As filed with the Securities and Exchange Commission on August 22, 2003
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1933 Act File No. 333-106334
1940 Act File No. 811-21374
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[X] Pre-Effective Amendment No. 2
[_] Post-Effective Amendment No.
and
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] Amendment No. 2
PIMCO Floating Rate Income Fund
(Exact Name of Registrant as Specified in Declaration of Trust)
c/o PIMCO Advisors Fund Management LLC
1345 Avenue of the Americas
New York, New York 10105
(Address of Principal Executive Offices)
(Number, Street, City, State, Zip Code)
(212) 739-3369
(Registrant's Telephone Number, including Area Code)
Newton B. Schott, Jr.
c/o PIMCO Advisors Distributors LLC
2187 Atlantic Street
Stamford, Connecticut 06902
(Name and Address (Number, Street, City, State, Zip Code) of Agent for Service)
Copies of Communications to:
Joseph B. Kittredge, Jr., Esq.
Ropes & Gray LLP
One International Place
Boston, Massachusetts 02110
Approximate Date of Proposed Public Offering:
As soon as practicable after the effective date of this Registration Statement
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If any of the securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box. [_]
It is proposed that this filing will become effective (check appropriate
box)
[X] when declared effective pursuant to section 8(c)
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed Maximum Proposed Maximum
Amount Being Offering Price Per Aggregate Amount of
Title of Securities Being Registered Registered Unit Offering Price/1/ Registration Fee/2/
------------------------------------ ------------ ------------------ ---------------- -------------------
Common Shares, par value $0.00001 1,000 Shares $ 20.00 $ 20,000 $ 1.62
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/1/ Estimated solely for the purpose of calculating the registration fee.
/2/ $1.62 of which has previously been paid.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such dates as the Commission, acting pursuant to said Section 8(a),
may determine.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN
OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED , 2003
P R O S P E C T U S
[LOGO] PIMCO
ADVISORS
SHARES
PIMCO FLOATING RATE INCOME FUND
COMMON SHARES
$20.00 PER SHARE
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INVESTMENT OBJECTIVE. The Fund is a newly organized, diversified,
closed-end management investment company. The Fund's investment objective is to
seek high current income, consistent with the preservation of capital.
PORTFOLIO MANAGEMENT STRATEGIES. The Fund is actively managed in
accordance with the portfolio manager's top down cyclical and secular economic
outlook, using strategies that focus on credit quality analysis, broad market
diversification among industries and sectors, and other risk management
techniques. The portfolio manager attempts to identify investments that provide
high current income through fundamental research, driven by independent credit
analysis and proprietary analytical tools, and also uses a variety of
techniques designed to control risk and minimize exposure to issues that the
portfolio manager believes are more likely to default or otherwise depreciate
in value over time. Under normal market conditions, the Fund seeks to achieve
its investment objective by investing at least 80% of its net assets (plus any
borrowings for investment purposes) in a diversified portfolio of floating rate
debt instruments, a substantial portion of which will be senior floating rate
loans. Senior floating rate loans generally hold the most senior position in
the capital structure of a borrower and are often secured with collateral. The
Fund may invest without limit and ordinarily expects to invest a substantial
portion of its assets in senior floating rate loans and other debt securities
that are, at the time of purchase, rated below investment grade (below Baa3 by
Moody's Investors Service, Inc. ("Moody's"), below BBB- by either Standard &
Poor's ("S&P") or Fitch, Inc. ("Fitch"), or below a comparable rating by
Dominion Bond Rating Service Limited ("Dominion")), or unrated but judged by
the portfolio manager to be of comparable quality. The Fund will not invest
more than 10% of its total assets in securities that are, at the time of
purchase, rated CCC+/Caa1 or lower by each agency rating the security or that
are unrated but judged by the portfolio manager to be of comparable quality.
DEBT SECURITIES OF BELOW INVESTMENT GRADE QUALITY ARE REGARDED AS HAVING
PREDOMINANTLY SPECULATIVE CHARACTERISTICS WITH RESPECT TO CAPACITY TO PAY
INTEREST AND REPAY PRINCIPAL, AND ARE COMMONLY REFERRED TO AS "HIGH YIELD"
SECURITIES OR "JUNK BONDS." DUE TO THE RISKS INVOLVED IN INVESTING IN HIGH
YIELD SECURITIES, AN INVESTMENT IN THE FUND SHOULD BE CONSIDERED SPECULATIVE.
(CONTINUED ON FOLLOWING PAGE)
INVESTING IN THE FUND'S COMMON SHARES INVOLVES CERTAIN RISKS. SEE "RISKS"
BEGINNING ON PAGE 36 OF THIS PROSPECTUS.
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PER SHARE TOTAL
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Public offering price............ $20.00 $
Sales load....................... $.65 $
Estimated offering expenses(1)(2) $.04 $
Proceeds to the Fund............. $19.31 $
(1) The Fund has agreed to pay the underwriters $.00667 per share as a
partial reimbursement of expenses incurred in connection with the
offering. See "Underwriting."
(2) The Fund will pay or reimburse organization and offering expenses
estimated at $ from the proceeds of the offering. PIMCO
Advisors Fund Management LLC has agreed to pay (i) the amount by
which the Fund's offering costs (other than the sales load) exceed
$.04 per share and (ii) all of the Fund's organizational expenses,
except that the Fund has agreed to reimburse PIMCO Advisors Fund
Management LLC for such organizational expenses to the extent that
the aggregate of all such organizational expenses and all offering
costs (other than the sales load, but inclusive of the reimbursement
of underwriter expenses of $.00667 per share) does not exceed $.04
per share.
The underwriters may also purchase up to an additional common
shares at the public offering price, less the sales load, within 45 days from
the date of this prospectus to cover overallotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
The common shares will be ready for delivery on or about , 2003.
----------------
MERRILL LYNCH & CO. WACHOVIA SECURITIES
A.G. EDWARDS & SONS, INC. RBC CAPITAL MARKETS ADVEST, INC.
ROBERT W. BAIRD & CO. CROWELL, WEEDON & CO. JANNEY MONTGOMERY SCOTT LLC
MCDONALD INVESTMENTS INC. TD WATERHOUSE WEDBUSH MORGAN SECURITIES INC.
QUICK & REILLY, INC.
----------------
The date of this prospectus is , 2003.
(CONTINUED FROM PREVIOUS PAGE)
Because most of the debt instruments held by the Fund will have variable
interest rates, the Fund's portfolio is generally expected to have less
interest rate risk (I.E., sensitivity to fluctuations in market interest rates)
and a more stable net asset value than funds with portfolios that invest in
fixed-income securities, although the net asset value will vary due to
fluctuations in interest rates and other factors such as changes in the credit
quality of securities in the portfolio. Due to its focus on variable rate
securities, the amounts of the Fund's monthly distributions to common
shareholders are expected to vary with fluctuations in market interest rates.
NO PRIOR HISTORY. Because the Fund is newly organized, its common
shares have no history of public trading. Shares of closed-end investment
companies frequently trade at a discount from their net asset value, which
creates a risk of loss for the investors purchasing shares in the initial
public offering. The common shares are expected to be listed on the New York
Stock Exchange under the symbol "PFL."
PORTFOLIO CONTENTS. As noted above, a substantial portion of the Fund's
investment assets will ordinarily consist of senior floating rate debt
securities and interests in senior floating rate loans ("Senior Loans") made to
or issued by U.S. or non-U.S. banks or other corporations. Senior Loans
typically pay interest at rates which are re-determined periodically on the
basis of a floating base lending rate (such as the London Inter-Bank Offered
Rate, "LIBOR") plus a premium. Although Senior Loans are typically of below
investment grade quality, they tend to have more favorable recovery rates than
those of other types of below investment grade quality debt obligations. Other
floating rate debt instruments in which the Fund may invest include catastrophe
and other event-linked bonds, bank capital securities, unsecured bank loans,
corporate bonds, money market instruments and certain types of mortgage-backed
and other asset-backed securities that pay interest at rates which adjust
whenever a specified interest rate changes and/or reset on predetermined dates
(such as the last day of a month or calendar quarter). The Fund may invest
without limit and ordinarily expects to invest a substantial portion of its
assets in Senior Loans and other floating rate debt instruments that are, at
the time of purchase, rated below investment grade or unrated but judged by the
portfolio manager to be of comparable quality. The Fund may invest up to 20% of
its net assets (plus any borrowings for investment purposes) in securities and
instruments other than floating rate debt instruments, including fixed-income
debt securities such as convertible securities, high-yield bonds and
mortgage-backed and other asset-backed securities issued on a public or private
basis. The Fund expects to invest predominantly in U.S. dollar-denominated debt
securities and will not invest more than 25% of its total assets in debt
securities denominated in currencies other than the U.S. dollar. The Fund
reserves the right to invest without limit in debt securities of non-U.S.
issuers, although it will not invest more than 10% of its total assets in debt
securities of issuers located in emerging markets. The Fund may make use of a
variety of other instruments, including collateralized debt obligations,
preferred shares, commercial paper, U.S. Government securities, zero-coupon and
inflation-indexed bonds, real estate investment trusts (REITs), structured
notes and other hybrid instruments, credit-linked trust certificates, total
return swaps, credit default swaps and other derivative instruments. The Fund
cannot assure you that it will achieve its investment objective.
Because of the floating rate feature of most of the Fund's investments,
it is expected that the Fund normally will have an average portfolio duration
of zero to one year. The portfolio manager believes that this duration range
and the Fund's exposure to lower-quality debt securities minimizes exposure to
interest rate risk while still offering the potential for higher current income
than would be expected from a higher quality portfolio.
BORROWINGS. The Fund presently intends to use leverage by issuing shares
of preferred stock ("Preferred Shares") representing approximately 38% of the
Fund's total assets immediately after their issuance. The Fund may also
leverage the portfolio by borrowing money, issuing debt securities or using
reverse repurchase agreements, loans of portfolio securities, credit default
swap contracts and other derivatives, as well as when-issued, delayed delivery
and forward commitment transactions. However, these forms of leverage will only
be used, if at all, as a substitute for, rather than in addition to, the
leverage obtained through the issuance of Preferred Shares. See "The Fund's
Investment Objective and Strategies--Portfolio Contents and Other Information."
By using leverage, the Fund will seek to obtain a higher return for holders of
common shares than if the Fund did not use leverage. Leveraging is a
speculative technique, and there are special risks involved. There can be no
assurance that a leveraging strategy will be used or that it will be successful
during any period in which it is employed. See "Preferred Shares and Related
Leverage" and "Risks--Leverage Risk."
You should read this prospectus, which contains important information
about the Fund, before deciding whether to invest, and retain it for future
reference. A Statement of Additional Information, dated , 2003,
containing additional information about the Fund, has been filed with the
Securities and Exchange Commission and is incorporated by reference in its
entirety into this prospectus, which means that it is part of the prospectus
for legal purposes. You can review the table of contents of the Statement of
Additional Information on page 59 of this prospectus. You may request a free
copy of the Statement of Additional Information by calling (877) 819-2224 or by
writing to the Fund, or obtain a copy (and other information regarding the
Fund) from the Securities and Exchange Commission's web site
(HTTP://WWW.SEC.GOV).
The Fund's common shares do not represent a deposit or obligation of, and
are not guaranteed or endorsed by, any bank or other insured depository
institution, and are not federally insured by the Federal Deposit Insurance
Corporation, the Federal Reserve Board or any other government agency.
2
TABLE OF CONTENTS
PAGE
----
Prospectus Summary............................................ 4
Summary of Fund Expenses...................................... 18
The Fund...................................................... 20
Use of Proceeds............................................... 20
The Fund's Investment Objective and Strategies................ 20
Preferred Shares and Related Leverage......................... 34
Risks......................................................... 36
How the Fund Manages Risk..................................... 43
Management of the Fund........................................ 44
Net Asset Value............................................... 47
Distributions................................................. 48
Dividend Reinvestment Plan.................................... 48
Description of Shares......................................... 50
Anti-Takeover and Other Provisions in the Declaration of Trust 52
Repurchase of Common Shares; Conversion to Open-End Fund...... 53
Tax Matters................................................... 54
Underwriting.................................................. 56
Custodian and Transfer Agent.................................. 58
Legal Matters................................................. 58
Table of Contents for the Statement of Additional Information. 59
Appendix A--Description of Securities Ratings................. 60
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YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS. THE FUND HAS NOT, AND THE UNDERWRITERS HAVE NOT,
AUTHORIZED ANYONE TO PROVIDE YOU WITH DIFFERENT INFORMATION. IF ANYONE PROVIDES
YOU WITH DIFFERENT OR INCONSISTENT INFORMATION, YOU SHOULD NOT RELY ON IT. THE
FUND IS NOT, AND THE UNDERWRITERS ARE NOT, MAKING AN OFFER OF THESE SECURITIES
IN ANY STATE WHERE THE OFFER IS NOT PERMITTED. YOU SHOULD NOT ASSUME THAT THE
INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE AS OF ANY DATE OTHER THAN
THE DATE ON THE FRONT OF THIS PROSPECTUS. THE FUND'S BUSINESS, FINANCIAL
CONDITION, RESULTS OF OPERATIONS AND PROSPECTS MAY HAVE CHANGED SINCE THAT DATE.
Until 2003 (25 days after the date of this prospectus), all
dealers that buy, sell or trade the common shares, whether or not participating
in this offering, may be required to deliver a prospectus. This is in addition
to the dealers' obligation to deliver a prospectus when acting as underwriters
and with respect to their unsold allotments or subscriptions.
3
PROSPECTUS SUMMARY
THIS IS ONLY A SUMMARY. THIS SUMMARY MAY NOT CONTAIN ALL OF THE
INFORMATION THAT YOU SHOULD CONSIDER BEFORE INVESTING IN THE COMMON SHARES. YOU
SHOULD REVIEW THE MORE DETAILED INFORMATION CONTAINED IN THIS PROSPECTUS AND IN
THE STATEMENT OF ADDITIONAL INFORMATION.
THE FUND.................. PIMCO Floating Rate Income Fund (the "Fund") is a
newly organized, diversified, closed-end
management investment company. See "The Fund."
THE OFFERING.............. The Fund is offering common shares of beneficial
interest, with a par value of $.00001 per share,
at $20.00 per share through a group of
underwriters (the "Underwriters") led by Merrill
Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") and Wachovia Capital Markets,
LLC ("Wachovia"). The common shares of beneficial
interest are called "Common Shares" in the rest of
this prospectus. You must purchase at least 100
Common Shares. The Fund has given the Underwriters
an option to purchase up to additional
Common Shares to cover orders in excess of
Common Shares. See "Underwriting." PIMCO
Advisors Fund Management LLC (the "Manager"), the
Fund's investment manager, has agreed to pay (i)
the amount by which the Fund's offering costs
(other than the sales load) exceed $.04 per Common
Share and (ii) all of the Fund's organizational
expenses, except that the Fund has agreed to
reimburse the Manager for such organizational
expenses to the extent that the aggregate of all
such organizational expenses and all offering
costs (other than the sales load, but inclusive of
the reimbursement of underwriter expenses of
$.00667 per Common Share) does not exceed $.04 per
Common Share.
INVESTMENT OBJECTIVE AND
STRATEGIES.............. INVESTMENT OBJECTIVE. The Fund's investment
objective is to seek high current income,
consistent with the preservation of capital. The
Fund attempts to achieve this objective by
normally investing at least 80% of its net assets
(plus any borrowings for investment purposes) in a
diversified portfolio of floating rate debt
instruments. The Fund expects that a substantial
portion of its investments will consist of Senior
Loans. See "Portfolio Contents" below. The Fund
may invest without limit, and ordinarily expects
to invest a substantial portion of its assets, in
Senior Loans and other floating rate debt
instruments that are, at the time of purchase,
rated below investment grade (or unrated but
judged by the portfolio manager to be of
comparable quality) as described under "Credit
Quality" below. The Fund cannot assure you that it
will achieve its investment objective.
PORTFOLIO MANAGEMENT STRATEGIES. In selecting
investments for the Fund, Pacific Investment
Management Company LLC ("PIMCO"), the Fund's
portfolio manager, attempts to identify floating
rate debt instruments that provide high current
income through fundamental research, driven by
independent credit analysis and proprietary
analytical tools. Investment decisions are based
primarily on PIMCO's assessment of the issuer's
credit characteristics and the position of the
security in the issuer's capital structure in
light of PIMCO's outlook for
4
particular industries, the economy and the market
generally. At the same time, PIMCO uses a variety
of techniques, such as credit default swaps,
designed to control risk and minimize the Fund's
exposure to debt instruments that PIMCO believes
are more likely to default or otherwise depreciate
in value over time and detract from the Fund's
overall return to investors. Because most of the
debt instruments held by the Fund will have
variable interest rates, the Fund's portfolio is
generally expected to have less interest rate risk
(i.e., sensitivity to fluctuations in market
interest rates) and a more stable net asset value
than portfolios of funds that invest in
fixed-income securities, although the net asset
value will vary due to fluctuations in interest
rates and other factors such as changes in the
credit quality of securities in the portfolio. The
Fund also attempts to preserve capital based on
PIMCO's assessment of the issuer's credit
characteristics and macro-economic factors.
Subject to the guidelines under "Credit Quality"
below, the Fund has the flexibility to invest in
debt obligations of any credit quality based on
its assessment of the particular issuer.
Within the floating rate debt investment universe,
the Fund does not invest its assets according to
predetermined weightings in particular issuers,
industries or sectors. Instead, PIMCO attempts to
identify quality investments in any industry or
sector through fundamental research, driven by
independent credit analysis and proprietary
analytical tools.
CREDIT QUALITY. Under normal market conditions,
the Fund may invest without limit, and ordinarily
expects to invest a substantial portion of its
assets, in Senior Loans and other floating rate
debt instruments that are, at the time of
purchase, rated below investment grade (below Baa3
by Moody's, below BBB- by either S&P or Fitch, or
below a comparable rating by Dominion), or unrated
but judged by PIMCO to be of comparable quality.
The Fund will not invest more than 10% of its
total assets in securities that are, at the time
of purchase, rated CCC+/Caa1 or lower by each
agency rating the security or that are unrated but
judged by PIMCO to be of comparable quality. Debt
securities of below investment grade quality are
regarded as having predominantly speculative
characteristics with respect to capacity to pay
interest and repay principal and are commonly
referred to as "high yield" securities or "junk
bonds." Debt securities in the lowest investment
grade category may also be considered to possess
some speculative characteristics.
INDEPENDENT CREDIT ANALYSIS. PIMCO relies heavily
on its own analysis of the credit quality and
risks associated with individual debt obligations
considered for the Fund, rather than relying
exclusively on rating agencies or third-party
research. In the case of Senior Loans, PIMCO
analyzes and takes into account the
legal/protective features associated with the
securities (such as their position in the
borrower's capital structure and any security
through collateral) in assessing their credit
characteristics. The individuals managing the Fund
utilize this
5
information in an attempt to manage credit risk
and identify issuers, industries or sectors that
offer attractive yields relative to PIMCO's
assessment of their credit characteristics. This
aspect of PIMCO's capabilities will be
particularly important because of the Fund's
emphasis on Senior Loans and other below
investment grade debt securities.
DURATION. The average portfolio duration of the
Fund will normally be within a short range (I.E.,
a zero to one-year time frame) due to the Fund's
predominant investment in floating rate debt
instruments, although it may be longer at any time
and from time to time to the extent that the Fund
invests in fixed-income securities. Duration is a
measure of the expected life of a debt security
that is used to determine the sensitivity of the
security's price to changes in interest rates.
PIMCO believes that the Fund's short duration
range minimizes exposure to price changes of its
portfolio securities due to interest rate
volatility and related risk while still offering
the potential opportunity for high current income.
DIVERSIFICATION. Subject to the availability of
suitable investment opportunities, PIMCO will
attempt to diversify the Fund's investments
broadly in an attempt to minimize the portfolio's
sensitivity to credit and other risks associated
with a particular issuer, industry or sector, or
to the impact of a single economic, political,
corporate or regulatory occurrence.
PORTFOLIO CONTENTS. Under normal market
conditions, the Fund seeks to achieve its
investment objective by investing at least 80% of
its net assets (plus any borrowings for investment
purposes) in a diversified portfolio of floating
rate debt instruments, a substantial portion of
which will be Senior Loans. Senior Loans are
typically originated, negotiated and structured by
a U.S. or foreign commercial bank, insurance
company, finance company or other financial
institution (the "Agent") for a lending syndicate
of financial institutions (the "Lenders"). Senior
Loans are normally accessible only to financial
institutions and large corporate and institutional
investors and are not widely available to
individual investors. Floating rate debt
instruments are debt instruments that pay interest
at rates which adjust whenever a specified
interest rate changes and/or reset on
predetermined dates (such as the last day of a
month or calendar quarter). These floating rate
debt instruments may include, in addition to
Senior Loans, instruments such as catastrophe and
other event-linked bonds, bank capital securities,
unsecured bank loans, corporate bonds, money
market instruments and certain types of
mortgage-backed and other asset-backed securities.
As noted above, the Fund may invest without limit
and ordinarily expects to invest a substantial
portion of its assets in Senior Loans and other
floating rate debt instruments that are, at the
time of purchase, rated below investment grade or
unrated but judged by PIMCO to be of comparable
quality. The Fund may invest up to 20% of its net
assets (plus any borrowings for investment
purposes) in
6
securities and instruments other than floating
rate debt instruments, including fixed-income debt
securities such as convertible securities,
high-yield bonds and mortgage-backed and other
asset-backed securities issued on a public or
private basis. The Fund expects to invest
predominantly in U.S. dollar-denominated debt
securities and will not invest more than 25% of
its total assets in debt securities denominated in
currencies other than the U.S. dollar. The Fund
reserves the right to invest without limit in debt
securities of non-U.S. issuers, although it will
not invest more than 10% of its total assets in
debt securities of issuers located in emerging
markets. The Fund may make use of a variety of
other instruments, including preferred shares,
commercial paper, U.S. Government securities,
zero-coupon and inflation-indexed bonds,
structured notes and other hybrid instruments,
credit-linked trust certificates, real estate
investment trusts (REITs), total return swaps,
credit default swaps and other derivative
instruments. The Fund may invest in securities of
companies with small market capitalizations. The
Fund may invest without limit in illiquid
securities. As a diversified fund, the Fund
generally may not, with respect to 75% of its
total assets, purchase the securities of any
issuer, except securities issued or guaranteed by
the U.S. Government or any of its agencies or
instrumentalities or securities of other
investment companies, if, as a result, (i) more
than 5% of the Fund's total assets would be
invested in the securities of that issuer, or (ii)
the Fund would hold more than 10% of the
outstanding voting securities of that issuer. The
Fund will not concentrate its investments in a
particular industry by investing more than 25% of
its total assets in that industry. The Fund's
industry concentration policy does not preclude it
from focusing investments in issuers in a group of
related industrial sectors (such as different
types of utilities).
PROPOSED OFFERING OF
PREFERRED SHARES AND
OTHER FORMS OF LEVERAGE. Subject to market conditions, approximately one to
six months after completion of this offering, the
Fund intends to offer preferred shares of
beneficial interest ("Preferred Shares")
representing approximately 38% of the Fund's total
assets immediately after their issuance. The
issuance of Preferred Shares will leverage your
investment in Common Shares. Leverage involves
special risks. There is no assurance that the Fund
will issue Preferred Shares or that, if Preferred
Shares are issued, the Fund's leveraging strategy
will be successful. See "Risks--Leverage Risk."
The net proceeds the Fund obtains from selling the
Preferred Shares will be invested in accordance
with the Fund's investment objective and policies
as described in this prospectus. The Preferred
Shares will pay dividends based on short-term
interest rates for high quality obligations, which
will be reset frequently. So long as the rate of
return, net of applicable Fund expenses, on the
floating rate high yield debt obligations and
other investments purchased by the Fund exceeds
Preferred Share dividend rates as reset
periodically, the investment of the proceeds of
the Preferred Shares will generate more income
than will be needed to pay dividends on the
Preferred Shares. If so, the excess will be used
to pay higher dividends to holders of
7
Common Shares ("Common Shareholders") than if the
Fund were not so leveraged through the issuance of
Preferred Shares. The Fund may also leverage the
portfolio by borrowing money, issuing debt
securities or using reverse repurchase agreements,
loans of portfolio securities, credit default swap
contracts and other derivatives, as well as
when-issued, delayed delivery and forward
commitment transactions. However, these forms of
leverage will only be used, if at all, as a
substitute for, rather than in addition to, the
leverage obtained through the issuance of
Preferred Shares. See "The Fund's Investment
Objective and Strategies--Portfolio Contents and
Other Information." The Fund cannot assure you
that the issuance of Preferred Shares or the use
of other forms of leverage will result in a higher
yield on your Common Shares. Once Preferred Shares
are issued and/or other forms of leverage are
used, the net asset value and market price of the
Common Shares and the yield to Common Shareholders
will be more volatile. See "Preferred Shares and
Related Leverage," "Description of
Shares--Preferred Shares" and "Risks--Leverage
Risk." In addition, fees and expenses paid by the
Fund are borne entirely by the Common Shareholders
(and not by Preferred Shareholders, if any). These
include costs associated with any offering of
Preferred Shares by the Fund (which costs are
estimated to be approximately 1.3% of the total
dollar amount of a Preferred Share offering),
which will be borne immediately by Common
Shareholders (as will the costs associated with
any borrowings or other forms of leverage utilized
by the Fund) and result in a reduction in the net
asset value of the Common Shares.
INVESTMENT MANAGER........ The Manager serves as the investment manager of
the Fund. Subject to the supervision of the Fund's
Board of Trustees, the Manager is responsible for
managing, either directly or through others
selected by it, the investment activities of the
Fund and the Fund's business affairs and other
administrative matters. The Manager will receive
an annual fee, payable monthly, in an amount equal
to .75% of the Fund's average weekly total managed
assets. "Total managed assets" means the total
assets of the Fund (including any assets
attributable to any Preferred Shares or other
forms of leverage that may be outstanding) minus
accrued liabilities (other than liabilities
representing leverage). The Manager is located at
1345 Avenue of the Americas, New York, New York
10105. Organized in 2000 as a subsidiary successor
of a business originally organized in 1987, the
Manager provides investment management and
advisory services to a number of closed-end and
open-end investment company clients. As of June
30, 2003, the Manager had approximately $23.7
billion in assets under management. Allianz
Dresdner Asset Management of America L.P. is the
direct parent company of PIMCO Advisors Retail
Holdings LLC, of which the Manager is a
wholly-owned subsidiary. As of June 30, 2003,
Allianz Dresdner Asset Management of America L.P.
and its subsidiary partnerships, including PIMCO,
had approximately $404 billion in assets under
management.
The Manager has retained its affiliate, PIMCO, as
a sub-adviser to manage the Fund's portfolio
investments. See "Portfolio Manager" below.
8
PORTFOLIO MANAGER......... PIMCO will serve as the Fund's sub-adviser
responsible for managing the Fund's portfolio
investments, and is sometimes referred to herein
as the "portfolio manager." Subject to the
supervision of the Manager, PIMCO has full
investment discretion and makes all determinations
with respect to the investment of the Fund's
assets.
PIMCO is located at 840 Newport Center Drive,
Newport Beach, California 92660. Organized in
1971, PIMCO provides investment management and
advisory services to private accounts of
institutional and individual clients and to mutual
funds. As of June 30, 2003, PIMCO had
approximately $349 billion in assets under
management.
The Manager (and not the Fund) will pay a portion
of the fees it receives to PIMCO in return for
PIMCO's services.
DISTRIBUTIONS............. Commencing with the Fund's first dividend, the
Fund intends to make regular monthly cash
distributions to Common Shareholders at a variable
rate based on the performance of the Fund and
income accrual. The dividend rate that the Fund
pays on its Common Shares will depend on a number
of factors including the variable rate of interest
received on the Fund's portfolio, dividends
payable on any Preferred Shares and the expenses
of any other leveraging transactions. Because the
Fund invests predominantly in debt instruments
with variable interest rates, the amount of the
Fund's monthly distributions to shareholders is
expected to vary with fluctuations in market
interest rates. Although there is a risk that
fluctuations in the dividend rates on Preferred
Shares may adversely affect the return to Common
Shareholders, PIMCO believes that this should be
mitigated when the Fund uses leverage with
floating rate costs, because the dividend rates on
the Preferred Shares and the interest rates on its
portfolio of Senior Loans and other floating rate
debt instruments will ordinarily vary in a similar
manner. Over time, the Fund will distribute
substantially all of its net investment income
(after it pays accrued dividends on any
outstanding Preferred Shares). In addition, at
least annually, the Fund intends to distribute to
you your pro rata share of any available net
capital gain. Your initial distribution is
expected to be declared approximately 45 days, and
paid approximately 60 to 90 days, from the
completion of this offering, depending on market
conditions. Unless you elect to receive
distributions in cash, all of your distributions
will be automatically reinvested in additional
Common Shares under the Fund's Dividend
Reinvestment Plan. See "Distributions" and
"Dividend Reinvestment Plan."
LISTING................... The Fund has applied for listing of the Common
Shares on the New York Stock Exchange, subject to
notice of issuance, under the symbol "PFL." See
"Description of Shares--Common Shares."
CUSTODIAN AND TRANSFER
AGENT................... State Street Bank and Trust Co. will serve as
custodian of the Fund's assets. PFPC Inc. will
serve as the Fund's transfer and dividend
disbursement agent. See "Custodian and Transfer
Agent."
9
MARKET PRICE OF SHARES.... Shares of closed-end investment companies
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 lower than net asset value. The Fund cannot
assure you that the Common Shares will trade at or
above the Fund's net asset value. Net asset value
will be reduced immediately following the offering
by the sales load and the amount of organization
and offering expenses paid or reimbursed by the
Fund. See "Use of Proceeds." In addition to net
asset value, market price may be affected by such
factors relating to the Fund or its portfolio
holdings as dividend levels (which are in turn
affected by changes in the floating rates of
interest on the Fund's investments and expenses,
including the costs of leverage), portfolio credit
quality, liquidity, call protection and market
supply and demand. See "Preferred Shares and
Related Leverage," "Risks," "Description of
Shares" and "Repurchase of Common Shares;
Conversion to Open-End Fund" in this prospectus,
and the Statement of Additional Information under
"Repurchase of Common Shares; Conversion to
Open-End Fund." The Common Shares are designed
primarily for long-term investors, and you should
not view the Fund as a vehicle for trading
purposes.
SPECIAL RISK CONSIDERATIONS The following describes various principal risks of
investing in the Fund. A more detailed description
of these and other risks of investing in the Fund
are described under "Risks" in this Prospectus and
under "Investment Objective and Policies" in the
Statement of Additional Information.
NEWLY ORGANIZED. The Fund is a newly organized,
diversified, closed-end management investment
company with no history of operations.
CREDIT RISK/HIGH YIELD RISK. Credit risk is the
risk that one or more debt obligations in the
Fund's portfolio will decline in price, or fail to
pay interest or principal when due, because the
issuer of the obligation or borrower experiences
an actual or perceived decline in its financial
status. The Fund may invest without limit and
ordinarily expects to invest a substantial portion
of its assets in debt instruments that are, at the
time of purchase, rated below investment grade
(below Baa3 by Moody's, below BBB- by either S&P
or Fitch or below a comparable rating by Dominion)
or that are unrated but judged by PIMCO to be of
comparable quality, including debt securities that
are in default or the issuers of which are in
bankruptcy. Debt obligations of below investment
grade quality are commonly referred to as "high
yield" securities or "junk bonds" and are
predominantly speculative with respect to the
issuer's capacity to pay interest and repay
principal when due, and therefore involve a
greater risk of default. Debt securities in the
lowest investment grade category may also be
considered to possess some speculative
characteristics. The prices of these lower grade
obligations are generally more volatile and
sensitive to actual or perceived negative
developments, such as a decline in the revenues of
the borrowers underlying Senior Loans or a general
economic downturn, than are the prices of higher
grade securities.
10
Although Senior Loans in which the Fund will
invest will often be secured by collateral, there
can be no assurance that liquidation of any such
collateral would satisfy the borrower's obligation
in the event of default or that such collateral
could be readily liquidated. However, PIMCO
believes that Senior Loans generally tend to have
more favorable recovery rates than most other
types of loans. In the event of bankruptcy of a
borrower, the Fund could experience delays or
limitations in its ability to realize the benefits
of any collateral securing a Senior Loan. Because
of the Fund's emphasis on Senior Loans and other
below investment grade debt securities, PIMCO's
capabilities in analyzing credit quality and
associated risks will be particularly important,
and there can be no assurance that PIMCO will be
successful in this regard. See "The Fund's
Investment Objective and Strategies--High Yield
Securities ("Junk Bonds")" and "Risks--High Yield
Risk" for additional information. Due to the risks
involved in investing in high yield securities, an
investment in the Fund should be considered
speculative.
MARKET DISCOUNT RISK. As with any stock, the
price of the Fund's shares will fluctuate with
market conditions and other factors. If shares are
sold, the price received may be more or less than
the original investment. Net asset value will be
reduced immediately following the initial offering
by a sales load and organizational and offering
expenses paid or reimbursed by the Fund and
immediately following any offering of Preferred
Shares by the costs of that offering paid by the
Fund. Common Shares are designed for long-term
investors and should not be treated as trading
vehicles. Shares of closed-end management
investment companies frequently trade at a
discount from their net asset value. The Fund's
shares may trade at a price that is less than the
initial offering price. This risk may be greater
for investors who sell their shares relatively
shortly after completion of the initial offering.
LIQUIDITY RISK. The Fund may invest without limit
in securities which are illiquid at the time of
investment (determined using the Securities and
Exchange Commission's standard applicable to
open-end investment companies, I.E., securities
that cannot be disposed of within seven days in
the ordinary course of business at approximately
the value at which the Fund has valued the
securities). Illiquid securities may trade at a
discount from comparable, more liquid investments,
and may be subject to wide fluctuations in market
value. Also, the Fund may not be able to dispose
of illiquid securities when that would be
beneficial at a favorable time or price. Below
investment grade debt securities tend to be less
liquid than higher-rated securities. The Senior
Loans in which the Fund invests will likely not be
registered with the Securities and Exchange
Commission or any state securities commission and
generally will not be listed on a national
securities exchange. PIMCO will determine the
liquidity of the Fund's investments by reference
to market conditions and contractual provisions.
For example, PIMCO will generally not consider
Senior Loans that are part of an issue of at least
$250 million in par value to be illiquid.
LEVERAGE RISK. The Fund presently intends to use
leverage by issuing Preferred Shares representing
approximately 38% of the Fund's total
11
assets immediately after their issuance. The Fund
may also leverage the portfolio by borrowing
money, issuing debt securities or using reverse
repurchase agreements, loans of portfolio
securities, credit default swap contracts and
other derivatives, as well as when-issued, delayed
delivery or forward commitment transactions.
However, these forms of leverage will only be
used, if at all, as a substitute for, rather than
in addition to, the leverage obtained through the
issuance of Preferred Shares. The Fund's use of
leverage creates the opportunity for increased
Common Share net income, but also creates special
risks for Common Shareholders. There is no
assurance that the Fund's leveraging strategies
will be successful. It is anticipated that
dividends on Preferred Shares (which would be
redetermined periodically, pursuant to an auction
process) will be based on short-term rates of
return for high quality short-term debt
instruments, and that the Fund will invest the net
proceeds of the Preferred Shares offering
principally in Senior Loans and other floating
rate debt instruments in accordance with the
Fund's investment objective and strategies. So
long as the Fund's securities portfolio provides a
higher rate of return (net of Fund expenses) than
the Preferred Share dividend rate, as reset
periodically, the leverage will allow Common
Shareholders to receive a higher current rate of
return than if the Fund were not leveraged.
Preferred Shares are expected to pay cumulative
dividends, which may tend to increase leverage
risk. Leverage creates two major types of risks
for Common Shareholders:
. the likelihood of greater volatility of net
asset value and market price of Common Shares,
because changes in the value of the Fund's
portfolio of income-producing securities
(including securities bought with the proceeds
of the Preferred Shares offering) are borne
entirely by the Common Shareholders; and
. the possibility either that Common Share
income will fall if the Preferred Share
dividend rate rises and there is no
corresponding increase, or a lagging increase,
in the interest rates on investments in the
Fund's portfolio, or that Common Share income
will fluctuate in part because the Preferred
Share dividend rate varies.
Because the fees received by the Manager are based
on the total managed assets of the Fund (including
assets attributable to any Preferred Shares and
other forms of leverage that may be outstanding),
the Manager has a financial incentive for the Fund
to issue Preferred Shares or utilize other forms
of leverage, which may create a conflict of
interest between the Manager and the Common
Shareholders.
ISSUER RISK. The value of floating rate and other
debt instruments may decline for a number of
reasons which directly relate to the issuer or
borrower, such as management performance,
financial leverage and reduced demand for the
issuer's goods and services.
VARIABLE DIVIDEND RISK. Because most of the debt
instruments held by the Fund will have variable
interest rates, the amounts of the Fund's
12
monthly distributions to Common Shareholders are
expected to vary with fluctuations in market
interest rates. Generally, when market interest
rates fall, the amount of the distributions to
Common Shareholders will likewise decrease.
SMALLER COMPANY RISK. The general risks
associated with floating rate and other debt
instruments are particularly pronounced for
securities issued by companies with smaller market
capitalizations. These companies may have limited
product lines, markets or financial resources or
they may depend on a few key employees. As a
result, they may be subject to greater levels of
credit, market and issuer risk.
MANAGEMENT RISK. The Fund is subject to
management risk because it is an actively managed
portfolio. PIMCO and the individual portfolio
managers will apply investment techniques and risk
analyses in making investment decisions for the
Fund, but there can be no guarantee that these
will produce the desired results.
FOREIGN (NON-U.S.) INVESTMENT RISK. The Fund
expects to invest predominantly in U.S.
dollar-denominated debt securities and will not
invest more than 25% of its net assets in debt
securities denominated in currencies other than
the U.S. dollar. The Fund reserves the right to
invest without limit in debt securities of foreign
(non-U.S.) issuers, although it will not invest
more than 10% of its total assets in debt
securities of issuers located in emerging markets.
The Fund's investments in foreign issuers and in
securities denominated in foreign currencies
involve special risks. For example, the value of
these investments may decline in response to
unfavorable political and legal developments,
unreliable or untimely information or economic and
financial instability. The value of securities
denominated in foreign currencies may fluctuate
based on changes in the value of those currencies
relative to the U.S. dollar, and a decline in
applicable foreign exchange rates could reduce the
value of such securities held by the Fund. Foreign
settlement procedures also may involve additional
risks.
EMERGING MARKETS RISK. The Fund may invest up to
10% of its total assets in debt securities of
issuers located in developing or emerging markets.
Foreign investment risk may be particularly high
to the extent that the Fund invests in securities
of issuers based in or securities denominated in
the currencies of emerging market countries.
Investing in securities of issuers based in
underdeveloped emerging markets entails all of the
risks of investing in securities of foreign
issuers to a heightened degree. These heightened
risks include: (i) greater risks of expropriation,
confiscatory taxation, nationalization and less
social, political and economic stability; (ii) the
smaller size of the market for such securities and
a lower volume of trading, resulting in lack of
liquidity and in price volatility; and (iii)
certain national policies which may restrict the
Fund's investment opportunities, including
restrictions on investing in issuers or industries
deemed sensitive to relevant national interests.
13
DERIVATIVES RISK. The Fund may utilize a variety
of derivative instruments for hedging, investment
or risk management purposes. The Fund may also use
derivatives to gain exposure to securities markets
in which it will invest (E.G., pending investment
of the proceeds of this offering in individual
securities) or to add leverage to the portfolio
(but only as a substitute for the leverage
obtained from Preferred Shares). The types of
derivative instruments the Fund may utilize
include, but are not limited to, option contacts,
futures contracts, options on future contracts,
swap agreements (including total return and credit
default swaps) and short sales. The Fund may also
have exposure to derivatives, such as interest
rate or credit-default swaps, through investment
in credit-linked trust certificates and other
securities issued by special purpose or structured
vehicles. Derivatives are subject to a number of
risks described elsewhere in this prospectus, such
as liquidity risk, issuer risk, interest rate
risk, credit risk, leveraging risk, counterparty
risk, smaller company risk and management risk.
They also involve the risk of mispricing or
improper valuation, the risk of ambiguous
documentation and the risk that changes in the
value of a derivative may not correlate perfectly
with an underlying asset, interest rate or index.
Suitable derivative transactions may not be
available in all circumstances and there can be no
assurance that the Fund will engage in these
transactions to reduce exposure to other risks
when that would be beneficial.
COUNTERPARTY RISK. In addition to credit risk
with respect to the counterparties to the Senior
Loans in which the Fund invests, the Fund will
also be subject to credit risk with respect to
derivative contracts entered into directly by the
Fund or held by special purpose or structured
vehicles in which the Fund invests. If a
counterparty becomes bankrupt or otherwise fails
to perform its obligations due to financial
difficulties, the Fund may experience significant
delays in obtaining any recovery in a bankruptcy
or other reorganization proceeding. The Fund may
obtain only a limited recovery or may obtain no
recovery in such circumstances.
MORTGAGE-RELATED AND ASSET-BACKED RISK. The Fund
may invest in a variety of mortgage-related and
other asset-backed securities, including both
commercial and residential mortgage securities and
other mortgage-backed instruments (public or
private). Asset-backed securities are subject to a
number of risks described elsewhere in this
prospectus, such as credit risk and liquidity
risk. Generally, rising interest rates tend to
extend the duration of fixed-rate mortgage-related
securities, making them more sensitive to changes
in interest rates, and may reduce the market value
of the securities. PIMCO expects the Fund's policy
of investing principally in adjustable rate
mortgage-related and other asset-backed securities
will minimize the Fund's overall sensitivity to
interest rate volatility. However, because
interest rates on most adjustable rate mortgage-
and asset-backed securities typically only reset
periodically (e.g., monthly or quarterly), changes
in prevailing interest rates (and particularly
sudden and significant
14
changes) can be expected to cause some fluctuation
in the market value of these securities, including
declines in value as market interest rates rise.
In addition, adjustable and fixed-rate
mortgage-related securities are subject to
prepayment risk--the risk that borrowers may pay
off their mortgages sooner than expected,
particularly when interest rates decline. This can
reduce the Fund's returns because the Fund may
have to reinvest that money at lower prevailing
interest rates. The Fund's investments in other
asset-backed securities, such as collateralized
debt obligations, are subject to risks similar to
those associated with mortgage-backed securities,
as well as additional risks associated with the
nature of the assets and the servicing of those
assets.
RISK OF INVESTING IN REITS. Investing in REITs
involves certain unique risks in addition to
investing in the real estate industry in general.
REITs are subject to interest rate risks
(especially mortgage REITs) and the risk of
default by lessees or borrowers. An equity REIT
may be affected by changes in the value of the
underlying properties owned by the REIT. A
mortgage REIT may be affected by the ability of
the issuers of its portfolio mortgages to repay
their obligations. REITs whose underlying assets
are concentrated in properties used by a
particular industry are also subject to risks
associated with such industry. REITs may have
limited financial resources, their securities
trade less frequently and in a limited volume, and
may be subject to more abrupt or erratic price
movements than larger company securities.
INTEREST RATE RISK. Generally, when market
interest rates rise, the prices of debt
obligations (and particularly fixed-rate debt
obligations) fall, and vice versa. This interest
rate risk is the risk that the debt obligations in
the Fund's portfolio will decline in value because
of increases in market interest rates. The prices
of short-term floating rate debt obligations
generally fluctuate less than prices of long-term
debt obligations as interest rates change. Because
the Fund will normally have a short portfolio
duration (I.E., a zero to one-year time frame),
the Common Share net asset value and market price
per share will tend to fluctuate less in response
to changes in market interest rates than if the
Fund invested mainly in long-term debt securities.
Although the Fund's net asset value will vary,
PIMCO expects the Fund's policy of investing
principally in floating rate debt instruments will
minimize the Fund's overall sensitivity to market
interest rate fluctuations. However, because rates
on certain floating rate debt instruments
typically only reset periodically (e.g., monthly
or quarterly), changes in prevailing interest
rates (and particularly sudden and significant
changes) can be expected to cause some fluctuation
in the Fund's net asset value. Moreover, up to 20%
of the Fund's net assets (plus any borrowings for
investment purposes) may be invested in debt
instruments with fixed rates of interest, which
will generally lose value in direct response to
rising interest rates. The Fund's use of leverage,
as described below, will tend to increase Common
Share interest rate risk.
REINVESTMENT RISK. Income from the Fund's
portfolio will decline if and when the Fund
invests the proceeds from prepaid, matured, traded
15
or called debt obligations at market interest
rates that are below the current earnings rate on
those obligations. A decline in income could
affect the Common Shares' market price or their
overall return.
INFLATION/DEFLATION RISK. Inflation risk is the
risk that the value of assets or income from the
Fund's investments will be worth less in the
future as inflation decreases the value of
payments at future dates. As inflation increases,
the real value of the Fund's portfolio could
decline. Deflation risk is the risk that prices
throughout the economy decline over time--the
opposite of inflation. Deflation may have an
adverse effect on the creditworthiness of issuers
and may make issuer default more likely, which may
result in a decline in the value of the Fund's
portfolio.
REGULATORY CHANGES. To the extent that
legislation or state or federal bank or other
regulators impose additional requirements or
restrictions on the ability of certain financial
institutions to make loans, particularly in
connection with highly leverage transactions, the
availability of Senior Loans and other related
investments sought after by the Fund may be
reduced. Further, such legislation or regulation
could depress the market value of Senior Loans and
other instruments held by the Fund.
MARKET DISRUPTION AND GEOPOLITICAL RISK. The war
with Iraq, its aftermath and the continuing
occupation of Iraq is likely to have a substantial
impact on the U.S. and world economies and
securities markets. The nature, scope and duration
of the war and occupation cannot be predicted with
any certainty. Terrorist attacks on the World
Trade Center and the Pentagon on September 11,
2001 closed some of the U.S. securities markets
for a four-day period and similar events cannot be
ruled out. The war and occupation, terrorism and
related geopolitical risks have led, and may in
the future lead to, increased short-term market
volatility and may have adverse long-term effects
on U.S. and world economies and markets generally.
Those events could also have an acute effect on
individual issuers or related groups of issuers.
These risks could also adversely affect individual
issuers and securities markets, interest rates,
auctions, secondary trading, ratings, credit risk,
inflation and other factors relating to the Common
Shares.
CERTAIN AFFILIATIONS. Certain broker-dealers may
be considered to be affiliated persons of the
Fund, the Manager and/or PIMCO due to their
possible affiliations with Allianz AG, the
ultimate parent of the Manager and PIMCO. Absent
an exemption from the Securities and Exchange
Commission or other regulatory relief, the Fund is
generally precluded from effecting certain
principal transactions with affiliated brokers,
and its ability to purchase securities being
underwritten by an affiliated broker or a
syndicate including an affiliated broker, or to
utilize affiliated brokers for agency
transactions, is subject to restrictions. This
could limit the Fund's ability to engage in
securities transactions and take advantage of
market opportunities. In addition,
16
unless and until the underwriting syndicate is
broken in connection with the initial public
offering of the Common Shares, the Fund will be
precluded from effecting principal transactions
with brokers who are members of the syndicate.
ANTI-TAKEOVER PROVISIONS. The Fund's Amended and
Restated Agreement and Declaration of Trust (the
"Declaration") includes provisions that could
limit the ability of other entities or persons to
acquire control of the Fund or convert the Fund to
open-end status. See "Anti-Takeover and Other
Provisions in the Declaration of Trust." These
provisions could deprive the Common Shareholders
of opportunities to sell their Common Shares at a
premium over the then current market price of the
Common Shares or at net asset value. In addition,
if the Fund issues Preferred Shares, the holders
of the Preferred Shares will have voting rights
that could deprive the Common Shareholders of such
opportunities.
17
SUMMARY OF FUND EXPENSES
The following table and the expenses shown assume the issuance of
Preferred Shares in an amount equal to 38% of the Fund's total assets (after
their issuance), and show Fund expenses as a percentage of net assets
attributable to Common Shares. Footnote 4 to the table also shows Fund expenses
as a percentage of net assets attributable to Common Shares, but assumes that
no Preferred Shares are issued or outstanding (such as will be the case prior
to the Fund's expected issuance of Preferred Shares).
SHAREHOLDER TRANSACTION EXPENSES
Sales Load (as a percentage of offering price)....................... 3.25%
Offering Costs Borne by the Fund (as a percentage of offering price). .20%(1)(2)
Dividend Reinvestment Plan Fees...................................... None(3)
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO
COMMON SHARES
(ASSUMING THE ISSUANCE OF
PREFERRED SHARES)(4)
-------------------------
ANNUAL EXPENSES
Management Fees(5)................................................... 1.22%
Other Expenses....................................................... .28%(1)(2)
Total Annual Expenses................................................ 1.50%
--------
(1)The Fund has agreed to pay the underwriters $.00667 per Common Share as a
partial reimbursement of expenses incurred in connection with the offering.
See "Underwriting." The Manager has agreed to pay (i) the amount by which
the Fund's offering costs (other than the sales load) exceed $.04 per Common
Share (.20% of the offering price), and (ii) all of the Fund's
organizational expenses, except that the Fund has agreed to reimburse the
Manager for such organizational expenses to the extent that the aggregate of
all such organizational expenses and all offering costs (other than the
sales load, but inclusive of the reimbursement of underwriter expenses of
$.00667 per Common Share) does not exceed $.04 per Common Share. The
organizational expenses and offering costs to be paid or reimbursed by the
Fund are not included among the expenses shown in the table. However, these
expenses will be borne by Common Shareholders and result in a reduction of
the net asset value of the Common Shares.
(2)If the Fund offers Preferred Shares, costs of that offering, estimated to be
approximately 1.3% of the total dollar amount of the Preferred Share
offering, will be borne immediately by Common Shareholders and result in a
reduction of the net asset value of the Common Shares. Assuming the issuance
of approximately 5,000,000 Common Shares and the issuance of Preferred
Shares in an amount equal to 38% of the Fund's capital (after their
issuance) these Preferred Share offering costs are estimated to be
approximately $835,000 or approximately $.17 per Common Share (.85% of the
offering price). These offering costs are not included among the expenses
shown in these tables.
(3)You will pay brokerage charges if you direct the plan agent to sell your
Common Shares held in a dividend reinvestment account.
(4)The table presented in this footnote estimates what the Fund's annual
expenses would be stated as percentages of the Fund's net assets
attributable to Common Shares but, unlike the table above, assumes that no
Preferred Shares are issued or outstanding. This will be the case, for
instance, prior to the Fund's expected issuance of Preferred Shares. In
accordance with these assumptions, the Fund's expenses would be estimated to
be as follows:
PERCENTAGE OF NET ASSETS
ATTRIBUTABLE TO
COMMON SHARES
(ASSUMING NO PREFERRED
SHARES ARE ISSUED OR
OUTSTANDING)
------------------------
ANNUAL EXPENSES
Management Fees(5)..... .75%
Other Expenses......... .18%(1)
Total Annual Expenses.. .93%
(5)Although the Fund's management fees are calculated on total managed assets,
the Fund's total managed assets are expected to be the same as its net
assets because the Fund has no present intention to utilize leverage or
other borrowings except through the issuance of Preferred Shares.
18
The purpose of the table above is to help you understand all fees and
expenses that you, as a Common Shareholder, would bear directly or indirectly.
The Other Expenses shown in the table and related footnotes are based on
estimated amounts for the Fund's first year of operations and assume that the
Fund issues approximately 5,000,000 Common Shares. If the Fund issues fewer
Common Shares, all other things being equal, these expenses would increase. See
"Management of the Fund" and "Dividend Reinvestment Plan."
As required by relevant Securities and Exchange Commission regulations,
the following example illustrates the expenses (including the sales load of
$32.50, estimated offering expenses of this offering of $2.00 and the estimated
offering costs of issuing Preferred Shares assuming the Fund issues Preferred
Shares representing 38% of the Fund's total assets (after their issuance) of
approximately $8.35) that you would pay on a $1,000 investment in Common
Shares, assuming the sales load and the offering expenses listed in the
parenthetical above, and (a) total net annual expenses of 1.50% of net assets
attributable to Common Shares (assuming the issuance of Preferred Shares) in
years 1 through 10, and (b) a 5% annual return(1):
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
Total Expenses Incurred $57 $88 $121 $214
--------
(1)THE EXAMPLE ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN. The
example assumes that the estimated Other Expenses set forth in the Annual
Expenses table are accurate and that all dividends and distributions are
reinvested at net asset value. Actual expenses may be greater or less than
those assumed. Moreover, the Fund's actual rate of return may be greater or
less than the hypothetical 5% annual return shown in the example.
19
THE FUND
The Fund is a newly organized, diversified, closed-end management
investment company registered under the Investment Company Act of 1940, as
amended, and the rules and regulations thereunder (the "1940 Act"). The Fund
was organized as a Massachusetts business trust on June 19, 2003, pursuant to
the Declaration, which is governed by the laws of The Commonwealth of
Massachusetts. As a newly organized entity, the Fund has no operating history.
The Fund's principal office is located at 1345 Avenue of the Americas, New
York, New York 10105, and its telephone number is (800) 331-1710.
USE OF PROCEEDS
The net proceeds of the offering of Common Shares will be approximately
$ (or $ if the underwriters exercise the overallotment option in
full) after payment or reimbursement of the estimated organizational and
offering costs. The Manager has agreed to pay (i) the amount by which the
Fund's offering costs (other than the sales load) exceed $.04 per Common Share
and (ii) all of the Fund's organizational expenses, except that the Fund has
agreed to reimburse the Manager for such organizational expenses to the extent
that the aggregate of all such organizational expenses and all offering costs
(other than the sales load, but inclusive of the reimbursement of underwriter
expenses of $.00667 per Common Share), does not exceed $.04 per Common Share.
The Fund will invest the net proceeds of the offering in accordance with the
Fund's investment objective and policies as stated below. It is presently
anticipated that the Fund will be able to invest substantially all of the net
proceeds in floating rate debt instruments and other securities that meet its
investment objective and policies within six months after the completion of the
offering. Pending such investment, it is anticipated that the proceeds will be
invested in high grade, short-term securities, credit-linked trust
certificates, and/or index futures contracts or similar derivative instruments
designed to give the Fund exposure to the markets in which it intends to invest
while PIMCO selects specific securities.
THE FUND'S INVESTMENT OBJECTIVE AND STRATEGIES
INVESTMENT OBJECTIVE
The Fund's investment objective is to seek high current income,
consistent with the preservation of capital. Under normal market conditions,
the Fund seeks to achieve its investment objective by investing at least 80% of
its net assets (plus any borrowings for investment purposes) in a diversified
portfolio of floating rate debt instruments, a substantial portion of which
will be Senior Loans. The Fund may invest without limit and ordinarily expects
to invest a substantial portion of its assets in debt securities that are, at
the time of purchase, rated below investment grade (below Baa3 by Moody's,
below BBB- by either S&P or Fitch, or below a comparable rating by Dominion) or
that are unrated but judged by PIMCO to be of comparable quality. Various types
of securities and other instruments in which the Fund may invest in are
described under "Portfolio Contents and Other Information" below. The Fund
cannot assure you that it will achieve its investment objective.
PORTFOLIO MANAGEMENT STRATEGIES
The Fund is actively managed in accordance with PIMCO's top down cyclical
and secular economic outlook, using strategies that focus on credit quality
analysis, broad market diversification among industries and sectors and other
risk management techniques. In selecting investments for the Fund, PIMCO
attempts to identify floating rate debt instruments and other debt securities
that provide high current income through fundamental research, driven by
independent credit analysis and proprietary analytical tools. Investment
decisions are based primarily on PIMCO's assessment of the issuer's credit
characteristics and the position of the particular security in the issuer's
capital structure, in light of PIMCO's outlook for particular industries, the
economy and the market generally. At the same time, PIMCO uses a variety of
techniques, such as credit default swaps, designed to control risk and minimize
the Fund's exposure to issues that PIMCO believes are more likely to default or
20
otherwise depreciate in value over time and detract from the Fund's overall
return to investors. The Fund cannot assure you that such securities will
ultimately continue to pay current income or be paid in full at maturity.
Because most of the debt instruments held by the Fund will have variable
interest rates, the Fund's portfolio is generally expected to have less
interest rate risk (i.e., sensitivity to fluctuations in market interest rates)
and a more stable net asset value than funds with portfolios that invest in
fixed-income securities, although the net asset value will vary due to
fluctuations in interest rates and other factors such as changes in the credit
quality of securities in the portfolio.
CREDIT QUALITY. The Fund may invest without limit and ordinarily expects
to invest a substantial portion of its assets in debt securities that are, at
the time of purchase, rated below investment grade or that are unrated but
judged by PIMCO to be of comparable quality. The Fund will not invest more than
10% of its total assets in securities that are, at the time of purchase, rated
CCC+/Caa1 or lower by each agency rating the security or that are unrated but
judged by PIMCO to be of comparable quality. The Fund may invest in issuers of
any credit quality (including bonds in the lowest ratings categories) if PIMCO
determines that the particular obligation offers an attractive yield relative
to its risk profile. As described under "High Yield Securities ("Junk Bonds")"
below, debt securities of below investment grade quality (including many Senior
Loans) are regarded as having predominantly speculative characteristics with
respect to capacity to pay interest and repay principal, and are commonly
referred to as "high yield" securities or "junk bonds." 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
PIMCO downgrades its assessment of the credit characteristics of a particular
issue.
INDEPENDENT CREDIT ANALYSIS. PIMCO relies heavily on its own analysis of
the credit quality and risks associated with individual debt obligations
considered for the Fund, rather than relying exclusively on rating agencies or
third-party research. In the case of Senior Loans, PIMCO analyzes and takes
into account the legal/protective features associated with the securities (such
as their position in the borrower's capital structure and any security through
collateral) in assessing their credit characteristics. PIMCO has a devoted team
of professionals that conducts fundamental credit research and analysis of
individual issuers, industries and sectors and uses proprietary analytical
tools (such as computer databases and Web-based applications) to assess and
monitor credit risk. The individuals managing the Fund utilize this information
in an attempt to manage credit risk and identify issuers, industries or sectors
that offer attractive yields relative to PIMCO's assessment of their credit
characteristics. This aspect of PIMCO's capabilities will be particularly
important because of the Fund's emphasis on Senior Loans and other below
investment grade securities.
DURATION. The average portfolio duration of the Fund will normally be
within a short range (I.E., a zero to one-year time frame) due to the Fund's
predominant investment in floating rate debt instruments, although it may be
longer at any time and from time to time to the extent that the Fund invests in
fixed-income securities. PIMCO believes that the Fund's short duration range
minimizes exposure to price changes of its portfolio securities due to interest
rate volatility and related risk while still offering the potential opportunity
for high current income.
Duration is a measure of the expected life of a debt security that is
used to determine the sensitivity of the security's price to changes in
interest rates. The longer a security's duration, the more sensitive it will be
to changes in interest rates. For example, the market price of a bond with a
duration of two years would be expected to decline 2% if interest rates were to
rise 1%. Conversely, the market price of the same bond would be expected to
increase 2% if interest rates were to fall 1%. The market price of a bond with
a duration of one year would be expected to increase or decline half as much as
the market price of a bond with a two-year duration. The maturity of a security
measures only the time until final payment is due. Duration, on the other hand,
takes into account the pattern of all payments of interest and principal on a
security over time, including how these payments are affected by prepayments
and by changes in interest rates, as well as the time until an interest rate on
a security is reset (in the case of variable rate securities).
21
PORTFOLIO CONTENTS AND OTHER INFORMATION
Under normal market conditions, the Fund seeks to achieve its investment
objective by investing at least 80% of its net assets (plus any borrowings for
investment purposes) in a diversified portfolio of floating rate debt
instruments, a substantial portion of which will be Senior Loans. Other
floating rate debt instruments in which the Fund may invest include catastrophe
and other event-linked bonds, bank capital securities, unsecured bank loans,
corporate bonds, money market instruments and certain types of mortgage-backed
and other asset-backed securities that pay interest at rates which adjust
whenever a specified interest rate changes and/or reset on predetermined dates
(such as the last day of a month or calendar quarter). The Fund may invest up
to 20% of its net assets (plus any borrowings for investment purposes) in
securities and instruments other than floating rate debt instruments, including
fixed income debt securities such as convertible securities, high-yield bonds
and mortgage-backed and other asset-backed securities issued on a public or
private basis. The Fund may make use of a variety of other instruments,
including collateralized debt obligations, preferred shares, commercial paper,
U.S. Government securities, zero-coupon and inflation-indexed bonds, real
estate investment trusts (REITs), structured notes and other hybrid
instruments, credit-linked trust certificates, total return swaps, credit
default swaps and other derivative instruments. Certain debt instruments, such
as convertible bonds, also may include the right to participate in equity
appreciation, and PIMCO will generally evaluate those instruments based
primarily on their debt characteristics. The Fund may invest in securities of
companies with small market capitalizations. The principal and/or interest rate
on some debt instruments may be determined by reference to the performance of a
benchmark asset or market, such as an index of securities, or the differential
performance of two assets or markets, such as the level of exchange rates
between the U.S. dollar and a foreign currency or currencies.
The Fund may invest without limit, and ordinarily expects to invest a
substantial portion of its assets, in debt securities that are, at the time of
purchase, rated below investment grade. See "High Yield Securities ("Junk
Bonds")." The Fund may also invest in investment grade securities.
The Fund expects to invest predominantly in U.S. dollar-denominated debt
securities, which may include those issued by foreign corporations or
supra-national government agencies. The Fund may invest up to 25% of its total
assets in debt instruments denominated in foreign currencies, including
obligations of non-U.S. governments and their respective sub-divisions,
agencies and government-sponsored enterprises. The Fund may invest up to 10% of
its total assets in securities of issuers located in "emerging markets." The
Fund may utilize a variety of derivative instruments for hedging, investment
and risk management purposes, such as option contracts (including options on
futures contracts), futures contracts, swap agreements (including total return
and credit default swaps) and short sales, and may seek to obtain market
exposure to the securities in which it primarily invests by entering into a
series of purchase and sales contracts. The Fund may also use derivatives to
leverage the portfolio, but only as a substitute for leverage attained through
Preferred Shares. The Fund may invest without limit in illiquid securities
(which are largely determined using the Securities and Exchange Commission's
standard applicable to open-end investment companies, I.E., securities that
cannot be disposed of within seven days in the ordinary course of business at
approximately the value at which the Fund has valued the securities). PIMCO
will determine the liquidity of the Fund's investments by reference to market
conditions and contractual provisions. For example, PIMCO will generally not
consider Senior Loans that are part of an issue of at least $250 million in par
value to be illiquid.
The Fund cannot change its investment objective without the approval of
the holders of a "majority of the outstanding" Common Shares and any Preferred
Shares voting together as a single class, and of the holders of a "majority of
the outstanding" Preferred Shares voting as a separate class. A "majority of
the outstanding" shares (whether voting together as a single class or voting as
a separate class) means (i) 67% or more of such shares present at a meeting, if
the holders of more than 50% of those shares are present or represented by
proxy, or (ii) more than 50% of such shares, whichever is less. See
"Description of Shares--Voting Rights" for additional information with respect
to the voting rights of holders of Preferred Shares. The Fund may not change
its policy to invest at least 80% of its net assets (plus any borrowings for
investment purposes) in floating rate debt instruments unless it provides
shareholders with at least 60 days' written notice of such change.
22
The Fund currently intends to leverage its portfolio through the issuance
of Preferred Shares. The Fund may also leverage the portfolio by borrowing
money, issuing debt securities or using reverse repurchase agreements, loans of
portfolio securities, credit default swap contracts and other derivatives, as
well as when-issued, delayed delivery and forward commitment transactions.
However, these forms of leverage will only be used, if at all, as a substitute
for, rather than in addition to, the leverage obtained through the issuance of
Preferred Shares. See "Preferred Shares and Related Leverage."
Upon PIMCO's recommendation, for temporary defensive purposes and in
order to keep the Fund's cash fully invested, including during the period in
which the net proceeds of this offering are being invested, the Fund may
deviate from its investment objective and policies and invest some or all of
its total assets in fixed-rate investment grade debt securities, including high
quality, short-term debt securities. The Fund may not achieve its investment
objective when it does so.
The following provides additional information regarding the types of
securities and other instruments in which the Fund will ordinarily invest. A
more detailed discussion of these and other instruments and investment
techniques that may be used by the Fund is provided under "Investment Objective
and Policies" in the Statement of Additional Information.
FLOATING RATE DEBT INSTRUMENTS
Under normal market conditions, the Fund will invest at least 80% of its
net assets (plus any borrowings for investment purposes) in a diversified
portfolio of floating rate debt instruments. Floating rate debt instruments are
debt instruments that pay interest at rates which adjust whenever a specified
interest rate changes and/or which reset on predetermined dates (such as the
last day of a month or calendar quarter). In addition to Senior Loans, these
floating rate debt instruments may include, without limitation, instruments
such as catastrophe and other event-linked bonds, bank capital securities,
unsecured bank loans, corporate bonds, money market instruments and certain
types of mortgage-backed and other asset-backed securities. Due to their
floating rate features, these instruments will generally pay higher levels of
income in a rising interest rate environment and lower levels of income as
interest rates decline. For the same reason, the market value of a floating
rate debt instrument is generally expected to have less sensitivity to
fluctuations in market interest rates than a fixed-rate debt instrument,
although the value of a floating rate instrument may nonetheless decline as
interest rates rise and due to other factors, such as changes in credit quality.
SENIOR LOANS
The Fund expects to ordinarily invest a substantial portion of its assets
in Senior Loans. Senior Loans include senior floating rate loans and
institutionally traded senior floating rate debt obligations issued by an
asset-backed pool or other issuers, as well as interests therein. Loan
interests generally take the form of direct interests acquired during a primary
distribution and may also take the form of assignments of, novations of, or
participations in a Senior Loan acquired in secondary markets.
Senior Loans typically pay interest at rates which are re-determined
periodically on the basis of a floating base lending rate (such as the London
Inter-Bank Offered Rate, "LIBOR") plus a premium. Although Senior Loans are
typically of below investment grade quality, they tend to have more favorable
recovery rates than other types of below investment grade quality debt
obligations. Senior Loans generally (but not always) hold the most senior
position in the capital structure of a borrower and are often secured with
collateral. A Senior Loan is typically originated, negotiated and structured by
a U.S. or foreign commercial bank, insurance company, finance company or other
financial institution (the "Agent") for a lending syndicate of financial
institutions ("Lenders"). The Agent typically administers and enforces the
Senior Loan on behalf of the other Lenders in the syndicate. In addition, an
institution, typically but not always the Agent, holds any collateral on behalf
of the Lenders. A financial institution's employment as an Agent might be
terminated in the event that it fails to observe a requisite standard of care
or becomes insolvent. A successor Agent would generally be appointed to replace
the terminated Agent, and assets held by the Agent under the loan agreement
would likely
23
remain available to holders of such indebtedness. However, if assets held by
the Agent for the benefit of the Fund were determined to be subject to the
claims of the Agent's general creditors, the Fund might incur certain costs and
delays in realizing payment on a loan or loan participation and could suffer a
loss of principal and/or interest. In situations involving other interposed
financial institutions (E.G., an insurance company or government agency)
similar risks may arise.
The Fund may purchase "assignments" of Senior Loans from Lenders. The
purchaser of an assignment typically succeeds to all the rights and obligations
under the loan agreement with the same rights and obligations as the assigning
Lender. Assignments may, however, be arranged through private negotiations
between potential assignees and potential assignors, and the rights and
obligations acquired by the purchaser of an assignment may differ from, and be
more limited than, those held by the assigning Lender.
The Fund may also invest in "participations" in Senior Loans, although it
expects to do so on a limited basis. Participations by the Fund in a Lender's
portion of a Senior Loan typically will result in the Fund having a contractual
relationship only with such Lender, not with the borrower. As a result, the
Fund may have the right to receive payments of principal, interest and any fees
to which it is entitled only from the Lender selling the participation and only
upon receipt by such Lender of such payments from the borrower. In connection
with purchasing participations, the Fund generally will have no right to
enforce compliance by the borrower with the terms of the loan agreement, nor
any rights with respect to any funds acquired by other Lenders through set-off
against the borrower, and the Fund may not directly benefit from any collateral
supporting the Senior Loan in which it has purchased the participation. As a
result, the Fund may assume the credit risk of both the borrower and the Lender
selling the participation.
Purchasers of Senior Loans and other forms of direct indebtedness depend
primarily upon the creditworthiness of the corporate or other borrower for
payment of principal and interest. If the Fund does not receive scheduled
interest or principal payments on such indebtedness, the Fund's share price and
yield could be adversely affected. Senior Loans that are fully secured may
offer the Fund more protection than an unsecured loan in the event of
non-payment of scheduled interest or principal. However, there is no assurance
that the liquidation of any collateral from a secured Senior Loan would satisfy
the borrower's obligation, or that such collateral could be liquidated. Also,
the Fund may invest in Senior Loans that are unsecured.
Senior Loans may not be readily marketable and may be subject to
restrictions on resale. In some cases, negotiations involved in disposing of
indebtedness may require weeks to complete. Consequently, some indebtedness may
be difficult or impossible to dispose of readily at what PIMCO believes to be a
fair price.
Senior Loans usually require, in addition to scheduled payments of
interest and principal, the prepayment of the Senior Loan from free cash flow.
The degree to which borrowers prepay Senior Loans, whether as a contractual
requirement or at their election, may be affected by general business
conditions, the financial condition of the borrower and competitive conditions
among lenders, among others. As such, prepayments cannot be predicted with
accuracy. Upon a prepayment, either in part or in full, the actual outstanding
debt on which the Fund derives interest income will be reduced. However, the
Fund may receive both a prepayment penalty fee from the prepaying borrower and
a facility fee upon the purchase of a new Senior Loan with the proceeds from
the prepayment of the former. The effect of prepayments on the Fund's
performance may be mitigated by the receipt of prepayment fees and the Fund's
ability to reinvest prepayments in other Senior Loans that have similar or
identical yields.
HIGH YIELD SECURITIES ("JUNK BONDS")
As noted above, the Fund may invest without limit and ordinarily expects
to invest a substantial portion of its assets in Senior Loans and other debt
securities that are, at the time of purchase, rated below investment grade
(below Baa3 by Moody's, below BBB- by either S&P or Fitch, or below a
comparable rating by Dominion) or that are unrated but judged by PIMCO to be of
comparable quality. These securities are sometimes referred to as "high yield"
securities or "junk bonds." Investing in high yield securities involves greater
risks (in
24
particular, greater risk of default) and special risks in addition to the risks
associated with investments in investment grade debt obligations. While
offering a greater potential opportunity for capital appreciation and higher
yields, high yield securities typically entail greater potential price
volatility and may be less liquid than higher-rated securities. High yield
securities may be regarded as predominantly speculative with respect to the
issuer's continuing ability to meet principal and interest payments. They also
may be more susceptible to real or perceived adverse economic and competitive
industry conditions than higher-rated securities. Debt securities in the lowest
investment grade category also may be considered to possess some speculative
characteristics.
The market values of high yield securities tend to reflect individual
developments of the issuer to a greater extent than do higher-quality
securities, which tend to react mainly to fluctuations in the general level of
interest rates. In addition, lower-quality debt securities tend to be more
sensitive to economic conditions. Certain "emerging market" governments that
issue high yield securities are among the largest debtors to commercial banks,
foreign governments and supra-national organizations such as the World Bank,
and may not be able or willing to make principal and/or interest payments as
they come due.
Senior Loans generally tend to have more favorable recovery rates than
most other types of loans. Although Senior Loans in which the Fund will invest
will often be secured by collateral, there can be no assurance that liquidation
of such collateral would satisfy the borrower's obligation in the event of
default or that such collateral could be readily liquidated.
CREDIT RATINGS AND UNRATED SECURITIES. Rating agencies are private
services that provide ratings of the credit quality of debt obligations,
including convertible securities. Appendix A to this prospectus describes the
various ratings assigned to debt obligations by Moody's, S&P, Fitch and
Dominion. Ratings assigned by a rating agency are not absolute standards of
credit quality and do not evaluate market risks. Rating agencies may fail to
make timely changes in credit ratings and an issuer's current financial
condition may be better or worse than a rating indicates. PIMCO relies heavily
on its own analysis of the credit quality and risks associated with individual
debt obligations considered for the Fund, rather than relying exclusively on
rating agencies or third-party research. See "Portfolio Management
Strategies--Independent Credit Analysis." In the case of Senior Loans, PIMCO
analyzes and takes into account the legal/protective features associated with
the securities (such as their position in the borrower's capital structure and
any security through collateral) in assessing their credit characteristics. The
Fund will not necessarily sell a security when its rating is reduced below its
rating at the time of purchase. The ratings of a debt security may change over
time. Moody's, S&P, Fitch and Dominion monitor and evaluate the ratings
assigned to securities on an ongoing basis. As a result, debt instruments held
by the Fund could receive a higher rating (which would tend to increase their
value) or a lower rating (which would tend to decrease their value) during the
period in which they are held.
The Fund may purchase unrated securities (which are not rated by a rating
agency) if PIMCO determines that the securities are of comparable quality to
rated securities that the Fund may purchase. Many of the Senior Loans and other
debt instruments in which the Fund invests may be unrated. Unrated securities
may be less liquid than comparable rated securities and involve the risk that
PIMCO may not accurately evaluate the security's comparative credit rating.
Analysis of the creditworthiness of issuers of high yield securities may be
more complex than for issuers of higher-quality debt obligations. The Fund's
success in achieving its investment objective may depend more heavily on
PIMCO's credit analysis than if the Fund invested primarily in higher-quality
and rated securities.
BONDS
The Fund may invest in bonds of varying maturities (with predominantly
low durations) issued by U.S. and foreign corporations, domestic and foreign
banks and other business entities. Bonds can be variable or fixed rate debt
obligations, including bills, notes, debentures, money market instruments and
similar instruments and securities. Bonds generally are used by corporations as
well as governments and other issuers to borrow money from investors. The
issuer pays the investor a variable or fixed rate of interest and normally must
repay the
25
amount borrowed on or before maturity. Certain bonds are "perpetual" in that
they have no maturity date. The Fund may also invest in catastrophe or other
"event-linked" bonds. Although the Fund will ordinarily invest in floating rate
bonds, it may invest up to 20% of its net assets (plus any borrowings for
investment purposes) in fixed rate bonds. Please see "Bonds" and "Event-Linked
Bonds" in the Statement of Additional Information for a more detailed
description of the investments described in this paragraph.
COMMERCIAL PAPER
Commercial paper represents short-term unsecured promissory notes issued
in bearer form by corporations such as banks or bank holding companies and
finance companies. The rate of return on commercial paper may be linked or
indexed to the level of exchange rates between the U.S. dollar and a foreign
currency or currencies.
PREFERRED STOCKS
Preferred stock represents an equity interest in a company that generally
entitles the holder to receive, in preference to the holders of other stocks
such as common stocks, dividends and a fixed share of the proceeds resulting
from liquidation of the company. Some preferred stocks also entitle their
holders to receive additional liquidation proceeds on the same basis as holders
of a company's common stock, and thus also represent an ownership interest in
the company. The preferred stocks in which the Fund invests will ordinarily
have a variable dividend, generally determined on a quarterly or other periodic
basis, either according to a formula based upon a specified premium or discount
to the yield on particular U.S. Treasury securities or based on an auction
process, involving bids submitted by holders and prospective purchasers of such
stocks. Some preferred stocks offer a fixed rate of return with no maturity
date. Because they never mature, these preferred stocks act like long-term
bonds and can be more volatile than other types of preferred stocks and may
have heightened sensitivity to changes in interest rates. Because preferred
stocks represent an equity ownership interest in a company, their value usually
will react more strongly than bonds and other debt instruments to actual or
perceived changes in a company's financial condition or prospects, or to
fluctuations in the equity markets.
CONVERTIBLE SECURITIES AND SYNTHETIC CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are debt securities
that may be converted at either a stated price or stated rate into underlying
shares of common stock. Convertible securities have general characteristics
similar to both debt securities and equity securities. PIMCO will generally
evaluate these instruments based primarily on their debt characteristics.
Because most convertible securities are fixed-rate instruments, 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, also will react to variations in the general market for
equity securities.
The Fund may also invest in synthetic convertible securities, which
differ from convertible securities in certain respects. Unlike a true
convertible security, which is a single security having a unitary market value,
a synthetic convertible comprises two or more separate securities, each with
its own market value. Therefore, the "market value" of a synthetic convertible
security is the sum of the values of its debt component and its convertibility
component. Synthetic convertible securities can be variable or fixed rate
instruments. For these reasons, the values of a synthetic convertible and a
true convertible security may respond differently to market fluctuations.
Convertible securities generally have higher yields than common stocks.
There can be no assurance of current income because the issuers of the
convertible securities may default on their obligations. 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 increases in the market price of the underlying common stock.
26
BANK CAPITAL SECURITIES AND OBLIGATIONS
The Fund may invest in bank capital securities. Bank capital securities
are issued by banks to help fulfill their regulatory capital requirements.
There are three common types of bank capital: Lower Tier II, Upper Tier II and
Tier I. To the extent that the Fund invests in bank capital, it expects to
primarily invest in floating rate Upper Tier II and Tier I bank capital. Bank
capital is generally, but not always, of investment grade quality. Upper Tier
II securities are commonly thought of as hybrids of debt and preferred stock.
Upper Tier II securities are often perpetual (with no maturity date), callable
and have a cumulative interest deferral feature. This means that under certain
conditions, the issuer bank can withhold payment of interest until a later
date. However, such deferred interest payments generally earn interest. Tier I
securities often take the form of trust preferred securities.
The Fund may also invest in bank obligations, including certificates of
deposit, bankers' acceptances and fixed time deposits. Certificates of deposit
are negotiable certificates issued against funds deposited in a commercial bank
for a definite period of time and earning a specified return. Bankers'
acceptances are negotiable drafts or bills of exchange, normally drawn by an
importer or exporter to pay for specific merchandise, which are "accepted" by a
bank, meaning, in effect, that the bank unconditionally agrees to pay the face
value of the instrument on maturity. Fixed time deposits are bank obligations
payable at a stated maturity date and bearing interest at a fixed rate. Fixed
time deposits may be withdrawn on demand by the investor, but may be subject to
early withdrawal penalties which vary depending upon market conditions and the
remaining maturity of the obligation.
ZERO-COUPON BONDS, STEP-UPS AND PAYMENT-IN-KIND SECURITIES
Zero-coupon bonds pay interest only at maturity rather than at intervals
during the life of the security. Like zero-coupon bonds, "step up" bonds pay no
interest initially but eventually begin to pay a coupon rate prior to maturity,
which rate may increase at stated intervals during the life of the security.
Payment-in-kind securities ("PIKs") are debt obligations that pay "interest" in
the form of other debt obligations, instead of in cash. Each of these
instruments is normally issued and traded at a deep discount from face value.
Zero-coupon bonds, step-ups and PIKs allow an issuer to avoid or delay the need
to generate cash to meet current interest payments and, as a result, may
involve greater credit risk than bonds that pay interest currently or in cash.
The Fund would be required to distribute the income on these instruments as it
accrues, even though the Fund will not receive the income on a current basis or
in cash. Thus, the Fund may have to sell other investments, including when it
may not be advisable to do so, to make income distributions to its shareholders.
FOREIGN (NON-U.S.) INVESTMENTS AND CURRENCIES
The Fund may invest some or all of its assets in U.S. dollar-denominated
debt obligations of foreign issuers and of supra-national government entities.
Supra-national entities include international organizations that are organized
or supported by one or more government entities to promote economic
reconstruction or development and by international banking institutions and
related governmental agencies. The Fund may invest up to 25% of its total
assets in debt instruments denominated in foreign currencies, including
obligations of non-U.S. governments and their respective sub-divisions,
agencies and government-sponsored enterprises. Up to 10% of the Fund's total
assets may be invested in debt securities of issuers located in "emerging
markets." Investing in foreign securities involves special risks and
considerations not typically associated with investing in U.S. securities. See
"Risks--Foreign (Non-U.S.) Investment Risk."
Most of the foreign investments of the Fund will consist of Senior Loans
originated in a foreign jurisdiction or to which a foreign lender or borrower
is a party, or other floating rate debt instruments of non-U.S. corporate
issuers.
The U.S. dollar-denominated foreign securities in which the Fund may
invest include Eurodollar obligations and "Yankee Dollar" obligations.
Eurodollar obligations are U.S. dollar-denominated certificates of
27
deposit and time deposits issued outside the U.S. capital markets by foreign
branches of U.S. banks and by foreign banks. Yankee Dollar obligations are U.S.
dollar-denominated obligations issued in the U.S. capital markets by foreign
banks. Eurodollar and Yankee Dollar obligations are generally subject to the
same risks that apply to domestic debt issues, notably credit risk, market risk
and liquidity risk. Additionally, Eurodollar (and to a limited extent, Yankee
Dollar) obligations are subject to certain sovereign risks. One such risk is
the possibility that a sovereign country might prevent capital, in the form of
U.S. dollars, from flowing across its borders. Other risks include adverse
political and economic developments; the extent and quality of government
regulation of financial markets and institutions; the imposition of foreign
withholding taxes; and the expropriation or nationalization of foreign issuers.
The Fund also may invest in sovereign debt issued by foreign governments,
their agencies or instrumentalities, or other government-related entities. As a
holder of sovereign debt, the Fund may be requested to participate in the
rescheduling of such debt and to extend further loans to governmental entities.
In addition, there are generally no bankruptcy proceedings similar to those in
the United States by which defaulted sovereign debt may be collected. The Fund
also may invest in Brady Bonds, which are securities created through the
exchange of existing commercial bank loans to sovereign entities for new
obligations in connection with a debt restructuring. Investments in Brady Bonds
may be viewed as speculative. Brady Bonds acquired by the Fund may be subject
to restructuring arrangements or to requests for new credit, which may cause
the Fund to realize a loss of interest or principal on any of its portfolio
holdings.
FOREIGN CURRENCIES AND RELATED TRANSACTIONS. The Fund's investments in
securities that trade in, or receive revenues in, foreign currencies will be
subject to currency risk, which is the risk that fluctuations in the exchange
rates between the U.S. dollar and foreign currencies may negatively affect any
investment. The Fund may engage in a variety of transactions involving foreign
currencies in order to hedge against foreign currency risk, to increase
exposure to a foreign currency or to shift exposure to foreign currency
fluctuations from one currency to another. For instance, the Fund may purchase
foreign currencies on a spot (cash) basis and enter into forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies and futures. Suitable hedging transactions may not be
available in all circumstances and there can be no assurance that the Fund will
engage in such transactions at any given time or from time to time. Also, these
transactions may not be successful and may eliminate any chance for the Fund to
benefit from favorable fluctuations in relevant foreign currencies.
Please see "Investment Objective and Policies--Foreign (Non-U.S.)
Securities," "Investment Objective and Policies--Foreign Currency Transactions"
and "Investment Objective and Policies--Foreign Currency Exchange-Related
Securities" in the Statement of Additional Information for a more detailed
description of the types of foreign investments and foreign currency
transactions in which the Fund may invest and their related risks.
DERIVATIVES
The Fund may, but is not required to, use a variety of derivative
instruments for hedging or risk management purposes or as part of its
investment strategies. Generally, derivatives are financial contracts whose
value depends upon, or is derived from, the value of an underlying asset,
reference rate or index, and may relate to individual debt instruments,
interest rates, currencies or currency exchange rates, commodities and related
indexes. The Fund may use derivatives to gain exposure to floating rate or high
yield securities and other securities in which the Fund may invest (including
pending investment of the proceeds of this offering). Examples of derivative
instruments that the Fund may use include, but are not limited to, options,
futures contracts, options on futures contracts, swap agreements (including
total return and credit default swaps) and short sales. The Fund may also
engage in credit spread trades. A credit spread trade is an investment position
relating to a difference in the prices or interest rates of two bonds or other
securities, where the value of the investment position is determined by changes
in the difference between such prices or interest rates, as the case may be, of
the respective securities. The Fund may also have exposure to derivatives, such
as interest rate or credit-default swaps, through investment in credit-linked
trust certificates and other securities issued by special
28
purpose or structured vehicles. The Fund may also use derivatives to add
leverage to the portfolio, but only as a substitute for leverage obtained
through Preferred Shares. The Fund's use of derivative instruments involves
risks different from, or possibly greater than, the risks associated with
investment directly in securities and other more traditional investments. See
"Risks--Derivatives Risk." Certain types of derivative instruments that the
Fund may utilize with some frequency are described elsewhere in this section,
including those described under "Certain Interest Rate Transactions,"
"Structured Notes and Related Instruments," "Credit Default Swaps" and
"Credit-Linked Trust Certificates." Please see "Investment Objective and
Policies--Derivative Instruments" in the Statement of Additional Information
for additional information about these and other derivative instruments that
the Fund may use and the risks associated with such instruments. There is no
assurance that these derivative strategies will be available at any time or
that PIMCO will determine to use them for the Fund or, if used, that the
strategies will be successful. In addition, the Fund may be subject to certain
restrictions on its use of derivative strategies imposed by guidelines of one
or more rating agencies that may issue ratings for Preferred Shares issued by
the Fund.
CREDIT DEFAULT SWAPS
The Fund may enter into credit default swap contracts for hedging
purposes, to add leverage to the portfolio or for general investment purposes.
When used for hedging purposes, the Fund would be the buyer of a credit default
swap contract. In that case, 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 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. When the Fund is the seller of a credit default swap contract, it
receives the stream of payments but is obligated to pay upon default of the
referenced debt obligation. As the seller, the Fund would effectively add
leverage to its portfolio because, in addition to its total assets, the Fund
would be subject to investment exposure on the notional amount of the swap.
COMMERCIAL AND OTHER MORTGAGE-RELATED AND ASSET-BACKED SECURITIES
Mortgage-related securities are debt instruments which provide periodic
payments consisting of interest and/or principal that are derived from or
related to payments of interest and/or principal on underlying mortgages.
Additional payments on mortgage-related securities may be made out of
unscheduled prepayments of principal resulting from the sale of the underlying
property, or from refinancing or foreclosure, net of fees or costs that may be
incurred. The mortgage-related securities in which the Fund invests will
typically pay variable rates of interest, although the Fund may invest in
fixed-rate obligations as well.
The Fund may invest in commercial mortgage-related securities issued by
corporations. These are securities that represent an interest in, or are
secured by, mortgage loans secured by commercial property, such as industrial
and warehouse properties, office buildings, retail space and shopping malls,
multifamily properties and cooperative apartments, hotels and motels, nursing
homes, hospitals and senior living centers. The commercial mortgage loans that
underlie commercial mortgage-related securities have certain distinct risk
characteristics. Commercial mortgage loans generally lack standardized terms,
which may complicate their structure. Commercial properties themselves tend to
be unique and difficult to value. Commercial mortgage loans tend to have
shorter maturities than residential mortgage loans, and may not be fully
amortizing, meaning that they may have a significant principal balance, or
"balloon" payment, due on maturity. In addition, commercial properties,
particularly industrial and warehouse properties, are subject to environmental
risks and the burdens and costs of compliance with environmental laws and
regulations.
Other mortgage-related securities in which the Fund may invest include
mortgage pass-through securities, collateralized mortgage obligations ("CMOs"),
mortgage dollar rolls, CMO residuals (other than residual interests in real
estate mortgage investment conduits), stripped mortgage-backed securities
("SMBSs")
29
and other securities that directly or indirectly represent a participation in,
or are secured by and payable from, mortgage loans on real property.
The Fund may invest in other types of asset-backed securities that are
offered in the marketplace, including Enhanced Equipment Trust Certificates
("EETCs") and collateralized debt obligations ("CDOs"). Although any entity may
issue EETCs, to date, U.S. airlines are the primary issuers. An airline EETC is
an obligation secured directly by aircraft or aircraft engines as collateral.
EETCs tend to be less liquid than bonds. CDOs include collateralized bond
obligations ("CBOs"), collateralized loan obligations ("CLOs") and other
similarly structured securities. A CBO is a trust typically backed by a
diversified pool of high-risk, below investment grade fixed income securities.
A CLO is a trust typically collateralized by a pool of loans, which may
include, among others, domestic and foreign senior secured loans, senior
unsecured loans, and subordinate corporate loans, including loans that may be
rated below investment grade or equivalent unrated loans. While the trusts that
issue CDOs may themselves be leveraged and may invest in lower-quality
instruments, the Fund will generally purchase only senior CDOs, will not
purchase residual CDOs and will only purchase CDOs that meet the Fund's credit
policies.
Other asset-backed securities may be collateralized by the fees earned by
service providers. The value of asset-backed securities may be substantially
dependent on the servicing of the underlying asset pools and are therefore
subject to risks associated with the negligence of, or defalcation by, their
servicers. In certain circumstances, the mishandling of related documentation
may also affect the rights of the security holders in and to the underlying
collateral. The insolvency of entities that generate receivables or that
utilize the assets may result in added costs and delays in addition to losses
associated with a decline in the value of the underlying assets. The issuers of
certain asset-backed securities bear various expenses, including, without
limitation, servicing and advisory fees.
Please see "Investment Objective and Policies--Mortgage-Related and Other
Asset-Backed Securities" in the Statement of Additional Information and
"Risks--Mortgage-Related and Asset-Backed Risk" in this prospectus for a more
detailed description of the types of mortgage-related and other asset-backed
securities in which the Fund may invest and their related risks.
REAL ESTATE INVESTMENT TRUSTS (REITS)
The Fund may invest in REITs. REITs primarily invest in income-producing
real estate or real estate related loans or interests. REITs are generally
classified as equity REITs, mortgage REITs or a combination of equity and
mortgage REITs. Equity REITs invest the majority of their assets directly in
real property and derive income primarily from the collection of rents. Equity
REITs can also realize capital gains by selling properties that have
appreciated in value. Mortgage REITs invest the majority of their assets in
real estate mortgages and derive income from the collection of interest
payments. REITs are not taxed on income distributed to shareholders provided
they comply with the applicable requirements of the Internal Revenue Code of
1986, as amended. The Fund will indirectly bear its proportionate share of any
management and other expenses paid by REITs in which it invests in addition to
the expenses paid by the Fund. Debt securities issued by REITs are, for the
most part, general and unsecured obligations and are subject to risks
associated with REITs. Please see "Investment Objective and Policies--Real
Estate Investment Trusts ("REITs")" in the Statement of Additional Information
for a more detailed description of these instruments.
DELAYED FUNDING LOANS AND REVOLVING CREDIT FACILITIES
The Fund may enter into, or acquire participations in, delayed funding
loans and revolving credit facilities, in which a lender agrees to make loans
up to a maximum amount upon demand by the borrower during a specified term.
These commitments may have the effect of requiring the Fund to increase its
investment in a company at a time when it might not be desirable to do so
(including at a time when the company's financial condition makes it unlikely
that such amounts will be repaid). Delayed funding loans and revolving credit
facilities are subject to credit, interest rate and liquidity risk and the
risks of being a lender.
30
CERTAIN INTEREST RATE TRANSACTIONS
The Fund may enter into long and short interest rate swap, cap or floor
transactions. One possible use of interest rate swaps involves the Fund's
agreement with the swap counterparty to pay a fixed rate payment in exchange
for the counterparty paying the Fund a variable rate payment. The payment
obligation would be based on the notional amount of the swap. The Fund may use
an interest rate cap or floor, which would require the Fund to pay a premium to
the cap or floor counterparty and would entitle the Fund, 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 may use interest rate swaps, caps and floors for hedging or general
investment purposes. The Fund may choose or be required to redeem some or all
of the Preferred Shares. This redemption may result in the Fund seeking to
terminate early all or a portion of any swap, cap or floor transaction. Such
early termination of a swap could result in a termination payment by or to the
Fund. Any termination of a cap or floor could result in a termination payment
by or to the Fund.
STRUCTURED NOTES AND RELATED INSTRUMENTS
The Fund may invest in "structured" notes and other related instruments,
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, such as indexes reflecting bonds.
Structured instruments may be issued by corporations, including banks, as well
as by governmental agencies. The terms of such structured instruments 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 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.
PIMCO may utilize structured instruments for investment purposes and also
for risk management purposes. While structured instruments may offer the
potential for a favorable rate of return from time to time, they also entail
certain risks. Structured instruments may be less liquid than other debt
securities, and the price of structured instruments may be more volatile. In
some cases, depending on the terms of the embedded index, a structured
instrument may provide that the principal and/or interest payments may be
adjusted below zero. Structured instruments also may involve significant credit
risk and risk of default by the counterparty. Although structured instruments
are not necessarily illiquid, the Manager believes that currently most
structured instruments are illiquid. Like other sophisticated strategies, the
Fund's use of structured instruments may not work as intended. If the value of
the embedded index changes in a manner other than that expected by PIMCO,
principal and/or interest payments received on the structured instrument may be
substantially less than expected.
REVERSE REPURCHASE AGREEMENTS
As described under "Preferred Shares and Related Leverage," the Fund may
utilize reverse repurchase agreements in order to add leverage to the portfolio
as a substitute for, rather than in addition to, leverage obtained through the
issuance of Preferred Shares. In a reverse repurchase agreement, the Fund sells
securities to a bank or broker-dealer and agrees to repurchase the securities
at a mutually agreed date and price. Generally, the effect of such a
transaction is that the Fund can recover and reinvest all or most of the cash
invested in the portfolio securities involved during the term of the reverse
repurchase agreement and still be entitled to the returns associated with those
portfolio securities. Such transactions are advantageous if the interest cost
to the Fund of the reverse repurchase transaction is less than the returns it
obtains on investments purchased with the cash.
31
Unless the Fund covers its positions in reverse repurchase agreements (by
segregating liquid assets at least equal in amount to the forward purchase
commitment), its obligations under the agreements will be subject to the Fund's
limitations on borrowings. Reverse repurchase agreements involve leverage risk
and also the risk that the market value of the securities that the Fund is
obligated to repurchase under the agreement may decline below the repurchase
price. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, the Fund's use of the
proceeds of the agreement may be restricted pending a determination by the
other party, or its trustee or receiver, whether to enforce the Fund's
obligation to repurchase the securities.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements, in which the Fund
purchases a security from a bank or broker-dealer and the bank or broker-dealer
agrees to repurchase the security at the Fund's cost plus interest within a
specified time. If the party agreeing to repurchase should default, the Fund
will seek to sell the securities which it holds. This could involve transaction
costs or delays in addition to a loss on the securities if their value should
fall below their repurchase price. Repurchase agreements maturing in more than
seven days are considered to be illiquid securities.
U.S. GOVERNMENT SECURITIES
The Fund may invest in U.S. Government securities, which are obligations
of, or guaranteed by, the U.S. Government, its agencies or government-sponsored
enterprises. U.S. Government securities include a variety of securities that
differ in their interest rates, maturities and dates of issue. Securities
issued or guaranteed by agencies or instrumentalities of the U.S. Government
may or may not be supported by the full faith and credit of the United States
or by the right of the issuer to borrow from the U.S. Treasury.
MUNICIPAL BONDS
Municipal bonds are generally issued by states, municipalities and other
political subdivisions, agencies, authorities and instrumentalities of states
and multi-state agencies or authorities. Like other debt obligations, municipal
bonds are subject to interest rate, credit and market risk. The ability of a
municipal issuer to make payments could be affected by litigation, legislation
or other political events or the bankruptcy of the issuer. The types of
municipal bonds in which the Fund may invest include municipal lease
obligations. The Fund also may invest in securities issued by entities whose
underlying assets are municipal bonds.
WHEN ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS
The Fund may purchase securities which it is eligible to purchase on a
when-issued basis, may purchase and sell such securities for delayed delivery
and may make contracts to purchase such securities for a fixed price at a
future date beyond normal settlement time (forward commitments). When-issued
transactions, delayed delivery purchases and forward commitments involve a risk
of loss if the value of the securities declines prior to the settlement date.
This risk is in addition to the risk that the Fund's other assets will decline
in value. Therefore, these transactions may result in a form of leverage and
increase the Fund's overall investment exposure. Typically, no income accrues
on securities the Fund has committed to purchase prior to the time delivery of
the securities is made, although the Fund may earn income on securities it has
segregated to cover these positions.
CREDIT-LINKED TRUST CERTIFICATES
Among the income-producing securities in which the Fund may invest are
credit-linked trust certificates, which are investments in a limited purpose
trust or other vehicle formed under State law which, in turn, invests in a
basket of derivative instruments, such as credit default swaps, interest rate
swaps and other
32
securities, in order to provide exposure to the high yield or another fixed
income market. For instance, the Fund may invest in credit-linked trust
certificates as a cash management tool in order to gain exposure to the high
yield markets and/or to remain fully invested when more traditional
income-producing securities are not available, including during the period when
the net proceeds of this offering and any offering of Preferred Shares are
being invested.
Like an investment in a bond, investments in these credit-linked trust
certificates represent the right to receive periodic income payments (in the
form of distributions) and payment of principal at the end of the term of the
certificate. However, these payments are conditioned on the trust's receipt of
payments from, and the trust's potential obligations to, the counterparties to
the derivative instruments and other securities in which the trust invests. For
instance, the trust may sell one or more credit default swaps, under which the
trust would receive a stream of payments over the term of the swap agreements
provided that no event of default has occurred with respect to the referenced
debt obligation upon which the swap is based. If a default occurs, the stream
of payments may stop and the trust would be obligated to pay to the
counterparty the par (or other agreed upon value) of the referenced debt
obligation. This, in turn, would reduce the amount of income and principal that
the Fund would receive as an investor in the trust. Please see "Investment
Objective and Policies--Derivative Instruments" in the Statement of Additional
Information for additional information about credit default swaps. The Fund's
investments in these instruments are indirectly subject to the risks associated
with derivative instruments, including, among others, credit risk, default or
similar event risk, counterparty risk, interest rate risk, leverage risk and
management risk. It is expected that the trusts which issue credit-linked trust
certificates will constitute "private" investment companies, exempt from
registration under the 1940 Act. Therefore, the certificates will be subject to
the risks described under "Other Investment Companies" in the Statement of
Additional Information, and will not be subject to applicable investment
limitations and other regulation imposed by the 1940 Act (although the Fund
will remain subject to such limitations and regulation, including with respect
to its investments in the certificates). Although the trusts are typically
private investment companies, they are generally not actively managed such as a
"hedge fund" might be. It is also expected that the certificates will be exempt
from registration under the Securities Act of 1933. Accordingly, there may be
no established trading market for the certificates and they may constitute
illiquid investments. See "Risks --Liquidity Risk." If market quotations are
not readily available for the certificates, they will be valued by the Fund at
fair value as determined by the Board of Trustees or persons acting at its
direction. See "Net Asset Value." The Fund may lose its entire investment in a
credit-linked trust certificate.
SHORT SALES
A short sale is a transaction in which the Fund sells an instrument that
it does not own in anticipation that the market price will decline. The Fund
may use short sales for investment and risk management purposes. When the Fund
engages in a short sale, it must borrow the security sold short and deliver it
to the counterparty. The Fund may have to pay a fee to borrow particular
securities and would often be obligated to pay over any payments received on
such borrowed securities. The Fund's obligation to replace the borrowed
security will be secured by collateral deposited with the lender, which is
usually a broker-dealer, and/or with the Fund's custodian. The Fund may not
receive any payments (including interest) on its collateral. Short sales expose
the Fund to the risk that it will be required to cover its short position at a
time when the securities have appreciated in value, thus resulting in a loss to
the Fund. The Fund may engage in so-called "naked" short sales where it does
not own or have the immediate right to acquire the security sold short at no
additional cost, in which case the Fund's losses could theoretically be
unlimited.
LENDING OF PORTFOLIO SECURITIES
For the purpose of achieving income, the Fund may lend its portfolio
securities to brokers, dealers, and other financial institutions provided a
number of conditions are satisfied, including that the loan is fully
collateralized. Please see "Investment Objective and Policies--Securities
Loans" in the Statement of Additional Information for details. When the Fund
lends portfolio securities, its investment performance will continue to
33
reflect changes in the value of the securities loaned, and the Fund will also
receive a fee or interest on the collateral. Securities lending involves the
risk of loss of rights in the collateral or delay in recovery of the collateral
if the borrower fails to return the security loaned or becomes insolvent. The
Fund may pay lending fees to the party arranging the loan.
Please see "Investment Objective and Policies" in the Statement of
Additional Information for additional information regarding the investments of
the Fund and their related risks.
PREFERRED SHARES AND RELATED LEVERAGE
Subject to market conditions, approximately one to six months after the
completion of the offering of the Common Shares, the Fund intends to offer
Preferred Shares representing approximately 38% of the Fund's total assets
immediately after their issuance. The Preferred Shares will have complete
priority upon distribution of assets over the Common Shares. The issuance of
Preferred Shares will leverage the Common Shares. Leverage involves special
risks and there is no assurance that the Fund's leveraging strategies will be
successful. Although the timing and other terms of the offering of the
Preferred Shares will be determined by the Fund's Board of Trustees, the Fund
expects to invest the net proceeds of the Preferred Shares predominantly in
Senior Loans and other floating rate debt instruments in accordance with the
Fund's investment objective and policies. The Preferred Shares will pay
dividends based on short-term interest rates for high quality debt obligations
(which would be redetermined periodically). So long as the Fund's portfolio is
invested in securities that provide a higher rate of return than the dividend
rate of the Preferred Shares (after taking expenses into consideration), the
leverage will allow Common Shareholders to receive a higher current rate of
return than if the Fund were not leveraged.
Changes in the value of the Fund's portfolio (including investments
bought with the proceeds of the Preferred Shares offering) will be borne
entirely by the Common Shareholders. If there is a net decrease (or increase)
in the value of the Fund's investment portfolio, the leverage will decrease (or
increase) the net asset value per Common Share to a greater extent than if the
Fund were not leveraged. During periods in which the Fund is using leverage,
the fees paid to the Manager will be higher than if the Fund did not use
leverage because the fees paid will be calculated on the basis of the Fund's
total managed assets, including the proceeds from the issuance of Preferred
Shares and any other forms of leverage that may be outstanding. Thus, the
Manager has a financial incentive for the Fund to issue Preferred Shares, which
may result in a conflict of interest between the Manager and the Common
Shareholders. Fees and expenses paid by the Fund are borne entirely by the
Common Shareholders (and not by Preferred Shareholders, if any). These include
costs associated with any offering of Preferred Shares by the Fund (which costs
are estimated to be approximately 1.3% of the total dollar amount of a
Preferred Share offering), which will be borne immediately by Common
Shareholders, as will the costs associated with any borrowings or other forms
of leverage utilized by the Fund.
Under the 1940 Act, the Fund is not permitted to issue Preferred Shares
unless immediately after such issuance the value of the Fund's total net assets
is at least 200% of the liquidation value of the outstanding Preferred Shares
plus the aggregate amount of any senior securities of the Fund representing
indebtedness (I.E., such liquidation value plus the aggregate amount of senior
securities representing indebtedness may not exceed 50% of the Fund's total net
assets). In addition, the Fund is not permitted to declare any cash dividend or
other distribution on its Common Shares unless, at the time of such
declaration, the value of the Fund's total net assets satisfies the
above-referenced 200% coverage requirement. If Preferred Shares are issued, the
Fund intends, to the extent possible, to purchase or redeem Preferred Shares
from time to time to the extent necessary in order to maintain coverage of at
least 200%. If the Fund has Preferred Shares outstanding, two of the Fund's
Trustees will be elected by the holders of Preferred Shares, voting separately
as a class. The remaining Trustees of the Fund will be elected by holders of
Common Shares and Preferred Shares voting together as a single class. In the
event the Fund were to fail to pay dividends on Preferred Shares for two years,
Preferred Shareholders would be entitled to elect a majority of the Trustees of
the Fund.
34
The Fund may be subject to certain restrictions imposed by guidelines of
one or more rating agencies that may issue ratings for Preferred Shares issued
by the Fund. These guidelines may impose asset coverage or portfolio
composition requirements that are more stringent than those imposed on the Fund
by the 1940 Act. It is not anticipated that these covenants or guidelines will
impede PIMCO from managing the Fund's portfolio in accordance with the Fund's
investment objective and policies.
Assuming that the Preferred Shares will represent approximately 38% of
the Fund's total assets and pay dividends at an annual average rate of 2.50%,
the income generated by the Fund's portfolio (net of expenses) would have to
exceed .95% in order to cover such dividend payments. Of course, these numbers
are merely estimates, used for illustration. Actual Preferred Share dividend
rates will vary frequently and may be significantly higher or lower than the
rate identified above.
The following table is furnished in response to requirements of the
Securities and Exchange Commission. It is designed to illustrate the effect of
leverage on Common Share total return, assuming investment portfolio total
returns (consisting of income and changes in the value of investments held in
the Fund's portfolio) of -10%, -5%, 0%, 5% and 10%. These assumed investment
portfolio returns are hypothetical figures and are not necessarily indicative
of the investment portfolio returns expected to be experienced by the Fund. The
table further assumes the issuance of Preferred Shares representing
approximately 38% of the Fund's total assets (immediately after their issuance)
and the Fund's current projected initial Preferred Share dividend rate of
2.50%. See "Risks."
Assumed Portfolio Total Return (10.00)% (5.00)% 0% 5.00% 10.00%
Common Share Total Return..... (17.66)% (9.60)% (1.53)% 6.53% 14.60%
Common Share total return is composed of two elements--the Common Share
dividends paid by the Fund (the amount of which is largely determined by the
net investment income of the Fund after paying dividends on Preferred Shares)
and gains or losses on the value of the securities the Fund owns. As required
by Securities and Exchange Commission rules, the table assumes that the Fund is
more likely to suffer capital losses than to enjoy capital appreciation. For
example, to assume a total return of 0%, the Fund must assume that the interest
it receives on its investments is entirely offset by losses in the value of
those investments.
OTHER FORMS OF LEVERAGE AND BORROWINGS. The Fund may use a variety of
other strategies to leverage the portfolio, including borrowing money, issuing
debt securities or using reverse repurchase agreements, loaning portfolio
securities, entering into credit default swap contracts and other derivatives,
as well as when-issued, delayed delivery and forward commitment transactions.
However, these forms of leverage will only be used, if at all, as a substitute
for, rather than in addition to, the leverage obtained through the issuance of
Preferred Shares. Like leverage obtained through Preferred Shares, these other
leveraging strategies would have the potential to increase returns to Common
Shareholders, but would also involve additional risks, such as increased
volatility of the Fund's investment portfolio and potentially larger losses
than if the strategies were not used.
Under the 1940 Act, the Fund generally is not permitted to engage in
borrowings (including through the use of reverse repurchase agreements, credit
default swaps and other derivatives to the extent that these instruments
constitute senior securities) unless immediately after a borrowing the value of
the Fund's total assets less liabilities (other than the borrowing) is at least
300% of the principal amount of such borrowing (I.E., such principal amount may
not exceed 33 1/3% of the Fund's total assets). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on Common Shares
unless, at the time of such declaration, the value of the Fund's total assets,
less liabilities other than borrowing, is at least 300% of such principal
amount. If the Fund borrows, it intends, to the extent possible, to prepay all
or a portion of the principal amount of the borrowing to the extent necessary
in order to maintain the required asset coverage. Failure to maintain certain
asset coverage requirements could result in an event of default and entitle
Preferred Shareholders and holders of any other senior securities of the Fund
to elect a majority of the Trustees of the Fund. Derivative instruments used by
the Fund will not constitute senior securities (and will not be subject to the
Fund's limitations on borrowings) to the extent that the Fund segregates liquid
assets at least equal in amount to its obligations under
35
the instruments, or enters into offsetting transactions or owns positions
covering its obligations. For instance, the Fund may cover its position in a
reverse repurchase agreement by segregating liquid assets at least equal in
amount to its forward purchase commitment.
The Fund also may borrow money in order to repurchase its shares or as a
temporary measure for extraordinary or emergency purposes, including for the
payment of dividends or the settlement of securities transactions which
otherwise might require untimely dispositions of the Fund's securities.
RISKS
The net asset value of the Common Shares will fluctuate with and be
affected by, among other things, the following principal risks of the Fund:
high yield risk, credit risk, market discount risk, liquidity risk, leverage
risk, issuer risk, variable dividend risk, smaller company risk, management
risk, foreign (non-U.S.) investment risk, emerging markets risk, derivatives
risk, counterparty risk, mortgage-related and asset-backed risk, risk of
investing in REITs, interest rate risk, reinvestment risk, inflation/deflation
risk, risk of regulatory changes and market disruption and geopolitical risk.
An investment in the Fund will also be subject to the principal risk associated
with the fact that the Fund is newly organized. These and other risks are
summarized below.
NEWLY ORGANIZED
The Fund is a newly organized, diversified, closed-end management
investment company and has no operating history.
HIGH YIELD RISK/CREDIT RISK
In general, lower rated debt securities (including many Senior Loans)
carry a greater degree of risk that the issuer will lose its ability to make
interest and principal payments, which could have a negative impact on the
Fund's net asset value or dividends. The Fund may invest without limit and
ordinarily expects to invest a substantial portion of its assets in debt
securities that are, at the time of purchase, rated below investment grade
(below Baa3 by Moody's, below BBB- by either S&P or Fitch, or below a
comparable rating by Dominion) or that are unrated but judged by PIMCO to be of
comparable quality, including debt securities that are in default or the
issuers of which are in bankruptcy. Debt securities rated below investment
grade quality are regarded as having predominantly speculative characteristics
with respect to capacity to pay interest and repay principal, and are commonly
referred to as "high yield" securities or "junk bonds." The prices of these
lower grade bonds are generally more volatile and sensitive to actual or
perceived negative developments, such as a decline in the issuer's revenues or
revenues of the borrowers underlying Senior Loans or a general economic
downturn, than are the prices of higher grade securities. In addition, the
secondary market on which high yield securities are traded may be less liquid
than the market for investment grade securities, meaning these securities are
subject to greater liquidity risk than investment grade securities. Bonds in
the lowest investment grade category also may be considered to possess some
speculative characteristics by certain rating agencies.
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 non-payment of all or
a portion of interest and principal, the Fund may incur additional expenses to
seek recovery. Although Senior Loans in which the Fund will invest will often
be secured by collateral, there can be no assurance that liquidation of such
collateral would satisfy the borrower's obligation in the event of a default or
that such collateral could be readily liquidated. In the event of bankruptcy of
a borrower, the Fund could experience delays or limitations in its ability to
realize the benefits of any collateral securing a Senior Loan. The Fund may
also invest in Senior Loans that are not secured.
36
In addition, the Fund may purchase interests in Senior Loans from financial
intermediaries whereby the Fund depends on the intermediary for payment of
principal and interest on the Senior Loan. A decline in the financial soundness
of the intermediary may adversely affect the Fund. The market prices of high
yield securities structured as zero-coupon, step-up or payment-in-kind
securities will normally be affected to a greater extent by interest rate
changes, and therefore tend to be more volatile than the prices of securities
that pay interest currently and in cash. PIMCO seeks to reduce these risks
through diversification, credit analysis and attention to current developments
and trends in both the economy and financial markets.
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 PIMCO downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, PIMCO may consider such factors as PIMCO'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. Analysis of creditworthiness may be more complex for issuers of high
yield securities than for issuers of higher quality debt securities. Because of
the Fund's emphasis on Senior Loans and other below investment grade debt
obligations, PIMCO's capabilities in this area will be particularly important.
In addition to the credit risks associated with high yield securities,
the Fund could also lose money if the issuer of other debt obligations, or the
counterparty to a derivatives contract, repurchase agreement, loan of portfolio
securities or other obligation, is, or is perceived to be, unable or unwilling
to make timely principal and/or interest payments, or to otherwise honor its
obligations. The downgrade of a security may further decrease its value.
MARKET DISCOUNT RISK
As with any stock, the price of the Fund's shares will fluctuate with
market conditions and other factors. If shares are sold, the price received may
be more or less than the original investment. Net asset value will be reduced
immediately following the initial offering by a sales load and organizational
and offering expenses paid or reimbursed by the Fund and immediately following
any offering of Preferred Shares by the costs of that offering paid by the
Fund. The Common Shares are designed for long-term investors and should not be
treated as trading vehicles. Shares of closed-end management investment
companies frequently trade at a discount from their net asset value. The Fund's
shares may trade at a price that is less than the initial offering price. This
risk may be greater for investors who sell their shares relatively shortly
after completion of the initial offering.
LIQUIDITY RISK
The Fund may invest without limit in securities which are illiquid at the
time of investment. The term "illiquid securities" for this purpose is
generally determined using the Securities and Exchange Commission's standard
applicable to open-end investment companies, I.E., securities that cannot be
disposed of within seven days in the ordinary course of business at
approximately the value at which the Fund has valued the securities. Illiquid
securities may be subject to wide fluctuations in market value. The Fund may be
subject to significant delays in disposing of illiquid securities. Accordingly,
the Fund may be forced to sell these securities at less than fair market value
or may not be able to sell them when PIMCO believes it is desirable to do so.
Illiquid securities also may entail registration expenses and other transaction
costs that are higher than those for liquid securities. Restricted securities,
I.E., securities subject to legal or contractual restrictions on resale, may
also be illiquid. In general, below investment grade debt securities tend to be
less liquid than higher-rated securities. PIMCO will determine the liquidity of
the Fund's investments by reference to market conditions and contractual
provisions. For example, PIMCO will generally not consider Senior Loans that
are part of an issue of at least $250 million in par value to be illiquid.
37
LEVERAGE RISK
Leverage risk includes the risk associated with the issuance of the
Preferred Shares, if any, or the loaning of portfolio securities, the borrowing
of money, the issuance of debt securities or the use of credit default swaps,
reverse repurchase agreements and other derivatives, as well as when-issued,
delayed delivery or forward commitment transactions, in order to leverage the
Fund's portfolio. There can be no assurance that the Fund's leveraging
involving Preferred Shares or other strategies will be successful. Once the
Preferred Shares are issued or other forms of leverage are used, the net asset
value and market value of Common Shares will be more volatile, and the yield
and total return to Common Shareholders will tend to fluctuate more in response
to changes in interest rates and with changes in the short-term dividend rates
on the Preferred Shares. The Fund anticipates that the Preferred Shares, at
least initially, would likely pay cumulative dividends at rates determined over
relatively short-term periods (such as seven days), by providing for the
periodic redetermination of the dividend rate through an auction or remarketing
procedures. See "Description of Shares--Preferred Shares." If the dividend rate
on the Preferred Shares approaches the net rate of return on the Fund's
investment portfolio, the benefit of leverage to Common Shareholders will be
reduced. If the dividend rate on the Preferred Shares exceeds the net rate of
return on the Fund's portfolio, the leverage will result in a lower rate of
return to Common Shareholders than if the Fund were not leveraged. Although
there is a risk that fluctuations in the dividend rates on the Preferred Shares
or fluctuations in interest rates on other forms of leverage may adversely
affect the Fund's returns to Common Shareholders, it is expected that this risk
should be partially mitigated because the dividend rates on Preferred Shares
and the interest rates on the Fund's portfolio of Senior Loans and other debt
instruments will ordinarily vary in a similar manner. The Fund will pay (and
Common Shareholders will bear) any costs and expenses relating to the issuance
and ongoing maintenance of the Preferred Shares. The Fund cannot assure you
that it will issue Preferred Shares or use other forms of leverage or, if used,
that these strategies will result in a higher yield or return to Common
Shareholders.
Similarly, any decline in the net asset value of the Fund's investments
will be borne entirely by Common Shareholders. Therefore, if the market value
of the Fund's portfolio declines, any leverage will result in a greater
decrease in net asset value to Common Shareholders than if the Fund were not
leveraged. Such greater net asset value decrease will also tend to cause a
greater decline in the market price for the Common Shares. The Fund might be in
danger of failing to maintain the required 200% asset coverage or of losing its
expected AAA/Aaa ratings on the Preferred Shares or, in an extreme case, the
Fund's current investment income might not be sufficient to meet the dividend
requirements on the Preferred Shares. In order to counteract such an event, or
in order to meet its other obligations, including obligations under credit
default swaps, the Fund might need to liquidate investments in order to fund a
redemption of some or all of the Preferred Shares. Liquidation at times of low
debt obligation prices may result in capital loss and may reduce returns to
Common Shareholders.
Because the fees received by the Manager are based on the total managed
assets of the Fund (including assets attributable to any Preferred Shares and
other forms of leverage that may be outstanding), the Manager has a financial
incentive for the Fund to issue Preferred Shares and other forms of leverage,
which may create a conflict of interest between the Manager and the Common
Shareholders.
ISSUER RISK
The value of floating rate and other debt instruments may decline for a
number of reasons which directly relate to the issuer, such as management
performance, financial leverage and reduced demand for the issuer's goods and
services.
VARIABLE DIVIDEND RISK
Because most of the debt instruments held by the Fund will have variable
interest rates, the amounts of the Fund's monthly distributions to common
shareholders are expected to vary with fluctuations in market
38
interest rates. Generally, when market interest rates fall, the amount of the
distributions to common shareholders will likewise decrease.
SMALLER COMPANY RISK
The Fund may invest in smaller companies. The general risks associated
with floating rate and other debt instruments are particularly pronounced for
securities issued by companies with smaller market capitalizations. These
companies may have limited product lines, markets or financial resources or
they may depend on a few key employees. As a result, they may be subject to
greater levels of credit, market and issuer risk. Securities of smaller
companies may trade less frequently and in lesser volume than more widely held
securities and their values may fluctuate more sharply than other securities.
Companies with medium-sized market capitalizations may have risks similar to
those of smaller companies.
MANAGEMENT RISK
The Fund is subject to management risk because it is an actively managed
investment portfolio. PIMCO and the individual portfolio managers will apply
investment techniques and risk analyses in making investment decisions for the
Fund, but there can be no guarantee that these will produce the desired results.
FOREIGN (NON-U.S.) INVESTMENT RISK
The Fund may invest some or all of its assets in U.S. dollar-denominated
debt obligations of foreign issuers or supra-national government agencies. The
Fund may invest up to 25% of its total assets in debt instruments denominated
in foreign currencies, including obligations of non-U.S. governments and their
respective sub-divisions, agencies and government-sponsored enterprises. The
Fund's investments in foreign issuers and in securities denominated in foreign
currencies involve special risks. There may be less information publicly
available about a foreign issuer than about a U.S. issuer, and foreign issuers
are not generally subject to accounting, auditing and financial reporting
standards and practices comparable to those in the United States. The
securities of some foreign issuers are less liquid and at times more volatile
than securities of comparable U.S. issuers. Foreign brokerage costs, custodial
expenses and other fees are also generally higher than for securities traded in
the United States. With respect to certain foreign countries, there is also a
possibility of expropriation of assets, confiscatory taxation, political or
financial instability and diplomatic developments which could affect the value
of investments in those countries. In addition, income received by the Fund
from sources within foreign countries may be reduced by withholding and other
taxes imposed by such countries.
The value of securities denominated in foreign currencies may fluctuate
based on changes in the value of those currencies relative to the U.S. dollar,
and a decline in applicable foreign exchange rates could reduce the value of
such securities held by the Fund. The values of foreign investments and the
investment income derived from them also may be affected unfavorably by changes
in currency exchange control regulations. In addition, although a portion of
the Fund's investment income may be received or realized in foreign currencies,
the Fund will be required to compute and distribute its income in U.S. dollars.
Therefore, if the exchange rate for any such currency declines after the Fund's
income has been earned and translated into U.S. dollars but before payment, the
Fund could be required to liquidate portfolio securities to make such
distributions.
EMERGING MARKETS RISK
The Fund may invest up to 10% of its total assets in debt securities of
issuers located in emerging markets. Foreign investment risk may be
particularly high to the extent that the Fund invests in securities of issuers
based in or securities denominated in the currencies of emerging market
countries. These securities may present market, credit, currency, liquidity,
legal, political and other risks different from, and greater than, the risks of
investing in developed foreign countries. Investing in securities of issuers
based in underdeveloped emerging markets entails all of the risks of investing
in securities of foreign issuers to a heightened degree. These
39
heightened risks include: (i) greater risks of expropriation, confiscatory
taxation, nationalization and less social, political and economic stability;
(ii) the smaller size of the market for such securities and a lower volume of
trading, resulting in lack of liquidity and in price volatility; and (iii)
certain national policies which may restrict the Fund's investment
opportunities, including restrictions on investing in issuers or industries
deemed sensitive to relevant national interests.
DERIVATIVES RISK
Derivatives are financial contracts whose value depends on, or is derived
from, the value of an underlying asset, reference rate or index (or
relationship between two indexes). The Fund may invest in a variety of
derivative instruments for hedging or risk management purposes or as part of
its investment strategies, such as options contracts (including options on
futures contracts), futures contracts, swap agreements (including total return
and credit-default swaps) and short sales. The Fund may also have exposure to
derivatives, such as interest rate or credit default swaps, through investment
in credit-linked trust certificates and other securities issued by special
purpose or structured vehicles. The Fund may use derivatives as a substitute
for taking a position in an underlying debt instrument or other asset and/or as
part of a strategy designed to reduce exposure to other risks, such as interest
rate or currency risk. The Fund also may use derivatives to add leverage to the
portfolio, but only as a substitute for leverage obtained through Preferred
Shares. The Fund's use of derivative instruments involves risks different from,
and possibly greater than, the risks associated with investing directly in
securities and other traditional investments. Derivatives are subject to a
number of risks described elsewhere in this prospectus, such as liquidity risk,
interest rate risk, issuer risk, credit risk, leveraging risk, counterparty
risk, management risk and, if applicable, smaller company risk. They also
involve the risk of mispricing or improper valuation, the risk of ambiguous
documentation, and the risk that changes in the value of the derivative may not
correlate perfectly with the underlying asset, rate or index. If the Fund
invests in a derivative instrument, it could lose more than the principal
amount invested. Also, suitable derivative transactions may not be available in
all circumstances and there can be no assurance that the Fund will engage in
these transactions to reduce exposure to other risks when that would be
beneficial. In addition, the Fund may be subject to certain restrictions on its
use of derivative strategies imposed by guidelines of one or more rating
agencies that may issue ratings for Preferred Shares issued by the Fund. The
use of derivatives also may increase the amount of taxes payable by
shareholders. In addition to the risks applicable to derivatives generally,
credit default swaps involve special risks because they are difficult to value,
are highly susceptible to liquidity and credit risk, and generally pay a return
to the party that has paid the premium only in the event of an actual default
by the issuer of the underlying obligation (as opposed to a credit downgrade or
other indication of financial difficulty).
COUNTERPARTY RISK
In addition to credit risk with respect to the counterparties to the
Senior Loans in which the Fund invests, the Fund will also be subject to credit
risk with respect to the derivative contracts entered into directly by the Fund
or held by special purpose or structured vehicles in which the Fund invests. If
a counterparty becomes bankrupt or otherwise fails to perform its obligations
due to financial difficulties, the Fund may experience significant delays in
obtaining any recovery in a bankruptcy or other reorganization proceeding. The
Fund may obtain only a limited recovery or may obtain no recovery in such
circumstances.
MORTGAGE-RELATED AND ASSET-BACKED RISK
The Fund may invest in a variety of mortgage-related securities,
including commercial mortgage securities and other mortgage-backed instruments.
Generally, rising interest rates tend to extend the duration of fixed-rate
mortgage-related securities, making them more sensitive to changes in interest
rates. As a result, in a period of rising interest rates, mortgage-related
securities held by the Fund may exhibit additional volatility. This is known as
extension risk. PIMCO expects the Fund's policy of investing principally in
floating rate mortgage-related and other asset-backed securities will minimize
the Fund's overall sensitivity to interest rate volatility and extension risk.
However, because interest rates on most adjustable rate mortgage- and other
asset-backed
40
securities typically only reset periodically (e.g., monthly or quarterly),
changes in prevailing interest rates (and particularly sudden and significant
changes) can be expected to cause some fluctuation in the market value of these
securities, including declines in market value as interest rates rise. In
addition, adjustable and fixed-rate mortgage-related securities are subject to
prepayment risk--the risk that borrowers may pay off their mortgages sooner
than expected, particularly when interest rates decline. This can reduce the
Fund's returns because the Fund may have to reinvest that money at lower
prevailing interest rates. The Fund's investments in other asset-backed
securities are subject to risks similar to those associated with
mortgage-related securities, as well as additional risks associated with the
nature of the assets and the servicing of those assets.
RISK OF INVESTING IN REITS
Like other mortgage-related securities, REITs are subject to interest
rate risk and prepayment risk. Investing in REITs also involves certain unique
risks in addition to those risks associated with investing in the real estate
industry in general. An equity REIT may be affected by changes in the value of
the underlying properties owned by the REIT. A mortgage REIT may be affected by
changes in interest rates and the ability of the issuers of its portfolio
mortgages to repay their obligations. REITs are dependent upon the skills of
their managers and are not diversified. REITs are generally dependent upon
maintaining cash flows to repay borrowings and to make distributions to
shareholders and are subject to the risk of default by lessees or borrowers.
REITs whose underlying assets are concentrated in properties used by a
particular industry, such as health care, are also subject to risks associated
with such industry.
REITs may have limited financial resources, may trade less frequently and
in a limited volume and may be subject to more abrupt or erratic price
movements than larger company securities. Historically, REITs have been more
volatile in price than the larger capitalization stocks included in Standard &
Poor's 500 Stock Index.
INTEREST RATE RISK
Generally, when market interest rates rise, the prices of debt
obligations (and particularly fixed-rate obligations) fall, and vice versa.
This interest rate risk is the risk that the debt obligations in the Fund's
portfolio will decline in value because of increases in market interest rates.
The prices of short-term floating rate debt obligations generally fluctuate
less than prices of long-term debt obligations as interest rates change.
Because the Fund will normally have a short portfolio duration (I.E., a zero to
one-year time frame), the Common Share net asset value and market price per
share will tend to fluctuate less in response to changes in market interest
rates than if the Fund invested mainly in long-term debt securities. Although
the Fund's net asset value will vary, PIMCO expects the Fund's policy of
investing principally in floating rate debt instruments will substantially
reduce the Fund's overall sensitivity to market interest rate fluctuations.
However, because rates on certain floating rate debt instruments typically only
reset periodically (e.g., monthly or quarterly), changes in prevailing interest
rates (and particularly sudden and significant changes) can be expected to
cause some fluctuation in the Fund's net asset value. Moreover, up to 20% of
the Fund's net assets (plus any borrowings for investment purposes) may be
invested in debt instruments with fixed rates of interest, which will generally
lose value in direct response to rising interest rates. The Fund's use of
leverage, as described below, will tend to increase Common Share interest rate
risk.
REINVESTMENT RISK
Reinvestment risk is the risk that income from the Fund's portfolio will
decline if and when the Fund invests the proceeds from prepaid, matured, traded
or called debt obligations at market interest rates that are below the
portfolio's current earnings rate. A decline in income could affect the Common
Shares' market price or their overall returns.
41
INFLATION/DEFLATION RISK
Inflation risk is the risk that the value of assets or income from the
Fund's investments will be worth less in the future as inflation decreases the
value of money. As inflation increases, the real, or inflation-adjusted, value
of the Common Shares and distributions can decline and the dividend payments on
the Fund's Preferred Shares, if any, or interest payments on Fund borrowings,
if any, may increase. Deflation risk is the risk that prices throughout the
economy decline over time--the opposite of inflation. Deflation may have an
adverse effect on the creditworthiness of issuers and may make issuer default
more likely, which may result in a decline in the value of the Fund's portfolio.
REGULATORY CHANGES
To the extent that legislation or state or federal bank or other
regulators impose additional requirements or restrictions on the ability of
certain financial institutions to make loans, particularly in connection with
highly leverage transactions, the availability of Senior Loans and other
related investments sought after by the Fund may be reduced. Further, such
legislation or regulation could depress the market value of Senior Loans and
other instruments held by the Fund.
MARKET DISRUPTION AND GEOPOLITICAL RISK
The war with Iraq, its aftermath and the continuing occupation of Iraq is
likely to have a substantial impact on the U.S. and world economies and
securities markets. The nature, scope and duration of the war and occupation
cannot be predicted with any certainty. Terrorist attacks on the World Trade
Center and the Pentagon on September 11, 2001 closed some of the U.S.
securities markets for a four-day period and similar events cannot be ruled
out. The war and occupation, terrorism and related geopolitical risks have led,
and may in the future lead to, increased short-term market volatility and may
have adverse long-term effects on U.S. and world economies and markets
generally. Those events could also have an acute effect on individual issuers
or related groups of issuers. These risks could also adversely affect
individual issuers and securities markets, interest rates, auctions, secondary
trading, ratings, credit risk, inflation, deflation and other factors relating
to the Common Shares.
CERTAIN AFFILIATIONS
Certain broker-dealers may be considered to be affiliated persons of the
Fund, the Manager and/or PIMCO due to their possible affiliations with Allianz
AG, the ultimate parent of the Manager and PIMCO. Absent an exemption from the
Securities and Exchange Commission or other regulatory relief, the Fund is
generally precluded from effecting certain principal transactions with
affiliated brokers, and its ability to purchase securities being underwritten
by an affiliated broker or a syndicate including an affiliated broker, or to
utilize affiliated brokers for agency transactions, is subject to restrictions.
This could limit the Fund's ability to engage in securities transactions and
take advantage of market opportunities. In addition, unless and until the
underwriting syndicate is broken in connection with the initial public offering
of the Common Shares, the Fund will be precluded from effecting principal
transactions with brokers who are members of the syndicate.
ANTI-TAKEOVER PROVISIONS
The Fund's Amended and Restated Agreement and Declaration of Trust (the
"Declaration") includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or convert the Fund to
open-end status. See "Anti-Takeover and Other Provisions in the Declaration of
Trust." These provisions could deprive the Common Shareholders of opportunities
to sell their Common Shares at a premium over the then current market price of
the Common Shares or at net asset value. In addition, if the Fund issues
Preferred Shares, the holders of the Preferred Shares will have voting rights
that could deprive the Common Shareholders of such opportunities.
42
HOW THE FUND MANAGES RISK
INVESTMENT LIMITATIONS
The Fund has adopted certain investment limitations designed to limit
investment risk and maintain portfolio diversification. These limitations (two
of which are listed below) are fundamental and may not be changed without the
approval of the holders of a majority of the outstanding Common Shares and, if
issued, Preferred Shares voting together as a single class, and the approval of
the holders of a majority of the Preferred Shares voting as a separate class.
The Fund may not:
. concentrate its investments in a particular "industry," as that term
is used in the 1940 Act and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to
time; and
. with respect to 75% of the Fund's total assets, purchase the
securities of any issuer, except securities issued or guaranteed by
the U.S. Government or any of its agencies or instrumentalities or
securities of other investment companies, if, as a result, (i) more
than 5% of the Fund's total assets would be invested in the
securities of that issuer, or (ii) the Fund would hold more than 10%
of the outstanding voting securities of that issuer.
The Fund would be deemed to "concentrate" its investments in a particular
industry if it invested more than 25% of its total assets in that industry. The
Fund's industry concentration policy does not preclude it from focusing
investments in issuers in a group of related industrial sectors (such as
different types of utilities).
The Fund may become subject to guidelines which are more limiting than
the investment restrictions set forth above and other restrictions set forth in
the Statement of Additional Information in order to obtain and maintain ratings
from Moody's, S&P and/or Fitch on the Preferred Shares that it intends to
issue. The Fund does not anticipate that such guidelines would have a material
adverse effect on the Fund's Common Shareholders or the Fund's ability to
achieve its investment objective. See "Investment Objective and Policies" and
"Investment Restrictions" in the Statement of Additional Information for
information about these guidelines and a complete list of the fundamental
investment policies of the Fund.
LIMITED ISSUANCE OF PREFERRED SHARES
Under the 1940 Act, the Fund could issue Preferred Shares having a total
liquidation value (original purchase price of the shares being liquidated plus
any accrued and unpaid dividends) of up to one-half of the value of the total
assets of the Fund, less liabilities. To the extent that the Fund has
outstanding any senior securities representing indebtedness (such as through
the use of reverse repurchase agreements, credit default swaps and other
derivative instruments that constitute senior securities), the aggregate amount
of such senior securities will be added to the total liquidation value of any
outstanding Preferred Shares for purposes of this asset coverage requirement.
If the total liquidation value of the Preferred Shares plus the aggregate
amount of such other senior securities were ever more than one-half of the
value of the Fund's total net assets, the Fund would not be able to declare
dividends on the Common Shares until such liquidation value and/or aggregate
amount of other senior securities, as a percentage of the Fund's total assets,
were reduced. The Fund intends to issue Preferred Shares representing
approximately 38% of the Fund's total assets immediately after their issuance
approximately one to six months after the completion of the offering of Common
Shares. This higher than required margin of net asset value provides a cushion
against later fluctuations in the value of the Fund's portfolio and will
subject Common Shareholders to less income and net asset value volatility than
if the Fund were more highly leveraged through Preferred Shares. No assurance
can be given that this cushion will not be reduced or eliminated. The Fund
intends to purchase or redeem Preferred Shares, if necessary, to keep the
liquidation value of the Preferred Shares plus the aggregate amount of other
senior securities representing indebtedness below one-half of the value of the
Fund's total net assets.
43
MANAGEMENT OF INVESTMENT PORTFOLIO AND CAPITAL STRUCTURE TO LIMIT LEVERAGE RISK
The Fund may take certain actions if market conditions change (or the
Fund anticipates such change) and the Fund's leverage begins (or is expected)
to adversely affect Common Shareholders. In order to attempt to offset such a
negative impact of leverage on Common Shareholders, the Fund may invest in
short-term, high quality securities, implement certain hedging strategies or
extend the maturity of outstanding Preferred Shares. The Fund also may attempt
to reduce leverage by redeeming or otherwise purchasing Preferred Shares or by
reducing any holdings in other instruments that create leverage. As explained
under "Risks--Leverage Risk," the success of any such attempt to limit leverage
risk depends on PIMCO's ability to accurately predict interest rate or other
market changes. Because of the difficulty of making such predictions, the Fund
may not be successful in managing its exposure to risks in the manner described
above.
If market conditions suggest that additional leverage would be
beneficial, the Fund may sell previously unissued Preferred Shares or Preferred
Shares that the Fund previously issued but later repurchased. The Fund may also
leverage the portfolio by borrowing money, issuing debt securities or using
reverse repurchase agreements, loans of portfolio securities, credit default
swap contracts and other derivatives, as well as when-issued, delayed delivery
and forward commitment transactions. However, these forms of leverage will only
be used, if at all, as a substitute for, rather than in addition to, the
leverage obtained through the issuance of Preferred Shares. See "The Fund's
Investment Objective and Strategies--Portfolio Contents and Other Information."
HEDGING AND RELATED STRATEGIES
The Fund may use various investment strategies designed to limit the risk
of price fluctuations of its portfolio securities and to preserve capital. For
instance, the Fund may purchase credit default swap contracts for the purpose
of hedging the Fund's exposure to certain issuers and, thereby, decreasing its
exposure to credit risk. See "The Fund's Investment Objective and
Strategies--Credit Default Swaps" in this prospectus. Other hedging strategies
that the Fund may use include: financial futures contracts; short sales; other
types of swap agreements or options thereon; options on financial futures; and
options based on either an index or individual debt securities whose prices,
PIMCO believes, correlate with the prices of the Fund's investments. Income
earned by the Fund from many hedging activities will be treated as capital gain
and, if not offset by net realized capital loss, will be distributed to
shareholders in taxable distributions. If effectively used, hedging strategies
will offset in varying percentages losses incurred on the Fund's investments
due to adverse changes involving issuers or economic conditions. There is no
assurance that these hedging strategies will be available at any time or that
PIMCO will determine to use them for the Fund or, if used, that the strategies
will be successful. In addition, the Fund may be subject to certain
restrictions on its use of hedging strategies imposed by guidelines of one or
more rating agencies that may issue ratings for Preferred Shares issued by the
Fund.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The Board of Trustees is responsible for the management of the Fund,
including supervision of the duties performed by the Manager and PIMCO. There
will be five Trustees of the Fund at the time of the offering, one of whom will
be treated by the Fund as an "interested person" (as defined in the 1940 Act).
The names and business addresses of the Trustees and officers of the Fund and
their principal occupations and other affiliations during the past five years
are set forth under "Management of the Fund" in the Statement of Additional
Information.
44
INVESTMENT MANAGER
The Manager serves as the investment manager of the Fund. Subject to the
supervision of the Board of Trustees, the Manager is responsible for managing,
either directly or through others selected by it, the investment activities of
the Fund and the Fund's business affairs and other administrative matters. The
Manager is located at 1345 Avenue of the Americas, New York, New York 10105.
Organized in 2000 as a subsidiary successor of a business originally
organized in 1987, the Manager provides investment management and advisory
services to a number of closed-end and open-end investment company clients. As
of June 30, 2003, the Manager had approximately $23.7 billion in assets under
management. Allianz Dresdner Asset Management of America L.P. is the direct
parent company of PIMCO Advisors Retail Holdings LLC, of which the Manager is a
wholly-owned subsidiary. As of June 30, 2003, Allianz Dresdner Asset Management
of America L.P. and its subsidiaries, including PIMCO, had approximately $404
billion in assets under management.
The Manager has retained its affiliate, PIMCO, to manage the Fund's
investments. See "Portfolio Manager" below. The Manager and PIMCO are each
majority-owned indirect subsidiaries of Allianz AG, a publicly traded German
insurance and financial services company.
PORTFOLIO MANAGER
PIMCO serves as the portfolio manager for the Fund. Subject to the
supervision of the Manager, PIMCO has full investment discretion and makes all
determinations with respect to the investment of the Fund's assets.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California
92660. Organized in 1971, PIMCO provides investment management and advisory
services to private accounts of institutional and individual clients and to
mutual funds. As of June 30, 2003, PIMCO had approximately $349 billion in
assets under management.
The Manager (and not the Fund) will pay a portion of the fees it receives
to PIMCO in return for PIMCO's services. For the period from the commencement
of Fund operations through August 31, 2008 (i.e., roughly the first five years
of Fund operations), the fee will be paid monthly at the annual rate of .39% of
the Fund's average weekly total managed assets, provided, however, that the
amounts payable for each month shall be reduced to reflect that PIMCO will bear
65% of the fees payable by the Manager to certain underwriters (other than
Merrill Lynch, Pierce, Fenner & Smith Incorporated) for such month as described
under "Underwriting." Beginning September 1, 2008 and thereafter, the Manager
will pay a monthly fee to PIMCO at the annual rate of .55% of the Fund's
average weekly total managed assets, provided, however, that the amounts
payable for each month shall be reduced by the amount of all fees payable by
the Manager to certain underwriters other than Merrill Lynch, Pierce, Fenner &
Smith Incorporated for such month as described under "Underwriting" (such that
the Manager retains from its management fee, on an annual basis, .05% of the
Fund's average weekly total managed assets, after having paid PIMCO and the
underwriters).
45
Bill Gross, a founder of PIMCO, serves as Managing Director and Chief
Investment Officer of PIMCO. In his role as Chief Investment Officer, he serves
as the head of the Investment Committee, which oversees setting investment
policy decisions, including duration positioning, yield curve management,
sector rotation, credit quality and overall portfolio composition, for all
PIMCO portfolios and strategies, including the Fund. The following individuals
at PIMCO share primary responsibility for the day-to-day portfolio management
of the Fund:
NAME SINCE RECENT PROFESSIONAL EXPERIENCE
---- ----- ------------------------------
Raymond G. Kennedy, CFA 2003 Mr. Kennedy is a Managing Director, portfolio manager
(Inception) and senior member of PIMCO's investment strategy
group. He also manages high yield funds and oversees
bank loan trading and collateralized debt obligations.
Mr. Kennedy joined PIMCO in 1996, having previously
been associated with the Prudential Insurance Company
of America as a private placement asset manager, where
he was responsible for investing and managing a
portfolio of investment grade and high yield privately-
placed fixed income securities. Prior to that, he was a
consultant for Arthur Andersen in Los Angeles and
London. He has 16 years of investment management
experience and holds a bachelor's degree from Stanford
University and an MBA from the Anderson Graduate
School of Management at the University of California,
Los Angeles. Mr. Kennedy is also a member of LSTA.
David C. Hinman, CFA 2003 Mr. Hinman is an Executive Vice President and portfolio
(Inception) manager at PIMCO. He focuses on high yield corporate
bonds and co-manages high yield funds and structured-
credit products at PIMCO. He joined PIMCO in 1995,
having been previously associated with Merrill Lynch &
Co. in New York where he underwrote high yield
corporate bonds. Prior to that, he was a credit analyst
with First Union Corporation. Mr. Hinman has 11 years
of investment management experience and holds a
bachelor's degree in Finance from the University of
Alabama and an MBA in Finance and Accounting from
The Wharton School at the University of Pennsylvania.
Jason R. Rosiak 2003 Mr. Rosiak is a Vice President and portfolio manager at
(Inception) PIMCO. He focuses on high yield corporate bonds and
bank loans, oversees the construction of PIMCO's
Structured Products and manages a trade desk research
group. He joined PIMCO in 1996, having been
previously associated with Bankers Trust NA, where he
worked in their mortgage-backed securities division. He
has 8 years of investment management experience and
holds a bachelor's degree in Economics from the
University of California, Los Angeles and an MBA from
the Marshall School of Business at the University of
Southern California.
Mr. Kennedy oversees Messrs. Hinman and Rosiak regarding the management
of the Fund.
46
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between the Manager and
the Fund (the "Investment Management Agreement"), the Fund has agreed to pay
the Manager an annual management fee payable on a monthly basis at the annual
rate of .75% of the Fund's average weekly total managed assets (including
assets attributable to Preferred Shares and any other forms of leverage that
may be outstanding) for the services and facilities it provides.
In addition to the fees of the Manager, the Fund pays all other costs and
expenses of its operations, including compensation of its Trustees (other than
those affiliated with the Manager), custodial expenses, shareholder servicing
expenses, transfer agency and dividend disbursing expenses, legal fees,
expenses of independent auditors, expenses of repurchasing shares, expenses of
issuing any Preferred Shares, expenses of preparing, printing and distributing
prospectuses, shareholder reports, notices, proxy statements and reports to
governmental agencies, and taxes, if any.
Because the fees received by the Manager are based on the total managed
assets of the Fund (including assets attributable to Preferred Shares and any
other forms of leverage outstanding), the Manager has a financial incentive for
the Fund to issue Preferred Shares and other forms of leverage, which may
create a conflict of interest between the Manager and the holders of the Fund's
Common Shares.
NET ASSET VALUE
The net asset value ("NAV") of the Fund equals the total value of the
Fund's portfolio investments and other assets, less any liabilities. For
purposes of calculating NAV, portfolio securities and other assets for which
market quotes are available are stated at market value. Market value is
generally determined on the basis of the last reported sales price or, if
available, the closing price reported for an issue traded on an
over-the-counter stock market (including the NASDAQ Official Closing Price for
NASD traded securities), or if no sales or closing prices are reported, based
on quotes obtained from a quotation reporting system, established market makers
or pricing services. Certain securities or investments for which market
quotations are not readily available (such as most Senior Loans) may be valued,
pursuant to guidelines established by the Board of Trustees, with reference to
other securities or indexes. For instance, a pricing service may recommend a
fair market value based on prices of comparable securities. Short-term
investments having a maturity of 60 days or less are generally valued at
amortized cost. Exchange traded options, futures and options on futures are
valued at the settlement price determined by the exchange. Other securities for
which market quotes are not readily available are valued at fair value as
determined in good faith by the Board of Trustees or persons acting at their
direction.
The NAV of the Fund will be determined weekly, generally on the last day
of the week that the New York Stock Exchange is open for trading, as of the
close of regular trading on the New York Stock Exchange that day (normally 4:00
p.m., Eastern time) (the "NYSE Close"). Domestic debt securities and foreign
securities are normally priced using data reflecting the earlier closing of the
principal markets for those securities. Information that becomes known to the
Fund or its agent after the Fund's NAV has been calculated on a particular day
will not be used to retroactively adjust the price of a security or the Fund's
NAV determined earlier that day.
Investments initially valued in currencies other than the U.S. dollar are
converted to U.S. dollars using exchange rates obtained from pricing services.
As a result, the NAV of the Fund's shares may be affected by changes in the
value of currencies in relation to the U.S. dollar. The value of securities
traded in markets outside the United States or denominated in currencies other
than the U.S. dollar may be affected significantly on a day that the New York
Stock Exchange is closed.
47
In unusual circumstances, instead of valuing securities in the usual
manner, the Fund may value securities at fair value as determined in good faith
by the Board of Trustees, generally based upon recommendations provided by
PIMCO. Fair valuation also may be required due to material events that occur
after the close of the relevant market but prior to the NYSE Close.
DISTRIBUTIONS
Commencing with the Fund's first dividend, the Fund intends to make
regular monthly cash distributions to Common Shareholders at a variable rate
based upon the performance of the Fund and income accrual. Distributions can
only be made from net investment income after paying any accrued dividends to
Preferred Shareholders. The dividend rate that the Fund pays on its Common
Shares will depend on a number of factors, including the variable rate of
interest received on the Fund's portfolio, dividends payable on the Preferred
Shares and the expenses of any other leveraging transactions. Because most of
the Fund's debt securities will have variable interest rates, the amount of the
Fund's monthly distributions to Common Shareholders is expected to vary with
fluctuations in market interest rates. Although there is a risk that
fluctuations in the dividend rates on Preferred Shares may adversely affect the
return to Common Shareholders, PIMCO believes that this should be mitigated
when the Fund uses leverage with floating rate costs, because dividend rates on
the Preferred Shares and the interest rate on the Fund's portfolio of Senior
Loans and other floating rate debt instruments will ordinarily vary in a
similar manner. The net income of the Fund consists of all income paid or
accrued on portfolio assets less all expenses of the Fund. Expenses of the Fund
are accrued each day. Over time, substantially all the net investment income of
the Fund will be distributed. At least annually, the Fund also intends to
distribute to you your pro rata share of any available net capital gain.
Initial distributions to Common Shareholders are expected to be declared
approximately 45 days, and paid approximately 60 to 90 days, from the
completion of this offering, depending on 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 investment income and the amount of the expenses
and dividend rates on any outstanding Preferred Shares.
To permit the Fund to maintain a more stable relationship between its
monthly distributions and the variable rates of interest it receives on its
investment portfolio, the Fund may 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. Unless you elect to receive
distributions in cash, all of your distributions will be automatically
reinvested in additional Common Shares under the Fund's Dividend Reinvestment
Plan. See "Dividend Reinvestment Plan."
DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Dividend Reinvestment Plan (the "Plan"), all
Common Shareholders whose shares are registered in their own names will have
all dividends, including any capital gain dividends, reinvested automatically
in additional Common Shares by PFPC Inc., as agent for the Common Shareholders
(the "Plan Agent"), unless the shareholder elects to receive cash. An election
to receive cash may be revoked or reinstated at the option of the shareholder.
In the case of record shareholders such as banks, brokers or other nominees
that hold Common Shares for others who are the beneficial owners, the Plan
Agent will administer the Plan on the basis of the number of Common Shares
certified from time to time by the record shareholder as representing the
48
total amount registered in such shareholder's name and held for the account of
beneficial owners who are to participate in the Plan. Shareholders whose shares
are held in the name of a bank, broker or nominee should contact the bank,
broker or nominee for details. Such shareholders may not be able to transfer
their shares to another bank or broker and continue to participate in the Plan.
All distributions to investors who elect not to participate in the Plan (or
whose broker or nominee elects not to participate on the investor's behalf)
will be paid in cash by check mailed, in the case of direct shareholders, to
the record holder by PFPC Inc., as the Fund's dividend disbursement agent.
Unless you elect (or your broker or nominee elects) not to participate in
the Plan, the number of Common Shares you will receive will be determined as
follows:
. If Common Shares are trading at or above net asset value on the
payment date, the Fund will issue new shares at the greater of (i)
the net asset value per Common Share on the payment date or (ii) 95%
of the market price per Common Share on the payment date; or
. If Common Shares are trading below net asset value (minus estimated
brokerage commissions that would be incurred upon the purchase of
Common Shares on the open market) on the payment date, the Plan Agent
will receive the dividend or distribution in cash and will purchase
Common Shares in the open market, on the New York Stock Exchange or
elsewhere, for the participants' accounts. It is possible that the
market price for the Common Shares may increase before the Plan Agent
has completed its purchases. Therefore, the average purchase price
per share paid by the Plan Agent may exceed the market price on the
payment date, resulting in the purchase of fewer shares than if the
dividend or distribution had been paid in Common Shares issued by the
Fund. The Plan Agent will use all dividends and distributions
received in cash to purchase Common Shares in the open market on or
shortly after the payment date, but in no event later than the
ex-dividend date for the next distribution. Interest will not be paid
on any uninvested cash payments.
You may withdraw from the Plan at any time by giving written notice to
the Plan Agent. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you
wish, the Plan Agent will sell your shares and send you the proceeds, minus
brokerage commissions.
The Plan Agent maintains all shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. The Plan Agent will also furnish each person who
buys Common Shares with written instructions detailing the procedures for
electing not to participate in the Plan and to instead receive distributions in
cash. Common Shares in your account will be held by the Plan Agent in
non-certificated form. Any proxy you receive will include all Common Shares you
have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or
distributions in Common Shares. However, all participants will pay a pro rata
share of brokerage commissions incurred by the Plan Agent when it makes open
market purchases.
Automatically reinvested dividends and distributions are taxed in the
same manner as cash dividends and distributions.
The Fund and the Plan Agent reserve the right to amend or terminate the
Plan. There is no direct service charge to participants in the Plan; however,
the Fund reserves the right to amend the Plan to include a service charge
payable by the participants. Additional information about the Plan may be
obtained from PFPC Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809,
telephone number 1-800-331-1710.
49
DESCRIPTION OF SHARES
COMMON SHARES
The Declaration authorizes the issuance of an unlimited number of Common
Shares. The Common Shares will be issued with a par value of $.00001 per share.
All Common Shares have equal rights to the payment of dividends and the
distribution of assets upon liquidation. Common Shares will, when issued, be
fully paid and, subject to matters discussed in "Anti-Takeover and Other
Provisions in the Declaration of Trust," non-assessable, and will have no
pre-emptive or conversion rights or rights to cumulative voting. Whenever
Preferred Shares are outstanding, Common Shareholders will not be entitled to
receive any distributions from the Fund unless all accrued dividends on
Preferred Shares have been paid, and unless asset coverage (as defined in the
1940 Act) with respect to Preferred Shares would be at least 200% after giving
effect to the distributions. See "Preferred Shares" below.
The Common Shares are expected to be listed on the New York Stock
Exchange. 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.
Net asset value will be reduced immediately following the offering by the
amount of the sales load and organization and offering expenses paid by the
Fund. The Manager has agreed to pay (i) the amount by which the Fund's offering
costs (other than the sales load) exceed $.04 per Common Share and (ii) all of
the Fund's organizational expenses, except that the Fund has agreed to
reimburse the Manager for such organizational expenses to the extent that the
aggregate of all such organizational expenses and all offering costs (other
than the sales load, but inclusive of the reimbursement of underwriter expenses
of $.00667 per Common Share) does not exceed $.04 per Common Share.
Unlike open-end funds, closed-end funds like the Fund do not continuously
offer shares and do not provide daily redemptions. Rather, if a shareholder
determines to buy additional Common Shares or sell shares already held, the
shareholder may do so by trading on the exchange through a broker or otherwise.
Shares of closed-end investment companies may frequently trade on an exchange
at prices lower than net asset value. Shares of closed-end investment companies
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. The
Fund's Declaration limits the ability of the Fund to convert to open-end
status. See "Anti-Takeover and Other Provisions in the Declaration of Trust."
Because the market value of the Common Shares may be influenced by such
factors as dividend levels (which are in turn affected by changes in the
floating rates of interest in the Fund's investments and expenses), call
protection, 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 the Common Shares will trade at a price equal to or higher than net asset
value in the future. 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 "Preferred Shares and Related Leverage" and
the Statement of Additional Information under "Repurchase of Common Shares;
Conversion to Open-End Fund."
PREFERRED SHARES
The Declaration authorizes the issuance of an unlimited number of
Preferred Shares. The Preferred Shares may be issued in one or more classes or
series, with such par value and rights as determined by the Board of Trustees,
by action of the Board of Trustees without the approval of the Common
Shareholders.
The Fund's Board of Trustees has indicated its intention to authorize an
offering of Preferred Shares, representing approximately 38% of the Fund's
total assets immediately after the time the Preferred Shares are issued,
approximately one to six months after completion of the offering of Common
Shares. Any such decision
50
is subject to market conditions and to the Board's continuing belief that
leveraging the Fund's capital structure through the issuance of Preferred
Shares is likely to achieve the benefits to the Common Shareholders described
in this prospectus. Although the terms of the Preferred Shares will be
determined by the Board of Trustees (subject to applicable law and the Fund's
Declaration) if and when it authorizes a Preferred Shares offering, the Board
has determined that the Preferred Shares, at least initially, would likely pay
cumulative dividends at rates determined over relatively short-term periods
(such as seven days), by providing for the periodic redetermination of the
dividend rate through an auction or remarketing procedure. The Board of
Trustees has indicated that the preference on distribution, liquidation
preference, voting rights and redemption provisions of the Preferred Shares
will likely be as stated below.
As used in this prospectus, unless otherwise noted, the Fund's "net
assets" include assets of the Fund attributable to any outstanding Preferred
Shares, with no deduction for the liquidation preference of the Preferred
Shares. Solely for financial reporting purposes, however, the Fund is required
to exclude the liquidation preference of Preferred Shares from "net assets," so
long as the Preferred Shares have redemption features that are not solely
within the control of the Fund. For all regulatory and tax purposes, the Fund's
Preferred Shares will be treated as stock (rather than indebtedness).
LIMITED ISSUANCE OF PREFERRED SHARES
Under the 1940 Act, the Fund could issue Preferred Shares with an
aggregate liquidation value of up to one-half of the value of the Fund's total
net assets (total assets less all liabilities and indebtedness not represented
by "senior securities," as defined in the 1940 Act), measured immediately after
issuance of the Preferred 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
Preferred 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. The liquidation value of the Preferred
Shares is expected to be approximately 38% of the value of the Fund's total net
assets. The Fund intends to purchase or redeem Preferred Shares, if necessary,
to keep that fraction below one-half.
DISTRIBUTION PREFERENCE
The Preferred 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 Preferred 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 the Common Shareholders.
VOTING RIGHTS
Preferred Shares are required to be voting shares. Except as otherwise
provided in the Declaration or the Fund's Bylaws or otherwise required by
applicable law, holders of Preferred Shares will vote together with Common
Shareholders as a single class.
Holders of Preferred Shares, voting as a separate class, will also be
entitled to elect two of the Fund's Trustees. The remaining Trustees will be
elected by Common Shareholders and holders of Preferred Shares, voting together
as a single class. In the unlikely event that two full years of accrued
dividends are unpaid on the Preferred Shares, the holders of all outstanding
Preferred Shares, voting as a separate class, will be entitled to
51
elect a majority of the Fund's Trustees until all dividends in arrears have
been paid or declared and set apart for payment.
REDEMPTION, PURCHASE AND SALE OF PREFERRED SHARES
The terms of the Preferred Shares may provide that they are redeemable at
certain times, in whole or in part, at the original purchase price per share
plus accumulated dividends. The terms also may state that the Fund may tender
for or purchase Preferred Shares and resell any shares so tendered. Any
redemption or purchase of Preferred Shares by the Fund will reduce the leverage
applicable to Common Shares, while any resale of Preferred Shares by the Fund
will increase such leverage. See "Preferred Shares and Related Leverage."
The discussion above describes the Board of Trustees' present intention
with respect to a possible offering of Preferred Shares. If the Board of
Trustees determines to authorize such an offering, the terms of the Preferred
Shares may be the same as, or different from, the terms described above,
subject to applicable law and the Fund's Declaration and Bylaws.
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
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. The Fund's Trustees are divided into three classes. At each
annual meeting of shareholders, the term of one class will expire and each
Trustee elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the
outstanding shares of the classes or series of shares entitled to vote for the
election of such Trustee, or (ii) by at least seventy-five percent (75%) of the
remaining Trustees.
As described below, the Declaration grants special approval rights with
respect to certain matters to members of the Board who qualify as "Continuing
Trustees," which term means a Trustee who either (i) has been a member of the
Board for a period of at least thirty-six months (or since the commencement of
the Fund's operations, if less than thirty-six months) or (ii) was nominated to
serve as a member of the Board of Trustees by a majority of the Continuing
Trustees then members of the Board.
The Declaration requires the affirmative vote or consent of at least
seventy-five percent (75%) of the Board of Trustees and holders of at least
seventy-five percent (75%) of the Fund's shares (including Common and Preferred
Shares) to authorize certain Fund transactions not in the ordinary course of
business, including a merger or consolidation, issuance or transfer by the Fund
of the Fund's shares (except as may be pursuant to a public offering, the
Fund's dividend reinvestment plan or upon exercise of any stock subscription
rights), a sale, transfer or other disposition of Fund assets, or any
shareholder proposal regarding specific investment decisions, unless the
transaction is authorized by both a majority of the Trustees and seventy-five
percent (75%) of the Continuing Trustees (in which case no shareholder
authorization would be required by the Declaration, but may be required in
certain cases under the 1940 Act). The Declaration also requires the
affirmative vote or consent of holders of at least seventy-five percent (75%)
of each class of the Fund's shares entitled to vote on the matter to authorize
a conversion of the Fund from a closed-end to an open-end investment company,
unless the conversion is authorized by both a majority of the Trustees and
seventy-five percent (75%) of the Continuing Trustees (in which case
shareholders would have only the minimum voting rights required by the 1940 Act
with respect to the conversion). Also, the Declaration provides that the Fund
may be terminated at any time by vote or consent of at least seventy-five
percent (75%) of the Fund's shares or, alternatively, by vote or consent of
both a majority of the Trustees and seventy-five percent (75%) of the
Continuing Trustees. See "Anti-Takeover and Other Provisions in the Declaration
of Trust" in the Statement of Additional Information for a more detailed
summary of these provisions.
52
The Trustees may from time to time grant other voting rights to
shareholders with respect to these and other matters in the Fund's Bylaws.
The overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control of the Fund 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
objective and policies. 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 the then current market price of the
Common Shares by discouraging a third party from seeking to obtain control of
the Fund in a tender offer or similar transaction. 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.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's
Bylaws, both of which are on file with the Securities and Exchange Commission.
Under Massachusetts law, shareholders could, in 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.
REPURCHASE OF COMMON 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
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
changes in the floating rates of interest on the Fund's investments and
expenses), net asset value, call protection, portfolio credit quality, relative
demand for and supply of such shares in the market, general market and economic
conditions, conditions affecting individual issuers and other factors. Shares
of a closed-end investment company may frequently trade at prices lower than
net asset value. The Fund's Board of Trustees regularly monitors the
relationship between the market price and net asset value of the Common Shares.
If the Common Shares were to trade at a substantial discount to net asset value
for an extended period of time, the Board may consider the repurchase of its
Common Shares on the open market or in private transactions, the making of a
tender offer for such shares, or the conversion of the Fund to an open-end
investment company. The Fund cannot assure you that its Board of Trustees will
decide to take or propose any of these actions, or that share repurchases or
tender offers will actually reduce market discount.
If the Fund were to convert to an open-end company, it would be required
to redeem all Preferred Shares then outstanding (requiring in turn that it
liquidate a portion of its investment portfolio), and the Common Shares would
no longer be listed on the New York Stock Exchange. In contrast to a closed-end
investment company, shareholders of an open-end investment company may require
the company to redeem their shares at any time (except in certain circumstances
as authorized by or under the 1940 Act) at their net asset value, less any
redemption charge that is in effect at the time of redemption.
Before deciding whether to take any action to convert the Fund to an
open-end investment company, the Board would consider all relevant factors,
including the extent and duration of the discount, the liquidity of the
53
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. See the Statement of Additional Information under "Repurchase
of Common Shares; Conversion to Open-End Fund" for a further discussion of
possible action to reduce or eliminate such discount to net asset value.
TAX MATTERS
FEDERAL INCOME TAX MATTERS
The following federal income tax discussion is based on the advice of
Ropes & Gray LLP, counsel to the Fund, and reflects provisions of the Internal
Revenue Code of 1986, as amended (the "Code"), existing Treasury regulations,
rulings published by the Internal Revenue Service (the "Service"), and other
applicable authority, as of the date of this prospectus. These authorities are
subject to change by legislative or administrative action, possibly with
retroactive effect. The following discussion is only a summary of some of the
important tax considerations generally applicable to investments in the Fund.
For more detailed information regarding tax considerations, see the Statement
of Additional Information. There may be other tax considerations applicable to
particular investors. In addition, income earned through an investment in the
Fund may be subject to state and local taxes.
The Fund intends to qualify each year for taxation as a regulated
investment company eligible for treatment under the provisions of Subchapter M
of the Code. If the Fund so qualifies and satisfies certain distribution
requirements, the Fund will not be subject to federal income tax on income
distributed in a timely manner to its shareholders in the form of dividends or
capital gain distributions.
To satisfy the distribution requirement applicable to regulated
investment companies, amounts paid as dividends by the Fund to its
shareholders, including holders of its Preferred Shares, must qualify for the
dividends-paid deduction. In certain circumstances, the Service could take the
position that dividends paid on the Preferred Shares constitute preferential
dividends under Section 562(c) of the Code, and thus do not qualify for the
dividends-paid deduction. The Fund believes this position, if asserted, would
be unlikely to prevail.
If at any time when Preferred Shares are outstanding the Fund does not
meet applicable asset coverage requirements, it will be required to suspend
distributions to Common Shareholders until the requisite asset coverage is
restored. Any such suspension may cause the Fund to pay a 4% federal excise tax
(imposed on regulated investment companies that fail to distribute for a given
calendar year, generally, at least 98% of their net investment income and
capital gain net income) and income tax on undistributed income or gains, and
may, in certain circumstances, prevent the Fund from qualifying for treatment
as a regulated investment company. The Fund may redeem or purchase Preferred
Shares in an effort to comply with the distribution requirement applicable to
regulated investment companies and to avoid income and excise taxes. The Fund
may have to dispose of portfolio securities to generate cash for such
redemptions, which may result in transaction expenses and gain at the Fund
level and in further distributions.
The Fund's investments in certain debt obligations may cause the Fund to
recognize taxable income in excess of the cash generated by such obligations.
Thus, the Fund could be required at times to liquidate other investments in
order to satisfy its distribution requirements.
For federal income tax purposes, distributions of investment income are
generally taxable as ordinary income. Taxes on distributions of capital gains
are determined by how long the Fund owned the investments that generated them,
rather than how long a shareholder has owned his or her shares. Distributions
of net capital gains from the sale of investments that the Fund owned for more
than one year and that are properly designated by the
54
Fund as capital gain dividends will be taxable as long-term capital gains.
Distributions of gains from the sale of investments that the Fund owned for one
year or less will be taxable as ordinary income.
For taxable years beginning on or before December 31, 2008, the Fund may
designate distributions of investment income derived from dividends of U.S.
corporations and some foreign corporations as "qualified dividend income,"
provided holding period and other requirements are met by the Fund. Qualified
dividend income will be taxed in the hands of individuals at the rates
applicable to long-term capital gain, provided the same holding period and
other requirements are met by the shareholder. Fund dividends representing
distributions of interest income and short-term capital gains cannot be
designated as qualified dividend income and will not qualify for the reduced
rates. In light of this, the Fund does not expect a significant portion of Fund
distributions to be derived from qualified dividend income.
Distributions are taxable to shareholders even if they are paid from
income or gains earned by the Fund before a shareholder's investment (and thus
were included in the price the shareholder paid). Distributions are taxable
whether shareholders receive them in cash or reinvest them in additional shares
through the Dividend Reinvestment Plan. Shareholders will be notified annually
as to the U.S. federal tax status of distributions. Any gain resulting from the
sale or exchange of Fund shares generally will be taxable as capital gains.
The long-term capital gain rates applicable to most shareholders will be
15% (with lower rates applying to taxpayers in the 10% and 15% ordinary income
tax brackets) for taxable years beginning on or before December 31, 2008.
The Fund's investments in foreign securities may be subject to foreign
withholding taxes. In that case, the Fund's yield on those securities would be
decreased. In addition, the Fund's investments in foreign securities or foreign
currencies may increase or accelerate the Fund's recognition of ordinary income
and may affect the timing or amount of the Fund's distributions.
Under current law, the backup withholding tax rate is 28% for amounts
paid through 2010 and will be 31% for amounts paid after December 31, 2010. The
Fund is required to apply backup withholding to certain taxable distributions
and redemption proceeds including, for example, distributions paid to any
individual shareholder who fails to properly furnish the Fund with a correct
taxpayer identification number. Please see "Tax Matters" in the Statement of
Additional Information for additional information about backup withholding.
This section relates only to federal income tax consequences of investing
in the Fund; the consequences under other tax laws may differ. You should
consult your tax advisor as to the possible application of foreign, state and
local income tax laws to Fund dividends and capital distributions. Please see
"Tax Matters" in the Statement of Additional Information for additional
information regarding the tax aspects of investing in the Fund.
55
UNDERWRITING
Subject to the terms and conditions stated in the Fund's purchase
agreement dated , 2003, each underwriter named below, for which Merrill
Lynch, Pierce, Fenner & Smith Incorporated and Wachovia Capital Markets, LLC
are acting as representatives, has severally agreed to purchase, and the Fund
has agreed to sell to such underwriter, the number of Common Shares set forth
opposite the name of such underwriter.
NUMBER OF
UNDERWRITER COMMON SHARES
----------- -------------
Merrill Lynch, Pierce, Fenner & Smith
Incorporated.......................
Wachovia Capital Markets, LLC...............
A.G. Edwards & Sons, Inc....................
RBC Dain Rauscher Inc.......................
Advest, Inc.................................
Robert W. Baird & Co. Incorporated..........
Crowell, Weedon & Co........................
Janney Montgomery Scott LLC.................
McDonald Investments Inc., a KeyCorp Company
TD Waterhouse Investor Services, Inc........
Wedbush Morgan Securities Inc...............
Quick & Reilly, Inc.........................
-------------
Total..............................
=============
The purchase agreement provides that the obligations of the underwriters
to purchase the shares included in this offering are subject to the approval of
certain legal matters by counsel and to certain other conditions. The
underwriters are obligated to purchase all the Common Shares sold under the
purchase agreement if any of the Common Shares are purchased. In the purchase
agreement, the Fund and the Manager have agreed to indemnify the underwriters
against certain liabilities, including certain liabilities arising under the
Securities Act of 1933, or to contribute to payments the underwriters may be
required to make for any of those liabilities.
The underwriters propose to initially offer some of the Common Shares
directly to the public at the public offering price set forth on the cover page
of this prospectus and some of the Common Shares to certain dealers at the
public offering price less a concession not in excess of $ per Common Share.
The sales load the Fund will pay of $.65 per Common Share is equal to 3.25% of
the initial offering price. The underwriters may allow, and the dealers may
reallow, a discount not in excess of $ per Common Share on sales to other
dealers. After the initial public offering, the public offering price,
concession and discount may be changed.
The following table shows the public offering price, sales load and
proceeds after estimated offering expenses to the Fund. The information assumes
either no exercise or full exercise by the underwriters of their overallotment
option.
PER SHARE WITHOUT OPTION WITH OPTION
--------- -------------- -----------
Public offering price...... $20.00 $ $
Sales load................. $.65 $ $
Estimated offering expenses $.04 $ $
Proceeds to the Fund....... $19.31 $ $
56
The expenses of the offering are estimated at $ and are payable by
the Fund. The Fund has agreed to pay the underwriters $.00667 per Common Share
as a partial reimbursement of expenses incurred in connection with the
offering. The Manager has agreed to pay (i) the amount by which the Fund's
offering costs (other than the sales load) exceed $.04 per Common Share and
(ii) all of the Fund's organizational expenses, except that the Fund has agreed
to reimburse the Manager for such organizational expenses to the extent that
the aggregate of all such organizational expenses and all offering costs (other
than the sales load, but inclusive of the reimbursement of underwriter expenses
of $.00667 per Common Share) does not exceed $.04 per Common Share.
The Fund has granted the underwriters an option to purchase up to
additional Common Shares at the public offering price, less the sales load,
within 45 days from the date of this prospectus solely to cover any
overallotments. If the underwriters exercise this option, each will be
obligated, subject to conditions contained in the purchase agreement, to
purchase a number of additional shares proportionate to that underwriter's
initial amount reflected in the above table.
Until the distribution of the Common Shares is complete, Securities and
Exchange Commission rules may limit underwriters and selling group members from
bidding for and purchasing the Fund's Common Shares. However, the
representatives may engage in transactions that stabilize the price of the
Common Shares, such as bids or purchases to peg, fix or maintain that price.
If the underwriters create a short position in the Common Shares in
connection with the offering, I.E., if they sell more Common Shares than are
listed on the cover of this prospectus, the representatives may reduce that
short position by purchasing Common Shares in the open market. The
representatives may also elect to reduce any short position by exercising all
or part of the overallotment option described above. The underwriters may also
impose a penalty bid, whereby selling concessions allowed to syndicate members
or other broker-dealers in respect of the Common Shares sold in this offering
for their account may be reclaimed by the syndicate if such Common Shares are
repurchased by the syndicate in stabilizing or covering transactions. Purchases
of the Common Shares to stabilize the price or to reduce a short position may
cause the price of the Common Shares to be higher than it might be in the
absence of such purchases.
Neither the Fund nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Shares. In addition,
neither the Fund nor any of the underwriters makes any representation that the
representatives will engage in these transactions or that these transactions,
once commenced, will not be discontinued without notice.
The Fund has agreed not to offer or sell any additional Common Shares,
for a period of 180 days after the date of this prospectus without the prior
written consent of the underwriters except for the sale of the Common Shares to
the underwriters pursuant to the provisions of the purchase agreement and
certain transactions related to the Fund's Dividend Reinvestment Plan.
The Fund anticipates that the underwriters may from time to time act as
brokers or, after they have ceased to be underwriters, dealers in executing the
Fund's portfolio transactions. The underwriters are active underwriters of, and
dealers in, securities and act as market makers in a number of such securities,
and therefore can be expected to engage in portfolio transactions with the Fund.
The Common Shares will be sold to ensure that the New York Stock Exchange
distribution standards (round lots, public shares and aggregate market value)
will be met.
The Manager (and not the Fund) has also agreed to pay from its own assets
a fee to Merrill Lynch quarterly at the annual rate of .15% of the Fund's
average weekly total managed assets, such fee to be paid during the continuance
of the Investment Management Agreement and subject to the limitation below.
Merrill Lynch has agreed to provide certain after-market services to the
Manager designed to maintain the visibility of
57
the Fund on an ongoing basis and to provide relevant information, studies or
reports regarding the Fund and the closed-end investment company industry. In
addition, the Manager (and not the Fund) has agreed to pay from its own assets
to certain underwriters other than Merrill Lynch (each a "Qualifying
Underwriter") that meet certain sales targets established by the Manager (which
may be waived or reduced in the discretion of the Manager) a quarterly
incentive fee at the annual rate of up to .10% of the Fund's average weekly
total managed assets attributable to Common Shares (including a proportionate
share of assets attributable to any Preferred Shares and other forms of
leverage that may be outstanding) sold by such Qualifying Underwriters in this
offering, such fees to be payable during the continuance of the Investment
Management Agreement and subject to the limitation below. Under standards
imposed by the National Association of Securities Dealers, Inc., the sum of the
total amount of the fees payable to Merrill Lynch and the Qualifying
Underwriters as described in this paragraph and the expense reimbursement of
$.00667 per Common Share payable by the Fund to the underwriters may not exceed
4.5% of the aggregate initial offering price of the Common Shares offered
hereby. These fee payments will be made subject to this limitation.
The address of Merrill Lynch, Pierce, Fenner & Smith Incorporated is 4
World Financial Center, New York, New York 10080. The address of Wachovia
Capital Markets, LLC is 301 South College Street, Charlotte, North Carolina
28288.
CUSTODIAN AND TRANSFER AGENT
The custodian of the assets of the Fund is State Street Bank and Trust
Co., 801 Pennsylvania, Kansas City, Missouri 64105. The Custodian performs
custodial and fund accounting services.
PFPC Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as
the Fund's transfer agent, registrar, dividend disbursement agent and
shareholder servicing agent, as well as agent for the Fund's Dividend
Reinvestment Plan.
LEGAL MATTERS
Certain legal matters in connection with the Common Shares will be passed
upon for the Fund by Ropes & Gray LLP, Boston, Massachusetts, and for the
Underwriters by Clifford Chance US LLP, New York, New York. Clifford Chance US
LLP may rely as to certain matters of Massachusetts law on the opinion of
Ropes & Gray LLP.
58
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
PAGE
----
Use of Proceeds...................................................... 3
Investment Objective and Policies.................................... 3
Investment Restrictions.............................................. 48
Management of the Fund............................................... 50
Investment Manager and Portfolio Manager............................. 61
Portfolio Transactions............................................... 66
Distributions........................................................ 68
Description of Shares................................................ 69
Anti-Takeover and Other Provisions in the Declaration of Trust....... 72
Repurchase of Common Shares; Conversion to Open-End Fund............. 74
Tax Matters.......................................................... 76
Performance Related and Comparative Information...................... 83
Custodian, Transfer Agent and Dividend Disbursement Agent............ 84
Independent Accountants.............................................. 84
Counsel.............................................................. 84
Registration Statement............................................... 84
Report of Independent Accountants.................................... 85
Financial Statements................................................. 86
Appendix A--Performance Related and Comparative and Other Information A-1
Appendix B--Proxy Voting Policies.................................... B-1
59
APPENDIX A
DESCRIPTION OF SECURITIES RATINGS
The Fund's investments may range in quality from securities rated in the
lowest category to securities rated in the highest category (as rated by
Moody's, S&P, Fitch, or Dominion or, if unrated, judged by PIMCO to be of
comparable quality). The percentage of a Fund's assets invested in securities
in a particular rating category will vary. The following terms are generally
used to describe the credit quality of debt securities:
HIGH QUALITY DEBT SECURITIES are those rated in one of the two highest
rating categories (the highest category for commercial paper) or, if unrated,
deemed comparable by PIMCO.
INVESTMENT GRADE DEBT SECURITIES are those rated in one of the four
highest rating categories or, if unrated, deemed comparable by PIMCO.
BELOW INVESTMENT GRADE, HIGH YIELD SECURITIES ("JUNK BONDS") are those
rated lower than Baa by Moody's, BBB by S&P, Fitch, or Dominion, and comparable
securities. They are deemed predominantly speculative with respect to the
issuer's ability to repay principal and interest.
Following is a description of Moody's, S&P's, Fitch's, and Dominion's
rating categories applicable to debt securities.
MOODY'S INVESTORS SERVICE, INC.
CORPORATE AND MUNICIPAL BOND RATINGS
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 edge." 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 that make the long-term risks appear somewhat larger than with 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 that 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.
60
B: Bonds which are rated B generally lack characteristics of a 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.
Moody's bond ratings, where specified, are applicable to financial
contracts, senior bank obligations and insurance company senior policyholder
and claims obligations with an original maturity in excess of one year.
Obligations relying upon support mechanisms such as letter-of-credit and bonds
of indemnity are excluded unless explicitly rated. Obligations of a branch of a
bank are considered to be domiciled in the country in which the branch is
located.
Unless noted as an exception, Moody's rating on a bank's ability to repay
senior obligations extends only to branches located in countries which carry a
Moody's Sovereign Rating for Bank Deposits. Such branch obligations are rated
at the lower of the bank's rating or Moody's Sovereign Rating for the Bank
Deposits for the country in which the branch is located. When the currency in
which an obligation is denominated is not the same as the currency of the
country in which the obligation is domiciled, Moody's ratings do not
incorporate an opinion as to whether payment of the obligation will be affected
by the actions of the government controlling the currency of denomination. In
addition, risk associated with bilateral conflicts between an investor's home
country and either the issuer's home country or the country where an issuer
branch is located are not incorporated into Moody's ratings.
Moody's makes no representation that rated bank obligations or insurance
company obligations are exempt from registration under the U.S. Securities Act
of 1933 or issued in conformity with any other applicable law or regulation.
Nor does Moody's represent any specific bank or insurance company obligation is
legally enforceable or a valid senior obligation of a rated issuer.
Moody's applies numerical modifiers, 1, 2, and 3, in each generic rating
classified from Aa through Caa in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
CORPORATE SHORT-TERM DEBT RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in
61
earnings coverage of fixed financial charges and high internal cash generation;
and well-established access to a range of financial markets and assured sources
of alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) 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. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term obligations. The effect
of industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial
leverage. Adequate alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime
rating categories.
STANDARD & POOR'S
ISSUE CREDIT RATING DEFINITIONS
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 and takes into account the
currency in which the obligation is denominated. 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 rating addresses the put feature, in addition
to the usual long-term rating. Medium-term notes are assigned long-term ratings.
Issue credit ratings are based, in varying degrees, on the following
considerations: 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; nature of and provisions of the obligation; protection
afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy
and other laws affecting creditors' rights.
The issue rating definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured obligations, or
operating company and holding company
62
obligations.) Accordingly, in the case of junior debt, the rating may not
conform exactly with the category definition.
CORPORATE AND MUNICIPAL BOND RATINGS
INVESTMENT GRADE
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.
SPECULATIVE GRADE
Obligations rated BB, B, CCC, CC, and C are regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. BB indicates the least degree of speculation and
C the highest. While such debt will likely have some quality and protective
characteristics, these are 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: An obligation rated CCC is currently vulnerable to nonpayment, and
is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC: An obligation rated CC is currently highly vulnerable to nonpayment.
C: A subordinated debt or preferred stock obligation rated C is CURRENTLY
HIGHLY VULNERABLE to nonpayment. The C rating may be used to cover a situation
where a bankruptcy petition has been filed or similar action taken, but
payments on this obligation are being continued. A C also will be assigned to a
preferred stock issue in arrears on dividends or sinking fund payments, but
that is currently paying.
CI: The rating CI is reserved for income bonds on which no interest is
being paid.
63
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.
Provisional ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and 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.
r: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
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.: This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
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.
COMMERCIAL PAPER RATING DEFINITIONS
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into several categories, ranging from A for
the highest quality obligations to D for the lowest. These categories are as
follows:
A-1: 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.
64
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 paper 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 Standard & Poor's by the issuer or obtained from other
sources it considers reliable. Standard & Poor's 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.
FITCH, INC.
A brief description of the applicable 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.
65
B: Highly speculative. "B" ratings indicate that significant credit risk
is present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
CCC, 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, 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.
C: High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon a sustained, favorable business
and economic environment.
D: Default. Denotes actual or imminent payment default.
"+" 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 does not rate the issuer or issue in question.
Withdrawn: A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
66
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, companies whose outlooks are "stable" could be
downgraded before an outlook moves to positive or negative if circumstances
warrant such an action. Occasionally, Fitch may be unable to identify the
fundamental trend. In these cases, the Rating Outlook may be described as
evolving.
DOMINION BOND RATING SERVICE LIMITED
DBRS ratings are meant to give an indication of the risk that the
borrower will not fulfill its obligations in a timely manner. DBRS ratings do
not take factors such as pricing or market risk into consideration and are
expected to be used by purchasers as one part of their investment process.
Every DBRS rating is based on quantitative and qualitative considerations which
are relevant for the borrowing entity.
DBRS BOND AND LONG TERM DEBT RATING SCALE
AAA: Bonds rated "AAA" are of the highest credit quality, with
exceptionally strong protection for the timely repayment of principal and
interest. Earnings are considered stable, the structure of the industry in
which the entity operates is strong, and the outlook for future profitability
is favorable. There are few qualifying factors present which would detract from
the performance of the entity, the strength of liquidity and coverage ratios is
unquestioned and the entity has established a creditable track record of
superior performance. Given the extremely tough definition which DBRS has
established for this category, few entities are able to achieve a AAA rating.
AA: Bonds rated "AA" are of superior credit quality, and protection of
interest and principal is considered high. In many cases, they differ from
bonds rated AAA only to a small degree. Given the extremely tough definition
which DBRS has for the AAA category (which few companies are able to achieve),
entities rated AA are also considered to be strong credits which typically
exemplify above-average strength in key areas of consideration and are unlikely
to be significantly affected by reasonably foreseeable events.
A: Bonds rated "A" are of satisfactory credit quality. Protection of
interest and principal is still substantial, but the degree of strength is less
than with AA rated entities. While a respectable rating, entities in the "A"
category are considered to be more susceptible to adverse economic conditions
and have greater cyclical tendencies than higher rated companies.
BBB: Bonds rated "BBB" are of adequate credit quality. Protection of
interest and principal is considered adequate, but the entity is more
susceptible to adverse changes in financial and economic conditions, or there
may be other adversities present which reduce the strength of the entity and
its rated securities.
BB: Bonds rated "BB" are defined to be speculative, where the degree of
protection afforded interest and principal is uncertain, particularly during
periods of economic recession. Entities in the BB area typically have limited
access to capital markets and additional liquidity support and, in many cases,
small size or lack of competitive strength may be additional negative
considerations.
B: Bonds rated "B" are highly speculative and there is a reasonably high
level of uncertainty which exists as to the ability of the entity to pay
interest and principal on a continuing basis in the future, especially in
periods of economic recession or industry adversity.
67
CCC, CC, C: Bonds rated in any of these categories are very highly
speculative and are in danger of default of interest and principal. The degree
of adverse elements present is more severe than bonds rated "B." Bonds rated
below "B" often have characteristics which, if not remedied, may lead to
default. In practice, there is little difference between the "C" to "CCC"
categories, with "CC" and "C" normally used to lower ranking debt of companies
where the senior debt is rated in the "CCC" to "B" range.
D: This category indicates Bonds in default of either interest or
principal.
High, Low: "high" and "low" grades are used to indicate the relative
standing of a credit within a particular rating category. The lack of one of
these designations indicates a rating which is essentially in the middle of the
category. Note that "high" and "low" grades are not used for the AAA category.
DBRS COMMERCIAL PAPER AND SHORT TERM DEBT RATING SCALE
All three DBRS rating categories for short term debt use "high", "middle"
or "low" as subset grades to designate the relative standing of the credit
within a particular rating category.
PRIME CREDIT QUALITY
R-1 (high): Short term debt rated "R-1 (high)" is of the highest credit
quality, and indicates an entity which possesses unquestioned ability to repay
current liabilities as they fall due. Entities rated in this category normally
maintain strong liquidity positions, conservative debt levels and profitability
which is both stable and above average. Companies achieving an "R-1 (high)"
rating are normally leaders in structurally sound industry segments with proven
track records, sustainable positive future results and no substantial
qualifying negative factors. Given the extremely tough definition which DBRS
has established for an "R-1 (high)," few entities are strong enough to achieve
this rating.
R-1 (middle): Short term debt rated "R-1 (middle)" is of superior credit
quality and, in most cases, ratings in this category differ from "R-1 (high)"
credits to only a small degree. Given the extremely tough definition which DBRS
has for the "R-1 (high)" category (which few companies are able to achieve),
entities rated "R-1 (middle)" are also considered strong credits which
typically exemplify above average strength in key areas of consideration for
debt protection.
R-1 (low): Short term debt rated "R-1 (low)" is of satisfactory credit
quality. The overall strength and outlook for key liquidity, debt and
profitability ratios is not normally as favorable as with higher rating
categories, but these considerations are still respectable. Any qualifying
negative factors which exist are considered manageable, and the entity is
normally of sufficient size to have some influence in its industry.
ADEQUATE CREDIT QUALITY
R-2 (high), R-2 (middle), R-2 (low): Short term debt rated "R-2" is of
adequate credit quality and within the three subset grades, debt protection
ranges from having reasonable ability for timely repayment to a level which is
considered only just adequate. The liquidity and debt ratios of entities in the
"R-2" classification are not as strong as those in the "R-1" category, and the
past and future trend may suggest some risk of maintaining the strength of key
ratios in these areas. Alternative sources of liquidity support are considered
satisfactory; however, even the strongest liquidity support will not improve
the commercial paper rating of the issuer. The size of the entity may restrict
its flexibility, and its relative position in the industry is not typically as
strong as an "R-1 credit." Profitability trends, past and future, may be less
favorable, earnings not as stable, and there are often negative qualifying
factors present which could also make the entity more vulnerable to adverse
changes in financial and economic conditions.
68
SPECULATIVE
R-3 (high), R-3 (middle), R-3 (low): Short term debt rated "R-3" is
speculative, and within the three subset grades, the capacity for timely
payment ranges from mildly speculative to doubtful. "R-3" credits tend to have
weak liquidity and debt ratios, and the future trend of these ratios is also
unclear. Due to its speculative nature, companies with "R-3" ratings would
normally have very limited access to alternative sources of liquidity. Earnings
would typically be very unstable, and the level of overall profitability of the
entity is also likely to be low. The industry environment may be weak, and
strong negative qualifying factors are also likely to be present.
DBRS PREFERRED SHARE RATING SCALE
Pfd-1: Preferred shares rated "Pfd-1" are of superior credit quality, and
are supported by entities with strong earnings and balance sheet
characteristics. "Pfd-1" generally corresponds with companies whose senior
bonds are rated in the "AAA" or "AA" categories. As is the case with all rating
categories, the relationship between senior debt ratings and preferred share
ratings should be understood as one where the senior debt rating effectively
sets a ceiling for the preferred shares issued by the entity. However, there
are cases where the preferred share rating could be lower than the normal
relationship with the issuer's senior debt rating.
Pfd-2: Preferred shares rated "Pfd-2" are of satisfactory credit quality.
Protection of dividends and principal is still substantial, but earnings, the
balance sheet, and coverage ratios are not as strong as Pfd-1 rated companies.
Generally, "Pfd-2" ratings correspond with companies whose senior bonds are
rated in the "A" category.
Pfd-3: Preferred shares rated "Pfd-3" are of adequate credit quality.
While protection of dividends and principal is still considered acceptable, the
issuing entity is more susceptible to adverse changes in financial and economic
conditions, and there may be other adversities present which detract from debt
protection. "Pfd-3" ratings generally correspond with companies whose senior
bonds are rated in the higher end of the "BBB" category.
Pfd-4: Preferred shares rated "Pfd-4" are speculative, where the degree
of protection afforded to dividends and principal is uncertain, particularly
during periods of economic adversity. Companies with preferred shares rated
"Pfd-4" generally coincide with entities that have senior bond ratings ranging
from the lower end of the "BBB" category through the "BB" category.
Pfd-5: Preferred shares rated "Pfd-5" are highly speculative and the
ability of the entity to maintain timely dividend and principal payments in the
future is highly uncertain. The "Pfd-5" rating generally coincides with
companies with senior bond ratings of "B" or lower. Preferred shares rated
"Pfd-5" often have characteristics which, if not remedied, may lead to default.
D: This category indicates preferred shares that are in arrears of paying
either dividends or principal.
High, Low: "high" and "low" grades are used to indicate the relative
standing of a credit within a particular rating category. The lack of one of
these designations indicates a rating that is essentially in the middle of the
category.
n: Non-Cumulative Risk. In the past several years, DBRS had designated
all non-cumulative preferred shares as "low" to alert subscribers to the fact
that non-cumulative shares have a higher risk of loss once dividend payments
have been missed. In the future, "high" and "low" designations will be used on
preferred share ratings to indicate the relative standing of a credit within a
particular rating category, and we will no longer use "low" to alert holders to
the non-cumulative nature of the shares. Rather, the "n" designation will be
attached to all ratings for securities that are non-cumulative. The risk with
non-cumulative securities is essentially no different than with cumulative
securities unless there is a default situation, in which case, the
non-cumulative shares have the
69
added risk of missing dividend payments that have no potential of being made up
in the future. However, non-cumulative shares do not have a higher risk of
default than do equivalently ranking cumulative shares of the same issuer. We
believe that the risk added under the non-cumulative covenant is a market risk
and not a credit risk. This supports our view that the ratings on equally
ranking cumulative and non-cumulative securities should be the same, with the
"n" used to alert subscribers to the additional potential for missed dividend
payments that exists with non-cumulative issues, if default should occur. After
several years of using our present scale, our conclusion is that trying to
provide all of this information with one rating symbol is confusing to the
market. We believe that it is more valuable to our subscribers if the rating
symbol simply provides our base evaluation of the credit, along with
information that alerts the holder to any unique covenants that can add market
risk.
y: Hybrid Instruments. While DBRS credit ratings are focused on providing
a measure of the issuer's ability to meet its obligations in a timely manner,
there are situations where securities carry unique covenants that can add a
variety of risks that are not captured in the DBRS rating. By definition,
hybrids are instruments that combine certain characteristics of debt and equity
and have been issued under various acronyms such as LYONS, PERCS, COPrS, TOPrS,
PRYDES, MIDS and MIPS. In some cases, holders of these instruments have agreed
that under set circumstances, the Company may repay certain obligations with
more of the security or with another security, such as common equity. In other
cases, the terms allow the Company to defer interest or dividend payments for a
period of time. While these are obviously important considerations for the
holder to understand, they normally do not cause any change in the likelihood
of default and, as such, DBRS has chosen not to penalize the instrument for the
special features associated with the hybrid. In order to alert hybrid holders
of the unique factors inherent in the security, DBRS will attach the "y"
appendage to the rating. Note that DBRS will not be adding the "y" to issues
that simply have more normal soft retraction or conversion features.
m: Market Risk. DBRS ratings represent an evaluation which is based on
only credit related factors and not market risk factors. The most obvious
example of a market risk factor would be the potential impact that changing
interest rates could have on a fixed pay security. While the absence of market
risk considerations in DBRS credit ratings should be well understood by
investors who use DBRS as part of their investment process, there are cases
where DBRS desires to draw attention to market risk for a given security
because the potential for volatility due to market risk factors greatly exceeds
what would be considered normal. To accomplish this, DBRS attaches the letter
"m" (market risk) to a rated security. Given the understanding that market risk
is present in every investment decision, it is important to note that the
absence of "m" does not indicate that there will be no volatility of returns
related to non-credit factors. DBRS uses "m" only in cases where market risk is
considered exceptionally high, or in cases where there are unusual
circumstances.
p: The symbol "p" indicates that the report and rating rely on public
information only.
70
================================================================================
SHARES
[LOGO] PIMCO
ADVISORS
PIMCO FLOATING RATE INCOME FUND
COMMON SHARES
$20.00 PER SHARE
----------------
P R O S P E C T U S
----------------
MERRILL LYNCH & CO.
WACHOVIA SECURITIES
A.G EDWARDS & SONS, INC.
RBC CAPITAL MARKETS
ADVEST, INC.
ROBERT W. BAIRD & CO.
CROWELL, WEEDON & CO.
JANNEY MONTGOMERY SCOTT LLC
MCDONALD INVESTMENTS INC.
TD WATERHOUSE
WEDBUSH MORGAN SECURITIES INC.
QUICK & REILLY, INC.
, 2003
================================================================================
The information in this Statement of Additional Information is not complete
and may be changed. We may not sell these securities until the registration
statement filed with the Securities and Exchange Commission is effective. This
Statement of Additional Information is not an offer to sell these securities and
it is not soliciting an offer to buy these securities in any state where the
offer or sale is not permitted.
SUBJECT TO COMPLETION - DATED , 2003
PIMCO FLOATING RATE INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
, 2003
PIMCO Floating Rate Income Fund (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") is not a prospectus, and should be read in conjunction
with the Fund's prospectus relating thereto dated , 2003 (the
"Prospectus"). This Statement of Additional Information does not include all
information that a prospective investor should consider before purchasing Common
Shares, and investors should obtain and read the Prospectus prior to purchasing
such shares. A copy of the Prospectus may be obtained without charge by calling
(877) 819-2224. You may also obtain a copy of the Prospectus on the web site
(http://www.sec.gov) of the Securities and Exchange Commission ("SEC").
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
----
USE OF PROCEEDS............................................................. 3
INVESTMENT OBJECTIVE AND POLICIES........................................... 3
INVESTMENT RESTRICTIONS..................................................... 48
MANAGEMENT OF THE FUND...................................................... 50
INVESTMENT MANAGER AND PORTFOLIO MANAGER.................................... 61
PORTFOLIO TRANSACTIONS...................................................... 67
DISTRIBUTIONS............................................................... 68
DESCRIPTION OF SHARES....................................................... 69
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST.............. 72
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND.................... 74
TAX MATTERS................................................................. 76
PERFORMANCE RELATED AND COMPARATIVE INFORMATION............................. 83
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT................... 84
INDEPENDENT ACCOUNTANTS..................................................... 84
COUNSEL..................................................................... 84
REGISTRATION STATEMENT...................................................... 84
REPORT OF INDEPENDENT AUDITORS.............................................. 85
FINANCIAL STATEMENTS........................................................ 86
APPENDIX A - Performance Related, Comparative and Other Information......... A-1
APPENDIX B - Proxy Voting Policies.......................................... B-1
This Statement of Additional Information is dated August__, 2003.
USE OF PROCEEDS
The net proceeds of the offering of Common Shares of the Fund will be
approximately $ (or $ if the Underwriters exercise the overallotment
option in full) after payment of offering costs.
PIMCO Advisors Fund Management LLC (the "Manager"), the Fund's investment
manager, has agreed to pay (i) the amount by which the Fund's offering costs
(other than the sales load) exceed $.04 per Common Share and (ii) all of the
Fund's organizational expenses, except that the Fund has agreed to reimburse the
Manager for such organizational expenses to the extent that the aggregate of all
such organizational expenses and all offering costs (other than the sales load,
but inclusive of the reimbursement of underwriter expenses of $.00667 per Common
Share) does not exceed $.04 per Common Share.
Pending investment in floating rate debt instruments and other securities
that meet the Fund's investment objective and policies, it is anticipated that
the net proceeds of the offering will be invested in high grade, short-term
securities, credit-linked trust certificates and/or index futures contracts or
similar derivative instruments designed to give the Fund exposure to the markets
in which it intends to invest while Pacific Investment Management Company LLC
("PIMCO"), the Fund's portfolio manager, selects specific securities.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and general investment policies of the Fund are
described in the Prospectus. Additional information concerning the
characteristics of certain of the Fund's investments is set forth below.
Floating Rate Debt Instruments
Under normal market conditions, the Fund will invest at least 80% of its
net assets (plus any borrowings for investment purposes) in a diversified
portfolio of floating rate debt instruments, a substantial portion of which will
be senior floating rate loans ("Senior Loans"). Floating rate debt instruments
are debt instruments that pay interest at rates which adjust whenever a
specified interest rate changes and/or which reset on predetermined dates (such
as the last day of a month or calendar quarter). These floating rate debt
instruments may include, in addition to Senior Loans, instruments such as
catastrophe bonds, bank capital securities, unsecured bank loans, corporate
bonds, money market instruments and certain types of mortgage-backed and other
asset-backed securities. Due to their floating rate features, these instruments
will generally pay higher levels of income in a rising interest rate environment
and lower levels of income as interest rates decline. For the same reason, the
market value of a floating rate debt instrument is generally expected to have
less sensitivity to fluctuations in market interest rates than a fixed-rate debt
instrument, although the value of a floating rate instrument may nonetheless
decline as interest rates rise and due to other factors, such as changes in
credit quality.
3
Senior Loans
The Fund expects to ordinarily invest a substantial portion of its assets
in Senior Loans. Senior Loans include senior floating rate loans and
institutionally traded senior floating rate debt obligations issued by
asset-backed pools and other issues, and interests therein. Loan interests
generally take the form of direct interests acquired during a primary
distribution and may also take the form of assignments of, novations of, or
participations in a Senior Loan acquired in secondary markets. Loan interests
may be acquired from U.S or foreign commercial banks, insurance companies,
finance companies or other financial institutions who have made loans or are
members of a lending syndicate or from other holders of loan interests.
Senior Loans typically pay interest at rates which are re-determined
periodically on the basis of a floating base lending rate (such as the London
Inter-Bank Offered Rate, "LIBOR") plus a premium. Although Senior Loans are
typically of below investment grade quality, they tend to have more favorable
recovery rates than other types of below investment grade quality debt
obligations. Senior Loans generally (but not always) hold the most senior
position in the capital structure of a borrower and are often secured with
collateral. A Senior Loan is typically originated, negotiated and structured by
a U.S. or foreign commercial bank, insurance company, finance company or other
financial institution (the "Agent") for a lending syndicate of financial
institutions ("Lenders"). The Agent typically administers and enforces the
Senior Loan on behalf of the other Lenders in the syndicate. In addition, an
institution, typically but not always the Agent, holds any collateral on behalf
of the Lenders.
The Fund may purchase assignments and participations in commercial loans,
as well as debtor-in-possession loans. Such indebtedness may be secured or
unsecured. Loan participations typically represent direct participations in a
loan to a corporate borrower, and generally are offered by banks or other
financial institutions or lending syndicates. The Fund may participate in such
syndications, or can buy part of a loan, becoming a part lender. When purchasing
loan participations, the Fund assumes the credit risk associated with the
corporate or other borrower and may assume the credit risk associated with an
interposed bank or other financial intermediary. The participation interests in
which the Fund intends to invest may not be rated by any nationally recognized
rating service.
Unless, under the terms of the loan or other indebtedness (such as may be
the case in an assignment), the Fund has direct recourse against the borrower,
the Fund may have to rely on the Agent or other financial intermediary to apply
appropriate credit remedies against a borrower.
4
Purchasers of loans and other forms of direct indebtedness depend primarily
upon the creditworthiness of the corporate or other borrower for payment of
principal and interest. If the Fund does not receive scheduled interest or
principal payments on such indebtedness, the Fund's share price and yield could
be adversely affected. Senior Loans that are fully secured offer the Fund more
protection than an unsecured loan in the event of non-payment of scheduled
interest or principal. However, there is no assurance that the liquidation of
collateral from a secured Senior Loan would satisfy the borrower's obligation,
or that such collateral could be liquidated.
The Fund may invest in loan participations with credit quality comparable
to that of many issuers of its other debt securities investments. Indebtedness
of companies whose creditworthiness is poor involves substantially greater
risks, and may be highly speculative. Some companies may never pay off their
indebtedness, or may pay only a small fraction of the amount owed. Consequently,
when investing in indebtedness of companies with poor credit, the Fund bears a
substantial risk of losing the entire amount invested.
The Fund limits the amount of its total assets that it will invest in any
one issuer or in issuers within the same industry. See "Investment
Restrictions". For purposes of these limits, the Fund generally will treat the
corporate or other borrower as the "issuer" of indebtedness held by the Fund. In
the case of loan participations where a bank or other lending institution serves
as a financial intermediary between the Fund and the borrower, if the
participation does not shift to the Fund the direct debtor-creditor relationship
with the borrower, SEC interpretations may take the position that the Fund
should treat both the lending bank or other lending institution and the borrower
as "issuers" for the purposes of determining whether the Fund has invested more
than 5% of its total assets in a single issuer. Treating a financial
intermediary as an issuer of indebtedness may restrict the Fund's ability to
invest in indebtedness related to a single financial intermediary, or a group of
intermediaries engaged in the same industry, even if the underlying borrowers
represent many different companies and industries.
Loans and other types of direct indebtedness may not be readily marketable
and may be subject to restrictions on resale. In some cases, negotiations
involved in disposing of indebtedness may require weeks to complete.
Consequently, some indebtedness may be difficult or impossible to dispose of
readily at what PIMCO believes to be a fair price. In addition, valuation of
illiquid indebtedness involves a greater degree of judgment in determining the
Fund's net asset value than if that value were based on available market
quotations. At the same time, many loan interests are actively traded among
certain financial institutions and considered to be liquid. PIMCO will determine
the liquidity of the Fund's investments by reference to market conditions and
contractual provisions. For example, PIMCO will generally not consider Senior
Loans that are part of an issue of at least $250 million in par value to be
illiquid. Investments in loan participations are considered to be debt
obligations for purposes of the Fund's investment restriction relating to the
lending of funds or assets.
Investments in loans through a direct assignment of the financial
institution's interests with respect to the loan may involve additional risks to
the Fund. For example, if a loan is foreclosed, the Fund could become part owner
of any collateral, and would bear the costs and liabilities associated with
owning and disposing of the collateral. In addition, it is conceivable that,
under emerging legal theories of lender liability, the Fund could be held liable
as co-lender. It is unclear whether loans and other forms of direct indebtedness
offer securities law protections against fraud and misrepresentation. In the
absence of definitive regulatory guidance, the Fund
5
relies on PIMCO's research in an attempt to avoid situations where fraud or
misrepresentations could adversely affect the Fund.
From time to time, PIMCO and its affiliates may borrow money from various
banks in connection with their business activities. Such banks may also sell
Senior Loans to or acquire them from the Fund or may be intermediate
participants with respect to Senior Loans in which the Fund owns interests. Such
banks may also act as Agents for Senior Loans held by the Fund.
Lending Fees. In the process of buying, selling and holding Senior Loans,
the Fund may receive and/or pay certain fees. These fees are in addition to
interest payments received and may include facility fees, commitment fees,
commissions and prepayment penalty fees. When the Fund buys a Senior Loan it may
receive a facility fee and when it sells a Senior Loan it may pay a facility
fee. On an ongoing basis, the Fund may receive a commitment fee based on the
undrawn portion of the underlying line of credit portion of the Senior Loan. In
certain circumstances, the Fund may receive a prepayment penalty fee upon the
prepayment of a Senior Loan by a borrower. Other fees received by the Fund may
include covenant waiver fees and covenant modification fees.
Borrower Covenants. A borrower under a Senior Loan typically must comply
with various restrictive covenants contained in a loan agreement or note
purchase agreement between the borrower and the Lender or lending syndicate (the
"Loan Agreement"). Such covenants, in addition to requiring the scheduled
payment of interest and principal, may include restrictions on dividend payments
and other distributions to stockholders, provisions requiring the borrower to
maintain specific minimum financial ratios, and limits on total debt. In
addition, the Loan Agreement may contain a covenant requiring the borrower to
prepay the Senior Loan with any free cash flow. Free cash flow is generally
defined as net cash flow after scheduled debt service payments and permitted
capital expenditures, and includes the proceeds from asset dispositions or sales
of securities. A breach of a covenant which is not waived by the Agent, or by
the lenders directly, as the case may be, is normally an event of acceleration;
i.e., the Agent, or the lenders directly, as the case may be, has the right to
call the outstanding Senior Loan. The typical practice of an Agent or a Lender
in relying exclusively or primarily on reports from the borrower may involve a
risk of fraud by the borrower. In the case of a Senior Loan in the form of a
participation, the agreement between the buyer and seller may limit the rights
of the holder of a Senior Loan to vote on certain changes which may be made to
the Loan Agreement, such as waiving a breach of a covenant. However, the holder
of the participation will, in almost all cases, have the right to vote on
certain fundamental issues such as changes in principal amount, payment dates
and interest rate.
Administration of Loans. In a typical Senior Loan, the Agent administers
the terms of the Loan Agreement. In such cases, the Agent is normally
responsible for the collection of principal and interest payments from the
borrower and the apportionment of these payments to the credit of all
institutions which are parties to the Loan Agreement. The Fund will generally
rely upon the Agent or an intermediate participant to receive and forward to the
Fund its portion of the principal and interest payments on the Senior Loan.
Furthermore, unless under the terms of a participation agreement the Fund has
direct recourse against the borrower, the Fund will rely on the Agent and the
other members of the lending syndicate to use appropriate credit remedies
against the borrower. The Agent is typically responsible for monitoring
compliance with covenants contained in the Loan Agreement based upon reports
prepared by the borrower. The
6
seller of the Senior Loan usually does, but is often not obligated to, notify
holders of Senior Loans of any failures of compliance. The Agent may monitor the
value of the collateral, if any, and if the value of such collateral declines,
may accelerate the Senior Loan, may give the borrower an opportunity to provide
additional collateral or may seek other protection for the benefit of the
participants in the Senior Loan. The Agent is compensated by the borrower for
providing these services under a Loan Agreement, and such compensation may
include special fees paid upon structuring and funding the Senior Loan and other
fees paid on a continuing basis. With respect to Senior Loans for which the
Agent does not perform such administrative and enforcement functions, PIMCO will
perform such tasks on behalf of the Fund, although a collateral bank will
typically hold any collateral on behalf of the Fund and the other lenders
pursuant to the applicable Loan Agreement.
A financial institution's appointment as Agent may usually be terminated in
the event that it fails to observe the requisite standard of care or becomes
insolvent, enters Federal Deposit Insurance Corporation ("FDIC") receivership,
or, if not FDIC insured, enters into bankruptcy proceedings. A successor Agent
would generally be appointed to replace the terminated Agent, and assets held by
the Agent under the Loan Agreement should remain available to holders of Senior
Loans. However, if assets held by the Agent for the benefit of the Fund were
determined to be subject to the claims of the Agent's general creditors, the
Fund might incur certain costs and delays in realizing payment on a Senior Loan,
or suffer a loss of principal and/or interest. In situations involving other
intermediate participants similar risks may arise.
Prepayments. Senior Loans usually require, in addition to scheduled
payments of interest and principal, the prepayment of the Senior Loan from free
cash flow, as defined above. The degree to which borrowers prepay Senior Loans,
whether as a contractual requirement or at their election, may be affected by
general business conditions, the financial condition of the borrower and
competitive conditions among lenders, among others. As such, prepayments cannot
be predicted with accuracy. Upon a prepayment, either in part or in full, the
actual outstanding debt on which the Fund derives interest income will be
reduced. However, the Fund may receive both a prepayment penalty fee from the
prepaying borrower and a facility fee upon the purchase of a new Senior Loan
with the proceeds from the prepayment of the former. Prepayments generally will
not materially affect the Fund's performance because the Fund should be able to
reinvest prepayments in other Senior Loans that have similar or identical yields
and because receipt of such fees may mitigate any adverse impact on the Fund's
yield.
Bridge Financings. The Fund may acquire interests in Senior Loans which are
designed to provide temporary or "bridge" financing to a borrower pending the
sale of identified assets or the arrangement of longer-term loans or the
issuance and sale of debt obligations. The Fund may also invest in Senior Loans
of borrowers who have obtained bridge loans from other parties. A borrower's use
of bridge loans involves a risk that the borrower may be unable to locate
permanent financing to replace the bridge loan, which may impair the borrower's
perceived creditworthiness.
Secured Senior Loans. To the extent that the collateral (if any) securing a
Senior Loan consists of the stock of the borrower's subsidiaries or other
affiliates, the Fund will be subject to the risk that this stock will decline in
value. Such a decline, whether as a result of bankruptcy proceedings or
otherwise, could cause the Senior Loan to be undercollateralized or unsecured.
In most credit agreements there is no formal requirement to pledge additional
7
collateral. In addition, the Fund may invest in Senior Loans guaranteed by, or
fully secured by assets of, shareholders or owners, even if the Senior Loans are
not otherwise collateralized by assets of the borrower. There may be temporary
periods when the principal asset held by a borrower is the stock of a related
company, which may not legally be pledged to secure a secured Senior Loan. On
occasions when such stock cannot be pledged, the secured Senior Loan will be
temporarily unsecured until the stock can be pledged or is exchanged for or
replaced by other assets, which will be pledged as security for such Senior
Loan. However, the borrower's ability to dispose of such securities, other than
in connection with such pledge or replacement, will be strictly limited for the
protection of the holders of secured Senior Loans.
If a borrower becomes involved in bankruptcy proceedings, a court may
invalidate the Fund's security interest in any loan collateral or subordinate
the Fund's rights under a secured Senior Loan to the interests of the borrower's
unsecured creditors. Such action by a court could be based, for example, on a
"fraudulent conveyance" claim to the effect that the borrower did not receive
fair consideration for granting the security interest in the loan collateral to
the Fund. For secured Senior Loans made in connection with a highly leveraged
transaction, consideration for granting a security interest may be deemed
inadequate if the proceeds of such loan were not received or retained by the
borrower, but were instead paid to other persons (such as shareholders of the
borrower) in an amount which left the borrower insolvent or without sufficient
working capital. There are also other events, such as the failure to perfect a
security interest due to faulty documentation or faulty official filings, which
could lead to the invalidation of the Fund's security interest in any loan
collateral. If the Fund's security interest in loan collateral is invalidated or
a secured Senior Loan is subordinated to other debt of a borrower in bankruptcy
or other proceedings, it is unlikely that the Fund would be able to recover the
full amount of the principal and interest due on the secured Senior Loan.
The Fund may also invest in Senior Loans that are not secured by collateral
or otherwise.
High Yield Securities ("Junk Bonds")
The Fund may invest without limit and ordinarily expects to invest a
substantial portion of its assets in Senior Loans and other debt securities that
are, at the time of purchase, rated below investment grade (below Baa3 by
Moody's Investors Service, Inc. ("Moody's"), below BBB- by either Standard &
Poor's ("S&P") or Fitch, Inc. ("Fitch"), or below a comparable rating by
Dominion Bond Rating Service Limited ("Dominion")) or unrated but judged by
PIMCO to be of comparable quality. These securities are sometimes referred to as
"high yield" securities or "junk bonds." The Fund will not invest more than 10%
of its total assets in securities that are, at the time of purchase, rated
CCC+/Caa1 or lower by each agency rating the security or that are unrated but
judged by PIMCO to be of comparable quality.
Many of the Senior Loans in which the Fund invests will be high yield
securities. See "Senior Loans."
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. Debt securities in the lowest investment grade category also may be
considered to possess some
8
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 non-payment of all or a portion of interest and
principal, the Fund may incur additional expenses to seek recovery. The market
prices of high yield securities structured as zero-coupon, step-up or
payment-in-kind securities will normally be affected to a greater extent by
interest rate changes, and therefore tend to be more volatile than the prices of
securities that pay interest currently and in cash.
The secondary market on which high yield securities are traded may be less
liquid than the market for investment grade securities. Less liquidity in the
secondary trading market could adversely affect the price at which the Fund
could sell a high yield security, and could adversely affect the net asset value
of the shares. 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
PIMCO's research and analysis when investing in high yield securities. PIMCO
seeks to minimize the risks of investing 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, S&P, Fitch
and Dominion is set forth in Appendix A to the Prospectus. The ratings of
Moody's, S&P, Fitch and Dominion 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, debt
obligations with the same maturity, coupon and rating may have different yields
while 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. PIMCO does not rely solely on credit ratings when
selecting securities for the Fund, and develops its 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 PIMCO downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, PIMCO may consider such factors as PIMCO's assessment of the
credit quality of the issuer of such security, the price at which such security
9
could be sold and the rating, if any, assigned to such security by other rating
agencies. However, analysis of creditworthiness may be more complex for issuers
of Senior Loans and other high yield securities than for issuers of higher
quality debt securities.
Distressed Securities
Securities in which the Fund invests may be subject to significant risk of
an issuer's inability to meet principal and interest payments on the obligations
and also may be subject to price volatility due to such factors as market
perception of the creditworthiness of an issuer and general market liquidity. If
PIMCO's evaluation of the anticipated outcome of an investment situation should
prove incorrect, such Fund investments could experience a loss.
Bonds
The Fund may invest in a variety of bonds and related debt obligations of
varying maturities (with predominantly low durations) issued by U.S.
corporations, foreign corporations, domestic banks, foreign banks and other
business entities. Bonds include bills, notes, debentures, money market
instruments and similar instruments and securities. Bonds generally are used by
corporations and other issuers to borrow money from investors. The issuer pays
the investor a variable or fixed 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's investments in bonds are often subject to a number of risks
described in the Prospectus and elaborated upon elsewhere in this section of the
Statement of Additional Information, including credit risk, high yield risk,
interest rate risk, issuer risk, foreign (non-U.S.) investment risk, inflation
risk, liquidity risk, smaller company risk and management risk.
Event-Linked Bonds
The Fund may invest in "event-linked bonds." Event-linked bonds, which are
sometimes referred to as "catastrophe bonds," are debt obligations for which the
return of principal and payment of interest is contingent on the non-occurrence
of a specific "trigger" event, such as a hurricane or an earthquake. They may be
issued by government agencies, insurance companies, reinsurers, special purpose
corporations or other on-shore or off-shore entities. If a trigger event causes
losses exceeding a specific amount in the geographic region and time period
specified in a bond, the Fund may lose a portion or all of its principal
invested in the bond. If no trigger event occurs, the Fund will recover its
principal plus interest. For some event-linked bonds, the trigger event or
losses may be based on company-wide losses, index-portfolio losses, industry
indexes or readings of scientific instruments rather than specified actual
losses. Often event-linked bonds provide for extensions of maturity that are
mandatory, or optional at the discretion of the issuer, in order to process and
audit loss claims in those cases when a trigger event has, or possibly has,
occurred. In addition to the specified trigger events, event-linked bonds may
also expose the Fund to certain unanticipated risks including but not limited to
issuer (credit) default, adverse regulatory or jurisdictional interpretations
and adverse tax consequences.
Event-linked bonds are a relatively new type of financial instrument. As
such, there is no significant trading history of these securities, and there can
be no assurance that a liquid market in these instruments will develop. Lack of
a liquid market may impose the risk of higher
10
transaction costs and the possibility that the Fund may be forced to liquidate
positions when it would not be advantageous to do so. Event-linked bonds are
typically rated.
Inflation-Indexed Bonds
The Fund may invest in inflation-indexed bonds, which are debt obligations
whose value is periodically adjusted according to the rate of inflation. Two
structures are common. The U.S. Treasury and some other issuers utilize a
structure that accrues inflation into the principal value of the bond. Most
other issuers pay out the Consumer Price Index accruals as part of a semiannual
coupon.
Inflation-indexed securities issued by the U.S. Treasury have maturities of
approximately five, ten or thirty years, although it is possible that securities
with other maturities will be issued in the future. The U.S. Treasury securities
pay interest on a semi-annual basis equal to a fixed percentage of the
inflation-adjusted principal amount. For example, if the Fund purchased an
inflation-indexed bond with a par value of $1,000 and a 3% real rate of return
coupon (payable 1.5% semi-annually), and the rate of inflation over the first
six months was 1%, the mid-year par value of the bond would be $1,010 and the
first semi-annual interest payment would be $15.15 ($1,010 times 1.5%). If
inflation during the second half of the year resulted in the whole year's
inflation equaling 3%, the end-of-year par value of the bond would be $1,030 and
the second semi-annual interest payment would be $15.45 ($1,030 times 1.5%).
If the periodic adjustment rate measuring inflation falls, the principal
value of inflation-indexed bonds will be adjusted downward, and consequently the
interest payable on these securities (calculated with respect to a smaller
principal amount) will be reduced. Repayment of the original bond principal upon
maturity (as adjusted for inflation) is guaranteed in the case of U.S. Treasury
inflation-indexed bonds, even during a period of deflation. However, the current
market value of the bonds is not guaranteed and will fluctuate. The Fund may
also invest in other inflation-related bonds which may or may not provide a
similar guarantee. If a guarantee of principal is not provided, the adjusted
principal value of the bond repaid at maturity may be less than the original
principal amount.
The value of inflation-indexed bonds is expected to change in response to
changes in real interest rates. Real interest rates in turn are tied to the
relationship between nominal interest rates and the rate of inflation.
Therefore, if the rate of inflation rises at a faster rate than nominal interest
rates, real interest rates might decline, leading to an increase in value of
inflation-indexed bonds. In contrast, if nominal interest rates increase at a
faster rate than inflation, real interest rates might rise, leading to a
decrease in value of inflation-indexed bonds.
While these securities are expected to be protected from long-term
inflationary trends, short-term increases in inflation may lead to a decline in
value. If interest rates rise due to reasons other than inflation (for example,
due to changes in currency exchange rates), investors in these securities may
not be protected to the extent that the increase is not reflected in the bond's
inflation measure.
The periodic adjustment of U.S. inflation-indexed bonds is tied to the
Consumer Price Index for Urban Consumers ("CPI-U"), which is calculated monthly
by the U.S. Bureau of Labor Statistics. The CPI-U is a measurement of changes in
the cost of living, made up of components such as housing, food, transportation
and energy. Inflation-indexed bonds issued by a foreign
11
government are generally adjusted to reflect a comparable inflation index
calculated by that government. There can be no assurance that the CPI-U or any
foreign inflation index will accurately measure the real rate of inflation in
the prices of goods and services. Moreover, there can be no assurance that the
rate of inflation in a foreign country will be correlated to the rate of
inflation in the United States.
For federal income tax purposes, any increase in the principal amount of an
inflation-indexed bond will be original issue discount which is taxable as
ordinary income in the year accrued, even though investors do not receive their
principal, including any increases thereto, until maturity. See "Tax
Matters--Discount Obligations and Payment-in-Kind Securities" below.
Mortgage-Related and Other Asset-Backed Securities
The Fund may invest in mortgage-related securities, and may also invest in
other asset-backed securities (unrelated to mortgage loans) that are offered to
investors currently or in the future. Mortgage-related securities are interests
in pools of residential or commercial mortgage loans, including mortgage loans
made by savings and loan institutions, mortgage bankers, commercial banks and
others. Pools of mortgage loans are assembled as securities for sale to
investors by various governmental, government-related and private organizations.
Like other debt obligations, the ability of the Fund to successfully utilize
these instruments may depend in part upon the ability of PIMCO to forecast
certain macro-economic factors correctly. See "--Mortgage Pass-Through
Securities" below. Certain debt obligations are also secured with collateral
consisting of mortgage-related securities. See "--Collateralized Mortgage
Obligations ("CMOs")" below.
The mortgage-related securities in which the Fund will invest will
typically pay variable rates of interest, although the Fund may invest in
fixed-rate obligations as well.
Commercial Mortgage-Backed Securities. Commercial mortgage-backed
securities include securities that reflect an interest in, and are secured by,
mortgage loans on commercial real property. The market for commercial
mortgage-backed securities developed more recently and in terms of total
outstanding principal amount of issues is relatively small compared to the
market for residential single-family mortgage-backed securities. Many of the
risks of investing in commercial mortgage-backed securities reflect the risks of
investing in the real estate securing the underlying mortgage loans. These risks
reflect the effects of local and other economic conditions on real estate
markets, the ability of tenants to make loan payments, and the ability of a
property to attract and retain tenants. Commercial mortgage-backed securities
may be less liquid and exhibit greater price volatility than other types of
mortgage- or asset-backed securities.
Mortgage Pass-Through Securities. Mortgage pass-through securities are
securities representing interests in "pools" of mortgage loans secured by
residential or commercial real property. Interests in pools of mortgage-related
securities differ from other forms of debt obligations, which normally provide
for periodic payment of interest in fixed or variable amounts with principal
payments at maturity or specified call dates. Instead, these securities provide
a monthly payment which consists of both interest and principal payments. In
effect, these payments are a "pass-through" of the monthly payments made by the
individual borrowers on their residential or commercial mortgage loans, net of
any fees paid to the issuer or guarantor of such securities. Additional payments
are caused by repayments of principal resulting from the
12
sale of the underlying property, refinancing or foreclosure, net of fees or
costs which may be incurred. Some mortgage-related securities (such as
securities issued by the Government National Mortgage Association (the "GNMA"))
are described as "modified pass-through." These securities entitle the holder to
receive all interest and principal payments owed on the mortgage pool, net of
certain fees, at the scheduled payment dates regardless of whether or not the
mortgagor actually makes the payment.
The rate of prepayments on underlying mortgages will affect the price and
volatility of a mortgage-related security, and may have the effect of shortening
or extending the effective maturity of the security beyond what was anticipated
at the time of purchase. Early repayment of principal on some mortgage-related
securities (arising from prepayments of principal due to the sale of the
underlying property, refinancing, or foreclosure, net of fees and costs which
may be incurred) may expose the Fund to a lower rate of return upon reinvestment
of principal. Also, if a security subject to prepayment has been purchased at a
premium, the value of the premium would be lost in the event of prepayment. Like
other fixed-rate debt obligations, when interest rates rise, the value of a
fixed-rate mortgage-related security generally will decline; however, when
interest rates are declining, the value of fixed-rate mortgage-related
securities with prepayment features may not increase as much as other debt
obligations. The Fund's policy of investing mostly in mortgage-backed and other
asset-backed securities with variable rates of interest minimizes the Fund's
sensitivity to such interest rate volatility. However, adjustable rate
mortgage-related and other asset-backed securities are also subject to some
interest rate risk. For example, because interest rates on most adjustable rate
mortgage- and other asset-backed securities only reset periodically (e.g.,
monthly or quarterly), changes in prevailing interest rates (and particularly
sudden and significant changes) can be expected to cause some fluctuations in
the market value of these securities, including declines in value as interest
rates rise. In addition, to the extent that unanticipated rates of prepayment on
underlying mortgages increase the effective maturity of a mortgage-related
security, the volatility of such security can be expected to increase.
Payment of principal and interest on some mortgage pass-through securities
(but not the market value of the securities themselves) may be guaranteed by the
full faith and credit of the U.S. Government (in the case of securities
guaranteed by the GNMA) or guaranteed by agencies or instrumentalities of the
U.S. Government (in the case of securities guaranteed by the Federal National
Mortgage Association (the "FNMA") or the Federal Home Loan Mortgage Corporation
(the "FHLMC"). The principal governmental guarantor of mortgage-related
securities is the GNMA. GNMA is a wholly-owned U.S. Government corporation
within the Department of Housing and Urban Development. GNMA is authorized to
guarantee, with the full faith and credit of the U.S. Government, the timely
payment of principal and interest on securities issued by institutions approved
by GNMA (such as savings and loan institutions, commercial banks and mortgage
bankers) and backed by pools of mortgages insured by the Federal Housing
Administration (the "FHA"), or guaranteed by the Department of Veterans Affairs
(the "VA").
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. Government) include the FNMA and the FHLMC. FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
agency) residential mortgages from a list of approved sellers/servicers which
include state and federally chartered savings and loan associations,
13
mutual savings banks, commercial banks, and credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the U.S. Government. Instead, they are supported only by the discretionary
authority of the U.S. Government to purchase the agency's obligations.
FHLMC was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. It is a
government-sponsored corporation formerly owned by the twelve Federal Home Loan
Banks and now owned entirely by private stockholders. FHLMC issues Participation
Certificates ("PCs") which represent interests in conventional mortgages from
FHLMC's national portfolio. FHLMC guarantees the timely payment of interest and
ultimate collection of principal, but PCs are not backed by the full faith and
credit of the U.S. Government. Instead, they are supported only by the
discretionary authority of the U.S. Government to purchase the agency's
obligations.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. Such issuers may,
in addition, be the originators and/or servicers of the underlying mortgage
loans as well as the guarantors of the mortgage-related securities. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than government and government-related pools because there are no
direct or indirect government or agency guarantees of payments in such pools.
However, timely payment of interest and principal of these pools may be
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit. The insurance and
guarantees are issued by governmental entities, private insurers and the
mortgage poolers. There can be no assurance that the private insurers or
guarantors can meet their obligations under the insurance policies or guarantee
arrangements. Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be readily
marketable.
Mortgage-related securities that are issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, are not subject to the Fund's
industry concentration restriction (see "Investment Restrictions") by virtue of
the exclusion from that restriction available to all U.S. Government securities.
In the case of privately issued mortgage-related securities, the Fund takes the
position that mortgage-related securities do not represent interests in any
particular "industry" or group of industries. The assets underlying such
securities may be represented by a portfolio of first lien residential mortgages
(including both whole mortgage loans and mortgage participation interests) or
portfolios of mortgage pass-through securities issued or guaranteed by GNMA,
FNMA or FHLMC. Mortgage loans underlying a mortgage-related security may in turn
be insured or guaranteed by the FHA or the VA. In the case of private issue
mortgage-related securities whose underlying assets are neither U.S. Government
securities nor U.S. Government-insured mortgages, to the extent that real
properties securing such assets may be located in the same geographical region,
the security may be subject to a greater risk of default than other comparable
securities in the event of adverse economic, political or business developments
that may affect such region and, ultimately, the ability of residential
homeowners to make payments of principal and interest on the underlying
mortgages.
14
Collateralized Mortgage Obligations ("CMOs"). A CMO is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, semi-annually. CMOs may
be collateralized by whole mortgage loans, but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds (the "Bonds"). Proceeds of the Bond
offering are used to purchase mortgages or mortgage pass-through certificates
(the "Collateral"). The Collateral is pledged to a third party trustee as
security for the Bonds. Principal and interest payments from the Collateral are
used to pay principal on the Bonds in the order A, B, C, Z. The Series A, B and
C Bonds all bear current interest. Interest on the Series Z Bond is accrued and
added to principal and a like amount is paid as principal on the Series A, B or
C Bond currently being paid off. When the Series A, B and C Bonds are paid in
full, interest and principal on the Series Z Bond begin to be paid currently.
With some CMOs, the issuer serves as a conduit to allow loan originators
(primarily builders or savings and loan associations) to borrow against their
loan portfolios.
CMOs that are issued or guaranteed by the U.S. Government or by any of its
agencies or instrumentalities will be considered U.S. Government securities by
the Fund, while other CMOs, even if collateralized by U.S. Government
securities, will have the same status as other privately issued securities for
purposes of applying the Fund's diversification tests.
FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC PCs, payments of principal and interest on the CMOs are made
semi-annually, as opposed to monthly. The amount of principal payable on each
semi-annual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which in turn, is equal to approximately 100% of FHA
prepayment experience applied to the mortgage collateral pool. All sinking fund
payments in the CMOs are allocated to the retirement of the individual classes
of bonds in the order of their stated maturities. Payments of principal on the
mortgage loans in the collateral pool in excess of the amount of FHLMC's minimum
sinking fund obligation for any payment date are paid to the holders of the CMOs
as additional sinking fund payments. Because of the "pass-through" nature of all
principal payments received on the collateral pool in excess of FHLMC's minimum
sinking fund requirement, the rate at which principal of the CMOs is actually
repaid is likely to be such that each class of bonds will be retired in advance
of its scheduled maturity date.
15
If collection of principal (including prepayments) on the mortgage loans
during any semi-annual payment period is not sufficient to meet FHLMC's minimum
sinking fund obligation on the next sinking fund payment date, FHLMC agrees to
make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the FHLMC CMOs are
identical to those of FHLMC PCs. FHLMC has the right to substitute collateral in
the event of delinquencies and/or defaults.
Other Mortgage-Related Securities. Other mortgage-related securities
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
on real property, including CMO residuals and stripped mortgage-backed
securities. Other mortgage-related securities may be equity or debt securities
issued by agencies or instrumentalities of the U.S. Government or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, homebuilders, mortgage banks, commercial banks, investment banks,
partnerships, trusts and special purpose entities of the foregoing.
CMO Residuals. CMO residuals are mortgage securities issued by agencies or
instrumentalities of the U.S. Government or by private originators of, or
investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
particular, the yield to maturity on CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets. In addition, if a series
of a CMO includes a class that bears interest at an adjustable rate, the yield
to maturity on the related CMO residual will also be extremely sensitive to
changes in the level of the index upon which interest rate adjustments are
based. The Fund may fail to recoup some or all of its initial investment in a
CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has developed fairly recently and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may, or pursuant to an exemption therefrom, may not,
have been registered under the Securities Act of 1933, as amended (the "1933
Act"). CMO residuals, whether or not registered under the 1933 Act, may be
subject to certain restrictions on transferability, and may be deemed
"illiquid." As used in this Statement of Additional
16
Information, the term CMO residual does not include residual interests in real
estate mortgage investment conduits.
Other Asset-Backed Securities. Similarly, PIMCO expects that other
asset-backed securities (unrelated to mortgage loans) will be offered to
investors in the future and may be purchased by the Fund. Several types of
asset-backed securities have already been offered to investors, including
Enhanced Equipment Trust Certificates ("EETCs"), Certificates for Automobile
Receivables(SM) ("CARS(SM)") and Collateralized Debt Obligations ("CDOs").
Although any entity may issue EETCs, to date, U.S. airlines are the primary
issuers. An airline EETC is an obligation secured directly by aircraft or
aircraft engines as collateral. Airline EETCs generally have credit enhancement
in the form of overcollateralization and cross-subordination (i.e., multiple
tranches and multiple aircraft as collateral). They also generally have a
dedicated liquidity facility provided by a third-party insurer to insure that
coupon payments are made on a timely basis until collateral is liquidated in the
event of a default by the lessor of the collateral. Aircraft EETCs issued by
registered U.S. carriers also benefit from a special section of the U.S.
Bankruptcy Code, which allows the aircraft to be sold by the trust holding the
collateral to repay note holders without participating in bankruptcy
proceedings. EETCs tend to be less liquid than bonds.
CARS(SM) represent undivided fractional interests in a trust whose assets
consist of a pool of motor vehicle retail installment sales contracts and
security interests in the vehicles securing the contracts. Payments of principal
and interest on CARS(SM) are passed through monthly to certificate holders, and
are guaranteed up to certain amounts and for a certain time period by a letter
of credit issued by a financial institution unaffiliated with the trustee or
originator of the trust. An investor's return on CARS(SM) may be affected by
early prepayment of principal on the underlying vehicle sales contracts. If the
letter of credit is exhausted, the trust may be prevented from realizing the
full amount due on a sales contract because of state law requirements and
restrictions relating to foreclosure sales of vehicles and the obtaining of
deficiency judgments following such sales or because of depreciation, damage or
loss of a vehicle, the application of federal and state bankruptcy and
insolvency laws, or other factors. As a result, certificate holders may
experience delays in payments or losses if the letter of credit is exhausted.
The Fund may invest in CDOs, which includes collateralized bond obligations
("CBOs"), collateralized loan obligations ("CLOs") and other similarly
structured securities. CBOs and CLOs are types of asset-backed securities. A CBO
is a trust which is backed by a diversified pool of high risk, below investment
grade fixed income securities. A CLO is a trust typically collateralized by a
pool of loans, which may include, among others, domestic and foreign senior
secured loans, senior unsecured loans, and subordinate corporate loans,
including loans that may be rated below investment grade or equivalent unrated
loans.
For both CBOs and CLOs, the cashflows from the trust are split into two or
more portions, called tranches, varying in risk and yield. The riskiest portion
is the residual or "equity" tranche which bears the bulk of defaults from the
bonds or loans in the trust and serves to protect the other, more senior
tranches from default in all but the most severe circumstances. Since it is
partially protected from defaults, a senior tranche from a CBO trust or CLO
trust typically have higher ratings and lower yields than their underlying
securities, and can be rated investment grade. Despite the protection from the
equity tranche, CBO or CLO tranches can
17
experience substantial losses due to actual defaults, increased sensitivity to
defaults due to collateral default and disappearance of protecting tranches,
market anticipation of defaults, as well as aversion to CBO or CLO securities as
a class.
The risks of an investment in a CDO depend largely on the type of the
collateral securities and the class of the CDO in which the Fund invests.
Normally, CBOs, CLOs and other CDOs are privately offered and sold, and thus,
are not registered under the securities laws. As a result, investments in CDOs
may be characterized by the Fund as illiquid securities; however, an active
dealer market may exist for CDOs allowing a CDO to qualify for Rule 144A
transactions. In addition to the normal risks associated with debt instruments
discussed elsewhere in this Statement of Additional Information and the
Prospectus (e.g., interest rate risk and default risk), CDOs carry additional
risks including, but not limited to, (i) the possibility that distributions from
collateral securities will not be adequate to make interest or other payments,
(ii) the quality of the collateral may decline in value or default, (iii) the
Fund may invest in CDOs that are subordinate to other classes, and (iv) the
complex structure of the security may not be fully understood at the time of
investment and may produce disputes with the issuer or unexpected investment
results.
Consistent with the Fund's investment objective and policies, PIMCO also
may invest in other types of asset-backed securities. Other asset-backed
securities may be collateralized by the fees earned by service providers. The
value of asset-backed securities may be substantially dependent on the servicing
of the underlying asset pools and are therefore subject to risks associated with
the negligence by, or defalcation of, their servicers. In certain circumstances,
the mishandling of related documentation may also affect the rights of the
security holders in and to the underlying collateral. The insolvency of entities
that generate receivables or that utilize the assets may result in added costs
and delays in addition to losses associated with a decline in the value of the
underlying assets.
Real Estate Investment Trusts ("REITs")
REITs are pooled investment vehicles which invest primarily in
income-producing real estate or real estate related loans or interests. REITs
are generally classified as equity REITs, mortgage REITs or a combination of
equity and mortgage REITs. Equity REITs invest the majority of their assets
directly in real property and derive income primarily from the collection of
rents. Equity REITs can also realize capital gains by selling properties that
have appreciated in value. Mortgage REITs invest the majority of their assets in
real estate mortgages and derive income from the collection of interest
payments. REITs are not taxed on income distributed to shareholders provided
they comply with the applicable requirements of the Code. The Fund will
indirectly bear its proportionate share of any management and other expenses
paid by REITs in which it invests in addition to the expenses paid by the Fund.
Debt securities issued by REITs are, for the most part, general and unsecured
obligations and are subject to risks associated with REITs.
Investing in REITs involves certain unique risks in addition to those risks
associated with investing in the real estate industry in general. An equity REIT
may be affected by changes in the value of the underlying properties owned by
the REIT. A mortgage REIT may be affected by changes in interest rates and the
ability of the issuers of its portfolio mortgages to repay their obligations.
REITs are dependent upon the skills of their managers and are not diversified.
18
REITs are generally dependent upon maintaining cash flows to repay borrowings
and to make distributions to shareholders and are subject to the risk of default
by lessees or borrowers. REITs whose underlying assets are concentrated in
properties used by a particular industry, such as health care, are also subject
to risks associated with such industry.
REITs (especially fixed-rate mortgage REITs) are also subject to interest
rate risks that apply generally to mortgage-related securities and other debt
instruments, as described above.
REITs may have limited financial resources, may trade less frequently and
in a limited volume and may be subject to more abrupt or erratic price movements
than larger company securities. Historically REITs have been more volatile in
price than the larger capitalization stocks included in Standard & Poor's 500
Stock Index.
Bank Capital Securities and Obligations
The Fund may invest in bank capital securities. Bank capital securities are
issued by banks to help fulfill their regulatory capital requirements. There are
three common types of bank capital: Lower Tier II, Upper Tier II and Tier I. To
the extent that the Fund invests in bank capital, it expects to primarily invest
in floating rate Upper Tier II and Tier I bank capital. Bank capital is
generally, but not always, of investment grade quality. Upper Tier II securities
are commonly thought of as hybrids of debt and preferred stock. Upper Tier II
securities are often perpetual (with no maturity date), callable and have a
cumulative interest deferral feature. This means that under certain conditions,
the issuer bank can withhold payment of interest until a later date. However,
such deferred interest payments generally earn interest. Tier I securities often
take the form of trust preferred securities.
The Fund may also invest in other bank obligations including certificates
of deposit, bankers' acceptances, and fixed time deposits. Certificates of
deposit are negotiable certificates that are issued against funds deposited in a
commercial bank for a definite period of time and earning a specified return.
Bankers' acceptances are negotiable drafts or bills of exchange, normally drawn
by an importer or exporter to pay for specific merchandise, which are "accepted"
by a bank, meaning, in effect, that the bank unconditionally agrees to pay the
face value of the instrument on maturity. Fixed time deposits are bank
obligations payable at a stated maturity date and bearing interest at a fixed
rate. Fixed time deposits may be withdrawn on demand by the investor, but may be
subject to early withdrawal penalties which vary depending upon market
conditions and the remaining maturity of the obligation. There are generally no
contractual restrictions on the right to transfer a beneficial interest in a
fixed time deposit to a third party, although there is no market for such
deposits. The Fund may also hold funds on deposit with its custodian bank in an
interest-bearing account for temporary purposes.
Subject to the Fund's limitation on concentration of no more than 25% of
its total assets in the securities of issuers in a particular industry, the Fund
may invest without limit in U.S. dollar-denominated obligations of foreign banks
and may invest up to 25% of its total assets in foreign bank obligations
denominated in foreign currencies, subject to the restriction that a maximum of
10% of the Fund's total assets may be invested in securities of "emerging
market" countries. Obligations of foreign banks involve certain risks associated
with investing in foreign securities described under "--Foreign (Non-U.S.)
Securities" below. Foreign banks are not generally subject to examination by any
U.S. Government agency or instrumentality.
19
Delayed Funding Loans and Revolving Credit Facilities
The Fund may also enter into, or acquire participations in, delayed funding
loans and revolving credit facilities. Delayed funding loans and revolving
credit facilities are borrowing arrangements in which the lender agrees to make
loans up to a maximum amount upon demand by the borrower during a specified
term. A revolving credit facility differs from a delayed funding loan in that as
the borrower repays the loan, an amount equal to the repayment may be borrowed
again during the term of the revolving credit facility. Delayed funding loans
and revolving credit facilities usually provide for floating or variable rates
of interest. These commitments may have the effect of requiring the Fund to
increase its investment in a company at a time when it might not otherwise be
desirable to do so (including a time when the company's financial condition
makes it unlikely that such amounts will be repaid).
The Fund may invest in delayed funding loans and revolving credit
facilities with credit quality comparable to that of issuers of its securities
investments. Delayed funding loans and revolving credit facilities may be
subject to restrictions on transfer, and only limited opportunities may exist to
resell such instruments. As a result, the Fund may be unable to sell such
investments at an opportune time or may have to resell them at less than fair
market value. Delayed funding loans and revolving credit facilities are
considered to be debt obligations for the purposes of the Fund's investment
restriction relating to the lending of funds or assets by the Fund.
Commercial Paper
Commercial paper represents short-term unsecured promissory notes issued in
bearer form by corporations such as banks or bank holding companies and finance
companies. The Fund may invest in commercial paper of any credit quality
consistent with the Fund's investment objective and policies, including unrated
commercial paper for which PIMCO has made a credit quality assessment. See
Appendix A to the Prospectus for a description of the ratings assigned by
Moody's, S&P, Fitch and Dominion to commercial paper. The rate of return on
commercial paper may be linked or indexed to the level of exchange rates between
the U.S. dollar and a foreign currency or currencies.
U.S. Government Securities
U.S. Government securities are obligations of, or guaranteed by, the U.S.
Government, its agencies or instrumentalities. The U.S. Government does not
guarantee the net asset value of the Fund's shares. Some U.S. Government
securities, such as Treasury bills, notes and bonds, and securities guaranteed
by the GNMA, are supported by the full faith and credit of the United States;
others, such as those of the Federal Home Loan Banks, are supported by the right
of the issuer to borrow from the U.S. Treasury; others, such as those of the
FNMA, are supported by the discretionary authority of the U.S. Government to
purchase the agency's obligations; and still others, such as those of the
Student Loan Marketing Association, are supported only by the credit of the
instrumentality. U.S. Government securities include securities that have no
coupons, or have been stripped of their unmatured interest coupons, individual
interest coupons from such securities that trade separately, and evidences of
receipt of such securities. Such securities may pay no cash income, and are
purchased at a deep discount from their value at maturity. See "--Zero-Coupon
Bonds, Step-Ups and Payment-In-Kind Securities." Custodial receipts issued in
connection with so-called trademark zero-coupon securities, such as CATs and
TIGRs, are not
20
issued by the U.S. Treasury, and are therefore not U.S. Government securities,
although the underlying bond represented by such receipt is a debt obligation of
the U.S. Treasury. Other zero-coupon Treasury securities (e.g., STRIPs and
CUBEs) are direct obligations of the U.S. Government.
Preferred Stock
Preferred stock represents an equity interest in a company that generally
entitles the holder to receive, in preference to the holders of other stocks
such as common stocks, dividends and a fixed share of the proceeds resulting
from a liquidation of the company. Some preferred stocks also entitle their
holders to receive additional liquidation proceeds on the same basis as holders
of a company's common stock, and thus also represent an ownership interest in
that company. The Fund will ordinarily invest in preferred stocks that pay
variable rates of return, but may also invest in fixed-rate preferred stocks.
See below. The value of a company's preferred stock may fall as a result of
factors relating directly to that company's products or services. A preferred
stock's value may also fall because of factors affecting not just the company,
but companies in the same industry or in a number of different industries, such
as increases in production costs. The value of preferred stock may also be
affected by changes in financial markets that are relatively unrelated to the
company or its industry, such as changes in interest rates or currency exchange
rates. In addition, a company's preferred stock generally pays dividends only
after the company makes required payments to holders of its bonds and other
debt. For this reason, the value of the preferred stock will usually react more
strongly than bonds and other debt to actual or perceived changes in the
company's financial condition or prospects. Preferred stocks of smaller
companies may be more vulnerable to adverse developments than those of larger
companies.
Adjustable Rate and Auction Preferred Stocks. Typically, the dividend rate
on an adjustable rate preferred stock is determined prospectively each quarter
by applying an adjustment formula established at the time of issuance of the
stock. Although adjustment formulas vary among issues, they typically involve a
fixed premium or discount relative to rates on specified debt securities issued
by the U.S. Treasury. Typically, an adjustment formula will provide for a fixed
premium or discount adjustment relative to the highest base yield of three
specified U.S. Treasury securities: the 90-day Treasury bill, the 10-year
Treasury note and the 20-year Treasury bond. The premium or discount adjustment
to be added to or subtracted from this highest U.S. Treasury base rate yield is
fixed at the time of issue and cannot be changed without the approval of the
holders of the stock. The dividend rate on other preferred stocks in which the
Fund may invest, commonly known as auction preferred stocks, is adjusted at
intervals that may be more frequent than quarterly, such as every 49 days, based
on bids submitted by holders and prospective purchasers of such stocks and may
be subject to stated maximum and minimum dividend rates. The issues of most
adjustable rate and auction preferred stocks currently outstanding are
perpetual, but are redeemable after a specified date at the option of the
issuer. Certain issues supported by the credit of a high-rated financial
institution provide for mandatory redemption prior to expiration of the credit
arrangement. No redemption can occur if full cumulative dividends are not paid.
Although the dividend rates on adjustable and auction preferred stocks are
generally adjusted or reset frequently, the market values of these preferred
stocks may still fluctuate in response to changes in interest rates. Market
values of adjustable preferred stocks also may substantially fluctuate if
interest rates increase or decrease once the maximum or minimum dividend rate
for a particular stock is approached.
21
Fixed Rate Preferred Stocks. Some fixed rate preferred stocks in which the
Fund may invest, known as perpetual preferred stocks, offer a fixed return with
no maturity date. Because they never mature, perpetual preferred stocks act like
long-term bonds, can be more volatile than other types of preferred stocks that
have a maturity date and may have heightened sensitivity to changes in interest
rates. The Fund may also invest in sinking fund preferred stocks. These
preferred stocks also offer a fixed return, but have a maturity date and are
retired or redeemed on a predetermined schedule. The shorter duration of sinking
fund preferred stocks makes them perform somewhat like intermediate-term bonds
and they typically have lower yields than perpetual preferred stocks.
Zero-Coupon Bonds, Step-Ups 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 obligations. Like
zero-coupon bonds, "step-up" bonds pay no interest initially but eventually
begin to pay a coupon rate prior to maturity, which rate may increase at stated
intervals during the life of the security. 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,
step-ups 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, step-ups 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 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, step-ups and PIKs may be illiquid, making it difficult for
the Fund to dispose of them or determine their current value.
Convertible Securities and Synthetic Convertible Securities
The Fund may invest in convertible securities, which are debt securities
that may be converted at either a stated price or stated rate into underlying
shares of common stock. Convertible securities have general characteristics
similar to both debt securities and equity securities. PIMCO will generally
evaluate these instruments based primarily on their debt characteristics.
Because most convertible securities are fixed-rate instruments, 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, also will react to variations in the general market for equity
securities.
The Fund may also invest in synthetic convertible securities, which differ
from convertible securities in certain respects. Unlike a true convertible
security, which is a single security having a unitary market value, a synthetic
convertible comprises two or more separate securities, each with its own market
value. Therefore, the "market value" of a synthetic convertible security is the
sum of the values of its debt component and its convertibility component.
Synthetic convertible securities can be variable or fixed rate instruments. For
these reasons, the values of a synthetic convertible and a true convertible
security may respond differently to market fluctuations.
22
Convertible securities generally have higher yields than common stocks.
There can be no assurance of current income because the issuers of the
convertible securities may default on their obligations. 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 increases in the market price of the underlying common stock.
Municipal Bonds
The Fund may invest in municipal bonds which pay interest that, in the
opinion of bond counsel to the issuer (or on the basis of other authority
believed by PIMCO to be reliable), is exempt from federal income taxes
("municipal bonds"), although dividends that the Fund pays that are attributable
to such interest will not be tax-exempt to shareholders of the Fund.
Municipal bonds share the attributes of debt obligations in general, but
are generally issued by states, municipalities and other political subdivisions,
agencies, authorities and instrumentalities of states and multi-state agencies
or authorities. The municipal bonds that the Fund may purchase include general
obligation bonds and limited obligation bonds (or revenue bonds), including
industrial development bonds issued pursuant to former federal tax law. General
obligation bonds are obligations involving the credit of an issuer possessing
taxing power and are payable from such issuer's general revenues and not from
any particular source. Limited obligation bonds are payable only from the
revenues derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special excise or other specific revenue source.
Tax-exempt private activity bonds and industrial development bonds generally are
also revenue bonds and thus are not payable from the issuer's general revenues.
The credit and quality of private activity bonds and industrial development
bonds are usually related to the credit of the user of the facilities. Payment
of interest on and repayment of principal of such bonds is the responsibility of
the user (and/or any guarantor).
Municipal bonds are subject to credit and market risk. Generally, prices of
higher quality issues tend to fluctuate less with changes in market interest
rates than prices of lower quality issues and prices of longer maturity issues
tend to fluctuate more than prices of shorter maturity issues. Prices and yields
on municipal bonds are dependent on a variety of factors, including general
money-market conditions, the financial condition of the issuer, general
conditions of the municipal bond market, the size of a particular offering, the
maturity of the obligation and the rating of the issue. A number of these
factors, including the ratings of particular issues, are subject to change from
time to time. Information about the financial condition of an issuer of
municipal bonds may not be as extensive as that which is made available by
corporations whose
23
securities are publicly traded. Obligations of issuers of municipal bonds are
subject to the provisions of bankruptcy, insolvency and other laws, such as the
Federal Bankruptcy Reform Act of 1978, affecting the rights and remedies of
creditors. Congress or state legislatures may seek to extend the time for
payment of principal or interest, or both, or to impose other constraints upon
enforcement of such obligations. There is also the possibility that as a result
of litigation or other conditions, the power or ability of issuers to meet their
obligations for the payment of interest and principal on their municipal bonds
may be materially affected or their obligations may be found to be invalid or
unenforceable.
The Fund may also invest in residual interest municipal bonds ("RIBS")
whose interest rates bear an inverse relationship to the interest rate on
another security or the value of an index. RIBS are created by dividing the
income stream provided by the underlying bonds to create two securities, one
short-term and one long-term. The interest rate on the short-term component is
reset by an index or auction process normally every seven to 35 days. After
income is paid on the short-term securities at current rates, the residual
income from the underlying bond(s) goes to the long-term securities. Therefore,
rising short-term interest rates result in lower income for the longer-term
portion, and vice versa. The longer-term bonds can be very volatile and may be
less liquid than other municipal bonds of comparable maturity. An investment in
RIBS typically will involve greater risk than an investment in a fixed rate
bond. Because increases in the interest rate on the other security or index
reduce the residual interest paid on a RIB, the value of a RIB is generally more
volatile than that of a fixed rate bond. RIBS have interest rate adjustment
formulas that generally reduce or, in the extreme, eliminate the interest paid
to the Fund when short-term interest rates rise, and increase the interest paid
to the Fund when short-term interest rates fall. RIBS have varying degrees of
liquidity that approximate the liquidity of the underlying bond(s), and the
market price for these securities is volatile. These securities generally will
underperform the market of fixed rate bonds in a rising interest rate
environment, but tend to outperform the market of fixed rate bonds when interest
rates decline or remain relatively stable. Although volatile, RIBS typically
offer the potential for yields exceeding the yields available on fixed rate
bonds with comparable credit quality, coupon, call provisions and maturity. The
Fund may also invest in RIBS for the purpose of increasing the Fund's leverage
as a more flexible alternative to the issuance of any preferred shares of
beneficial interest that the Fund may issue (the "Preferred Shares"). Should
short-term and long-term interest rates rise, the combination of the Fund's
investment in RIBS and its use of other forms of leverage (including through the
issuance of Preferred Shares or the use of other derivative instruments) likely
will adversely affect the Fund's net asset value per share and income,
distributions and total returns to shareholders. Trusts in which RIBS may be
held could be terminated, in which case the residual bond holder would take
possession of the underlying bond(s) on an unleveraged basis.
Foreign (Non-U.S.) Securities
The Fund may invest some or all of its assets in U.S. dollar-denominated
debt obligations of corporate and other foreign (non-U.S.) issuers, including
obligations of foreign banks (see "--Bank Obligations" above), foreign
governments or their subdivisions, agencies and instrumentalities, international
agencies and supra-national government entities. The Fund may invest up to 25%
of its total assets in securities denominated in currencies other than the U.S.
dollar.
24
The foreign securities in which the Fund may invest include Eurodollar
obligations and "Yankee Dollar" obligations. Eurodollar obligations are U.S.
dollar-denominated certificates of deposit and time deposits issued outside the
U.S. capital markets by foreign branches of U.S. banks and by foreign banks.
Yankee Dollar obligations are U.S. dollar-denominated obligations issued in the
U.S. capital markets by foreign banks. Eurodollar and Yankee Dollar obligations
are generally subject to the same risks that apply to domestic debt issues,
notably credit risk, market risk and liquidity risk. Additionally, Eurodollar
(and to a limited extent, Yankee Dollar) obligations are subject to certain
sovereign risks. One such risk is the possibility that a sovereign country might
prevent capital, in the form of U.S. dollars, from flowing across its borders.
Other risks include adverse political and economic developments; the extent and
quality of government regulation of financial markets and institutions; the
imposition of foreign withholding taxes; and the expropriation or
nationalization of foreign issuers.
The Fund may invest in American Depository Receipts ("ADRs"), European
Depository Receipts ("EDRs") or Global Depository Receipts ("GDRs"). ADRs are
U.S. dollar-denominated receipts issued generally by domestic banks and
represent the deposit with the bank of a security of a foreign issuer. EDRs are
foreign currency-denominated receipts similar to ADRs and are issued and traded
in Europe, and are publicly traded on exchanges or over-the-counter in the
United States. GDRs may be offered privately in the United States and also trade
in public or private markets in other countries. ADRs, EDRs and GDRs may be
issued as sponsored or unsponsored programs. In sponsored programs, an issuer
has made arrangements to have its securities trade in the form of ADRs, EDRs or
GDRs. In unsponsored programs, the issuer may not be directly involved in the
creation of the program. Although regulatory requirements with respect to
sponsored and unsponsored programs are generally similar, in some cases it may
be easier to obtain financial information from an issuer that has participated
in the creation of a sponsored program.
The Fund may invest in Brady Bonds. Brady Bonds are securities created
through the exchange of existing commercial bank loans to sovereign entities for
new obligations in connection with debt restructurings under a debt
restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas
F. Brady (the "Brady Plan"). Brady Plan debt restructurings have been
implemented in a number of countries, including: Argentina, Bolivia, Brazil,
Bulgaria, Costa Rica, the Dominican Republic, Ecuador, Jordan, Mexico, Niger,
Nigeria, Panama, Peru, the Philippines, Poland, Uruguay, and Venezuela.
Brady Bonds may be collateralized or uncollateralized, are issued in
various currencies (primarily the U.S. dollar) and are actively traded in the
over-the-counter secondary market. Brady Bonds are not considered to be U.S.
Government securities. U.S. dollar-denominated, collateralized Brady Bonds,
which may be fixed rate par bonds or floating rate discount bonds, are generally
collateralized in full as to principal by U.S. Treasury zero-coupon bonds having
the same maturity as the Brady Bonds. Interest payments on these Brady Bonds
generally are collateralized on a one-year or longer rolling-forward basis by
cash or securities in an amount that, in the case of fixed rate bonds, is equal
to at least one year of interest payments or, in the case of floating rate
bonds, initially is equal to at least one year's interest payments based on the
applicable interest rate at that time and is adjusted at regular intervals
thereafter. Certain Brady Bonds are entitled to "value recovery payments" in
certain circumstances, which in effect constitute supplemental interest payments
but generally are not collateralized. Brady Bonds are often viewed as having
three or four valuation components: (i) the collateralized repayment of
25
principal at final maturity; (ii) the collateralized interest payments; (iii)
the uncollateralized interest payments; and (iv) any uncollateralized repayment
of principal at maturity (the uncollateralized amounts constitute the "residual
risk").
Most Mexican Brady Bonds issued to date have principal repayments at final
maturity fully collateralized by U.S. Treasury zero-coupon bonds (or comparable
collateral denominated in other currencies) and interest coupon payments
collateralized on an 18-month rolling-forward basis by funds held in escrow by
an agent for the bondholders. A significant portion of the Venezuelan Brady
Bonds and the Argentine Brady Bonds issued to date have repayments at final
maturity collateralized by U.S. Treasury zero-coupon bonds (or comparable
collateral denominated in other currencies) and/or interest coupon payments
collateralized on a 14-month (for Venezuela) or 12-month (for Argentina)
rolling-forward basis by securities held by the Federal Reserve Bank of New York
as collateral agent.
Brady Bonds involve various risk factors including residual risk and the
history of defaults with respect to commercial bank loans by public and private
entities of countries issuing Brady Bonds. There can be no assurance that Brady
Bonds in which the Fund may invest will not be subject to restructuring
arrangements or to requests for new credit, which may cause the Fund to suffer a
loss of interest or principal on any of its holdings.
Investing in the securities of foreign issuers involves special risks and
considerations not typically associated with investing in U.S. companies. These
include: differences in accounting; auditing and financial reporting standards;
generally higher commission rates on foreign portfolio transactions; the
possibility of expropriation or confiscatory taxation; adverse changes in
investment or exchange control regulations (which may include suspension of the
ability to transfer currency from a country); political instability which can
affect U.S. investments in foreign countries and potential restrictions on the
flow of international capital. In addition, foreign securities and dividends and
interest payable on those securities may be subject to foreign taxes, including
taxes withheld from payments on those securities. Foreign securities often trade
with less frequency and volume than domestic securities and therefore may
exhibit greater price volatility. Changes in foreign exchange rates will affect
the value of those securities which are denominated or quoted in currencies
other than the U.S. dollar.
Emerging Market Securities. The Fund may invest up to 10% of its total
assets in issuers located in "emerging markets." PIMCO generally considers an
emerging market to be one located in any country that is defined as an emerging
or developing economy by the World Bank or its related organizations, or the
United Nations or its subsidiaries. The risks of investing in foreign securities
are particularly high when securities of issuers based in or denominated in
currencies of developing or emerging market countries are involved. Investing in
emerging market countries involves certain risks not typically associated with
investing in U.S. securities, and imposes risks greater than, or in addition to,
risks of investing in foreign, developed countries. These risks include: greater
risks of nationalization or expropriation of assets or confiscatory taxation;
currency devaluations and other currency exchange rate fluctuations; greater
social, economic and political uncertainty and instability (including the risk
of war); more substantial government involvement in the economy; less government
supervision and regulation of the securities markets and participants in those
markets; controls on foreign investment and limitations on repatriation of
invested capital and on the Fund's ability to exchange local currencies for U.S.
dollars; unavailability of currency hedging techniques in certain emerging
26
market countries; the fact that companies in emerging market countries may be
smaller, less seasoned and newly organized; the difference in, or lack of,
auditing and financial reporting standards, which may result in unavailability
of material information about issuers; the risk that it may be more difficult to
obtain and/or enforce a judgment in a court outside the United States; and
greater price volatility, substantially less liquidity and significantly smaller
market capitalization of securities markets. In addition, a number of emerging
market countries restrict, to various degrees, foreign investment in securities,
and high rates of inflation and rapid fluctuations in inflation rates have had,
and may continue to have, negative effects on the economies and securities
markets of certain emerging market countries. Also, any change in the leadership
or politics of emerging market countries, or the countries that exercise a
significant influence over those countries, may halt the expansion of or reverse
the liberalization of foreign investment policies now occurring and adversely
affect existing investment opportunities.
Sovereign Debt. The Fund may invest in sovereign debt issued by foreign
developed and emerging market governments and their respective sub-divisions,
agencies or instrumentalities, government sponsored enterprises and
supra-national government entities. Supra-national entities include
international organizations that are organized or supported by one or more
government entities to promote economic reconstruction or development and by
international banking institutions and related governmental agencies. Investment
in sovereign debt can involve a high degree of risk. The governmental entity
that controls the repayment of sovereign debt may not be able or willing to
repay the principal and/or interest when due in accordance with the terms of the
debt. A governmental entity's willingness or ability to repay principal and
interest due in a timely manner may be affected by, among other factors, its
cash flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the governmental entity's
policy toward the International Monetary Fund, and the political constraints to
which a governmental entity may be subject. Governmental entities may also
depend on expected disbursements from foreign governments, multilateral agencies
and others to reduce principal and interest arrearages on their debt. The
commitment on the part of these governments, agencies and others to make such
disbursements may be conditioned on a governmental entity's implementation of
economic reforms and/or economic performance and the timely service of such
debtor's obligations. Failure to implement such reforms, achieve such levels of
economic performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds to the
governmental entity, which may further impair such debtor's ability or
willingness to service its debts in a timely manner. Consequently, governmental
entities may default on their sovereign debt. Holders of sovereign debt
(including the Fund) may be requested to participate in the rescheduling of such
debt and to extend further loans to governmental entities. There is no
bankruptcy proceeding by which sovereign debt on which governmental entities
have defaulted may be collected in whole or in part.
The Fund's investments in foreign currency-denominated debt obligations and
hedging activities will likely produce a difference between its book income and
its taxable income. This difference may cause a portion of the Fund's income
distributions to constitute returns of capital for tax purposes or require the
Fund to make distributions exceeding book income to qualify as a regulated
investment company for federal income tax purposes.
27
Foreign Currency Transactions
Subject to the limitations discussed above and in the Prospectus, the Fund
also may purchase and sell foreign currency options and foreign currency futures
contracts and related options (see "--Derivative Instruments" below), and may
engage in foreign currency transactions either on a spot (cash) basis at the
rate prevailing in the currency exchange market at the time or through forward
foreign currency exchange contracts ("forwards") with terms generally of less
than one year. The Fund may engage in these transactions in order to protect
against uncertainty in the level of future foreign exchange rates in the
purchase and sale of securities. The Fund may also use foreign currency options
and foreign currency forward contracts to increase exposure to a foreign
currency or to shift exposure to foreign currency fluctuations from one country
to another. Suitable currency hedging transactions may not be available in all
circumstances and PIMCO may decide not to use hedging transactions that are
available.
A forward involves an obligation to purchase or sell a specific currency at
a future date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time of the contract.
These contracts may be bought or sold to protect the Fund against a possible
loss resulting from an adverse change in the relationship between foreign
currencies and the U.S. dollar or to increase exposure to a particular foreign
currency. Although forwards are intended to minimize the risk of loss due to a
decline in the value of the hedged currencies, at the same time, they tend to
limit any potential gain which might result should the value of such currencies
increase. Forwards will be used primarily to adjust the foreign exchange
exposure of the Fund with a view to protecting the outlook, and the Fund might
be expected to enter into such contracts under the following circumstances:
Lock In. When PIMCO desires to lock in the U.S. dollar price on the
purchase or sale of a security denominated in a foreign currency.
Cross Hedge. If a particular currency is expected to decrease against
another currency, the Fund may sell the currency expected to decrease and
purchase a currency that is expected to increase against the currency sold in an
amount approximately equal to some or all of the Fund's portfolio holdings
denominated in the currency sold.
Direct Hedge. If PIMCO wants to eliminate substantially all of the risk of
owning a particular currency, and/or if PIMCO believes that the Fund can benefit
from price appreciation in a given country's debt obligations but does not want
to hold the currency, it may employ a direct hedge back into the U.S. dollar. In
either case, the Fund would enter into a forward contract to sell the currency
in which a portfolio security is denominated and purchase U.S. dollars at an
exchange rate established at the time it initiated a contract. The cost of the
direct hedge transaction may offset most, if not all, of the yield advantage
offered by the foreign security, but the Fund would hope to benefit from an
increase (if any) in the value of the debt obligation.
Proxy Hedge. PIMCO might choose to use a proxy hedge, which may be less
costly than a direct hedge. In this case, the Fund, having purchased a security,
will sell a currency whose value is believed to be closely linked to the
currency in which the security is denominated. Interest rates prevailing in the
country whose currency was sold would be expected to be close to those in the
United States and lower than those of securities denominated in the currency of
the
28
original holding. This type of hedging entails greater risk than a direct hedge
because it is dependent on a stable relationship between the two currencies
paired as proxies and the relationships can be very unstable at times.
Costs of Hedging. When the Fund purchases a foreign bond with a higher
interest rate than is available on U.S. bonds of a similar maturity, the
additional yield on the foreign bond could be substantially reduced or lost if
the Fund were to enter into a direct hedge by selling the foreign currency and
purchasing the U.S. dollar. This is what is known as the "cost" of hedging.
Proxy hedging attempts to reduce this cost through an indirect hedge back to the
U.S. dollar.
It is important to note that hedging costs are treated as capital
transactions and are not, therefore, deducted from the Fund's dividend
distribution and are not reflected in its yield.
Tax Consequences of Hedging. Under applicable tax law, the Fund's hedging
activities may result in the application of the mark-to-market and straddle
provisions of the Code. Those provisions could result in an increase (or
decrease) in the amount of taxable dividends paid by the Fund and could affect
whether dividends paid by the Fund are classified as capital gains or ordinary
income.
Foreign Currency Exchange-Related Securities
Foreign Currency Warrants. Foreign currency warrants, such as Currency
Exchange Warrants(SM) ("CEWs(SM)"), are warrants that entitle their holders to
receive from their issuer an amount of cash (generally, for warrants issued in
the United States, in U.S. dollars) that is calculated pursuant to a
predetermined formula and based on the exchange rate between a specified foreign
currency and the U.S. dollar as of the exercise date of the warrant. Foreign
currency warrants generally are exercisable upon their issuance and expire as of
a specific date and time. Foreign currency warrants have been issued in
connection with U.S. dollar-denominated debt offerings by major issuers in an
attempt to reduce the foreign currency exchange risk that, from the point of
view of the prospective purchasers of the securities, is inherent in the
international debt obligation marketplace. Foreign currency warrants may attempt
to reduce the foreign exchange risk assumed by purchasers of a security by, for
example, providing for a supplement payment in the event that the U.S. dollar
depreciates against the value of a major foreign currency such as the Japanese
yen. The formula used to determine the amount payable upon exercise of a foreign
currency warrant may make the warrant worthless unless the applicable foreign
currency exchange rate moves in a particular direction (e.g., unless the U.S.
dollar appreciates or depreciates against the particular foreign currency to
which the warrant is linked or indexed). Foreign currency warrants are severable
from the debt obligations with which they may be offered, and may be listed on
exchanges. Foreign currency warrants may be exercisable only in certain minimum
amounts, and an investor wishing to exercise warrants who possesses less than
the minimum number required for exercise may be required either to sell the
warrants or to purchase additional warrants, thereby incurring additional
transaction costs. In the case of any exercise of warrants, there may be a time
delay between the time a holder of warrants gives instructions to exercise and
the time the exchange rate relating to exercise is determined, during which time
the exchange rate could change significantly, thereby affecting both the market
and cash settlement values of the warrants being exercised. The expiration date
of the warrants may be accelerated if the warrants should be delisted from an
exchange or if their trading should be suspended permanently, which would result
in the loss of
29
any remaining "time values" of the warrants (i.e., the difference between the
current market value and the exercise value of the warrants), and, if the
warrants were "out-of-the-money," in a total loss of the purchase price of the
warrants. Warrants are generally unsecured obligations of their issuers and are
not standardized foreign currency options issued by the Options Clearing
Corporation ("OCC"). Unlike foreign currency options issued by the OCC, the
terms of foreign exchange warrants generally will not be amended in the event of
government or regulatory actions affecting exchange rates or in the event of the
imposition of other regulatory controls affecting the international currency
markets. The initial public offering price of foreign currency warrants is
generally considerably in excess of the price that a commercial user of foreign
currencies might pay in the interbank market for a comparable option involving
significantly larger amounts of foreign currencies. Foreign currency warrants
are subject to significant foreign exchange risk, including risks arising from
complex political or economic factors.
Principal Exchange Rate Linked Securities. Principal exchange rate linked
securities ("PERLs(SM)") are debt obligations the principal on which is payable
at maturity in an amount that may vary based on the exchange rate between the
U.S. dollar and a particular foreign currency at or about that time. The return
on "standard" principal exchange rate linked securities is enhanced if the
foreign currency to which the security is linked appreciates against the U.S.
dollar, and is adversely affected by increases in the foreign exchange value of
the U.S. dollar; "reverse" principal exchange rate linked securities are like
"standard" securities, except that their return is enhanced by increases in the
value of the U.S. dollar and adversely impacted by increases in the value of
foreign currency. Interest payments on the securities are generally made in U.S.
dollars at rates that reflect the degree of foreign currency risk assumed or
given up by the purchaser of the notes (i.e., at relatively higher interest
rates if the purchaser has assumed some of the foreign exchange risk, or
relatively lower interest rates if the issuer has assumed some of the foreign
exchange risk, based on the expectations of the current market). Principal
exchange rate linked securities may in limited cases be subject to acceleration
of maturity (generally, not without the consent of the holders of the
securities), which may have an adverse impact on the value of the principal
payment to be made at maturity.
Performance Indexed Paper. Performance indexed paper ("PIPs(SM)") is U.S.
dollar-denominated commercial paper the yield of which is linked to certain
foreign exchange rate movements. The yield to the investor on performance
indexed paper is established at maturity as a function of spot exchange rates
between the U.S. dollar and a designated currency as of or about that time
(generally, the index maturity two days prior to maturity). The yield to the
investor will be within a range stipulated at the time of purchase of the
obligation, generally with a guaranteed minimum rate of return that is below,
and a potential maximum rate of return that is above, market yields on U.S.
dollar-denominated commercial paper, with both the minimum and maximum rates of
return on the investment corresponding to the minimum and maximum values of the
spot exchange rate two business days prior to maturity.
Derivative Instruments
The Fund may, but is not required to, use a variety of derivative
instruments for hedging or risk management purposes or as part of its investment
strategies. Generally, derivatives are financial contracts whose value depends
upon, or is derived from, the value of an underlying asset, reference rate or
index, and may relate to individual debt instruments, interest rates, currencies
or currency exchange rates, commodities or related indexes. The Fund may use
30
derivatives to gain exposure to floating rate or high yield securities and other
securities in which the Fund may invest (including pending investment of the
proceeds of this offering). Examples of derivative instruments that the Fund may
use include, but are not limited to, options contracts, futures contracts,
options on futures contracts, swap agreements (including total return and credit
default swaps) and short sales. The Fund may also engage in credit spread
trades. A credit spread trade is an investment position relating to a difference
in the prices or interest rates of two bonds or other securities, where the
value of the investment position is determined by changes in the difference
between such prices or interest rates, as the case may be, of the respective
securities. The Fund may also have exposure to derivatives, such as interest
rate or credit-default swaps, through investment in credit-linked trust
certificates and other securities issued by special purpose or structured
vehicles. The Fund may also use derivatives to add leverage to the portfolio,
but only as a substitute for leverage obtained through Preferred Shares. If
other types of financial instruments, including other types of options, futures
contracts or futures options are traded in the future, the Fund may also use
those instruments, provided that their use is consistent with the Fund's
investment objective and policies.
Like the other investments of the Fund, the ability of the Fund to
successfully utilize derivative instruments may depend in part upon the ability
of PIMCO to assess the issuer's credit characteristics and other macro-economic
factors correctly. If PIMCO incorrectly forecasts such factors and has taken
positions in derivative instruments contrary to prevailing market trends, the
Fund could be exposed to the risk of loss.
The Fund might not employ any of the strategies described below, and no
assurance can be given that any strategy used will succeed. If PIMCO incorrectly
forecasts market values or other economic factors in utilizing a derivatives
strategy for the Fund, the Fund might have been in a better position if it had
not entered into the transaction at all. Also, suitable derivative transactions
may not be available in all circumstances. The use of these strategies involves
certain special risks, including a possible imperfect correlation, or even no
correlation, between price movements of derivative instruments and price
movements of related investments. While some strategies involving derivative
instruments can reduce the risk of loss, they can also reduce the opportunity
for gain or even result in losses by offsetting favorable price movements in
related investments or otherwise, due to the possible inability of the Fund to
purchase or sell a portfolio security at a time that otherwise would be
favorable or the possible need to sell a portfolio security at a disadvantageous
time because the Fund is required to maintain asset coverage or offsetting
positions in connection with transactions in derivative instruments, and the
possible inability of the Fund to close out or to liquidate its derivatives
positions. Income earned by the Fund from many derivative strategies will be
treated as capital gain and, if not offset by net realized capital loss, will be
distributed to shareholders in taxable distributions.
Options on Securities, Swap Agreements and Indexes. The Fund may purchase
and sell both put and call options on securities, swap agreements or 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, and agreements, sometimes called cash puts, which may accompany the
purchase of a new issue of debt obligations from a dealer.
An 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 (in the case of a
call) or sell to (in the case of a put) the writer of the option the security
underlying the option (or the cash value of the index) at a
31
specified exercise price at any time during the term of the option. The writer
of an option on a security has the obligation upon exercise of the option to
deliver the underlying security upon payment of the exercise price or to pay the
exercise price upon delivery of the underlying security. Upon exercise, the
writer of an option on an index is obligated to pay the difference between the
cash value of the index and the exercise price multiplied by the specified
multiplier for the index option. (An index is designed to reflect features of a
particular securities market, a specific group of financial instruments or
securities, or certain economic indicators.)
The Fund may (but is not required to) cover its obligations when it writes
call options or put options. In the case of a call option on a debt obligation
or other security, the option is covered if the Fund owns the security
underlying the call or has an absolute and immediate right to acquire that
security without additional cash consideration (or, if additional cash
consideration is required, cash or other assets determined to be liquid by PIMCO
in accordance with procedures established by the Board of Trustees, in such
amount are segregated by its custodian) upon conversion or exchange of other
securities held by the Fund. For a call option on an index, the option is
covered if the Fund maintains with its custodian assets determined to be liquid
by PIMCO in accordance with procedures established by the Board of Trustees, in
an amount equal to the contract value of the index. A call option is also
covered if the Fund holds a call on the same security or index as the call
written where the exercise price of the call held is (i) equal to or less than
the exercise price of the call written, or (ii) greater than the exercise price
of the call written, provided the difference is maintained by the Fund in
segregated assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees. A put option on a security or an index is
covered if the Fund segregates assets determined to be liquid by PIMCO in
accordance with procedures established by the Board of Trustees equal to the
exercise price. A put option is also covered if the Fund holds a put on the same
security or index as the put written where the exercise price of the put held is
(i) equal to or greater than the exercise price of the put written, or (ii) less
than the exercise price of the put written, provided the difference is
maintained by the Fund in segregated assets determined to be liquid by PIMCO in
accordance with procedures established by the Board of Trustees. Obligations
under written call and put options so covered will not be construed to be
"senior securities" for purposes of the Fund's investment restrictions
concerning senior securities and borrowings.
If an option written by the Fund expires unexercised, the Fund realizes on
the expiration date a capital gain equal to the premium the Fund received at the
time the option was written. 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 put or call options it has previously purchased, which
could result in a net gain or loss depending on whether the amount realized on
the sale is more or less than the premium and other transaction costs paid on
the put or call option which is sold. Prior to exercise or expiration, an option
may be closed out by an offsetting purchase or sale of an option of the same
series. The Fund will realize a capital gain from a closing purchase transaction
if the cost of the closing option is less than the premium received from writing
the option, or, if it is more, the Fund will realize a capital loss. If the
premium received from a closing sale transaction is more than the premium paid
to purchase the option, the Fund will realize a capital gain or, if it is less,
the Fund will realize a capital loss. The principal factors affecting the market
value of a put or a call option include supply and demand, interest rates, the
current market price
32
of the underlying security or index in relation to the exercise price of the
option, the volatility of the underlying security or index, and the time
remaining until the expiration date.
The premium paid for a put or call option purchased by the Fund is an asset
of the Fund. The premium received for an option written by the Fund is recorded
as a deferred credit. The value of an option purchased or written is marked to
market daily and is valued at the closing price on the exchange on which it is
traded or, if not traded on an exchange or no closing price is available, at the
mean between the last bid and asked prices.
The Fund may write straddles (covered or uncovered) consisting of a
combination of a call and a put written on the same underlying security. A
straddle will be covered when sufficient assets are deposited to meet the Fund's
immediate obligations. The Fund may use the same liquid assets to cover both the
call and put options where the exercise price of the call and put are the same,
or the exercise price of the call is higher than that of the put. In such cases,
the Fund will also segregate liquid assets equivalent to the amount, if any, by
which the put is "in the money."
Risks Associated with Options on Securities and Indexes. There are several
risks associated with transactions in options on securities and on indexes. For
example, there are significant differences between the securities and options
markets that could result in an imperfect correlation between these markets,
causing a given transaction not to achieve its objective. A decision as to
whether, when and how to use options involves the exercise of skill and
judgment, and even a well-conceived transaction may be unsuccessful to some
degree because of market behavior or unexpected events.
During the option period, the covered call writer has, in return for the
premium on the option, given up the opportunity to profit from a price increase
in the underlying security above the exercise price, but, as long as its
obligation as a writer continues, has retained the risk of loss should the price
of the underlying security decline. The writer of an option has no control over
the time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying security at the exercise price. If a put
or call option purchased by the Fund is not sold when it has remaining value,
and if the market price of the underlying security remains equal to or greater
than the exercise price (in the case of a put), or remains less than or equal to
the exercise price (in the case of a call), the Fund will lose its entire
investment in the option. Also, where a put or call option on a particular
security is purchased to hedge against price movements in a related security,
the price of the put or call option may move more or less than the price of the
related security.
There can be no assurance that a liquid market will exist when 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 the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
33
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. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
Foreign Currency Options. The Fund may buy or sell put and call options on
foreign currencies for investment purposes or as a hedge against changes in the
value of the U.S. dollar (or another currency) in relation to a foreign currency
in which the Fund's securities may be denominated. The Fund may buy or sell put
and call options on foreign currencies either on exchanges or in the
over-the-counter market. A put option on a foreign currency gives the purchaser
of the option the right to sell a foreign currency at the exercise price until
the option expires. A call option on a foreign currency gives the purchaser of
the option the right to purchase the currency at the exercise price until the
option expires. Currency options traded on U.S. or other exchanges may be
subject to position limits which may limit the ability of the Fund to reduce
foreign currency risk using such options.
Futures Contracts and Options on Futures Contracts. The Fund may invest in
futures contracts and options thereon ("futures options"), including interest
rates, securities indexes, debt obligations (to the extent they are available)
and U.S. Government and agency securities, as well as purchase put and call
options on such futures contracts.
A futures contract provides for the future sale by one party and purchase
by another party of a specified quantity of the security or other financial
instrument at a specified price and time. A futures contract on an index is an
agreement pursuant to which two parties agree to take or make delivery of an
amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, physical delivery of
these securities is not always made. A public market exists in futures contracts
covering a number of indexes as well as financial instruments, including,
without limitation: U.S. Treasury bonds; U.S. Treasury notes; GNMA Certificates;
three-month U.S. Treasury bills; 90-day commercial paper; bank certificates of
deposit; Eurodollar certificates of deposit; the Australian dollar; the Canadian
dollar; the British pound; the Japanese yen; the Swiss franc; the Mexican peso;
and certain multinational currencies, such as the euro. It is expected that
other futures contracts will be developed and traded in the future.
The Fund may purchase and write call and put futures options. Futures
options possess many of the same characteristics as options on securities and
indexes (discussed above). A futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
To comply with applicable rules of the Commodity Futures Trading Commission
("CFTC") under which the Fund avoids being deemed a "commodity pool" or a
"commodity pool operator," the Fund intends generally to limit its use of
futures contracts and futures options
34
to "bona fide hedging" transactions, as such term is defined in applicable
regulations, interpretations and practice. For example, the Fund might use
futures contracts to hedge against anticipated changes in interest rates that
might adversely affect either the value of the Fund's debt obligations or the
price of the debt obligations that the Fund intends to purchase. The Fund's
hedging activities may include sales of futures contracts as an offset against
the effect of expected increases in interest rates, and purchases of futures
contracts as an offset against the effect of expected declines in interest
rates. Although other techniques could be used to reduce the Fund's exposure to
interest rate fluctuations, the Fund may be able to hedge its exposure more
effectively and perhaps at a lower cost by using futures contracts and futures
options.
The Fund may enter into futures contracts and futures options that are
standardized and traded on a U.S. or other exchange, board of trade, or similar
entity, or quoted on an automated quotation system, and the Fund may also enter
into OTC options on futures contracts.
When a purchase or sale of a futures contract is made by the Fund, the Fund
is required to deposit with its custodian (or broker, if legally permitted) a
specified amount of assets determined to be liquid by PIMCO in accordance with
procedures established by the Board of Trustees ("initial margin"). The margin
required for a futures contract is set by the exchange on which the contract is
traded and may be modified during the term of the contract. The initial margin
is in the nature of a performance bond or good faith deposit on the futures
contract that is returned to the Fund upon termination of the contract, assuming
all contractual obligations have been satisfied. The Fund expects to earn
taxable interest income on its initial margin deposits. A futures contract held
by the Fund is valued daily at the official settlement price of the exchange on
which it is traded. Each day the Fund pays or receives cash, called "variation
margin," equal to the daily change in value of the futures contract. This
process is known as "marking to market." Variation margin does not represent a
borrowing or loan by the Fund but is instead a settlement between the Fund and
the broker of the amount one would owe the other if the futures contract
expired. In computing daily net asset value, the Fund will mark to market its
open futures positions.
The Fund is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts
(involving the same exchange, underlying security or index, and delivery month).
If an offsetting purchase price is less than the original sale price, the Fund
realizes a capital gain, or if it is more, the Fund realizes a capital loss.
Conversely, if an offsetting sale price is more than the original purchase
price, the Fund realizes a capital gain, or if it is less, the Fund realizes a
capital loss. The transaction costs must also be included in these calculations.
The Fund may write straddles (covered or uncovered) consisting of a call
and a put written on the same underlying futures contract. A straddle will be
covered when sufficient assets are deposited to meet the Fund's immediate
obligations. The Fund may use the same liquid assets to cover both the call and
put options where the exercise price of the call and put are
35
the same, or the exercise price of the call is higher than that of the put. In
such cases, the Fund will also segregate liquid assets equivalent to the amount,
if any, by which the put is "in the money."
Limitations on Use of Futures and Futures Options. As noted above, the Fund
generally intends to enter into positions in futures contracts and related
options only for "bona fide hedging" purposes. With respect to positions in
futures and related options that do not constitute bona fide hedging positions,
in accordance with current CFTC rules, the Fund will not enter into a futures
contract or futures option contract if, immediately thereafter, the aggregate
initial margin deposits relating to such positions plus premiums paid by it for
open futures option positions, less the amount by which any such options are "in
the money," would exceed 5% of the Fund's liquidation value, after taking into
account unrealized profits and unrealized losses on any such contracts into
which the Fund has entered. A call option is "in the money" if the value of the
futures contract that is the subject of the option exceeds the exercise price. A
put option is "in the money" if the exercise price exceeds the value of the
futures contract that is the subject of the option. The Fund notes that the CFTC
has recently proposed rules that would eliminate certain aspects of the
restrictions set forth in this paragraph. In the event that such rules are
adopted, the Fund would reserve the flexibility to utilize futures contracts and
related options to the maximum extent permitted by any such rules.
When purchasing a futures contract, the Fund will maintain with its
custodian (and mark to market on a daily basis) assets determined to be liquid
by PIMCO in accordance with procedures established by the Board of Trustees,
that, when added to the amounts deposited with a futures commission merchant as
margin, are equal to the market value of the futures contract. Alternatively,
the Fund may "cover" its position by purchasing a put option on the same futures
contract with a strike price as high as or higher than the price of the contract
held by the Fund.
When selling a futures contract, the Fund will maintain with its custodian
(and mark to market on a daily basis) assets determined to be liquid by PIMCO in
accordance with procedures established by the Board of Trustees, that are equal
to the market value of the instruments underlying the contract. Alternatively,
the Fund may "cover" its position by owning the instruments underlying the
contract (or, in the case of an index futures contract, a portfolio with a
volatility substantially similar to that of the index on which the futures
contract is based), or by holding a call option permitting the Fund to purchase
the same futures contract at a price no higher than the price of the contract
written by the Fund (or at a higher price if the difference is maintained in
liquid assets with the Fund's custodian).
When selling a call option on a futures contract, the Fund will maintain
with its custodian (and mark to market on a daily basis) assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees, that, when added to the amounts deposited with a futures commission
merchant as margin, equal the total market value of the futures contract
underlying the call option. Alternatively, the Fund may cover its position by
entering into a long position in the same futures contract at a price no higher
than the strike price of the call option, by owning the instruments underlying
the futures contract, or by holding a separate call option permitting the Fund
to purchase the same futures contract at a price not higher than the strike
price of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark to market on a daily basis) assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees, that equal the purchase price of the futures contract, less any margin
on deposit. Alternatively, the Fund may cover the position either by entering
into a short position in the same futures contract, or by owning a separate put
option
36
permitting it to sell the same futures contract so long as the strike price of
the purchased put option is the same as or higher than the strike price of the
put option sold by the Fund.
To the extent that securities with maturities greater than one year are
used to segregate assets to cover the Fund's obligations under futures contracts
and related options, such use will not eliminate the leverage risk arising from
such use, which may tend to exaggerate the effect on net asset value of any
increase or decrease in the market value of the Fund's portfolio, and may
require liquidation of portfolio positions when it is not advantageous to do so.
The requirements for qualification as a regulated investment company also
may limit the extent to which the Fund may enter into futures, futures options
or forward contracts. See "Tax Matters."
Risks Associated with Futures and Futures Options. There are several risks
associated with the use of futures contracts and futures options as hedging
techniques. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be no guarantee
that there will be a correlation between price movements in the hedging vehicle
and in the Fund securities being hedged. In addition, there are significant
differences between the securities and futures markets that could result in an
imperfect correlation between the markets, causing a given hedge not to achieve
its objective. The degree of imperfection of correlation depends on
circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest rate levels, maturities, and
creditworthiness of issuers. A decision as to whether, when and how to hedge
involves the exercise of skill and judgment, and even a well-conceived hedge may
be unsuccessful to some degree because of market behavior or unexpected interest
rate trends.
Futures contracts on U.S. Government securities historically have reacted
to an increase or decrease in interest rates in a manner similar to that in
which the underlying U.S. Government securities reacted. To the extent, however,
that the Fund enters into such futures contracts, the value of such futures will
not vary in direct proportion to the value of the Fund's holdings of debt
obligations. Thus, the anticipated spread between the price of the futures
contract and the hedged security may be distorted due to differences in the
nature of the markets. The spread also may be distorted by differences in
initial and variation margin requirements, the liquidity of such markets and the
participation of speculators in such markets.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous 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.
37
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a futures contract or a futures option position, and
the Fund would remain obligated to meet margin requirements until the position
is closed. In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Additional Risks of Options on Securities, Futures Contracts, Options on
Futures Contracts and Forward Currency Exchange Contracts and Options thereon.
Options on securities, futures contracts, options on futures contracts, and
options on currencies may be traded on foreign exchanges. Such transactions may
not be regulated as effectively as similar transactions in the United States,
may not involve a clearing mechanism and related guarantees, and are subject to
the risk of governmental actions affecting trading in, or the prices of, foreign
securities. Some foreign exchanges may be principal markets so that no common
clearing facility exists and a trader may look only to the broker for
performance of the contract. The value of such positions also could be adversely
affected by (i) other complex foreign political, legal and economic factors,
(ii) lesser availability than in the United States of data on which to make
trading decisions, (iii) delays in the Fund's ability to act upon economic
events occurring in foreign markets during non-business hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States and (v) lesser
trading volume. In addition, unless the Fund hedges against fluctuations in the
exchange rate between the U.S. dollar and the currencies in which trading is
done on foreign exchanges, any profits that the Fund might realize in trading
could be eliminated by adverse changes in the exchange rate, or the Fund could
incur losses as a result of those changes. The Fund's use of such instruments
may cause the Fund to realize higher amounts of short-term capital gains
(generally taxed to shareholders at ordinary income tax rates) than if the Fund
had not used such instruments.
Swap Agreements. The Fund may enter into total return swap agreements,
credit default swap agreements and other swap agreements made with respect to
interest rates, currencies, indexes of securities and other assets or measures
of risk or return. The Fund may also enter into options on swap agreements
("swaptions"). These transactions are entered into in an attempt to obtain a
particular return when it is considered desirable to do so, possibly at a lower
cost to the Fund than if the Fund had invested directly in an instrument that
yielded that desired return. Swap agreements are two-party contracts entered
into primarily by institutional investors for periods ranging from a few weeks
to more than one year. In a standard "swap" transaction, two parties agree to
exchange the returns (or differentials in rates of return) earned or realized on
particular predetermined investments or instruments, which may be adjusted for
an interest factor. The gross returns to be exchanged or "swapped" between the
parties are generally calculated with respect to a "notional amount," i.e., the
return on or increase in value of a particular dollar amount invested at a
particular interest rate or in a "basket" of securities representing a
particular index. Forms of swap agreements include interest rate caps, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates exceed a specified rate, or "cap"; interest
rate floors, under which, in return for a premium, one party agrees to make
payments to the other to the extent that interest rates fall below a specified
rate, or "floor"; and interest rate collars, under which a party sells a cap and
purchases a floor or vice versa in an attempt to protect itself against interest
rate movements exceeding given minimum or maximum levels. The Fund may use
interest rate caps, floors and collars to a substantial degree in connection
with its leveraging strategies. See "--Certain
38
Interest Rate Transactions" below and "The Fund's Investment Objective and
Strategies--Certain Interest Rate Transactions" in the Prospectus. A swaption is
a contract that gives a counterparty the right (but not the obligation) to enter
into a new swap agreement or to shorten, extend, cancel or otherwise modify an
existing swap agreement, at some designated future time on specified terms. The
Fund may write (sell) and purchase put and call swaptions.
Most swap agreements entered into by the Fund would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, the
Fund's current obligations (or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received under the agreement based on
the relative values of the positions held by each party to the agreement (the
"net amount"). The Fund's current obligations under a swap agreement will be
accrued daily (offset against any amounts owed to the Fund). The Fund may (but
is not required to) cover any accrued but unpaid net amounts owed to a swap
counterparty through the segregation of assets determined to be liquid by PIMCO
in accordance with procedures established by the Board of Trustees. Obligations
under swap agreements so covered will not be construed to be "senior securities"
for purposes of the Fund's investment restriction concerning senior securities
and borrowings.
Whether the Fund's use of swap agreements or swaptions will be successful
in furthering its investment objective will depend on PIMCO's ability to predict
correctly whether certain types of investments are likely to produce greater
returns than other investments. Because they are two-party contracts and because
they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. The Fund will enter into
swap agreements only with counterparties that meet certain standards of
creditworthiness. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect the Fund's ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Depending on the terms of the particular option agreement, the Fund will
generally incur a greater degree of risk when it writes a swaption than it will
incur when it purchases a swaption. When the Fund purchases a swaption, it risks
losing only the amount of the premium it has paid should it decide to let the
option expire unexercised. However, when the Fund writes a swaption, upon
exercise of the option the Fund will become obligated according to the terms of
the underlying agreement.
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the CEA.
Credit Default Swaps
The Fund may enter into credit default swap contracts for both investment
and risk management purposes. As the seller in a credit default swap contract,
the Fund would be required to pay the par (or other agreed-upon) value of a
referenced debt obligation to the counterparty in the event of a default by a
third party, such as a U.S. or foreign issuer, on the debt obligation. In
return, the Fund would receive from the counterparty a periodic stream of
payments over the term of the contract provided that no event of default has
occurred. If no
39
default occurs, the Fund would keep the stream of payments and would have no
payment obligations. As the seller, the Fund would effectively add leverage to
its portfolio because, in addition to its total net assets, the Fund would be
subject to investment exposure on the notional amount of the swap.
The Fund may also purchase credit default swap contracts in order to hedge
against the risk of default of debt securities held in its portfolio, in which
case the Fund would function as the counterparty referenced in the preceding
paragraph. This would involve the risk that the investment may expire worthless
and would generate income only in the event of an actual default by the issuer
of the underlying obligation (as opposed to a credit downgrade or other
indication of financial instability). It would also involve credit risk - that
the seller may fail to satisfy its payment obligations to the Fund in the event
of a default.
Credit-Linked Trust Certificates
Among the income-producing securities in which the Fund may invest are
credit-linked trust certificates, which are investments in a limited purpose
trust or other vehicle formed under State law which, in turn, invests in a
basket of derivative instruments, such as credit default swaps, interest rate
swaps and other securities, in order to provide exposure to the high yield or
another fixed income market. For instance, the Fund may invest in credit-linked
trust certificates as a cash management tool in order to gain exposure to the
high yield markets and/or to remain fully invested when more traditional
income-producing securities are not available, including during the period when
the net proceeds of this offering and any offering of Preferred Shares are being
invested.
Like an investment in a bond, investments in these credit-linked trust
certificates represent the right to receive periodic income payments (in the
form of distributions) and payment of principal at the end of the term of the
certificate. However, these payments are conditioned on the trust's receipt of
payments from, and the trust's potential obligations to, the counterparties to
the derivative instruments and other securities in which the trust invests. For
instance, the trust may sell one or more credit default swaps, under which the
trust would receive a stream of payments over the term of the swap agreements
provided that no event of default has occurred with respect to the referenced
debt obligation upon which the swap is based. If a default occurs, the stream of
payments may stop and the trust would be obligated to pay to the counterparty
the par (or other agreed upon value) of the referenced debt obligation. This, in
turn, would reduce the amount of income and principal that the Fund would
receive as an investor in the trust. Please see "Investment Objective and
Policies--Credit Default Swaps" in this Statement of Additional Information for
additional information about credit default swaps. The Fund's investments in
these instruments are indirectly subject to the risks associated with derivative
instruments, including, among others, credit risk, default or similar event
risk, counterparty risk, interest rate risk, leverage risk and management risk.
It is expected that the trusts which issue credit-linked trust certificates will
constitute "private" investment companies, exempt from registration under the
Investment Company Act of 1940, as amended (the "1940 Act"). Therefore, the
certificates will be subject to the risks described under "Other Investment
Companies" below, and will not be subject to applicable investment limitations
and other regulation imposed by the 1940 Act (although the Fund will remain
subject to such limitations and regulation, including with respect to its
investments in the certificates). Although the trusts are typically private
investment companies, they are generally not actively managed such as a
40
"hedge fund" might be. It is also expected that the certificates will be exempt
from registration under the 1933 Act. Accordingly, there may be no established
trading market for the certificates and they may constitute illiquid
investments. See "Risks --Liquidity Risk" in the Prospectus. If market
quotations are not readily available for the certificates, they will be valued
by the Fund at fair value as determined by the Board of Trustees or persons
acting at its direction. See "Net Asset Value" in the Prospectus.
Structured Notes and Other Hybrid Instruments
The Fund may invest in "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, such as
selected securities, an index of securities or specified interest rates, or the
differential performance of two assets or markets, such as indexes reflecting
bonds. Depending on the terms of the note, the Fund may forgo all or part of the
interest and principal that would be payable on a comparable conventional note.
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 which
will serve to magnify the potential for gain and the risk of loss. The Fund may
use structured notes to add leverage to the portfolio (as a substitute for
Preferred Shares) and for investment as well as risk management purposes. Like
other sophisticated strategies, the Fund's use of structured notes may not work
as intended. Although structured instruments are not necessarily illiquid, PIMCO
believes that currently most structured instruments are illiquid.
The Fund may invest in other types of "hybrid" instruments which combine
the characteristics of securities, futures, and options. For example, the
principal amount or interest rate of a hybrid could be tied (positively or
negatively) to the price of some commodity, currency or securities index or
another interest rate (each a "benchmark"). The interest rate or (unlike most
debt obligations) the principal amount payable at maturity of a hybrid security
may be increased or decreased, depending on changes in the value of the
benchmark. Hybrids can be used as an efficient means of pursuing a variety of
investment goals, including duration management and increased total return.
Hybrids may not bear interest or pay dividends. The value of a hybrid or its
interest rate may be a multiple of a benchmark and, as a result, may be
leveraged and move (up or down) more steeply and rapidly than the benchmark.
These benchmarks may be sensitive to economic and political events that cannot
be readily foreseen by the purchaser of a hybrid. Under certain conditions, the
redemption value of a hybrid could be zero. Thus, an investment in a hybrid may
entail significant market risks that are not associated with a similar
investment in a traditional, U.S. dollar-denominated bond that has a fixed
principal amount and pays a floating rate or fixed rate of interest. The
purchase of hybrids also exposes the Fund to the credit risk of the issuer of
the hybrids. These risks may cause significant fluctuations in the net asset
value of the Fund.
Certain issuers of structured products such as hybrid instruments may be
deemed to be investment companies as defined in the 1940 Act. As a result, the
Fund's investments in these products may be subject to limits applicable to
investments in investment companies and may be subject to restrictions contained
in the 1940 Act.
41
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements and economically
similar transactions in order to add leverage to the portfolio (as a substitute
for Preferred Shares) or for hedging or cash management purposes. A reverse
repurchase agreement involves the sale of a portfolio-eligible security by the
Fund, coupled with its agreement to repurchase the instrument at a specified
time and price. Under a reverse repurchase agreement, the Fund continues to
receive any principal and interest payments on the underlying security during
the term of the agreement. Reverse repurchase agreements involve leverage risk
and the risk that the market value of securities retained by the Fund may
decline below the repurchase price of the securities sold by the Fund which it
is obligated to repurchase. The Fund may (but is not required to) segregate
assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees, equal (on a daily mark-to-market basis) to
its obligations under reverse repurchase agreements. To the extent that
positions in reverse repurchase agreements are not so covered, such transactions
would be subject to the Fund's limitations on borrowings, which would, among
other things, restrict the aggregate of such transactions (plus any other
borrowings) to one-third of the Fund's total assets.
The Fund also may effect simultaneous purchase and sale transactions that
are known as "sale-buybacks." A sale-buyback is similar to a reverse repurchase
agreement, except that in a sale-buyback, the counterparty who purchases the
security is entitled to receive any principal or interest payments made on the
underlying security pending settlement of the Fund's repurchase of the
underlying security.
Mortgage Dollar Rolls
A "mortgage dollar roll" is similar to a reverse repurchase agreement in
certain respects. In a "dollar roll" transaction, the Fund sells a
mortgage-related security, such as a security issued by GNMA, to a dealer and
simultaneously agrees to repurchase a similar security (but not the same
security) in the future at a pre-determined price. A "dollar roll" can be
viewed, like a reverse repurchase agreement, as a collateralized borrowing in
which the Fund pledges a mortgage-related security to a dealer to obtain cash.
However, unlike reverse repurchase agreements, the dealer with which the Fund
enters into a dollar roll transaction is not obligated to return the same
securities as those originally sold by the Fund, but only securities which are
"substantially identical." To be considered "substantially identical," the
securities returned to the Fund generally must: (1) be collateralized by the
same types of underlying mortgages; (2) be issued by the same agency and be part
of the same program; (3) have a similar original stated maturity; (4) have
identical net coupon rates; (5) have similar market yields (and therefore
price); and (6) satisfy "good delivery" requirements, meaning that the aggregate
principal amounts of the securities delivered and received back must be within
2.5% of the initial amount delivered.
As with reverse repurchase agreements, to the extent that positions in
dollar roll agreements are not covered by segregated liquid assets at least
equal to the amount of any forward purchase commitment, such transactions would
be subject to the Fund's restrictions on borrowings. Furthermore, because dollar
roll transactions may be for terms ranging between one and six months, dollar
roll transactions may be deemed "illiquid."
42
Repurchase Agreements
For the purposes of maintaining liquidity and achieving income, the
Fund may enter into repurchase agreements with domestic commercial banks or
registered broker/dealers. A repurchase agreement is a contract under which the
Fund would acquire a security for a relatively short period (usually not more
than one week) subject to the obligation of the seller to repurchase and the
Fund to resell such security at a fixed time and price (representing the Fund's
cost plus interest). In the case of repurchase agreements with broker-dealers,
the value of the underlying securities (or collateral) will be at least equal at
all times to the total amount of the repurchase obligation, including the
interest factor. The Fund bears a risk of loss in the event that the other party
to a repurchase agreement defaults on its obligations and the Fund is delayed or
prevented from exercising its rights to dispose of the collateral securities.
This risk includes the risk of procedural costs or delays in addition to a loss
on the securities if their value should fall below their repurchase price. PIMCO
will monitor the creditworthiness of the counter parties.
When-Issued, Delayed Delivery and Forward Commitment Transactions
The Fund may purchase or sell securities on a when-issued, delayed
delivery, or forward commitment basis. When such purchases are outstanding, the
Fund will segregate until the settlement date assets determined to be liquid by
PIMCO in accordance with procedures established by the Board of Trustees, in an
amount sufficient to meet the purchase price. Typically, no income accrues on
securities the Fund has committed to purchase prior to the time delivery of the
securities is made, although the Fund may earn income on securities it has
segregated.
When purchasing a security on a when-issued, delayed delivery, or
forward commitment basis, the Fund assumes the rights and risks of ownership of
the security, including the risk of price and yield fluctuations, and takes such
fluctuations into account when determining its net asset value. Because the Fund
is not required to pay for the security until the delivery date, these risks are
in addition to the risks associated with the Fund's other investments. If the
Fund remains substantially fully invested at a time when when-issued, delayed
delivery, or forward commitment purchases are outstanding, the purchases may
result in a form of leverage.
When the Fund has sold a security on a when-issued, delayed delivery,
or forward commitment basis, the Fund does not participate in future gains or
losses with respect to the security. If the other party to a transaction fails
to deliver or pay for the securities, the Fund could miss a favorable price or
yield opportunity or could suffer a loss. The Fund may dispose of or renegotiate
a transaction after it is entered into, and may sell when-issued, delayed
delivery or forward commitment securities before they are delivered, which may
result in a capital gain or loss. There is no percentage limitation on the
extent to which the Fund may purchase or sell securities on a when-issued,
delayed delivery, or forward commitment basis.
Borrowing
The Fund may borrow money to the extent permitted under the 1940 Act as
interpreted, modified or otherwise permitted by regulatory authority having
jurisdiction, from time to time. The Fund may from time to time borrow money to
add leverage to the portfolio as a substitute
43
for the leverage obtained with Preferred Shares. The Fund may also borrow money
for temporary administrative purposes.
Under the 1940 Act, the Fund generally is not permitted to engage in
borrowings unless immediately after a borrowing the value of the Fund's total
assets less liabilities (other than the borrowing) is at least 300% of the
principal amount of such borrowing (i.e., such principal amount may not exceed
33 1/3% of the Fund's total assets). In addition, the Fund is not permitted to
declare any cash dividend or other distribution on Common Shares unless, at the
time of such declaration, the value of the Fund's total assets, less liabilities
other than borrowing, is at least 300% of such principal amount. If the Fund
borrows it intends, to the extent possible, to prepay all or a portion of the
principal amount of the borrowing to the extent necessary in order to maintain
the required asset coverage. Failure to maintain certain asset coverage
requirements could result in an event of default and entitle the holders of
Preferred Shares ("Preferred Shareholders") and holders of any other senior
securities of the Fund to elect a majority of the Trustees of the Fund.
As described in the Prospectus, the Fund may also enter into
transactions that may give rise to a form of leverage. Such transactions may
include, among others, issuing debt securities or using reverse repurchase
agreements, loans of portfolio securities, credit default swap contracts and
other derivatives, as well as when-issued, delayed delivery or forward
commitment transactions. However, borrowings and these other forms of leverage
will only be used, if at all, as a substitute for, rather than in addition to,
the leverage obtained through the issuance of Preferred Shares. See "Preferred
Shares and Related Leverage" in the Prospectus.
As described above, the Fund will, under certain circumstances, cover
its commitment under these instruments by the segregation of assets determined
to be liquid by PIMCO in accordance with procedures adopted by the Trustees,
equal in value to the amount of the Fund's commitment, or by entering into
offsetting transactions or owning positions covering its obligations. In such
cases, the instruments will not be considered "senior securities" under the 1940
Act for purposes of the asset coverage requirements otherwise applicable to
borrowings by the Fund or the Fund's issuance of Preferred Shares. Borrowing
will tend to exaggerate the effect on net asset value of any increase or
decrease in the market value of the Fund's portfolio. Money borrowed will be
subject to interest costs which may or may not be recovered by appreciation of
the securities purchased. The Fund also may be required to maintain minimum
average balances in connection with such borrowing or to pay a commitment or
other fee to maintain a line of credit; either of these requirements would
increase the cost of borrowing over the stated interest rate.
Short Sales
The Fund may make short sales of securities as part of its overall
portfolio management strategy and to offset potential declines in long positions
in securities in the Fund's portfolio. A short sale is a transaction in which
the Fund sells a security it does not own in anticipation that the market price
of that security will decline.
When the Fund makes a short sale on a security, it must borrow the
security sold short and deliver it to the broker-dealer through which it made
the short sale as collateral for its obligation to deliver the security upon
conclusion of the sale. The Fund may have to pay a fee to
44
borrow particular securities and is often obligated to pay over any accrued
interest and dividends on such borrowed securities.
If the price of the security sold short increases between the time of
the short sale and the time the Fund replaces the borrowed security, the Fund
will incur a loss; conversely, if the price declines, the Fund will realize a
capital gain. Any gain will be decreased, and any loss increased, by the
transaction costs described above. The successful use of short selling may be
adversely affected by imperfect correlation between movements in the price of
the security sold short and the securities being hedged.
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer. A short sale is "against the box" to the extent
that the Fund contemporaneously owns, or has the right to obtain at no added
cost, securities identical to those sold short. The Fund may engage in so-called
"naked" short sales where it does not own or have the immediate right to acquire
the security sold short at no additional cost, in which case the Fund's losses
could theoretically be unlimited.
Illiquid Securities
The Fund may invest without limit in illiquid securities (determined
using the Securities and Exchange Commission's standard applicable to open-end
investment companies, i.e., securities that cannot be disposed of within seven
days in the ordinary course of business at approximately the value at which the
Fund has valued the securities). Illiquid securities are considered to include,
among other things, written over-the-counter options, securities or other liquid
assets being used as cover for such options, repurchase agreements with
maturities in excess of seven days, certain loan participation interests, fixed
time deposits which are not subject to prepayment or provide for withdrawal
penalties upon prepayment (other than overnight deposits), and other securities
whose disposition is restricted under the federal securities laws (other than
securities issued pursuant to Rule 144A under the 1933 Act and certain
commercial paper that PIMCO has determined to be liquid under procedures
approved by the Board of Trustees). PIMCO will determine the liquidity of the
Fund's investments by reference to market conditions and contractual provisions.
For example, PIMCO will generally not consider Senior Loans that are part of an
issue of at least $250 million in par value to be illiquid.
Illiquid securities may include privately placed securities, which are
sold directly to a small number of investors, usually institutions. Unlike
public offerings, such securities are not registered under the federal
securities laws. Although certain of these securities may be readily sold,
others may be illiquid, and their sale may involve substantial delays and
additional costs.
Portfolio Trading and Turnover Rate
Portfolio trading may be undertaken to accomplish the investment
objective of the Fund. In addition, a security may be sold and another of
comparable quality purchased at approximately the same time to take advantage of
what PIMCO 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 bonds may cause a temporarily low price for such bonds, as
compared with other bonds of like quality and characteristics. The Fund may also
engage in short-term trading
45
consistent with its investment objective. 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, or to recognize a
gain.
A change in the securities held by the Fund is known as "portfolio
turnover." PIMCO manages the Fund without regard generally to restrictions on
portfolio turnover. The use of certain derivative instruments with relatively
short maturities may tend to exaggerate the portfolio turnover rate for the
Fund. Trading in debt obligations does not generally involve the payment of
brokerage commissions, but does involve indirect transaction costs. The use of
futures contracts may involve the payment of commissions to futures commission
merchants. High portfolio turnover (e.g., greater than 100%) involves
correspondingly greater expenses to the Fund, including brokerage commissions or
dealer mark-ups and other transaction costs on the sale of securities and
reinvestments in other securities. The higher the rate of portfolio turnover of
the Fund, the higher these transaction costs borne by the Fund generally will
be. Transactions in the Fund's portfolio securities may result in realization of
taxable capital gains (including short-term capital gains which are generally
taxed to shareholders at ordinary income tax rates). The trading costs and tax
effects associated with portfolio turnover may adversely affect the Fund's
performance.
The portfolio turnover rate of the Fund is calculated by dividing (a)
the lesser of purchases or sales of portfolio securities for the particular
fiscal year by (b) the monthly average of the value of the portfolio securities
owned by the Fund during the particular fiscal year. In calculating the rate of
portfolio turnover, there is excluded from both (a) and (b) all securities,
including options, whose maturities or expiration dates at the time of
acquisition were one year or less.
Warrants to Purchase Securities
The Fund may invest in warrants to purchase debt securities. Debt
obligations with warrants attached to purchase equity securities have many
characteristics of convertible bonds 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 the warrants at a profit. If interest
rates rise, the warrants would generally expire with no value.
Other Investment Companies
The Fund may invest in securities of open- or closed-end investment
companies to the extent that such investments are consistent with the Fund's
investment objective and policies and permissible under the 1940 Act. In
general, under the 1940 Act, an investment company such as the Fund may not (i)
invest more than 10% of its total assets in securities of other investment
companies, (ii) own more than 3% of the outstanding voting securities of any one
investment company, or (iii) invest more than 5% of its total assets in the
securities of any single investment company. The Fund may invest in other
investment companies either during periods when it has large amounts of
uninvested cash, such as the period shortly after the Fund receives the proceeds
of the offering of its Common Shares or Preferred Shares, during periods when
there is a shortage of attractive variable rate and other debt instruments
available in the market, or when PIMCO believes share prices of other investment
companies
46
offer attractive values. The Fund may invest in investment companies that are
advised by PIMCO or its affiliates to the extent permitted by applicable law
and/or pursuant to exemptive relief from the SEC. As a stockholder in an
investment company, the Fund will bear its ratable share of that investment
company 's expenses and would remain subject to payment of the Fund's management
fees with respect to assets so invested. Holders of the Common Shares would
therefore be subject to duplicative expenses to the extent the Fund invests in
other investment companies. PIMCO will take expenses into account when
evaluating the investment merits of an investment in an investment company
relative to available debt instruments. In addition, the securities of other
investment companies may also be leveraged and will therefore be subject to the
same leverage risks described in the Prospectus and herein. As described in the
Prospectus in the section entitled "Risks--Leverage Risk," 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.
Securities Loans
Subject to the Fund's "Investment Restrictions" listed below, the Fund
may make secured loans of its portfolio securities to brokers, dealers and other
financial institutions amounting to no more than one-third of its total assets.
The risks in lending portfolio securities, as with other extensions of credit,
consist of possible delay in recovery of the securities or possible loss of
rights in the collateral should the borrower fail financially. However, such
loans will be made only to broker-dealers that are believed by PIMCO to be of
relatively high credit standing. Securities loans are made to broker-dealers
pursuant to agreements requiring that loans be continuously secured by
collateral consisting of U.S. Government securities, cash or cash equivalents
(negotiable certificates of deposit, bankers' acceptances or letters of credit)
maintained on a daily mark-to-market basis in an amount at least equal at all
times to the market value of the securities lent. The borrower pays to the Fund,
as the lender, an amount equal to any dividends or interest received on the
securities lent. The Fund may invest only the cash collateral received in
interest-bearing, short-term securities or receive a fee from the borrower. In
the case of cash collateral, the Fund typically pays a rebate to the lender.
Although voting rights or rights to consent with respect to the loaned
securities pass to the borrower, the Fund, as the lender, retains the right to
call the loans and obtain the return of the securities loaned at any time on
reasonable notice, and it will do so in order that the securities may be voted
by the Fund if the holders of such securities are asked to vote upon or consent
to matters materially affecting the investment. The Fund may also call such
loans in order to sell the securities involved. When engaged in securities
lending, the Fund's performance will continue to reflect changes in the value of
the securities loaned and will also reflect the receipt of either interest,
through investment of cash collateral by the Fund in permissible investments, or
a fee, if the collateral is U.S. Government securities.
Participation on Creditors Committees
The Fund may from time to time participate on committees formed by
creditors to negotiate with the management of financially troubled issuers of
securities held by the Fund. Such participation may subject the Fund to expenses
such as legal fees and may make the Fund an "insider" of the issuer for purposes
of the federal securities laws, and therefore may restrict the Fund's ability to
trade in or acquire additional positions in a particular security when it might
otherwise desire to do so. Participation by the Fund on such committees also may
expose the
47
Fund to potential liabilities under the federal bankruptcy laws or other laws
governing the rights of creditors and debtors. The Fund would participate on
such committees only when PIMCO believes that such participation is necessary or
desirable to enforce the Fund's rights as a creditor or to protect the value of
securities held by the Fund.
Short-Term Investments/Temporary Defensive Strategies
Upon PIMCO's recommendation, for temporary defensive purposes and in
order to keep the Fund's cash 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 net assets in investment grade debt securities, including high
quality, short-term debt instruments, credit-linked trust certificates and/or
index futures contracts or similar derivative instruments. Such investments may
prevent the Fund from achieving its investment objective.
INVESTMENT RESTRICTIONS
Fundamental 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, Preferred Shares voting together as a single class, and
of the holders of a majority of the outstanding Preferred Shares voting as a
separate class:
(1) Concentrate its investments in a particular "industry," as
that term is used in the Investment Company Act of 1940, as amended,
and as interpreted, modified, or otherwise permitted by regulatory
authority having jurisdiction, from time to time.
(2) With respect to 75% of the Fund's total assets, purchase
the securities of any issuer, except securities issued or guaranteed by
the U.S. Government or any of its agencies or instrumentalities or
securities issued by other investment companies, if, as a result, (i)
more than 5% of the Fund's total assets would be invested in the
securities of that issuer, or (ii) the Fund would hold more than 10% of
the outstanding voting securities of that issuer.
(3) Purchase or sell real estate, although it may purchase
securities secured by real estate or interests therein, or securities
issued by companies which invest in real estate, or interests therein.
(4) Purchase or sell commodities or commodities contracts or
oil, gas or mineral programs. This restriction shall not prohibit the
Fund, subject to restrictions described in the Prospectus and elsewhere
in this Statement of Additional Information, from purchasing, selling
or entering into futures contracts, options on futures contracts,
forward contracts, or any interest rate, securities-related or other
hedging instrument, including swap agreements and other derivative
instruments, subject to compliance with any applicable provisions of
the federal securities or commodities laws.
48
(5) Borrow money or issue any senior security, except to the
extent permitted under the 1940 Act, as amended, and as interpreted,
modified, or otherwise permitted by regulatory authority having
jurisdiction, from time to time.
(6) Make loans, except to the extent permitted under the
1940 Act, as amended, and as interpreted, modified, or otherwise
permitted by regulatory authority having jurisdiction, from time to
time.
(7) Act as an underwriter of securities of other issuers,
except to the extent that in connection with the disposition of
portfolio securities, it may be deemed to be an underwriter under the
federal securities laws.
Currently, under the 1940 Act, the Fund generally is not permitted to
engage in borrowings unless immediately after a borrowing the value of the
Fund's total assets less liabilities (other than the borrowing) is at least 300%
of the principal amount of such borrowing (i.e., such principal amount may not
exceed 33 1/3% of the Fund's total assets). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on Common Shares
unless, at the time of such declaration, the value of the Fund's total assets,
less liabilities other than the borrowing, is at least 300% of such principal
amount.
Currently, under the 1940 Act, the Fund may generally not lend money or
property to any person, directly or indirectly, if such person controls or is
under common control with the Fund, except for a loan from the Fund to a company
which owns all of the outstanding securities of the Fund, except directors' and
qualifying shares.
For purposes of the foregoing and "Description of Shares--Preferred
Shares--Voting Rights" below, "majority of the outstanding," when used with
respect to particular shares of the Fund (whether voting together as a single
class or voting as separate classes), means (i) 67% or more of such shares
present at a meeting, if the holders of more than 50% of such shares are present
or represented by proxy, or (ii) more than 50% of such shares, whichever is
less.
Unless otherwise indicated, all limitations applicable to the Fund's
investments (as stated above and elsewhere in this Statement of Additional
Information) apply only at the time a transaction is entered into. Any
subsequent change in a rating assigned by any rating service to a security (or,
if unrated, deemed by PIMCO to be of comparable quality), or change in the
percentage of the Fund's total assets invested in certain securities or other
instruments, or change in the average maturity or duration of the Fund's
investment portfolio, resulting from market fluctuations or other changes in the
Fund's total assets, will not require the Fund to dispose of an investment until
PIMCO determines that it is practicable to sell or close out the investment
without undue market or tax consequences to the Fund. In the event that rating
agencies assign different ratings to the same security, PIMCO will determine
which rating it believes best reflects the security's quality and risk at that
time, which may be the higher of the several assigned ratings.
Under the 1940 Act, a "senior security" does not include any promissory
note or evidence of indebtedness where such loan is for temporary purposes only
and in an amount not exceeding 5% of the value of the total assets of the issuer
at the time the loan is made. A loan is presumed to be for temporary purposes if
it is repaid within sixty days and is not extended or renewed.
49
The Fund would be deemed to "concentrate" in a particular industry if
it invested 25% or more of its total assets in that industry. The Fund's
industry concentration policy does not preclude it from focusing investments in
issuers in a group of related industrial sectors (such as different types of
utilities).
The Fund may not change its policy to invest at least 80% of its net
assets (plus any borrowings for investment purposes) in a diversified portfolio
of floating rate debt instruments, unless it provides shareholders with at least
60 days' written notice of such change.
To the extent the Fund covers its commitment under a reverse repurchase
agreement, credit default swap or other derivative instrument by the segregation
of assets determined by PIMCO to be liquid in accordance with procedures adopted
by the Trustees, equal in value to the amount of the Fund's commitment, such
instrument will not be considered a "senior security" for purposes of the asset
coverage requirements otherwise applicable to borrowings by the Fund or the
Fund's issuance of Preferred Shares.
The Fund interprets its policies with respect to borrowing and lending
to permit such activities as may be lawful for the Fund, to the full extent
permitted by the 1940 Act or by exemption from the provisions therefrom pursuant
to exemptive order of the SEC.
The Fund intends to apply for ratings for its Preferred Shares from
Moody's, S&P and/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 Moody's, S&P and/or Fitch. Such guidelines will
likely be more restrictive than the restrictions set forth above. The Fund does
not anticipate that such guidelines would have a material adverse effect on
Common Shareholders or its ability to achieve its investment objective. The Fund
presently anticipates that any Preferred Shares that it intends to issue would
be initially given the highest ratings by Moody's ("Aaa"), S&P ("AAA") and/or
Fitch ("AAA"), but no assurance can be given that such ratings will be obtained.
No minimum rating is required for the issuance of Preferred Shares by the Fund.
Moody's, S&P and Fitch receive fees in connection with their ratings issuances.
MANAGEMENT OF THE FUND
Trustees and Officers
The business of the Fund is managed under the direction of the Fund's
Board of Trustees. Subject to the provisions of the Fund's Agreement and
Declaration of Trust (the "Declaration"), its Bylaws and Massachusetts law, the
Trustees have all powers necessary and convenient to carry out this
responsibility, including the election and removal of the Fund's officers.
The Trustees and officers of the Fund, their ages, the position they
hold with the Fund, their term of office and length of time served, a
description of their principal occupations during the past five years, the
number of portfolios in the fund complex (as defined in SEC regulations) that
the Trustee oversees and any other directorships held by the Trustee are listed
in the two tables immediately following. Except as shown, each Trustee's and
officer's principal occupation and business experience for the last five years
have been with the employer(s) indicated, although in some cases the Trustee may
have held different positions with such
50
employer(s). Unless otherwise indicated, the business address of the persons
listed below is c/o PIMCO Advisors Fund Management LLC, 1345 Avenue of the
Americas, New York, New York 10105.
Independent Trustees
Number of
Portfolios
Term of in Fund Other
Positions(s) Office and Complex Directorships
Name, Address and Held with Length of Principal Occupation(s) Overseen Held by
Age Fund Time Served During the Past 5 Years by Trustee Trustee
Paul Belica Trustee Since Trustee, Fixed Income 14 None.
Age 81 July, 2003 SHares,
Nicholas-Applegate
Convertible & Income
Fund, PIMCO Corporate
Opportunity Fund,
PIMCO Corporate Income
Fund, PIMCO Municipal
Income Fund, PIMCO
California Municipal
Income Fund, PIMCO New
York Municipal Income
Fund, PIMCO Municipal
Income Fund II, PIMCO
California Municipal
Income Fund II, PIMCO
New York Municipal
Income Fund II, PIMCO
Municipal Income Fund
III, PIMCO California
Municipal Income Fund
III, PIMCO New York
Municipal Income Fund
III; Manager,
Stratigos Fund, LLC,
Whistler Fund, LLC,
Xanthus Fund, LLC and
Wynstone Fund, LLC;
Director, Student Loan
Finance Corp.,
Education Loans, Inc.,
Goal Funding, Inc.,
Goal Funding II, Inc.;
Formerly, Advisor,
Salomon Smith Barney
Inc.; Director,
Central European Value
Fund, Inc., Deck House
Inc., The Czech
Republic Fund, Inc.
Robert E. Connor* Trustee Since Trustee, Fixed Income 17 None.
Age 68 July, 2003. SHares,
Nicholas-Applegate
Convertible & Income
Fund,
Nicholas-Applegate
Convertible & Income
Fund II, PIMCO
51
Number of
Portfolios
Term of in Fund Other
Positions(s) Office and Complex Directorships
Name, Address and Held with Length of Principal Occupation(s) Overseen Held by
Age Fund Time Served During the Past 5 Years by Trustee Trustee
Corporate Opportunity
Fund, PIMCO Corporate
Income Fund, PIMCO
High Income Fund,
PIMCO Municipal Income
Fund, PIMCO California
Municipal Income Fund,
PIMCO New York
Municipal Income Fund,
PIMCO Municipal Income
Fund II, PIMCO
California Municipal
Income Fund II, PIMCO
New York Municipal
Income Fund II, PIMCO
Municipal Income Fund
III, PIMCO California
Municipal Income Fund
III, PIMCO New York
Municipal Income Fund
III; Director,
Municipal Advantage
Fund, Inc.; Corporate
Affairs Consultant.
Formerly, Senior Vice
President, Corporate
Office, Citigroup
Global Markets Inc.
(formerly, Salomon
Smith Barney Inc.).
John J. Dalessandro Trustee Since President and Director, 15 None.
II** July, 2003. J.J. Dalessandro II Ltd.,
Age 65 registered
broker-dealer and
member of the New
York Stock Exchange;
Trustee,
Nicholas-Applegate
Convertible & Income
Fund,
Nicholas-Applegate
Convertible & Income
Fund II, PIMCO
Corporate
Opportunity Fund,
PIMCO Corporate
Income Fund, PIMCO
High Income Fund,
PIMCO Municipal
Income Fund, PIMCO
California Municipal
Income Fund, PIMCO
New York Municipal
Income Fund, PIMCO
Municipal Income
52
Number of
Portfolios
Term of in Fund Other
Positions(s) Office and Complex Directorships
Name, Address and Held with Length of Principal Occupation(s) Overseen Held by
Age Fund Time Served During the Past 5 Years by Trustee Trustee
Fund II, PIMCO
California Municipal
Income Fund II, PIMCO
New York Municipal
Income Fund II, PIMCO
Municipal Income Fund
III, PIMCO California
Municipal Income Fund
III, PIMCO New York
Municipal Income Fund
III.
Hans W. Kertess Trustee Since President, H. Kertess 11 None.
Age 64 July 2003 & Co.; Trustee, PIMCO
Corporate Income Fund,
PIMCO High Income
Fund,
Nicholas-Applegate
Convertible & Income
Fund II, PIMCO
Municipal Income Fund,
PIMCO California
Municipal Income Fund,
PIMCO New York
Municipal Income Fund,
PIMCO Municipal Income
Fund II, PIMCO
California Municipal
Income Fund II and
PIMCO New York
Municipal Income Fund
II. Formerly, Managing
Director and Consultant,
Royal Bank of Canada
Capital Markets.
----------------
* In addition to the positions noted, Mr. Connor previously provided occasional
editorial consulting services as an independent contractor to an administrative
unit of Smith Barney, an affiliate of Citigroup Inc., the parent company of
Citigroup Global Markets Inc.
** Mr. Dalessandro is treated by the Fund as not being an "interested person"
(as defined in Section 2(a)(19) of the 1940 Act) of the Fund, the Manager, PIMCO
or the Underwriters, despite his affiliation with J.J. Dalessandro II Ltd., a
member of the New York Stock Exchange, Inc. (the "Exchange") that operates as a
floor broker and effects portfolio transactions for other brokers, generally
other members of the Exchange, and one unrelated investment adviser.
53
Interested Trustees
Number of
Portfolios
Term of in Fund Other
Positions(s) Office and Complex Directorships
Name, Address and Held with Length of Principal Occupation(s) Overseen Held by
Age Fund Time Served During the Past 5 Years by Trustee Trustee
Stephen J. Treadway Chairman Since Managing Director, 53 None.
2187 Atlantic Street and Trustee July, 2003 Allianz Dresdner Asset
Stamford, CT 06902 Management of America
Age 55 L.P.; Managing
Director and Chief
Executive Officer,
PIMCO Advisors Fund
Management LLC;
Managing Director and
Chief Executive
Officer, PIMCO
Advisors Distributors
LLC ("PAD"); Trustee
and Chairman, PIMCO
Funds: Multi-Manager
Series; Chairman,
Fixed Income SHares;
Trustee, Chairman and
President, PIMCO
Advisors VIT (formerly
OCC Accumulation
Trust); Trustee and
Chairman, PIMCO
Corporate Income Fund,
PIMCO Municipal Income
Fund, PIMCO California
Municipal Income Fund,
PIMCO New York
Municipal Income Fund,
PIMCO Municipal Income
Fund II, PIMCO
California Municipal
Income Fund II, PIMCO
New York Municipal
Income Fund II and
Municipal Advantage
Fund, Inc.; Chairman,
Nicholas-Applegate
Convertible & Income
Fund,
Nicholas-Applegate
Convertible & Income
Fund II, PIMCO
Corporate Opportunity
Fund, PIMCO Municipal
Income Fund III, PIMCO
California Municipal
Income Fund III, PIMCO
New York Municipal
Income Fund III and
54
Number of
Portfolios
Term of in Fund Other
Positions(s) Office and Complex Directorships
Name, Address and Held with Length of Principal Occupation(s) Overseen Held by
Age Fund Time Served During the Past 5 Years by Trustee Trustee
PIMCO High Income
Fund; Member of the
Board of Management,
Allianz Dresdner Asset
Management GmbH.
Mr. Treadway is an "interested person" (as defined in Section 2(a)(19) of
the 1940 Act) of the Fund because, in addition to his service as Chairman and
Trustee of the Fund, he is also a Managing Director and the Chief Executive
Officer of the Manager and holds various other positions with affiliates of the
Manager.
In accordance with the Fund's staggered board (see "Anti-Takeover and Other
Provisions in the Declaration of Trust"), the Common Shareholders of the Fund
will elect Trustees to fill the vacancies of Trustees whose terms expire at each
annual meeting of Common Shareholders, unless any Preferred Shares are
outstanding, in which event Preferred Shareholders, voting as a separate class,
will elect two Trustees and the remaining two Trustees shall be elected by
Common Shareholders and Preferred Shareholders, voting together as a single
class. Preferred Shareholders will be entitled to elect a majority of the Fund's
Trustees under certain circumstances.
Officers
Positions(s) Term of Office
Name, Address and Held with and Length of
Age Fund Time Served Principal Occupation(s) During the Past 5 Years
Stephen J. Treadway Chairman Chairman, See above.
2187 Atlantic Street and Trustee since inception
Stamford, CT 06902 (June, 2003);
Age 55 Trustee, since
July, 2003
Brian S. Shlissel President Since Senior Vice President, PIMCO Advisors
Age 38 and Chief inception Fund Management LLC; Executive Vice
Executive (June, 2003). President and Treasurer, PIMCO Advisors
Officer VIT (formerly OCC Accumulation Trust);
President and Chief Executive Officer,
Fixed Income SHares, Nicholas-Applegate
Convertible & Income Fund,
Nicholas-Applegate Convertible & Income
Fund II, PIMCO Corporate Opportunity
Fund, PIMCO Corporate Income Fund, PIMCO
Municipal Income Fund, PIMCO California
Municipal Income Fund, PIMCO New York
Municipal Income Fund, PIMCO Municipal
Income Fund II, PIMCO California
Municipal Income Fund II, PIMCO New York
Municipal Income Fund II, PIMCO Municipal
Income Fund III, PIMCO California
Municipal Income Fund III, PIMCO New York
Municipal
55
Positions(s) Term of Office
Name, Address and Held with and Length of
Age Fund Time Served Principal Occupation(s) During the Past 5 Years
Income Fund III, Municipal Advantage
Fund, Inc., and PIMCO High Income Fund;
Formerly, Vice President, Mitchell
Hutchins Asset Management Inc.
Lawrence G. Altadonna Treasurer; Since Vice President, PIMCO Advisors Fund
Age 36 Principal inception Management LLC; Treasurer and Principal
Financial (June, 2003). Financial and Accounting Officer,
and Nicholas-Applegate Convertible & Income
Accounting Fund, Nicholas-Applegate Convertible &
Officer Income Fund II, PIMCO Corporate
Opportunity Fund, PIMCO Corporate Income
Fund, PIMCO Municipal Income Fund, PIMCO
California Municipal Income Fund, PIMCO
New York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO
California Municipal Income Fund II,
PIMCO New York Municipal Income Fund II,
PIMCO Municipal Income Fund III, PIMCO
California Municipal Income Fund III,
PIMCO New York Municipal Income Fund III,
Municipal Advantage Fund, Inc. and PIMCO
High Income Fund; Treasurer, Fixed Income
SHares; Assistant Treasurer, PIMCO
Advisors VIT (formerly OCC Accumulation
Trust). Formerly, Director of Fund
Administration, Prudential Investments.
Newton B. Schott, Jr. Vice Since Managing Director, Chief Administrative
2187 Atlantic Street President, inception Officer, Secretary and General Counsel,
Stamford, CT 06902 Secretary (June, 2003). PAD; Managing Director, Chief Legal
Age 60 Officer and Secretary, PIMCO Advisors
Fund Management LLC; President, Chief
Executive Officer and Secretary, PIMCO
Funds: Multi-Manager Series; Vice
President and Secretary,
Nicholas-Applegate Convertible & Income
Fund, Nicholas-Applegate Convertible &
Income Fund II, PIMCO Corporate
Opportunity Fund, PIMCO Corporate Income
Fund, PIMCO Municipal Income Fund, PIMCO
California Municipal Income Fund, PIMCO
New York Municipal Income Fund, PIMCO
Municipal Income Fund II, PIMCO
California Municipal Income Fund II,
PIMCO New York Municipal Income Fund II,
PIMCO Municipal Income Fund III, PIMCO
California Municipal Income Fund III,
PIMCO New York Municipal Income Fund III,
Municipal Advantage Fund, Inc. and PIMCO
High Income Fund; Secretary, Fixed Income
SHares.
Raymond Kennedy Vice Since Managing Director, PIMCO; co-portfolio manager
840 Newport Center Drive President inception of the Fund and other investment vehicles
Newport Beach, CA 92660 (June, 2003). managed by PIMCO; joined PIMCO in 1996.
Age 41
56
For interested Trustees and officers, positions held with affiliated
persons or principal underwriters of the Fund are listed in the following table:
Positions Held with Affiliated Persons or
Name Principal Underwriters of the Fund
Stephen J. Treadway See above.
Brian S. Shlissel See above.
Lawrence Altadonna See above.
Newton B. Schott, Jr. See above.
Raymond Kennedy See above.
Committees of the Board of Trustees
Audit Oversight Committee
Provides oversight with respect to the internal and external accounting and
auditing procedures of the Fund and, among other things, considers the selection
of independent public accountants for the Fund and the scope of the audit and
approves all audit and permitted non-audit services proposed to be performed by
those auditors on behalf of the Fund and certain affiliates, including the
Manager and PIMCO, and the possible effect of those services on the independence
of those accountants. Messrs. Belica, Kertess and Connor, each of whom is an
Independent Trustee, serve on this committee.
Nominating Committee
Responsible for reviewing and recommending qualified candidates to the
Board in the event that a position is vacated or created. The Nominating
Committee will review and consider nominees recommended by shareholders to serve
as Trustee, provided any such recommendation is submitted in writing to the
Fund, c/o Newton B. Schott, Jr., Secretary, at the address of the principal
executive offices of the Fund. The Nominating Committee has full discretion to
reject nominees recommended by shareholders, and there is no assurance that any
such person so recommended and considered by a committee will be nominated for
election to the Board. Messrs. Belica, Kertess and Connor, each of whom is an
Independent Trustee, serve on this committee.
Valuation Committee
Reviews procedures for the valuation of securities and periodically reviews
information from the Manager and PIMCO regarding fair value and liquidity
determination made pursuant to the Board-approved procedures, and makes related
recommendations to the full Board and assists the full Board in resolving
particular valuation matters. Messrs. Belica, Kertess and Connor, each of whom
is an Independent Trustee, and Mr. Treadway, who is an Interested Trustee, serve
on this committee.
Compensation Committee
The Compensation Committee periodically reviews and sets compensation
payable to the
57
Trustees of the Fund who are not directors, officers, partners or
employees of the Manager, PIMCO or any entity controlling, controlled by or
under common control with the Manager or PIMCO. Messrs. Belica, Kertess and
Connor, each of whom is an Independent Trustee, serve on this committee.
Securities Ownership
For each Trustee, the following table discloses the dollar range of equity
securities beneficially owned by the Trustee in the Fund and, on an aggregate
basis, in any registered investment companies overseen by the Trustee within the
Fund's family of investment companies as of December 31, 2002:
Aggregate Dollar Range of Equity Securities in All
Dollar Range of Equity Registered Investment Companies Overseen by
Name of Trustee Securities in the Fund Trustee in Family of Investment Companies
Paul Belica None. >$100,000
Robert E. Connor None. None.
John J. Dalessandro II None. None.
Hans W. Kertess None. None.
Stephen J. Treadway None. >$100,000
For independent Trustees and their immediate family members, the following
table provides information regarding each class of securities owned beneficially
in an investment adviser or principal underwriter of the Fund, or a person
(other than a registered investment company) directly or indirectly controlling,
controlled by, or under common control with an investment adviser or principal
underwriter of the Fund as of December 31, 2002:
Name of Owners and
Relationships to Value of Percent of
Name of Trustee Trustee Company Title of Class Securities Class
Paul Belica None.
Robert E. Connor None.
John J. Dalessandro II None.
Hans W. Kertess None.
As of August 19, 2003, the Fund's officers and Trustees as a group owned
less than 1% of the outstanding Common Shares.
As of August 19, 2003, the following persons owned of record the number of
Common Shares noted below, representing the indicated percentage of the Fund's
outstanding shares as of such date.
58
Percentage of the
Number of Fund's outstanding
Common shares as of
Shareholder Shares August 19, 2003
----------- ------ ---------------
Allianz Dresdner Asset Management of America L.P. 5,168 100%
1345 Avenue of the Americas
New York, New York 10105
Compensation
Messrs. Connor and Dalessandro also serve as Trustees of PIMCO Municipal
Income Fund, PIMCO California Municipal Income Fund, PIMCO New York Municipal
Income Fund, PIMCO Municipal Income Fund II, PIMCO California Municipal Income
Fund II, PIMCO New York Municipal Income Fund II, PIMCO Municipal Income Fund
III, PIMCO California Municipal Income Fund III and PIMCO New York Municipal
Income Fund III (together, the "Municipal Funds"), Nicholas-Applegate
Convertible & Income Fund, Nicholas-Applegate Convertible & Income Fund II,
PIMCO Corporate Opportunity Fund, PIMCO High Income and PIMCO Corporate Income
Fund, fourteen closed-end funds for which the Manager serves as investment
manager and PIMCO or Nicholas-Applegate Capital Management LLC, each an
affiliate of the Manager, serves as portfolio manager. Mr. Belica serves as a
Trustee of each of these Funds except for PIMCO High Income Fund and
Nicholas-Applegate Convertible & Income Fund II. Mr. Kertess serves as a Trustee
of each of these Funds except for Nicholas-Applegate Convertible & Income Fund,
PIMCO Municipal Income Fund III, PIMCO California Municipal Income Fund III,
PIMCO New York Municipal Income Fund III and PIMCO Corporate Opportunity Fund.
Mr. Connor is a director or trustee, as the case may be, of one open-end
investment company (comprising two separate investment portfolios) and one
closed-end investment company advised by the Manager. Mr. Belica is also a
trustee of one open-end investment company (comprising two separate investment
portfolios) advised by the Manager. As indicated above, certain of the officers
and Trustees of the Fund are affiliated with the Manager and/or PIMCO.
The Municipal Funds, Nicholas-Applegate Convertible & Income Fund,
Nicholas-Applegate Convertible & Income Fund II, PIMCO Corporate Opportunity
Fund, PIMCO High Income Fund, PIMCO Corporate Income Fund and the Fund
(together, the "PIMCO Closed-End Funds") are expected to hold joint meetings of
their Boards of Trustees whenever possible. Each Trustee, other than any Trustee
who is a director, officer, partner or employee of the Manager, PIMCO or any
entity controlling, controlled by or under common control with the Manager or
PIMCO, receives compensation for their attendance at joint meetings and their
service on Board committees. For their service as Trustees of the PIMCO
Closed-End Funds, Messrs. Connor and Dalessandro receive $25,000 for each joint
meeting for the first four joint meetings in each year and $5,000 for each
additional joint meeting in such year if the meetings are attended in person.
Messrs. Connor and Dalessandro receive $1,000 per joint meeting if the meetings
are
59
attended telephonically. For his service as a Trustee of the PIMCO Closed-End
Funds (other than the PIMCO High Income Fund and in Nicholas-Applegate
Convertible & Income Fund II, for which he does not serve as Trustee), Mr.
Belica receives approximately $17,250 for each joint meeting for the first four
joint meetings in each year and approximately $3,500 for each additional joint
meeting in such year if the meetings are attended in person. Mr. Belica receives
approximately $700 per joint meeting if the meetings are attended
telephonically. For his service as a Trustee of the PIMCO Closed-End Funds
(other than the Nicholas-Applegate Convertible & Income Fund, PIMCO Municipal
Income Fund III, PIMCO California Municipal Income Fund III, PIMCO New York
Municipal Income Fund III and PIMCO Corporate Opportunity Fund, for which he
does not serve as Trustee), Mr. Kertess receives approximately $17,000 for each
joint meeting for the first four joint meetings in each year and approximately
$3,400 for each additional joint meeting in such year if the meetings are
attended in person. Mr. Kertess receives approximately $700 per joint meeting if
the meetings are attended telephonically. For their services as members of
various Audit Oversight Committees, Messrs. Belica, Connor and Kertess will
receive $1,000 per fund per meeting for those PIMCO Closed-End Funds for which
they serve as Trustee. Trustees will also be reimbursed for meeting-related
expenses.
The PIMCO Closed-End Funds will allocate each Trustee's compensation
and other costs of their joint meetings pro rata among the PIMCO Closed-End
Funds for which such Trustee serves as Trustee based on each such Fund's net
assets, including assets attributable to any Preferred Shares.
It is estimated that the Trustees will receive the amounts set forth in
the following table from the Fund for its initial fiscal year ending July 31,
2004. For the calendar year ended December 31, 2002, the Trustees received the
compensation set forth in the following table for serving as trustees of other
funds in the "Fund Complex." Each officer and Trustee who is a director,
officer, partner or employee of the Manager, PIMCO or any entity controlling,
controlled by or under common control with the Manager or PIMCO serves without
any compensation from the Fund.
Total Compensation
Estimated Compensation from the Fund Complex Paid
from the Fund for the to the Trustees for the
Fiscal Year Ending Calendar Year Ending
Name of Trustee July 31, 2004* December 31, 2002**
--------------- ------------------ -----------------
Paul Belica $5,000 $78,400
Robert E. Connor $5,000 $87,170
John J. Dalessandro II $5,000 $76,400
Hans W. Kertess $5,000 $62,000
----------
* Since the Fund has not completed its first full fiscal year,
compensation is estimated based upon future payments to be made by the Fund
during the current fiscal year and upon estimated relative net assets of the
PIMCO Closed-End Funds.
** In addition to the PIMCO Closed-End Funds, during the year ended
December 31, 2002, Mr. Belica served as a Trustee of one open-end investment
company (comprising two separate investment portfolios) advised
60
by the Manager, and Mr. Connor served as a director or trustee of one open-end
investment company (comprising two separate investment portfolios) and one
closed-end investment company advised by the Manager. These investment companies
are considered to be in the same "Fund Complex" as the Fund.
The Fund has no employees. Its officers are compensated by the Manager
and/or PIMCO.
Codes of Ethics
The Fund, the Manager and PIMCO have each adopted a separate code of
ethics governing personal trading activities of, as applicable, all Trustees and
officers of the Fund, and directors, officers and employees of the Manager and
PIMCO, who, in connection with their regular functions, play a role in the
recommendation of any purchase or sale of a security by the Fund or obtain
information pertaining to such purchase or sale or who have the power to
influence the management or policies of the Fund, the Manager or PIMCO, as
applicable. Such persons are prohibited from effecting certain transactions,
allowed to effect certain exempt transactions (including with respect to
securities that may be purchased or held by the Fund), and are required to
preclear certain security transactions with the applicable compliance officer or
his designee and to report certain transactions on a regular basis. The Fund,
the Manager and PIMCO have each developed procedures for administration of their
respective codes. Text-only versions of the codes of ethics 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 the 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.
INVESTMENT MANAGER AND PORTFOLIO MANAGER
Investment Manager
The Manager serves as investment manager to the Fund pursuant to an
investment management agreement (the "Investment Management Agreement") between
it and the Fund. The Manager, a Delaware limited liability company organized in
2000 as a subsidiary successor of a business originally organized in 1987, is
wholly-owned by PIMCO Advisors Retail Holdings LLC, a wholly-owned subsidiary of
Allianz Dresdner Asset Management of America L.P. ("ADAM of America"). ADAM of
America was organized as a limited partnership under Delaware law in 1987. ADAM
of America's sole general partner is Allianz-Paclife Partners LLC.
Allianz-Paclife Partners LLC is a Delaware limited liability company with three
members, ADAM U.S. Holding LLC, a Delaware limited liability company, Pacific
Asset Management LLC, a Delaware limited liability company, and Pacific Life
Insurance Company ("Pacific Life"), a California stock life insurance company.
Pacific Asset Management LLC is a wholly-owned subsidiary of Pacific Life, which
is a wholly-owned subsidiary of Pacific Mutual Holding Company. Pacific Life
also owns an indirect minority equity interest in ADAM of America. The sole
member of ADAM U.S. Holding LLC is Allianz Dresdner Asset Management of America
LLC. Allianz Dresdner Asset Management of America LLC has two members, Allianz
of America, Inc. ("Allianz of America"), a Delaware corporation
61
which owns a 99.9% non-managing interest, and Allianz Dresdner Asset
Management of America Holding Inc., a Delaware corporation which owns a 0.01%
managing interest. Allianz of America is a wholly-owned subsidiary of Allianz
Aktiengesellschaft ("Allianz AG"). Allianz Dresdner Asset Management of America
Holding Inc. is a wholly-owned subsidiary of ADAM GmbH, which is a wholly-owned
subsidiary of Allianz AG. Allianz AG indirectly holds a controlling interest in
ADAM of America. Allianz AG is a European-based, multinational insurance and
financial services holding company. Allianz AG's address is Koeniginstrasse 28,
D-80802, Munich, Germany. Pacific Life's address is 700 Newport Center Drive,
Newport Beach, California 92660. ADAM of America's address is 888 San Clemente
Drive, Suite 100, Newport Beach, California 92660.
The general partner of ADAM of America has substantially delegated its
management and control of ADAM of America to an Executive Committee. The
Executive Committee of ADAM of America is comprised of William S. Thompson, Jr.
and David C. Flattum.
The Manager is located at 1345 Avenue of the Americas, New York, New
York 10105. As of June 30, 2003, the Manager had approximately $23.7 billion in
assets under management. As of June 30, 2003, ADAM of America and its
subsidiaries, including PIMCO, had approximately $404 billion in assets under
management.
In connection with the acquisition of ADAM of America by Allianz of
America in May of 2000, the Pacific Life interest in ADAM of America was
converted into an interest in 3,722 Class E Units in ADAM of America. The Class
E Units are entitled to distributions based largely on the performance of
Pacific Investment Management Company, a subsidiary of ADAM of America, and for
periods after January 31, 2003, the distributions are capped at a maximum of $98
million (annualized) for 2003, $96 million for 2004, $94 million for 2005, $92
million for 2006 and $90 million in 2007 and thereafter. Pursuant to a
Continuing Investment Agreement dated May 5, 2000, as amended and restated March
10, 2003, Allianz of America, Pacific Asset Management LLC and Pacific Life are
party to a call and put arrangement regarding the Class E Units. Under the
restated agreement, the quarterly put and/or call options are limited in amount
to a maximum of $250 million per quarter through March 2004. In any month
subsequent to March 2004, Pacific Life and Allianz of America can put or call,
respectively, all Allianz of America's units owned directly or indirectly by
Pacific Life. The repurchase price for the Class E Units is calculated based on
the financial performance of Pacific Investment Management Company over the
preceding four calendar quarters prior to repurchase, but the amount can
increase or decrease in value by a maximum of 2% per year from the per unit
amount as defined in the Continuing Investment Agreement, calculated as of
December 31 of the preceding calendar year. The initial per unit amount as of
December 31, 2002 was approximately $551,900 per unit ($2.054 billion in
aggregate). The per unit amount is also subject to a cap and a floor of $600,000
and $500,000 per unit, respectively.
As of the date of this Statement of Additional Information, significant
institutional shareholders of Allianz AG currently include Munchener
Ruckversicherungs-Gesellschaft AG ("Munich Re") and HypoVereinsbank. Allianz AG
in turn owns more than 95% of Dresdner Bank AG. Certain broker-dealers that
might be controlled by or affiliated with these entities or Dresdner Bank AG,
including Dresdner Klienwort Wasserstein, Dresdner Kleinwort Benson and
Grantchester Securities, Inc., may be considered to be affiliated persons of the
Manager and NACM. (Broker-dealer affiliates of such significant institutional
shareholders are sometimes
62
referred to herein as "Affiliated Brokers.") Absent an SEC exemption or other
relief, the Fund generally is precluded from effecting principal transactions
with the Affiliated Brokers, and its ability to purchase securities being
underwritten by an Affiliated Broker or a syndicate including an Affiliated
Broker is subject to restrictions. Similarly, the Fund's ability to utilize the
Affiliated Brokers for agency transactions is subject to the restrictions of
Rule 17e-1 under the 1940 Act. PIMCO does not believe that the restrictions on
transactions with the Affiliated Brokers described above will materially
adversely affect its ability to provide services to the Fund, the Fund's ability
to take advantage of market opportunities, or the Fund's overall performance.
The Manager, subject to the supervision of the Board of Trustees, is
responsible for managing, either directly or through others selected by the
Manager, the investments of the Fund. The Manager also furnishes to the Board of
Trustees periodic reports on the investment performance of the Fund. As more
fully discussed below, the Manager has retained PIMCO to serve as the Fund's
portfolio manager.
Under the terms of the Investment Management Agreement, subject to such
policies as the Trustees of the Fund may determine, the Manager, at its expense,
will furnish continuously an investment program for the Fund and will make
investment decisions on behalf of the Fund and place all orders for the purchase
and sale of portfolio securities subject always to the Fund's investment
objective, policies and restrictions; provided that, so long as PIMCO serves as
the portfolio manager for the Fund, the Manager's obligation under the
Investment Management Agreement with respect to the Fund is, subject always to
the control of the Trustees, to determine and review with PIMCO the investment
policies of the Fund.
Subject to the control of the Trustees, the Manager also manages,
supervises and conducts the other affairs and business of the Fund, furnishes
office space and equipment, provides bookkeeping and certain clerical services
(excluding determination of the net asset value of the Fund, shareholder
accounting services and the accounting services for the Fund) and pays all
salaries, fees and expenses of officers and Trustees of the Fund who are
affiliated with the Manager. As indicated under "Portfolio
Transactions--Brokerage and Research Services," the Fund's portfolio
transactions may be placed with broker-dealers which furnish the Manager and
PIMCO, without cost, certain research, statistical and quotation services of
value to them or their respective affiliates in advising the Fund or their other
clients. In so doing, the Fund may incur greater brokerage commissions and other
transactions costs than it might otherwise pay.
Pursuant to the Investment Management Agreement, the Fund has agreed to
pay the Manager an annual management fee, payable on a monthly basis, at the
annual rate of .75% of the Fund's average weekly total managed assets for the
services and facilities it provides. "Total managed assets" means the total
assets of the Fund (including any assets attributable to Preferred Shares or
other forms of leverage that may be outstanding) minus accrued liabilities
(other than liabilities representing leverage). All fees and expenses are
accrued daily and deducted before payment of dividends to investors.
Except as otherwise described in the Prospectus, the Fund pays, in
addition to the investment management fee described above, all expenses not
assumed by the Manager, including, without limitation, fees and expenses of
Trustees who are not "interested persons" of the Manager or the Fund, interest
charges, taxes, brokerage commissions, expenses of issue of
63
shares, fees and expenses of registering and qualifying the Fund and its classes
of shares for distribution under federal and state laws and regulations, charges
of custodians, auditing and legal expenses, expenses of determining net asset
value of the Fund, reports to shareholders, expenses of meetings of
shareholders, expenses of printing and mailing prospectuses, proxy statements
and proxies to existing shareholders, and its proportionate share of insurance
premiums and professional association dues or assessments. The Fund is also
responsible for such nonrecurring expenses as may arise, including litigation in
which the Fund may be a party, and other expenses as determined by the Trustees.
The Fund may have an obligation to indemnify its officers and Trustees with
respect to such litigation.
Portfolio Manager
PIMCO serves as portfolio manager for the Fund pursuant to a portfolio
management agreement (the "Portfolio Management Agreement") between PIMCO and
the Manager. Under the Portfolio Management Agreement, subject always to the
control of the Trustees and the supervision of the Manager, PIMCO's obligation
is to furnish continuously an investment program for the Fund, to make
investment decisions on behalf of the Fund and to place all orders for the
purchase and sale of portfolio securities and all other investments for the
Fund.
The Manager (and not the Fund) will pay a portion of the fees it
receives to PIMCO in return for PIMCO's services. For the period from the
commencement of Fund operations through August 31, 2008 (i.e., roughly the first
five years of Fund operations), the fee will be paid monthly at the annual rate
of .39% of the Fund's average weekly total managed assets, provided, however,
that the amounts payable for each month shall be reduced to reflect that PIMCO
will bear 65% of the fees payable by the Manager to certain underwriters (other
than Merrill Lynch, Pierce, Fenner & Smith Incorporated) for such month as
described under "Underwriting" in the Prospectus. Beginning September 1, 2008
and thereafter, the Manager will pay a monthly fee to PIMCO at the annual rate
of .55% of the Fund's average weekly total managed assets, provided, however,
that the amounts payable for each month shall be reduced by the amount of all
fees payable by the Manager to certain underwriters other than Merrill Lynch,
Pierce, Fenner & Smith Incorporated for such month as described under
"Underwriting" in the Prospectus (such that the Manager retains from its
management fee, on an annual basis, .05% of the Fund's average weekly total
managed assets, after having paid PIMCO and the underwriters).
Originally organized in 1971, reorganized as a Delaware general
partnership in 1994 and reorganized as a Delaware limited liability company in
2000, PIMCO provides investment management and advisory services to private
accounts of institutional and individual clients and to mutual funds. The
membership interests of PIMCO as of December 1, 2002, were held 91% by ADAM of
America and 9% by the managing directors of PIMCO. As of June 30, 2003, PIMCO
had approximately $349 billion in assets under management. PIMCO is located at
840 Newport Center Drive, Newport Beach, California 92660.
Certain Terms of the Investment Management and Portfolio Management Agreements
The Investment Management Agreement and the Portfolio Management
Agreement were each approved by the Trustees of the Fund (including all of the
Trustees who are not "interested persons" of the Manager or PIMCO). The
Investment Management Agreement and Portfolio Management Agreement will each
continue in force with respect to the Fund for two years from their respective
dates, and from year to year thereafter, but only so long as their continuance
is
64
approved at least annually by (i) vote, cast in person at a meeting called
for that purpose, of a majority of those Trustees who are not "interested
persons" of the Manager, PIMCO or the Fund, and (ii) the majority vote of either
the full Board of Trustees or the vote of a majority of the outstanding shares
of all classes of the Fund. Each of the Investment Management Agreement and
Portfolio Management Agreement automatically terminates on assignment. The
Investment Management Agreement may be terminated on not less than 60 days'
notice by the Manager to the Fund or by the Fund to the Manager. The Portfolio
Management Agreement may be terminated on not less than 60 days' notice by the
Manager to PIMCO or by PIMCO to the Manager, or by the Fund at any time by
notice to the Manager and PIMCO.
The Investment Management Agreement and the Portfolio Management
Agreement each provide that the Manager or PIMCO, as applicable, shall not be
subject to any liability in connection with the performance of its services
thereunder in the absence of willful misfeasance, bad faith, gross negligence or
reckless disregard of its obligations and duties.
Basis for Approval of the Investment Management and Portfolio Management
Agreements
In determining to approve the Investment Management Agreement and the
Portfolio Management Agreement, the Trustees met with the relevant investment
advisory personnel from the Manager and PIMCO and considered information
relating to the education, experience and number of investment professionals and
other personnel who would provide services under the applicable agreement. See
"Management of the Fund" in the Prospectus and this Statement of Additional
Information. The Trustees also took into account the time and attention to be
devoted by senior management to the Fund and the other funds in the complex. The
Trustees evaluated the level of skill required to manage the Fund and concluded
that the human resources to be available at the Manager and PIMCO were
appropriate to fulfill effectively the duties of the Manager and PIMCO on behalf
of the Fund under the applicable agreement. The Trustees also considered the
business reputation of the Manager and PIMCO, their financial resources and
professional liability insurance coverage and concluded that they would be able
to meet any reasonably foreseeable obligations under the applicable agreement.
The Trustees received information concerning the investment philosophy
and investment process to be applied by PIMCO in managing the Fund. In this
connection, the Trustees considered PIMCO's in-house research capabilities as
well as other resources available to PIMCO's personnel, including research
services available to PIMCO as a result of securities transactions effected for
the Fund and other investment advisory clients. The Trustees concluded that
PIMCO's investment process, research capabilities and philosophy were well
suited to the Fund, given the Fund's investment objective and policies.
The Trustees considered the scope of the services provided by the
Manager and PIMCO to the Fund under the Investment Management Agreement and
Portfolio Management Agreement, respectively, relative to services provided by
third parties to other mutual funds. The Trustees noted that the Manager's and
PIMCO's standard of care was comparable to that found in most investment company
advisory agreements. See "--Certain Terms of the Investment Management and
Portfolio Management Agreements" above. The Trustees concluded that the scope of
the Manager's and PIMCO's services to be provided to the Fund was consistent
with the Fund's operational requirements, including, in addition to its
investment objective, compliance with the Fund's investment restrictions, tax
and reporting requirements
65
and related shareholder services.
The Trustees considered the quality of the services to be provided by
the Manager and PIMCO to the Fund. The Trustees also evaluated the procedures of
the Manager and PIMCO designed to fulfill their fiduciary duty to the Fund with
respect to possible conflicts of interest, including their codes of ethics
(regulating the personal trading of their officers and employees) (see
"Management of the Fund--Code of Ethics" above), the procedures by which PIMCO
allocates trades among its various investment advisory clients, the integrity of
the systems in place to ensure compliance with the foregoing and the record of
PIMCO in these matters. The Trustees also received information concerning
standards of the Manager and PIMCO with respect to the execution of portfolio
transactions. See "Portfolio Transactions" below.
In approving the agreements, the Trustees also gave substantial
consideration to the fees payable under the agreements. The Trustees reviewed
information concerning fees paid to investment advisers of similar bond funds.
The Trustees also considered the fees of the Fund as a percentage of assets at
different asset levels and possible economies of scale to the Manager. The
Trustees evaluated the Manager's profitability with respect to the Fund,
concluding that such profitability was not inconsistent with levels of
profitability that had been determined by courts not to be "excessive." In
evaluating the Fund's advisory fees, the Trustees also took into account the
complexity of investment management for the Fund relative to other types of
funds.
Proxy Voting Policies
The Fund and its Board of Trustees have delegated to the Manager, and
the Manager has in turn delegated to PIMCO, responsibility for voting any
proxies relating to portfolio securities held by the Fund in accordance with
PIMCO's proxy voting policies and procedures. A copy of the proxy voting
policies and procedures to be followed by PIMCO on behalf of the Fund, including
procedures to be used when a vote presents a conflict of interest, is attached
hereto as Appendix B ("Proxy Voting Policies").
PORTFOLIO TRANSACTIONS
Investment Decisions and Portfolio Transactions
Investment decisions for the Fund and for the other investment advisory
clients of the Manager and PIMCO are made with a view to achieving their
respective investment objective. Investment decisions are the product of many
factors in addition to basic suitability for the particular client involved
(including the Fund). Some securities considered for investments by the Fund may
also be appropriate for other clients served by the Manager and PIMCO. Thus, a
particular security may be bought or sold for certain clients even though it
could have been bought or sold for other clients at the same time. If a purchase
or sale of securities consistent with the investment policies of the Fund and
one or more of these clients served by the Manager or PIMCO is considered at or
about the same time, transactions in such securities will be allocated among the
Fund and clients in a manner deemed fair and reasonable by the Manager or PIMCO,
as applicable. The Manager or PIMCO may aggregate orders for the Fund with
simultaneous transactions entered into on behalf of its other clients so long as
price and transaction expenses are averaged either for that transaction or for
the day. Likewise, a particular security may be bought for one or more clients
when one or more clients are selling the security. In some instances, one client
may sell a particular security to another client. It also sometimes happens that
two or more clients simultaneously purchase or sell the same security, in which
event each day's transactions in such security are, insofar as possible,
averaged as to price and allocated between such clients in a manner which the
Manager or PIMCO believes is equitable to each and in accordance with the amount
being purchased or sold by each. There may be circumstances when purchases or
sales of portfolio securities for one or more clients will have an adverse
effect on other clients.
66
Brokerage and Research Services
There is generally no stated commission in the case of debt securities,
which are traded in the over-the-counter markets, but the price paid by the Fund
usually includes an undisclosed dealer commission or mark-up. In underwritten
offerings, the price paid by the Fund includes a disclosed, fixed commission or
discount retained by the underwriter or dealer. Transactions on U.S. stock
exchanges and other agency transactions involve the payment by the Fund of
negotiated brokerage commissions. Such commissions vary among different brokers.
Also, a particular broker may charge different commissions according to such
factors as the difficulty and size of the transaction.
Subject to the supervision of the Manager, PIMCO places all orders for
the purchase and sale of portfolio securities, options, futures contracts and
other instruments for the Fund and buys and sells such securities, options,
futures contracts and other instruments for the Fund through a substantial
number of brokers and dealers. In so doing, PIMCO uses its best efforts to
obtain for the Fund the most favorable price and execution available, except to
the extent it may be permitted to pay higher brokerage commissions as described
below. In seeking the most favorable price and execution, PIMCO, having in mind
the Fund's best interests, considers all factors it deems relevant, including,
by way of illustration, price, the size of the transaction, the nature of the
market for the security, the amount of the commission, the timing of the
transaction taking into account market prices and trends, the reputation,
experience and financial stability of the broker-dealer involved and the quality
of service rendered by the broker-dealer in other transactions.
Subject to the supervision of the Manager, PIMCO places orders for the
purchase and sale of portfolio investments for the Fund's account with brokers
or dealers selected by it in its discretion. In effecting purchases and sales of
portfolio securities for the account of the Fund, PIMCO will seek the best price
and execution of the Fund's orders. In doing so, the Fund may pay higher
commission rates than the lowest available when PIMCO believes it is reasonable
to do so in light of the value of the brokerage and research services provided
by the broker effecting the transaction, as discussed below.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research services from broker-dealers which execute portfolio
transactions for the clients of such advisers. Consistent with this practice,
PIMCO may receive research services from many broker-dealers with which PIMCO
places the Fund's portfolio transactions. PIMCO may also receive research or
research credits from brokers which are generated from underwriting commissions
when purchasing new issues of debt securities or other assets for the Fund.
These services, which in some cases may also be purchased for cash, include such
matters as general economic and security market reviews, industry and company
reviews, evaluations of securities and recommendations as to the purchase and
sale of securities. Some of these services are of value to PIMCO in advising
various of its clients (including the Fund), although not all of these services
are necessarily useful and of value in managing the Fund. Neither the management
fee paid by the Fund to the Manager nor the portfolio management fee paid by the
Manager to PIMCO is reduced because PIMCO and its affiliates receive such
services.
67
As permitted by Section 28(e) of the Securities Exchange Act of 1934,
PIMCO may cause the Fund to pay a broker-dealer which provides "brokerage and
research services" (as defined in such Act) to PIMCO an amount of disclosed
commission for effecting a securities transaction for the Fund in excess of the
commission which another broker-dealer would have charged for effecting that
transaction.
The Fund may use broker-dealers that are affiliates (or affiliates of
affiliates) of the Fund, the Manager and/or PIMCO, subject to certain
restrictions discussed above under "Investment Manager and Portfolio
Manager--Investment Manager."
References to PIMCO in this section would apply equally to the Manager
if the Manager were to assume portfolio management responsibilities for the Fund
and place orders for the purchase and sale of the Fund's portfolio investments.
DISTRIBUTIONS
As described in the Prospectus, initial distributions to Common
Shareholders are expected to be declared approximately 45 days, and paid
approximately 60 to 90 days, from the completion of the offering of the Common
Shares, depending on market conditions. Because the Fund invests predominantly
in debt securities with variable interest rates, the amount of the Fund's
monthly distributions to shareholders is expected to vary with fluctuations in
market interest rates. The Fund may initially, and from time to time thereafter,
distribute less than the entire amount of net investment income earned in a
particular period. Such undistributed net investment income would be available
to supplement future distributions, including distributions that might otherwise
have been reduced by a decrease in the Fund's monthly net income due to
fluctuations in investment income or expenses, or due to an increase in the
dividend rate on the Fund's outstanding Preferred Shares. As a result, the
distributions paid by the Fund for any particular period may be more or less
than the amount of net investment income actually earned by the Fund during such
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.
For tax purposes, the Fund is currently required to allocate net
capital gain and other taxable income, if any, between and among Common Shares
and any series of Preferred Shares in proportion to total distributions 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 Preferred
Shares on the distributions made by the Fund to Common Shareholders, see the
Prospectus under "Preferred Shares and Related Leverage."
While any Preferred 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 Preferred 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 Preferred Shares. This latter
limitation on the Fund's ability to make distributions on its Common Shares
could cause the Fund to incur income and excise tax and, under certain
circumstances, impair the ability of the Fund to maintain its qualification for
taxation as a regulated investment company. See "Tax Matters."
68
DESCRIPTION OF SHARES
Common Shares
The Fund's Declaration authorizes the issuance of an unlimited number
of Common Shares. The Common Shares will be issued with a par value of $0.00001
per share. All Common Shares of the Fund have equal rights as to the payment of
dividends and the distribution of assets upon liquidation of the Fund. Common
Shares will, when issued, be fully paid and, subject to matters discussed in
"Anti-Takeover and Other Provisions in the Declaration of Trust--Shareholder
Liability" below, non-assessable, and will have no pre-emptive or conversion
rights or rights to cumulative voting. At any time when the Fund's Preferred
Shares are outstanding, Common Shareholders will not be entitled to receive any
distributions from the Fund unless all accrued dividends on Preferred Shares
have been paid, and unless asset coverage (as defined in the 1940 Act) with
respect to Preferred Shares would be at least 200% after giving effect to such
distributions. See "--Preferred Shares" below.
The Fund has applied 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 traded at prices lower than net asset value.
There can be no assurance that Common Shares or shares of other similar funds
will trade at a price higher than net asset value in the future. Net asset value
will be reduced immediately following the offering of Common Shares after
payment of the sales load and organization and offering expenses and immediately
following any offering of Preferred Shares by the costs of that offering paid by
the Fund. Whether investors will realize gains or losses upon the sale of Common
Shares will not depend upon the 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 Common Shares; Conversion to Open-End Fund"
and the Prospectus under "Preferred Shares and Related Leverage" and
"Description of Shares--Common Shares."
Preferred Shares
The Declaration authorizes the issuance of an unlimited number of
Preferred Shares. The Preferred Shares may be issued in one or more classes or
series, with such par value and 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 indicated its intention to authorize
an offering of Preferred Shares (representing approximately 38% of the Fund's
capital immediately after the time the Preferred Shares are issued) within
approximately one to six months after completion of
69
the offering of Common Shares, subject to market conditions and to the Board's
continuing belief that leveraging the Fund's capital structure through the
issuance of Preferred Shares is likely to achieve the benefits to the Common
Shareholders described in the Prospectus and this Statement of Additional
Information. Although the terms of the Preferred Shares, including their
dividend rate, voting rights, liquidation preference and redemption provisions,
will be determined by the Board of Trustees (subject to applicable law and the
Declaration) if and when it authorizes a Preferred Shares offering, the Board
has stated that the initial series of Preferred Shares would likely pay
cumulative dividends at relatively short-term periods (such as 7 days), by
providing for the periodic redetermination of the dividend rate through an
auction or remarketing procedure. The liquidation preference, preference on
distribution, voting rights and redemption provisions of the Preferred Shares
are expected to be as stated below.
As used in this Statement of Additional Information, unless otherwise
noted, the Fund's "net assets" include assets of the Fund attributable to any
outstanding Preferred Shares, with no deduction for the liquidation preference
of the Preferred Shares. Solely for financial reporting purposes, however, the
Fund is required to exclude the liquidation preference of Preferred Shares from
"net assets," so long as the Preferred Shares have redemption features that are
not solely within the control of the Fund. For all regulatory and tax purposes,
the Fund's Preferred Shares will be treated as stock (rather than indebtedness).
Limited Issuance of Preferred Shares. Under the 1940 Act, the Fund
could issue Preferred Shares with an aggregate liquidation value of up to
one-half of the value of the Fund's total net assets (total assets less all
liabilities and indebtedness not represented by "senior securities," as defined
in the 1940 Act), measured immediately after issuance of the Preferred 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 Preferred 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.
To the extent that the Fund has outstanding any senior securities representing
indebtedness (such as through the use of reverse repurchase agreements, credit
default swaps and other derivative instruments that constitute senior
securities), the aggregate amount of such senior securities will be added to the
total liquidation value of any outstanding Preferred Shares for purposes of
these asset coverage requirements. The liquidation value of the Preferred Shares
is expected to be approximately 38% of the value of the Fund's total net assets.
The Fund intends to purchase or redeem Preferred Shares, if necessary, to keep
the liquidation value of the Preferred Shares plus the aggregate amount of other
senior securities representing indebtedness at or below one-half of the value of
the Fund's total net assets.
Distribution Preference. The Preferred Shares will 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, Preferred
Shareholders 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 the Common Shareholders. After payment of the
full amount of the liquidating distribution to which they are entitled,
Preferred Shareholders will not
70
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 Preferred Shares, the
Fund must comply with Section 18(i) of the 1940 Act which requires, among other
things, that Preferred Shares be voting shares. Except as otherwise provided in
the Declaration or the Fund's Bylaws or otherwise required by applicable law,
Preferred Shareholders will vote together with Common Shareholders as a single
class.
In connection with the election of the Fund's Trustees, Preferred
Shareholders, voting as a separate class, will also be entitled to elect two of
the Fund's Trustees, and the remaining Trustees shall be elected by Common
Shareholders and Preferred Shareholders, voting together as a single class. In
addition, if at any time dividends on the Fund's outstanding Preferred Shares
shall be unpaid in an amount equal to two full years' dividends thereon, the
holders of all outstanding Preferred 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.
The affirmative vote of the holders of a majority of the outstanding
Preferred Shares, voting as a separate class, shall be required to approve any
action requiring a vote of security holders under Section 13(a) of the 1940 Act
including, among other things, changes in the Fund's investment objective, the
conversion of the Fund from a closed-end to an open-end company, or changes in
the investment restrictions described as fundamental policies under "Investment
Restrictions." The class or series vote of Preferred Shareholders described
above shall in each case be in addition to any separate vote of the requisite
percentage of Common Shares and Preferred Shares necessary to authorize the
action in question.
The foregoing voting provisions will not apply with respect to the
Fund's Preferred 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 Preferred Shares by the Fund. The
terms of the Preferred Shares may provide that they are redeemable 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 Preferred Shares
and that the Fund may subsequently resell any shares so tendered for or
purchased. Any redemption or purchase of Preferred 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 present intention of the Board of
Trustees of the Fund with respect to a possible offering of Preferred Shares. If
the Board of Trustees determines to authorize such an offering, the terms of the
Preferred Shares may be the same as, or different from, the terms described
above, subject to applicable law and the Declaration.
71
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
Shareholder Liability
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 acts or obligations of the Fund and requires that notice of such disclaimer
be given in each agreement, obligation or instrument entered into or executed by
the Fund or the Trustees. The Declaration also provides for indemnification out
of the Fund's property for all loss and expense of any shareholder held
personally liable on account of being or having been a shareholder. Thus, the
risk of a shareholder incurring financial loss on account of shareholder
liability is limited to circumstances in which such disclaimer is inoperative or
the Fund is unable to meet its obligations, and thus should be considered
remote.
Anti-Takeover Provisions
As described below, the Declaration includes provisions that could have
the effect of limiting the ability of other entities or persons to acquire
control of the Fund or to change the composition of its Board of Trustees, and
could have the effect of depriving shareholders of opportunities to sell their
shares at a premium over prevailing market prices by discouraging a third party
from seeking to obtain control of the Fund.
The Fund's Trustees are divided into three classes (Class I, Class II
and Class III), having initial terms of one, two and three years, respectively.
At each annual meeting of shareholders, the term of one class will expire and
each Trustee elected to that class will hold office for a term of three years.
The classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the outstanding
shares of the classes or series of shares entitled to vote for the election of
such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining
Trustees.
Except as provided in the next paragraph, the affirmative vote or
consent of at least seventy-five percent (75%) of the Board of Trustees and at
least seventy-five percent (75%) of the shares of the Fund outstanding and
entitled to vote thereon are required to authorize any of the following
transactions (each a "Material Transaction"): (1) a merger, consolidation or
share exchange of the Fund or any series or class of shares of the Fund with or
into any other person or company, or of any such person or company with or into
the Fund or any such series or class of shares; (2) the issuance or transfer by
the Fund or any series or class of shares (in one or a series of transactions in
any twelve-month period) of any securities of the Fund or such series or class
to any other person or entity for cash, securities or other property (or
combination thereof) having an aggregate fair market value of $1,000,000 or
more, excluding sales of securities of the Fund or such series or class in
connection with a public offering, issuances of securities of the Fund or such
series or class pursuant to a dividend reinvestment plan adopted by the Fund and
issuances of securities of the Fund or such series or class upon the exercise of
any stock subscription rights distributed by the Fund; or (3) a sale, lease,
exchange, mortgage, pledge, transfer or other disposition by the Fund or any
series or class of shares (in one or a series of transactions in any
twelve-month period) to or with any person of any assets of the Fund or such
series or class having an aggregate fair market value of $1,000,000 or more,
except for
72
transactions in securities effected by the Fund or such series or class in the
ordinary course of its business. The same affirmative votes are required with
respect to any shareholder proposal as to specific investment decisions made or
to be made with respect to the Fund's assets or the assets of any series or
class of shares of the Fund.
Notwithstanding the approval requirements specified in the preceding
paragraph, the Declaration requires no vote or consent of the Fund's
shareholders to authorize a Material Transaction if the transaction is approved
by a vote of both a majority of the Board of Trustees and seventy-five percent
(75%) of the Continuing Trustees (as defined below), so long as all other
conditions and requirements, if any, provided for in the Fund's Bylaws and
applicable law (including any shareholder voting rights under the 1940 Act) have
been satisfied.
In addition, the Declaration provides that the Fund may be terminated
at any time by vote or consent of at least seventy-five percent (75%) of the
Fund's shares or, alternatively, by vote or consent of both a majority of the
Board of Trustees and seventy-five percent (75%) of the Continuing Trustees (as
defined below).
In certain circumstances, the Declaration also imposes shareholder
voting requirements that are more demanding than those required under the 1940
Act in order to authorize a conversion of the Fund from a closed-end to an
open-end investment company. See "Repurchase of Common Shares; Conversion to
Open-End Fund" below.
As noted, the voting provisions described above could have the effect
of depriving Common Shareholders of an opportunity to sell their Common Shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund in a tender offer or similar transaction.
In the view of the Fund's Board of Trustees, however, these provisions offer
several possible advantages, including: (1) requiring persons seeking control of
the Fund to negotiate with its management regarding the price to be paid for the
amount of Common Shares required to obtain control; (2) promoting continuity and
stability; and (3) enhancing the Fund's ability to pursue long-term strategies
that are consistent with its investment objective and management policies. The
Board of Trustees has determined that the voting requirements described above,
which are generally greater than the minimum requirements under the 1940 Act,
are in the best interests of the Fund's Common Shareholders generally.
A "Continuing Trustee," as used in the discussion above, is any member
of the Fund's Board of Trustees who either (i) has been a member of the Board
for a period of at least thirty-six months (or since the commencement of the
Fund's operations, if less than thirty-six months) or (ii) was nominated to
serve as a member of the Board of Trustees by a majority of the Continuing
Trustees then members of the Board.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's Bylaws,
both of which have been filed as exhibits to the Fund's registration statement
on file with the SEC.
Liability of Trustees
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
73
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 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 COMMON 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 changes in the floating rates of interest on the Fund's
investments and expenses), net asset value, call protection, price, relative
demand for and supply of such shares in the market, general market and economic
conditions and other factors. Shares of a closed-end investment company may
frequently trade at prices lower than net asset value. The Fund's Board of
Trustees regularly monitors the relationship between the market price and net
asset value of the Common Shares. If the Common Shares were to trade at a
substantial discount to net asset value for an extended period of time, the
Board may consider the repurchase of its Common Shares on the open market or in
private transactions, or the making of a tender offer for such shares. There can
be no assurance, however, that the Board of Trustees will decide to take or
propose any of these actions, or that share repurchases or tender offers, if
undertaken, will reduce market discount. The Fund has no present intention to
repurchase its Common Shares and would do so only in the circumstances described
in this section.
Notwithstanding the foregoing, at any time when the Fund's Preferred
Shares are outstanding, the Fund may not purchase, redeem or otherwise acquire
any of its Common Shares unless (1) all accrued dividends on Preferred Shares
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 Preferred Shares (expected to equal the original
purchase price per share plus any accrued and unpaid dividends thereon).
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.
The Fund's Board of Trustees may also from time to time consider
submitting to the holders of the shares of beneficial interest of the Fund a
proposal to convert the Fund to an open-end investment company. In determining
whether to exercise its sole discretion to submit this issue to shareholders,
the Board of Trustees would consider all factors then relevant, including the
relationship of the market price of the Common Shares to net asset value, the
extent to which the Fund's capital structure is leveraged and the possibility of
re-leveraging, the spread, if any, between the yields on securities in the
Fund's portfolio and interest and dividend charges on Preferred Shares issued by
the Fund and general market and economic conditions.
74
The Declaration requires the affirmative vote or consent of holders of
at least seventy-five percent (75%) of each class of the Fund's shares entitled
to vote on the matter to authorize a conversion of the Fund from a closed-end to
an open-end investment company, unless the conversion is authorized by both a
majority of the Board of Trustees and seventy-five percent (75%) of the
Continuing Trustees (as defined above under "Anti-Takeover and Other Provisions
in the Declaration of Trust--Anti-Takeover Provisions"). This seventy-five
percent (75%) shareholder approval requirement is higher than is required under
the 1940 Act. In the event that a conversion is approved by the Trustees and the
Continuing Trustees as described above, the minimum shareholder vote required
under the 1940 Act would be necessary to authorize the conversion. Currently,
the 1940 Act would require approval of the holders of a "majority of the
outstanding" Common Shares and, if issued, Preferred Shares voting together as a
single class, and the holders of a "majority of the outstanding" Preferred
Shares voting as a separate class, in order to authorize a conversion.
If the Fund converted to an open-end company, it would be required to
redeem all Preferred Shares then outstanding (requiring in turn that it
liquidate a portion of its investment portfolio), and the Fund's Common Shares
likely 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 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. This would likely have the effect of increasing the
Fund's expense ratio. Any purchase by the Fund of its Common Shares at a time
when Preferred Shares are outstanding will increase the leverage applicable to
the outstanding Common Shares then remaining. See the Prospectus under
"Risks--Leverage Risk."
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of Trustees 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.
75
TAX MATTERS
Taxation of the Fund. The Fund intends to qualify each year as a
regulated investment company under Subchapter M of the Code. In order to qualify
for the special tax treatment accorded regulated investment companies and their
shareholders, the Fund must, among other things:
(a) derive at least 90% of its gross income from dividends,
interest, payments with respect to certain securities loans, and gains
from the sale of stock, securities or foreign currencies, or other
income (including but not limited to gains from options, futures, or
forward contracts) derived with respect to its business of investing in
such stock, securities, or currencies;
(b) distribute with respect to each taxable year at least 90%
of the sum of its investment company taxable income (as that term is
defined in the Code without regard to the deduction for dividends
paid--generally taxable ordinary income and the excess, if any, of net
short-term capital gains over net long-term capital losses) and net
tax-exempt interest income, for such year; and
(c) diversify its holdings so that, at the end of each quarter
of the Fund's taxable year, (i) at least 50% of the market value of the
Fund's total assets is represented by cash and cash items, U.S.
Government securities, securities of other regulated investment
companies, and other securities limited in respect of any one issuer to
a value not greater than 5% of the value of the Fund's total assets and
not more than 10% of the outstanding voting securities of such issuer,
and (ii) not more than 25% of the value of the Fund's total assets is
invested in the securities (other than those of the U.S. Government or
other regulated investment companies) of any one issuer or of two or
more issuers which the Fund controls and which are engaged in the same,
similar, or related trades or businesses.
If the Fund qualifies as a regulated investment company that is
accorded special tax treatment, the Fund will not be subject to federal income
tax on income distributed in a timely manner to its shareholders in the form of
dividends (including Capital Gain Dividends, as defined below).
If the Fund failed to qualify as a regulated investment company
accorded special tax treatment in any taxable year, the Fund would be subject to
tax on its taxable income at corporate rates, and all distributions from
earnings and profits, including any distributions of net tax-exempt income and
net long-term capital gains, would be taxable to shareholders as ordinary
income. Some portions of such distributions may be eligible for the dividends
received deduction in the case of corporate shareholders and reduced rates of
taxation on qualified dividend income in the case of individuals. In addition,
the Fund could be required to recognize unrealized gains, pay substantial taxes
and interest and make substantial distributions before requalifying as a
regulated investment company that is accorded special tax treatment.
The Fund intends to distribute at least annually to its shareholders
all or substantially all of its investment company taxable income and any net
tax-exempt interest, and may distribute its net capital gain. The Fund may also
retain for investment its net capital gain. If the Fund does retain 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
76
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 shares 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.
Treasury regulations permit a regulated investment company, in
determining its investment company taxable income and net capital gain, to elect
to treat all or part of any net capital loss, any net long-term capital loss or
any net foreign currency loss incurred after October 31 as if it had been
incurred in the succeeding year.
If the Fund fails to distribute in a calendar year at least an amount
equal to the sum of 98% of its ordinary income for such year and 98% of its
capital gain net income for the one-year period ending October 31 of such year,
plus any retained amount from the prior year, the Fund will be subject to a
nondeductible 4% excise tax on the undistributed amounts. For these purposes,
the Fund will be treated as having distributed any amount for which it is
subject to income tax. A dividend paid to shareholders in January of a year
generally is deemed to have been paid by the Fund on December 31 of the
preceding year, if the dividend was declared and payable to shareholders of
record on a date in October, November or December of that preceding year. The
Fund intends generally to make distributions sufficient to avoid imposition of
the 4% excise tax.
Fund Distributions. For federal income tax purposes, distributions of
investment income are generally taxable as ordinary income. Taxes on
distributions of capital gains are determined by how long the Fund owned the
investments that generated them, rather than how long a shareholder has owned
his or her shares. Distributions of net capital gains from the sale of
investments that the Fund owned for more than one year and that are properly
designated by the Fund as capital gain dividends ("Capital Gain Dividends") will
be taxable as long-term capital gains. Distributions from capital gains are
generally made after applying any available capital loss carryovers. Capital
losses may be carried forward to each of the eight taxable years succeeding the
loss year. Distributions of gains from the sale of investments that the Fund
owned for one year or less will be taxable as ordinary income.
For taxable years beginning on or before December 31, 2008, the Fund
may designate distributions of investment income derived from dividends of U.S.
corporations and some foreign corporations as "qualified dividend income,"
provided holding period and other requirements are met by the Fund. Qualified
dividend income will be taxed in the hands of individuals at the rates
applicable to long-term capital gain, provided the shareholder meets the same
holding period and other requirements with respect to qualified dividend income.
Fund dividends representing distributions of interest income and short-term
capital gains cannot be designated as qualified dividend income and will not
qualify for the reduced rates. In light of this, the Fund does not expect a
significant portion of Fund distributions to be derived from qualified dividend
income.
77
Distributions are taxable to shareholders even if they are paid from
income or gains earned by the Fund before a shareholder's investment (and thus
were included in the price the shareholder paid). Distributions are taxable
whether shareholders receive them in cash or reinvest them in additional shares
through the Dividend Reinvestment Plan. A shareholder whose distributions are
reinvested in shares will be treated as having received a dividend equal to
either (i) the fair market value of the new shares issued to the shareholder, or
(ii) if the shares are trading below net asset value, the amount of cash
allocated to the shareholder for the purchase of shares on its behalf in the
open market. Any gain resulting from the sale or exchange of Fund shares
generally will be taxable as capital gains.
The long-term capital gain rates applicable to most shareholders will
be 15% (with lower rates applying to taxpayers in the 10% and 15% ordinary
income tax brackets) for taxable years beginning on or before December 31, 2008.
Dividends of net investment income designated by the Fund and received
by corporate shareholders of the Fund will qualify for the 70% dividends
received deduction generally available to corporations to the extent of the
amount of qualifying dividends received by the Fund from domestic corporations
for the taxable year. It is not expected that any significant percentage of the
Fund's distributions will so qualify.
The Internal Revenue Service currently requires that a regulated
investment company that has two or more classes of stock allocate to each such
class proportionate amounts of each type of its income (such as ordinary income
and capital gains) based upon the percentage of total dividends distributed to
each class for the tax year. Accordingly, the Fund intends each year to allocate
Capital Gain Dividends between and among its Common Shares and any series of its
Preferred Shares in proportion to the total dividends paid to each class with
respect to such tax year. Dividends qualifying and not qualifying for the
dividends received deduction or reduced rates applicable to qualified dividend
income will similarly be allocated between and among the two (or more) classes.
Return of Capital Distributions. If the Fund makes a distribution to a
shareholder in excess of the Fund's current and accumulated earnings and profits
(including earnings and profits arising from tax-exempt income) in any taxable
year, the excess distribution will be treated as a return of capital to the
extent of such shareholder's tax basis in its shares, and thereafter as capital
gain. A return of capital is not taxable, but it reduces a shareholder's tax
basis in its shares, thus reducing any loss or increasing any gain on a
subsequent taxable disposition by the shareholder of its shares. Where one or
more such distributions occur in any taxable year of the Fund, the available
earnings and profits will be allocated, first, to the distributions made to the
holders of Preferred Shares, and only thereafter to distributions made to
holders of Common Shares. As a result, the holders of Preferred Shares will
receive a disproportionate share of the distributions treated as dividends, and
the holders of the Common Shares will receive a disproportionate share of the
distributions treated as a return of capital. Although the Fund may generate
tax-exempt income, it does not expect to satisfy the criteria necessary to pass
through the tax-free nature of the income to its shareholders.
Dividends and distributions on the Fund's shares are generally subject
to federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular
78
shareholder's investment. Such distributions are likely to occur in respect of
shares purchased at a time when the Fund's net asset value reflects gains that
are either unrealized, or realized but not distributed. Such realized gains may
be required to be distributed even when the Fund's net asset value also reflects
unrealized losses.
Sale or Redemption of Shares. The sale, exchange or redemption of Fund
shares may give rise to a gain or loss. In general, any gain or loss realized
upon a taxable disposition of shares will be treated as long-term capital gain
or loss if the shares have been held for more than 12 months. Otherwise, the
gain or loss on the taxable disposition of Fund shares will be treated as
short-term capital gain or loss. However, any loss realized upon a taxable
disposition of shares held for six months or less will be treated as long-term,
rather than short-term, to the extent of any long-term capital gain
distributions received (or deemed received) by the shareholder with respect to
the shares. All or a portion of any loss realized upon a taxable disposition of
Fund shares will be disallowed if other substantially identical shares of the
Fund are purchased within 30 days before or after the disposition. In such a
case, the basis of the newly purchased shares will be adjusted to reflect the
disallowed loss.
From time to time the Fund may make a tender offer for its Common
Shares. It is expected that the terms of any such offer will require a tendering
shareholder to tender all Common Shares and dispose of all Preferred Shares
held, or considered under certain attribution rules of the Code to be held, by
such shareholder. Shareholders who tender all Common Shares and dispose of all
Preferred Shares held, or considered to be held, by them will be treated as
having sold their shares and generally will realize a capital gain or loss. If a
shareholder tenders fewer than all of its Common Shares, or retains a
substantial portion of its Preferred Shares, such shareholder may be treated as
having received a taxable dividend upon the tender of its Common Shares. In such
a case, there is a remote risk that non-tendering shareholders will be treated
as having received taxable distributions from the Fund. Likewise, if the Fund
redeems some but not all of the Preferred Shares held by a Preferred Shareholder
and such shareholder is treated as having received a taxable dividend upon such
redemption, there is a remote risk that Common Shareholders and non-redeeming
Preferred Shareholders will be treated as having received taxable distributions
from the Fund. To the extent that the Fund recognizes net gains on the
liquidation of portfolio securities to meet such tenders of Common Shares, the
Fund will be required to make additional distributions to its Common
Shareholders.
Original Issue Discount and Payment-in-Kind Securities. Some of the
debt obligations (with a fixed maturity date of more than one year from the date
of issuance) that may be acquired by the Fund may be (and all zero-coupon debt
obligations acquired by the Fund will be) treated as debt obligations that are
issued originally at a discount. Generally, the amount of the original issue
discount ("OID") is treated as interest income and is included in taxable income
(and required to be distributed) over the term of the debt security, even though
payment of that amount is not received until a later time, usually when the debt
security matures. Increases in the principal amount of an inflation indexed bond
will be treated as OID. In addition, payment-in-kind securities will give rise
to income which is required to be distributed and is taxable even though the
Fund holding the security receives no interest payment in cash on the security
during the year.
Some of the debt obligations (with a fixed maturity date of more than
one year from the date of issuance) that may be acquired by the Fund in the
secondary market may be treated as
79
having market discount. Generally, any gain recognized on the disposition of,
and any partial payment of principal on, a debt security having market discount
is treated as ordinary income to the extent the gain, or principal payment, does
not exceed the "accrued market discount" on such debt security. Market discount
generally accrues in equal daily installments. The Fund may make one or more of
the elections applicable to debt obligations having market discount, which could
affect the character and timing of recognition of income.
Some debt obligations (with a fixed maturity date of one year or less
from the date of issuance) that may be acquired by the Fund may be treated as
having acquisition discount, or OID in the case of certain types of debt
obligations. Generally, the Fund will be required to include the acquisition
discount, or OID, in income over the term of the debt security, even though
payment of that amount is not received until a later time, usually when the debt
security matures. The Fund may make one or more of the elections applicable to
debt obligations having acquisition discount, or OID, which could affect the
character and timing of recognition of income.
If the Fund holds the foregoing kinds of securities, it may be required
to pay out as an income distribution each year an amount which is greater than
the total amount of cash interest the Fund actually received. Such distributions
may be made from the cash assets of the Fund or by liquidation of portfolio
securities, if necessary. The Fund may realize gains or losses from such
liquidations. In the event the Fund realizes net capital gains from such
transactions, its shareholders may receive a larger capital gain distribution
than they would in the absence of such transactions.
Higher-Risk Securities. The Fund may invest to a significant extent in
debt obligations that are in the lowest rating categories or are unrated,
including debt obligations of issuers not currently paying interest or who are
in default. Investments in debt obligations that are at risk of or in default
present special tax issues for the Fund. Tax rules are not entirely clear about
issues such as when the Fund may cease to accrue interest, original issue
discount or market discount, when and to what extent deductions may be taken for
bad debts or worthless securities and how payments received on obligations in
default should be allocated between principal and income. These and other
related issues will be addressed by the Fund when, as and if it invests in such
securities, in order to seek to ensure that it distributes sufficient income to
preserve its status as a regulated investment company and does not become
subject to U.S. federal income or excise tax.
Issuer Deductibility of Interest. A portion of the interest paid or
accrued on certain high yield discount obligations owned by the Fund may not be
deductible to the issuer. If a portion of the interest paid or accrued on
certain high yield discount obligations is not deductible, that portion will be
treated as a dividend for purposes of the corporate dividends received
deduction. In such cases, if the issuer of the high yield discount obligations
is a domestic corporation, dividend payments by the Fund may be eligible for the
dividends received deduction to the extent of the deemed dividend portion of
such accrued interest.
Interest paid on debt obligations owned by the Fund, if any, that are
considered for tax purposes to be payable in the equity of the issuer or a
related party will not be deductible to the issuer, possibly affecting the cash
flow of the issuer.
Certain Investments in REITs. The Fund may invest in REITs that hold
residual interests in real estate mortgage investment conduits ("REMICs"). Under
Treasury regulations that have
80
not yet been issued, but may apply retroactively, a portion of the Fund's income
from a REIT that is attributable to the REIT's residual interest in a REMIC
(referred to in the Code as an "excess inclusion") will be subject to federal
income tax in all events. These regulations are also expected to provide that
excess inclusion income of a regulated investment company, such as the Fund,
will be allocated to shareholders of the regulated investment company in
proportion to the dividends received by such shareholders, with the same
consequences as if the shareholders held the related REMIC residual interest
directly. Dividends paid by REITs generally will not be eligible to be treated
as "qualified dividend income."
In general, excess inclusion income allocated to shareholders (i)
cannot be offset by net operating losses (subject to a limited exception for
certain thrift institutions), (ii) will constitute unrelated business taxable
income to entities (including a qualified pension plan, an individual retirement
account, a 401(k) plan, a Keogh plan or other tax-exempt entity) subject to tax
on unrelated business income, thereby potentially requiring such an entity that
is allocated excess inclusion income, and otherwise might not be required to
file a tax return, to file a tax return and pay tax on such income, and (iii) in
the case of a non-U.S. shareholder, will not qualify for any reduction in U.S.
federal withholding tax. In addition, if at any time during any taxable year a
"disqualified organization" (as defined in the Code) is a record holder of a
share in a regulated investment company, then the regulated investment company
will be subject to a tax equal to that portion of its excess inclusion income
for the taxable year that is allocable to the disqualified organization,
multiplied by the highest federal income tax rate imposed on corporations. The
Fund does not intend to invest directly in residual interests in REMICs or to
invest in REITS in which a substantial portion of the assets will consist of
residual interests in REMICs or in residual interests in REMICs.
Options, Futures, Forward Contracts and Swap Agreements. The Fund's
transactions in options, futures contracts, hedging transactions, forward
contracts, swap agreements, straddles and foreign currencies will be subject to
special tax rules (including mark-to-market, constructive sale, straddle, wash
sale and short sale rules), the effect of which may be to accelerate income to
the Fund, defer losses to the Fund, cause adjustments in the holding periods of
the Fund's securities, convert long-term capital gains into short-term capital
gains and convert short-term capital losses into long-term capital losses. These
rules could therefore affect the amount, timing and character of distributions
to shareholders. The Fund will monitor its transactions, will make appropriate
tax elections and will make appropriate entries in its books and records in
order to mitigate the effect of these rules.
Certain of the Fund's hedging activities (including its transactions,
if any, in foreign currencies or foreign currency-denominated instruments) are
likely to produce a difference between its book income and its taxable income.
If the Fund's book income exceeds its taxable income, the distribution (if any)
of such excess generally will be treated as described under "--Return of Capital
Distributions." If the Fund's book income is less than taxable income, the Fund
could be required to make distributions exceeding book income to qualify as a
regulated investment company that is accorded special tax treatment.
Foreign Currency Transactions. The Fund's transactions in foreign
currencies, foreign currency-denominated debt obligations and certain foreign
currency options, futures contracts and forward contracts (and similar
instruments) may give rise to ordinary income or loss to the
81
extent such income or loss results from fluctuations in the value of the foreign
currency concerned.
Foreign Taxation. Income received by the Fund from sources within
foreign countries may be subject to withholding and other taxes imposed by such
countries. Tax conventions between certain countries and the U.S. may reduce or
eliminate such taxes. As the Fund may not pass through its foreign taxes to
shareholders, shareholders generally will not be entitled to claim a credit or
deduction with respect to foreign taxes.
Shares Purchased Through Tax-Qualified Plans. Special tax rules apply
to investments through defined contribution plans and other tax-qualified plans.
Shareholders should consult their tax advisers to determine the suitability of
shares of the Fund as an investment through such plans and the precise effect of
an investment on their particular tax situation.
Non-U.S. Shareholders. Under U.S. federal tax law, dividends other than
Capital Gain Dividends paid on shares beneficially held by a person who is not a
"U.S. person" within the meaning of the Code (or a "foreign person"), are, in
general, subject to withholding of U.S. federal income tax at a rate of 30% of
the gross dividend, which rate may, in some cases, be reduced by an applicable
tax treaty. Dividends are subject to withholding even if they are funded by
income or gains (such as portfolio interest, short-term capital gains, or
foreign-source dividend and interest income) that, if paid to a foreign person
directly, would not be subject to withholding. However, Capital Gain Dividends
will not be subject to withholding of U.S. federal income tax. If a beneficial
holder who is a foreign person has a trade or business in the United States, and
the dividends are effectively connected with the conduct by the beneficial
holder of a trade or business in the United States, the dividend will be subject
to U.S. federal net income taxation at regular income tax rates.
Under U.S. federal tax law, a beneficial holder of shares who is a
foreign person is not, in general, subject to U.S. federal income tax on gains
(and is not allowed a deduction for losses) realized on the sale of shares of
the Fund or on Capital Gain Dividends unless (i) such gain or Capital Gain
Dividend is effectively connected with the conduct of a trade or business
carried on by such holder within the United States or (ii) in the case of an
individual holder, the holder is present in the United States for a period or
periods aggregating 183 days or more during the year of the sale or Capital Gain
Dividend and certain other conditions are met.
If you are eligible for the benefits of a tax treaty, any effectively
connected income or gain will generally be subject to U.S. federal income tax on
a net basis only if it is also attributable to a permanent establishment
maintained by you in the United States.
A beneficial holder of shares who is a foreign person may be subject to
state and local tax and to the U.S. federal estate tax in addition to the
federal tax on income referred to above.
Backup Withholding. The Fund generally is required to withhold and
remit to the U.S. Treasury a percentage of the taxable distributions and
redemption proceeds paid to any individual shareholder who fails to properly
furnish the Fund with a correct taxpayer identification number ("TIN"), who has
under-reported dividend or interest income, or who fails to certify to the Fund
that he or she is not subject to such withholding. The backup withholding tax
rate is 28% for amounts paid through 2010. The backup withholding tax rate will
be 31% for amounts paid after December 31, 2010.
82
In order for a foreign investor to qualify for exemption from the
backup withholding tax rates under income tax treaties, the foreign investor
must comply with special certification and filing requirements. Foreign
investors in the Fund should consult their tax advisers in this regard. Backup
withholding is not an additional tax. Any amounts withheld may be credited
against the shareholder's U.S. federal income tax liability, provided the
appropriate information is furnished to the Internal Revenue Service.
Recent Tax Shelter Reporting Regulations. 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 advisers to determine the
applicability of these regulations in light of their individual circumstances.
General. The federal income tax discussion set forth above is for
general information only. Prospective investors should consult their tax
advisers regarding the specific federal tax consequences of purchasing, holding,
and disposing of shares of the Fund, as well as the effects of state, local and
foreign tax law and any proposed tax law changes.
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 as categorized by Lipper, Inc. ("Lipper"), Morningstar
Inc. or other independent services. 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.
The Fund, in its advertisements, may refer to pending legislation from
time to time and the possible impact of such legislation on investors,
investment strategy and related matters. At any time in the future, yields and
total return may be higher or lower than past yields and there can be no
assurance that any historical results will continue.
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 A for additional performance related, comparative and
other information.
83
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT
State Street Bank and Trust Co., 801 Pennsylvania, Kansas City, Missouri 64105,
serves as custodian for assets of the Fund. The custodian performs custodial and
fund accounting services.
PFPC Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as
the transfer agent, registrar and dividend disbursement agent for the Common
Shares, as well as agent for the Dividend Reinvestment Plan relating to the
Common Shares.
INDEPENDENT AUDITORS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New
York 10036, serves as independent auditors for the Fund. PricewaterhouseCoopers
LLP provides audit services, tax return preparation and assistance and
consultation in connection with review of SEC filings to the Fund.
COUNSEL
Ropes & Gray LLP, One International Place, Boston, Massachusetts 02110,
passes upon certain legal matters in connection with shares offered by the Fund,
and also acts as counsel to the Fund.
REGISTRATION STATEMENT
A Registration Statement on Form N-2, including any amendments thereto
(the "Registration Statement"), relating to the shares of the Fund offered
hereby, has been filed by the Fund with the SEC, Washington, D.C. The 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 or to be offered hereby, reference is made to the Fund's
Registration Statement. Statements contained in the 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 SEC's principal office in Washington, D.C., and copies of all or
any part thereof may be obtained from the SEC upon the payment of certain fees
prescribed by the SEC.
84
REPORT OF INDEPENDENT AUDITORS
To the Shareholder and Board of Trustees of
PIMCO Floating Rate Income Fund
In our opinion, the accompanying statement of net assets presents fairly, in all
material respects, the financial position of PIMCO Floating Rate Income Fund
(the "Fund") at August 19, 2003 in conformity with accounting principles
generally accepted in the United States of America. This financial statement is
the responsibility of the Fund's management; our responsibility is to express an
opinion on this financial statement based on our audit. We conducted our audit
of this financial statement in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statement
is free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statement,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
August 20, 2003
85
FINANCIAL STATEMENTS
PIMCO FLOATING RATE INCOME FUND
Statement of Net Assets
August 19, 2003
Assets
Cash $ 100,001
----------
Total Assets 100,001
----------
Net Assets (5,168 shares of $0.00001 par value shares of
beneficial interest issued and outstanding; unlimited
shares authorized) $ 100,001
----------
Net asset value per share $ 19.35
==========
Notes to Financial Statements:
1. Organization
PIMCO Floating Rate Income Fund (the "Fund") was organized as a Massachusetts
business trust on June 19, 2003. The Fund has had no operations to date other
than 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 sale and issuance to Allianz Dresdner Asset Management
of America, L.P. ("ADAM") of 5,168 shares of beneficial interest at an aggregate
purchase price of $100,001. PIMCO Advisors Fund Management LLC (the "Investment
Manager") serves as the Fund's investment manager, and is an indirect,
wholly-owned subsidiary of ADAM and an indirect, majority-owned subsidiary of
Allianz AG, a publicly traded German insurance and financial services company.
The Investment Manager has agreed to pay the Fund's organizational expenses of
approximately $25,000, except the Fund has agreed to reimburse the Investment
Manager for such organizational expenses to the extent that the aggregate of all
such organizational expenses and all offering costs (other than the sales load)
does not exceed $0.04 per common share issued. The Fund's offering costs are
estimated to be $650,000 assuming 15,000,000 shares of beneficial interest are
sold in the Fund's initial public offering. Offering costs will be charged to
paid-in capital at the time such shares of beneficial interest are issued. The
Investment Manager has agreed to pay the amount by which the Fund's offering
costs (other than the sales load) exceed $0.04 per common share issued. The
actual number of shares that are sold in the initial public offering, and
associated offering costs, may differ significantly from the above estimates.
2. Accounting Policies
The preparation of the financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
and disclosures in the financial statements. Actual results could differ from
these estimates. In the normal course of business, the Fund enters into
contracts that contain a variety of representations which provide general
indemnifications. The Fund's maximum exposure under these arrangements is
unknown as this would involve future claims that may be made against the Fund
that have not yet occurred. However, the Fund expects the risk of any loss to be
remote.
3. Investment Manager and Related Parties
The Fund has entered into an Investment Management Agreement (the "Agreement")
with the Investment Manager to serve as investment manager to the Fund. Pursuant
to the Agreement, the Fund will pay the Investment Manager an annual management
fee, payable monthly, at the annual rate of 0.75% of the Fund's average weekly
total managed assets. Total managed assets refers to the total assets of the
Fund (including any assets attributable to any Preferred Shares or other forms
of leverage that may be outstanding) minus accrued liabilities (other than
liabilities representing leverage). The Investment Manager has retained its
affiliate, Pacific Investment Management Company LLC ("PIMCO"), to manage the
Fund's investments. The Investment Manager (not the Fund) will pay a portion of
the fees it receives as Investment Manager to PIMCO in return for its services,
at the annual rate of 0.39% of the Fund's average weekly total managed assets,
provided, however, that the amounts payable for each month shall be reduced to
reflect that PIMCO will bear 65% of the fees payable by the Investment Manager
to certain underwriters (other than Merrill Lynch, Pierce, Fenner & Smith
Incorporated). Commencing, September 1, 2008 and thereafter, the Investment
Manager will pay a monthly fee to PIMCO at the annual rate of 0.55% of the
Fund's average weekly total managed assets, provided, however, that the amounts
payable for each month shall be reduced by the amount of all fees payable by the
Investment Manager to certain underwriters other than Merrill Lynch, Pierce,
Fenner & Smith Incorporated for such month, such that the Investment Manager
retains from its management fee, 0.05% of the Fund's average weekly total
managed assets, on an annual basis, after having paid PIMCO and the
underwriters.
4. Federal Income Taxes
The Fund intends to comply with the requirements of the Internal Revenue Code of
1986, as amended, applicable to regulated investment companies. Accordingly, no
provision for U.S. federal income taxes is required. In addition, by
distributing substantially all of its ordinary income and long-term capital
gains, if any, during each calendar year, the Fund intends not to be subject to
U.S. federal excise tax.
86
APPENDIX A
PERFORMANCE RELATED,
COMPARATIVE AND OTHER INFORMATION
From time to time, the Fund, the Manager and/or PIMCO may report to
shareholders or to the public in advertisements concerning the performance of
the Manager and/or PIMCO as adviser to clients other than the Fund, or on the
comparative performance or standing of the Manager and/or PIMCO in relation to
other money managers. The Manager and/or PIMCO also may provide current or
prospective private account clients, in connection with standardized performance
information for the Fund, performance information for the Fund gross of fees and
expenses for the purpose of assisting such clients in evaluating similar
performance information provided by other investment managers or institutions.
Comparative information may be compiled or provided by independent ratings
services or by news organizations. Any performance information, whether related
to the Fund, the Manager or PIMCO, should be considered in light of the Fund's
investment objective and policies, characteristics and quality of the Fund, and
the market conditions during the time period indicated, and should not be
considered to be representative of what may be achieved in the future.
Performance information for the Fund may be compared to various unmanaged
indexes.
[GRAPHIC APPEARS HERE]
The above graphic depicts headshots of Bill Gross, PIMCO Founder and Chief
Investment Officer, and Ray Kennedy, lead Portfolio Manager.
Introducing PIMCO Floating Rate Income Fund, a newly created investment
opportunity offering access to senior floating rate loans (a market not widely
available to individual investors) an other floating rate debt instruments. The
Fund utilizes a portfolio that focuses on senior loans and other floating rate
debt instruments designed to offer high current income, consistent with capital
preservation; minimal sensitivity to fluctuations in market interest rates; and
the expertise of one of America's leading bond managers.
The portfolio manager, PIMCO (Pacific Investment Management Company LLC) is one
of America's leading bond managers.
Duration. The Fund's average portfolio duration is within a short range of 0 to
1 year, with expected initial duration of approximately 0.4 years. PIMCO
believes that the Fund's short duration range minimizes exposure to interest
rate volatility and related risk while still offering the opportunity for high
current income.
Why Invest in the Fund? For investors willing to take on credit risk, the Fund
offers enhanced yield potential, making it an attractive choice for a part of a
portfolio's short-term bond
A-1
allocation. Also, the Fund offers the potential to add an additional level of
diversification to core stock and bond holdings. Finally, floating rate debt
instruments offer the potential for high income with less interest rate
sensitivity and lower volatility than similar fixed-rate instruments.
The potential advantages of floating rate debt instruments include high income
potential (historically, floating rate loans have tended to maintain a favorable
yield spread over other short-term, fixed income alternatives) and less
interest rate sensitivity.
Floating Rate Debt Instruments May Offer An Attractive Balance of Risk and
Reward. High quality, short-term fixed-rate debt investments, typically have
lower interest-rate and credit risk but also a relatively low yield. Long-term
fixed-rate bonds, on the other hand, typically offer higher yields and capital
appreciation potential but are also more sensitive to interest rate fluctuations
and tend to decline more in value in a rising interest rate environment. Senior
floating rate loans, however, often combine higher potential yields, albeit with
more credit risk, than high-quality, short-term, fixed-rate investments. At the
same time, senior floating rate loans generally have less sensitivity to
fluctuations in market interest rates than longer-term fixed-rate bonds (and
therefore less potential for capital appreciation or depreciation from interest
rate changes). The chart below shows the average yields and durations of senior,
secured floating rate bank loans compared with those of short-term Treasuries,
3-month T-Bills, intermediate-term bonds, high yield bonds and long-term
Treasuries.
[CHART APPEARS HERE]
The chart above plots the yields and average durations of senior secured
floating rate bank loans, short-term Treasuries, 3-month T-Bills,
intermediate-term bonds, high yield bonds and long-term Treasuries as of
6/30/03. The horizontal axis presents average duration in years and increases
from left to right in two year increments from zero to twelve years. The
vertical axis measures current yield (as of 6/30/03) and increases vertically in
two percent increments from zero percent to ten percent. The plot point for
short-term Treasuries appears between 0 and 2 years on the Average Duration axis
and between 0% and 2% on the Current Yield axis. The plot point for 3-month
T-Bills appears between 0 and 2 years on the Average Duration axis and between
0% and 2% on the Current Yield axis, but with an Average Duration that is lower
than that of short-term Treasuries. The plot point for senior secured floating
rate bank loans appears between 0 and 2 years on the Average Duration axis and
between 4% and 6% on the Current Yield axis. The plot point for intermediate
term bonds intersects the 4 year point on the Average Duration axis and appears
between 2% and 4% on the Current Yield axis. The plot point for high yield bonds
appears between 4 and 6 years on the Average Duration axis, but with an Average
Duration that is longer than intermediate term bonds and between 8% and 10% on
the Current Yield axis. The plot point for long-term treasuries appears between
10 and 12 years on the Average Duration axis and between 4% and 6% on the
Current Yield axis, but with a Current Yield that is slightly less than the
Current Yield for senior secured floating rate bank loans.
Source: Bloomberg, Lehman Brothers and CSFB. All data as of 6/30/03. Past
performance is no guarantee of future results. This chart measures the yields
and average durations of senior secured floating rate bank loans, short-term
Treasuries, 3-month T-Bills, intermediate-term bonds, high yield bonds and
long-term Treasuries as of 6/30/03. *Please see the next page for a description
of the Indexes represented in the chart. The information provided in this chart
is as of a recent date (June 30, 2003) only and does not show what the yields
and average durations of the various asset classes and Indexes represented (as
described on the next page) have been historically or predict what they will be
on future dates or in future periods. The yield/average duration relationships
shown among the various asset classes are likely to change on a continuous basis
due to changes in market interest rates, changes to the securities represented
in the Indexes and economic and other factors. Nor does the chart indicate what
the yield and average duration of the Fund would have been on June 30, 2003 or
will be at any time or from time to time,
A-2
each of which is expected to vary with changing market conditions and the
specific contents of the Fund's portfolio holdings. The securities that the Fund
will own will not match, and are not intended to be representative of, those of
the CSFB Leveraged Loan Index or any other Index represented. Not all of the
senior floating rate loans in which the Fund invests will be secured by
collateral. The Fund expects to invest in floating rate debt instruments other
than senior, floating rate loans and may invest in fixed rate instruments. This
chart is not intended to predict the Fund's yield or performance. It is not
possible to invest directly in any of these Indexes. The current yields shown
for the Indexes do not reflect any management fees, account charges or other
fees and expenses that will apply to the Fund. Senior secured floating rate bank
loans are represented by the CSFB Leveraged Loan Index, a representative index
of tradable, senior, secured, U.S. dollar-denominated syndicated floating rate
bank loans, which are made to noninvestment grade borrowers. Short-term
Treasuries are represented by the Merrill Lynch 1-3 year Treasury Index, an
unmanaged index made up of US Treasury issues with maturities from 1 to 3 years.
Three-month T-bills are represented by the Salomon Smith Barney 3-Month T-Bill
Index, an unmanaged index of three-month Treasury bills. Intermediate term bonds
are represented by the Lehman Brothers Aggregate Bond Index, which is composed
of securities from Lehman Brothers Government/Credit Bond Index, Mortgage-Backed
Securities Index, and Asset-Backed Securities Index and is generally considered
to be representative of the taxable bond market. High yield bonds are
represented by the Merrill Lynch High Yield Master Index, an unmanaged index
consisting of bonds that are issued in U.S. Domestic markets with at least one
year remaining until maturity. All bonds in the Merrill Lynch High Yield Master
Index must have a credit rating below investment grade but not in default.
Long-term Treasuries are represented by the Lehman Brothers Long-Term Treasury
Index, an unmanaged index comprised of various fixed income instruments with
maturities greater than 10 years. Money market funds are not insured or
guaranteed by FDIC or any other government agency and although the fund seeks to
preserve the value of your investment at $1.00 per share, it is possible to lose
money by investing in money market funds. Government bonds and Treasury
securities are guaranteed by the U.S. government and, if held to maturity, offer
a fixed rate of return and fixed principal value. Shares of funds that invest in
them are not. Duration is a measure of the expected life of a debt security that
is used to determine the sensitivity of the security's price to changes in
interest rates. Duration for CSFB Leveraged Loan Index is approximate and based
on the short-term, floating rate nature of the securities in the Index. Duration
for iMoneyNet Money Market Funds Taxable 30 Day Compound Yield Index is
approximate and based on the short-term, limited maturity constraints of Money
Market Funds, which are required to have an average portfolio maturity of 90
days or less.
Capital Structure of a Typical Company
[GRAPH]
Highest Priority
Senior secured debt
Senior unsecured debt
Subordinated unsecured debt
Preferred stock
Common stock
Lowest Priority
A-3
The protective features of senior loans include that they are one of the highest
priorities in a companies capital structure and are often secured by company
assets. Senior loans have the highest, or one of the highest, priority positions
in a borrower's capital structure. This means that in the event of default,
bankruptcy or liquidation of the borrower, senior loan holders typically would
be entitled to recovery payments prior to any funds being distributed to most or
all bondholders or equity investors, although there is no assurance that any
such payments would be available. The graphic at the right shows a typical
priority ranking in a company's capital structure (although any particular
company may have a different structure). Additionally, many of these senior
loans in which the Fund may invest will also be secured, which means they will
be backed by collateral for the term of the loan. This collateral may include:
working capital assets, such as accounts receivable and inventory, tangible
fixed assets, such as real property, buildings and equipment and security
interests in shares of stock of subsidiaries or affiliates. This collateral
offers an added protection for the loan holder. Even if the company cannot pay
back the loan, the loan holder would generally assume ownership of the assets
that were pledged as collateral.
Understanding the Credit Quality of a Senior Loan: Credit Risk Versus Interest
Rate Risk. Bond investors may seek to increase yields by assuming more interest
rate risk and/or more credit risk. By investing in this Fund, investors will
generally have limited exposure to interest rate risk, but will be exposed to
credit risk (see "Other Risks"). Although senior loans generally have the
highest, or one of the highest, primary positions in a borrower's capital
structure and are often secured by collateral, they are typically of below
investment grade quality and may have below investment grade ratings. Largely
due to their protective features, PIMCO believes senior loans tend to have more
favorable recovery rates as compared to most non-senior debt obligations of
similar quality
One of America's leading bond managers, PIMCO is responsible for managing the
Fund's investments. As of 6/30/03, PIMCO is one of the nation's largest active
bond managers, with over $340 billion in assets under management and a client
list that includes over half of the 100 largest corporations in America.
Additionally, PIMCO has bank loan expertise and has been actively managing
floating rate loans since 1996, with approximately $3.9 billion in floating rate
loan assets under management and has unique in-house research and analytical
capabilities.
Bill Gross, PIMCO's founder and Chief Investment Officer, heads the firm's
Investment Committee, which oversees investment policy decisions, including
duration positioning, yield curve management, and credit quality composition for
all PIMCO portfolios and strategies, including the Fund. Primary day-to-day
portfolio management responsibilities are shared by Raymond Kennedy, David
Hinman and Jason Rosiak, with Raymond Kennedy serving as the lead portfolio
manager
The Fund's advantages include the use of leverage to help enhance yield, the
payment on monthly dividends, low minimum investment and exchange-traded
liquidity (the Fund expects its to list its shares on the New York Stock
Exchange (NYSE), which should promote liquidity and convenient access to daily
share prices through electronic services and/or in newspaper stock tables. The
Fund's expected symbol is PFL).
PIMCO Advisors Fund Management LLC, the Fund's investment manager, is a leading
closed-end fund advisor with $11.3 billion in closed-end fund assets under
management (as of 6/30/03).
A-4
"PIMCO has got some of the best minds in the business." - Baron's, 9/28/02.
While all the portfolio managers at PIMCO receive strategic input from the
firm's Investment Committee regarding investment policy decisions and have
access to a devoted team of professionals that conduct fundamental credit
research and analysis of individual issuers, industries and sectors and utilize
proprietary analytical tools (such as computer databases and Web-based
applications) to assess and monitor credit risk, none of the members of the
Investment Committee have primary day-to-day portfolio management
responsibilities for the Fund. Such day-to-day responsibilities are shared by
Raymond Kennedy, David Hinman and Jason Rosiak, with Mr. Kennedy serving as lead
portfolio manager.
A-5
APPENDIX B
PACIFIC INVESTMENT MANAGEMENT COMPANY LLC
PROXY VOTING POLICIES AND PROCEDURES
The following are general proxy voting policies and procedures ("Policies and
Procedures") adopted by Pacific Investment Management Company LLC ("PIMCO"), an
investment adviser registered under the Investment Advisers Act of 1940, as
amended ("Advisers Act").1 PIMCO serves as the investment adviser to a wide
range of domestic and international clients, including investment companies
registered under the Investment Company Act of 1940, as amended ("1940 Act") and
separate investment accounts for other clients.2 These Policies and Procedures
are adopted to ensure compliance with Rule 206(4)-6 under the Advisers Act,
other applicable fiduciary obligations of PIMCO and the applicable rules and
regulations of the Securities and Exchange Commission ("SEC") and
interpretations of its staff. In addition to SEC requirements governing
advisers, PIMCO's Policies and Procedures reflect the long-standing fiduciary
standards and responsibilities applicable to investment advisers with respect to
accounts subject to the Employee Retirement Income Security Act of 1974
("ERISA"), as set forth in the Department of Labor's rules and regulations.3
PIMCO will implement these Policies and Procedures for each of its respective
clients as required under applicable law, unless expressly directed by a client
in writing to refrain from voting that client's proxies. PIMCO's authority to
vote proxies on behalf of its clients is established by its advisory contracts,
comparable documents or by an overall delegation of discretionary authority over
its client's assets. Recognizing that proxy voting is a rare event in the realm
of fixed income investing and is typically limited to solicitation of consent to
changes in features of debt securities, these Policies and Procedures also apply
to any voting rights and/or consent rights of PIMCO, on behalf of its clients,
with respect to debt securities, including but not limited to, plans of
reorganization, and waivers and consents under applicable indentures.4
B-1
--------
1 These Policies and Procedures are adopted by PIMCO pursuant to Rule 206(4)-6
under the Advisers Act, effective August 6, 2003. See Proxy Voting by
Investment Advisers, IA Release No. 2106 (January 31, 2003).
2 These Policies and Procedures address proxy voting considerations under U.S.
law and regulations and do not address the laws or requirements of other
jurisdictions.
3 Department of Labor Bulletin 94-2, 29 C.F.R. 2509.94-2 (July 29, 1994). If a
client is subject to ERISA, PIMCO will be responsible for voting proxies
with respect to the client's account, unless the client has expressly
retained the right and obligation to vote the proxies, and provided prior
written notice to PIMCO of this retention.
4 For purposes of these Policies and Procedures, proxy voting includes any
voting rights, consent rights or other voting authority of PIMCO on behalf
of its clients.
Set forth below are PIMCO's Policies and Procedures with respect to any voting
or consent rights of advisory clients over which PIMCO has discretionary voting
authority. These Policies and Procedures may be revised from time to time.
General Statements of Policy
These Policies and Procedures are designed and implemented in a manner
reasonably expected to ensure that voting and consent rights are exercised in
the best interests of PIMCO's clients. Each proxy is voted on a case-by-case
basis taking into consideration any relevant contractual obligations as well as
other relevant facts and circumstances.
PIMCO may abstain from voting a client proxy under the following circumstances:
(1) when the economic effect on shareholders' interests or the value of the
portfolio holding is indeterminable or insignificant; or (2) when the cost of
voting the proxies outweighs the benefits.
Conflicts of Interest
PIMCO seeks to resolve any material conflicts of interest by voting in good
faith in the best interest of its clients. If a material conflict of interest
should arise, PIMCO will seek to resolve such conflict in the client's best
interest by pursuing any one of the following courses of action:
1. convening an ad-hoc committee to assess and resolve the
conflict;/5/
2. voting in accordance with the instructions/consent of a client
after providing notice of and disclosing the conflict to that
client;
3. voting the proxy in accordance with the recommendation of an
independent third-party service provider;
4. suggesting that the client engage another party to determine
how the proxies should be voted;
5. delegating the vote to an independent third-party service
provider; or
6. voting in accordance with the factors discussed in these
Policies and Procedures.
PIMCO will document the process of resolving any identified material conflict of
interest.
--------
/5/ Any committee must be comprised of personnel who have no direct interest in
the outcome of the potential conflict.
B-2
Reporting Requirements and the Availability of Proxy Voting Records
Except to the extent required by applicable law or otherwise approved by PIMCO,
PIMCO will not disclose to third parties how it voted a proxy on behalf of a
client. However, upon request from an appropriately authorized individual, PIMCO
will disclose to its clients or the entity delegating the voting authority to
PIMCO for such clients (e.g., trustees or consultants retained by the client),
how PIMCO voted such client's proxy. In addition, PIMCO provides its clients
with a copy of these Policies and Procedures or a concise summary of these
Policies and Procedures: (i) in Part II of Form ADV; (ii) together with a
periodic account statement in a separate mailing; or (iii) any other means as
determined by PIMCO. The summary will state that these Policies and Procedures
are available upon request and will inform clients that information about how
PIMCO voted that client's proxies is available upon request.
PIMCO Record Keeping
PIMCO or its agent maintains proxy voting records as required by Rule 204-2(c)
of the Advisers Act. These records include: (1) a copy of all proxy voting
policies and procedures; (2) proxy statements (or other disclosures accompanying
requests for client consent) received regarding client securities (which may be
satisfied by relying on obtaining a copy of a proxy statement from the SEC's
Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system or a third
party provided that the third party undertakes to provide a copy promptly upon
request); (3) a record of each vote cast by PIMCO on behalf of a client; (4) a
copy of any document created by PIMCO that was material to making a decision on
how to vote proxies on behalf of a client or that memorializes the basis for
that decision; and (5) a copy of each written client request for proxy voting
records and any written response from PIMCO to any (written or oral) client
request for such records. Additionally, PIMCO or its agent maintains any
documentation related to an identified material conflict of interest.
Proxy voting books and records are maintained by PIMCO or its agent in an easily
accessible place for a period of five years from the end of the fiscal year
during which the last entry was made on such record, the first two years in the
offices of PIMCO or its agent.
Review and Oversight
PIMCO's proxy voting procedures are described below. PIMCO's Compliance Group
will provide for the supervision and periodic review, no less than on a
quarterly basis, of its proxy voting activities and the implementation of these
Policies and Procedures.
Because PIMCO has contracted with State Street Investment Manager Solutions, LLC
("IMS West") to perform portfolio accounting, securities processing and
settlement processing on behalf of PIMCO, certain of the following procedures
involve IMS West in administering and implementing the proxy voting process. IMS
West will review and monitor the proxy voting process to ensure that proxies are
voted on a timely basis.
B-3
1. Transmit Proxy to PIMCO. IMS West will forward to PIMCO's Middle
Office Group each proxy received from registered owners of record (e.g.,
custodian bank or other third party service providers).
2. Conflicts of Interest. PIMCO's Middle Office Group will review each
proxy to determine whether there may be a material conflict between PIMCO and
its client. As part of this review, the group will determine whether the issuer
of the security or proponent of the proposal is a client of PIMCO, or if a
client has actively solicited PIMCO to support a particular position. If no
conflict exists, this group will forward each proxy to the appropriate portfolio
manager for consideration. However, if a conflict does exist, PIMCO's Middle
Office Group will seek to resolve any such conflict in accordance with these
Policies and Procedures.
3. Vote. The portfolio manager will review the information, will vote
the proxy in accordance with these Policies and Procedures and will return the
voted proxy to PIMCO's Middle Office Group.
4. Review. PIMCO's Middle Office Group will review each proxy that was
submitted to and completed by the appropriate portfolio manager. PIMCO's Middle
Office Group will forward the voted proxy back to IMS West with the portfolio
manager's decision as to how it should be voted.
5. Transmittal to Third Parties. IMS West will document the portfolio
manager's decision for each proxy received from PIMCO's Middle Office Group in a
format designated by the custodian bank or other third party service provider.
IMS West will maintain a log of all corporate actions, including proxy voting,
which indicates, among other things, the date the notice was received and
verified, PIMCO's response, the date and time the custodian bank or other third
party service provider was notified, the expiration date and any action taken.
6. Information Barriers. Certain entities controlling, controlled by,
or under common control with PIMCO ("Affiliates") may be engaged in banking,
investment advisory, broker-dealer and investment banking activities. PIMCO
personnel and PIMCO's agents are prohibited from disclosing information
regarding PIMCO's voting intentions to any Affiliate. Any PIMCO personnel
involved in the proxy voting process who are contacted by an Affiliate regarding
the manner in which PIMCO or its delegate intend to vote on a specific issue
must terminate the contact and notify the Compliance Group immediately.
Categories of Proxy Voting Issues
In general, PIMCO reviews and considers corporate governance issues related to
proxy matters and generally supports proposals that foster good corporate
governance practices. PIMCO considers each proposal on a case-by-case basis,
taking into consideration various factors and all relevant facts and
circumstances at the time of the vote. PIMCO may vote proxies as recommended by
management on routine matters related to the operation of the issuer and on
matters not expected to have a significant economic impact on the issuer and/or
shareholders, because PIMCO believes the recommendations by the issuer generally
are in shareholders' best
B-4
interests, and therefore in the best economic interest of PIMCO's clients. The
following is a non-exhaustive list of issues that may be included in proxy
materials submitted to clients of PIMCO, and a non-exhaustive list of factors
that PIMCO may consider in determining how to vote the client's proxies.
Board of Directors
1. Independence. PIMCO may consider the following factors when voting
on director independence issues: (i) majority requirements for the board and the
audit, nominating, compensation and/or other board committees; and (ii) whether
the issuer adheres to and/or is subject to legal and regulatory requirements.
2. Director Tenure and Retirement. PIMCO may consider the following
factors when voting on limiting the term of outside directors: (i) the
introduction of new viewpoints on the board; (ii) a reasonable retirement age
for the outside directors; and (iii) the impact on the board's stability and
continuity.
3. Nominations in Elections. PIMCO may consider the following factors
when voting on uncontested elections: (i) composition of the board; (ii) nominee
availability and attendance at meetings; (iii) any investment made by the
nominee in the issuer; and (iv) long-term corporate performance and the price of
the issuer's securities.
4. Separation of Chairman and CEO Positions. PIMCO may consider the
following factors when voting on proposals requiring that the positions of
chairman of the board and the chief executive officer not be filled by the same
person: (i) any potential conflict of interest with respect to the board's
ability to review and oversee management's actions; and (ii) any potential
effect on the issuer's productivity and efficiency.
5. D&O Indemnification and Liability Protection. PIMCO may consider the
following factors when voting on proposals that include director and officer
indemnification and liability protection: (i) indemnifying directors for conduct
in the normal course of business; (ii) limiting liability for monetary damages
for violating the duty of care; (iii) expanding coverage beyond legal expenses
to acts that represent more serious violations of fiduciary obligation than
carelessness (e.g. negligence); and (iv) providing expanded coverage in cases
where a director's legal defense was unsuccessful if the director was found to
have acted in good faith and in a manner that he or she reasonably believed was
in the best interests of the company.
6. Stock Ownership. PIMCO may consider the following factors when
voting on proposals on mandatory share ownership requirements for directors: (i)
the benefits of additional vested interest in the issuer's stock; (ii) the
ability of a director to fulfill his duties to the issuer regardless of the
extent of his stock ownership; and (iii) the impact of limiting the number of
persons qualified to be directors.
B-5
Proxy Contests and Proxy Contest Defenses
1. Contested Director Nominations. PIMCO may consider the following
factors when voting on proposals for director nominees in a contested election:
(i) background and reason for the proxy contest; (ii) qualifications of the
director nominees; (iii) management's track record; (iv) the issuer's long-term
financial performance within its industry; (v) assessment of what each side is
offering shareholders; (vi) the likelihood that the proposed objectives and
goals can be met; and (vii) stock ownership positions of the director nominees.
2. Reimbursement for Proxy Solicitation Expenses. PIMCO may consider
the following factors when voting on reimbursement for proxy solicitation
expenses: (i) identity of the persons who will pay the expenses; (ii) estimated
total cost of solicitation; (iii) total expenditures to date; (iv) fees to be
paid to proxy solicitation firms; and (v) when applicable, terms of a proxy
contest settlement.
3. Ability to Alter the Size of the Board by Shareholders. PIMCO may
consider whether the proposal seeks to fix the size of the board and/or require
shareholder approval to alter the size of the board.
4. Ability to Remove Directors by Shareholders. PIMCO may consider
whether the proposal allows shareholders to remove directors with or without
cause and/or allow shareholders to elect directors and fill board vacancies.
5. Cumulative Voting. PIMCO may consider the following factors when
voting on cumulative voting proposals: (i) the ability of significant
stockholders to elect a director of their choosing; (ii) the ability of minority
shareholders to concentrate their support in favor of a director(s) of their
choosing; and (iii) any potential limitation placed on the director's ability to
work for all shareholders.
6. Supermajority Shareholder Requirements. PIMCO may consider all
relevant factors, including but not limited to limiting the ability of
shareholders to effect change when voting on supermajority requirements to
approve an issuer's charter or bylaws, or to approve a merger or other
significant business combination that would require a level of voting approval
in excess of a simple majority.
Tender Offer Defenses
1. Classified Boards. PIMCO may consider the following factors when
voting on classified boards: (i) providing continuity to the issuer; (ii)
promoting long-term planning for the issuer; and (iii) guarding against
unsolicited takeovers.
2. Poison Pills. PIMCO may consider the following factors when voting
on poison pills: (i) supporting proposals to require a shareholder vote on other
shareholder rights plans; (ii) ratifying or redeeming a poison pill in the
interest of protecting the value of the issuer; and (iii) other alternatives to
prevent a takeover at a price clearly below the true value of the issuer.
B-6
3. Fair Price Provisions. PIMCO may consider the following factors when
voting on proposals with respect to fair price provisions: (i) the vote required
to approve the proposed acquisition; (ii) the vote required to repeal the fair
price provision; (iii) the mechanism for determining fair price; and (iv)
whether these provisions are bundled with other anti-takeover measures (e.g.,
supermajority voting requirements) that may entrench management and discourage
attractive tender offers.
Capital Structure
1. Stock Authorizations. PIMCO may consider the following factors to
help distinguish between legitimate proposals to authorize increases in common
stock for expansion and other corporate purchases and those proposals designed
primarily as an anti-takeover device: (i) the purpose and need for the stock
increase; (ii) the percentage increase with respect to the authorization
currently in place; (iii) voting rights of the stock; and (iv) overall
capitalization structure of the issuer.
2. Issuance of Preferred Stock. PIMCO may consider the following
factors when voting on the issuance of preferred stock: (i) whether the new
class of preferred stock has unspecified voting, conversion, dividend
distribution, and other rights; (ii) whether the issuer expressly states that
the stock will not be used as a takeover defense or carry superior voting
rights; (iii) whether the issuer specifies the voting, dividend, conversion, and
other rights of such stock and the terms of the preferred stock appear
reasonable; and (iv) whether the stated purpose is to raise capital or make
acquisitions in the normal course of business.
3. Stock Splits. PIMCO may consider the following factors when voting
on stock splits: (i) the percentage increase in the number of shares with
respect to the issuer's existing authorized shares; and (ii) the industry that
the issuer is in and the issuer's performance in that industry.
4. Reversed Stock Splits. PIMCO may consider the following factors when
voting on reverse stock splits: (i) the percentage increase in the shares with
respect to the issuer's existing authorized stock; and (ii) issues related to
delisting the issuer's stock.
Executive and Director Compensation
1. Stock Option Plans. PIMCO may consider the following factors when
voting on stock option plans: (i) whether the stock option plan expressly
permits the repricing of options; (ii) whether the plan could result in earnings
dilution of greater than a specified percentage of shares outstanding; (iii)
whether the plan has an option exercise price below the market price on the day
of the grant; (iv) whether the proposal relates to an amendment to extend the
term of options for persons leaving the firm voluntarily or for cause; and (v)
whether the stock option plan has certain other embedded features.
B-7
2. Director Compensation. PIMCO may consider the following factors when
voting on director compensation: (i) whether director shares are at the same
market risk as those of the issuer's shareholders; and (ii) how stock option
programs for outside directors compare with the standards of internal stock
option programs.
3. Golden and Tin Parachutes. PIMCO may consider the following factors
when voting on golden and/or tin parachutes: (i) whether they will be submitted
for shareholder approval; and (ii) the employees covered by the plan and the
quality of management.
State of Incorporation
State Takeover Statutes. PIMCO may consider the following factors when
voting on proposals to opt out of a state takeover statute: (i) the power the
statute vests with the issuer's board; (ii) the potential of the statute to
stifle bids; and (iii) the potential for the statute to empower the board to
negotiate a better deal for shareholders.
Mergers and Restructurings
1. Mergers and Acquisitions. PIMCO may consider the following factors
when voting on a merger and/or acquisition: (i) anticipated financial and
operating benefits as a result of the merger or acquisition; (ii) offer price;
(iii) prospects of the combined companies; (iv) how the deal was negotiated; and
(v) changes in corporate governance and the potential impact on shareholder
rights. PIMCO may also consider what impact the merger or acquisition may have
on groups/organizations other than the issuer's shareholders.
2. Corporate Restructurings. With respect to a proxy proposal that
includes a spin-off, PIMCO may consider the tax and regulatory advantages,
planned use of sale proceeds, market focus, and managerial incentives. With
respect to a proxy proposal that includes an asset sale, PIMCO may consider the
impact on the balance sheet or working capital and the value received for the
asset. With respect to a proxy proposal that includes a liquidation, PIMCO may
consider management's efforts to pursue alternatives, the appraisal value of
assets, and the compensation plan for executives managing the liquidation.
Investment Company Proxies
For a client that is invested in an investment company, PIMCO votes each proxy
of the investment company on a case-by-case basis and takes all reasonable steps
to ensure that proxies are voted consistent with all applicable investment
policies of the client and in accordance with any resolutions or other
instructions approved by authorized persons of the client.
For a client that is invested in an investment company that is advised by PIMCO
or its affiliates, if there is a conflict of interest which may be presented
when voting for the client (e.g., a proposal to approve a contract between PIMCO
and the investment company), PIMCO will resolve the conflict by doing any one of
the following: (i) voting in accordance with the instructions/consent of the
client after providing notice of and disclosing the conflict to that
B-8
client; (ii) voting the proxy in accordance with the recommendation of an
independent third-party service provider; or (iii) delegating the vote to an
independent third-party service provider.
1. Election of Directors or Trustees. PIMCO may consider the following
factors when voting on the director or trustee nominees of a mutual fund: (i)
board structure, director independence and qualifications, and compensation paid
by the fund and the family of funds; (ii) availability and attendance at board
and committee meetings; (iii) investments made by the nominees in the fund; and
(iv) the fund's performance.
2. Converting Closed-end Fund to Open-end Fund. PIMCO may consider the
following factors when voting on converting a closed-end fund to an open-end
fund: (i) past performance as a closed-end fund; (ii) the market in which the
fund invests; (iii) measures taken by the board to address any discount of the
fund's shares; (iv) past shareholder activism; (v) board activity; and (vi)
votes on related proposals.
3. Proxy Contests. PIMCO may consider the following factors related to
a proxy contest: (i) past performance of the fund; (ii) the market in which the
fund invests; (iii) measures taken by the board to address past shareholder
activism; (iv) board activity; and (v) votes on related proposals.
4. Investment Advisory Agreements. PIMCO may consider the following
factors related to approval of an investment advisory agreement: (i) proposed
and current fee arrangements/schedules; (ii) fund category/investment objective;
(iii) performance benchmarks; (iv) share price performance as compared with
peers; and (v) the magnitude of any fee increase and the reasons for such fee
increase.
5. Policies Established in Accordance with the 1940 Act. PIMCO may
consider the following factors: (i) the extent to which the proposed changes
fundamentally alter the investment focus of the fund and comply with SEC
interpretation; (ii) potential competitiveness; (iii) regulatory developments;
and (iv) current and potential returns and risks.
6. Changing a Fundamental Restriction to a Non-fundamental Restriction.
PIMCO may consider the following when voting on a proposal to change a
fundamental restriction to a non-fundamental restriction: (i) reasons given by
the board and management for the change; and (ii) the projected impact of the
change on the fund's portfolio.
7. Distribution Agreements. PIMCO may consider the following when
voting on a proposal to approve a distribution agreement: (i) fees charged to
comparably sized funds with similar investment objectives; (ii) the
distributor's reputation and past performance; and (iii) competitiveness of the
fund among other similar funds in the industry.
8. Names Rule Proposals. PIMCO may consider the following factors when
voting on a proposal to change a fund name, consistent with Rule 35d-1 of the
1940 Act: (i) whether the fund invests a minimum of 80% of its assets in the
type of investments suggested by the
B-9
proposed name; (ii) the political and economic changes in the target market; and
(iii) current asset composition.
9. Disposition of Assets/Termination/Liquidation. PIMCO may consider
the following when voting on a proposal to dispose of fund assets, terminate, or
liquidate the fund: (i) strategies employed to salvage the fund; (ii) the fund's
past performance; and (iii) the terms of the liquidation.
10. Changes to Charter Documents. PIMCO may consider the following when
voting on a proposal to change a fund's charter documents: (i) degree of change
implied by the proposal; (ii) efficiencies that could result; (iii) state of
incorporation; and (iv) regulatory standards and implications.
11. Changing the Domicile of a Fund. PIMCO may consider the following
when voting on a proposal to change the domicile of a fund: (i) regulations of
both states; (ii) required fundamental policies of both states; and (iii) the
increased flexibility available.
12. Change in Fund's Subclassification. PIMCO may consider the
following when voting on a change in a fund's subclassification from diversified
to non-diversified or to permit concentration in an industry: (i) potential
competitiveness; (ii) current and potential returns; (iii) risk of
concentration; and (iv) consolidation in the target industry.
Distressed and Defaulted Securities
1. Waivers and Consents. PIMCO may consider the following when
determining whether to support a waiver or consent to changes in provisions of
indentures governing debt securities which are held on behalf of clients: (i)
likelihood that the granting of such waiver or consent will potentially increase
recovery to clients; (ii) potential for avoiding cross-defaults under other
agreements; and (iii) likelihood that deferral of default will give the obligor
an opportunity to improve its business operations.
2. Voting on Chapter 11 Plans of Liquidation or Reorganization. PIMCO
may consider the following when determining whether to vote for or against a
Chapter 11 plan in a case pending with respect to an obligor under debt
securities which are held on behalf of clients: (i) other alternatives to the
proposed plan; (ii) whether clients are treated appropriately and in accordance
with applicable law with respect to their distributions; (iii) whether the vote
is likely to increase or decrease recoveries to clients.
B-10
Miscellaneous Provisions
1. Such Other Business. Proxy ballots sometimes contain a proposal
granting the board authority to "transact such other business as may properly
come before the meeting." PIMCO may consider the following factors when
developing a position on proxy ballots that contain a proposal granting the
board authority to "transact such other business as may properly come before the
meeting": (i) whether the board is limited in what actions it may legally take
within such authority; and (ii) PIMCO's responsibility to consider actions
before supporting them.
2. Equal Access. PIMCO may consider the following factors when voting
on equal access: (i) the opportunity for significant company shareholders to
evaluate and propose voting recommendations on proxy proposals and director
nominees, and to nominate candidates to the board; and (ii) the added complexity
and burden of providing shareholders with access to proxy materials.
3. Charitable Contributions. PIMCO may consider the following factors
when voting on charitable contributions: (i) the potential benefits to
shareholders; and (ii) the potential impact on the issuer's resources that could
have been used to increase shareholder value.
4. Special Interest Issues. PIMCO may consider the following factors
when voting on special interest issues: (i) the long-term benefit to
shareholders of promoting corporate accountability and responsibility on social
issues; (ii) management's responsibility with respect to special interest
issues; (iii) any economic costs and restrictions on management; (iv) a client's
instruction to vote proxies in a specific manner and/or in a manner different
from these Policies and Procedures; and (v) the responsibility to vote proxies
for the greatest long-term shareholder value.
* * * * *
B-11
PART C - OTHER INFORMATION
Item 24: Financial Statements and Exhibits
1. Financial Statements:
Registrant has not conducted any business as of the date of this
filing, other than in connection with its organization. Financial
Statements indicating that the Registrant has met the net worth
requirements of Section 14(a) of the 1940 Act are filed herewith as part
of the Statement of Additional Information.
2. Exhibits:
a.1 Agreement and Declaration of Trust dated June 19, 2003.(1)
a.2 Amended and Restated Agreement and Declaration of Trust dated August 14,
2003, filed herewith.
b.1 Bylaws of Registrant dated June 19, 2003.(1)
b.2 Amended and Restated Bylaws of the Registrant, dated August 14, 2003,
filed herewith.
c. None.
d.1 Article III (Shares) and Article V (Shareholders' Voting Powers and
Meetings) of the Amended and Restated Agreement and Declaration of Trust,
filed herewith as part of Exhibit a.2.
d.2 Article 10 (Shareholders' Voting Powers and Meetings) of the Amended and
Restated Bylaws of Registrant, filed herewith as part of Exhibit b.2.
d.3 Form of Share Certificate of the Common Shares, filed herewith.
e. Terms and Conditions of Dividend Reinvestment Plan, filed herewith.
f. None.
g.1 Investment Management Agreement between Registrant and PIMCO Advisors
Fund Management LLC dated August 19, 2003, filed herewith.
g.2 Form of Portfolio Management Agreement between PIMCO Advisors Fund
Management LLC and Pacific Investment Management Company LLC, filed
herewith.
h.1 Form of Purchase Agreement, filed herewith.
h.2 Form of Master Broker-Dealer Agreement, filed herewith.
h.3 Form of Master Agreement Among Underwriters, filed herewith.
h.4 Form of Additional Compensation Agreement between PIMCO Advisors Fund
Management LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated,
filed herewith.
i. None.
j. Form of Custodian and Investment Accounting Agreement between Registrant
and State Street Bank & Trust Co, filed herewith.
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc, filed herewith.
C-1
k.2 Organizational and Offering Expenses Reimbursement Agreement between
Registrant and PIMCO Advisors Fund Management LLC dated August 19, 2003,
filed herewith.
l. Opinion and consent of Ropes & Gray LLP, to be filed by amendment.
m. None.
n. Consent of Registrant's independent accountants, filed herewith.
o. None.
p. Subscription Agreement of Allianz Dresdner Asset Management of America
L.P. dated August 19, 2003, filed herewith.
q. None.
r.1 Code of Ethics of Registrant dated August 14, 2003, filed herewith.
r.2 Code of Ethics of PIMCO Advisors Fund Management LLC, filed herewith.
r.3 Code of Ethics of Pacific Investment Management Company LLC, filed
herewith.
s.1 Power of Attorney for Messrs. Shlissel, Belica, Conner, Dalessandro,
Kertess, Altadonna and Schott.(2)
s.2 Power of Attorney for Mr. Treadway.(2)
--------------------------
(1) Incorporated by reference to the Registrant's Initial Registration
Statement on Form N-2, File No. 333-106334, filed on June 20, 2003.
(2) Incorporated by reference to Pre-Effective Amendment No. 1 to the
Registrant's Initial Registration Statement on Form N-2, File No.
333-106334, Filed on July 25, 2003.
C-2
Item 25: Marketing Arrangements
To be filed by amendment.
Item 26: Other Expenses of Issuance and Distribution
Securities and Exchange Commission Fees $ 24,270*
National Association of Securities Dealers, Inc. Fees 30,500*
Underwriter Reimbursement 100,050*
Printing and engraving expenses 120,000*
Legal fees 250,000*
New York Stock Exchange listing fees 82,800*
Accounting expenses 12,000*
Transfer Agent fees 3,000*
Marketing expenses 25,000*
Miscellaneous expenses 2,380*
---------
Total 650,000*
* Estimated Expenses. Expenses may be reduced pursuant to an
contractual arrangement whereby PIMCO Advisors Fund Management LLC,
the Fund's Investment Manager, has agreed to pay (i) the amount by
which the Fund's offering costs (other than the sales load) exceed
$0.04 per share and (ii) all of the Fund's organizational expenses,
except that the Fund has agreed to reimburse PIMCO Advisors Fund
Management LLC for such organizational expenses to the extent that
the aggregate of all such organizational expenses and all offering
costs (other than the sales load, but inclusive of the reimbursement
of underwriter expenses of $.00667 per share) does not exceed $0.04
per share.
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At August 19, 2003
Number of
Title of Class Record Holders
-------------- --------------
Common Shares, par value $0.00001 1
Item 29: Indemnification
Reference is made to Article VIII, Sections 1 through 4, of the
Registrant's Amended and Restated Agreement and Declaration of Trust, which is
filed herewith.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to trustees, officers and
controlling persons of the Registrant by the Registrant pursuant to the Trust's
Amended and Restated Agreement and Declaration of Trust, its Amended and
Restated Bylaws or otherwise, the Registrant is aware that in the opinion of the
Securities and Exchange Commission, such indemnification is against public
policy as expressed in the Act and, therefore, is unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by trustees, officers or
controlling persons of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such trustees, officers or controlling
persons in connection with the securities being registered, the Registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
C-3
Item 30: Business and Other Connections of Investment Adviser
Descriptions of the business of PIMCO Advisors Fund Management LLC, the
Registrant's investment manager, and Pacific Investment Management Company LLC,
the Registrant's portfolio manager, are set forth under the captions "Investment
Manager" and "Portfolio Manager" under "Management of the Fund" in both the
prospectus and Statement of Additional Information forming part of this
Registration Statement. The following sets forth business and other connections
of each director and executive officer (and persons performing similar
functions) of PIMCO Advisors Fund Management LLC and Pacific Investment
Management Company LLC.
PIMCO Advisors Fund Management LLC
1345 Avenue of the Americas
New York, NY 10105
Name Position with Advisor Other Connections
---------------- -------------------------- ------------------------------
Larry Altadonna Vice President Vice President, OpCap Advisors
LLC
Andrew Bocko Senior Vice President and Senior Vice President,
Director of IT PIMCO Advisors Fund Management
LLC, Allianz Dresdner Asset
Management U.S. Equities LLC,
PIMCO Advisors Fund Management
LLC, Allianz Dresdner Asset
Management of America L.P.
Tim Clark Managing Director
Cindy Columbo Vice President
Patrick Coyne Vice President
Derek Hayes Senior Vice President
Steve Jobe Senior Vice President
Alan Kwan Vice President
John C. Maney Chief Financial Officer Executive Vice President and
Chief Financial Officer,
Allianz Dresdner Asset
Management of America L.P.,
Chief Financial Officer, PIMCO
Advisors Fund Management
LLC, Allianz Dresdner Asset
Management U.S. Equities
LLC, Cadence Capital
Management LLC, NFJ
Investment Group L.P., OCC
Distributors LLC, OpCap
Advisors LLC, Oppenheimer
Capital LLC, Pacific
Investment Management
Company LLC, PIMCO Advisors
Managed Accounts LLC, PIMCO
Advisors CD Distributors
LLC, PIMCO Equity Advisors
LLC, PIMCO Equity Partners
LLC, PIMCO Advisors
Advertising Agency Inc.,
PIMCO Advisors Distributors
LLC, Allianz Private Client
Services LLC, and StocksPLUS
Management Inc. and Value
Advisors LLC
Vinh T. Nguyen Vice President and Vice President and Controller,
Controller PIMCO Advisors Fund Management
LLC, Allianz Dresdner Asset
Management of America L.P.,
Allianz Dresdner Asset
Management U.S. Equities LLC,
Cadence Capital Management
LLC, NFJ Investment Group
L.P., OCC Distributors LLC,
OpCap Advisors LLC,
Oppenheimer Capital LLC,
Pacific Investment Management
Company LLC, PIMCO Advisors
Managed Accounts LLC, PIMCO
Advisors CD Distributors LLC,
PIMCO Equity Advisors LLC,
C-4
PIMCO Equity Partners LLC,
PIMCO Advisors Advertising
Agency Inc., PIMCO Advisors
Distributors LLC, Allianz
Private Client Services LLC,
and StocksPLUS Management Inc.
Francis C. Poli Executive Vice President, Chief Legal and Compliance
Director of Compliance Officer, PIMCO Advisors Fund
and Assistant Secretary Management LLC, Allianz
Dresdner Asset Management of
America L.P., Allianz Dresdner
Asset Management U.S. Equities
LLC, Allianz Hedge Fund
Partners L.P., Allianz Private
Client Services LLC, Cadence
Capital Management LLC, NFJ
Investment Group L.P., OCC
Distributors LLC, OpCap
Advisors LLC, Oppenheimer
Capital LLC, PIMCO Advisors
Retail Holdings LLC, PIMCO
Advisors Managed Accounts LLC,
PIMCO Advisors CD Distributors
LLC, PIMCO Equity Advisors LLC
Bob Rokose Vice President and
Assistant Controller
Newton B. Schott, Jr. Managing Director, Vice President, PIMCO Advisors
Chief Legal Officer Managed Accounts LLC,
and Secretary Executive Vice President,
Chief Legal Officer and
Secretary, PIMCO Advisors
Advertising Agency Inc.,
Managing Director,
Executive Vice President,
General Counsel and Secretary,
PIMCO Advisors Distributors
LLC
Brian S. Shlissel Senior Vice President Senior Vice President and
Treasurer, OpCap Advisors LLC
Stewart A. Smith Vice President and Secretary, PIMCO Advisors Fund
Assistant Secretary Management LLC, Allianz
Dresdner Asset Management of
America L.P., Allianz Dresdner
Asset Management U.S.
Equities LLC, Allianz Hedge
Fund Partners L.P., Allianz
Private Client Services LLC,
Cadence Capital Management
LLC, NFJ Investment Group
L.P., PIMCO Advisors Retail
Holdings LLC, PIMCO Advisors
Managed Accounts LLC, PIMCO
Advisors CD Distributors LLC
and PIMCO Equity Advisors LLC,
Assistant Secretary,
Oppenheimer Capital LLC, OpCap
Advisors and OCC Distributors
LLC
Stephen J. Treadway Managing Director and Chairman, President and Chief
Chief Executive Officer Executive Officer, PIMCO
Advisors Advertising Agency
Inc.; Managing Director and
Chief Executive Officer,
PIMCO Advisors Distributors
LLC, Managing Director,
PIMCO Advisors Managed
Accounts LLC, Allianz
Private Client Services LLC,
Allianz Dresdner Asset
Management of America L.P.,
Member, Board of Management of
Allianz Dresdner Asset
Management GmbH
James G. Ward Executive Vice President Executive Vice President,
and Director of Human Allianz Asset Management of
Resources America L.P., Director of
Human Resources, Allianz Asset
Management U.S. Equities LLC,
PIMCO Advisors Distributors
LLC
C-5
Pacific Investment Management Company LLC
("PIMCO")
840 Newport Center Drive
Newport Beach, CA 92660
Name Business and Other Connections
----------------------------- --------------------------------------------------
Arnold, Tammie J. Executive Vice President, PIMCO
Benz, William R. II Managing Director, Executive Committee Member,
PIMCO
Bhansali, Vineer Executive Vice President, PIMCO
Brynjolfsson, John B. Executive Vice President, PIMCO
Burns, R. Wesley Managing Director, PIMCO; President and Trustee of
PIMCO Funds and PIMCO Variable Insurance Trust;
President and Director of PIMCO Commercial
Mortgage Securities Trust, Inc.; Director, PIMCO
Funds: Global Investors Series plc and PIMCO
Global Advisors (Ireland) Limited
Cupps, Wendy W. Executive Vice President, PIMCO
Dialynas, Chris P. Managing Director, PIMCO
El-Erian, Mohamed A. Managing Director, PIMCO
Gross, William H. Managing Director and Executive Committee Member,
PIMCO; Director and Vice President, StocksPLUS
Management, Inc.; Senior Vice President of PIMCO
Funds and PIMCO Variable Insurance Trust
Hague, John L. Managing Director, PIMCO
Hally, Gordon C. Executive Vice President, PIMCO
Hamalainen, Pasi M. Managing Director, PIMCO
Harris, Brent R. Managing Director and Executive Committee Member,
PIMCO; Director and Vice President, StocksPLUS
Management, Inc.; Trustee and Chairman of PIMCO
Funds and PIMCO Variable Insurance Trust; Director
and Chairman, PIMCO Commercial Mortgage Securities
Trust, Inc.; Managing Director, PIMCO Specialty
Markets LLC
Hinman, David C. Executive Vice President, PIMCO
Hodge, Douglas M. Executive Vice President, PIMCO; Director,
PIMCO JAPAN LTD
Holden, Brent L. Managing Director, PIMCO
Isberg, Margaret E. Managing Director, PIMCO; Senior Vice President of
PIMCO Funds
Keller, James M. Managing Director, PIMCO
Kennedy, Raymond G. Managing Director, PIMCO
Kiesel, Mark Executive Vice President, PIMCO
Loftus, John S. Managing Director, PIMCO; Senior Vice President of
PIMCO Funds; Vice President and Assistant
Secretary, StocksPLUS Management, Inc.
Mariappa, Sudesh N. Executive Vice President, PIMCO
C-6
Mather, Scott A. Executive Vice President, PIMCO; Senior Vice
President, PIMCO Commercial Mortgage Securities
Trust, Inc.
McCray, Mark V. Executive Vice President, PIMCO
McCulley, Paul A. Managing Director, PIMCO
McDevitt, Joseph E. Executive Vice President, PIMCO; Director and
Chief Executive Officer, PIMCO Europe Ltd
Meiling, Dean S. Managing Director, PIMCO
Monson, Kristen S. Executive Vice President, PIMCO
Muzzy, James F. Managing Director, PIMCO; Director and Vice
President, StocksPLUS Management, Inc.; Senior
Vice President, PIMCO Variable Insurance Trust;
Vice President of PIMCO Funds; Director, PIMCO
Europe Ltd., PIMCO JAPAN LTD., PIMCO Asia Pte
Ltd., PIMCO Australia Pty Ltd.
Otterbein, Thomas J. Executive Vice President, PIMCO
Phansalkar, Mohan V. Executive Vice President, Secretary and Chief
Legal Officer, PIMCO; Vice President and
Secretary, StocksPLUS Management, Inc.
Podlich, William F. Managing Director, PIMCO
Powers, William C. Managing Director and Executive Committee Member,
PIMCO; Senior Vice President, PIMCO Commercial
Mortgage Securities Trust, Inc.
Schmider, Ernest L. Managing Director, PIMCO
Simon, W. Scott Executive Vice President, PIMCO
Thomas, Lee R. Managing Director, PIMCO
Thompson, William S. Managing Director and Executive Committee Member,
PIMCO; Director and President, StocksPLUS
Management, Inc.; Senior Vice President of PIMCO
Variable Insurance Trust; Vice President of PIMCO
Funds and PIMCO Commercial Mortgage Securities
Trust, Inc.
Trosky, Benjamin L. Managing Director, PIMCO; Senior Vice President,
PIMCO Commercial Mortgage Securities Trust, Inc.
Weil, Richard M. Managing Director, Chief Operating Officer and
Executive Committee Member, PIMCO
Wood, George H. Executive Vice President, PIMCO
Wyman, Charles C. Executive Vice President, PIMCO
C-7
Item 31: Location of Accounts and Records
The account books and other documents required to be maintained by the
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the Rules thereunder will be maintained at the offices of State Street Bank &
Trust Co., 225 Franklin Street, Boston, MA 02110 and/or PFPC Inc., 400 Bellevue
Parkway, Wilmington, Delaware 19809.
Item 32: Management Services
Not applicable.
Item 33: Undertakings
1. Registrant undertakes to suspend the offering of its Common Shares
until it amends the prospectus filed herewith if (1) subsequent to the effective
date of its registration statement, the net asset value declines more than 10
percent from its net asset value as of the effective date of the registration
statement, or (2) the net asset value increases to an amount greater than its
net proceeds as stated in the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
a. For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and
contained in the form of prospectus filed by the Registrant under Rule
497(h) under the Securities Act of 1933 shall be deemed to be part of this
registration statement as of the time it was declared effective; and
b. For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of the securities at that
time shall be deemed to be the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or other means
designed to ensure equally prompt delivery, within two business days of receipt
of a written or oral request, any Statement of Additional Information.
Notice
A copy of the Agreement and Declaration of Trust of PIMCO Floating Rate
Income Fund (the "Fund"), together with all amendments thereto, is on file with
the Secretary of State of The Commonwealth of Massachusetts, and notice is
hereby given that this instrument is executed on behalf of the Fund by any
officer of the Fund as an officer and not individually and that the obligations
of or arising out of this instrument are not binding upon any of the Trustees of
the Fund or shareholders of the Fund individually, but are binding only upon the
assets and property of the Fund.
C-8
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant has duly caused this Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of New York, and the State of New York on the 22nd day of August, 2003.
PIMCO Floating Rate Income Fund
By: /s/ Brian S. Shlissel
-------------------------------------
Brian S. Shlissel,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
Name Capacity Date
---- -------- ----
/s/ Brian S. Shlissel President, Chief Executive Officer August 22, 2003
----------------------------------
Brian S. Shlissel
Stephen J. Treadway* Chairman and Trustee August 22, 2003
----------------------------------
Stephen J. Treadway
Paul Belica* Trustee August 22, 2003
----------------------------------
Paul Belica
Robert E. Connor* Trustee August 22, 2003
----------------------------------
Robert E. Connor
John J. Dalessandro II* Trustee August 22, 2003
----------------------------------
John J. Dalessandro II
Hans W. Kertess* Trustee August 22, 2003
----------------------------------
Hans W. Kertess
/s/ Lawrence G. Altadonna Treasurer, Principal Financial and August 22, 2003
---------------------------------- Accounting Officer
Lawrence G. Altadonna
*By: /s/ Brian S. Shlissel
---------------------
Brian S. Shlissel
Attorney-In-Fact
Date: August 22, 2003
INDEX TO EXHIBITS
Exhibit Exhibit Name
------- ------------
a.2. Amended and Restated Agreement and Declaration of Trust, dated
August 14, 2003.
b.2 Amended and Restated Bylaws of the Registrant, dated August 14,
2003.
d.3 Form of Share Certificate of the Common Shares.
e. Terms and Conditions of Dividend Reinvestment Plan.
g.1 Investment Management Agreement between Registrant and PIMCO
Advisors Fund Management LLC dated August 19, 2003.
g.2 Form of Portfolio Management Agreement between PIMCO Advisors Fund
Management LLC and Pacific Investment Management Company LLC.
h.1 Form of Purchase Agreement.
h.2 Form of Master Broker-Dealer Agreement.
h.3 Form of Master Agreement Among Underwriters.
h.4 Form of Additional Compensation Agreement between PIMCO Advisors
Fund Management LLC and Merril Lynch, Piere, Fenner & Smith
Incorporated.
j. Form of Custodian and Investment Accounting Agreement between
Registrant and State Street Bank & Trust Co.
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC, Inc.
k.2 Organizational and Offering Expenses Reimbursement Agreement
between Registrant and PIMCO Advisors Fund Management LLC dated
August 19, 2003.
n. Consent of Registrant's independent accountants.
p. Subscription Agreement's of Allianz Dresdner Asset Management of
America L.P. dated August 19, 2003.
r.1 Code of Ethics of Registrant dated August 14, 2003.
r.2 Code of Ethics of PIMCO Advisors Fund Management LLC.
r.3 Code of Ethics of Pacfic Investment Management Company LLC.