the positions in its portfolio (i.e., treat them as if they were closed out),
and (b) may cause the Fund to recognize income without receiving cash with
which to make distributions in amounts necessary to satisfy the 90%
distribution requirement for qualifying to be taxed as a regulated investment
company and the 98% distribution requirement for avoiding excise taxes. The
Fund will monitor its transactions, will make the appropriate tax elections and
will make the appropriate entries in its books and records when it acquires any
futures contract, option or hedged investment in order to
36
mitigate the effect of these rules and prevent disqualification of the Fund
from being taxed as a regulated investment company.
RECOGNITION OF INCOME IN THE ABSENCE OF CASH
Investments by the Fund in zero coupon or other discount securities
will result in income to the Fund equal to a portion of the excess of the face
value of the securities over their issue price (the "original issue discount")
each year that the securities are held, even though the Fund receives no cash
interest payments. In other circumstances, whether pursuant to the terms of a
security or as a result of other factors outside the control of the Fund, the
Fund may recognize income without receiving a commensurate amount of cash. Such
income is included in determining the amount of income which the Fund must
distribute to maintain its status as a regulated investment company and to avoid
the payment of federal income tax and the 4% excise tax. Because such income may
not be matched by a corresponding cash distribution to the Fund, the Fund may be
required to borrow money or dispose of other securities to be able to make
distributions to its shareholders.
The Code imposes constructive sale treatment for federal income tax
purposes on certain hedging strategies with respect to appreciated financial
positions. Under these rules, taxpayers will recognize gain, but not loss, with
respect to securities if they enter into short sales or "offsetting notional
principal contracts" (as defined by the Code) with respect to, or futures or
forward contracts to deliver, the same or substantially identical property, or
if they enter into such transactions and then acquire the same or substantially
identical property. The Secretary of the Treasury is authorized to promulgate
regulations that will treat as constructive sales certain transactions that have
substantially the same effect as these transactions.
INVESTMENTS IN SECURITIES OF UNCERTAIN TAX CHARACTER
The Fund may invest in preferred securities, convertible securities or
other securities the federal income tax treatment of which is uncertain or
subject to recharacterization by the Internal Revenue Service. To the extent
the tax treatment of such securities or income differs from the tax treatment
expected by the Fund, it could affect the timing or character of income
recognized by the Fund, requiring the Fund to purchase or sell securities, or
otherwise change its portfolio, in order to comply with the tax rules applicable
to regulated investment companies under the Code.
BACKUP WITHHOLDING
The Fund may be required to withhold U.S. federal income tax from all
taxable 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 Internal Revenue
Service that they are subject to backup withholding. As modified by the Jobs and
Growth Tax Relief Reconciliation Act of 2003, the backup withholding percentage
is 28% for amounts paid through 2010, after which time the rate will increase to
31% absent legislative change. Corporate shareholders and certain other
shareholders specified in the Code generally are exempt from such backup
withholding. This withholding is not an additional tax. Any amounts withheld may
be credited against the shareholder's U.S. federal income tax liability.
NON-U.S. SHAREHOLDERS
U.S. taxation of a shareholder who, as to the United States, is a
nonresident alien individual, a foreign trust or estate, a foreign corporation
or foreign partnership (a "non-U.S. shareholder") depends on whether the income
of the Fund is "effectively connected" with a U.S. trade or business carried on
by the shareholder.
Income Not Effectively Connected. If the income from the Fund is not
"effectively connected" with a U.S. trade or business carried on by the
non-U.S. shareholder, distributions of
37
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.
Capital gain dividends and any amounts retained by the Fund which are
designated as undistributed capital gains will not be subject to U.S. federal
withholding tax at the rate of 30% (or lower treaty rate) unless the non-U.S.
shareholder is a nonresident alien individual and is physically present in the
United States for more than 182 days during the taxable year and meets certain
other requirements. However, this 30% tax on capital gains of nonresident alien
individuals who are physically present in the United States for more than the
182 day period only applies in exceptional cases because any individual present
in the United States for more than 182 days during the taxable year is generally
treated as a resident for U.S. income tax purposes; in that case, he or she
would be subject to U.S. income tax on his or her worldwide income at the
graduated rates applicable to U.S. citizens, rather than the 30% U.S. federal
withholding tax. In the case of a non-U.S. shareholder who is a nonresident
alien individual, the Fund may be required to withhold U.S. income tax from
distributions of net capital gain unless the non-U.S. shareholder certifies his
or her non-U.S. status under penalties of perjury or otherwise establishes an
exemption. See "Tax Matters--Backup Withholding," above. Any gain a non-U.S.
shareholder realizes upon the sale or exchange of such shareholder's shares of
the Fund in the United States will ordinarily be exempt from U.S. tax unless, in
the case of a non-U.S. shareholder that is a nonresident alien individual, the
gain is U.S. source income and such shareholder is physically present in the
United States for more than 182 days during the taxable year and meets certain
other requirements, or is otherwise considered to be a resident alien of the
United States.
Income Effectively Connected. If the income from the Fund is
"effectively connected" with a U.S. trade or business carried on by a non-U.S.
shareholder, then distributions of investment company taxable income and
capital gain dividends, any amounts retained by the Fund which are designated
as undistributed capital gains and any gains realized upon the sale or exchange
of shares of the Fund will be subject to U.S. income tax at the graduated rates
applicable to U.S. citizens, residents and domestic corporations. Non-U.S.
corporate shareholders may also be subject to the branch profits tax imposed by
the Code.
The tax consequences to a non-U.S. shareholder entitled to claim the
benefits of an applicable tax treaty may differ from those described herein.
Non-U.S. shareholders are advised to consult their own tax advisors with respect
to the particular tax consequences to them of an investment in the Fund.
THE JOBS AND GROWTH TAX RELIEF RECONCILIATION ACT OF 2003
The Jobs and Growth Tax Relief Reconciliation Act of 2003 (the "Act")
reduced the maximum tax rate on long-term capital gains of noncorporate
investors from 20% to 15%. The Act also reduced to 15% the maximum tax rate on
"qualified dividend income" received by noncorporate shareholders; to be
eligible for this reduced rate, a shareholder must satisfy certain holding
period requirements. In the case of a regulated investment company, the amount
of dividends paid by the company that may be eligible for the reduced rate may
not exceed the amount of aggregate qualifying dividends received by the company.
Because most of the dividends paid out of the Funds's investment company taxable
income are expected to be attributable to interest on convertible securities,
high-yield securities, preferred securities, or other securities not treated as
stock for federal income tax purposes, the Fund's dividends generally will not
be eligible for the reduced rates of tax applicable to "qualified dividend
income." To the extent the Fund distributes amounts of dividends, including
capital gain dividends, eligible for the reduced rates, it will identify the
relevant amounts in its annual tax information reports to its shareholders.
Without further legislative change, the rate reductions enacted by the Act will
lapse, and the previous rates will be reinstated, for taxable years beginning on
or after January 1, 2009.
REGULATIONS ON "REPORTABLE TRANSACTIONS"
Under recently promulgated Treasury regulations, if a shareholder
recognizes a loss with respect to Common 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 Internal Revenue Service a disclosure statement
on Form 8886. Direct shareholders of portfolio securities are in many cases
excepted from this reporting requirement, but under current guidance,
shareholders of a regulated investment company are not excepted. Future guidance
may extend the current exception from this reporting requirement to shareholders
of most or all regulated investment companies. The fact that a loss is
reportable under these regulations does not affect the legal determination of
whether the taxpayer's treatment of the loss is proper. Shareholders should
consult their tax advisors to determine the applicability of these regulations
in light of their individual circumstances.
OTHER TAXES
Fund shareholders may be subject to state, local and foreign taxes on
their Fund distributions. Shareholders are advised to consult their own tax
advisors with respect to the particular tax consequences to them of an
investment in the Fund.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may quote certain performance-related information and may
compare certain aspects of its portfolio and structure to other substantially
similar closed-end funds. In reports or other communications to shareholders of
the Fund or in advertising materials, the Fund may compare its performance with
that of (i) other investment companies listed in the rankings prepared by
Lipper, Inc. ("Lipper"), Morningstar Inc. or other independent services;
38
publications such as Barrons, Business Week, Forbes, Fortune, Institutional
Investor, Kiplinger's Personal Finance, Money, Morningstar Mutual Fund Values,
The New York Times, The Wall Street Journal and USA Today; or other industry or
financial publications or (ii) the Standard and Poor's Index of 500 Stocks, the
Dow Jones Industrial Average, Dow Jones Utility Index, the Merril Lynch Hybrid
Preferred Securities Index, the Lehman Brothers Aggregate Bond Index, the Lehman
Brothers Government Bond Index, the NAREIT Equity REIT Index, the Lehman
Brothers High Yield Index, the Lehman Brothers Credit Index and other relevant
indices and industry publications. The Fund may also compare the historical
volatility of its portfolio to the volatility of such indices during the same
time periods. (Volatility is a generally accepted barometer of the market risk
associated with a portfolio of securities and is generally measured in
comparison to the stock market as a whole - the beta - or in absolute terms -
the standard deviation.) Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may obtain data from sources or reporting services, such
as Bloomberg Financial ("Bloomberg") and Lipper, that the Fund believes to be
generally accurate.
From time to time, the Fund may quote the Fund's total return,
aggregate total return or yield in advertisements or in reports and other
communications to shareholders. The Fund's performance will vary depending upon
market conditions, the composition of its portfolio and its operating expenses.
Consequently any given performance quotation should not be considered
representative of the Fund's performance in the future. In addition, because
performance will fluctuate, it may not provide a basis for comparing an
investment in the Fund with certain bank deposits or other investments that pay
a fixed yield for a stated period of time. Investments comparing the Fund's
performance with that of other investment companies should give consideration
to the quality and maturity of the respective investment companies' portfolio
securities.
The Fund's "average annual total return" is computed according to a
formula prescribed by the Commission. The formula can be expressed as follows:
Average Annual Total Return will be computed as follows:
ERV = P(1+T)/n/
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1-, 5-, or 10-year periods at the end
of the 1-, 5-, or 10-year periods (or fractional portion).
39
The Funds may also quote after-tax total returns to show the impact
of assumed federal income taxes on an investment in a Fund. A Fund's total
return "after taxes on distributions" shows the effect of taxable
distributions, but not any taxable gain or loss, on an investment in shares of
the Fund for a specified period of time. A Fund's total return "after taxes on
distributions and sale of Fund shares" shows the effect of both taxable
distributions and any taxable gain or loss realized by the shareholder upon the
sale of fund shares at the end of a specified period. To determine these
figures, all income, short-term capital gain distributions, and long-term
capital gains distributions are assumed to have been taxed at the highest
marginal individualized federal tax rate then in effect. Those maximum tax
rates are applied to distributions prior to reinvestment and the after-tax
portion is assumed to have been reinvested in the Fund. State and local taxes
are ignored.
Actual after-tax returns depend on a shareholder's tax situation and
may differ from those shown. After-tax returns reflect past tax effects and are
not predictive of future tax effects.
Average Annual Total Return (After Taxes on Distributions) will be
computed as follows:
ATV/D/ = P(1+T)/n/
Where: P = a hypothetical initial investment of $1,000
T = average annual total return (after taxes on distributions)
n = number of years
ATV/D/ = ending value of a hypothetical $1,000 investment
made at the beginning of the period, at the end of
the period (or fractional portion thereof), after
taxes on fund distributions but not after taxes on
redemptions.
Average Annual Total Return (After Taxes on Distributions and Sale of
Fund Shares) will be computed as follows:
ATV/DR/ = P(1+T)/n/
Where: P = a hypothetical initial investment of $1,000
T = average annual total return (after taxes on
distributions and redemption)
n = number of years
ATV/DR/ = ending value of a hypothetical $1,000 investment
made at the beginning periods, at the end of the
periods (or fractional portion thereof), after taxes
on fund distributions and redemptions.
Quotations of yield for the Fund will be based on all investment income
per share earned during a particular 30-day period (including dividends and
interest), less expenses accrued during the period ("net investment income") and
are computed by dividing net investment income by the maximum offering price per
share on the last day of the period, according to the following formula:
40
Yield = 2 [( a-b/cd +1)/6/ - 1]
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends
d = the maximum offering price per share on the last day of
the period
Past performance is not indicative of future results. At the time
Common Shareholders sell their shares, they may be worth more or less than their
original investment. See Appendix B for additional performance related and
comparative information.
EXPERTS
The Financial Statements of the Fund as of June 3, 2003, appearing in
this Statement of Additional Information have been audited by Ernst & Young LLP,
independent auditors, as set forth in their report thereon appearing elsewhere
herein, and is included in reliance upon such report given upon the authority of
such firm as experts in accounting and auditing. Ernst & Young LLP provides
accounting and auditing services to the Fund. The principal business address of
Ernst & Young LLP is 233 South Wacker Drive, Chicago, Illinois 60606.
CUSTODIAN AND TRANSFER AGENT
The custodian of the assets of the Fund is State Street Bank and Trust
Company, One Federal Street, Boston, Massachusetts 02110. The custodian performs
custodial, fund accounting and portfolio accounting services. The Fund's
transfer, shareholder services and dividend paying agent is also State Street
Bank and Trust Company, 225 Franklin Street, Boston, Massachusetts 02110.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, including amendments thereto,
relating to the shares of the Fund offered hereby, has been filed by the Fund
with the Commission, Washington, D.C. The Fund's Prospectus and this Statement
of Additional Information do not contain all of the information set forth in the
Registration Statement, including any exhibits and schedules thereto. For
further information with respect to the Fund and the shares offered hereby,
reference is made to the Fund's Registration Statement. Statements contained in
the Fund's Prospectus and this Statement of Additional Information as to the
contents of any contract or other document referred to are not necessarily
complete and in each instance reference is made to the copy of such contract or
other document filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference. Copies of the
Registration Statement may be inspected without charge at the Commission's
principal office in Washington, D.C., and copies of all or any part thereof may
be obtained from the Commission upon the payment of certain fees prescribed by
the Commission.
41
REPORT OF INDEPENDENT AUDITORS
The Board of Trustees and Shareholder of
Nuveen Preferred and Convertible Income Fund 2
We have audited the accompanying statement of assets and liabilities of Nuveen
Preferred and Convertible Income Fund 2 (the "Fund") as of June 3, 2003
and the related statement of operations for the period from March 17, 2003
(date of organization) through June 3, 2003. These financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above presents fairly, in
all material respects, the financial position of the Fund at June 3, 2003, and
the results of its operations for the period from March 17, 2003 (date of
organization) through June 3, 2003, in conformity with accounting principles
generally accepted in the United States.
/s/ ERNST & YOUNG LLP
Chicago, Illinois
June 4, 2003
42
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
FINANCIAL STATEMENTS
Nuveen Preferred and Convertible Income Fund 2
Statement of Assets and Liabilities
June 3, 2003
Assets:
Cash............................................................... $ 100,275
Offering costs..................................................... 1,330,000
Receivable from Adviser............................................ 11,500
----------
Total assets.................................................... 1,441,775
----------
Liabilities:
Accrued offering costs............................................. 1,330,000
Payable for organization costs..................................... 11,500
----------
Total liabilities............................................... 1,341,500
----------
FundPreferred Shares, $25,000 liquidation value; unlimited number of
shares authorized, no shares outstanding........................... -
----------
Net assets applicable to Common Shares................................. $ 100,275
==========
Net asset value per Common Share outstanding ($100,275 divided
by 7,000 Common Shares outstanding)................................ $ 14.325
==========
Net Assets Applicable to Common Shares Represent:
Common Shares, $.01 par value; unlimited number of shares
authorized, 7,000 shares outstanding............................ $ 70
Paid-in surplus.................................................... 100,205
----------
$ 100,275
==========
43
NUVEEN PREFERRED AND CONVERTIBLE INCOME FUND 2
Statement of Operations
Period from March 17, 2003 (date of organization) through June 3, 2003
Investment income.................................................... $ -
--------
Expenses:
Organization costs................................................ $ 11,500
Expense reimbursement............................................. (11,500)
--------
Total expenses................................................. -
--------
Net investment income................................................ $ -
========
Note 1: Organization
The Fund was organized as a Massachusetts business trust on March 17, 2003,
and has been inactive since that date except for matters relating to its
organization and registration as a diversified, closed-end management
investment company under the Investment Company Act of 1940, as amended, and the
Securities Act of 1933, as amended, and the sale of 7,000 Common Shares to
Nuveen Institutional Advisory Corp., the Fund's investment adviser (the
"Adviser"), a wholly owned subsidiary of Nuveen Investments, Inc.
Nuveen Investments, LLC, also a wholly owned subsidiary of Nuveen Investments,
Inc., has agreed to reimburse all organization expenses (approximately $11,500)
and pay all Common Share offering costs (other than the sales load) that exceed
$.03 per Common Share.
The Fund's primary investment objective is high current income.
The Fund is authorized by its Declaration of Trust to issue FundPreferred shares
having a liquidation value of $25,000 per share in one or more classes or
series, with dividend, liquidation preference and other rights as determined by
the Fund's Board of Trustees without approval of the Common Shareholders.
Note 2: Significant Accounting Policies
The Fund's financial statements are prepared in accordance with accounting
principles generally accepted in the United States which require the use of
management estimates. Actual results may differ from those estimates.
The Fund's share of Common Share offering costs will be recorded as a reduction
of the proceeds from the sale of Common Shares upon the commencement of Fund
operations. If the Fund offers FundPreferred Shares, the offering costs will be
borne by Common Shareholders as a direct reduction to paid-in surplus.
Note 3: Investment Management Agreement
Pursuant to an investment management agreement between the Adviser and the Fund,
the Fund has agreed to pay a management fee, payable on a monthly basis, at an
annual rate ranging from 0.9000% of the first $500 million of the average daily
net assets (including net assets attributable to FundPreferred Shares and the
principal amount of borrowings ("Managed Assets")) to 0.8000% of the average
daily Managed Assets in excess of $2 billion.
In addition to the reimbursement and waiver of organization and Common Share
offering costs discussed in Note 1, the Adviser has contractually agreed to
reimburse the Fund for fees and expenses in the amount of .32% of average daily
Managed Assets for the first 5 full years of the Fund's operations, .24% in year
6, .16% in year 7 and .08% in year 8. The Adviser has not agreed to reimburse
the Fund for any portion of its fees and expenses beyond June 30, 2011.
Note 4: Income Taxes
The Fund intends to comply with the requirements of the Internal Revenue Code
applicable to regulated investment companies and to distribute all of its net
investment income, in addition to any realized capital gains from investment
transactions.
44
APPENDIX A
Ratings of Investments
Standard & Poor's Corporation --A brief description of the applicable
Standard & Poor's Corporation, a division of The McGraw-Hill Companies
("Standard & Poor's" or "S&P"), rating symbols and their meanings (as published
by S&P) follows:
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program
(including ratings on medium term note programs and commercial paper programs).
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation. The issue credit rating is
not a recommendation to purchase, sell, or hold a financial obligation, inasmuch
as it does not comment as to market price or suitability for a particular
investor.
Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short-term in the
relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days - including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an
obligor with respect to put features on long-term obligations. The result is a
dual rating, in which the short-term ratings address the put feature, in
addition to the usual long-term rating. Medium-term notes are assigned long-term
ratings.
LONG-TERM ISSUE CREDIT RATINGS
Issue credit ratings are based in varying degrees, on the following
considerations:
1. Likelihood of payment - capacity and willingness of the
obligor to meet its financial commitment on an obligation
in accordance with the terms of the obligation;
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 ratings
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.
A-1
AAA
An obligation rated 'AAA' has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its financial
commitment on the obligation is extremely strong.
AA
An obligation rated 'AA' differs from the highest-rated
obligations only in small degree. The obligor's capacity to meet its
financial commitment on the obligation is very strong.
A
An obligation rated 'A' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions
than obligations in higher-rated categories. However, the obligor's
capacity to meet its financial commitment on the obligation is still
strong.
BBB
An obligation rated 'BBB' exhibits adequate protection
parameters. However, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity of the
obligor to meet its financial commitment on the obligation.
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 obligor's inadequate capacity to
meet its financial commitment on the obligation.
B
An obligation rated 'B' is more vulnerable to nonpayment than
obligations rated 'BB', but the obligor currently has the capacity to
meet its financial commitment on the obligation. Adverse business,
financial, or economic conditions will likely impair the obligor's
capacity or willingness to meet its financial commitment on the
obligation.
CCC
A-2
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
The 'C' rating may be used to cover a situation where a
bankruptcy petition has been filed or similar action has been taken,
but payments on this obligation are being continued.
D
An obligation rated 'D' is in payment default. The 'D' rating
category is used when payments on an obligation are not made on the
date due even if the applicable grace period has not expired, unless
Standard & Poor's believes that such payments will be made during such
grace period. The 'D' rating also will be used upon the filing of a
bankruptcy petition or the taking of a similar action if payments on an
obligation are jeopardized.
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.
C
The 'c' subscript is used to provide additional information to
investors that the bank may terminate its obligation to purchase
tendered bonds if the long-term credit rating of the issuer is below an
investment-grade level and/or the issuer's bonds are deemed taxable.
p
The letter 'p' indicates 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.
*
A-3
Continuance of the ratings is contingent upon Standard &
Poor's receipt of an executed copy of the escrow agreement or closing
documentation confirming investments and cash flows.
r
The 'r' highlights derivative, hybrid, and certain other
obligations that Standard & Poor's believes may experience high
volatility or high variability in expected returns as a result of
noncredit risks. Examples of such obligations are securities with
principal or interest return indexed to equities, commodities, or
currencies; certain swaps and options; and interest-only and
principal-only mortgage securities. The absence of an 'r' symbol should
not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
N.R.
Not rated.
Debt obligations of issuers outside the United States and its
territories are rated on the same basis as domestic corporate and
municipal issues. The ratings measure the creditworthiness of the
obligor but do not take into account currency exchange and related
uncertainties.
Bond Investment Quality Standards
Under present commercial bank regulations issued by the
Comptroller of the Currency, bonds rated in the top four categories
('AAA', 'AA', 'A', 'BBB', commonly known as investment-grade ratings)
generally are regarded as eligible for bank investment. Also, the laws
of various states governing legal investments impose certain rating or
other standards for obligations eligible for investment by savings
banks, trust companies, insurance companies, and fiduciaries in
general.
Short-Term Issue Credit Ratings
Notes
A Standard & Poor's note ratings 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:
. Amortization schedule -- the larger the final
maturity relative to other maturities, the more
likely it will be treated as a note; and
. Source of payment -- the more dependent the issue is
on the market for its refinancing, the more likely
it will be treated as a note.
Note rating symbols are as follows:
A-4
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.
A note rating is not a recommendation to purchase, sell, or hold a
security inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained by S&P from other sources it considers reliable.
S&P does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in or unavailability of such
information or based on other circumstances.
Commercial Paper
An S&P 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-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1
A short-term obligation rated 'A-1' is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2
A short-term obligation rated 'A-2' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
A-3
A short-term obligation rated 'A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
A-5
B
A short-term obligation rated 'B' is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C
A short-term obligation rated 'C' is currently vulnerable to nonpayment
and is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation.
D
A short-term obligation rated 'D' is in payment default. The 'D' rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The 'D'
rating also will be used upon the filing of a bankruptcy petition or the taking
of a similar action if payments on an obligation are jeopardized.
A commercial rating is not a recommendation to purchase, sell, or hold
a security inasmuch as it does not comment as to market price or suitability for
a particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained by S&P from other sources it considers reliable.
S&P does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in or unavailability of such
information or based on other circumstances.
A-6
Moody's Investors Service, Inc.-- A brief description of the applicable
Moody's Investors Service, Inc. ("Moody's") rating symbols and their meanings
(as published by Moody's) follows:
Municipal Bonds
Aaa
Bonds which are rated 'Aaa' are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa
Bonds which are rated 'Aa' are judged to be of high quality by all
standards. Together with the 'Aaa' group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in 'Aaa' securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in 'Aaa'
securities.
A
Bonds which are rated 'A' possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa
Bonds which are rated 'Baa' are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba
Bonds which are rated 'Ba' are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B
A-7
Bonds which are rated 'B' generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa
Bonds which are rated 'Caa' are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca
Bonds which are rated 'Ca' represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C
Bonds which are rated 'C' are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
#(hatchmark): Represents issues that are secured by escrowed funds held
in cash, held in trust, invested and reinvested in direct, non-callable,
non-prepayable United States government obligations or non-callable,
non-prepayable obligations unconditionally guaranteed by the U.S. Government,
Resolution Funding Corporation debt obligations.
Con. (...): Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. The parenthetical rating denotes probable credit stature upon
completion of construction or elimination of the basis of the condition.
(P): When applied to forward delivery bonds, indicates the rating is
provisional pending delivery of the bonds. The rating may be revised prior to
delivery if changes occur in the legal documents or the underlying credit
quality of the bonds.
Note: Moody's applies numerical modifiers 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
issue ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates that the issue ranks
in the lower end of its generic rating category.
Short-Term Loans
MIG 1/VMIG 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/VMIG 2
This designation denotes strong credit quality. Margins of protection
are ample, although not as large as in the preceding group.
A-8
MIG 3/VMIG 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.
Commercial Paper
Issuers (or supporting institutions) rated Prime-1 have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will normally be evidenced by the following characteristics:
-- Leading market positions in well-established industries.
-- High rates of return on funds employed.
-- Conservative capitalization structures with moderate reliance on
debt and ample asset protection.
-- Broad margins in earnings coverage of fixed financial charges and
high internal cash generation.
-- Well-established access to a range of financial markets and assured
sources of alternate liquidity.
Issuers (or supporting institutions) rated Prime-2 have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation than is the case for Prime-2 securities. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternate liquidity is maintained.
Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability for repayment of senior short-term debt obligations. The effect of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
A-9
Fitch Ratings --A brief description of the applicable Fitch Ratings
("Fitch") ratings symbols and meanings (as published by Fitch) follows:
Long-Term Credit 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
timely payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA
Very high credit quality. 'AA' ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A
High credit quality. 'A' ratings denote a low expectation of credit
risk. The capacity for timely 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 a
low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
Speculative Grade
BB
Speculative. 'BB' ratings indicate that there is a possibility of
credit risk developing, particularly as the result of adverse economic change
over time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment grade.
B
Highly speculative. 'B' ratings indicate that significant credit risk
is present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
A-10
CCC, CC, C
High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon sustained, favorable business or
economic developments. A 'CC' rating indicates that default of some kind appears
probable. 'C' ratings signal imminent default.
DDD, DD, and D Default
The ratings of obligations in this category are based on their
prospects for achieving partial or full recovery in a reorganization or
liquidation of the obligor. While expected recovery values are highly
speculative and cannot be estimated with any precision, the following serve as
general guidelines. 'DDD' obligations have the highest potential for recovery,
around 90%-100% of outstanding amounts and accrued interest. `DD' indicates
potential recoveries in the range of 50%-90%, and 'D' the lowest recovery
potential, i.e., below 50%. Entities rated in this category have defaulted on
some or all of their obligations. Entities rated 'DDD' have the highest prospect
for resumption of performance or continued operation with or without a formal
reorganization process. Entities rated 'DD' and 'D' are generally undergoing a
formal reorganization or liquidation process; those rated 'DD' are likely to
satisfy a higher portion of their outstanding obligations, while entities rated
'D' have a poor prospect for repaying all obligations.
Short-Term Credit Ratings
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and 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.
B
Speculative Minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
C
A-11
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. Denotes actual or imminent payment default.
Notes to Long-term and Short-term ratings:
"+" 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'.
'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.
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.
A Rating 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
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.
A-12
APPENDIX B
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
A Fund Designed to Provide High Current Income From A Quality-Oriented Portfolio
Attractive Current Yields
As of April 30, 2003, investment-grade quality taxable preferred
securities, as well as convertible securities generally, offered attractive
yields to maturity when compared with other fixed-income investments. At least
80% of the Fund's portfolio will be invested in investment-grade quality taxable
preferred securities and in investment-grade and non-investment grade quality
convertible securities.
[BAR CHART APPEARS HERE]
Attractive Yields to Maturity
As of 4/30/03 Yield to Maturity
Taxable Preferred Securities 6.86%
Corporate Bonds 4.41%
Convertible Securities 3.92%
Gov't Bonds 3.07%
Source: Merrill Lynch, Lehman Brothers, Bloomberg
Please see the paragraph below for more information on the indexes used. All
yields shown are as of April 30, 2003. It is not possible to invest directly in
any of these indexes. The Fund differs from any of these indexes in several
important respects. The Fund will invest in more than one asset class. The
taxable preferred securities index discussed below consists only of
exchange-traded preferred securities, while the Fund may invest in
over-the-counter preferred securities. The convertible securities index
discussed below consists only of companies operating in the U.S., while the Fund
may invest in securities of non-U.S. operating companies. The Fund likely will
use leverage, although there is no assurance leverage will be used. Leverage
carries some risks. Unlike an index, the Fund will charge management fees and
expenses. The yields shown here are for comparison purposes only, and none of
these yields is intended to be predictive of the future yields of these asset
classes or of the Fund.
For the charts and graphs in this Appendix B, convertible securities are
represented by the Merrill Lynch All U.S. Convertibles Index, which consists of
approximately 575 securities with par values greater than $50 million that were
issued by U.S. companies or non-U.S. based issuers that have a significant
business presence in the U.S. Taxable preferred securities are represented by
the Merrill Lynch Preferred Stock Hybrid Securities Index, an unmanaged index of
investment-grade, exchange-traded preferred stocks with outstanding market
values of at least $30 million and at least one year to maturity. Government
bonds are represented by the Lehman Brothers Government Bond Index, an unmanaged
index that includes all public obligations of the U.S. Treasury and all
publicly-issued debt of U.S. Government agencies and quasi-federal corporations,
and corporate debt guaranteed by the U.S. Government, excluding foreign-targeted
issues. Corporate bonds are represented by the Lehman Brothers U.S. Credit
Index, an unmanaged index that includes all publicly-issued, fixed rate,
non-convertible, investment-grade, dollar-denominated SEC-registered corporate
debt having at least one year to maturity and an outstanding par value of $100
million. High yield bonds are represented by the CSFB High Yield Index, which
includes approximately $375 billion of $US-denominated high yield debt with a
minimum of $75 million in par value and at least one rating below
investment-grade. The S&P 500 is an unmanaged index of 500 large-capitalization,
publicly-traded common stocks representing various industries.
Looking for Attractive Yields from Quality Preferred Securities
The Fund will invest at least 50% of its assets in preferred securities.
Spectrum, the Fund's preferred securities subadviser, will invest in preferred
securities that, at the time of investment, are of investment-grade quality.
Spectrum believes there is a potential advantage in seeking higher yields by
investing in the subordinated preferred securities of solidly-rated
issuers rather than the senior debt of the same companies.
Preferred Securities May Offer Attractive Yields Relative to the Yields of Bonds
Issued by the Same Company
Same Same Yield
Company's Company's Pick-up
(as of 4/30/03) Preferred Preferred 10-Year 10-Year (in basis
Security Security Rating Security Yield Bond Rating Bond Yield points)
--------------------------------------------------------------------------------------------------
Harris Bankcorp A 7.37% AA- 4.93% 244
Hartford Financial Services BBB 7.67% A- 4.76% 291
HRPT Properties Trust BBB- 9.17% BBB 5.20% 397
National Australia Bank A 7.89% AA- 4.15% 374
US Bancorp BBB+ 7.14% A 4.27% 287
--------------------------------------------------------------------------------------------------
Source: Bloomberg
This table is for illustrative purposes only, and is designed to highlight one
of the criteria Spectrum may use when evaluating securities for the Fund.
Spectrum will use other criteria as well when selecting the Fund's investments.
There can be no assurance the Fund will or will not invest in the securities of
any of the companies shown here. Yields on these securities do not represent the
yield on the Fund's common shares. This is not a recommendation to purchase any
of these securities.
An Income Fund Positioned For
Enhanced Total Return
If Stock Prices or Interest Rates Rise
Relatively High Correlation Between Equities and Convertible Securities May Lead
to Enhanced Fund Total Return if Equity Prices Rise
Historically, convertible securities have shown relatively high return
correlations with common stocks. We believe that adding convertible securities
to a portfolio of non-convertible fixed-income investments has the potential to
enhance the total return of the portfolio over time if equity prices rise.
[BAR CHART APPEARS HERE]
Stocks and Convertible Securities Have Had a Relatively High Return Correlation
April 1998 - April 2003
Correlation of Returns with the S&P 500
S&P 500 1.00
Convertible Securities 0.77
High Yield Bonds 0.50
Government Bonds (0.40)
Taxable Preferred Securities (0.08)
Corporate Bonds (0.05)
Source: Merrill Lynch, Lehman Brothers, Ibbotson Associates
Past correlations are not necessarily predictive of future correlations between
any of these asset classes, or between the asset classes and the Fund. It is not
possible to invest directly in any of these indexes. Please see the third
paragraph on page 1 of this Appendix B for more information on the indexes used.
Correlation coefficients are based on monthly return data from April 1998
through April 2003.
Convertible Securities May Enhance the Fund's Total Return if Interest Rates
Rise
Over the past 15 years, the returns of convertible securities have performed
much more consistently in both rising and falling interest rate environments
than most non-convertible fixed-income investments. If this historical pattern
persists, the inclusion of convertible securities in the Fund's portfolio may
provide opportunities for enhanced total return, especially if interest rates
rise in the future.
[BAR CHART APPEARS HERE]
Historically, Convertible Securities Have Performed Well in Rising Rate
Environments.
January 1, 1988 - April 1, 2003
Average Annual Returns
Taxable
Convertible Corporate Government Preferred
Securities Bonds Bonds Securities
Jan-88 2.666% Jan-88 3.92% Jan-88 3.27% Jan-88
Feb-88 4.216% Feb-88 1.37% Feb-88 1.07% Feb-88
Mar-88 0.503% Mar-88 -0.86% Mar-88 -1.03% Mar-88
Apr-88 1.165% Apr-88 -0.71% Apr-88 -0.53% Apr-88
May-88 -0.258% May-88 -0.54% May-88 -0.71% May-88
Jun-88 3.652% Jun-88 2.39% Jun-88 2.21% Jun-88
Jul-88 -0.298% Jul-88 -0.23% Jul-88 -0.68% Jul-88
Aug-88 -1.715% Aug-88 0.42% Aug-88 0.20% Aug-88
Sep-88 1.635% Sep-88 2.16% Sep-88 2.18% Sep-88
Oct-88 0.730% Oct-88 1.75% Oct-88 1.76% Oct-88
Nov-88 -1.692% Nov-88 -0.96% Nov-88 -1.18% Nov-88
Dec-88 1.699% Dec-88 0.27% Dec-88 0.38% Dec-88
Jan-89 4.135% Jan-89 1.48% Jan-89 1.27% Jan-89
Feb-89 0.676% Feb-89 -0.56% Feb-89 -0.81% Feb-89
Mar-89 0.857% Mar-89 0.29% Mar-89 0.61% Mar-89
Apr-89 2.607% Apr-89 2.03% Apr-89 2.14% Apr-89
May-89 2.015% May-89 2.73% May-89 2.36% May-89
Jun-89 0.072% Jun-89 2.96% Jun-89 3.34% Jun-89
Jul-89 2.200% Jul-89 1.94% Jul-89 2.11% Jul-89
Aug-89 2.382% Aug-89 -1.08% Aug-89 -1.68% Aug-89
Sep-89 -0.532% Sep-89 0.46% Sep-89 0.43% Sep-89
Oct-89 -3.379% Oct-89 2.30% Oct-89 2.59% Oct-89
Nov-89 0.722% Nov-89 0.69% Nov-89 0.97% Nov-89
Dec-89 0.245% Dec-89 0.11% Dec-89 0.17% Dec-89
Jan-90 -3.852% Jan-90 -1.25% Jan-90 -1.42% Jan-90
Feb-90 1.029% Feb-90 0.29% Feb-90 0.20% Feb-90
Mar-90 1.843% Mar-90 0.09% Mar-90 -0.02% Mar-90
Apr-90 -1.783% Apr-90 -1.04% Apr-90 -0.88% Apr-90
May-90 5.097% May-90 3.23% May-90 2.79% May-90
Jun-90 0.156% Jun-90 1.71% Jun-90 1.58% Jun-90
Jul-90 -1.495% Jul-90 1.13% Jul-90 1.28% Jul-90
Aug-90 -6.517% Aug-90 -1.59% Aug-90 -1.39% Aug-90
Sep-90 -3.996% Sep-90 0.46% Sep-90 0.96% Sep-90
Oct-90 -4.929% Oct-90 0.45% Oct-90 1.63% Oct-90
Nov-90 5.607% Nov-90 2.06% Nov-90 2.22% Nov-90
Dec-90 2.454% Dec-90 1.41% Dec-90 1.55% Dec-90
Jan-91 5.124% Jan-91 1.27% Jan-91 1.07% Jan-91
Feb-91 7.895% Feb-91 1.71% Feb-91 0.57% Feb-91
Mar-91 2.760% Mar-91 1.23% Mar-91 0.51% Mar-91
Apr-91 1.599% Apr-91 1.30% Apr-91 1.10% Apr-91
May-91 3.193% May-91 0.69% May-91 0.39% May-91
Jun-91 -2.743% Jun-91 -0.01% Jun-91 -0.14% Jun-91
Jul-91 2.350% Jul-91 1.44% Jul-91 1.19% Jul-91
Aug-91 3.323% Aug-91 2.26% Aug-91 2.32% Aug-91
Sep-91 0.183% Sep-91 2.06% Sep-91 2.10% Sep-91
Oct-91 1.646% Oct-91 0.95% Oct-91 0.88% Oct-91
Nov-91 -1.427% Nov-91 0.98% Nov-91 1.00% Nov-91
Dec-91 4.935% Dec-91 3.27% Dec-91 3.41% Dec-91
Jan-92 4.487% Jan-92 -1.25% Jan-92 -1.56% Jan-92
Feb-92 2.742% Feb-92 0.96% Feb-92 0.39% Feb-92
Mar-92 -0.630% Mar-92 -0.43% Mar-92 -0.58% Mar-92
Apr-92 1.369% Apr-92 0.50% Apr-92 0.63% Apr-92
May-92 1.769% May-92 2.23% May-92 1.85% May-92
Jun-92 -1.178% Jun-92 1.56% Jun-92 1.43% Jun-92
Jul-92 3.200% Jul-92 2.67% Jul-92 2.52% Jul-92
Aug-92 -0.252% Aug-92 0.78% Aug-92 0.93% Aug-92
Sep-92 2.069% Sep-92 1.21% Sep-92 1.41% Sep-92
Oct-92 0.259% Oct-92 -1.78% Oct-92 -1.44% Oct-92
Nov-92 2.837% Nov-92 0.16% Nov-92 -0.17% Nov-92
Dec-92 3.049% Dec-92 1.85% Dec-92 1.68% Dec-92
Jan-93 3.228% Jan-93 2.33% Jan-93 2.13% Jan-93
Feb-93 0.739% Feb-93 2.30% Feb-93 2.00% Feb-93
Mar-93 3.813% Mar-93 0.35% Mar-93 0.33% Mar-93
Apr-93 -0.576% Apr-93 0.77% Apr-93 0.77% Apr-93
May-93 2.286% May-93 0.12% May-93 -0.11% May-93
Jun-93 0.656% Jun-93 2.43% Jun-93 2.22% Jun-93
Jul-93 0.372% Jul-93 0.72% Jul-93 0.61% Jul-93
Aug-93 2.817% Aug-93 2.49% Aug-93 2.23% Aug-93
Sep-93 0.990% Sep-93 0.24% Sep-93 0.38% Sep-93
Oct-93 2.456% Oct-93 0.50% Oct-93 0.38% Oct-93
Nov-93 -1.384% Nov-93 -1.23% Nov-93 -1.10% Nov-93
Dec-93 1.524% Dec-93 0.59% Dec-93 0.39% Dec-93
Jan-94 2.610% Jan-94 1.94% Jan-94 1.37% Jan-94
Feb-94 -1.266% Feb-94 -2.36% Feb-94 -2.12% Feb-94
Mar-94 -4.131% Mar-94 -3.07% Mar-94 -2.25% Mar-94
Apr-94 -1.962% Apr-94 -0.96% Apr-94 -0.79% Apr-94
May-94 -0.031% May-94 -0.37% May-94 -0.13% May-94
Jun-94 -1.130% Jun-94 -0.25% Jun-94 -0.23% Jun-94
Jul-94 1.775% Jul-94 2.53% Jul-94 1.84% Jul-94
Aug-94 2.586% Aug-94 0.11% Aug-94 0.02% Aug-94
Sep-94 -1.277% Sep-94 -1.86% Sep-94 -1.41% Sep-94
Oct-94 0.352% Oct-94 -0.23% Oct-94 -0.07% Oct-94
Nov-94 -3.054% Nov-94 -0.16% Nov-94 -0.18% Nov-94
Dec-94 -0.400% Dec-94 0.83% Dec-94 0.61% Dec-94
Jan-95 0.718% Jan-95 2.12% Jan-95 1.86% Jan-95
Feb-95 3.126% Feb-95 2.88% Feb-95 2.15% Feb-95
Mar-95 2.715% Mar-95 0.82% Mar-95 0.63% Mar-95
Apr-95 2.086% Apr-95 1.69% Apr-95 1.31% Apr-95
May-95 2.761% May-95 4.71% May-95 4.03% May-95
Jun-95 3.413% Jun-95 0.90% Jun-95 0.77% Jun-95
Jul-95 3.382% Jul-95 -0.44% Jul-95 -0.37% Jul-95
Aug-95 1.465% Aug-95 1.61% Aug-95 1.17% Aug-95
Sep-95 1.301% Sep-95 1.18% Sep-95 0.96% Sep-95
Oct-95 -2.719% Oct-95 1.30% Oct-95 1.52% Oct-95
Nov-95 3.836% Nov-95 1.91% Nov-95 1.56% Nov-95
Dec-95 0.370% Dec-95 1.65% Dec-95 1.42% Dec-95
Jan-96 3.083% Jan-96 0.65% Jan-96 0.61% Jan-96
Feb-96 2.258% Feb-96 -2.38% Feb-96 -2.04% Feb-96
Mar-96 1.044% Mar-96 -0.85% Mar-96 -0.83% Mar-96
Apr-96 1.859% Apr-96 -0.83% Apr-96 -0.64% Apr-96
May-96 2.210% May-96 -0.18% May-96 -0.17% May-96
Jun-96 -1.481% Jun-96 1.47% Jun-96 1.29% Jun-96
Jul-96 -4.260% Jul-96 0.19% Jul-96 0.25% Jul-96
Aug-96 3.857% Aug-96 -0.31% Aug-96 -0.22% Aug-96
Sep-96 2.753% Sep-96 2.12% Sep-96 1.66% Sep-96
Oct-96 1.206% Oct-96 2.73% Oct-96 2.20% Oct-96
Nov-96 3.379% Nov-96 2.14% Nov-96 1.74% Nov-96
Dec-96 -0.735% Dec-96 -1.38% Dec-96 -1.02% Dec-96
Jan-97 2.914% Jan-97 0.14% Jan-97 0.11% Jan-97
Feb-97 -0.373% Feb-97 0.42% Feb-97 0.14% Feb-97 1.26%
Mar-97 -2.146% Mar-97 -1.56% Mar-97 -1.06% Mar-97 -0.81%
Apr-97 0.909% Apr-97 1.52% Apr-97 1.44% Apr-97 1.17%
May-97 5.073% May-97 1.13% May-97 0.86% May-97 1.13%
Jun-97 3.137% Jun-97 1.42% Jun-97 1.12% Jun-97 1.05%
Jul-97 5.709% Jul-97 3.66% Jul-97 2.84% Jul-97 2.01%
Aug-97 -0.542% Aug-97 -1.48% Aug-97 -0.99% Aug-97 -0.07%
Sep-97 4.623% Sep-97 1.75% Sep-97 1.50% Sep-97 1.67%
Oct-97 -1.926% Oct-97 1.27% Oct-97 1.73% Oct-97 -0.43%
Nov-97 0.042% Nov-97 0.56% Nov-97 0.51% Nov-97 1.52%
Dec-97 0.978% Dec-97 1.06% Dec-97 1.05% Dec-97 1.17%
Jan-98 0.308% Jan-98 1.19% Jan-98 1.50% Jan-98 0.80%
Feb-98 4.428% Feb-98 -0.03% Feb-98 -0.27% Feb-98 0.06%
Mar-98 3.676% Mar-98 0.37% Mar-98 0.28% Mar-98 -0.24%
Apr-98 0.628% Apr-98 0.63% Apr-98 0.45% Apr-98 0.18%
May-98 -2.209% May-98 1.19% May-98 1.03% May-98 0.80%
Jun-98 0.844% Jun-98 0.74% Jun-98 1.14% Jun-98 1.06%
Jul-98 -1.588% Jul-98 -0.09% Jul-98 0.15% Jul-98 0.69%
Aug-98 -11.490% Aug-98 0.47% Aug-98 2.60% Aug-98 0.51%
Sep-98 1.996% Sep-98 3.24% Sep-98 2.70% Sep-98 0.98%
Oct-98 2.583% Oct-98 -1.54% Oct-98 -0.34% Oct-98 0.59%
Nov-98 4.777% Nov-98 1.88% Nov-98 0.03% Nov-98 0.81%
Dec-98 5.851% Dec-98 0.29% Dec-98 0.22% Dec-98 0.90%
Jan-99 4.933% Jan-99 0.99% Jan-99 0.58% Jan-99 0.53%
Feb-99 -3.494% Feb-99 -2.37% Feb-99 -2.38% Feb-99 0.00%
Mar-99 4.138% Mar-99 0.71% Mar-99 0.39% Mar-99 0.34%
Apr-99 4.059% Apr-99 0.29% Apr-99 0.23% Apr-99 0.68%
May-99 -0.505% May-99 -1.34% May-99 -0.88% May-99 0.22%
Jun-99 3.686% Jun-99 -0.52% Jun-99 -0.20% Jun-99 -0.30%
Jul-99 -0.639% Jul-99 -0.55% Jul-99 -0.15% Jul-99 -0.75%
Aug-99 -1.260% Aug-99 -0.24% Aug-99 0.00% Aug-99 0.28%
Sep-99 0.658% Sep-99 1.09% Sep-99 0.81% Sep-99 -0.44%
Oct-99 3.920% Oct-99 0.46% Oct-99 0.16% Oct-99 0.17%
Nov-99 5.792% Nov-99 0.11% Nov-99 -0.14% Nov-99 -1.96%
Dec-99 13.546% Dec-99 -0.53% Dec-99 -0.65% Dec-99 -3.46%
Jan-00 -0.024% Jan-00 -0.35% Jan-00 0.14% Jan-00 2.40%
Feb-00 8.413% Feb-00 0.93% Feb-00 1.42% Feb-00 -1.31%
Mar-00 -0.142% Mar-00 0.85% Mar-00 1.76% Mar-00 2.12%
Apr-00 -6.896% Apr-00 -0.88% Apr-00 -0.28% Apr-00 0.99%
May-00 -4.331% May-00 -0.37% May-00 0.06% May-00 0.16%
Jun-00 5.148% Jun-00 2.51% Jun-00 1.78% Jun-00 3.20%
Jul-00 -2.967% Jul-00 1.21% Jul-00 0.97% Jul-00 2.22%
Aug-00 7.681% Aug-00 1.30% Aug-00 1.48% Aug-00 2.23%
Sep-00 -3.263% Sep-00 0.53% Sep-00 0.28% Sep-00 0.99%
Oct-00 -3.912% Oct-00 0.10% Oct-00 0.96% Oct-00 0.06%
Nov-00 -11.953% Nov-00 1.30% Nov-00 1.97% Nov-00 1.83%
Dec-00 3.828% Dec-00 1.94% Dec-00 1.99% Dec-00 1.65%
Jan-01 6.220% Jan-01 2.74% Jan-01 1.01% Jan-01 1.17%
Feb-01 -7.510% Feb-01 0.87% Feb-01 1.14% Feb-01 0.61%
Mar-01 -4.329% Mar-01 0.62% Mar-01 0.35% Mar-01 0.89%
Apr-01 6.711% Apr-01 -0.36% Apr-01 -1.02% Apr-01 -0.20%
May-01 -0.624% May-01 0.92% May-01 0.33% May-01 1.26%
Jun-01 -1.578% Jun-01 0.51% Jun-01 0.46% Jun-01 1.35%
Jul-01 -1.439% Jul-01 2.61% Jul-01 2.40% Jul-01 0.69%
Aug-01 -1.765% Aug-01 1.34% Aug-01 1.24% Aug-01 1.26%
Sep-01 -5.967% Sep-01 -0.15% Sep-01 1.74% Sep-01 -0.54%
Oct-01 2.056% Oct-01 2.48% Oct-01 2.58% Oct-01 1.02%
Nov-01 2.676% Nov-01 -0.87% Nov-01 -2.24% Nov-01 0.55%
Dec-01 2.104% Dec-01 -0.69% Dec-01 -0.87% Dec-01 0.60%
Jan-02 -1.580% Jan-02 0.85% Jan-02 0.65% Jan-02 0.69%
Feb-02 -2.836% Feb-02 0.76% Feb-02 0.92% Feb-02 0.14%
Mar-02 3.590% Mar-02 -1.85% Mar-02 -2.17% Mar-02 -1.06%
Apr-02 -1.455% Apr-02 1.39% Apr-02 2.38% Apr-02 0.85%
May-02 -0.873% May-02 1.32% May-02 0.60% May-02 0.61%
Jun-02 -5.417% Jun-02 0.16% Jun-02 1.40% Jun-02 0.33%
Jul-02 -5.991% Jul-02 -0.05% Jul-02 2.20% Jul-02 -0.08%
Aug-02 1.242% Aug-02 2.59% Aug-02 1.98% Aug-02 2.40%
Sep-02 -3.525% Sep-02 1.90% Sep-02 2.34% Sep-02 1.13%
Oct-02 2.230% Oct-02 -1.16% Oct-02 -0.80% Oct-02 -1.98%
Nov-02 7.212% Nov-02 1.30% Nov-02 -0.86% Nov-02 1.83%
Dec-02 -0.753% Dec-02 2.95% Dec-02 2.42% Dec-02 1.39%
Jan-03 1.608% Jan-03 0.32% Jan-03 -0.25% Jan-03 1.11%
Feb-03 -0.239% Feb-03 2.00% Feb-03 1.61% Feb-03 0.62%
Mar-03 1.689% Mar-03 0.07% Mar-03 -0.29% Mar-03 0.23%
Apr-03 5.044% Apr-03 1.85% Apr-03 0.46% Apr-03 1.59%
Rising Rate Environment
Convertible Securities 13.76%
Corporate Bonds 1.44%
Government Bonds 1.20%
Taxable Preferred Securities 0.77%
Falling Rate Environment
Convertible Securities 9.55%
Corporate Bonds 11.99%
Government Bonds 11.10%
Taxable Preferred Securities 10.19%
All Environments
Convertible Securities 10.64%
Corporate Bonds 9.13%
Government Bonds 8.43%
Taxable Preferred Securities 7.72%
Rising rate environments include: 1/88-3/89, 11/93-12/94, 11/98-5/00
Falling rate environments include: 4/89-10/93, 1/95-10/98, 6/00-4/03
Preferred Securities returns are for the period from February 1997 (the
inception of the index) through April 2003
Source: Merrill Lynch, Lehman Brothers
Past performance does not guarantee future results. These average annual total
returns were calculated using monthly returns for each index over the respective
rising rate and falling rate time periods, as well as for the entire time
period. Please see the third paragraph on page 1 of this Appendix B for more
information on the indexes used. It is not possible to invest directly in any of
these indexes.
Yield Spreads Are Now Wide by
10-Year Historical Standards
Looking at the last ten years, the current yield spread between high yield bonds
and the ten-year U.S. Treasury bond is relatively wide. By investing a portion
of its portfolio in high yield bonds, the Fund will position those assets to
earn high current income and potentially enhance the Fund's total return if the
high yield/Treasury spread narrows in the future.
[GRAPH APPEARS HERE]
Yield Spread Between High Yield Bonds and 10-Year Treasuries is Wide
April 1993 - April 2003
Current Yield
Date High Yield Bonds 10-Year Treasury Yield Spread
---- ---------------- ---------------- ------------
Apr-93 0.0971 5.97% 3.74%
May-93 0.0962 6.04% 3.58%
Jun-93 0.093 5.96% 3.34%
Jul-93 0.0925 5.81% 3.44%
Aug-93 0.0926 5.68% 3.58%
Sep-93 0.0943 5.36% 4.07%
Oct-93 0.0927 5.33% 3.94%
Nov-93 0.0932 5.72% 3.60%
Dec-93 0.0926 5.77% 3.49%
Jan-94 0.0887 5.75% 3.12%
Feb-94 0.0912 5.97% 3.15%
Mar-94 0.1012 6.48% 3.64%
Apr-94 0.1058 6.97% 3.61%
May-94 0.1066 7.18% 3.48%
Jun-94 0.1092 7.10% 3.82%
Jul-94 0.1101 7.30% 3.71%
Aug-94 0.1113 7.24% 3.89%
Sep-94 0.1134 7.46% 3.88%
Oct-94 0.1156 7.74% 3.82%
Nov-94 0.1196 7.96% 4.00%
Dec-94 0.1198 7.81% 4.17%
Jan-95 0.1192 7.78% 4.14%
Feb-95 0.1147 7.47% 4.00%
Mar-95 0.1147 7.20% 4.27%
Apr-95 0.1116 7.06% 4.10%
May-95 0.1069 6.63% 4.06%
Jun-95 0.1073 6.17% 4.56%
Jul-95 0.1053 6.28% 4.25%
Aug-95 0.1063 6.49% 4.14%
Sep-95 0.1056 6.20% 4.36%
Oct-95 0.104 6.04% 4.36%
Nov-95 0.1037 5.93% 4.44%
Dec-95 0.1018 5.71% 4.47%
Jan-96 0.0995 5.65% 4.30%
Feb-96 0.0994 5.81% 4.13%
Mar-96 0.1023 6.27% 3.96%
Apr-96 0.103 6.51% 3.79%
May-96 0.1034 6.74% 3.60%
Jun-96 0.1044 6.91% 3.53%
Jul-96 0.1046 6.87% 3.59%
Aug-96 0.1036 6.64% 3.72%
Sep-96 0.0997 6.83% 3.14%
Oct-96 0.0998 6.53% 3.45%
Nov-96 0.0978 6.20% 3.58%
Dec-96 0.0958 6.30% 3.28%
Jan-97 0.0958 6.58% 3.00%
Feb-97 0.094 6.42% 2.98%
Mar-97 0.0999 6.69% 3.30%
Apr-97 0.0996 6.89% 3.07%
May-97 0.0963 6.71% 2.92%
Jun-97 0.0951 6.49% 3.02%
Jul-97 0.0916 6.22% 2.94%
Aug-97 0.0938 6.30% 3.08%
Sep-97 0.0906 6.21% 2.85%
Oct-97 0.0933 6.03% 3.30%
Nov-97 0.0926 5.88% 3.38%
Dec-97 0.0928 5.81% 3.47%
Jan-98 0.0905 5.54% 3.51%
Feb-98 0.0906 5.57% 3.49%
Mar-98 0.0905 5.65% 3.40%
Apr-98 0.0919 5.64% 3.55%
May-98 0.0938 5.65% 3.73%
Jun-98 0.0955 5.50% 4.05%
Jul-98 0.0948 5.46% 4.02%
Aug-98 0.1105 5.34% 5.71%
Sep-98 0.112 4.81% 6.39%
Oct-98 0.1176 4.53% 7.23%
Nov-98 0.1077 4.83% 5.94%
Dec-98 0.1101 4.65% 6.36%
Jan-99 0.1086 4.72% 6.14%
Feb-99 0.1108 5.00% 6.08%
Mar-99 0.11 5.23% 5.77%
Apr-99 0.1061 5.18% 5.43%
May-99 0.1102 5.54% 5.48%
Jun-99 0.1118 5.90% 5.28%
Jul-99 0.1134 5.79% 5.55%
Aug-99 0.1163 5.94% 5.69%
Sep-99 0.119 5.92% 5.98%
Oct-99 0.1213 6.11% 6.02%
Nov-99 0.1193 6.03% 5.90%
Dec-99 0.1191 6.28% 5.63%
Jan-00 0.122 6.66% 5.54%
Feb-00 0.123 6.52% 5.78%
Mar-00 0.1285 6.26% 6.59%
Apr-00 0.1301 5.99% 7.02%
May-00 0.1346 6.44% 7.02%
Jun-00 0.1317 6.10% 7.07%
Jul-00 0.1317 6.05% 7.12%
Aug-00 0.1319 5.83% 7.36%
Sep-00 0.1351 5.80% 7.71%
Oct-00 0.1421 5.74% 8.47%
Nov-00 0.1504 5.72% 9.32%
Dec-00 0.1499 5.24% 9.75%
Jan-01 0.1357 5.16% 8.41%
Feb-01 0.1305 5.10% 7.95%
Mar-01 0.1324 4.89% 8.35%
Apr-01 0.1322 5.15% 8.07%
May-01 0.1283 5.39% 7.44%
Jun-01 0.1314 5.28% 7.86%
Jul-01 0.1289 5.24% 7.65%
Aug-01 0.1264 4.97% 7.67%
Sep-01 0.1408 4.73% 9.35%
Oct-01 0.1354 4.57% 8.97%
Nov-01 0.1282 4.19% 8.63%
Dec-01 0.1299 5.09% 7.90%
Jan-02 0.1277 5.04% 7.73%
Feb-02 0.1273 4.91% 7.82%
Mar-02 0.1218 5.28% 6.90%
Apr-02 0.1173 5.21% 6.52%
May-02 0.1163 5.16% 6.47%
Jun-02 0.1227 4.93% 7.34%
Jul-02 0.1312 4.65% 8.47%
Aug-02 0.1302 4.26% 8.76%
Sep-02 0.1342 3.87% 9.55%
Oct-02 0.1378 3.94% 9.84%
Nov-02 0.1263 4.05% 8.58%
Dec-02 0.1231 4.03% 8.28%
Jan-03 0.1186 4.05% 7.81%
Feb-03 0.1158 3.90% 7.68%
Mar-03 0.1103 3.81% 7.22%
Apr-03 0.1020 3.84% 6.36%
Source: Bloomberg
Past performance does not guarantee future results. Investing in high yield
securities carries special risks. Please see the Fund's prospectus for more
information on these risks. There can be no assurance that the yield spread
between high yield bonds in which the Fund may invest and U.S. Government bonds
will narrow. Please see the third paragraph on page 1 of this Appendix B for
more information on the High Yield Index used. It is not possible to invest
directly in an index. Ten-year Treasury notes are backed by the full faith and
credit of the U.S. Government.
Who Might Be Interested?
The features and objectives of this Fund might be especially appealing to those:
.. Already investing in preferred or convertible securities
.. Looking for high current income and the opportunity for enhanced total return
.. Seeking additional diversification within their investment portfolios
.. Interested in trading convenience and flexibility
.. Reassured by the experience of Nuveen, Spectrum and Froley, Revy
For Which Accounts is this Fund Appropriate?
Although this Fund may be appropriate for a wide range of investors and
accounts, it may be particularly attractive for investors with:
.. Tax-deferred or tax-advantaged accounts such as retirement plans
.. Taxable accounts with relatively low current taxable income
.. Accounts that now contain preferred or convertible securities
Benefits of Purchasing In The IPO
We believe investors can take advantage of several benefits by purchasing
shares during the initial public offering, including:
- Known price - $15 per share
- The same price for all shares in an order - no matter what the order size, all
orders are filled at the same $15 per share (100 share minimum)
Exchange-Traded Liquidity
The Fund expects to list its shares on the New York Stock Exchange, which should
provide you with liquidity, convenience and daily price visibility through
electronic services and in newspaper stock tables.
Like any stock, the Fund's share price will fluctuate with market conditions and
other factors. At the time of sale, your shares may have a market price that is
above or below net asset value, and may be worth more or less than your original
investment. The common shares are designed primarily for long-term investors,
and you should not view the Fund as a vehicle for trading purposes.
Proven Management
According to Thomson Wealth Management, Nuveen is the leading sponsor of
closed-end exchange-traded funds, as measured by the number of funds (103) and
fund assets under management (approximately $42 billion), as of April 30, 2003.
Spectrum Asset Management was founded in 1987 and is one of the country's
leading specialists in the management of preferred securities. With
approximately $8 billion in assets under management (as of April 30, 2003),
Spectrum is led by two principals with a combined 50 years of preferred
securities experience. Each member of the investment team averages more than 15
years' experience in the preferred securities market.
Founded in 1975, Froley, Revy is one of the oldest firms specializing in
convertible securities management. As of April 30, 2003, the firm managed
approximately $2.5 billion in assets on behalf of pension funds, closed-end
exchange-traded funds, insurance companies, endowments, foundations and high net
worth individuals. Each member of the Froley, Revy portfolio management team has
more than 9 years' experience in the convertible securities markets.
A three-person team of high yield debt specialists from NIAC will manage the
high yield and other debt instruments portion of the Fund's portfolio. This team
has more than 25 years' cumulative experience in the high yield and related debt
markets.
B-1
Nuveen Preferred and Convertible Income Fund 2 135,000,000 Common Shares
-------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
-------------------------------------------
June 25, 2003