As filed with the Securities and Exchange Commission on June 20, 2003
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1933 Act File No. 333-
1940 Act File No. 811-
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[_] Pre-Effective Amendment No.
[_] Post-Effective Amendment No.
and
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[_] Amendment No.
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
------------------------------------ ------------ ------------------ ---------------- -------------------
Common Shares, par value $0.00001 1,000 Shares $ 15.00 $ 15,000 $ 1.22
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/1/ Estimated solely for the purpose of calculating the registration fee.
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, DATED_____, 2003
PROSPECTUS PIMCO LOGO
Shares
PIMCO Floating Rate Income Fund
Common Shares
$15.00 per share
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 secured floating
rate loans. Senior secured loans hold the most senior position in the capital
structure of a borrower and are secured with specific collateral. The Fund may
invest without limit and ordinarily expects to invest a substantial portion of
its assets in senior secured 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.
Because most of the debt instruments held by the Fund will have variable
interest rates, the value of the Fund's portfolio is generally expected to have
less interest rate risk (i.e., sensitivity to fluctuations in market interest
rates) than portfolios of funds that invest in fixed-income securities. For the
same reason, the amounts of the Fund's monthly distributions to common
shareholders are expected to vary.
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 " ."
---------------
Investing in the Fund's common shares involves additional risks. See
"Risks" beginning on page of this prospectus.
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.
------------
1
Per Share Total
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Public Offering Price $ 15.00 $
Sales Load $ 0.675 $
Estimated Offering Expenses (1) $ $
Proceeds to the Fund $ $
(1) 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 $0.03 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) does not exceed
$0.03 per share.
The Underwriters (defined below) expect to deliver the common shares to
purchasers on or about , 2003.
---------------
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 over-allotments.
_________________________________________________, 2003.
2
(continued from previous page)
Portfolio Contents. As noted above, a substantial portion of the Fund's
investment assets will ordinarily consist of senior secured floating rate debt
securities and assignments of senior secured 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
loss 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 bonds, bank capital, 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). As also 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 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 of U.S. issuers 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
collateralized debt obligations, structured notes and other hybrid instruments,
credit-linked trust certificates, preferred shares, commercial paper, U.S.
Government securities, zero-coupon and inflation-indexed bonds, 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 two years. 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 _______ 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.
3
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.
--------------------------------------------------------------------------------
TABLE OF CONTENTS
Page
----
Prospectus Summary.................................................
Summary of Fund Expenses...........................................
The Fund...........................................................
Use of Proceeds....................................................
The Fund's Investment Objective and Strategies.....................
Preferred Shares and Related Leverage..............................
Risks..............................................................
How the Fund Manages Risk..........................................
Management of the Fund.............................................
Net Asset Value....................................................
Distributions......................................................
Dividend Reinvestment Plan.........................................
Description of Shares..............................................
Anti-Takeover and Other Provisions in the Declaration of Trust.....
Repurchase of Common Shares; Conversion to Open-End Fund...........
Tax Matters........................................................
Underwriting.......................................................
Custodian and Transfer Agent.......................................
Legal Matters......................................................
Table of Contents for the Statement of Additional Information......
Appendix A--Description of Securities Ratings......................
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.
4
PROSPECTUS SUMMARY
This is only a summary. 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 $0.00001 per
share, at $15.00 per share through a group of
underwriters (the "Underwriters") led by ___________.
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 $0.03 per 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) does not
exceed $0.03 per share.
Investment Objective Investment Objective. The Fund's investment objective
and Strategies 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 "--Portfolio
Contents" 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 issuers
credit characteristics and the position of the 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 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. 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
5
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
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." 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 senior position in the
borrower's capital structure and security through
specific collateral) in assessing their credit
characteristics. The individuals managing the Fund
utilize this information in an attempt to manage credit
risk and identify issuers, industries or sectors that
are undervalued or 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 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
two-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 interest rate
volatility and related risk while still offering the
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 bonds, bank capital, 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 the portfolio manager to be of comparable
quality. The
6
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 of U.S. issuers 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 collateralized debt obligations,
structured notes and other hybrid instruments,
credit-linked trust certificates, preferred shares,
commercial paper, U.S. Government securities,
zero-coupon and inflation-indexed bonds, real estate
investment trusts, credit default swaps and other
derivative instruments. The Fund may invest in
securities of companies with small market
capitalizations. 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 Subject to market conditions, approximately one to
of Preferred Shares six months after completion of this offering, the Fund
and Other Forms of intends to offer preferred shares of beneficial
Leverage interest ("Preferred Shares") representing
approximately 38% of the Fund's total assets 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 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 slightly
more than [1]%
7
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 of 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 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 ___________% 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 in the
restructuring of a business originally organized in
1987, the Manager provides investment management and
advisory services to several closed-end and open-end
investment company clients. As of March 31, 2003, the
Manager had approximately $17.7 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 March 31, 2003, Allianz
Dresdner Asset Management of America L.P. and its
subsidiary partnerships, including PIMCO, had
approximately $392 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.
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 March 31, 2003,
PIMCO had approximately $323 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 dividends
payable on any Preferred Shares and the expenses of any
other leveraging transactions. Because the Fund invests
primarily in debt securities with variable interest
rates, the amount of the Fund's monthly distributions
to shareholders is expected to vary. 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."
8
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 "____________." See
"Description of Shares--Common Shares."
Custodian and State Street Bank and Trust Co. will serve as custodian
Transfer Agent of the Fund's assets. PFPC Inc. will serve as the
Fund's transfer and dividend disbursement agent. See
"Custodian and Transfer Agent."
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 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.
The following describes various principal risks of
investors 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.
Special Risk No Prior History. The Fund is a newly organized,
Considerations 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 the portfolio manager 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 the Senior
Loans or a general economic downturn, than are the
prices of higher grade securities. Although Senior
Loans in which the Fund will invest will be secured
by specific 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.
However, Senior Loans do generally tend to have more
favorable loss 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 below investment grade debt
securities, PIMCO's capabilities in this area will
be particularly important. See "The Fund's
Investment Objectives 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.
9
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 SEC 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.
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 by the Fund
and immediately following any offering of Preferred
Shares by the costs of that offering paid or reimbursed
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.
Leverage Risk. The Fund presently intends to use
leverage by issuing 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 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 will be
based on short-term rates of return for high quality
short-term debt instruments (which would be
redetermined periodically, pursuant to an auction
process), and that the Fund will invest the net
proceeds of the Preferred Shares offering principally
in Senior Loans and other floating rate debt
instrument in accordance with the Fund's investment
objectives 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
10
. the possibility either that Common Share income will
fall if the Preferred Share dividend rate rises, or
that Common Share income will fluctuate 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
securities 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 monthly
distributions to common shareholders are expected to
vary. 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 securities 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.
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. The types of derivative
instruments the Fund may utilize include, but are not
limited to, options, 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. The Fund will be subject to credit
risk with respect to the counterparties to the Senior
Loans in which the Fund invests as well as 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.
11
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. Rising interest rates
tend to extend the duration of mortgage-related
securities, making them more sensitive to changes in
interest rates, and may reduce the market value of the
securities. In addition, 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.
Foreign (Non-U.S.) Investment Risk. The Fund expects to
invest predominantly in U.S. dollar-denominated debt
securities of U.S. issuers 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. 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 developing or
"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.
Reinvestment Risk. 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 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.
Interest Rate Risk. Generally, when market interest
rates fall, the prices of fixed-rate debt obligations
rise, and vice versa. This interest rate risk is the
risk that the debt
12
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 two-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 net assets (plus any borrowings for
investment purposes) of the Fund may be invested in
income securities with fixed rates of interest,
which may lose value in direct response to market
interest rate increases. The Fund's use of leverage,
as described below, will tend to increase Common
Share interest rate risk. See "Risks--Interest Rate
Risk" for additional information.
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 in the Declaration 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.
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
13
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 2 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) %
Dividend Reinvestment Plan Fees None(1)
Percentage of Net Assets
Attributable to
Common Shares
(assuming the issuance of
Preferred Shares)(2)
------------------------
Annual Expenses
Management Fees+ %
Other Expenses %(3)
Total Annual Expenses %(4)
----------
(1) You will pay brokerage charges if you direct the plan agent to sell your
Common Shares held in a dividend reinvestment account.
(2) 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+ %
Other Expenses %
Total Annual Expenses %(4)
(3) If the Fund offers Preferred Shares, costs of that offering, estimated to be
approximately % 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
Preferred Shares in an amount equal to 38% of the Fund's total assets (after
their issuance), these offering costs are estimated to be approximately $ or
approximately $ per Common Share ( % of the offering price). These offering
costs are not included among the expenses shown in this table.
(4) The Manager has agreed to pay (i) the amount by which the Fund's offering
costs (other than the sales load) exceed $0.03 per share ( % of the offering
price), and (ii) all of the Fund's 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 $0.03 per 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.
+ Although the Fund's management fees are calculated based 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.
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 million 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 $ ,
estimated offering expenses of this offering of $ and the estimated offering
costs of issuing Preferred Shares assuming the Fund issues Preferred Shares
representing 38% of the Fund's total assets
14
(after their issuance) of approximately $ ) 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 % 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 $ $ $ $
----------
(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.
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 over-allotment option in full) after
payment 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 $0.03 per 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) does
not exceed $0.03 per 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. The types of securities
that 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 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. 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
15
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 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.
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
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. The Fund may
invest in issuers of any credit quality (including bonds in the lowest ratings
categories) if PIMCO determines that the particular obligation is undervalued or
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 (which may include 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 "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 senior position in the borrower's capital structure and security through
specific 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 are undervalued or 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
below investment grade securities.
Duration. The average portfolio duration of the Fund will normally be
within a short range (i.e., a zero- to two-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 interest rate volatility and related risk while still
offering the 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,
another commonly used measure of price sensitivity, measures only the time until
final payment is due, whereas duration 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.
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 bonds,
bank capital, 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
16
or private basis. The Fund may make use of collateralized debt obligations,
structured notes and other hybrid instruments, credit-linked trust certificates,
preferred shares, commercial paper, U.S. Government securities, zero-coupon and
inflation-indexed bonds, real estate investment trusts, 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. U.S. dollar-denominated debt securities may include
those issued by foreign corporations or supra-national government agencies. 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.
While 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, the Fund may invest in investment grade
securities. The Fund may invest up to 25% of its total assets in debt
instruments denominated in foreign currencies (of both developed and "emerging
market" countries), 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 market" countries. The Fund also 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 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). Given the current structure of the
markets for loan participations and assignments and Rule 144A securities, the
Fund expects to treat these securities as illiquid, although such securities may
be deemed liquid by PIMCO. 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. Although structured notes and credit default swaps are not necessarily
illiquid, the Manager believes that currently most structured notes and credit
default swaps are 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 a diversified portfolio of floating rate debt instruments unless it
provides shareholders with at least 60 days' written notice of such change.
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
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 Securities
17
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 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, unsecured bank loans, corporate bonds, money market instruments
and certain types of mortgage-backed and other asset-backed securities. The Fund
may also engage in credit spread trades. While floating rate debt instruments
provide a certain degree of protection against rising interest rates, the Fund
will participate in any decline in interest rates as well. 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.
Senior Loans
The Fund will invest substantially in Senior Loans. 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.
Senior Loans include senior secured floating rate loans and institutionally
traded senior secured floating rate debt obligations issued by an asset-backed
pool, 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, and participations in a Senior Loan acquired in
secondary markets. Such 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.
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 the 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.
Assignments and Participations involve credit risk, interest rate risk,
liquidity risk, and the risks of being a lender.
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 the portfolio manager 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 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
18
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.
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. The Fund will not necessarily sell a
security when its rating is reduced below its rating at the time of purchase. As
described above under "--Portfolio Management Strategies--Independent Credit
Analysis," PIMCO does not rely solely on credit ratings, and develops its own
analysis of issuer credit quality. The ratings of a debt security may change
over time. Moody's, S&P 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. 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 and other business entities.
Bonds can be fixed or variable 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 fixed or
variable rate of interest and normally must repay the amount borrowed on or
before maturity. Certain bonds are "perpetual" in that they have no maturity
date. The Fund may also invest in catastrophe or "event-linked" bonds.
Credit Default Swaps
As described under "Preferred Shares and Related Leverage," 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. The Fund will segregate assets in the form
of cash and cash equivalents in an amount equal to the aggregate market value of
the credit default swaps of which it is the seller, marked to market on a daily
basis. The Manager currently considers credit default swaps to be illiquid.
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.
19
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. 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. Other preferred stocks 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. 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.
Although to a lesser extent than with debt obligations, 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.
Convertible securities are investments that provide for a stable stream of
income with generally 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. Convertible securities, however, generally
offer lower interest or dividend yields than non-convertible securities of
similar credit quality because of the potential for capital appreciation. A
convertible security, in addition to providing current income, offers the
potential for capital appreciation through the conversion feature, which enables
the holder to benefit from increases in the market price of the underlying
common stock.
Synthetic convertible securities 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. For this reason, the values of a
synthetic convertible and a true convertible security may respond differently to
market fluctuations.
Bank Obligations
The Fund may 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.
20
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 also may invest up to 25% of its total
assets in debt instruments denominated in foreign currencies (of both developed
and "emerging market" countries), including obligations of non-U.S. governments
and their respective sub-divisions, agencies and government-sponsored
enterprises. 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."
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 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,
including up to 10% of its total assets in debt of developing or "emerging
market" issuers. 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 to add leverage to the portfolio, 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. Examples of derivative instruments that the Fund may use
include options contracts, futures contracts, options on futures contracts and
swap agreements. 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
21
Related Instruments" and "--Credit Default Swaps." 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.
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 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. They may pay fixed or adjustable
rates of interest. 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") 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 credits that are lower than what
the Fund can invest in directly, 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--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.
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.
22
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.
Certain Interest Rate Transactions
The Fund may enter into interest rate swap or cap transactions. Interest
rate swaps involve 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 that is intended to approximate the Fund's variable rate payment
obligation on Preferred Shares. The payment obligation would be based on the
notional amount of the swap. The Fund may use an interest rate cap, which would
require the Fund to pay a premium to the cap 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 or caps for hedging or
general investment purposes. The Fund may choose or be required to redeem some
or all of the Preferred Shares. This redemption would likely result in the Fund
seeking to terminate early all or a portion of any swap or cap transaction. Such
early termination of a swap could result in a termination payment by or to the
Fund. Any termination of a cap could result in a termination payment 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. Structured instruments frequently are assembled in the
form of medium-term notes, but a variety of forms are available and may be used
in particular circumstances. The terms of such structured 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.
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.
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
23
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.
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, provided that the
Fund will not engage in such naked short sales in excess of 5% of the Fund's
total assets and that the Fund will not engage in any such naked short sales
within 90 days from the date of this prospectus.
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.
24
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 in floating rate debt
instruments other debt securities 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 net assets,
including the proceeds from the issuance of Preferred Shares. 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 in excess of [1]% 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.
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 __%, the
income generated by the Fund's portfolio (net of expenses) would have to exceed
__% 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),
a __% yield on the
25
Fund's investment portfolio, net of expenses, and the Fund's currently projected
annual Preferred Share dividend rate of %. See "Risks."
Assumed Portfolio Total Return (10.00)% (5.00)% 0.00% 5.00% 10.00%
Common Share Total Return % % % % %
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. In addition to the issuance of
Preferred Shares, the Fund may use a variety of additional strategies to add
leverage to the portfolio. These include 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. By adding additional leverage, these strategies have the
potential to increase returns to Common Shareholders, but also involve
additional risks. Additional leverage will increase the volatility of the Fund's
investment portfolio and could result in 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 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 Fund securities.
26
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, smaller company risk, management risk, foreign (non-U.S.)
investment risk, emerging markets risk, derivatives risk, counterparty risk,
asset-backed risk, interest rate risk, reinvestment risk, inflation/deflation
risk 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.
Newly Organized
The Fund is a newly organized, diversified, closed-end management
investment company and has no operating history.
High Yield Risk
In general, lower rated debt securities (which may include 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 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. Because of the Fund's
emphasis on below investment grade debt obligations, PIMCO's capabilities in
this area will be particularly important.
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. 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.
Credit Risk
The Fund could lose money if the issuer of a debt obligation, or the
counterparty to a derivatives contract or Senior Loan, 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.
27
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 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.
However, some restricted securities (such as securities issued pursuant to Rule
144A under the Securities Act of 1933 and certain commercial paper) may be
treated as liquid for these purposes. 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.
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
strategies involving Preferred Shares or derivatives 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." The rates
of return on intermediate- and long-term debt obligations are typically,
although not always, higher than the rates of return on short-term debt
obligations. 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. Because the short-term debt securities included in the Fund's
portfolio will typically pay variable rates of interest and the dividend rate on
the Preferred Shares will be likewise adjusted periodically, this will lessen
the probability that this would occur. In addition, 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
28
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. The Fund
will seek to mitigate this risk by segregating assets in the form of cash and
cash equivalents in an amount equal to the aggregate market value of the credit
default swaps of which it is the seller, marked to market on a daily basis.
While the Fund may from time to time consider reducing leverage in response
to actual or anticipated changes in interest rates in an effort to mitigate the
increased volatility of current income and net asset value associated with
leverage, there can be no assurance that the Fund will actually reduce leverage
in the future or that any reduction, if undertaken, will benefit the Common
Shareholders. Changes in the future direction of interest rates are very
difficult to predict accurately. If the Fund were to reduce leverage based on a
prediction about future changes to interest rates, and that prediction turned
out to be incorrect, the reduction in leverage would likely operate to reduce
the income and/or total returns to Common Shareholders relative to the
circumstance if the Fund had not reduced leverage. The Fund may decide that this
risk outweighs the likelihood of achieving the desired reduction to volatility
in income and Common Share price if the prediction were to turn out to be
correct, and determine not to reduce leverage as described above.
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 income-producing securities 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. 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
income-producing securities 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 also may invest up to 25% of its total assets in debt instruments
denominated in foreign currencies (of both developed and "emerging market"
countries), 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.
29
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
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 developing or "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. The Fund may invest up to 10% of its total assets in securities
(regardless of the currency in which such securities are denominated) of issuers
based in developing or "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.
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. 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, credit risk, leveraging risk, the risk of ambiguous
documentation, 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 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
The Fund will be subject to credit risk with respect to the counterparties
to the derivative contracts and Senior Loans purchased by the Fund. If a
counterparty becomes bankrupt or otherwise fails to perform its obligations
under a derivative contract due to financial difficulties, the Fund may
experience significant delays in obtaining any recovery under the derivative
contract in a bankruptcy or other reorganization proceeding. The Fund may obtain
only a limited recovery or may obtain no recovery in such circumstances.
Defaulted Senior Loans have a more favorable rate of recovery than other types
of defaulted loans.
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. Rising
interest rates tend to extend the duration of mortgage-related securities,
making
30
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. In addition,
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.
Interest Rate Risk
Interest rate risk is the risk that debt obligations (and the Fund's total
assets) will decline in value because of changes in interest rates. Generally,
debt securities will decrease in value when interest rates rise and increase in
value when interest rates decline. This means that the net asset value of the
Common Shares will fluctuate with interest rate changes and the corresponding
changes in the value of the Fund's holdings. The prices of long-term debt
obligations generally fluctuate more than prices of short-term debt obligations
as interest rates change. Because the Fund will normally have a short portfolio
duration (i.e., a zero- to two-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 adjustable rates on floating rate debt
instruments typically only reset periodically, 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 net
assets (plus any borrowings for investment purposes) of the Fund may be invested
in income securities with fixed rates of interest, which may lose value in
direct response to market interest rate increases. 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.
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.
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 and duration of the war and occupation, and the
political costs of rebuilding the Iraqi infrastructure and political systems
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
31
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.
32
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. For the purpose of this restriction, each state and each separate
political subdivision, agency, authority or instrumentality of such state,
each multi-state agency or authority, and each obligor, if any, is treated
as a separate issuer of municipal bonds.
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, Inc. 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. It also gives the Fund flexibility to utilize
other forms of leverage in addition to Preferred Shares from time to time in
accordance with the 1940 Act asset coverage requirements (such as reverse
repurchase agreements, credit default swaps and other derivatives) that may be
more efficient or cost effective sources of leverage than Preferred Shares under
the circumstances. 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.
Management of Investment Portfolio and Capital Structure to Limit Leverage Risk
The Fund may take certain actions if short-term interest rates increase or
market conditions otherwise change (or the Fund anticipates such an increase or
change) and the Fund's leverage begins (or is expected) to adversely affect
33
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 above 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 interest rate exposure 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, or utilize other forms of
leverage, such as credit default swaps and other derivative instruments. 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 interest rate changes. 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.
34
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
are currently three Trustees of the Fund, none of whom is currently 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.
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 in the restructuring of a
business originally organized in 1987, the Manager provides investment
management and advisory services to several closed-end and open-end investment
company clients. As of March 31, 2003, the Manager had approximately $17.7
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 March 31, 2003, Allianz
Dresdner Asset Management of America L.P. and its subsidiary partnerships,
including PIMCO, had approximately $392 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 March 31, 2003, PIMCO had approximately $323 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, at the maximum annual rate of % of the
Fund's average weekly total managed assets (including assets attributable to any
Preferred Shares and other forms of leverage that may be outstanding).
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:
35
Name Since Recent Professional Experience
----------------------- ----------- ----------------------------------------
Raymond G. Kennedy, CFA 2003 Mr. Kennedy is a Managing Director,
(Inception) portfolio manager 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
(Inception) President and portfolio 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
(Inception) portfolio manager. 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. Mr. Rosiak joined
the firm 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 experience and holds a
bachelor's degree in Economics from the
University of California, Los Angeles
and a master's degree in Business
Administration from the Marshall School
of Business at the University of
Southern California.
Mr. Kennedy oversees David Hinman and Jason Rosiak regarding the management
of the Fund.
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 ___% 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.
36
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.
37
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 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 certain 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.
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 dividends payable on the Preferred
Shares and the expenses of any other leveraging transactions. Because the
majority of the Fund's debt securities will have variable interest rates, the
monthly dividends payable to shareholders are also expected to vary. As
portfolio and market conditions change, the rate of dividends on the Common
Shares will change. 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 monthly distribution, the Fund
will initially distribute less than the entire amount of net investment income
earned in a particular period. The undistributed net investment income would be
available to supplement future distributions. As a result, the distributions
paid by the Fund for any particular monthly period may be more or less than the
amount of net investment income actually earned by the Fund during the period.
Undistributed net investment income will be added to the Fund's net asset value
and, correspondingly, distributions from undistributed net investment income
will be deducted from the Fund's net asset value. 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."
38
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 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:
(1) 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
(2) 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.
39
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 $0.00001 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 $0.03 per 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)
does not exceed $0.03 per 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
like the Fund that invest predominantly in debt obligations 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 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.
40
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 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.
41
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.
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.
42
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 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.
43
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 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. Any gain resulting from the sale or exchange of
Fund shares generally will be taxable as capital gains.
44
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.
45
UNDERWRITING
are acting as representatives of the Underwriters named below. Subject to
the terms and conditions stated in the Fund's underwriting agreement dated
__________, 2003, each Underwriter named below 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
---------------------------------- -------------
-------------
Total
-------------
The underwriting agreement provides that the obligations of the
Underwriters to purchase the Common Shares included in this offering are subject
to approval of legal matters by counsel and to other conditions. The
Underwriters are obligated to purchase all the Common Shares (other than those
covered by the over-allotment option described below) if they purchase any of
the Common Shares.
The Underwriters propose to 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 dealers at the public offering price
less a concession not to exceed $_____ per Common Share. The sales load the Fund
will pay of $_____ per Common Share is equal to _____% of the initial
offering price. The Underwriters may allow, and such dealers may reallow, a
concession not to exceed $ per Common Share on sales to certain other dealers.
If all of the Common Shares are not sold at the initial offering price, the
representatives may change the public offering price and other selling terms.
Investors must pay for any Common Shares purchased on or before _____, 2003.
The representatives have advised the Fund that the Underwriters do not intend to
confirm any sales to any accounts over which they exercise discretionary
authority.
The Fund has granted to the Underwriters an option, exercisable for 45 days
from the date of this prospectus, to purchase up to __________ additional Common
Shares at the public offering price less the sales load. The Underwriters may
exercise such option solely for the purpose of covering over-allotments, if any,
in connection with this offering. To the extent such option is exercised, each
Underwriter will be obligated, subject to certain conditions, to purchase a
number of additional Common Shares approximately proportionate to such
Underwriter's initial purchase commitment.
The Fund and the Manager have agreed that, for a period of 180 days from
the date of this prospectus, they will not, without the prior written consent of
__________, on behalf of the Underwriters, dispose of or hedge any Common
Shares or any securities convertible into or exchangeable for Common Shares.
__________ in its sole discretion may release any of the securities subject to
these agreements at any time without notice.
Prior to the offering, there has been no public market for the Common
Shares. Consequently, the initial public offering price for the Common Shares
was determined by negotiation among the Fund, the Manager and the
representatives. There can be no assurance, however, that the price at which the
Common Shares will sell in the public market after this offering will not be
lower than the price at which they are sold by the Underwriters or that an
active trading market in the Common Shares will develop and continue after this
offering. The Common Shares are expected to be listed on the New York Stock
Exchange, subject to notice of issuance.
The Fund and the Manager have each agreed to indemnify the several
Underwriters or contribute to losses arising out of certain liabilities,
including liabilities under the Securities Act of 1933, as amended.
The Manager has agreed to pay (i) the amount by which the Fund's offering
costs (other than the sales load) exceed $0.03 per 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)
does not exceed $0.03 per share.
In addition, the Fund has agreed to reimburse the Underwriters for certain
expenses incurred by the Underwriters in the offering.
46
In connection with the requirements for listing the Common Shares on the
New York Stock Exchange, the Underwriters have undertaken to sell lots of 100 or
more Common Shares to a minimum of ________ beneficial owners in the United
States. The minimum investment requirement is 100 Common Shares.
Certain Underwriters may make a market in the Common Shares after trading
in the Common Shares has commenced on the New York Stock Exchange. No
Underwriter is, however, obligated to conduct market-making activities and any
such activities may be discontinued at any time without notice, at the sole
discretion of the Underwriter. No assurance can be given as to the liquidity of,
or the trading market for, the Common Shares as a result of any market-making
activities undertaken by any Underwriter. This prospectus is to be used by any
Underwriter in connection with the offering and, during the period in which a
prospectus must be delivered, with offers and sales of the Common Shares in
market-making transactions in the over-the-counter market at negotiated prices
related to prevailing market prices at the time of the sale.
The Underwriters have advised the Fund that, pursuant to Regulation M under
the Securities Exchange Act of 1934, as amended, certain persons participating
in the offering may engage in transactions, including stabilizing bids, covering
transactions or the imposition of penalty bids, which may have the effect of
stabilizing or maintaining the market price of the Common Shares at a level
above that which might otherwise prevail in the open market. A "stabilizing bid"
is a bid for or the purchase of the Common Shares on behalf of an Underwriter
for the purpose of fixing or maintaining the price of the Common Shares. A
"covering transaction" is a bid for or purchase of the Common Shares on behalf
of an Underwriter to reduce a short position incurred by the Underwriters in
connection with the offering. A "penalty bid" is a contractual arrangement
whereby if, during a specified period after the issuance of the Common Shares,
the Underwriters purchase Common Shares in the open market for the account of
the underwriting syndicate and the Common Shares purchased can be traced to a
particular Underwriter or member of the selling group, the underwriting
syndicate may require the Underwriter or selling group member in question to
purchase the Common Shares in question at the cost price to the syndicate or may
recover from (or decline to pay to) the Underwriter or selling group member in
question any or all compensation (including, with respect to a representative,
the applicable syndicate management fee) applicable to the Common Shares in
question. As a result, an Underwriter or selling group member and, in turn,
brokers may lose the fees that they otherwise would have earned from a sale of
the Common Shares if their customer resells the Common Shares while the penalty
bid is in effect. The Underwriters are not required to engage in any of these
activities, and any such activities, if commenced, may be discontinued at any
time. These transactions may be effected on the New York Stock Exchange or
otherwise.
The underwriting agreement provides that it may be terminated in the
absolute discretion of the representatives, without liability on the part of any
Underwriter to the Fund or the Manager, by notice to the Fund or the Manager if,
prior to the delivery of and payment for the Common Shares, (i) trading in the
Common Shares shall have been suspended by the Securities and Exchange
Commission or the New York Stock Exchange or trading in securities generally on
the New York Stock Exchange shall have been suspended or limited or minimum
prices for trading in securities generally shall have been established on such
exchange, (ii) a commercial banking moratorium shall have been declared by
either federal or New York state authorities, or (iii) there shall have occurred
any outbreak or escalation of hostilities, declaration by the United States of a
national emergency or war, or other calamity or crisis the effect of which on
financial markets in the United States is such as to make it, in the
representatives' sole judgment, impracticable or inadvisable to proceed with the
offering or delivery of the Common Shares as contemplated by this prospectus
(exclusive of any supplement hereto).
The Fund anticipates that from time to time the representatives of the
Underwriters and certain other Underwriters may act as brokers or dealers in
connection with the execution of the Fund's portfolio transactions after they
have ceased to be Underwriters and, subject to certain restrictions, may act as
brokers while they are Underwriters.
Prior to the public offering of Common Shares, an affiliate of the Manager
will purchase Common Shares from the Fund in an amount satisfying the net worth
requirements of Section 14(a) of the 1940 Act.
The principal business address of __________ is __________.
47
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 __________.
48
TABLE OF CONTENTS FOR THE STATEMENT OF ADDITIONAL INFORMATION
Use of Proceeds
Investment Objective and Policies
Investment Restrictions
Management of the Fund
Investment Manager and Portfolio Manager
Portfolio Transactions
Distributions
Description of Shares
Anti-Takeover and Other Provisions in the Declaration of Trust
Repurchase of Common Shares; Conversion to Open-End Fund
Tax Matters
Performance Related and Comparative Information
Custodian, Transfer Agent and Dividend Disbursement Agent
Independent Accountants
Counsel
Registration Statement
Report of Independent Accountants
Financial Statements
Appendix A - Performance Related and Comparative and Other Information A-1
49
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.
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.
50
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 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.
51
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 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
52
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.
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.
53
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.
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
54
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.
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
55
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.
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.
56
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.
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.
57
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 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.
58
--------------------------------------------------------------------------------
Shares
PIMCO Floating Rate Income Fund
Common Shares
-------------
PROSPECTUS
____, 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.
1
TABLE OF CONTENTS
USE OF PROCEEDS................................................................3
INVESTMENT OBJECTIVE AND POLICIES..............................................3
INVESTMENT RESTRICTIONS.......................................................48
MANAGEMENT OF THE FUND........................................................50
INVESTMENT MANAGER AND PORTFOLIO MANAGER......................................59
PORTFOLIO TRANSACTIONS........................................................63
DISTRIBUTIONS.................................................................65
DESCRIPTION OF SHARES.........................................................66
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST................69
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND......................71
TAX MATTERS...................................................................73
PERFORMANCE RELATED AND COMPARATIVE INFORMATION...............................80
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT.....................81
INDEPENDENT ACCOUNTANTS.......................................................81
COUNSEL.......................................................................81
REGISTRATION STATEMENT........................................................81
REPORT OF INDEPENDENT ACCOUNTANTS.............................................83
FINANCIAL STATEMENTS..........................................................84
APPENDIX A - Performance Related, Comparative and Other Information..........A-1
APPENDIX B - Description of Proxy Voting Policies............................B-1
This Statement of Additional Information is dated ______, 2003.
2
USE OF PROCEEDS
The net proceeds of the offering of Common Shares of the Fund will be
approximately $______ (or $______ if the Underwriters exercise the
over-allotment 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 $0.03 per 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)
does not exceed $0.03 per 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 PIMCO 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.
High Yield Securities ("Junk Bonds")
As described under "The Fund's Investment Objective and Strategies" in the
Prospectus, under normal market conditions, the Fund will normally invest up to
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 secured floating rate loans ("Senior Loans"). Senior
secured loans hold the most senior position in the capital structure of a
borrower and are secured with specific collateral. 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 Pacific Investment Management Company LLC
("PIMCO"), the Fund's portfolio manager, 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 the portfolio manager to be of
comparable quality.
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
3
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 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. 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 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.
4
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. However, analysis of creditworthiness may be more complex for issuers
of high yield securities than for issuers of higher quality debt securities.
Corporate Bonds
The Fund may invest in a variety of bonds and related debt obligations of
varying maturities 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 fixed or variable rate of interest and
normally must repay the amount borrowed on or before maturity. Certain bonds are
"perpetual" in that they have no maturity date.
The Fund's investments in corporate bonds are subject to a number of risks
described in the Prospectus and elaborated upon elsewhere in this section of the
Statement of Additional Information, including interest rate risk, credit risk,
high yield risk, issuer risk, foreign (non-U.S.) investment risk, inflation
risk, liquidity risk, smaller company risk and management risk.
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 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.
PIMCO currently considers credit default swaps to be illiquid.
5
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.
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. As described below, the Fund may invest in preferred stocks that
pay fixed or adjustable rates of return. 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.
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.
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
6
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.
Convertible Securities and Synthetic Convertible Securities
The Fund may invest in convertible securities, which are bonds, debentures,
notes or other securities that entitle the holder to acquire common stock or
other equity securities of the same or a different issuer. Convertible
securities have general characteristics similar to both debt and equity
securities. PIMCO will generally evaluate these instruments based on their debt
characteristics.
A convertible security generally entitles the holder to receive interest
paid or accrued until the convertible security matures or is redeemed, converted
or exchanged. Before conversion, convertible securities have characteristics
similar to non-convertible debt obligations. Convertible securities rank senior
to common stock in a corporation's capital structure and, therefore, generally
entail less risk than the corporation's common stock, although the extent to
which such risk is reduced depends in large measure upon the degree to which the
convertible security sells above its value as a debt obligation.
Because of the conversion feature, the price of the convertible security
will normally fluctuate in some proportion to changes in the price of the
underlying asset, and will therefore be subject to risks relating to the
activities of the issuer and/or general market and economic conditions. The
income component of convertible securities may tend to cushion the securities
against declines in the price of the underlying asset. However, the income
component of convertible securities will typically cause fluctuations based upon
changes in interest rates and the credit quality of the issuer. In addition,
convertible securities are often lower-rated securities. See "--High Yield
Securities ("Junk Bonds") above.
A convertible security may be subject to redemption at the option of the
issuer at a predetermined price. If a convertible security held by the Fund is
called for redemption, the Fund would be required to permit the issuer to redeem
the security and convert it to underlying common stock, or would sell the
convertible security to a third party, which may have an adverse effect on the
Fund's ability to achieve its investment objective.
The Fund may invest in so-called "synthetic convertible securities," which
are composed of two or more different securities whose investment
characteristics, taken together, resemble
7
those of convertible securities. For example, the Fund may purchase a
non-convertible debt security and a warrant or option. The synthetic convertible
security differs from the true convertible security in several respects. Unlike
a true convertible security, which is a single security having a unitary market
value, a synthetic convertible security 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 convertible component. For this reason, the values of a synthetic
convertible security and a true convertible security may respond differently to
market fluctuations.
Investments in Equity Securities
The Fund may have exposure to equity securities. The Fund may hold equity
securities in its portfolio upon conversion of a convertible security or through
direct investment in preferred stocks. Although equity securities have
historically generated higher average returns than debt securities, equity
securities have also experienced significantly more volatility in those returns.
An adverse event, such as an unfavorable earnings report, may depress the value
of a particular equity security held by the Fund. Also, the price of an equity
security, particularly a common stock, is sensitive to general movements in the
stock market. A drop in the stock market may depress the price of equity
securities held by the Fund.
Bank Obligations
Bank obligations in which the Fund may invest include 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 that earn 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 (of both developed and "emerging market"
countries), 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, including
the possibilities that their liquidity could be impaired because of future
political and economic developments, that their obligations may be less
marketable than comparable obligations of U.S. banks, that a foreign
jurisdiction might impose withholding taxes on interest income payable on those
obligations, that foreign deposits may be seized or nationalized, that foreign
governmental restrictions such as exchange controls may be
8
adopted which might adversely affect the payment of principal and interest on
those obligations and that the selection of those obligations may be more
difficult because there may be less publicly available information concerning
foreign banks or the accounting, auditing and financial reporting standards,
practices and requirements applicable to foreign banks may differ from those
applicable to U.S. banks. Foreign banks are not generally subject to examination
by any U.S. Government agency or instrumentality.
Loan Assignments and Participations
The Fund will invest substantially in Senior Loans. 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.
Senior Loans include senior secured floating rate loans and institutionally
traded senior secured floating rate debt obligations issued by an asset-backed
pool, 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, and participations in a Senior Loan acquired in
secondary markets. The Fund will invest only to a limited extent in
participations. 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.
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 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. Given the current structure of the markets for loan participations and
assignments, the Fund expects to generally treat these securities as illiquid.
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 corporate
borrower, the Fund may have to rely on the agent bank or other financial
intermediary to apply appropriate credit remedies against a corporate borrower.
A financial institution's employment as agent bank might be terminated in
the event that it fails to observe a requisite standard of care or becomes
insolvent. A successor agent bank would generally be appointed to replace the
terminated agent bank, and assets held by the agent bank under the loan
agreement should remain available to holders of such indebtedness. However, if
assets held by the agent bank for the benefit of the Fund were determined to be
subject to the claims of the agent bank'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
9
and/or interest. In situations involving other interposed financial institutions
(e.g., an insurance company or government agency) similar risks may arise.
Purchasers of loans and other forms of direct indebtedness depend primarily
upon the creditworthiness of the corporate 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. 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
loan would satisfy the corporate borrower's obligation, or that the collateral
can be liquidated.
The Fund may invest in loan participations with credit quality comparable
to that of issuers of its 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 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 corporate borrower, if the
participation does not shift to the Fund the direct debtor-creditor relationship
with the corporate borrower, SEC interpretations require the Fund to treat both
the lending bank or other lending institution and the corporate 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, and could result in significant variations in the Fund's daily share
price. At the same time, some loan interests are traded among certain financial
institutions and accordingly may be deemed liquid. For these purposes, PIMCO
will generally not consider Senior Loans that are part of an issue of at least
$250 million in par value to be illiquid. As the market for different types of
indebtedness develops, the liquidity of these instruments is expected to
improve. In addition, the Fund currently intends to treat indebtedness for which
there is no readily available market as 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
10
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 relies on PIMCO's research in an attempt to avoid
situations where fraud or misrepresentations could adversely affect the Fund.
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.
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
11
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.
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 mortgage REITs) are also subject to interest rate risks.
When interest rates decline, the value of a REIT's investment in fixed rate
obligations can be expected to rise. Conversely, when interest rates rise, the
value of a REIT's investment in fixed rate obligations can be expected to
decline. If the REIT invests in adjustable rate mortgage loans the interest
rates on which are reset periodically, yields on a REIT's investments in such
loans will gradually align themselves to reflect changes in market interest
rates. This causes the value of such investments to fluctuate less dramatically
in response to interest rate fluctuations than would investments in fixed rate
obligations.
REITs may have limited financial resources, may trade less frequently and
in a limited volume and may be subject to more abrupt or erratic price movements
than larger company securities. Historically REITs have been more volatile in
price than the larger capitalization stocks included in Standard & Poor's 500
Stock Index.
Foreign (Non-U.S.) Securities
The Fund may invest in 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 also invest up to 25% of its total assets in securities
denominated in foreign currencies of developed and "emerging markets" countries.
Foreign (non-U.S.) issuers include obligations of non-U.S. governments and their
respective sub-divisions, agencies and government-sponsored enterprises.
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
12
regulation of financial markets and institutions; the imposition of foreign
withholding taxes; and the expropriation or nationalization of foreign issuers.
The Fund may also 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 also 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
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
13
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 tied to "emerging" securities markets. An issuer is considered to be
economically tied to an emerging market country if its securities are
principally traded on the country's securities markets, or the issuer is
organized or principally operates in the country, derives a majority of its
income from its operations within the country, or has a majority of its assets
located in the country. PIMCO has broad discretion to identify and invest in
countries that it considers to qualify as emerging securities markets, but
generally considers an emerging securities 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. PIMCO
will emphasize emerging market countries with relatively low gross national
product per capita and with the potential for rapid economic growth. PIMCO will
select the Fund's country and currency composition based on its evaluation of
relative interest rates, inflation rates, exchange rates, monetary and fiscal
policies, trade and current account balances, and any other factors PIMCO
believes to be relevant. 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 market countries; the fact that companies in
emerging
14
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.
15
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. [The Fund normally will seek to hedge at least 75% of its exposure
to foreign currencies in order to reduce the risk of loss due to fluctuations in
currency exchange rates.] 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. Open positions in forwards used for non-hedging purposes will be
covered by the segregation with the Fund's custodian of assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees, and are marked to market daily. 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.
16
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 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
17
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 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.
18
Derivative Instruments
In pursuing its investment objective, the Fund may purchase and sell
(write) both put options and call options on securities, swap agreements, and
securities indexes, and enter into interest rate and index futures contracts and
purchase and sell options on such futures contracts ("futures options") for
hedging or risk management purposes or as part of its overall investment
strategy. The Fund also may enter into total return swaps, credit default swaps,
and other swap agreements with respect to interest rates, currencies, securities
indexes and other assets and measures of risk or return. 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 the Trustees determine that their use is consistent
with the Fund's investment objective. For these purposes, "hedging purposes"
shall include the use of a derivative instrument to cause the Fund to more
closely resemble the [CSFB Leverage Loan Index] with respect to credit quality,
average portfolio duration, and/or average portfolio yield-to-maturity.
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
19
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 will write call options and put options only if they are
"covered." 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.
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
20
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 covered straddles 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.
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
21
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
interest rate futures contracts and options thereon ("futures options"). The
Fund may also purchase and sell futures contracts on 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 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
22
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 covered straddles 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 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."
23
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,
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.
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 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.
24
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.
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
25
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 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,
26
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 use
swap agreements to add leverage to the portfolio. The Fund, except with regard
to credit default swaps, as described below, 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.
Certain Interest Rate Transactions. As described above, the Fund may enter
into interest rate swaps and caps. Interest rate swaps involve 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 that may be structured
so as to approximate the Fund's variable rate payment obligation on any
preferred shares of beneficial interest that the Fund may issue (the "Preferred
Shares") or any variable rate borrowing. The payment obligation would be based
on the notional amount of the swap. The Fund may use an interest rate cap, which
would require the Fund to pay a premium to the cap counterparty and would
entitle the Fund, to the extent that a specified variable rate index exceeds a
predetermined fixed rate, to receive from the
27
counterparty payment of the difference based on the notional amount. The Fund
may use interest rate swaps or caps with the intent to reduce or eliminate the
risk that an increase in short-term interest rates could have on the performance
of the Common Shares as a result of the Fund's investments and capital
structure, and may also use these instruments for other hedging purposes.
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 such 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.
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.
The value of some mortgage-related or asset-backed securities in which the Fund
may invest may be particularly sensitive to changes in prevailing interest
rates, and, 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 interest rates and other 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.
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 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 sale of the
28
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 debt obligations, when interest rates rise, the value of a
mortgage-related security generally will decline; however, when interest rates
are declining, the value of mortgage-related securities with prepayment features
may not increase as much as other debt obligations. 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, 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
29
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.
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
30
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.
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.
31
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 or 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"
and subject to the Fund's limitations on investment in illiquid securities. As
used in this Statement of Additional 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
ReceivablesSM ("CARSSM") and Collateralized Debt Obligations ("CDOs").
32
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 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.
33
In addition to the normal risks associated with fixed income securities
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.
Floating Rate Debt Instruments
As described under "The Fund's Investment Objective and Strategies" in the
Prospectus, under normal market conditions, the Fund will invest up to 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
ordinarily consist of senior secured debt securities and assignments of Senior
Loans made to or issued by U.S. or non-U.S. banks or other corporations.
Additional Information About Senior Loans.
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
34
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 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 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 and, if the value
of the 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, the Fund will perform such tasks on its own behalf,
although a collateral bank will typically hold any collateral on behalf of the
Trust 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
35
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.
Other Information Regarding Senior Loans. 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.
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.
To the extent that collateral 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 collateral. In addition, the Trust 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;
provided, however, that such guarantees are fully secured. 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 Senior Loan. On
occasions when such stock cannot be pledged, the 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 the 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 Senior Loans.
36
If a Borrower becomes involved in bankruptcy proceedings, a court may
invalidate the Fund's security interest in the loan collateral or subordinate
the Fund's rights under the 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 Senior Loans made in connection with a highly leveraged
transaction, consideration for granting a security interest may be deemed
inadequate if the proceeds of the 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 loan
collateral. If the Fund's security interest in loan collateral is invalidated or
the 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 Loan.
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
37
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 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.
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 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.
38
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). To the extent that the Fund
is committed to advance additional funds, it will at all times segregate assets,
determined to be liquid by PIMCO in accordance with procedures established by
the Board of Trustees, in an amount sufficient to meet such commitments.
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. The Fund currently intends to treat delayed funding loans and
revolving credit facilities for which there is no readily available market as
illiquid for purposes of the Fund's limitation on illiquid investments. For a
further discussion of the risks involved in investing in loan participations and
other forms of direct indebtedness see "--Loan Participations and Assignments."
Participation interests in revolving credit facilities will be subject to the
limitations discussed in "--Loan Participations and Assignments." 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.
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 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; for example, by reducing the
duration of the Fund's portfolio, structured notes may limit the Fund's return
when having a longer duration would be beneficial (for instance, when interest
rates decline). Although structured instruments are not necessarily illiquid,
PIMCO believes that currently most structured instruments are illiquid.
39
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 fixed rate or floating 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 Investment Company Act of
1940, as amended (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.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements and economically
similar transactions in order to add leverage to the portfolio 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.
40
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.
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 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.
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.
41
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 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 Bonds ("RIBS"), which are
created by dividing the income stream provided by an underlying bond 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 goes to the long-term securities. Therefore, rising
short-term interest rates result in lower income for the longer-term portion,
and vice versa. An investment in RIBS typically will involve greater risk than
an investment in a fixed rate bond. RIBS have interest rates that bear an
inverse relationship to the interest rate on another security or the value of an
index. 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. The longer-term bonds can be very
volatile and may be less liquid than other Municipal Bonds of comparable
maturity. These securities will generally 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. To the extent
42
permitted by the Fund's investment objective and general investment policies,
the Fund, without limitation, may invest in RIBS.
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. 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.
43
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, 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. To mitigate leverage risk from such
transactions, the Fund will segregate liquid assets against or otherwise cover
its future obligations under such transactions, to the extent that, immediately
after entering into such a transaction, the Fund's future commitments that it
has not segregated liquid assets against or otherwise covered, together with any
outstanding Preferred Shares, would exceed 38% of the Fund's total assets. The
Fund's use of these transactions may also be limited by the Fund's limitations
on illiquid investments to the extent they are determined to be illiquid. See
"The Fund's Investment Objective and Strategies--Portfolio Contents and Other
Information," "Risks--Liquidity Risk" and "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.
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
44
borrowings. Furthermore, because dollar roll transactions may be for terms
ranging between one and six months, dollar roll transactions may be deemed
"illiquid."
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 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, provided that the Fund will not engage in such
naked short sales in excess of 5% of the Fund's total assets and that the Fund
will not engage in any such naked short sales within 90 days from the date of
the Prospectus.
Illiquid Securities
The Fund may invest without limit in illiquid securities (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). Because Senior Loans
may be of below investment grade quality and are subject to contractual
restrictions on resale they may be illiquid securities, which may impair the
Fund's ability to realize the full value of its assets in the event of a
voluntary or involuntary liquidation of such assets. PIMCO will generally not
consider Senior Loans that are part of an issue of at least $250 million in par
value to be illiquid.
45
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 relation to actual and anticipated movements in interest rates.
In addition, a security may be sold and another of comparable quality purchased
at approximately the same time to take advantage of what 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
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
46
at the favorable rate or to sell the warrants at a profit. If interest rates
rise, the warrants would generally expire with no value.
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 acquir e 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 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. Such investments may prevent the Fund from
achieving its investment objective.
47
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. For the purpose of this restriction, each state
and each separate political subdivision, agency, authority or
instrumentality of such state, each multi-state agency or authority, and
each obligor, if any, is treated as a separate issuer of municipal bonds.
(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.
(5) Borrow money or issue any senior security, except to the extent
permitted under the Investment Company Act of 1940, 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 Investment
Company Act of 1940, 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
48
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.
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).
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.
49
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 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
Position(s) Office and Complex Other
Held with Length of Principal Occupation(s) Overseen Directorships
Name, Address and Age Fund Time Served During the Past 5 Years by Trustee Held by Trustee
[ ] [ ] [ ] [ ] [ ] [ ]
Robert E. Connor* Trustee Since Trustee, Fixed Income 17 None.
Age 68 inception SHares,
( 2003). Nicholas-Applegate
Convertible & Income
Fund, PIMCO Corporate
50
Number of
Portfolios
Term of in Fund
Position(s) Office and Complex Other
Held with Length of Principal Occupation(s) Overseen Directorships
Name, Address and Age Fund Time Served During the Past 5 Years by Trustee Held by Trustee
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
and PIMCO High Income
Fund, [PIMCO Diversified
Income Fund]; 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 II** Trustee Since President and Director, 14 None.
Age 65 inception J.J. Dalessandro II Ltd.,
( 2003). registered broker-dealer
and member of the New
York Stock Exchange;
Trustee,
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
51
Number of
Portfolios
Term of in Fund
Position(s) Office and Complex Other
Held with Length of Principal Occupation(s) Overseen Directorships
Name, Address and Age Fund Time Served During the Past 5 Years by Trustee Held by Trustee
Fund III, PIMCO California
Municipal Income Fund III,
PIMCO New York Municipal
Income Fund III; PIMCO
Diversified Income Fund
and PIMCO High Income
Fund.
----------
* 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 does not effect portfolio transactions for entities other than
other members of the Exchange.
Interested Trustees
-------------------
Currently no Trustees are treated as "interested persons" (as defined in
Section 2(a)(19) of the 1940 Act) of the Fund.
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 Trustee 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
--------
Term of Office
Position(s) and Length of
Name, Address and Age Held with Fund Time Served Principal Occupation(s) During the Past 5 Years
Stephen J. Treadway Chairman Since Managing Director, Allianz Dresdner Asset Management
2187 Atlantic Street inception of America L.P.; Managing Director and Chief
Stamford, CT 06902 ( 2003). Executive Officer, PIMCO Advisors Fund Management
Age 55 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,
52
Term of Office
Position(s) and Length of
Name, Address and Age Held with Fund Time Served Principal Occupation(s) During the Past 5 Years
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, PIMCO High Income Fund [and PIMCO Diversified
Income Fund.].
Brian S. Shlissel President Since Senior Vice President, PIMCO Advisors Fund
Age 38 and Chief inception Management LLC; Executive Vice President and
Executive ( 2003). Treasurer, OCC Accumulation Trust; President and
Officer Chief Executive Officer, Fixed Income 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, Municipal Advantage Fund,
Inc., PIMCO High Income Fund [and PIMCO Diversified
Income Fund;] [Trustee, President and Chief Executive
Officer, PIMCO Nicholas-Applegate Convertible & Income
Fund II;]Formerly, Vice President, Mitchell Hutchins
Asset Management Inc.
Lawrence G. Altadonna Treasurer; Since Vice President, PIMCO Advisors Fund Management LLC;
Age 36 Principal inception Treasurer and Principal Financial and Accounting
Financial ( 2003). Officer, Nicholas-Applegate Convertible & Income Fund,
and Nicholas-Applegate Convertible & Income Fund II, PIMCO
Accounting Corporate Opportunity Fund, PIMCO Corporate Income
Officer 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., PIMCO High Income Fund [and PIMCO Diversified
Income Fund;] Treasurer,
53
Term of Office
Position(s) and Length of
Name, Address and Age Held with Fund Time Served Principal Occupation(s) During the Past 5 Years
Fixed Income SHares; Assistant Treasurer, OCC
Accumulation Trust. Formerly, Director of Fund
Administration, Prudential Investments.
Newton B. Schott, Jr. Vice Since Managing Director, Chief Administrative Officer,
2187 Atlantic Street President, inception Secretary and General Counsel, PAD; Managing Director,
Stamford, CT 06902 Secretary ( 2003). Chief Legal Officer and Secretary, PIMCO Advisors Fund
Age 60 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., PIMCO High Income Fund [and PIMCO Diversified
Income Fund]; Secretary, Fixed Income SHares.
54
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.
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,
approves all significant services proposed to be performed by those accountants
on behalf of the Fund, and considers other services provided by those
accountants to the Fund, the Manager and PIMCO and the possible effect of those
services on the independence of those accountants. Messrs. [ ] 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. [ ] 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. [ ] and Connor, each of whom is an
Independent Trustee, serve on this committee.
Compensation Committee
----------------------
The Compensation Committee periodically reviews and sets compensation
payable to the 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
55
PIMCO. Messrs. [ ] 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 Trustee
Name of Trustee Securities in the Fund in Family of Investment Companies
[ ] [ ] [ ]
Robert E. Connor None. None.
John J. Dalessandro II None. None.
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 Value of Percent of
Name of Trustee Relationships to Trustee Company Title of Class Securities Class
[ ] TO BE PROVIDED
Robert E. Connor
John J. Dalessandro II
As of ______, 2003, the Fund's officers and Trustees as a group owned less
than 1% of the outstanding Common Shares.
As of ______, 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.
56
Number of Percentage of the
Common Fund's outstanding
Shareholder Shares shares as of, 2003
--------------------------------------- --------- ------------------
Allianz Dresdner Asset Management of
America L.P. [ ] [ ]
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, PIMCO Corporate Opportunity Fund, PIMCO High Income
and PIMCO Corporate Income Fund, [thirteen] 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.
In addition to the Fund, the Municipal Funds, Nicholas-Applegate Convertible &
Income Fund, PIMCO Corporate Opportunity Fund, PIMCO High Income Fund and PIMCO
Corporate Income 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. 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, [PIMCO Diversified
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 $[ ] for each joint meeting for the
first four joint meetings in each year and $[ ] for each additional joint
meeting in such year if the meetings are attended in person. Trustees receive
$[ ] per joint meeting if the meetings are attended telephonically. Members of
the Audit Oversight Committee will receive $[500] per joint meeting of the PIMCO
Closed-End Funds' Audit Oversight Committees if the meeting takes place on a day
other than the day of a regularly scheduled Board meeting. Trustees will also be
reimbursed for meeting-related expenses.
57
The PIMCO Closed-End Funds will allocate the Trustees' compensation and
other costs of their joint meetings pro rata based on each PIMCO Closed-End
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 ____________,
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 ___________, 2004* December 31, 2002**
---------------------- ---------------------- --------------------------
[ ] $ [ ] $ [ ]
Robert E. Connor $ [ ] $ 87,170
John J. Dalessandro II $ [ ] $ 76,400
----------
* 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. 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
58
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 in the restructuring 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 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 March 31, 2003, the Manager had approximately $17.7 billion in
assets under management. As of March 31, 2003, ADAM of America and its
subsidiary partnerships had approximately $392 billion in assets under
management.
59
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 PIMCO. (Broker-dealer affiliates of such significant institutional
shareholders are sometimes 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
60
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 _________% 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 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.
61
Under the Portfolio Management Agreement, the Manager (and not the Fund)
pays a portion of the fees it receives from the Fund to PIMCO in return for
PIMCO's services, at the annual rate of _______% of the Fund's average weekly
total managed assets.
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 March 31, 2003, PIMCO had
approximately $323 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 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
62
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 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.
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
63
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.
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
64
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.
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. The Fund will initially, and may 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.
65
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."
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 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.
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 that invest predominantly in below investment-grade debt obligations 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. Net
asset value generally increases when interest rates decline, and decreases when
interest rates rise, and these changes are likely to be greater in the case of a
fund, such as the Fund, having a leveraged capital structure. Whether investors
will realize gains or
66
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 three months after completion of 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
67
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 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
68
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.
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
69
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 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,
70
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 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
71
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.
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.
72
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.
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
73
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. 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 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.
74
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 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. 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 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 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
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
75
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.
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 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.
Capital Loss Carryover. Distributions from capital gains are generally made
after applying any available capital loss carryovers.
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
76
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. 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 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
77
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 (and
interest paid on debt obligations, 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. This may affect the cash flow of 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.
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 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. Under current law, if a charitable remainder trust
(defined in section 664 of the Code) realizes any unrelated business taxable
income for a taxable year, it will lose its tax-exempt status for the year. The
Bush Administration has proposed imposing a 100% tax on a charitable remainder
trust's unrelated business income in lieu of removing the trust's income tax
exemption. 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 in REITS in which a substantial portion of the assets will
consist of 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
78
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 (i) a dividend to the extent of the
Fund's remaining earnings and profits (including earnings and profits arising
from tax-exempt income), (ii) thereafter, as a return of capital to the extent
of the recipient's basis in its shares, and (iii) thereafter, as gain from the
sale or exchange of a capital asset. 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 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. 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
79
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.
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
80
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.
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 ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036, serves as independent accountants 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
81
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.
82
REPORT OF INDEPENDENT ACCOUNTANTS
[TO BE PROVIDED]
83
FINANCIAL STATEMENTS
PIMCO FLOATING RATE INCOME FUND
STATEMENT OF NET ASSETS
__________, 2003
[TO BE PROVIDED]
84
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 objectives 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.
[ADDITIONAL INFORMATION TO BE PROVIDED]
A-1
APPENDIX B
DESCRIPTION OF PROXY VOTING POLICIES
[TO BE PROVIDED]
A-1
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 will be filed as part of the
Statement of Additional Information.
2. Exhibits:
a. Agreement and Declaration of Trust dated June 19, 2003, filed herewith.
b. Bylaws of Registrant dated charges June 19, 2003, filed herewith.
c. None.
d.1 Article III (Shares) and Article V (Shareholders' Voting Powers and
Meetings) of the Agreement and Declaration of Trust, filed herewith as
part of Exhibit a.
d.2 Article 10 (Shareholders' Voting Powers and Meetings) of the Bylaws of
Registrant, filed herewith as part of Exhibit b.
d.3 Form of Share Certificate of the Common Shares.*
e. Terms and Conditions of Dividend Reinvestment Plan.*
f. None.
g.1 Form of Investment Management Agreement between Registrant and PIMCO
Advisors Fund Management LLC.*
g.2 Form of Portfolio Management Agreement between PIMCO Advisors Fund
Management LLC and Pacific Investment Management Company LLC.*
h.1 Form of Underwriting Agreement.*
h.2 Form of Master Selected Dealer Agreement.*
h.3 Form of Master Agreement Among Underwriters.*
h.4 Form of Additional Compensation Agreement.*
i. None.
j. Form of Custodian Agreement between Registrant and State Street Bank &
Trust Co.*
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc.*
C-1
k.2 Form of Organizational and Offering Expenses Reimbursement Agreement
between Registrant and PIMCO Advisors Fund Management LLC.*
l. Opinion and consent of Ropes & Gray LLP.*
m. None.
n. Consent of Registrant's independent accountants.*
o. None.
p. Subscription Agreement of Allianz Dresdner Asset Management of America
L.P. dated _________ 2003.*
q. None.
r.1 Code of Ethics of Registrant dated ________ 2003.*
r.2 Code of Ethics of PIMCO Advisors Fund Management LLC.*
r.3 Code of Ethics of Pacific Investment Management Company LLC.*
--------------------------
* To be filed by amendment.
C-2
Item 25: Marketing Arrangements
To be filed by amendment.
Item 26: Other Expenses of Issuance and Distribution
Securities and Exchange Commission Fees $ *
National Association of Securities Dealers, Inc. Fees *
Printing and engraving expenses *
Legal fees *
New York Stock Exchange listing fees *
Accounting expenses *
Transfer Agent fees *
Marketing expenses *
Miscellaneous expenses *
---------
Total *
* To be completed by amendment. Expenses may be reduced pursuant to an
expected contractual arrangement of PIMCO Advisors Fund Management
LLC to pay (i) the amount by which the Fund's offering costs (other
than the sales load) exceed $0.03 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) does not
exceed $0.03 per share.
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At June 20, 2003
Number of
Title of Class Record Holders
-------------- --------------
Common Shares, par value $0.00001 0
Item 29: Indemnification
Reference is made to Article VIII, Sections 1 through 4, of the
Registrant's Agreement and Declaration of Trust, which is incorporated by
reference herein.
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
Agreement and Declaration of Trust, its 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, Suite 300
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 20th day
of June, 2003.
PIMCO Floating Rate Income Fund
/s/ Brian S. Shlissel
By: ---------------------------------
Brian S. Shlissel,
President
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 Trustee and President June 20, 2003
---------------------------------
Brian S. Shlissel
/s/ Lawrence Altadonna Treasurer and Principal June 20, 2003
--------------------------------- Financial and Accounting
Lawrence Altadonna Officer
INDEX TO EXHIBITS
Exhibit Exhibit Name
------- ------------
a. Agreement and Declaration of Trust dated June 19, 2003.
b. Bylaws of Registrant dated June 19, 2003.