STATEMENT
OF ADDITIONAL INFORMATION
VIRTUS
NEWFLEET MULTI-SECTOR BOND ETF
(Ticker:
NFLT)
February
28, 2020
a
series of
ETFis
Series Trust I
1540
Broadway
New
York, NY 10036
Telephone:
(888) 383-0553
TABLE
OF CONTENTS
This
Statement of Additional Information (“SAI”) is meant to be read in conjunction with the prospectus (“Prospectus”)
for the Virtus Newfleet Multi-Sector Bond ETF (Ticker: NFLT) (the “Fund”), a series of ETFis Series Trust I
(the “Trust”), dated the same date as this SAI, which incorporates this SAI by reference in its entirety. Because
this SAI is not itself a prospectus, no investment in shares of the Fund should be made solely upon the information contained
herein. Copies of the Prospectus for the Fund may be obtained at no charge by writing or calling the Fund at the address or phone
number shown above. Capitalized terms used but not defined herein have the same meanings as in the Prospectus. No person has been
authorized to give any information or to make any representations other than those contained in this SAI and the Prospectus, and,
if given or made, such information or representations may not be relied upon as having been authorized by the Trust. The SAI does
not constitute an offer to sell securities.
Portions
of the Fund’s financial statements are incorporated into this SAI by reference to the Fund’s most recent annual report
to shareholders. You may obtain a copy of the Fund’s annual report at no charge by request to the Fund at the address or
phone number noted below.
A
copy of the Prospectus for the Fund may be obtained, without charge, by calling (888) 383-0553 or visiting www.virtusetfs.com,
or writing to the Trust, c/o VP Distributors, LLC, One Financial Plaza, Hartford, CT 06103.
GENERAL
DESCRIPTION OF THE TRUST AND THE FUND
The
Trust was organized as a Delaware statutory trust on September 20, 2012 and is registered with the Securities and Exchange Commission
(the “SEC”) as an open-end management investment company under the Investment Company Act of 1940 (the “1940
Act”). The Trust currently consists of 10 investment portfolios: InfraCap MLP ETF (Ticker: AMZA); InfraCap REIT Preferred
ETF (Ticker: PFFR); Virtus InfraCap U.S. Preferred Stock ETF (Ticker: PFFA); Virtus LifeSci Biotech Clinical Trials ETF (Ticker:
BBC); Virtus LifeSci Biotech Products ETF (Ticker: BBP); Virtus Newfleet Multi-Sector Bond ETF (Ticker: NFLT); Virtus Private
Credit Strategy ETF (Ticker: VPC); Virtus Real Asset Income ETF (Ticker: VRAI); Virtus Reaves Utilities ETF (Ticker: UTES); and
Virtus WMC Global Factor Opportunities ETF (Ticker: VGFO). Other portfolios may be added to the Trust in the future. The Fund
is classified as a diversified management investment company under the 1940 Act. The shares of the Fund are referred to herein
as “Fund Shares” or “Shares”. The offering of Shares is registered under the Securities
Act of 1933, as amended (the “Securities Act”).
The
Fund’s investment adviser is Virtus ETF Advisers LLC (the “Adviser”). The Adviser has been registered
as an investment adviser with the SEC since October 2013. The Fund’s sub-adviser is Newfleet Asset Management, LLC (the
“Sub-Adviser”), an affiliate of the Adviser.
The
Fund offers and issues Shares at net asset value (the “NAV”) only in aggregations of a specified number of
Shares (each, a “Creation Unit”), generally in exchange for cash or a basket of equity securities included
in the Fund’s portfolio (the “Deposit Securities”), together with the deposit of a specified cash payment
(the “Cash Component”). Shares are generally redeemable only in Creation Units and, generally, in exchange
for Deposit Securities and a Cash Component. Creation Units are aggregations of 50,000 Shares of the Fund and are available only
to certain large institutions, referred to as “Authorized Participants”, that enter into agreements with VP
Distributors, LLC (the “Distributor”). In the event of the liquidation of the Fund, the Trust may lower the
number of Shares in a Creation Unit.
FUND
NAME AND INVESTMENT POLICY. The Fund has a name that suggests a focus on a particular type of investment. In accordance with
Rule 35d-1 under the 1940 Act, the Fund has adopted a policy that it will, under normal circumstances, invest at least 80% of
its assets in bonds (the “Names Rule Policy”). For this Names Rule Policy, “assets” means net assets
plus the amount of any borrowings for investment purposes. In addition, in appropriate circumstances, synthetic investments may
be included in the 80% basket of the Names Rule Policy if they have economic characteristics similar to the other investments
included in the basket. To the extent sufficient information is reasonably available, the Fund will also consider the holdings
of any ETF in which it invests when determining compliance with the Fund's Names Rule Policy. The Fund’s Names Rule Policy
to invest at least 80% of its assets in such a manner is not a “fundamental” policy, which means that it may be changed
without a vote of a majority of the Fund’s outstanding shares as defined in the 1940 Act. However, under Rule 35d-1, shareholders
must be given notice at least 60 days prior to any change by the Fund of its Names Rule Policy.
EXCHANGE LISTING AND TRADING
Fund
Shares trade on the NYSE Arca, Inc. (the “Exchange”) at market prices that may be below, at or above NAV. There
can be no assurance that the requirements of the Exchange necessary for the Fund to maintain the listing of its Shares will continue
to be met. The Exchange will consider the suspension of trading and delisting of the Shares of the Fund if (i) following the initial
12-month period beginning upon the commencement of trading of Fund Shares, there are fewer than 50 beneficial owners of Shares
of the Fund, (ii) the intra-day NAV of the Fund is no longer calculated or available, or (iii) any other event occurs or condition
exists that, in the opinion of the Exchange, makes further dealings on the Exchange inadvisable. The Exchange will remove the
Shares of the Fund from listing and trading upon termination of the Fund.
As
in the case of other stocks traded on the Exchange, brokers’ commissions on transactions will be based on negotiated commission
rates at customary levels.
The
Trust reserves the right to adjust the price levels of the Shares in the future to maintain convenient trading ranges for investors.
Any adjustments would be accomplished through stock splits or reverse stock splits, which would have no effect on the net assets
of the Fund.
OTHER INVESTMENT POLICIES
The
following policies supplement the Fund’s investment objective and policies as described in the Prospectus for the Fund.
GENERAL
INVESTMENT RISKS. All investments in securities and other financial instruments involve a risk of financial loss. No assurance
can be given that the Fund’s investment program will be successful. Investors should carefully review the descriptions of
the Fund’s investments and its risks in this SAI and the Prospectus.
CONVERTIBLE
SECURITIES. In addition to common and preferred stocks, the Fund may invest directly or indirectly in securities convertible
into common stock if, for example, the Sub-Adviser believes that a company’s convertible securities are undervalued in the
market. Convertible securities eligible for purchase by the Fund include convertible bonds, convertible preferred stocks and warrants.
Convertible securities are subject to risks associated with the performance of the company underlying the securities, as well
as the underlying instruments.
DERIVATIVE
INSTRUMENTS. A derivative is a financial instrument whose value is dependent upon the value of other assets, rates or indices.
The Fund will comply with and adhere to all limitations on the manner and extent to which it effects transactions in derivative
instruments (including, without limitation, futures and options on such futures) imposed by the provisions of the 1940 Act applicable
to the issuance of senior securities. Additionally, the Trust, on behalf of the Fund, has claimed an exclusion from the definition
of the term “commodity pool operator” pursuant to Rule 4.5 under the Commodity Exchange Act, as amended (the “CEA”).
Therefore, the Fund is not subject to regulation or registration as a commodity pool operator under the CEA.
Recent
legal and regulatory changes, and additional legal and regulatory changes in the future, may substantially affect over-the-counter
derivatives markets, and such changes may impact the Fund’s use of such instruments. In particular, the Dodd-Frank Wall
Street Reform and Consumer Protection Act, enacted in July 2010, provides for new regulation of the derivatives market, including
clearing, margin, reporting and registration requirements. Because the legislation leaves much to rule making, its ultimate impact
remains unclear. New regulations could, among other things, restrict the Fund’s ability to engage in derivatives transactions
(for example, by making certain types of derivatives transactions no longer available to the Fund) and/or increase the costs of
such derivatives transactions (for example, by increasing margin or capital requirements), and the Fund may be unable to execute
its investment strategy as a result. It is unclear how the regulatory changes will affect counterparty risk.
Options.
An option is a contract that gives the purchaser the option, in return for the premium paid, the right, but not the obligation,
to buy from or sell to the writer of the option at the exercise price during the term of the option or on a specific date, the
security, currency, or other instrument underlying the option. The Fund may write call and put options on securities, ETFs or
security indexes to seek income or may purchase or write put or call options for hedging purposes. Options may either be listed
on an exchange or traded in over-the-counter markets.
Although not required to do so, the Fund will typically write a call option only if the
option is “covered” by the Fund holding a position in the underlying securities or by other means which would permit
immediate satisfaction of the Fund’s obligation as writer of the option. The purchase and writing of options involves certain
risks. During the option period, a 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 securities 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 securities 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, in the case of a put, remains equal to or greater than
the exercise price or, in the case of a call, remains less than or equal to the exercise price, the Fund will lose its entire
investment in the option. There can be no assurance that a liquid market will exist when the Fund seeks to close out an option
position. Furthermore, if trading restrictions or suspensions are imposed on the options market, the Fund may be unable to close
out a position.
Futures
Contracts. A futures contract is a bilateral agreement to buy or sell a security (or deliver a cash settlement price, in the
case of a contract relating to an index or otherwise not calling for physical delivery at the end of trading in the contracts)
for a set price in the future. Futures contracts are designated by boards of trade that have been designated “contracts
markets” by the Commodity Futures Trading Commission (“CFTC”). No purchase price is paid or received
when the contract is entered into. Instead, the Fund, upon entering into a futures contract (and to maintain the Fund’s
open positions in futures contracts), would be required to deposit with its custodian in a segregated account in the name of the
futures commission merchant (“FCM”) an amount of cash, U.S. government securities, suitable money market instruments
or liquid, high-grade fixed income securities, known as “initial margin”. The margin required for a particular futures
contract is set by the exchange on which the contract is traded, and may be significantly modified from time to time by the exchange
during the term of the contract. Futures contracts are customarily purchased and sold on margin that may range upward from less
than 5% of the value of the contract being traded. By using futures contracts as a risk management technique, given the greater
liquidity in the futures market than in the cash market, it may be possible to accomplish certain results more quickly and with
lower transaction costs.
If
the price of an open futures contract changes (by increase in the case of a sale or by decrease in the case of a purchase) so
that the loss on the futures contract reaches a point at which the margin on deposit does not satisfy margin requirements, the
FCM will require an increase in the margin. However, if the value of a position increases because of favorable price changes in
the futures contract so that the margin deposit exceeds the required margin, the FCM will pay the excess to the Fund. These subsequent
payments, called “variation margin,” to and from the FCM, are made on a daily basis as the price of the underlying
assets fluctuate, making the long and short positions in the futures contract more or less valuable, a process known as “marking
to market”. When the futures contract is
closed
out, if the Fund has a loss equal to or greater than the margin amount, then the margin amount is paid to the FCM along with any
loss in excess of the margin amount. If the Fund has a loss of less than the margin amount, the excess margin is returned to the
Fund. If the Fund has a gain, then the full margin amount and the amount of the gain are paid to the Fund and the FCM pays the
Fund any excess gain over the margin amount.
There
is a risk of loss by the Fund of the initial and variation margin deposits in the event of bankruptcy of the FCM with which the
Fund has an open position in a futures contract. The assets of the Fund may not be fully protected in the event of the bankruptcy
of the FCM or central counterparty because the Fund might be limited to recovering only a pro rata share of all available funds
and margin segregated on behalf of an FCM’s customers. If the FCM does not provide accurate reporting, the Fund is also
subject to the risk that the FCM could use the Fund’s assets, which are held in an omnibus account with assets belonging
to the FCM’s other customers, to satisfy its own financial obligations or the payment obligations of another customer to
the central counterparty.
The
Fund will incur brokerage fees when it purchases and sell futures contracts, and margin deposits must be maintained at all times
when a futures contract is outstanding. Positions taken in the futures markets are not normally held until delivery or cash settlement
is required, but are instead liquidated through offsetting transactions which may result in a gain or a loss. There can be no
assurance, however, that the Fund will be able to enter into an offsetting transaction with respect to a particular futures contract
at a particular time. If the Fund is not able to enter into an offsetting transaction, it will continue to be required to maintain
the margin deposits on the futures contract.
While
futures positions taken by the Fund will usually be liquidated in this manner, the Fund may instead make or take delivery of underlying
securities whenever it appears economically advantageous for the Fund to do so. A clearing organization associated with the exchange
on which futures are traded assumes responsibility for closing out transactions and guarantees that, as between the clearing members
of an exchange, the sale and purchase obligations will be performed with regard to all positions that remain open at the termination
of the contract. If the Fund were unable to liquidate a futures contract or an option on a futures contract position due to the
absence of a liquid secondary market or the imposition of price limits, it could incur substantial losses. The Fund would continue
to be subject to market risk with respect to the position. In addition, except in the case of purchased options, the Fund would
continue to be required to make daily variation margin payments.
Securities
Index Futures Contracts. Purchases or sales of securities index futures contracts may be used in an attempt to protect the
Fund’s current or intended investments from broad fluctuations in securities prices. A securities index futures contract
does not require the physical delivery of securities, but merely provides for profits and losses resulting from changes in the
market value of the contract to be credited or debited at the close of each trading day to the respective accounts of the parties
to the contract. On the contract’s expiration date, a final cash settlement occurs, and the futures positions are simply
closed out. Changes in the market value of a particular index futures contract reflect changes in the specified index of securities
on which the future is based.
By
establishing an appropriate “short” position in an index future, the Fund may also seek to protect the value of its
portfolio against an overall decline in the market for the securities on which the future is based. Alternatively, in anticipation
of a generally rising market, the Fund can seek to avoid losing the benefit of apparently low current prices by establishing a
“long” position in securities index futures and later liquidating that position as particular securities are in fact
acquired. To the extent that these hedging strategies are successful, the Fund will be affected to a lesser degree by adverse
overall market price movements than would otherwise be the case.
Limitations
on Purchase and Sale of Futures Contracts. Futures can be volatile instruments and involve certain risks. If the Sub-Adviser
applies a hedge in the Fund’s portfolio at an inappropriate time or judges market movements incorrectly, futures strategies
may lower the Fund’s return. The Fund could also experience losses if the prices of its futures positions were poorly correlated
with its other investments, or if it could not close out its positions because of an illiquid market.
In
general, the Fund will not purchase or sell futures contracts unless either (i) the futures contracts are purchased for “bona
fide hedging” purposes (as defined under the CFTC regulations); or (ii) if purchased for other purposes, (A) the sum of
the amounts of initial margin deposits and premiums required to establish such positions on the Fund’s existing futures
would not exceed 5% of the liquidation value of the Fund’s portfolio or (B) the aggregate net notional value of commodity
futures, commodity options contracts, or swaps positions determined at the time the most recent position was established does
not exceed 100% of the liquidation value of the Fund’s portfolio, after taking into account unrealized profits and unrealized
losses on any such positions it has entered into.
In
instances involving the purchase of futures contracts, the Fund will deposit in a segregated account with its custodian an amount
of cash, cash equivalents and/or appropriate securities equal to the cost of such futures contracts, to the extent that such deposits
are required under the 1940 Act.
Additional
Information Regarding Leverage. Certain derivatives involve leverage; that is, the amount invested may be less than the full
economic exposure of the derivative instrument, and the Fund could lose more than the amount invested. Federal securities laws,
regulations and guidance may require the Fund to segregate assets or to otherwise hold instruments that offset the Fund’s
current obligations under the derivative instrument. This process is known as “cover.” The Fund will not enter into
any derivative transaction unless it can comply with guidance from the SEC regarding cover, and, if SEC guidance so requires,
the Fund will segregate cash or liquid assets with a value at least sufficient to cover its current obligations under the derivative
transaction or otherwise “cover” the transaction in accordance with applicable SEC guidance. If a large portion of
the Fund’s assets is used for cover, it could affect portfolio management or the Fund’s ability to meet redemption
requests or other current obligations. The leverage involved in certain derivative transactions may result in the Fund’s
NAV being more sensitive to changes in the value of the related investment. To the extent the Fund writes put and call options,
the Fund will “cover” its obligations in accordance with applicable SEC guidance.
EQUITY
SECURITIES.
Direct
and Indirect Common Stock. The Fund may invest in equity securities, both directly and indirectly through investments in shares
of ETFs and other investment companies, American Depositary Receipts (“ADRs”) and other types of securities
and instruments described in this SAI and in the Prospectus. The equity portion of the Fund’s portfolio may include common
stocks traded on domestic or foreign securities exchanges or on the over-the-counter market. In addition to common stocks, the
equity portion of the Fund’s portfolio may also include preferred stocks, convertible preferred stocks, convertible bonds
and other equity securities. Prices of equity securities in which the Fund may invest may fluctuate in response to many factors,
including, but not limited to, the activities of the individual companies whose securities the Fund owns, general market and economic
conditions, interest rates and specific industry changes. Such price fluctuations subject the Fund to potential losses. In addition,
regardless of any one company’s particular prospects, a declining stock market may produce a decline in prices for all equity
securities, which could also result in losses for the Fund. Market declines may continue for an indefinite period of time, and
investors should understand that during temporary or extended bear markets, the value of equity securities will decline.
Exchange-Traded
Products (“ETPs”). The Fund may invest in (or sell short) exchange-traded funds (“ETFs”), exchange-traded
notes (“ETNs”) and other ETPs. The shares of an ETF may be assembled in a block (typically 50,000 shares) known
as a creation unit and redeemed in kind for a portfolio of the underlying securities (based on the ETF’s NAV) together with
a cash payment generally equal to accumulated dividends as of the date of redemption. Conversely, a creation unit may be purchased
from the ETF by depositing a specified portfolio of the ETF’s underlying securities, as well as a cash payment generally
equal to accumulated dividends of the securities (net of expenses) up to the time of deposit. The Fund’s ability to redeem
creation units may be limited by the 1940 Act, which provides that the ETFs will not be obligated to redeem shares held by the
Fund in an amount exceeding one percent of their total outstanding securities during any period of less than 30 days. ETPs other
than ETFs are issued in shares or units, and trade on exchanges like ETFs.
There
is a risk that the underlying ETPs in which the Fund invests may terminate due to extraordinary events that may cause any of the
service providers to the ETPs, such as the trustees or sponsors, to close or otherwise fail to perform their obligations to the
ETPs. Also, because the ETPs in which the Fund invests may be granted licenses by agreement to use various indices as a basis
for determining their compositions and/or otherwise to use certain trade names, the ETPs may terminate if such license agreements
are terminated. In addition, an ETP may terminate if its net assets fall below a certain amount. Although the Fund believes that,
in the event of the termination of an underlying ETP, it will be able to invest instead in shares of an alternate ETP with a similar
strategy, there is no guarantee that shares of an alternate ETP would be available for investment at that time.
Investments
in ETPs involve certain inherent risks generally associated with investments in conventional registered investment companies (e.g.,
mutual funds) that hold a portfolio of securities including, without limitation: (1) risks that the general level of security
prices for the ETP’s investment strategy may decline, thereby adversely affecting the value of each share or unit of the
ETP; (2) an index-based ETP may not fully replicate the performance of its benchmark index because of the temporary unavailability
of certain index securities in the secondary market or discrepancies between the ETP and the index with respect to the weighting
of securities or number of stocks held; and (3) an index-based ETP may also be adversely affected by the performance of the specific
index, market sector or group of industries on which it is based.
In
addition, ETPs are subject to the following risks that do not apply to conventional funds: (1) the market price of an ETP’s
shares may trade at a discount to its NAV; (2) an active trading market for an ETP’s shares may not develop or be maintained;
(3) trading of an ETP’s shares may be halted if the listing exchange deems such action appropriate; and (4) ETP shares may
be delisted from the exchange on which they trade, or activation of “circuit breakers” (which are tied to large decreases
in stock prices) may halt trading temporarily. ETPs are also subject to the risks of the underlying securities or sectors in which
the ETP is designed to track or invest.
Investments
in Companies with Business Related to Commodities. The Fund may from time to time invest in securities of companies whose
business is related to commodities, or in registered investment companies or other companies that invest directly or
indirectly
in commodities. For example, the Fund may invest in companies whose business is related to mining of precious or other metals
(e.g., gold, silver, etc.) or registered investment companies or publicly or privately traded companies that invest in securities
of mining companies and related instruments (including, without limitation, the underlying commodities). Investments in equity
securities of companies involved in mining or related precious metals industries, and the value of the investment companies and
other companies that invest in precious metals and other commodities are subject to a number of risks. For example, the prices
of precious metals or other commodities can make sharp movement, up or down, in response to cyclical economic conditions, political
events or the monetary policies of various countries, any of which may adversely affect the value of companies whose business
is related to such commodities, or the value of investment companies and other companies investing in such business or commodities.
Furthermore, such companies are subject to risks related to fluctuations of prices and perceptions of value in commodities markets
generally.
Money
Market Funds. In order to maintain sufficient liquidity, to implement investment strategies or for temporary defensive purposes,
the Fund may invest a significant portion of its assets in shares of one or more money market funds. Generally, money market funds
are registered investment companies that seek to earn income consistent with the preservation of capital and maintenance of liquidity
by investing primarily in high quality money market instruments, including, without limitation, U.S. government obligations, bank
obligations and high-grade corporate instruments. An investment in a money market fund is not insured or guaranteed by the Federal
Deposit Insurance Company or any other governmental agency, entity or person. While investor losses in money market funds have
been rare, they are possible. In addition, the Fund will incur additional indirect expenses to the extent it invests in shares
of money market funds due to acquired fund fees and other costs.
Other
Investment Companies. Under the 1940 Act, the Fund may not acquire shares of another investment company (ETFs or other investment
companies) if, immediately after such acquisition, the Fund and its affiliated persons would hold more than 3% of the ETF’s
or investment company’s total outstanding stock (“3% Limitation”). Accordingly, the Fund is subject to
the 3% Limitation unless (i) the ETF or the Fund has received an order for exemptive relief from the 3% Limitation from the SEC
that is applicable to the Fund; and (ii) the ETF and the Fund take appropriate steps to comply with any conditions in such order.
The SEC has issued such exemptive orders to numerous ETFs and their investment advisers, which permit investment companies to
invest in such ETFs (“Exempted ETFs”) beyond the 3% Limitation, subject to certain terms and conditions, including,
without limitation, that such investment companies enter into an agreement with the Exempted ETF.
To
the extent the 3% Limitation applies to certain ETFs, that limitation may prevent the Fund from allocating its investments in
the manner that the Sub-Adviser considers optimal, or cause the Sub-Adviser to select a similar basket of stocks (pre-selected
groups of securities related by index or sector made available through certain brokers at a discount brokerage rate) (“Stock
Baskets”) or a similar index-based mutual fund or other investment company as an alternative. The Fund’s investments
in other investment companies will be subject to the same 3% Limitation described above.
Under
the 1940 Act, to the extent that the Fund relies upon Section 12(d)(1)(F) in purchasing securities issued by another investment
company, the Fund must either seek instructions from its shareholders with regard to the voting of all proxies with respect to
its investment in such securities (ETFs and other investment companies) and vote such proxies only in accordance with the instructions,
or vote the shares held by it in the same proportion as the vote of all other holders of the securities. In the event that there
is a vote of ETF or other investment company shares held by the Fund, the Fund intends to vote such shares in the same proportion
as the vote of all other holders of such securities.
Preferred
Stock. Preferred stocks are securities that represent an ownership interest providing the holder with claims on the issuer’s
earnings and assets before common stock owners but after bond owners. Unlike debt securities, the obligations of an issuer of
preferred stock, including, without limitation, dividend and other payment obligations, may not typically be accelerated by the
holders of such preferred stock on the occurrence of an event of default or other non-compliance by the issuer of the preferred
stock. Preferred stocks may include the obligation to pay a stated dividend. The price of preferred stocks could depend more on
the size of the dividend than on the company’s performance. If a company fails to pay the dividend, its preferred stock
is likely to drop in price. Changes in interest rates can also affect the price of preferred stock.
Real
Estate Securities. The Fund will not invest directly in real estate, but may invest in readily marketable securities issued
by companies that invest in real estate or interests therein. The Fund may also invest in readily marketable interests issued
by real estate investment trusts (“REITs”). REITs are generally publicly traded on national stock exchanges
and in the over-the-counter market and have varying degrees of liquidity. Investments in real estate securities are subject to
risks inherent in the real estate market, including, without limitation, risks related to changes in interest rates, possible
declines in the value of and demand for real estate, adverse general and local economic conditions, possible lack of availability
of mortgage funds, overbuilding in a given market and environmental problems.
The
Fund may invest in global real estate companies outside the U.S. These companies include, but are not limited to, companies with
similar characteristics to a REIT structure, in which revenue consists primarily of rent derived from owned, income producing
real estate properties, dividend distributions as a percentage of taxable net income are high (generally greater than 80%), debt
levels are generally conservative and income derived from development activities is generally limited.
Warrants
and Rights. Warrants are essentially options to purchase equity securities at specific prices and are valid for a specific
period of time. Rights are similar to warrants but generally have a short duration and are distributed directly by the issuer
to its shareholders. The holders of warrants and rights have no voting rights, and receive no dividends, with respect to the equity
interests underlying warrants or rights, and will have no rights with respect to the assets of the issuer, until the warrant or
right is exercised. Investments in warrants and rights involve certain risks, including, without limitation, the possible lack
of a liquid market for resale, potential price fluctuations as a result of speculation or other factors, and failure of the price
of the underlying security to reach or have reasonable prospects of reaching a level at which the warrant or right can be prudently
exercised (in which event the warrant or right may expire without being exercised, resulting in a loss of the Fund’s entire
investment therein).
FIXED
INCOME SECURITIES.
Corporate
and Municipal Debt Securities. Corporate and municipal debt securities purchased by the Fund may be of any credit quality, maturity
or yield. Accordingly, the Fund’s debt securities may include “investment grade” securities (those rated at
least Baa by Moody’s Investors Service, Inc. (“Moody’s”), BBB by S&P Global Ratings (“S&P”)
or Fitch, Inc. (“Fitch”) or, if not rated, deemed to be of equivalent quality in the Sub-Adviser’s opinion).
In addition, the Fund’s debt securities may include lower-rated debt securities including, without limitation, “junk”
bonds whose ratings are below investment grade. Debt securities rated Baa by Moody’s or BBB by S&P or Fitch may be considered
speculative and are subject to risks of non-payment of interest and principal. Debt securities rated lower than Baa by Moody’s
or lower than BBB by S&P or Fitch are generally considered speculative and subject to significant risks of non- payment of
interest and principal and greater market fluctuations than higher-rated debt securities. Lower-rated debt securities are usually
issued by companies without long track records of sales and earnings, or by companies with questionable credit strength. The retail
secondary market for these “junk bonds” may be less liquid than that of higher-rated debt securities, and adverse
conditions could make it difficult at times to sell certain securities or could result in lower prices than those used in calculating
a Fund’s NAV. These risks can reduce the value of the Fund’s shares and the income it earns. Descriptions of the quality
ratings of Moody’s, S&P and Fitch are included as Appendix A to this SAI. While the Sub-Adviser utilizes the ratings
of various credit rating services as one factor in establishing creditworthiness, it relies primarily upon its own analysis of
factors establishing creditworthiness.
Zero
Coupon Securities. The Fund may purchase zero coupon securities. Zero coupon securities do not pay interest or principal until
final maturity, unlike debt securities that provide periodic payments of interest (referred to as a coupon payment). Zero coupon
securities are bought at a price below the amount payable at maturity. The difference between the purchase price and the amount
paid at maturity represents interest on the zero coupon security. One must wait until maturity to receive interest and principal,
which increases the market and credit risks of a zero coupon security. A zero coupon step-up security converts to a coupon security
before final maturity.
Loan
Risk: Investing in loans (including loan assignments, loan participations and other loan instruments) carries certain risks
in addition to the risks typically associated with fixed income securities, including the risk of insolvency of the lending bank
or other intermediary. Loans may be unsecured or not fully collateralized, may be subject to restrictions on resale and sometimes
trade infrequently on the secondary market. In the event a borrower defaults, a fund’s access to the collateral may be limited
or delayed by bankruptcy or other insolvency laws. There is a risk that the value of the collateral securing the loan may decline
after a fund invests and that the collateral may not be sufficient to cover the amount owed to the fund. If the loan is unsecured,
there is no specific collateral on which the fund can foreclose. In addition, if a secured loan is foreclosed, a fund may bear
the costs and liabilities associated with owning and disposing of the collateral, including the risk that collateral may be difficult
to sell.
Loans
also may be subject to restrictions on resale and sometimes trade infrequently on the secondary market. As a result, valuing a
loan can be more difficult, and buying and selling a loan at an acceptable price can be more difficult or delayed, than other
investments. Difficulty in selling a loan can result in a loss. Loans made to finance highly leveraged corporate acquisitions
may be especially vulnerable to adverse changes in economic or market conditions. Certain loans may not be considered “securities,”
and purchasers, such as a fund, therefore may not be entitled to rely on the strong anti-fraud protections of the federal securities
laws. With loan participations, a fund may not be able to control the exercise of any remedies that the lender would have under
the loan and likely would not have any rights against the borrower directly, so that delays and expense may be greater than those
that would be involved if a fund could enforce its rights directly against the borrower.
Strips
(“STRIPS”). STRIPS are created by separating the income and principal components of a debt instrument and
selling them separately. U.S. Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities) are created
when the coupon payments and the principal payment are stripped from an outstanding Treasury bond by the Federal Reserve Bank.
Zero coupon U.S.
government
securities such as STRIPS are debt obligations that are issued or purchased at a significant discount from face value. The discount
approximates the total amount of interest the security will accrue and compound over the period until maturity or the particular
interest payment date at a rate of interest reflecting the market rate of the security at the time of issuance. STRIPS do not
require the periodic payment of interest. These investments benefit the issuer by mitigating its need for cash to meet debt service,
but generally require a higher rate of return to attract investors who are willing to defer receipt of cash. These investments
may experience greater volatility in market value than U.S. government securities that make regular payments of interest. If the
Fund invests in STRIPS, the Fund will accrue income on the investment for tax and accounting purposes, which is distributable
to shareholders and which, because no cash is received at the time of accrual, may require the liquidation of other portfolio
securities to satisfy the Fund’s distribution obligations, in which case the Fund would forgo the purchase of additional
income producing assets with these funds. The value of these instruments tends to fluctuate more in response to changes in interest
rates than the value of ordinary interest-paying debt securities with similar maturities. The risk is greater when the period
to maturity is longer.
Debentures.
A debenture is a long-term, unsecured, debt instrument backed only by the integrity of the borrower, not by collateral, and
documented by an indenture. Governments often issue debentures, in part because they generally cannot guarantee debt with assets
(government assets are public property). The primary risk with this type of investment is that the issuer will default or go into
bankruptcy. As an unsecured creditor, in the event of default or bankruptcy, the holder of a debenture does not have a claim against
any specific asset(s) of the issuing firm, so the investor will only be paid from the issuer’s assets after the secured
creditors have been paid. The Fund may invest in all types of debentures, including, without limitation, corporate and government
debentures.
Demand
Notes. Variable and Floating Rate Demand Notes are notes that bear variable or floating interest rates and carry rights that
permit holders to demand payment of the unpaid principal balance plus accrued interest from the issuers or certain financial intermediaries.
Variable rate demand notes have a stated maturity in excess of one year, but permit a holder to demand payment of principal plus
accrued interest upon a specified number of days notice. Frequently, such obligations are secured by letters of credit or other
credit support arrangements provided by banks. The issuer has a corresponding right, after a given period, to prepay in its discretion
the outstanding principal of the obligation plus accrued interest upon a specific number of days notice to the holders. The interest
rate of a floating rate instrument may be based on a known lending rate, such as a bank’s prime rate, and is reset whenever
such rate is adjusted. The interest rate on a variable rate demand note is reset at specified intervals at a market rate. These
formulas are designed to result in a market value for the Variable Rate Demand Note or Floating Rate Demand Note that approximates
its par value. Variable and Floating Rate Demand Notes are subject to interest rate risks.
Inverse
Floaters. Inverse floaters are municipal obligations on which the interest rates typically fall as market rates increase and
increase as market rates fall. Changes in market interest rates or the floating rate of the security inversely affect the residual
interest rate of an inverse floater. As a result, the price of an inverse floater will be considerably more volatile than that
of a fixed-rate obligation when interest rates change. Inverse floaters are a form of derivative investment. Certain derivatives
can be used to increase or decrease the Fund’s exposure to changing security prices, interest rates or other factors that
affect the value of securities. However, these techniques could result in losses to the Fund if the Sub-Adviser judges market
conditions incorrectly or employs a strategy that does not correlate well with the Fund’s other investments. These techniques
can cause losses if the counterparty does not perform its promises. An additional risk of investing in municipal securities that
are derivative investments is that their market value could be expected to vary to a much greater extent than the market value
of municipal securities that are not derivative investments but have similar credit quality, redemption provisions and maturities.
Private
Activity Bonds. Private activity bonds are generally revenue bonds payable not from general taxes, but 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, that do not generally carry the pledge of the credit of the issuing municipality. Interest paid from passive activity
bonds is generally taxable as ordinary income and, if the proceeds from private activity bonds are used for the construction,
repair or improvement of privately operated industrial or commercial facilities, the interest paid on such bonds may be excluded
from gross income for U.S. federal income tax purposes, although current federal tax laws place substantial limitations on the
size of these issues. Sizable investments in these obligations could involve an increased risk to the Fund should any of the related
facilities experience financial difficulties. The obligations of issuers may become subject to laws enacted in the future by Congress,
state legislatures, or local governments of referenda extending the time for payment of principal or interest, or imposing other
constraints upon enforcement of such obligations or upon the ability of municipalities to levy taxes. Furthermore, as a result
of legislation or other conditions, the power or ability of any issuer to pay, when due, the principal of and interest on its
municipal obligations may be materially affected.
Mortgage-Backed
Securities. Mortgage-backed securities may or may not be issued or guaranteed by the U.S. Government, its agencies or instrumentalities.
Mortgage-backed securities are interests in pools of residential or commercial mortgage loans, including, without limitation,
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 private entities or various governmental and government-related entities. The
value of some mortgage-backed securities in which the Fund may invest may be particularly sensitive to changes in
prevailing
interest rates, and, like other debt securities investments, the ability of the Fund to successfully utilize these instruments
may depend in part upon the ability of the Sub-Adviser to forecast interest rates and other economic factors correctly. Prepayment
risk is a major risk of mortgage-backed securities.
Mortgage
Pass-Through Certificates. Obligations of Government National Mortgage Association (“GNMA”), Federal National
Mortgage Association (“FNMA”), and Federal Home Loan Mortgage Corporation (“FHLMC”) include
direct pass-through certificates representing undivided ownership interests in pools of mortgages. The Fund may invest in such
certificates, which are guaranteed as to payment of principal and interest (but not as to price and yield) by the issuer. For
securities issued by GNMA, the payment of principal and interest is backed by the full faith and credit of the U.S. government.
Mortgage pass-through certificates issued by FNMA or FHLMC are guaranteed as to payment of principal and interest by the credit
of the issuing U.S. government agency. Securities issued by other non-governmental entities (such as commercial banks or mortgage
bankers) may offer credit enhancement such as guarantees, insurance, or letters of credit. Mortgage pass-through certificates
are subject to more rapid prepayment than their stated maturity date would indicate; their rate of prepayment tends to accelerate
during periods of declining interest rates or increased property transfers and, as a result, the proceeds from such prepayments
may be reinvested in instruments which have lower yields. The impact of prepayments on the price of a security may be difficult
to predict and may increase the volatility of the price.
Collateralized
Mortgage Obligations (“CMOs”). CMOs are generally backed by mortgage pass-through securities or whole mortgage
loans. CMOs are usually structured into classes of varying maturities and principal payment priorities. The prepayment sensitivity
of each class may or may not resemble that of the CMO’s collateral depending on the maturity and structure of that class.
CMOs pay interest and principal (including, without limitation, prepayments) monthly, quarterly, or semi-annually. The prices
and yields of CMOs are determined, in part, by assumptions about cash flows from the rate of payments of the underlying mortgage.
Changes in interest rates may cause the rate of expected prepayments of those mortgages to change. These prepayment risks can
make the prices of CMOs very volatile when interest rates change. That volatility will affect the Fund’s share price. Most
CMOs are AAA rated, reflecting the credit quality of the underlying collateral; however, some classes carry greater price risk
than that of their underlying collateral. The Sub-Adviser will invest in classes of CMOs only if their characteristics and interest
rate sensitivity fit the investment objective and policies of the Fund.
Other
Mortgage Related Securities. In addition to the mortgage pass-through securities and the CMOs mentioned above, the Fund may
also invest in other mortgage derivative products. In addition to the prepayment risks described above, rapidly rising interest
rates could cause prepayments of mortgages to occur at a slower rate than expected, and the expected maturity of short or medium
term mortgage-related securities could lengthen as a result. That could cause their values to fluctuate more, and the share price
of the Fund to fluctuate more and to fall. Governmental, government-related, and private entities may create other mortgage-related
securities offering mortgage pass-through and mortgage collateralized instruments in addition to those described herein. As new
types of mortgage-related securities are developed and offered to the investment community, the Fund may consider making investments
in such new types of mortgage-related securities.
Asset-Backed
Securities. The Fund may invest in asset-backed securities backed by loans such as automobile loans, credit card receivables,
marine loans, recreational vehicle loans and manufactured housing loans. Typically asset-backed securities represent undivided
fractional interests in a trust whose assets consist of a pool of loans and security interests in the collateral securing the
loans. Payments of principal and interest on asset-backed securities are passed through monthly to certificate holders and are
usually guaranteed up to a certain amount and time period by a letter of credit issued by a financial institution. In some cases
asset-backed securities are divided into senior and subordinated classes so as to enhance the quality of the senior class. Underlying
loans are subject to risks of prepayment, which may reduce the overall return to certificate holders. If the letter of credit
is exhausted and the full amounts due on underlying loans are not received because of unanticipated costs, depreciation, damage
or loss of the collateral securing the contracts, or other factors, certificate holders may experience delays in payment or losses
on asset-backed securities. The Fund may invest in other asset-backed securities (e.g., equipment trust certificates), including
those that may be developed in the future.
Equipment
Trust Certificates. The Fund may invest in equipment trust certificates which are a type of asset-backed security that represents
undivided fractional interests in a trust whose assets consist of a pool of equipment retail installment contracts or leased equipment.
The debt issue is secured by the equipment or physical assets, as the title for the equipment is held in trust for the holders
of the issue. Equipment trust certificates are subject to the risk that the lessee or payee defaults on its payments, and risks
related to potential declines in the value of the equipment that serves as collateral for the issue.
FOREIGN
SECURITIES.
Foreign
Securities Generally. The Fund may invest directly or indirectly in foreign securities traded on U.S. exchanges, in over-the-counter
markets or in the form of ADRs described below. The Fund may also invest in foreign currency and foreign currency-
denominated
securities. Investing in securities issued by companies whose principal business activities are outside the United States may
involve significant risks not present in domestic investments. The value of securities denominated in or indexed to foreign currencies,
and of dividends and interest from such securities, can change significantly when foreign currencies strengthen or weaken relative
to the U.S. dollar. Foreign securities markets generally have less trading volume and less liquidity than U.S. markets and prices
on some foreign markets can be highly volatile. Many foreign countries lack uniform accounting and disclosure standards comparable
to those applicable to U.S. companies, and it may be more difficult to obtain reliable information regarding an issuer’s
financial condition and operations. Some foreign countries impose conditions and restrictions on foreigners’ ownership of
interests in local issuers, including, without limitation, restricting ownership to certain classes of investment in an issuer,
which may reduce potential investment returns and impair disposition of those investments. Additional costs associated with an
investment in foreign securities may include higher custodial fees than those applicable to domestic custodial arrangements and
transaction costs of foreign currency conversions.
Foreign
markets may offer less protection to investors than U.S. markets. Foreign issuers, brokers and securities markets may be subject
to less government supervision. Foreign securities trading practices, including, without limitation, those involving the release
of assets in advance of payment, may involve increased risks in the event of a failed trade or the insolvency of a broker-dealer,
and may involve substantial delays. It may also be difficult to enforce legal rights in foreign countries because of inconsistent
legal interpretations or less defined legal and regulatory provisions or because of corruption or influence on local courts.
Investing
abroad also involves different political and economic risks. Foreign investments may be affected by actions of foreign governments
adverse to the interests of U.S. investors, including, without limitation, the possibility of expropriation or nationalization
of assets, confiscatory taxation, restrictions on U.S. investment or on the ability to repatriate assets or convert currency into
U.S. dollars or other governmental intervention. There may be a greater possibility of default by foreign governments or foreign
government-sponsored enterprises and securities issued or guaranteed by foreign governments, their agencies, instrumentalities
or political subdivisions, may or may not be supported by the full faith and credit and taxing power of the foreign government.
Investments in foreign countries also involve a risk of local political, economic or social instability, military action or unrest
or adverse diplomatic developments. There is no assurance that the Sub-Adviser will be able to anticipate these potential events
or counter their effects.
Foreign
Fixed-Income Securities. Investing in foreign fixed-income securities has the same risks as investing in foreign securities
generally. In addition, foreign corporate bonds are subject to the risks that foreign companies may not be subject to uniform
audit, financial reporting or disclosure standards, practices or requirements comparable to those found in the U.S., which may
make it more difficult to evaluate the business and/or financial position of the issuer and the value of the bond. Foreign government
bonds are also subject to the risks that governmental issuers of fixed-income securities may be unwilling to pay interest and
repay principal when due or may require that conditions for payment be renegotiated.
American
Depositary Receipts (“ADRs”). ADRs provide a method whereby the Fund may invest in securities issued by companies
whose principal business activities are outside the United States. ADRs are receipts typically issued by a U.S. bank or trust
company evidencing ownership of the underlying securities, and 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. 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 participates
in a sponsored program. Generally, ADRs are designed for use in the U.S. securities markets, and are denominated in U.S. dollars,
while the underlying securities of the ADRs in the Fund’s portfolio are usually denominated or quoted in currencies other
than the U.S. dollar. Changes in foreign currency exchange rates affect the value of the ADR and, therefore, the value of the
Fund’s portfolio, either positively or negatively (i.e., foreign currency risk). In addition to foreign currency risk, ADRs
present certain risks not ordinarily associated with investments in securities of U.S. issuers. These risks include political,
economic or legal developments in the company’s home country (including war or other instability, expropriation of assets,
nationalization and confiscatory taxation), withholding taxes on dividend or interest payments or capital transactions or other
restrictions. In addition, although the ADRs in which the Fund invests are listed on major U.S. exchanges, there can be no assurance
that a market for these securities will be made or maintained or that any such market will be or remain liquid. If that happens,
the Fund may have difficulty selling securities, or selling them quickly and efficiently at the prices at which they have been
valued.
Emerging
Market Securities. An “emerging market” is any country that the World Bank, the International Finance Corporation
or the United Nations or its authorities has determined to have a low or middle income economy. Investing in emerging markets
involves exposure to potentially unstable governments, the risk of nationalization of business, restrictions on foreign ownership,
prohibitions on repatriation of assets and a system of laws that may offer less protection of property rights. Emerging market
economies may be based on only a few industries, may be highly vulnerable to changes in local and global trade conditions, and
may suffer from extreme and volatile debt burdens or inflation rates. The securities markets in emerging markets are substantially
smaller, less liquid and more volatile than the major securities markets in the United States and other developed countries. A
high proportion of the shares of many
issuers
may be held by a limited number of persons and financial institutions, which may limit the number of shares available for investment
by the Fund. A limited number of issuers in emerging markets may represent a disproportionately large percentage of market capitalization
and trading value. The limited liquidity of securities markets in these countries may also affect the Fund’s ability to
acquire or dispose of securities at the price and time it wishes to do so. The inability of the Fund to dispose fully and promptly
of positions in declining markets would cause the Fund’s NAV to decline as the values of the unsold positions are marked
to lower prices. In addition, these securities markets are susceptible to being influenced by large investors trading significant
blocks of securities.
Foreign
Currency Transactions. Investments in foreign securities involve currency risk. The Fund may engage in various transactions
to hedge currency risk, but is not required to do so. The instruments the Fund may use for this purpose include forward foreign
currency contracts, foreign currency futures contracts and options on foreign currencies.
A
forward foreign currency contract is an obligation to purchase or sell a specified 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 established at the time of the contract.
These contracts are entered into directly between currency traders and their customers. The Fund may use these contracts to purchase
or sell a foreign currency for the purpose of locking in the U.S. dollar price of foreign securities the Fund has agreed to purchase
or the amount in U.S. dollars that the Fund will receive when it has sold foreign securities.
Currency
futures contracts are similar to forward currency contracts, except that they are traded on exchanges (and have margin requirements)
and are standardized as to contract size and delivery date. The Fund may purchase or sell foreign currency futures contracts to
protect against fluctuations in the U.S. dollar values of foreign securities. For example, the Fund may sell a futures contract
on a foreign currency when it holds securities denominated in that currency and it anticipates a decline in the value of that
currency relative to the U.S. dollar. If such a decline were to occur, the resulting adverse effect on the value of the foreign-denominated
securities may be offset, in whole or in part, by gains on the futures contract.
A
currency option is the right - but not the obligation - to buy (in the case of a call) or sell (in the case of a put) a set amount
of one currency for another at a predetermined time in the future. The two parties to a currency option contract are the option
buyer and the option seller/writer. The option buyer may, for an agreed upon price, purchase from the option writer a commitment
that the option writer will sell (or purchase) a specified amount of a foreign currency upon demand. The option extends only until
the stated expiration date. The rate at which one currency can be purchased or sold is one of the terms of the option and is called
the strike price. The total description of a currency option includes the underlying currencies, the contract size, the expiration
date, the strike price and whether the option is an option to purchase the underlying currency (a call) or an option to sell the
underlying currency (a put). There are three types of option expirations, American-style, European- style and Bermuda-style. American-style
options can be exercised on any business day prior to the expiration date. European-style options can be exercised at expiration
only. Bermuda-style options can be exercised at the date of expiration, and on certain specified dates that occur between the
purchase date and the date of expiration.
The
use of foreign currency transactions involves risks, including, without limitation, the risk of imperfect correlation between
movements in futures or options prices and movements in the price of currencies which are the subject of the hedge. The successful
use of foreign currency transactions also depends on the ability of the Sub-Adviser to correctly forecast interest rate movements,
currency rate movements and general stock market price movements. There can be no assurance that the Sub-Adviser’s judgment
will be accurate. The use of foreign currency transactions also exposes the Fund to the general risks of investing in futures
and options contracts, including, without limitation: the risk of an illiquid market and the risk of adverse regulatory actions.
Any of these factors may cause the Fund to lose money on its foreign currency transactions.
FORWARD
COMMITMENT AND WHEN-ISSUED SECURITIES. The Fund may purchase securities on a when-issued basis or for settlement at a future
date if the Fund holds sufficient liquid assets to meet the purchase price. In such purchase transactions, the Fund will not accrue
interest on the purchased security until the actual settlement. Similarly, if a security is sold for a forward date, the Fund
will accrue the interest until the settlement of the sale. When-issued security purchases and forward commitments have a higher
degree of risk of price movement before settlement due to the extended time period between the execution and settlement of the
purchase or sale. As a result, the exposure to the counterparty of the purchase or sale is increased. Although the Fund would
generally purchase securities on a forward commitment or when-issued basis with the intention of taking delivery, the Fund may
sell such a security prior to the settlement date if the Sub-Adviser felt such action was appropriate. In such a case, the Fund
could incur a short-term gain or loss.
ILLIQUID
AND RESTRICTED INVESTMENTS. Illiquid investments are those that
the Fund reasonably expects cannot be sold or disposed of in current market conditions in seven calendar days or less without
the sale or disposition significantly changing the market value of the investment. The Fund may invest up to 15% of its net assets
in illiquid investments. Historically, illiquid investments have included those subject to contractual or legal restrictions on
resale because they have not been registered under the Securities Act (“restricted securities”), investments that
are otherwise not readily marketable, such as over-the-counter options, and repurchase agreements not entitling the holder to
payment of principal in seven days. Such investments may offer higher yields than comparable publicly traded securities, and they
also may incur higher risks.
Although
the investments described in this section generally will be considered illiquid, an investment’s contractual or legal restrictions
on resale to the general public or to certain institutions may not be indicative of the liquidity of the investment and therefore
these investments may be determined to be liquid in accordance with guidelines established by the Board. The Trustees have delegated
to the Adviser the determination of the liquidity of such investments in the respective Fund’s portfolio as administrator
of the Fund’s liquidity risk management program. The Adviser will take into account relevant market, trading and investment-specific
considerations when determining whether an investment is illiquid.
If illiquid investments exceed 15%
of the Fund’s net assets after the time of purchase, the Fund will take steps to reduce in an orderly fashion its holdings
of illiquid investments. Because illiquid investments may not be readily marketable, the Adviser may not be able to dispose of
them in a timely manner. As a result, the Fund may be forced to hold illiquid investments while their price depreciates. Depreciation
in the price of illiquid investments held by the Fund may cause the NAV of the Fund holding them to decline. An investment that
is determined by the Adviser to be liquid may subsequently revert to being illiquid if not enough buyer interest exists.
The Fund may purchase Rule 144A securities
sold to institutional investors without registration under the 1933 Act and commercial paper issued in reliance upon the exemption
in Section 4(a)(2) of the 1933 Act, for which an institutional market has developed. Institutional investors depend on an efficient
institutional market in which the unregistered security can be readily resold or on the issuer’s ability to honor a demand
for repayment of the unregistered security.
Restricted securities ordinarily can
be sold by the Fund in secondary market transactions to certain qualified investors pursuant to rules established by the SEC,
in privately negotiated transactions to a limited number of purchasers or in a public offering made pursuant to an effective registration
statement under the Securities Act. Limitations on the resale of restricted securities may have an adverse effect on their marketability,
which may prevent the Fund from disposing of them promptly at reasonable prices. When registration is required, the Fund may be
obligated to pay all or part of the registration expenses and a considerable amount of time may elapse between the decision to
sell and the sale date. If, during such period, adverse market conditions were to develop, the Fund might obtain a less favorable
price than the price which prevailed when it decided to sell. Restricted securities will be priced at fair value as determined
in good faith by the Trustees or their delegate.
The Fund’s difficulty valuing and selling restricted
securities and illiquid investments may result in a loss or be costly to the Fund. If a substantial market develops for a restricted
security or other illiquid investment held by the Fund, it may be treated as a liquid security, in accordance with procedures
and guidelines adopted by the Trust on behalf of the Fund.
MONEY
MARKET INSTRUMENTS. The Fund may invest directly and indirectly in money market instruments, including, without limitation,
U.S. Government obligations or corporate debt obligations (including, without limitation, those subject to repurchase agreements).
Money market instruments also may include Banker’s Acceptances and Certificates of Deposit of domestic branches of banks,
Commercial Paper, and Master Notes. Banker’s Acceptances are time drafts drawn on and “accepted” by a
bank. When a bank “accepts” such a time draft, it assumes liability for its payment. When the Fund acquires a Banker’s
Acceptance, the bank that “accepted” the time draft is liable for payment of interest and principal when due. The
Banker’s Acceptance carries the full faith and credit of such bank. A Certificate of Deposit is an unsecured, interest
bearing debt obligation of a bank. Commercial Paper is an unsecured, short-term debt obligation of a bank, corporation,
or other borrower. Commercial Paper maturity generally ranges from two to 270 days and is usually sold on a discounted basis rather
than as an interest-bearing instrument. The Fund will invest directly in Commercial Paper only if it is rated in one of the top
two rating categories by Moody’s, S&P or Fitch or, if not rated, is of equivalent quality in the Sub-Adviser’s
opinion. Commercial Paper may include Master Notes of the same quality. Master Notes are unsecured obligations which are
redeemable upon demand of the holder and which permit the investment of fluctuating amounts at varying rates of interest. Master
Notes may be acquired by the Fund through the Master Note program of the Fund’s custodian bank, acting as administrator
thereof. The Sub-Adviser will monitor, on a continuous basis, the earnings power, cash flow and other liquidity ratios of the
issuer of each Master Note held by the Fund.
SHORT
SALES. The Fund may enter into short sales, which are transactions in which the Fund sells a security it does not own in anticipation
of a decline in the market value of that security. To complete a short sale transaction, the Fund will borrow the security from
a broker-dealer, which generally involves the payment of a premium and transaction costs. The Fund then sells the borrowed security
to a buyer in the market. The Fund will then cover the short position by buying shares in the market either (i) at its discretion
or (ii) when called by the broker-dealer lender. Until the security is replaced, the Fund is required to pay the broker-dealer
lender any dividends or interest that accrue during the period of the loan. In addition, the net proceeds of the short sale will
be retained by the broker to the extent necessary to meet regulatory or other requirements, until the short position is closed
out.
The
Fund will incur a loss as a result of a short sale if the price of the security increases between the date of the short sale and
the date on which the Fund replaces the borrowed security. The Fund will realize a gain if the security declines in price between
those dates. The amount of any gain will be decreased, and the amount of any loss increased by the amount of the premium, dividends,
interest or expenses the Fund may be required to pay in connection with a short sale. When the Fund makes a short sale, the Fund
will segregate
liquid
assets (such as cash, U.S. government securities, or equity securities) on the Fund’s books and/or in a segregated account
at the Fund’s custodian or broker (or an affiliate thereof) in an amount sufficient to cover the current value of the securities
to be replaced as well as any dividends, interest and/or transaction costs due to the broker-dealer lender, to the extent such
deposit is required by applicable law and/or the parties involved in the transaction. In determining the amount to be segregated,
any securities that have been sold short by the Fund will be marked to market daily. To the extent the market price of the security
sold short increases and more assets are required to meet the Fund’s short sale obligations, additional assets will be segregated
to ensure adequate coverage of the Fund’s short position obligations.
In
addition, the Fund may make short sales “against the box,” which occur when the Fund sells a security short while
owning securities equivalent in kind and amount to the securities sold short (or securities convertible or exchangeable into such
securities) and will hold such securities while the short sale is outstanding. The Fund will incur transaction costs, including,
without limitation, interest, in connection with opening, maintaining and closing short sales against the box.
TEMPORARY
DEFENSIVE POSITIONS. The Fund may, from time to time, take temporary defensive positions that are inconsistent with its principal
investment strategies in an attempt to respond to adverse market, economic, political or other conditions. In such circumstances,
the Fund may also hold up to 100% of its portfolio in cash and cash equivalent positions. When the Fund takes a temporary defensive
position, the Fund may not be able to achieve its investment objective.
BORROWING.
The Fund may, subject to the restrictions of the 1940 Act, borrow money from banks. In the event the Fund should ever borrow
money, such borrowing could increase the Fund’s costs and thus reduce the value of the Fund’s assets. The 1940 Act
presently allows the Fund to borrow from any bank (including, without limitation, pledging, mortgaging or hypothecating assets)
provided that, immediately after any such borrowing, there is an asset coverage of at least 300% for all such borrowings, and
provided further that, in the event that the Fund’s asset coverage at any time falls below 300%, the Fund reduce its existing
borrowings (within three days, excluding Sundays and holidays) to the extent necessary to comply with the foregoing limitation.
CYBERSECURITY
RISK. The Fund, like all companies, may be susceptible to operational and information security risks, or risks of catastrophic
systems failures by critical service providers. Cybersecurity or critical systems failures or breaches of the Fund, its service
providers, Authorized Participants or the issuers of securities in which the Fund invests, have the ability to cause disruptions,
impact business operations and impede trading, potentially resulting in financial losses, the inability of Authorized Participants
to process transactions, violations of applicable privacy and other laws, regulatory fines, penalties, reputational damage, reimbursement
or other compensation costs, and/or additional compliance costs. The Fund and its shareholders could be negatively impacted as
a result.
INVESTMENT
LIMITATIONS
The
Fund has adopted the following investment limitations, which cannot be changed without approval by holders of a majority of its
outstanding voting Shares. A “majority” for this purpose means the lesser of (i) 67% of the Fund’s outstanding
Shares represented in person or by proxy at a meeting at which more than 50% of its outstanding Shares are represented; or (ii)
more than 50% of the Fund’s outstanding Shares. Unless otherwise indicated, percentage limitations apply at the time of
purchase of the applicable securities.
FUNDAMENTAL
RESTRICTIONS. As a matter of fundamental policy, the Fund may not:
|
|
(1)
|
With
respect to 75% of its total assets, purchase securities of an issuer (other than the U.S. Government, its agencies, instrumentalities
or authorities or repurchase agreements collateralized by U.S. Government securities and other investment companies),
if: (a) such purchase would, at the time, cause more than 5% of the Fund’s total assets taken at market value to
be invested in the securities of such issuer; or (b) such purchase would, at the time, result in more than 10% of the
outstanding voting securities of such issuer being held by the Fund;
|
|
|
(2)
|
Issue senior securities,
except as permitted by the 1940 Act;
|
|
|
(3)
|
Borrow money (including,
without limitation, borrowing to meet redemptions), except to the extent permitted under the 1940 Act;
|
|
|
(4)
|
Pledge, mortgage
or hypothecate its assets;
|
|
|
(5)
|
Act
as underwriter except to the extent that, in connection with the disposition of portfolio securities, the Fund may be deemed
to be an underwriter under certain federal securities laws;
|
|
|
(6)
|
Make loans, provided
that the Fund may lend its portfolio securities in an amount up to 33⅓% of total Fund assets;
|
|
|
(7)
|
Purchase
or sell real estate or interests in real estate; provided, however, that the Fund may purchase and sell securities which are
secured by real estate and securities of companies which invest or deal in real estate (including, without limitation, investments
in REITs and mortgage-backed securities);
|
|
|
(8)
|
Invest more than
25% of its total assets in any particular industry; and
|
|
|
(9)
|
Invest in commodities.
|
NON-FUNDAMENTAL
RESTRICTIONS. The following investment limitations are not fundamental and may be changed by the Board without shareholder
approval. As a matter of non-fundamental policy, the Fund may not:
|
|
(1)
|
Purchase
securities on margin (but the Fund may obtain such short-term credits as may be necessary for the clearance of transactions);
|
|
|
(2)
|
Make investments
for the purpose of exercising control or management over a portfolio company;
|
|
|
(3)
|
Invest in securities
of other registered investment companies, except as permitted under the 1940 Act;
|
|
|
(4)
|
Invest in interests
in oil, gas or other mineral exploration or development programs, although the Fund may invest in the common stock of companies
that invest in or sponsor such programs;
|
|
|
(5)
|
Purchase
warrants if as a result the Fund would then have more than 5% of its total net assets (taken at the lower of cost or current
value) invested in warrants; or
|
|
|
(6)
|
Invest
more than 15% of its net assets in illiquid investments.
|
With
respect to the fundamental and non-fundamental investment restrictions above, if a percentage limitation is adhered to at the
time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result
in a violation of such restriction (i.e., percentage limitations are determined at the time of purchase); provided, however, that
the treatment of the fundamental restrictions related to borrowing money and issuing senior securities are exceptions to this
general rule.
With
respect to the above fundamental investment restriction on borrowing money, the entry into options, forward contracts, futures
contracts, including those relating to indices, and options on futures contracts or indices will not constitute borrowing.
With
respect to the above fundamental investment restriction on pledging, mortgaging or hypothecating assets, any such activity to
the extent necessary to secure permitted borrowings and to the extent related to the deposit of assets in escrow in connection
with (i) writing covered put or call options, (ii) the purchase of securities on a when-issued or forward commitment basis, or
(iii) collateral or initial or variation margin arrangements with respect to options, forward contracts, futures contracts (including,
without limitation, those relating to indices), or options on futures contracts or indices will not be considered pledging, mortgaging
or hypothecating assets.
With
respect to the above fundamental investment restriction on making loans, investment in U.S. government obligations, short-term
commercial paper, certificates of deposit, bankers’ acceptances and repurchase agreements will not be deemed to be the making
of a loan.
With
respect to the above fundamental investment restriction regarding concentration in a particular industry, (i) securities of the
U.S. Government (including its agencies and instrumentalities), tax-exempt securities of state or municipal governments and their
political subdivisions and investments in other registered investment companies are not considered to be issued by members of
any industry, and (ii) if the Fund invests in a revenue bond tied to a particular industry, the Fund will consider such investment
to be issued by a member of the industry to which the revenue bond is tied.
With
respect to the above fundamental investment restriction on investments in commodities, the purchase or sale by the Fund of options,
forward contracts, futures contracts (including, without limitation, those relating to indices), options on futures contracts
or indices or interests in equity securities issued by companies (including, without limitation, investment companies) that hold
or invest in one or more commodities as their sole or principal business activity will not be considered an investment in commodities.
With
respect to the above non-fundamental investment restriction on purchasing securities on margin, short sales of securities and
futures trades, forward contracts or similar trades requiring margin deposits or other use of a margin account will not be considered
purchasing securities on margin.
The
1940 Act allows the Fund to borrow from any bank (including, without limitation, pledging, mortgaging or hypothecating assets)
in an amount up to 33⅓% of its total assets and the Fund will, to the extent necessary, reduce its existing borrowings (within
three days, excluding Sundays and holidays) to comply with the provisions of the 1940 Act.
MANAGEMENT
AND OTHER SERVICE PROVIDERS
The Board
is responsible for the supervision and oversight of the Fund. The Board approves all significant agreements between the Trust,
on behalf of the Fund, and those companies that furnish services to the Fund; reviews the performance of the Fund; and oversees
the business activities of the Fund. This section of the SAI provides information about the persons who serve as trustees (“Trustees”)
and executive officers to the Trust, as well as the entities that provide services to the Trust.
TRUSTEES
AND OFFICERS. Following are the Trustees and executive officers of the Trust, their years of birth and addresses, their present
positions with the Trust, and their principal occupations during the past five years. Those Trustees who are “interested
persons” as defined in the 1940 Act (“Interested Trustees”) and those Trustees who are not “interested
persons” as defined in the 1940 Act (“Independent Trustees”), are identified in the table. The address
of each Trustee and executive officer of the Trust, unless otherwise indicated, is 1540 Broadway, New York, New York 10036.
|
Name and Year
of Birth
|
Position(s)
held with Trust
|
Length
of Time Served
|
Principal
Occupation(s) During Past Five Years
|
Number
of Portfolios in Fund Complex Overseen by Trustee*
|
Other
Directorships Held by
Trustee During
Past Five Years
|
|
INDEPENDENT TRUSTEES
|
|
James
Simpson
Year of Birth: 1970
|
Trustee
|
Since
Inception (2014)
|
President (since 2009),
ETP Resources, LLC (a financial services consulting company).
|
12
|
Trustee
(since 2018), Asset Management Fund (5 portfolios); Trustee (since 2015), Virtus ETF Trust II (2 portfolios)
|
|
Robert
S. Tull
Year of Birth: 1952
|
Trustee
|
Since
Inception (2014)
|
Independent Consultant
(since 2013); President (since 2017), ProcureAM, LLC.
|
12
|
Trustee
(since 2015), Virtus ETF Trust II (2 portfolios); Trustee (since 2018), Procure ETF Trust II (1 portfolio)
|
|
Stephen
O’Grady
Year of Birth: 1946
|
Trustee
|
Since
2014
|
Lead Market Maker
(2011 to 2012), GFI Group; Partner (2004 to 2011), Kellogg Capital Markets.
|
12
|
Trustee
(since 2015), Virtus ETF Trust II (2 portfolios); Trustee (2013 to 2015), Greenhaven LLC; Trustee (since 2014), Acacia Group
LLC; Trustee (since 2014), ETFS Trust (5 portfolios)
|
|
Myles
J. Edwards
Year of Birth: 1961
|
Trustee
|
Since
2016
|
General
Counsel and CCO (since 2019), Bruderman Brothers, LLC; General Counsel and CCO (since 2019), Bruderman Asset Management, LLC;
CCO (since 2018), Netrex Capital Markets, LLC; Chief Executive Officer (since 2018), Final Compliance; Chief Compliance Officer
(since 2018), Knight Vinke; General Counsel, CCO and COO (2014 to 2018), Shufro, Rose & Co., LLC; General Counsel and
CCO (2011 to 2014), Constellation Wealth Advisers, LLC.
|
12
|
Trustee
(since 2015), Virtus ETF Trust II (2 portfolios)
|
|
INTERESTED
TRUSTEE**
|
|
William
J. Smalley
Year of Birth: 1983
|
Trustee, President
and Chief Executive Officer
|
Since
Inception (2014)
|
President (since 2012),
Virtus ETF Solutions LLC; Managing Principal (2012 to 2016) and Executive Vice President (2016 to 2019), ETF Distributors
LLC; Managing Director (since 2012), Virtus ETF Advisers LLC; President and Chief Executive Officer (since 2012), ETFis Series
Trust I; and President and Chief Executive Officer (since 2015), Virtus ETF Trust II.
|
10
|
None
|
|
Name and Year of Birth
|
Position(s)
held with Trust
|
Length
of Time Served
|
Principal
Occupation(s) During Past Five Years
|
Number
of Portfolios in Fund Complex Overseen by Trustee*
|
Other
Directorships Held by
Trustee During
Past Five Years
|
|
OTHER EXECUTIVE OFFICERS
|
|
Brinton
W. Frith
Year of Birth: 1969
|
Treasurer and Chief
Financial Officer
|
Since
Inception (2014)
|
President (since 2013),
Virtus ETF Advisers LLC; Managing Director (since 2013), Virtus ETF Solutions LLC; Treasurer and Chief Financial Officer (since
2013), ETFis Series Trust I; and Treasurer and Chief Financial Officer (since 2015), Virtus ETF Trust II.
|
N/A
|
N/A
|
|
Nancy
J. Engberg
Year of Birth: 1956
|
Chief Compliance Officer
|
Since
2015
|
Senior Vice President
(since 2017); Vice President (2008 to 2017) and Chief Compliance Officer (2008 to 2011 and since 2016), Virtus Investment
Partners, Inc. and/or certain of its subsidiaries; various officer positions (since 2003) with Virtus affiliates;
Senior Vice President (since 2017), Vice President (2011 to 2017) and Chief Compliance Officer (since 2011), Virtus
Mutual Fund Family; Senior Vice President (since 2017), Vice President (2010 to 2017) and Chief Compliance Officer (since
2011), Virtus Variable Insurance Trust; Senior Vice
President (since 2017), Vice President (2011 to 2017) and Chief Compliance Officer (since 2011), Virtus Global Multi-Sector
Income Fund; Senior Vice President (since 2017), Vice President (2012 to 2017) and Chief Compliance Officer (since 2012),
Virtus Total Return Fund Inc.; Senior Vice President (since 2017), Vice President (2013 to 2017) and Chief Compliance Officer
(since 2013), Virtus Alternative Solutions Trust; Senior Vice President (since 2017), Vice President (2014 to 2017) and Chief
Compliance Officer (since 2014), Duff & Phelps Select MLP and Midstream Energy Fund Inc.; Chief Compliance Officer
(since 2015), ETFis Series Trust I and Virtus ETF Trust II.
|
N/A
|
N/A
|
|
Kevin
J. Carr
Year of Birth: 1954
|
Secretary
|
Since
2015
|
Vice President and
Senior Counsel (since 2017); Senior Vice President (2009 to 2017), Vice President, Counsel and Secretary (2008 to 2009), Virtus
Investment Partners, Inc. and/or certain of its subsidiaries; various senior officer positions (since 2005) with Virtus
affiliates; Senior Vice President (since 2013), Vice President (2005 to 2013), Chief Legal Officer, Counsel and
Secretary (since 2005), Virtus Mutual Fund Family; Senior Vice President (2013 to 2014), Vice President (2012 to 2013), Secretary
and Chief Legal Officer (2005 to 2013), and Assistant Secretary (2013 to 2014 and since 2017), Virtus Total Return Fund
Inc.; Senior Vice President (since 2017), Assistant Secretary (since 2013), Vice President, Chief Legal Officer, Counsel
and Secretary (2010 to 2013), Virtus Variable Insurance Trust; Senior Vice President (2013 to 2014), Vice President (2011
to 2013), and Assistant Secretary (since 2011), Virtus Global Multi-Sector Income Fund; Assistant Secretary (since
2015), Duff & Phelps Select MLP and Midstream Energy Fund Inc.; Senior Vice President (since 2017), Assistant Secretary
(since 2013), Virtus Alternative Solutions Trust; and Secretary (since 2015), ETFis Series Trust I and Virtus ETF Trust II.
|
N/A
|
N/A
|
* As of the date of this SAI, the
Fund Complex consisted of the Trust, which consisted of 10 portfolios — InfraCap MLP ETF, InfraCap REIT Preferred ETF, Virtus
InfraCap U.S. Preferred Stock ETF, Virtus LifeSci Biotech Clinical Trials ETF, Virtus LifeSci Biotech Products ETF, Virtus Newfleet
Multi-Sector Bond ETF, Virtus Private Credit Strategy ETF, Virtus Real Asset Income ETF, Virtus Reaves Utilities ETF and Virtus
WMC Global Factor Opportunities ETF — and Virtus ETF Trust II, which consisted of two portfolios — Virtus Newfleet
Dynamic Credit ETF and Virtus Seix Senior Loan ETF.
** Mr. Smalley is an Interested Trustee
because he is an employee of the Adviser.
Board
Structure. The Trust’s Board includes four Independent Trustees and one Interested Trustee, Mr. Smalley, who is Chairman
of the Board. Each Trustee serves an indefinite term, until a successor is elected, qualified and serving as a Trustee. The Board
has not appointed an Independent Trustee to serve as lead Independent Trustee. The Board believes this structure is appropriate
because, among other things, the Board’s current small size and the small number of funds in the Trust permit Trust management
to communicate with each Independent Trustee as and when needed, and permit each Independent Trustee to be involved in each committee
of the Board (each a “Committee”) as well as each Board function. The Board may consider appointing an independent
Chairman or a lead Independent Trustee in the future, particularly if the Board’s size or the Trust’s complexity materially
increases.
With
respect to risk oversight, the Board holds four regular meetings each year to consider and address matters involving the Trust
and the Fund. During these meetings, the Board receives reports from the Adviser, the Trust’s sub-advisers, Trust management,
the Fund’s administrator, transfer agent and distributor, and the Trust’s Chief Compliance Officer (the “CCO”),
on regular quarterly items and, where appropriate and as needed, on specific issues. As part of its oversight function, the Board
also may hold special meetings or communicate directly with Trust management or the CCO to address matters arising between regular
meetings. The Board has established a committee structure that includes an Audit Committee and a Nominating Committee (discussed
in more detail below). Each Committee is comprised entirely of Independent Trustees. The Independent Trustees have engaged independent
legal counsel to assist them in performing their oversight responsibilities.
Qualification
of Trustees. The Board has considered each Trustee’s experience, qualifications, attributes and skills in light of the
Board’s function and the Trust’s business and structure, and has determined that each Trustee possesses experience,
qualifications, attributes and skills that enable the Trustee to be an effective member of the Board. In this regard, the Board
has considered the following specific experience, qualifications, attributes and/or skills for each Trustee:
|
James
Simpson
|
Mr.
Simpson has experience as an independent trustee for other ETFs and as President of ETP Resources, a financial information
services company that provides detailed reference data on U.S.-listed exchange-traded products. He also has experience working
for financial institutions and securities exchanges and has consulted with respect to the development of exchange-traded products.
|
|
Robert
S. Tull
|
Mr.
Tull has experience as an independent trustee for other ETFs and as a consultant to financial companies and as chief operating
officer to financial services companies. Mr. Tull has also assisted with the development of exchange-traded products.
|
|
Stephen
O’Grady
|
Mr.
O’Grady has experience as an independent trustee for other ETFs and in the development and operation of ETF trading
systems and futures exchanges and has served as president of an options brokerage firm.
|
|
Myles
J. Edwards
|
Mr.
Edwards has experience as general counsel, chief compliance officer and chief operating officer of SEC registered investment
advisers, hedge funds and FINRA member broker-dealers.
|
|
William
J. Smalley
|
Mr.
Smalley has experience in the financial industry, including the development of exchange-traded products, and is a founder
of the Adviser and the Distributor.
|
The
Board has determined that each of the Trustees’ careers and background, combined with their interpersonal skills and general
understanding of financial and other matters, enable the Trustees to effectively participate in and contribute to the Board’s
functions and oversight of the Trust. References to the qualifications, attributes and skills of Trustees are pursuant to requirements
of the SEC, do not constitute holding out the Board or any Trustee as having any special expertise or experience, and shall not
impose any greater responsibility on any such person or on the Board by reason thereof.
Trustee
Standing Committees. The Board has established the following standing committees:
Audit
Committee: The Independent Trustees are the current members of the Audit Committee. The Audit Committee oversees the Fund’s
accounting and financial reporting policies and practices, reviews the results of the annual audits of the Fund’s financial
statements and interacts with the Fund’s independent auditors on behalf of the Board. The Audit Committee also serves in
the role of the Trust’s qualified legal compliance committee and, as such, receives, investigates and makes recommendations
as to appropriate remedial action in connection with any report of evidence of a material violation of securities laws or breach
of fiduciary duty or similar violation by the Trust, its officers, Trustees or agents. The Audit Committee operates pursuant to
an Audit Committee Charter and meets periodically as necessary. The Audit Committee met six times during the past fiscal year.
Nominating
Committee: The Independent Trustees are the current members of the Nominating Committee. The Nominating Committee nominates,
selects and appoints Independent Trustees to fill vacancies on the Board and to stand for election at appropriate meetings of
the shareholders of the Trust. The Nominating Committee meets only as necessary. The Nominating Committee did not meet during
the past fiscal year. The Nominating Committee generally will not consider nominees recommended by shareholders of the Trust.
Beneficial
Ownership of Shares of the Fund. The table below shows, for each Trustee, the value of shares of the Fund beneficially owned,
and the aggregate value of investments in shares of all funds in the Fund complex, as of December 31, 2019, and stated as one
of the following ranges: A = None; B = $1–$10,000; C = $10,001–$50,000; D = $50,001–$100,000; and E = over $100,000.
|
Name
of Trustee
|
Dollar
Range of Equity
Securities in the Fund
|
Aggregate
Dollar Range of Equity
Securities in All Registered
Investment Companies Overseen By
Trustee in Family of Investment
Companies
|
|
James
Simpson
|
A
|
B
|
|
Robert
S. Tull
|
A
|
A
|
|
Stephen
O’Grady
|
A
|
B
|
|
Myles
J. Edwards
|
A
|
C
|
|
William
J. Smalley
|
C
|
D
|
Ownership
In Fund Affiliates. As of December 31, 2019, none of the Independent Trustees, nor members of their immediate families, owned,
beneficially or of record, securities of the Adviser, the Sub-Adviser, the Fund’s principal underwriter or any affiliate
of the Adviser, the Sub-Adviser or the principal underwriter.
Compensation.
Officers of the Trust and the Trustees who are interested persons of the Trust or the Adviser receive
no salary from the Trust. Each Independent Trustee receives $32,000 per year for the entire Fund Complex. In addition, the Audit
Committee chair receives an additional $4,000 per year for the entire Fund Complex. The Trust reimburses each Trustee and officer
of the Trust for his or her travel and other expenses relating to attendance at Board or committee meetings. Unless otherwise
noted, the Trustees received the following compensation for the fiscal year ended October 31, 2019:
|
Name
of Trustee
|
Aggregate
Compensation
From the Fund
|
Pension
or Retirement
Benefits Accrued As
Part of Fund Expenses
|
Estimated
Annual Benefits Upon Retirement
|
Total
Compensation From Fund Complex Paid to Trustees*
|
|
INDEPENDENT
TRUSTEES
|
|
James Simpson
|
$2,853
|
None
|
None
|
$36,000
|
|
Robert
S. Tull
|
$2,536
|
None
|
None
|
$32,000
|
|
Stephen O’Grady
|
$2,536
|
None
|
None
|
$32,000
|
|
Myles
J. Edwards
|
$2,536
|
None
|
None
|
$32,000
|
|
INTERESTED
TRUSTEE
|
|
William
J. Smalley
|
None
|
None
|
None
|
None
|
*For
the calendar year ended December 31, 2019.
CODES
OF ETHICS. The Trust, the Adviser, the Sub-Adviser and the Fund’s principal underwriter have each adopted a code of
ethics, as required by Rule 17j-1 under the 1940 Act, that is designed to prevent personnel of the Trust, the Adviser, the Sub-Adviser
and the Fund’s principal underwriter subject to the codes from engaging in deceptive, manipulative or fraudulent activities
in connection with securities held or to be acquired by the Fund (which securities may also be held by persons subject to the
codes). The codes of ethics permit personnel of the Trust, the Adviser, the Sub-Adviser and the principal underwriter subject
to the codes to invest
in
securities, including securities that may be purchased or held by the Fund, subject to certain restrictions and pre-approval requirements.
In addition, the codes of ethics of the Trust, the Adviser, the Sub-Adviser and the principal underwriter require that access
persons of such entities report their personal securities transactions and holdings, which are reviewed for compliance with the
code of ethics.
ANTI-MONEY
LAUNDERING PROGRAM. The Trust has adopted an anti-money laundering (“AML”) program, as required by applicable
law, that is designed to prevent the Fund from being used for money laundering or the financing of terrorist activities. The Trust’s
AML Compliance Officer is responsible for implementing and monitoring the operations and internal controls of the program. Compliance
officers at certain of the Fund’s service providers are also responsible for monitoring aspects of the AML program. The
AML program is subject to the continuing oversight of the Board.
PROXY
VOTING POLICIES. The Trust has adopted a proxy voting and disclosure policy that delegates to the Fund’s proxy voting
manager the authority to vote proxies for the Fund, subject to oversight of the Board. The Sub-Adviser serves as the proxy voting
manager for the Fund. Copies of the Trust’s Proxy Voting Policy and Procedures and the Sub-Adviser’s Proxy Voting
Policy and Procedures are included as Appendix B and Appendix C, respectively, to this SAI.
No
later than August 31 of each year, the Trust files Form N-PX with the SEC. Form N-PX states how the Fund voted proxies relating
to portfolio securities during the most recent 12-month period ended June 30. The Fund’s proxy voting records, as set forth
in its most recent Form N-PX filing, are available upon request, without charge, by calling the Fund at (866) 383-7636. This information
is also available on the SEC’s website at http://www.sec.gov.
CONTROL
PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As
of February 3, 2020, the Trustees and officers of the Trust as a group owned beneficially (i.e., had direct or indirect voting
and/or investment power) less than 1% of the then outstanding shares in the Fund.
Although
the Fund does not have information concerning the beneficial ownership of shares held in the names of Depository Trust Company
(“DTC”) participants, as of February 3, 2020, the name and percentage ownership of each DTC participant that owned
of record 5% or more of the outstanding shares of the Fund is set forth in the table below.
|
Name &
Address
|
|
%
|
|
National Financial Services LLC
|
|
28.63%
|
|
Newport Office Center 3
|
|
|
|
499 Washington Blvd., NJ4C
|
|
|
|
Jersey City, NJ 07310
|
|
|
|
|
|
|
|
LPL Financial LLC
|
|
15.45%
|
|
4707 Executive Drive
|
|
|
|
San Diego, CA 92121-1968
|
|
|
|
|
|
|
|
Charles Schwab & Co., Inc.
|
|
13.73%
|
|
2423 E Lincoln Drive
|
|
|
|
Phoenix, Arizona 85016-1215
|
|
|
|
|
|
|
|
Pershing LLC
|
|
10.02%
|
|
1 Pershing Plaza
|
|
|
|
Jersey City, NJ 07399
|
|
|
|
|
|
|
|
TD Ameritrade Clearing, Inc.
|
|
8.94%
|
|
4211 S. 102nd Street
|
|
|
|
Omaha, NE 68127
|
|
|
|
|
|
|
|
The Bank of New York Mellon
|
|
5.14%
|
|
525 William Penn Place
|
|
|
|
Suite 153-0400
|
|
|
|
Pittsburgh, PA 15259
|
|
|
MANAGEMENT
SERVICES
The
following information supplements and should be read in conjunction with the section in the Prospectus entitled “Management
of the Fund.”
ADVISER.
The Fund’s investment adviser is Virtus ETF Advisers LLC, located at 1540 Broadway, New York,
New York 10036. The Adviser was organized as a Delaware limited liability company in August 2013 and is an indirect wholly-owned
subsidiary of Virtus Investment Partners, Inc. (Ticker: VRTS) (together with its affiliates, “Virtus”). Virtus
is a public company that operates a multi-manager asset management business and has substantial experience in the investment management
and investment company industries. As of December 31, 2019, on a collective basis, Virtus-affiliated registered investment advisers
managed approximately $109 billion in assets. The Adviser has served as the investment adviser to the Fund since the inception
of the Fund’s operations. The Adviser also serves as investment adviser to each other series of the Trust and each series
of Virtus ETF Trust II, an open end management investment company registered with the SEC. The Adviser is responsible for the
oversight and management of all service providers to the Trust.
The
Adviser has overall responsibility for the general management and administration of the Trust, pursuant to an investment advisory
agreement between the Trust, on behalf of the Fund, and the Adviser (the “Advisory Agreement”). The Advisory
Agreement is effective for an initial two-year period and will remain in effect thereafter only so long as such renewal and continuance
is specifically approved at least annually by the Board or by vote of a majority of the Fund’s outstanding voting securities,
provided the continuance is also approved by a majority of the Independent Trustees. The Advisory Agreement is terminable without
penalty on 60 days’ notice by the Board or by vote of a majority of the outstanding voting securities of the Fund. The Advisory
Agreement provides that it will terminate automatically in the event of its “assignment,” as such term is defined
in the 1940 Act.
Under
the Advisory Agreement, the Adviser is not liable for any error of judgment or mistake of law or for any loss suffered by the
Fund in connection with the matters to which the Advisory Agreement relates, except a loss resulting from a breach of fiduciary
duty with respect to the receipt of compensation for services; or a loss resulting from willful misfeasance, bad faith or gross
negligence on the part of the Adviser in the performance of its duties; or from the reckless disregard of its duties and obligations
under the Advisory Agreement.
The
Adviser has engaged the Sub-Adviser to manage the Fund’s investments in accordance with the stated investment objective
and policies of the Fund, subject to the oversight and supervision of the Adviser and the Board, and will oversee the Sub-Adviser’s
compliance with the terms and conditions of the ETF exemptive order issued to the Adviser and the Trust.
Adviser
Compensation. Effective January 1, 2020, the Adviser contractually agreed to reduce its management fee to the annual rate
of 0.45% of the Fund’s average daily net assets. Prior to January 1, 2020, the Adviser received monthly compensation from
the Fund at the annual rate of 0.70% of the Fund’s average daily net assets. The Fund paid the Adviser advisory fees equal
to $1,221,742, $928,278 and $233,044 (net of reimbursements) for the fiscal years ended October 31, 2017, 2018 and 2019, respectively.
Expense
Limitation Agreement. The Adviser has entered into an expense limitation agreement (“Expense Limitation Agreement”)
to limit the Fund’s total operating expenses (excluding interest, taxes, brokerage fees and commissions, other expenditures
that are capitalized in accordance with generally accepted accounting principles, acquired fund fees and expenses, other extraordinary
expenses not incurred in the ordinary course of the Fund’s business, and amounts, if any, payable pursuant to a plan adopted
in accordance with Rule 12b-1 under the 1940 Act) so that such expenses do not exceed 0.49% of the Fund’s average daily
net assets through at least February 28, 2021. While the Adviser or the Fund may discontinue the Expense Limitation Agreement
after the contractual period, it may only be terminated during its term by either party upon written notice; provided that such
termination shall require the approval of the Fund’s Board of Trustees. Pursuant to the Expense Limitation Agreement, the
Adviser may recapture operating expenses waived or reimbursed under this arrangement for a period of three years following the
date on which such waiver or reimbursement occurred; provided that such recapture may not cause the Fund’s total operating
expenses to exceed 0.49% of the average daily net assets of the Fund (or any lower expense limitation or limitations to which
the Fund and the Adviser may otherwise agree).
For the fiscal years ended
October 31, 2017, 2018 and 2019, the Adviser waived fees and reimbursed expenses for the Fund as follows. The Fund may recoup
such waivers until the date indicated.
|
|
|
Expenses
|
|
Recoupment
|
|
Recoupment
|
|
Fund
|
|
Reimbursed
|
|
Balance
|
|
Expiration
|
|
2017
|
|
$83,625
|
|
$83,625
|
|
10/31/20
|
|
2018
|
|
$81,340
|
|
$81,340
|
|
10/31/21
|
|
2019
|
|
$135,034
|
|
$135,034
|
|
10/31/22
|
SUB-ADVISER.
The Fund’s Sub-Adviser is Newfleet Asset Management, LLC, located at 100 Pearl Street, Hartford, Connecticut 06103.
The Sub-Adviser serves in that capacity pursuant to a sub-advisory contract (the “Sub-Advisory Agreement”)
with the Trust on behalf of the Fund as approved by the Board. The Sub-Adviser makes day-to-day investment decisions for the Fund
and selects broker-dealers for executing portfolio transactions, subject to the Sub-Adviser’s best execution obligations
and the Trust’s and the Sub-Adviser’s brokerage policies. The Adviser, however, will continue to have overall responsibility
for the management and investment of the assets and responsibility for all advisory services furnished by the Sub-Adviser, and
will supervise the Sub-Adviser in the performance of its duties for the Fund pursuant to written policies and procedures designed
to prevent violations of applicable laws and regulations, Board procedures, and the provisions of the Fund’s prospectus
and SAI, as supplemented from time to time.
The
Sub-Adviser is an indirect, wholly-owned subsidiary of a publicly-traded company, Virtus Investment Partners, Inc., and has been
providing investment advisory services since 1989. In addition to the Fund, the Sub-Adviser provides investment advisory services
to foundations, endowments, trusts, pension and profit sharing plans, corporations, public funds, multi-employer plans, a privately
placed comingled trust and private clients, and provides sub-advisory services to registered investment companies and other private
and institutional clients. As of December 31, 2019, the Sub-Adviser had approximately $10.61 billion in assets under management.
Sub-Adviser
Compensation. As full compensation for its services to the Fund, the Sub-Adviser receives monthly compensation at the annual
rate of 50% of the Adviser’s net advisory fee, which means that, in the event the Adviser waives its entire fee and also
assumes expenses of the Trust pursuant to an applicable expense limitation agreement, the Sub-Adviser will similarly waive its
entire fee and will share in the expense assumption by promptly paying to the Adviser (or its designee) 50% of the assumed amount.
If during the term of the Sub-Advisory Agreement the Adviser later recaptures some or all of fees waived or expenses reimbursed
by the Adviser and the Sub-Adviser together, then the Adviser will pay to the Sub-Adviser 50% of the amount recaptured.
PORTFOLIO
MANAGERS.
Ownership of Fund Shares. The
following employees of the Sub-Adviser are the Fund’s portfolio managers: David L. Albrycht and Benjamin Caron. The table
below shows, for each portfolio manager, the value of shares of the Fund beneficially owned, as of October 31, 2019, and stated
as one of the following ranges: A = None; B = $1–$10,000; C = $10,001–$50,000; D = $50,001–$100,000; E = $100,001-$500,000;
F = $500,001-$1,000,000; and G = over $1,000,000.
Name
of
Portfolio Manager
|
Dollar
Range of Equity
Securities in the Fund
|
|
David
L. Albrycht
|
A
|
|
Benjamin Caron
|
A
|
Other
Accounts. In addition to the Fund, the portfolio managers are responsible for the day-to-day management of certain other accounts.
The table below shows the number of, and total assets in, such other accounts as of October 31, 2019. Except as indicated, none
of these accounts has an advisory fee based on the performance of the account.
|
|
Total
number of other accounts managed by Portfolio Manager(s) within each category below and the total assets in the accounts managed
within each category below.
|
|
Name
|
Registered
Investment Companies
|
Other
Pooled Investment Vehicles
|
Other
Accounts
|
|
Number
of Accounts
|
Total
Assets
(in
millions)
|
Number
of Accounts
|
Total
Assets
(in
millions)
|
Number
of Accounts
|
Total
Assets (in millions)
|
|
David
Albrycht
|
17
|
$9,301.6
|
2
|
$83.6
|
0
|
0
|
|
Benjamin Caron
|
5
|
$1,095.1
|
0
|
0
|
0
|
0
|
|
|
For
other accounts managed by Portfolio Manager(s) within each category below, number of accounts and the total assets in the
accounts with respect to which the advisory fee is based on the performance of the account.
|
|
Name
|
Registered
Investment Companies
|
Other
Pooled Investment Vehicles
|
Other
Accounts
|
|
Number
of Accounts
|
Total
Assets
(in millions)
|
Number
of Accounts
|
Total
Assets
(in
millions)
|
Number
of Accounts
|
Total
Assets (in millions)
|
|
David
Albrycht
|
2
|
$242.7
|
0
|
0
|
0
|
0
|
|
Benjamin Caron
|
0
|
0
|
0
|
0
|
0
|
0
|
Material
Conflicts of Interest. Because each of the portfolio managers may at times manage multiple portfolios for multiple clients,
the potential for conflicts of interest exists. The portfolio managers may manage portfolios having substantially the same investment
style as the Fund. However, the portfolios managed by the portfolio managers may not have portfolio compositions identical to
those of the Fund due, for example, to specific investment limitations or guidelines present in some portfolios or accounts, but
not others. The portfolio managers may purchase securities for one portfolio and not another portfolio, and the performance of
securities purchased for one portfolio may vary from the performance of securities purchased for other portfolios. The portfolio
managers may place transactions on behalf of other accounts that are directly or indirectly contrary to investment decisions made
on behalf of the Fund, or make investment decisions that are similar to those made for the Fund, both of which have the potential
to adversely impact the Fund depending on market conditions. For example, the portfolio managers may purchase a security in one
portfolio while appropriately selling that same security in another portfolio. In addition, some of these portfolios may have
fee structures that are or have the potential to be higher than the advisory fees paid by the Fund, which can cause potential
conflicts in the allocation of investment opportunities between the Fund and the other accounts. In addition, current trading
practices would not allow the Sub-Adviser to intentionally favor one portfolio over another as trades are executed as trade orders
are received.
Compensation.
The portfolio managers are compensated by the Sub-Adviser and do not receive any compensation directly from the Fund or the Adviser.
Each portfolio manager receives their compensation in the form of base salary that is determined by the advisory fee revenue generated
by the firm’s assets under management. Thus, portfolio manager compensation is aligned with the interests of the firm’s
clients, including the Fund and its investors. The portfolio managers may also earn a bonus each year based on the profitability
of the Sub-Adviser.
OTHER
SERVICE PROVIDERS
ADMINISTRATOR. Under
the Administrative Services Agreement, Virtus ETF Solutions LLC (the “Administrator”) serves as the
operational administrator of the Trust. The Administrator’s address is 1540 Broadway, New York, New York 10036. Under
the Administrative Services Agreement, the Administrator supervises the overall administration of the Trust and the Fund
including, among other responsibilities, the coordination and day-to-day oversight of the Fund’s operations, the
service providers’ communications with the Fund and each other and assistance with Trust, Board and contractual matters
related to the Fund and other series of the Trust. The Administrator also provides persons satisfactory to the Board to serve
as officers of the Trust. The Administrator will be indemnified in connection with or arising out of performance of its
obligations and duties under this Agreement, except for losses resulting from the willful malfeasance, bad faith or gross
negligence of Administrator in the performance of such obligations and duties. The Fund paid the Administrator fees equal to
$18,648, $13,714 and $5,248 for the fiscal years ended October 31, 2017, 2018 and 2019, respectively.
ACCOUNTING,
CUSTODIAN AND TRANSFER AGENT. Under the Fund Administration and Accounting Agreement (the “Accounting Services Agreement”),
The Bank of New York Mellon (“BNY Mellon” or the “Accounting Services Administrator”) serves
as accounting administrator for the Fund. BNY Mellon’s principal address is 240 Greenwich Street, New York, New York 10286.
Under the Accounting Services Agreement, BNY Mellon provides necessary administrative, legal, tax, accounting services and financial
reporting for the maintenance and operations of the Trust and the Fund. In addition, BNY Mellon makes available the office space,
equipment, personnel and facilities required to provide such services. BNY Mellon is the principal operating subsidiary of The
Bank of New York Mellon Corporation.
BNY Mellon provides accounting and
administration services to the Trust, including, among other responsibilities, assisting in the preparation and filing of
documents required for compliance by the Fund with applicable laws and regulations and arranging for the maintenance of books
and records of the Fund. The Fund paid BNY Mellon fees for accounting and administration services equal to $177,668, $106,291
and $84,432 for the fiscal years ended October 31, 2017, 2018 and 2019 , respectively.
BNY
Mellon serves as custodian of the Fund’s assets (the “Custodian”). The Custodian has agreed to (1) make
receipts and disbursements of money on behalf of the Fund; (2) collect and receive all income and other payments and distributions
on account of the Fund’s portfolio investments; (3) respond to correspondence from Fund shareholders and others relating
to its duties; and (4) make periodic reports to the Fund concerning the Fund’s operations. The Custodian does not exercise
any supervisory function over the purchase and sale of securities.
BNY
Mellon serves as transfer agent and dividend paying agent for the Fund (the “Transfer Agent”). The Transfer
Agent has agreed to (1) issue and redeem Shares of the Fund; (2) make dividend and other distributions to shareholders of the
Fund; (3) respond to correspondence by Fund shareholders and others relating to its duties; (4) maintain shareholder accounts;
and (5) make periodic reports to the Fund.
DISTRIBUTOR.
VP Distributors, LLC (the “Distributor”) is located at One Financial Plaza, Hartford,
CT 06103. The Distributor is a broker-dealer registered under the Securities Exchange Act of 1934 (the “Exchange Act”),
and a member of the Financial Industry Regulatory Authority, Inc. (“FINRA”).
Shares
will be continuously offered for sale by the Trust through the Distributor only in whole Creation Units, as described in the section
of this SAI entitled “Purchase and Redemption of Creation Units”. The Distributor also acts as an agent for the Trust.
The Distributor will deliver a Prospectus to persons purchasing Shares in Creation Units and will maintain records of both orders
placed with it and confirmations of acceptance furnished by it. The Distributor has no role in determining the investment policies
of the Fund or which securities are to be purchased or sold by the Fund.
PAYMENTS
TO FINANCIAL INTERMEDIARIES. The Adviser, the Sub-Adviser or their respective affiliates may, out of their own resources,
pay amounts to third parties for distribution or marketing services on behalf of the Fund. Additionally, the Adviser, the Sub-Adviser
or their respective affiliates may pay, out of their own resources, amounts to financial intermediaries for assistance with communication,
distribution of materials and other services for their clients that are shareholders of the Fund, or for other services in connection
with the organization or operation of the Fund. The making of these payments could create a conflict of interest for a financial
intermediary receiving such payments.
INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM. The Board has selected the firm of PricewaterhouseCoopers LLP, located at Two Commerce
Square, Suite 1800, 2001 Market Street, Philadelphia, PA 19103, to serve as the independent registered public accounting firm
for each Fund for the current fiscal year, to audit the annual financial statements of the Funds and to sign as Paid Preparer
the federal and state tax returns, as well as apply procedures to the required distribution calculation for federal excise tax
purposes. The Board has selected the firm of PricewaterhouseCoopers LLP, located at Two Commerce
Square, Suite 1800, 2001 Market Street, Philadelphia, PA 19103, to serve as the independent registered public accounting firm
for the Fund for the current fiscal year, to audit the annual financial statements of the Fund and to prepare the Fund’s
federal, state and excise tax returns. Such firm will audit the financial statements of the Fund at least once each year. A copy
of the most recent annual report containing the audit report will accompany this SAI whenever a shareholder or a prospective investor
requests it.
LEGAL
COUNSEL. Stradley Ronon Stevens& Young, LLP, located at 2005 Market Street, Suite 2600, Philadelphia, PA 19103-7018, serves
as legal counsel to the Trust and the Independent Trustees.
SECURITIES
LENDING
Subject
to certain investment restrictions, the Fund may, subject to the Trustees’ and Trust Treasurer’s approval, lend securities
from its portfolio to brokers, dealers and financial institutions deemed creditworthy and receive, as collateral, cash or cash
equivalents which at all times while the loan is outstanding will be maintained in amounts equal to at least 100% of the current
market value of the loaned securities. Any cash collateral will be invested in short-term securities that will increase the current
income of the Fund lending its securities.
The
Fund will have the right to regain record ownership of loaned securities to exercise beneficial rights such as voting rights and
subscription rights. While a securities loan is outstanding, the Fund is to receive an amount equal to any dividends, interest
or other distributions with respect to the loaned securities. The Fund may pay reasonable fees to persons unaffiliated with the
Trust for services in arranging such loans.
Even
though securities lending usually does not impose market risks on the lending Fund, as with any extension of credit, there are
risks of delay in recovery of the loaned securities and in some cases loss of rights in the collateral should the borrower of
the securities fail financially. In addition, the value of the collateral taken as security for the securities loaned may decline
in value or may be difficult to convert to cash in the event that the Fund must rely on the collateral to recover the value of
the securities. Moreover, if the borrower of the securities is insolvent, under current bankruptcy law, the Fund could be ordered
by a court not to liquidate the collateral for an indeterminate period of time. If the borrower is the subject of insolvency proceedings
and the collateral held might not be liquidated, the result could be a material adverse impact on the liquidity of the lending
Fund.
The
Fund will not lend securities having a value in excess of 33 1/3% of its assets, including collateral received for loaned securities
(valued at the time of any loan).
During
the fiscal year ended October 31, 2019, the Fund did not engage in securities lending.
PORTFOLIO
TRANSACTIONS AND BROKERAGE
Subject
to the general supervision of the Board and the Adviser, the Sub-Adviser is responsible for, makes decisions with respect to and
places orders for all purchases and sales of portfolio securities for, the Fund. The Sub-Adviser will manage the Fund’s
portfolio in accordance with the terms of the Sub-Advisory Agreement by and among the Trust, on behalf of the Fund, the Sub-Adviser
and the Adviser. The Sub-Adviser serves as investment adviser for a number of client accounts, in addition to the Fund.
BROKERAGE
SELECTION. The Fund has adopted, and the Board has approved, policies and procedures relating
to the direction of portfolio securities transactions to brokers. In accordance with these policies and procedures, in selecting
brokers to be used in portfolio transactions, the Sub-Adviser’s general guiding principle is to obtain the best overall
execution for each trade, which is a combination of price and execution. With respect to execution, the Sub-Adviser considers
a number of factors, including, without limitation, the size of the order, the difficulty of execution, the efficiency of the
facilities of the executing broker-dealer (including research services), any risk assumed by an executing broker-dealer and other
factors that may be unique to a particular order. Recognizing the value of these judgmental factors, the Sub-Adviser may select
brokers that charge a brokerage commission that is higher than the lowest commission that might otherwise be available for any
given trade. The Sub-Adviser may not give consideration to sales of Shares of the Fund as a factor in selecting brokers to execute
portfolio transactions. The Sub-Adviser may, however, place portfolio transactions with brokers that are affiliated with the Adviser
or the Sub-Adviser or that promote or sell the Fund’s Shares, so long as such transactions are done in accordance with the
policies and procedures established by the Board that are designed to ensure that the selection is consistent with the Sub-Adviser’s
obligation to seek best execution and not based upon the broker’s sales efforts. During the fiscal years ended October 31,
2017, 2018 and 2019, the Fund paid brokerage commissions of $0, $673 and $0, respectively.
Under
Section 28(e) of the Exchange Act and the Sub-Advisory Agreement, the Sub-Adviser may, in its discretion, purchase and sell portfolio
securities from and to brokers and dealers who provide the Sub-Adviser with brokerage, research, analysis, advice and similar
services, and the Sub-Adviser may pay to these brokers and dealers, in return for such services, a higher commission or spread
than may be charged by other brokers and dealers, provided that the Sub-Adviser determines in good faith that such commission
is reasonable in terms either of that particular transaction or of the overall responsibility of the Sub-Adviser to the Fund and
its other clients and that the total commission paid by the Fund will be reasonable in relation to the benefits to the Fund and
its other clients over the long-term. The research received by the Sub-Adviser may include, without limitation: information on
the United States and other world economies; information on specific industries, sectors, groups of securities, individual companies,
and political and other relevant news developments affecting markets and specific securities; technical and quantitative information
about markets; analysis
of
proxy proposals affecting specific companies; accounting and performance systems that allow the Sub-Adviser to determine and track
investment results; and trading systems that allow the Sub-Adviser to interface electronically with brokerage firms, custodians
and other providers. Research is received in the form of written reports, telephone contacts, personal meetings, research seminars,
software programs and access to computer databases. In some instances, research products or services received by the Sub-Adviser
may also be used by the Sub-Adviser for functions that are not research related (i.e. not related to the making of investment
decisions). Where a research product or service has a mixed use, the Sub-Adviser will make a reasonable allocation according to
its use and will pay for the non-research function in cash using its own funds.
The
research and investment information services described above make available to the Sub-Adviser for its analysis and consideration
the views and information of individuals and research staffs of other securities firms. These services may be useful to the Sub-Adviser
in connection with advisory clients other than the Fund, and not all such services may be useful to the Sub-Adviser in connection
with the Fund. Although such information may be a useful supplement to the Sub-Adviser’s own investment research in rendering
services to the Fund, the value of such research and services is not expected to materially reduce the expenses of the Sub-Adviser
in the performance of its services under the Sub-Advisory Agreement and will not reduce the advisory fees payable by the Fund.
The
Fund may invest in securities traded in the over-the-counter market. In these cases, the Fund may initiate trades through brokers
on an agency basis and may pay a commission in connection with the transaction. The Fund may also effect these transactions by
dealing directly with the dealers that make a market in the securities involved, in which case the costs of such transactions
would involve dealer spreads rather than brokerage commissions.
PORTFOLIO
TURNOVER. The portfolio turnover rate for the Fund is calculated by dividing the lesser of purchases or sales of portfolio
securities for the reporting period by the monthly average value of the portfolio securities owned during the reporting period.
The calculation excludes all securities whose maturities or expiration dates at the time of acquisition are one year or less.
Portfolio turnover of the Fund may vary greatly from year to year as well as within a particular year, and may be affected by
cash requirements for redemption of Shares and by requirements that enable the Fund to receive favorable tax treatment. Portfolio
turnover will not be a limiting factor in making investment decisions, and the Fund may engage in short-term trading to achieve
its investment objectives. High rates of portfolio turnover could lower performance of the Fund due to increased transaction costs
and may also result in the realization of short-term capital gains taxed at ordinary income tax rates.
DISCLOSURE
OF PORTFOLIO HOLDINGS
PORTFOLIO
DISCLOSURE POLICY. The Trust has adopted a Portfolio Holdings Policy (the “Policy”) designed to govern
the disclosure of Fund portfolio holdings and the use of material non-public information about Fund holdings. The Policy applies
to all officers, employees and agents of the Fund. The Policy is designed to ensure that the disclosure of information about the
Fund’s portfolio holdings is consistent with applicable legal requirements and otherwise in the best interest of the Fund.
As
an ETF, information about the Fund’s portfolio holdings is made available on a daily basis in accordance with the provisions
of any order of the SEC applicable to the Fund, the regulations of the Exchange and other applicable SEC regulations, orders and
no-action relief. Such information typically reflects all or a portion of the Fund’s anticipated portfolio holdings as of
the next Business Day (as defined below). This information is used in connection with the creation and redemption process and
is disseminated on a daily basis through the facilities of the Exchange, the National Securities Clearing Corporation (the “NSCC”)
and/or third party service providers.
A
“Business Day” with respect to the Fund is any day on which the Exchange is open for business. As of the date
of this SAI, the Exchange observes the following holidays: New Year’s Day, Martin Luther King, Jr. Day, Presidents’
Day, Good Friday, Memorial Day (observed), Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
The
Trust will disclose on the Fund’s website at the start of each Business Day the identities and quantities of the securities
and other assets held by the Fund that will form the basis of the Fund’s calculation of its NAV on that Business Day. The
portfolio holdings so disclosed will be based on information as of the close of business on the prior Business Day and/or trades
that have been completed prior to the opening of business on that Business Day and that are expected to settle on the Business
Day. Online disclosure of such holdings is publicly available at no charge. The website for the Fund is www.virtusetfs.com.
The
Fund may also send a portion or all of this information to shareholders of the Fund and to investment company analysts and rating
and trading entities. However, the Fund will not send this information to shareholders of the Fund or to analysts or rating and/or
trading entities until such information is at least 30 days old or until one Business Day after the information has been posted
to the Fund’s website.
The officers of the Trust, the Adviser and/or the Sub-Adviser may share non-public portfolio holdings
information with the Fund’s service providers that require such information for legitimate business and Fund oversight purposes,
such as the Fund’s operating administrator, fund accounting administrator, transfer agent, distributor, custodian, independent
registered public accounting firm, legal counsel as identified in the Fund’s Prospectus and this SAI, and Doremus FP and
Quality EDGAR Solutions (financial EDGARizing, typesetting and printing firms). The Fund, the Adviser and/or the Sub-Adviser may
also provide non-public portfolio holdings information to appropriate regulatory agencies as required by applicable laws and regulations.
The Fund’s service providers receiving such non-public information are subject to confidentiality obligations requiring such
service providers to keep non-public portfolio holdings information confidential. Certain of the service providers have codes of
ethics that prohibit trading based on, among other things, non-public portfolio holdings information.
The
Fund’s policies regarding disclosure of portfolio holdings are subject to the continuing oversight and direction of the
Board. The Adviser, the Sub-Adviser and the Administrator are required to report to the Board any known disclosure of the Fund’s
portfolio holdings to unauthorized third parties. The Fund has not entered (and does not currently intend to enter) into any arrangement
providing for the receipt of compensation or other consideration in exchange for the disclosure of non-public portfolio holdings
information, other than the benefits that result to the Fund and its shareholders from providing such information, which include
the publication of Fund ratings and rankings.
The Fund is also required to make available to the public a complete schedule of its portfolio holdings,
as reported on a fiscal quarter basis. This information is generally available within 60 days of the Fund’s fiscal quarter
end and will remain available until the next fiscal quarter’s portfolio holdings report becomes available. You may obtain
a copy of these quarterly portfolio holdings reports by calling the Fund at (888) 383-0553. The Fund will also file these quarterly
portfolio holdings reports with the SEC on Form N-CSR or Form N-PORT, as applicable. The Fund’s Form N-CSR and Form N-PORT
filings are available on the SEC’s website at http://www.sec.gov. The first and third quarter portfolio holdings reports
will be filed with the SEC as an exhibit to the Fund’s reports on Form N-PORT, and the second and fourth fiscal quarter portfolio
holdings reports will be included with the semi-annual and annual reports, respectively, which are sent to shareholders and filed
with the SEC on Form N-CSR.
INDICATIVE
INTRA-DAY VALUE
The
approximate value of the Fund’s investments on a per-Share basis, the Indicative Intra-Day Value (“IIV”),
is disseminated by the Exchange every 15 seconds during hours of trading on the Exchange. The IIV should not be viewed as a “real-time”
update of NAV because the IIV will be calculated by an independent third party and may not be calculated in the exact same manner
as NAV, which is computed once per day.
The
IIV for the Fund is calculated during hours of trading on the Exchange by dividing the “Estimated Fund Value” as of
the time of the calculation by the total number of outstanding Shares. “Estimated Fund Value” is the sum of the estimated
amount of cash held in the Fund’s portfolio, the estimated amount of accrued interest owing to the Fund and the estimated
value of the securities held in the Fund’s portfolio, minus the estimated amount of the Fund’s liabilities. The IIV
will be calculated based on the same portfolio holdings disclosed on the Fund’s website. In determining the estimated value
for each of the component securities, the IIV will use last sale, market prices or other methods that would be considered appropriate
for pricing equity securities held by registered investment companies.
The
IIV calculations are based on local market prices and may not reflect events that occur subsequent to the local market’s
close, which could affect premiums and discounts between the IIV and the market price of the Fund’s Shares. Although the
Trust provides the information used to calculate the IIV, the Trust is not involved in the actual calculation of the IIV and is
not responsible for the calculation or dissemination of the IIV. The Trust makes no warranty as to the accuracy of the IIV.
ADDITIONAL
INFORMATION CONCERNING SHARES
ORGANIZATION
AND DESCRIPTION OF SHARES OF BENEFICIAL INTEREST. The Trust is a Delaware statutory trust and a registered investment company.
The Trust was organized on September 20, 2012, and it has authorized capital of an unlimited number of Shares of beneficial interest
of no par value, which may be issued in more than one class or series.
Under
Delaware law, the Trust is not required to hold an annual shareholders meeting if the 1940 Act does not require such a meeting.
Generally, there will not be annual meetings of Trust shareholders. If requested by shareholders of at least one-third of the
outstanding shares of the Trust or any series thereof, the Trust will call a meeting of the shareholders of the Trust or the series,
as applicable. Shareholders holding two-thirds of all Trust shares outstanding may remove Trustees from office by votes cast at
a meeting of Trust shareholders or by written consent.
All
Shares will be freely transferable; provided, however, that Shares may not be redeemed individually, but only in Creation Units.
The Shares will not have preemptive rights or cumulative voting rights, and none of the Shares will have any preference to conversion,
exchange, dividends, retirements, liquidation, redemption or any other feature. Shares have equal voting rights, except that,
if the Trust creates additional series, only shares of that series may be entitled to vote on a matter affecting that particular
series. Trust shareholders are entitled to require the Trust to redeem Creation Units if such shareholders are Authorized Participants.
The Declaration of Trust confers upon the Board the power, by resolution, to alter the number of Shares constituting a Creation
Unit or to specify that Shares of the Trust may be individually redeemable. The Trust reserves the right to adjust the prices
of Shares to maintain convenient trading ranges for investors. Any such adjustments would be accomplished through splits or reverse
splits, which would have no effect on the net assets of the Fund. If the Fund does not grow to a size to permit it to be economically
viable, the Fund may cease operations. In such an event, you may be required to liquidate or transfer your Shares at an inopportune
time and you may lose money on your investment.
BOOK
ENTRY ONLY SYSTEM. Depository Trust Company (“DTC”) acts as securities depository for the Fund’s
Shares. Shares of the Fund are represented by securities registered in the name of DTC or its nominee, Cede & Co., and deposited
with, or on behalf of, DTC.
DTC,
a limited-purpose trust company, was created to hold securities of its participants (the “DTC Participants”)
and to facilitate the clearance and settlement of securities transactions among the DTC Participants in such securities through
electronic book-entry changes in accounts of the DTC Participants, thereby eliminating the need for physical movement of securities
certificates. DTC Participants include securities brokers and dealers, banks, trust companies, clearing corporations and certain
other organizations, some of which (and/or their representatives) own DTC. More specifically, DTC is owned by a number of its
DTC Participants and by the New York Stock Exchange, LLC and FINRA. Access to the DTC system is also available to others such
as banks, brokers, dealers and trust companies that clear through or maintain a custodial relationship with a DTC Participant,
either directly or indirectly (the “Indirect Participants”).
Beneficial
ownership of Shares is limited to DTC Participants, Indirect Participants and persons holding interests through DTC Participants
and Indirect Participants. Ownership of beneficial interests in Shares (owners of such beneficial interests are referred to herein
as “Beneficial Owners”) is shown on, and the transfer of ownership is effected only through, records maintained
by DTC (with respect to DTC Participants) and on the records of DTC Participants (with respect to Indirect Participants and Beneficial
Owners that are not DTC Participants). Beneficial Owners will receive from or through the DTC Participant a written confirmation
relating to their purchase of Shares.
Conveyance
of all notices, statements and other communications to Beneficial Owners is effected as follows. Pursuant to the Depositary Agreement
between the Trust and DTC, DTC is required to make available to the Trust upon request and for a fee to be charged to the Trust
a listing of the Shares of the Fund held by each DTC Participant. The Trust will inquire of each DTC Participant as to the number
of Beneficial Owners holding Shares, directly or indirectly, through such DTC Participant. The Trust will provide each DTC Participant
with copies of such notice, statement or other communication, in such form, number and at such place as such DTC Participant may
reasonably request, in order that such notice, statement or communication may be transmitted by the DTC Participant, directly
or indirectly, to such Beneficial Owners. In addition, the Trust will pay to each DTC Participants a fair and reasonable amount
as reimbursement for the expenses attendant to such transmittal, all subject to applicable statutory and regulatory requirements.
Share
distributions will be made to DTC or its nominee, Cede & Co., as the registered holder of all Shares. DTC or its nominee,
upon receipt of any such distributions, will credit immediately with respect to the DTC Participants’ accounts with payments
in amounts proportionate to their respective beneficial interests in Shares of the Fund as shown on the records of DTC or its
nominee. Payments by DTC Participants to Indirect Participants and Beneficial Owners with respect to the Shares held through such
DTC Participants will be governed by standing instructions and customary practices, as is now the case with securities held for
the accounts of customers in bearer form or registered in a “street name,” and will be the responsibility of such
DTC Participants.
The
Trust has no responsibility or liability for any aspect of the records relating to or notices to Beneficial Owners, or payments
made on account of beneficial ownership interests in such Shares, or for maintaining, supervising or reviewing any records relating
to such beneficial ownership interests, or for any other aspect of the relationship between DTC and the DTC Participants or the
relationship between the DTC Participants and the Indirect Participants and Beneficial Owners owning through such DTC Participants.
DTC
may decide to discontinue providing its service with respect to Shares at any time by giving reasonable notice to the Trust and
discharging its responsibilities with respect thereto under applicable law. Under such circumstances, the Trust will take action
to find a replacement for DTC to perform its functions at a comparable cost. The DTC Participants’ rules and policies are
made publicly available through DTC’s website at: www.dtcc.com.
PURCHASE
AND REDEMPTION OF CREATION UNITS
CREATION.
The Trust issues and sells Shares of the Fund only in Creation Units on a continuous basis through the Distributor, at their
NAV next determined after receipt, on any Business Day, for an order received in proper form.
Fund
Deposit. The consideration for purchase of a Creation Unit of the Fund generally consists of cash or an in-kind deposit of
Deposit Securities for each Creation Unit constituting a substantial replication, or a representation, of the securities included
in the Fund’s portfolio and a Cash Component computed as described below. Together, the Deposit Securities and the Cash
Component constitute the “Fund Deposit”, which represents the minimum initial and subsequent investment amount
for a Creation Unit of the Fund. The Cash Component is an amount equal to the difference between the NAV of the Shares (per Creation
Unit) and the market value of the Deposit Securities. If the Cash Component is a positive number (i.e., the NAV per Creation Unit
exceeds the market value of the Deposit Securities), the Cash Component will be such positive amount. If the Cash Component is
a negative number (i.e., the NAV per Creation Unit is less than the market value of the Deposit Securities), the Cash Component
will be such negative amount, and the creator will be entitled to receive cash from the Fund in an amount equal to the Cash Component.
The Cash Component serves the function of compensating for any differences between the NAV per Creation Unit and the market value
of the Deposit Securities.
The
Fund, through the NSCC, makes available on each Business Day, immediately prior to the opening of business on the Exchange (currently
9:30 a.m., Eastern time), the list of the names and the required number of Shares of each Deposit Security to be included in the
current Fund Deposit (based on information at the end of the previous Business Day) for the Fund. Such Fund Deposit is applicable,
subject to any adjustments as described below, in order to effect creations of Creation Units of the Fund until such time as the
next-announced composition of the Deposit Securities is made available.
The
identity and number of Shares of the Deposit Securities required for the Fund Deposit for the Fund changes as rebalancing adjustments
and corporate action events are reflected from time to time by the Sub-Adviser with a view to the investment objective of the
Fund. In addition, the Trust reserves the right to permit or require the substitution of an amount of cash - i.e., a “cash
in lieu” amount - to be added to the Cash Component to replace any Deposit Security that may not be available in sufficient
quantity for delivery, that may not be eligible for transfer through the Clearing Process (discussed below) or that may not be
eligible for trading by an Authorized Participant or the investor for which it is acting.
In
addition to the list of names and numbers of securities constituting the current Deposit Securities of the Fund Deposit, the Fund,
through NSCC, also makes available on each Business Day the estimated Cash Component, effective through and including the previous
Business Day, per outstanding Creation Unit of the Fund.
Procedures
for Creation of Creation Units. To be eligible to place orders to create a Creation Unit of the Fund, an entity must be (i)
a “Participating Party”, i.e., a broker-dealer or other participant in the clearing process through the Continuous
Net Settlement System of NSCC (the “Clearing Process”) or a clearing agency that is registered with the SEC,
or (ii) a DTC Participant (see “Book Entry Only System”) and, in each case, must have executed an agreement with the
Trust, the Distributor and the Transfer Agent with respect to creations and redemptions of Creation Units (“Participant
Agreement”). A Participating Party and DTC Participant are collectively referred to as an “Authorized Participant”.
Investors should contact the Distributor for the names of Authorized Participants that have signed a Participant Agreement with
the Fund. All Shares of the Fund, however created, will be entered on the records of DTC in the name of Cede & Co. for the
account of a DTC Participant.
All
orders to create Creation Units must be placed for one or more Creation Unit size aggregations of Shares (50,000 in the case of
the Fund). All orders to create Creation Units, whether through the Clearing Process (through a Participating Party) or outside
the Clearing Process (through a DTC Participant), must be received by the Distributor no later than 3:00 p.m. Eastern time (“Order
Cut-Off Time”), in each case on the date such order is placed in order for the creation of Creation Units to be effected
based on the NAV of Shares of the Fund as next determined on such date after receipt of the order in proper form. The date on
which an order to create Creation Units (or an order to redeem Creation Units as discussed below) is placed is referred to as
the “Transmittal Date”. Orders must be transmitted by an Authorized Participant by telephone or other transmission
method acceptable to the Distributor pursuant to procedures set forth in the Participant Agreement (see “Placement of Creation
Orders Using the Clearing Process” and “Placement of Creation Orders Outside the Clearing Process”). Severe
economic or market disruptions or changes, or telephone or other communication failure, may impede the ability to reach the Distributor
or an Authorized Participant.
Orders
to create Creation Units of the Fund will be placed with an Authorized Participant in the form required by such Authorized Participant.
In addition, an Authorized Participant may request the investor to make certain representations or enter into agreements with
respect to the order, i.e., to provide for payments of cash, when required. Investors should be aware that their particular broker
may not have executed a Participant Agreement, and that, therefore, orders to create Creation Units of the Fund will need to be
placed by the investor’s broker through an Authorized Participant that has executed a Participant Agreement. At any given
time there may be
only
a limited number of broker-dealers that have executed a Participant Agreement. Those placing orders for Creation Units through
the Clearing Process should afford sufficient time to permit proper submission of the order to the Distributor prior to the Order
Cut-Off Time on the Transmittal Date.
Orders
for creation that are effected outside the Clearing Process are likely to require transmittal of the Deposit Securities by the
DTC Participant earlier on the Transmittal Date than orders effected using the Clearing Process. Those persons placing orders
outside the Clearing Process should ascertain the deadlines applicable to DTC and the Federal Reserve Bank wire system by contacting
the operations department of the broker or depository institution effectuating the transfer of Deposit Securities and the Cash
Component.
Placement
of Creation Orders Using the Clearing Process. The Clearing Process is the process of creating or redeeming Creation Units
through the Continuous Net Settlement System of NSCC. Fund Deposits made through the Clearing Process must be delivered through
a Participating Party that has executed a Participant Agreement. The Participant Agreement authorizes the Distributor to transmit
through the Transfer Agent to NSCC, on behalf of the Participating Party, such trade instructions as are necessary to effect the
Participating Party’s creation order. Pursuant to such trade instructions to NSCC, the Participating Party agrees to deliver
the requisite Deposit Securities and the Cash Component to the Trust, together with such additional information as may be required
by the Distributor. An order to create Creation Units through the Clearing Process is deemed received by the Distributor on the
Transmittal Date if (i) such order is received by the Distributor not later than the Order Cut-Off Time on such Transmittal Date
and (ii) all other procedures set forth in the Participant Agreement are properly followed.
Placement
of Creation Orders Outside the Clearing Process. Fund Deposits made outside the Clearing Process must be delivered through
a DTC Participant that has executed a Participant Agreement. A DTC Participant that wishes to place an order creating Creation
Units to be effected outside the Clearing Process need not be a Participating Party, but such orders must state that the DTC Participant
is not using the Clearing Process and that the creation of Creation Units will instead be effected through a transfer of securities
and cash directly through DTC. A Fund Deposit transfer must be ordered by the DTC Participant on the Transmittal Date in a timely
fashion so as to ensure the delivery of the requisite number of Deposit Securities through DTC to the account of the Trust by
no later than 11:00 a.m., Eastern time, of the next Business Day immediately following the Transmittal Date. All questions as
to the number of Deposit Securities to be delivered, and the validity, form and eligibility (including time of receipt) for the
deposit of any tendered securities, will be determined by the Trust, whose determination will be final and binding. Cash equal
to the Cash Component must be transferred directly to the Trust through the Federal Reserve wire system in a timely manner so
as to be received by the Trust no later than 2:00 p.m., Eastern time, on the next Business Day immediately following such Transmittal
Date. An order to create Creation Units outside the Clearing Process is deemed received by the Distributor on the Transmittal
Date if (i) such order is received by the Distributor not later than the Order Cut-Off Time on such Transmittal Date, and (ii)
all other procedures set forth in the Participant Agreement are properly followed. However, if the Trust does not receive both
the requisite Deposit Securities and the Cash Component by 11:00 a.m. and 2:00 p.m., respectively, on the next Business Day immediately
following the Transmittal Date, such order will be cancelled. Upon written notice to the Distributor, such cancelled order may
be resubmitted the following Business Day using the Fund Deposit as newly constituted to reflect the then current NAV of the Fund.
The delivery of Creation Units of the Fund so created will occur no later than the second Business Day following the day on which
the purchase order is deemed received by the Distributor.
Creation
Units may be created in advance of receipt by the Trust of all or a portion of the applicable Deposit Securities as described
below. In these circumstances, the initial deposit will have a value greater than the NAV of the Shares on the date the order
is placed in proper form since, in addition to available Deposit Securities, cash must be deposited in an amount equal to the
sum of (i) the Cash Component plus (ii) 115% of the market value of the undelivered Deposit Securities (the “Additional
Cash Deposit”). The order will be deemed to be received on the Business Day on which the order is placed, provided that
the order is placed in proper form prior to the Order Cut-Off Time, on such date and federal funds in the appropriate amount are
deposited with the Trust by 11:00 a.m., Eastern time, the following Business Day. If the order is not placed in proper form by
the Order Cut-Off Time, or federal funds in the appropriate amount are not received by 11:00 a.m. the next Business Day, then
the order may be deemed to be rejected and the investor will be liable to the Trust for losses, if any, resulting therefrom. An
additional amount of cash will be required to be deposited with the Trust, pending delivery of the missing Deposit Securities
to the extent necessary to maintain the Additional Cash Deposit with the Trust in an amount at least equal to 115% of the daily
mark-to-market value of the missing Deposit Securities. To the extent that missing Deposit Securities are not received by 1:00
p.m., Eastern time, on the second Business Day following the day on which the purchase order is deemed received by the Distributor
or in the event a mark-to-market payment is not made within one Business Day following notification by the Distributor that such
a payment is required, the Trust may use the cash on deposit to purchase the missing Deposit Securities. Authorized Participants
will be liable to the Trust for the costs incurred by the Trust in connection with any such purchases. These costs will be deemed
to include the amount by which the actual purchase price of the Deposit Securities exceeds the market value of such Deposit Securities
on the day the purchase order was deemed received by the Distributor plus the brokerage and related transaction costs associated
with such purchases. The Trust will return any unused portion of the Additional Cash Deposit once all of the missing Deposit Securities
have been properly received by the Trust or purchased by the Trust and deposited into the Trust. In addition, a transaction fee
will be charged in all cases. The delivery of Creation Units of the Fund so
created
will occur no later than the second Business Day following the day on which the purchase order is deemed received by the Distributor.
Acceptance
of Orders for Creation Units. The Trust reserves the absolute right to reject a creation order transmitted to it by the Distributor
in respect of the Fund if (a) the order is not in proper form; (b) the investor(s), upon obtaining the Shares ordered, would own
80% or more of the currently outstanding Shares of the Fund; (c) the Deposit Securities delivered are not as disseminated through
the facilities of the Exchange for that date by the Trust, as described above; (d) acceptance of the Deposit Securities would
have certain adverse tax consequences to the Fund; (e) the acceptance of the Fund Deposit would, in the opinion of counsel, be
unlawful; (f) the acceptance of the Fund Deposit would otherwise, in the discretion of the Trust or the Adviser, have an adverse
effect on the Trust or the rights of Beneficial Owners; or (g) as a result of circumstances outside the control of the Trust,
the Distributor and the Adviser make it for all practical purposes impossible to process creation orders. Examples of such circumstances
include acts of God or public service or utility problems such as fires, floods, extreme weather conditions and power outages
resulting in telephone, facsimile or computer failures; market conditions or activities causing trading halts; systems failures
involving computer or other information systems affecting the Trust, the Adviser, the Distributor, DTC, NSCC or any other participant
in the creation process; and similar extraordinary events. The Distributor will notify a prospective creator of a Creation Unit
and/or the Authorized Participant acting on behalf of the creator of a Creation Unit of its rejection of the order of such person.
The Trust, the Transfer Agent and the Distributor are under no duty, however, to give notification of any defects or irregularities
in the delivery of Fund Deposits nor will any of them incur any liability for the failure to give any such notification.
All questions
as to the number of shares of each security in the Deposit Securities and the validity, form, eligibility and acceptance for deposit
of any securities to be delivered will be determined by the Trust, and the Trust’s determination will be final and binding.
Creation
Transaction Fee. To compensate the Trust for transfer and other transaction costs involved in creation transactions through
the Clearing Process, investors will be required to pay a minimum creation transaction fee, assessed per transaction, as follows:
|
Fund
Name
|
Creation
Transaction Fee
|
|
Virtus Newfleet Multi-Sector Bond ETF (Ticker:
NFLT)
|
$500
|
The
Trust, subject to approval by the Board, may adjust the fee from time to time based upon actual experience. Investors who use
the services of a broker or other such intermediary in addition to an Authorized Participant to effect a creation of a Creation
Unit may be charged a fee for such services.
REDEMPTION.
Shares may be redeemed only in Creation Units at their NAV next determined after receipt of a redemption request in proper
form by the Distributor and the Fund and only on a Business Day. The Trust will not redeem Shares in amounts less than Creation
Units. Beneficial Owners must accumulate enough Shares in the secondary market to constitute a Creation Unit in order to have
such Shares redeemed by the Trust. There can be no assurance, however, that there will be sufficient liquidity in the public trading
market at any time to permit assembly of a Creation Unit. Investors should expect to incur brokerage and other costs in connection
with assembling a sufficient number of Shares to constitute a redeemable Creation Unit.
With
respect to the Fund, the Trust, through NSCC, makes available immediately prior to the opening of business on the Exchange (currently
9:30 a.m., Eastern time) on each Business Day, the Deposit Securities that will be applicable (subject to possible amendment or
correction) to redemption requests received in proper form (as defined below) on that day. To the extent permitted by the Fund’s
exemptive relief, the Fund may, in its sole discretion, provide such redeemer a basket of cash and/or securities which differs
from the exact composition of the Deposit Securities but does not differ in NAV. Deposit Securities received on redemption may
not be identical to Deposit Securities which are applicable to creations of Creation Units.
The
Fund will typically effect redemptions principally for cash. To the extent that the Fund effects redemptions in kind, the redemption
proceeds for a Creation Unit generally consist of Deposit Securities, as announced by the Trust on the Business Day of the request
for redemption received in proper form, plus cash in an amount equal to the difference between the NAV of the Shares being redeemed,
as next determined after a receipt of a request in proper form, and the value of the Deposit Securities (the “Cash Redemption
Amount”), less a redemption transaction fee described below in the section entitled “Redemption Transaction Fee”.
In the event that the Deposit Securities have a value greater than the NAV of the Shares, a compensating cash payment equal to
the differential is required to be made by or through an Authorized Participant by the redeeming shareholder.
Placement
of Redemption Orders Using Clearing Process. Orders to redeem Creation Units through the Clearing Process must be delivered
through a Participating Party that has executed the Participant Agreement. An order to redeem Creation Units using the
Clearing
Process is deemed received on the Transmittal Date if (i) such order is received by the Trust not later than the Order Cut-Off
Time, on such Transmittal Date; and (ii) all other procedures set forth in the Participant Agreement are properly followed; such
order will be effected based on the NAV of the Fund as next determined. An order to redeem Creation Units using the Clearing Process
made in proper form but received by the Fund after the Order Cut-Off Time, will be deemed received on the next Business Day immediately
following the Transmittal Date and will be effected at the NAV next determined on such Business Day. To the extent that the Fund
effects redemptions in kind, the requisite Deposit Securities and the Cash Redemption Amount will be transferred by the second
Business Day following the date on which such request for redemption is deemed received.
Placement
of Redemption Orders Outside Clearing Process. Orders to redeem Creation Units outside the Clearing Process must be delivered
through a DTC Participant that has executed the Participant Agreement. A DTC Participant that wishes to place an order for redemption
of Creation Units to be effected outside the Clearing Process need not be a Participating Party, but such orders must state that
the DTC Participant is not using the Clearing Process and that redemption of Creation Units will instead be effected through transfer
of Shares directly through DTC. An order to redeem Creation Units outside the Clearing Process is deemed received by the Trust
on the Transmittal Date if (i) such order is received by the Trust not later than the Order Cut-Off Time on such Transmittal Date;
(ii) such order is accompanied or proceeded by the requisite number of Shares of the Fund and the Cash Redemption Amount specified
in such order, which delivery must be made through DTC to the Trust not later than 11:00 a.m. and 2:00 p.m., respectively, Eastern
time, on the next Business Day following such Transmittal Date (the “DTC Cut-Off-Time”); and (iii) all other
procedures set forth in the Participant Agreement are properly followed.
To
the extent that the Fund effects redemptions in kind, after the Trust has deemed an order for redemption outside the Clearing
Process received, the Trust will initiate procedures to transfer the requisite Deposit Securities, which are expected to be delivered
within two Business Days, and the Cash Redemption Amount to the Authorized Participant on behalf of the redeeming Beneficial Owner
by the second Business Day following the Transmittal Date on which such redemption order is deemed received by the Trust.
To
the extent that the Fund effects redemptions in kind, the calculation of the value of the Deposit Securities and the Cash Redemption
Amount to be delivered upon redemption will be made by the Trust according to the procedures set forth under “Determination
of Net Asset Value” computed on the Business Day on which a redemption order is deemed received by the Trust. Therefore,
if a redemption order in proper form is submitted to the Trust by a DTC Participant not later than the Order Cut-Off Time on the
Transmittal Date, and the requisite number of Shares of the Fund are delivered to the Custodian prior to the DTC Cut-Off-Time,
then the value of the Deposit Securities and the Cash Redemption Amount to be delivered will be determined by the Trust on such
Transmittal Date. In the event that the requisite number of Shares of the Fund are not delivered to the Custodian prior to the
DTC Cut-Off-Time, the Trust may deliver the Deposit Securities notwithstanding such deficiency in reliance on the undertaking
of the Authorized Participant to deliver the missing Shares as soon as possible, which undertaking shall be secured by the Authorized
Participant’s delivery, prior to the DTC Cut-Off-Time, and subsequent maintenance of collateral consisting of cash having
a value at least equal to 115% of the value of the missing Shares (the “Cash Collateral”). If, however, a redemption
order is submitted to the Trust by a DTC Participant not later than the Order Cut-Off Time on the Transmittal Date but either
(1) the requisite number of Shares of the Fund (including any Cash Collateral) are not delivered by the DTC Cut-Off-Time as described
above or (2) the redemption order is not submitted in proper form, then the redemption order will not be deemed received as of
the Transmittal Date. In such case, the value of the Deposit Securities and the Cash Redemption Amount to be delivered will be
computed on the Business Day that such order is deemed received by the Trust, i.e., the Business Day on which the Shares of the
Fund (including any Cash Collateral) are delivered through DTC to the Trust by the DTC Cut-Off-Time on such Business Day pursuant
to a properly submitted redemption order.
To
the extent that the Fund effects redemptions in kind, redemptions of Shares for Deposit Securities will be subject to compliance
with applicable federal and state securities laws, and the Trust (whether or not it otherwise permits cash redemptions) reserves
the right to redeem Creation Units for cash to the extent that the Trust could not lawfully deliver specific Deposit Securities
upon redemptions or could not do so without first registering the offering and sale of the Deposit Securities under such laws.
An Authorized Participant or an investor for which it is acting that is subject to a legal restriction with respect to a particular
security included in the Deposit Securities applicable to the redemption of a Creation Unit may be paid an equivalent amount of
cash. The Authorized Participant may request the redeeming Beneficial Owner of the Shares to complete an order form or to enter
into agreements with respect to such matters as compensating cash payment, beneficial ownership of Shares or delivery instructions.
The
right of redemption may be suspended or the date of payment postponed with respect to the Fund (1) for any period during which
the Exchange is closed (other than customary weekend and holiday closings); (2) for any period during which trading on the Exchange
is suspended or restricted; (3) for any period during which an emergency exists as a result of which disposal of the Shares of
the Fund or determination of the Shares’ NAV is not reasonably practicable; or (4) in such other circumstance as is permitted
by the SEC.
Redemption
Transaction Fee. To compensate the Trust for transfer and other transaction costs involved in redemption transactions through
the Clearing Process, investors will be required to pay a minimum redemption transaction fee, assessed per transaction as follows:
|
Fund
Name
|
Redemption
Transaction Fee
|
|
Virtus Newfleet Multi-Sector Bond ETF (Ticker:
NFLT)
|
$500
|
Where
Shares are redeemed for cash, the redemption transaction fee will be deducted from such redemption proceeds. The Trust, subject
to approval by the Board, may adjust the fee from time to time based upon actual experience. Investors who use the services of
a broker or other such intermediary in addition to an Authorized Participant to effect a redemption of a Creation Unit may be
charged a fee for such services.
SECURITIES
SETTLEMENTS FOR REDEMPTIONS
Because
the portfolio securities of the Fund may trade on their relevant exchange(s) on days that the Exchange is closed or are otherwise
not Business Days for the Fund, shareholders may not be able to purchase and sell Shares on the Exchange on days when the NAV
of the Fund could be significantly affected by events in the relevant foreign markets. The Trust generally intends to pay for
redemptions of Creation Units on a basis of “T” (i.e., trade date) plus two business days. The Trust may pay for redemptions
of Creation Units on a basis other than T plus two in order to accommodate local holiday schedules, to account for different treatment
among foreign and U.S. markets of dividend record dates and ex-dividend dates, or under certain other circumstances. The ability
of the Trust to pay for redemptions within two business days of receipt of an order in good form is subject, among other things,
to the condition that, within the time period from the date of the order to the date of delivery of the securities, there are
no days that are holidays in the applicable foreign market. For every occurrence of one or more intervening holidays in the applicable
foreign market that are not holidays observed in the U.S. equity market, the redemption settlement cycle will be extended by the
number of such intervening holidays. In addition to holidays, other unforeseeable closings in a foreign market due to emergencies
may also prevent the Trust from delivering securities within the normal settlement period.
The
securities delivery cycles currently practicable for transferring portfolio securities to redeeming Authorized Participants, coupled
with foreign market holiday schedules, may require a delivery process longer than the standard settlement period. In certain circumstances
during the calendar year, the settlement period may be greater than seven calendar days. The holidays applicable to the Fund during
such periods are set forth on Appendix D to this SAI. Pursuant to an exemptive order issued to the Adviser, the Fund will
be required to deliver redemption proceeds in not more than 15 calendar days. Although certain holidays may occur on different
dates in subsequent years, the number of days required to deliver redemption proceeds in any given year is not expected to exceed
15 calendar days. The proclamation of new holidays, the treatment by market participants of certain days as “informal holidays”
(e.g., days on which no or limited securities transactions occur, as a result of substantially shortened trading hours), the elimination
of existing holidays, or changes in local securities delivery practices, could affect the information set forth herein at some
time in the future and longer (worse) redemption periods are possible.
A list of the holiday schedules applicable
to the Fund for calendar years 2020 and 2021 (the only years for which holidays are known at the time of this SAI filing) is set
forth on Appendix D to this SAI.
CONTINUOUS
OFFERING
The
method by which Creation Units are created and traded may raise certain issues under applicable securities laws. Because new Creation
Units are issued and sold by the Trust on an ongoing basis, at any point a “distribution,” as such term is used in
the Securities Act, may occur. Broker-dealers and other persons are cautioned that some activities on their part may, depending
on the circumstances, result in their being deemed participants in a distribution in a manner which could render them statutory
underwriters and subject them to the prospectus delivery and liability provisions of the Securities Act.
For
example, a broker-dealer firm or its client may be deemed a statutory underwriter if it takes Creation Units after placing an
order with the Distributor, breaks them down into constituent Shares, and sells such Shares directly to customers, or if it chooses
to couple the creation of a supply of new Shares with an active selling effort involving solicitation of secondary market demand
for Shares. A determination of whether one is an underwriter for purposes of the Securities Act must take into account all the
facts and circumstances pertaining to the activities of the broker-dealer or its client in the particular case, and the examples
mentioned above should not be considered a complete description of all the activities that could lead to a categorization as an
underwriter.
Broker-dealers
who are not “underwriters” but are participating in a distribution (as contrasted to ordinary secondary trading transactions),
and thus dealing with Shares that are part of an “unsold allotment” within the meaning of Section 4(a)(3)(C) of the
Securities Act, would be unable to take advantage of the prospectus-delivery exemption provided by Section 4(a)(3) of the Securities
Act. This is because the prospectus delivery exemption in Section 4(a)(3) of the Securities Act is not available in respect of
such
transactions
as a result of Section 24(d) of the 1940 Act. As a result, broker-dealer firms should note that dealers who are not underwriters
but are participating in a distribution (as contrasted with ordinary secondary market transactions) and thus dealing with the
Shares that are part of an unsold allotment within the meaning of Section 4(a)(3)(C) of the Securities Act would be unable to
take advantage of the prospectus delivery exemption provided by Section 4(a)(3) of the Securities Act. Firms that incur a prospectus
delivery obligation with respect to Shares are reminded that, under Rule 153 of the Securities Act, a prospectus delivery obligation
under Section 5(b)(2) of the Securities Act owed to an exchange member in connection with a sale on the Exchange is satisfied
by the fact that the prospectus is available at the Exchange upon request. The prospectus delivery mechanism provided in Rule
153 is only available with respect to transactions on a national securities exchange.
DETERMINATION
OF NET ASSET VALUE
The
following information supplements and should be read in conjunction with the section in the Prospectus entitled “Investing
in the Fund – Determination of Net Asset Value.”
The
NAV per Share for the Fund is computed by dividing the value of the net assets of the Fund (i.e., the value of its total assets
less total liabilities) by the total number of Shares outstanding, rounded to the nearest cent. Expenses and fees, including,
without limitation, management fees, are accrued daily and taken into account for purposes of determining NAV. The NAV of the
Fund is determined as of the close of the regular trading session on the Exchange (ordinarily 4:00 p.m., Eastern time) on each
day that the Exchange is open. Any assets or liabilities denominated in currencies other than the U.S. dollar are converted into
U.S. dollars at the current market rates on the date of valuation as quoted by one or more sources.
The
pricing and valuation of portfolio securities is determined in good faith in accordance with procedures approved by, and under
the direction of, the Board. In determining the value of the Fund’s assets, equity securities are generally valued at market
using quotations from the primary market in which they are traded. Debt securities (other than short-term investments) are valued
on the basis of broker quotes or valuations provided by a pricing service, which in determining value utilizes information regarding
recent sales, market transactions in comparable securities, quotations from dealers, and various relationships between securities.
Other assets, such as accrued interest, accrued dividends and cash are also included in determining the NAV. The Fund normally
uses third party pricing services to obtain portfolio security prices.
Securities
and assets for which market quotations are not readily available or which cannot be accurately valued using the Fund’s normal
pricing procedures are valued by the Trust’s Fair Value Pricing Committee at fair value as determined in good faith under
policies approved by the Board. The Trust may use fair value pricing in a variety of circumstances, including but not limited
to, situations when the value of the Fund’s portfolio security has been materially affected by events occurring after the
close of the market on which such security is principally traded (such as a corporate action or other news that may materially
affect the price of such security) or trading in such security has been suspended or halted. In addition, the Trust may fair value
foreign equity portfolio securities each day the Trust calculates the Fund’s NAV. Accordingly, the Fund’s NAV may
reflect certain portfolio securities’ fair values rather than their market prices. Fair value pricing involves subjective
judgments, and it is possible that a fair value determination for a portfolio security will be materially different than the value
that could be realized upon the sale of such security. With respect to securities that are primarily listed on foreign exchanges,
the value of the Fund’s portfolio securities may change on days when you will not be able to purchase or sell your Shares.
DIVIDENDS
AND DISTRIBUTIONS
GENERAL
POLICIES. Dividends from net investment income are declared and paid monthly by the Fund. Distributions of net realized capital
gains, if any, generally are declared and paid once a year, but the Trust may make distributions on a more frequent basis for
the Fund to comply with the distribution requirements of the Internal Revenue Code of 1986, as amended (the “Code”),
in all events in a manner consistent with the provisions of the 1940 Act. In addition, the Trust may distribute at least annually
amounts representing the full dividend yield on the underlying portfolio securities of the Fund, net of expenses of the Fund,
as if the Fund owned such underlying portfolio securities for the entire dividend period in which case some portion of each distribution
may result in a return of capital for tax purposes for certain shareholders.
Dividends
and other distributions on Shares are distributed, as described below, on a pro rata basis to Beneficial Owners of such Shares.
Dividend payments are made through DTC Participants and Indirect Participants to Beneficial Owners then of record with proceeds
received from the Trust. The Trust makes additional distributions to the minimum extent necessary (i) to distribute the entire
annual taxable income of the Trust, plus any net capital gains and (ii) to avoid imposition of the excise tax imposed by Section
4982 of the Code. Management of the Trust reserves the right to declare special dividends if, in its reasonable discretion, such
action is necessary or advisable to preserve the status of the Fund as a “regulated investment company” (a “RIC”)
or to avoid imposition of income or excise taxes on undistributed income.
DIVIDEND
REINVESTMENT SERVICE. No reinvestment service is provided by the Trust. Broker-dealers may make available the DTC book-entry
Dividend Reinvestment Service for use by Beneficial Owners of Shares through DTC Participants for reinvestment of their dividend
distributions. If this service is used, dividend distributions of both income and realized gains will be automatically reinvested
in additional whole Shares of the Fund. Beneficial Owners should contact their broker to determine the availability and costs
of the service and the details of participation therein. Brokers may require Beneficial Owners to adhere to specific procedures
and timetables.
TAXATION
The
following is a summary of certain additional tax considerations generally affecting the Fund and its shareholders that are not
described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the Fund or its shareholders,
and the discussion here and in the Prospectus is not intended as a substitute for careful tax planning.
This
“Taxes” section is based on the Code and applicable regulations in effect on the date of this SAI. Future legislative,
regulatory or administrative changes, including provisions of current law that sunset and thereafter no longer apply, or court
decisions may significantly change the tax rules applicable to the Fund and its shareholders. Any of these changes or court decisions
may have a retroactive effect.
This
is for general information only and not tax advice. All investors should consult their own tax advisors as to the federal, state,
local and foreign tax provisions applicable to them.
Taxation
of the Fund
The
Fund is a Separate Corporation. The Fund is treated as a separate corporation for federal income tax purposes. Losses in one
Fund do not offset gains in another Fund and the requirements (other than certain organizational requirements) for qualifying
for regulated investment company status as described below are determined at the Fund level rather than the Trust level.
Election
to be Taxed as a Regulated Investment Company. The Fund has elected and intends to qualify, or, if newly organized, intends
to elect and qualify, each year as a regulated investment company (sometimes referred to as a “regulated investment company,”
“RIC” or “fund”) under Subchapter M of the Code. If the Fund so qualifies, the Fund will not be subject
to federal income tax on the portion of its investment company taxable income (that is, generally, taxable interest, dividends,
net short-term capital gains, and other taxable ordinary income, net of expenses, without regard to the deduction for dividends
paid) and net capital gain (that is, the excess of net long-term capital gains over net short-term capital losses) that it distributes
to shareholders.
In
order to qualify for treatment as a regulated investment company, the Fund must satisfy the following requirements:
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Distribution
Requirement —the Fund must distribute an amount equal to the sum of at least 90% of its investment company taxable income
and 90% of its net tax-exempt income, if any, for the tax year (including, for purposes of satisfying this distribution requirement,
certain distributions made by the Fund after the close of its taxable year that are treated as made during such taxable year).
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Income
Requirement —the Fund must derive at least 90% of its gross income from dividends, interest, certain payments with respect
to securities loans, and gains from the sale or other disposition of stock, securities or foreign currencies, or other income
(including, but not limited to, gains from options, futures or forward contracts) derived from its business of investing in
such stock, securities or currencies and net income derived from qualified publicly traded partnerships (“QPTPs”).
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Asset
Diversification Test —the Fund must satisfy the following asset diversification test at the close of each quarter of
the Fund’s tax year: (1) at least 50% of the value of the Fund’s assets must consist of cash and cash items, U.S.
government securities, securities of other regulated investment companies, and securities of other issuers (as to which the
Fund has not invested more than 5% of the value of the Fund’s total assets in securities of an issuer and as to which
the Fund does not hold more than 10% of the outstanding voting securities of the issuer); and (2) no more than 25% of the
value of the Fund’s total assets may be invested in the securities of any one issuer (other than U.S. government securities
or securities of other regulated investment companies) or of two or more issuers which the Fund controls and which are engaged
in the same or similar trades or businesses, or, in the securities of one or more QPTPs.
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In some
circumstances, the character and timing of income realized by the Fund for purposes of the Income Requirement or the identification
of the issuer for purposes of the Asset Diversification Test is uncertain under current law with respect to a particular investment,
and an adverse determination or future guidance by the Internal Revenue Service (“IRS”) with respect to such type
of
investment
may adversely affect the Fund’s ability to satisfy these requirements. See, “Tax Treatment of Portfolio Transactions”
below with respect to the application of these requirements to certain types of investments. In other circumstances, the Fund
may be required to sell portfolio holdings in order to meet the Income Requirement, Distribution Requirement, or Asset Diversification
Test, which may have a negative impact on the Fund’s income and performance.
If
for any taxable year the Fund does not qualify as a regulated investment company, all of its taxable income (including its net
capital gain) would be subject to tax at the corporate income tax rate without any deduction for dividends paid to shareholders,
and the dividends would be taxable to the shareholders as ordinary income (or possibly as qualified dividend income) to the extent
of the Fund’s current and accumulated earnings and profits. Failure to qualify as a regulated investment company would thus
have a negative impact on the Fund’s income and performance. Subject to savings provisions for certain failures to satisfy
the Income Requirement or Asset Diversification Test, which, in general, are limited to those due to reasonable cause and not
willful neglect, it is possible that the Fund will not qualify as a regulated investment company in any given tax year. Even if
such savings provisions apply, the Fund may be subject to a monetary sanction of $50,000 or more. Moreover, the Board reserves
the right not to maintain the qualification of the Fund as a regulated investment company if it determines such a course of action
to be beneficial to shareholders.
Portfolio
Turnover. For investors that hold their Fund Shares in a taxable account, a high portfolio turnover rate may result in higher
taxes. This is because the Fund with a high turnover rate is likely to accelerate the recognition of capital gains and more of
such gains are likely to be taxable as short-term rather than long-term capital gains in contrast to a comparable fund with a
low turnover rate. Any such higher taxes would reduce the Fund’s after-tax performance. See, “Taxation of Fund Distributions
- Distributions of Capital Gains” below. For non-U.S. investors, any such acceleration of the recognition of capital gains
that results in more short-term and less long-term capital gains being recognized by the Fund may cause such investors to be subject
to increased U.S. withholding taxes. See, “Non-U.S. Investors – Capital Gain Dividends” and “– Interest-Related
Dividends and Short-Term Capital Gain Dividends” below.
Capital
Loss Carryovers. The capital losses of the Fund, if any, do not flow through to shareholders. Rather, the Fund may use its
capital losses, subject to applicable limitations, to offset its capital gains without being required to pay taxes on or distribute
to shareholders such gains that are offset by the losses. If the Fund has a “net capital loss” (that is, capital losses
in excess of capital gains), the excess (if any) of the Fund’s net short-term capital losses over its net long-term capital
gains is treated as a short-term capital loss arising on the first day of the Fund’s next taxable year, and the excess (if
any) of the Fund’s net long-term capital losses over its net short-term capital gains is treated as a long-term capital
loss arising on the first day of the Fund’s next taxable year. Any such net capital losses of the Fund that are not used
to offset capital gains may be carried forward indefinitely to reduce any future capital gains realized by the Fund in succeeding
taxable years. The amount of capital losses that can be carried forward and used in any single year is subject to an annual limitation
if there is a more than 50% “change in ownership” of the Fund. An ownership change generally results when shareholders
owning 5% or more of the Fund increase their aggregate holdings by more than 50% over a three-year lookback period. An ownership
change could result in capital loss carryovers being used at a slower rate, thereby reducing the Fund’s ability to offset
capital gains with those losses. An increase in the amount of taxable gains distributed to the Fund’s shareholders could
result from an ownership change. The Fund undertakes no obligation to avoid or prevent an ownership change, which can occur in
the normal course of shareholder purchases and redemptions or as a result of engaging in a tax-free reorganization with another
fund. Moreover, because of circumstances beyond the Fund’s control, there can be no assurance that the Fund will not experience,
or has not already experienced, an ownership change. Additionally, if the Fund engages in a tax-free reorganization with another
fund, the effect of these and other rules not discussed herein may be to disallow or postpone the use by the Fund of its capital
loss carryovers (including any current year losses and built-in losses when realized) to offset its own gains or those of the
other fund, or vice versa, thereby reducing the tax benefits Fund shareholders would otherwise have enjoyed from use of such capital
loss carryovers.
Deferral
of Late Year Losses. The Fund may elect to treat part or all of any “qualified late year loss” as if it had been
incurred in the succeeding taxable year in determining the Fund’s taxable income, net capital gain, net short-term capital
gain, and earnings and profits. The effect of this election is to treat any such “qualified late year loss” as if
it had been incurred in the succeeding taxable year in characterizing Fund distributions for any calendar year (see, “Taxation
of Fund Distributions— Distributions of capital gains” below). A “qualified late year loss” includes:
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(i)
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any net capital
loss incurred after October 31 of the current taxable year, or, if there is no such loss, any net long-term capital loss or
any net short-term capital loss incurred after October 31 of the current taxable year (“post-October capital losses”),
and
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(ii)
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the sum of (1) the
excess, if any, of (a) specified losses incurred after October 31 of the current taxable year, over (b) specified gains incurred
after October 31 of the current taxable year and (2) the excess, if any, of (a) ordinary losses incurred after December 31
of the current taxable year, over (b) the ordinary income incurred after December 31 of the current taxable year.
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The
terms “specified losses” and “specified gains” mean ordinary losses and gains from the sale, exchange,
or other disposition of property (including the termination of a position with respect to such property), foreign currency losses
and gains, and losses and gains
resulting
from holding stock in a passive foreign investment company (“PFIC”) for which a mark-to-market election is in effect.
The terms “ordinary losses” and “ordinary income” mean other ordinary losses and income that are not described
in the preceding sentence.
Undistributed
Capital Gains. The Fund may retain or distribute to shareholders its net capital gain for each taxable year. The Fund currently
intends to distribute net capital gains. If the Fund elects to retain its net capital gain, the Fund will be taxed thereon (except
to the extent of any available capital loss carryovers) at the corporate income tax rate . If the Fund elects to retain its net
capital gain, it is expected that the Fund also will elect to have shareholders treated as if each received a distribution of
its pro rata share of such gain, with the result that each shareholder will be required to report its pro rata share of such gain
on its tax return as long-term capital gain, will receive a refundable tax credit for its pro rata share of tax paid by the Fund
on the gain, and will increase the tax basis for its Shares by an amount equal to the deemed distribution less the tax credit.
Federal
Excise Tax. To avoid a 4% non-deductible excise tax, the Fund must distribute by December 31 of each year an amount equal
to at least: (1) 98% of its ordinary income for the calendar year, (2) 98.2% of capital gain net income (that is, the excess of
the gains from sales or exchanges of capital assets over the losses from such sales or exchanges) for the one-year period ended
on October 31 of such calendar year, and (3) any prior year undistributed ordinary income and capital gain net income. The Fund
may elect to defer to the following year any net ordinary loss incurred for the portion of the calendar year which is after the
beginning of the Fund’s taxable year. Also, the Fund will defer any “specified gain” or “specified loss”
which would be properly taken into account for the portion of the calendar year after October 31. Any net ordinary loss, specified
gain, or specified loss deferred shall be treated as arising on January 1 of the following calendar year. Generally, the Fund
intends to make sufficient distributions prior to the end of each calendar year to avoid any material liability for federal income
and excise tax, but can give no assurances that all or a portion of such liability will be avoided. In addition, under certain
circumstances, temporary timing or permanent differences in the realization of income and expense for book and tax purposes can
result in the Fund having to pay an excise tax.
Foreign
income tax. Investment income received by the Fund from sources within foreign countries may be subject to foreign income
tax withheld at the source and the amount of tax withheld generally will be treated as an expense of the Fund. The U.S. has entered
into tax treaties with many foreign countries that entitle the Fund to a reduced rate of, or exemption from, tax on such income.
Some countries require the filing of a tax reclaim or other forms to receive the benefit of the reduced tax rate; whether or when
the Fund will receive the tax reclaim is within the control of the individual country. Information required on these forms may
not be available such as shareholder information; therefore, the Fund may not receive the reduced treaty rates or potential reclaims.
Other countries have conflicting and changing instructions and restrictive timing requirements which may cause the Fund not to
receive the reduced treaty rates or potential reclaims. Other countries may subject capital gains realized by the Fund on sale
or disposition of securities of that country to taxation. It is impossible to determine the effective rate of foreign tax in advance
since the amount of the Fund’s assets to be invested in various countries is not known. Under certain circumstances, the
Fund may elect to pass-through foreign taxes paid by the Fund to shareholders, although it reserves the right not to do so. If
the Fund makes such an election and obtains a refund of foreign taxes paid by the Fund in a prior year, the Fund may be eligible
to reduce the amount of foreign taxes reported by the Fund, generally by the amount of the foreign taxes refunded, for the year
in which the refund is received.
Purchase
of Shares. As a result of tax requirements, the Trust on behalf of the Fund has the right to reject an order to purchase Shares
if the purchaser (or group of purchasers acting in concert with each other) would, upon obtaining the Shares so ordered, own 80%
or more of the outstanding Shares of the Fund and if, pursuant to Sections 351 and 362 of the Code, the Fund would have a basis
in the Deposit Securities different from the market value of such securities on the date of deposit. The Trust also has the right
to require information necessary to determine beneficial Share ownership for purposes of the 80% determination.
Taxation
of Fund Distributions
The
Fund anticipates distributing substantially all of its investment company taxable income and net capital gain for each taxable
year. Distributions by the Fund will be treated in the manner described below regardless of whether such distributions are paid
in cash or reinvested in additional Shares of the Fund (or of another fund). You will receive information annually as to the federal
income tax consequences of distributions made (or deemed made) during the year.
Distributions
of Net Investment Income. The Fund receives ordinary income generally in the form of dividends and/or interest on its investments.
The Fund may also recognize ordinary income from other sources, including, but not limited to, certain gains on foreign currency-
related transactions. This income, less expenses incurred in the operation of the Fund, constitutes the Fund’s net investment
income from which dividends may be paid to you. If you are a taxable investor, distributions of net investment income generally
are taxable as ordinary income to the extent of the Fund’s earnings and profits. See the discussion below under the headings,
“–Qualified Dividend Income for Individuals” and “– Dividends-Received Deduction for Corporations.”
Distributions
of Capital Gains. The Fund may derive capital gain and loss in connection with sales or other dispositions of its portfolio
securities. Distributions derived from the excess of net short-term capital gain over net long-term capital loss will be taxable
to you as ordinary income. Distributions paid from the excess of net long-term capital gain over net short-term capital loss will
be taxable to you as long-term capital gain, regardless of how long you have held your Shares in the Fund. Any net short-term
or long-term capital gain realized by the Fund (net of any capital loss carryovers) generally will be distributed once each year
and may be distributed more frequently, if necessary, in order to reduce or eliminate federal excise or income taxes on the Fund.
Returns
of Capital. Distributions by the Fund that are not paid from earnings and profits will be treated as a return of capital to
the extent of (and in reduction of) the shareholder’s tax basis in his Shares; any excess will be treated as gain from the
sale of his Shares. Thus, the portion of a distribution that constitutes a return of capital will decrease the shareholder’s
tax basis in his Fund Shares (but not below zero), and will result in an increase in the amount of gain (or decrease in the amount
of loss) that will be recognized by the shareholder for tax purposes on the later sale of such Fund Shares. Return of capital
distributions can occur for a number of reasons including, among others, the Fund over- estimates the income to be received from
certain investments such as those classified as partnerships or equity real estate investment trusts (“REITs”).
Qualified
Dividend Income for Individuals. Ordinary income dividends reported by the Fund as derived from qualified dividend income
will be taxed in the hands of individuals and other noncorporate shareholders at the rates applicable to long-term capital gain.
“Qualified dividend income” means dividends paid to the Fund (a) by domestic corporations, (b) by foreign corporations
that are either (i) incorporated in a possession of the United States, or (ii) are eligible for benefits under certain income
tax treaties with the United States that include an exchange of information program, or (c) with respect to stock of a foreign
corporation that is readily tradable on an established securities market in the United States. Both the Fund and the investor
must meet certain holding period requirements to qualify Fund dividends for this treatment. Specifically, the Fund must hold the
stock for at least 61 days during the 121-day period beginning 60 days before the stock becomes ex- dividend. Similarly, investors
must hold their Fund Shares for at least 61 days during the 121-day period beginning 60 days before the Fund distribution goes
ex-dividend. Income derived from investments in derivatives, fixed-income securities, U.S. REITs, PFICs, and income received “in
lieu of” dividends in a securities lending transaction generally is not eligible for treatment as qualified dividend income.
If the qualifying dividend income received by the Fund is equal to or greater than 95% of the Fund’s gross income (exclusive
of net capital gain) in any taxable year, all of the ordinary income dividends paid by the Fund will be qualifying dividend income.
Because the income of the Fund is derived primarily from interest on debt securities, none or only a small amount of the Fund’s
dividends will be qualified dividend income. Income dividends from interest earned by the Fund on debt securities will continue
to be taxed at the higher ordinary income tax rate.
Dividends-Received
Deduction for Corporations. For corporate shareholders, a portion of the dividends paid by the Fund may qualify for the 50%
corporate dividends-received deduction. The portion of dividends paid by the Fund that so qualifies will be reported by the Fund
each year and cannot exceed the gross amount of dividends received by the Fund from domestic (U.S.) corporations. The availability
of the dividends-received deduction is subject to certain holding period and debt financing restrictions that apply to both the
Fund and the investor. Specifically, the amount that the Fund may report as eligible for the dividends-received deduction will
be reduced or eliminated if the Shares on which the dividends earned by the Fund were debt-financed or held by the Fund for less
than a minimum period of time, generally 46 days during a 91- day period beginning 45 days before the stock becomes ex-dividend.
Similarly, if your Fund Shares are debt-financed or held by you for less than a 46-day period then the dividends-received deduction
for Fund dividends on your Shares may also be reduced or eliminated. Income derived by the Fund from investments in derivatives,
fixed-income and foreign securities generally is not eligible for this treatment. Because the income of the Fund is derived primarily
from interest on debt securities, none or only a small amount of its distributions are expected to qualify for the corporate dividends-received
deduction.
Impact
of Realized but Undistributed Income and Gains, and Net Unrealized Appreciation of Portfolio Securities. At the time of your
purchase of Shares, the price of Shares may reflect undistributed income, undistributed capital gains, or net unrealized appreciation
of portfolio securities held by the Fund. A subsequent distribution to you of such amounts, although constituting a return of
your investment, would be taxable, and would be taxed as ordinary income (some portion of which may be taxed as qualified dividend
income), capital gains, or some combination of both, unless you are investing through a tax-advantaged arrangement, such as a
401(k) plan or an individual retirement account. The Fund may be able to reduce the amount of such distributions from capital
gains by utilizing its capital loss carryovers, if any.
Pass-Through
of Foreign Tax Credits. If more than 50% of the Fund’s total assets at the end of a fiscal year is invested in foreign
securities, the Fund may elect to pass through foreign taxes paid by the Fund. If this election is made, the Fund may report more
taxable income than it actually distributes. Shareholders then are entitled either to deduct their share of these taxes in computing
taxable income, or to claim a foreign tax credit for these taxes against their U.S. federal income tax (subject to limitations
for certain
shareholders).
The Fund will provide the information necessary to claim this deduction or credit if it makes this election. No deduction for
foreign tax may be claimed by a noncorporate shareholder who does not itemize deductions or who is subject to the alternative
minimum tax. Shareholders may be unable to claim a credit for the full amount of their proportionate shares of the foreign income
tax paid by the Fund due to certain limitations that may apply. Each Fund reserves the right not to pass through the amount of
foreign income taxes paid by the Fund. Additionally, any foreign tax withheld on payments made “in lieu of” dividends
or interest will not qualify for the pass-through of foreign tax credits to shareholders. See, “Tax Treatment of Portfolio
Transactions – Securities Lending” below.
Tax
credit bonds. If the Fund holds, directly or indirectly, one or more "tax credit bonds" (including build America
bonds, clean renewable energy bonds and qualified tax credit bonds) on one or more applicable dates during a taxable year, the
Fund may elect to permit its shareholders to claim a tax credit on their income tax returns equal to each shareholder's proportionate
share of tax credits from the applicable bonds that otherwise would be allowed to the Fund. In such a case, shareholders must
include in gross income (as interest) their proportionate share of the income attributable to their proportionate share of those
offsetting tax credits. A shareholder's ability to claim a tax credit associated with one or more tax credit bonds may be subject
to certain limitations imposed by the Code. (Under the 2017 legislation commonly known as the “Tax Cuts and Jobs Act”,
the build America bonds, clean renewable energy bonds and certain other qualified bonds may no longer be issued after December
31, 2017.) Even if the Fund is eligible to pass-through tax credits to shareholders, the Fund may choose not to do so.
U.S.
Government Securities. Income earned on certain U.S. government obligations is exempt from state and local personal income
taxes if earned directly by you. States also grant tax-free status to dividends paid to you from interest earned on direct obligations
of the U.S. government, subject in some states to minimum investment or reporting requirements that must be met by the Fund. Income
on investments by the Fund in certain other obligations, such as repurchase agreements collateralized by U.S. government obligations,
commercial paper and federal agency-backed obligations (e.g., GNMA or FNMA obligations), generally does not qualify for tax-free
treatment. The rules on exclusion of this income are different for corporations.
Dividends
Declared in December and Paid in January. Ordinarily, shareholders are required to take distributions by the Fund into account
in the year in which the distributions are made. However, dividends declared in October, November or December of any year and
payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders
(and made by the Fund) on December 31 of such calendar year if such dividends are actually paid in January of the following year.
Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during
the year in accordance with the guidance that has been provided by the IRS.
Medicare
Tax. A 3.8% Medicare tax is imposed on net investment income earned by certain individuals, estates and trusts. “Net
investment income,” for these purposes, means investment income, including ordinary dividends and capital gain distributions
received from the Fund and net gains from taxable dispositions of Fund Shares, reduced by the deductions properly allocable to
such income. In the case of an individual, the tax will be imposed on the lesser of (1) the shareholder’s net investment
income or (2) the amount by which the shareholder’s modified adjusted gross income exceeds $250,000 (if the shareholder
is married and filing jointly or a surviving spouse), $125,000 (if the shareholder is married and filing separately) or $200,000
(in any other case). Net investment income does not include exempt-interest dividends. This Medicare tax, if applicable, is reported
by you on, and paid with, your federal income tax return.
Sales
of Fund Shares
Sales
of Fund Shares are taxable transactions for federal and state income tax purposes. If you sell your Fund Shares, the IRS requires
you to report any gain or loss on your sale. If you held your Shares as a capital asset, the gain or loss that you realize will
be a capital gain or loss and will be long-term or short-term, generally depending on how long you have held your Shares. Capital
losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of
ordinary income.
Taxes
on Purchase and Redemption of Creation Units. An Authorized Participant who exchanges equity securities for Creation Units
generally will recognize a gain or a loss. The gain or loss will be equal to the difference between the market value of the Creation
Units at the time of purchase (plus any cash received by the Authorized Participant as part of the issue) and the Authorized Participant’s
aggregate basis in the securities surrendered (plus any cash paid by the Authorized Participant as part of the issue). An Authorized
Participant who exchanges Creation Units for equity securities generally will recognize a gain or loss equal to the difference
between the Authorized Participant’s basis in the Creation Units (plus any cash paid by the Authorized Participant as part
of the redemption) and the aggregate market value of the securities received (plus any cash received by the Authorized Participant
as part of the redemption). The IRS, however, may assert that a loss realized upon an exchange of securities for Creation Units
cannot be deducted currently under the rules governing “wash sales,” or on the basis that there has been no significant
change in economic position. Persons exchanging securities should consult their own tax advisor with respect to whether wash sale
rules apply and when a loss might be deductible.
Under
current federal tax laws, any capital gain or loss realized upon redemption of Creation Units is generally treated as long-term
capital gain or loss if the Shares have been held for more than one year and as a short-term capital gain or loss if the Shares
have been held for one year or less.
The
Fund generally redeems Creation Units for cash, and therefore may recognize more capital gains than if it redeemed Creation Units
in-kind.
Tax
Basis Information. A shareholder’s cost basis information will be provided on the sale of any of the shareholder’s
Shares, subject to certain exceptions for exempt recipients. Please contact the broker (or other nominee) that holds your Shares
with respect to reporting of cost basis and available elections for your account.
Wash
Sales. All or a portion of any loss that you realize on a sale of your Fund Shares will be disallowed to the extent that you
buy other Shares in the Fund (through reinvestment of dividends or otherwise) within 30 days before or after your Share sale.
Any loss disallowed under these rules will be added to your tax basis in the new Shares.
Sales
at a Loss Within Six Months of Purchase. Any loss incurred on a sale of Shares held for six months or less will be treated
as long-term capital loss to the extent of any long-term capital gain distributed to you by the Fund on those Shares.
Reportable
Transactions. Under Treasury regulations, if a shareholder recognizes a loss with respect to the Fund’s Shares of $2
million or more for an individual shareholder or $10 million or more for a corporate shareholder (or certain greater amounts over
a combination of years), the shareholder must file with the IRS a disclosure statement on Form 8886. The fact that a loss is reportable
under these regulations does not affect the legal determination of whether the taxpayer’s treatment of the loss is proper.
Shareholders should consult their tax advisors to determine the applicability of these regulations in light of their individual
circumstances.
Tax
Treatment of Portfolio Transactions
Set
forth below is a general description of the tax treatment of certain types of securities, investment techniques and transactions
that may apply to the Fund and, in turn, affect the amount, character and timing of dividends and distributions payable by the
fund to its shareholders. This section should be read in conjunction with the discussion above under “Investment Strategies”
for a detailed description of the various types of securities and investment techniques that apply to the Fund.
In
General. In general, gain or loss recognized by the Fund on the sale or other disposition of portfolio investments will be
a capital gain or loss. Such capital gain and loss may be long-term or short-term depending, in general, upon the length of time
a particular investment position is maintained and, in some cases, upon the nature of the transaction. Property held for more
than one year generally will be eligible for long- term capital gain or loss treatment. The application of certain rules described
below may serve to alter the manner in which the holding period for a security is determined or may otherwise affect the characterization
as long-term or short-term, and also the timing of the realization and/or character, of certain gains or losses.
Certain
Fixed Income Investments. Gain recognized on the disposition of a debt obligation purchased by the Fund at a market discount
(generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the
market discount that accrued during the period of time the fund held the debt obligation unless the fund made a current inclusion
election to accrue market discount into income as it accrues. If the Fund purchases a debt obligation (such as a zero-coupon security
or payment-in-kind security) that was originally issued at a discount, the Fund generally is required to include in gross income
each year the portion of the original issue discount that accrues during such year. Therefore, the Fund’s investment in
such securities may cause the Fund to recognize income and make distributions to shareholders before it receives any cash payments
on the securities. To generate cash to satisfy those distribution requirements, the Fund may have to sell portfolio securities
that it otherwise might have continued to hold or to use cash flows from other sources such as the sale of fund shares.
Investments
in Debt Obligations that are at Risk of or in Default Present Tax Issues for the Fund. Tax rules are not entirely clear about
issues such as whether and to what extent the Fund should recognize market discount on a debt obligation, when the Fund may cease
to accrue interest, original issue discount or market discount, when and to what extent the Fund may take deductions for bad debts
or worthless securities and how the Fund should allocate payments received on obligations in default between principal and income.
These
and other related issues will be addressed by the Fund in order to ensure that it distributes sufficient income to preserve its
status as a regulated investment company.
Options,
Futures, Forward Contracts, Swap Agreements and Hedging Transactions. In general, option premiums received by the Fund are
not immediately included in the income of the fund. Instead, the premiums are recognized when the option contract expires, the
option is exercised by the holder, or the fund transfers or otherwise terminates the option (e.g., through a closing transaction).
If an option written by the Fund is exercised and the fund sells or delivers the underlying stock, the fund generally will recognize
capital gain or loss equal to (a) the sum of the strike price and the option premium received by the fund minus (b) the fund’s
basis in the stock. Such gain or loss generally will be short-term or long-term depending upon the holding period of the underlying
stock. If securities are purchased by the Fund pursuant to the exercise of a put option written by it, the fund generally will
subtract the premium received from its cost basis in the securities purchased. The gain or loss with respect to any termination
of the Fund’s obligation under an option other than through the exercise of the option and related sale or delivery of the
underlying stock generally will be short-term gain or loss depending on whether the premium income received by the fund is greater
or less than the amount paid by the fund (if any) in terminating the transaction. Thus, for example, if an option written by the
Fund expires unexercised, the fund generally will recognize short-term gain equal to the premium received.
The
tax treatment of certain futures contracts entered into by the Fund as well as listed non-equity options written or purchased
by the fund on U.S. exchanges (including options on futures contracts, broad-based equity indices and debt securities) may be
governed by section 1256 of the Code (“section 1256 contracts”). Gains or losses on section 1256 contracts generally
are considered 60% long-term and 40% short-term capital gains or losses (“60/40”), although certain foreign currency
gains and losses from such contracts may be treated as ordinary in character. Also, any section 1256 contracts held by the Fund
at the end of each taxable year (and, for purposes of the 4% excise tax, on certain other dates as prescribed under the Code)
are “marked to market” with the result that unrealized gains or losses are treated as though they were realized and
the resulting gain or loss is treated as ordinary or 60/40 gain or loss, as applicable. Section 1256 contracts do not include
any interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity
index swap, credit default swap, or similar agreement.
In
addition to the special rules described above in respect of options and futures transactions, the Fund’s transactions in
other derivative instruments (including options, forward contracts and swap agreements) as well as its other hedging, short sale,
or similar transactions, may be subject to one or more special tax rules (including the constructive sale, notional principal
contract, straddle, wash sale and short sale rules). These rules may affect whether gains and losses recognized by the Fund are
treated as ordinary or capital or as short-term or long-term, accelerate the recognition of income or gains to the fund, defer
losses to the fund, and cause adjustments in the holding periods of the fund’s securities. These rules, therefore, could
affect the amount, timing and/or character of distributions to shareholders. Moreover, because the tax rules applicable to derivative
instruments are in some cases uncertain under current law, an adverse determination or future guidance by the IRS with respect
to these rules (which determination or guidance could be retroactive) may affect whether the Fund has made sufficient distributions,
and otherwise satisfied the relevant requirements, to maintain its qualification as a regulated investment company and avoid the
Fund-level tax.
Certain
of the Fund’s investments in derivatives and foreign currency-denominated instruments, and the fund’s transactions
in foreign currencies and hedging activities, may produce a difference between its book income and its taxable income. If the
Fund’s book income is less than the sum of its taxable income and net tax-exempt income (if any), the fund could be required
to make distributions exceeding book income to qualify as a regulated investment company. If the Fund’s book income exceeds
the sum of its taxable income and net tax-exempt income (if any), the distribution of any such excess will be treated as (i) a
dividend to the extent of the fund’s remaining earnings and profits (including current earnings and profits arising from
tax-exempt income, reduced by related deductions), (ii) thereafter, as a return of capital to the extent of the recipient’s
basis in the Shares, and (iii) thereafter, as gain from the sale or exchange of a capital asset.
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. This
treatment could increase or decrease the Fund’s ordinary income distributions to you, and may cause some or all of the fund’s
previously distributed income to be classified as a return of capital. In certain cases, the Fund may make an election to treat
such gain or loss as capital.
Securities
Lending. While securities are loaned out by the Fund, the fund generally will receive from the borrower amounts equal to any
dividends or interest paid on the borrowed securities. For federal income tax purposes, payments made “in lieu of”
dividends are not considered dividend income. These distributions will neither qualify for the reduced rate of taxation for individuals
on qualified dividends nor the 50% dividends-received deduction for corporations. Also, any foreign tax withheld on payments made
“in lieu of” dividends or interest will not qualify for the pass-through of foreign tax credits to shareholders.
Investments
in Convertible Securities. Convertible debt is ordinarily treated as a “single property” consisting of a pure
debt interest until conversion, after which the investment becomes an equity interest. If the security is issued at a premium
(i.e., for cash in excess of the face amount payable on retirement), the creditor-holder may amortize the premium over the life
of the bond. If the security is issued for cash at a price below its face amount, the creditor-holder must accrue original issue
discount in income over the life of the debt. The creditor-holder’s exercise of the conversion privilege is treated as a
nontaxable event. Mandatorily convertible debt (e.g., an exchange traded note or ETN issued in the form of an unsecured obligation
that pays a return based on the performance of a specified market index, exchange currency, or commodity) is often, but not always,
treated as a contract to buy or sell the reference property rather than debt. Similarly, convertible preferred stock with a mandatory
conversion feature is ordinarily, but not always, treated as equity rather than debt. Dividends received generally are qualified
dividend income and eligible for the corporate dividends-received deduction. In general, conversion of preferred stock for common
stock of the same corporation is tax-free. Conversion of preferred stock for cash is a taxable redemption. Any redemption premium
for preferred stock that is redeemable by the issuing company might be required to be amortized under original issue discount
principles.
Investments
in Securities of Uncertain Tax Character. The Fund may invest in securities the U.S. federal income tax treatment of which
may not be clear or may be subject to recharacterization by the IRS. To the extent the tax treatment of such securities or the
income from such securities differs from the tax treatment expected by the Fund, it could affect the timing or character of income
recognized by the fund, requiring the fund to purchase or sell securities, or otherwise change its portfolio, in order to comply
with the tax rules applicable to regulated investment companies under the Code.
Backup
Withholding
By
law, a portion of your taxable dividends and sales proceeds may be withheld unless you:
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provide your correct
social security or taxpayer identification number,
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certify that this
number is correct,
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certify that you
are not subject to backup withholding, and
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certify that you
are a U.S. person (including a U.S. resident alien).
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Withholding
is also imposed if the IRS requires it. When withholding is required, the amount will be 24% of any distributions or proceeds
paid. 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 IRS. Certain payees and payments are exempt from
backup withholding and information reporting. The special U.S. tax certification requirements applicable to non-U.S. investors
to avoid backup withholding are described under the “Non-U.S. Investors” heading below.
Non-U.S.
Investors
Non-U.S.
investors (shareholders who, as to the United States, are nonresident alien individuals, foreign trusts or estates, foreign corporations,
or foreign partnerships) may be subject to U.S. withholding and estate tax and are subject to special U.S. tax certification requirements.
Non- U.S. investors should consult their tax advisors about the applicability of U.S. tax withholding and the use of the appropriate
forms to certify their status.
In
General. The United States imposes a flat 30% withholding tax (or a withholding tax at a lower treaty rate) on U.S. source
dividends, including on income dividends paid to you by the Fund, subject to certain exemptions described below.
However,
notwithstanding such exemptions from U.S. withholding at the source, any dividends and distributions of income and capital gains,
including the proceeds from the sale of your Fund Shares, will be subject to backup withholding at a rate of 24% if you fail to
properly certify that you are not a U.S. person.
Capital
Gain Dividends. In general, capital gain dividends reported by the Fund as paid from its net long-term capital gains, other
than long- term capital gains realized on the disposition of certain U.S. real property interests, are not subject to U.S. withholding
tax unless you are a nonresident alien individual present in the United States for a period or periods aggregating 183 days or
more during the calendar year.
Exempt-interest
dividends. In general, exempt-interest dividends reported to shareholders as paid from net tax-exempt income are not subject
to U.S. withholding tax.
Interest-related
dividends and short-term capital gain dividends. Generally, dividends reported by the Fund as interest-related dividends and
paid from its qualified net interest income from U.S. sources are not subject to U.S. withholding tax. “Qualified interest
income” includes, in general, U.S. source (1) bank deposit interest, (2) short-term original discount, (3) interest (including
original issue discount, market discount, or acquisition discount) on an obligation that is in registered form, unless it is earned
on an obligation issued by a corporation or partnership in which the Fund is a 10-percent shareholder or is contingent interest,
and (4) any interest-related dividend from another regulated investment company. Similarly, short-term capital gain dividends
reported by the Fund as paid from its net short-term capital gains, other than short-term capital gains realized on the disposition
of certain U.S. real property interests, are not subject to U.S. withholding tax unless you were a nonresident alien individual
present in the United States for a period or periods aggregating 183 days or more during the calendar year. The Fund reserves
the right to not report interest-related dividends or short-term capital gain dividends. Additionally, the Fund’s reporting
of interest-related dividends or short-term capital gain dividends may not be passed through to shareholders by intermediaries
who have assumed tax reporting responsibilities for this income in managed or omnibus accounts due to systems limitations or operational
constraints.
Net
Investment Income from Dividends on Stock and Foreign Source Interest Income Continue to be Subject to Withholding Tax; Foreign
Tax Credits. Ordinary dividends paid by the Fund to non-U.S. investors on the income earned on portfolio investments in (i)
the stock of domestic and foreign corporations and (ii) the debt of foreign issuers continue to be subject to U.S. withholding
tax.
Foreign
shareholders may be subject to U.S. withholding tax at a rate of 30% on the income resulting from an election to pass-through
foreign tax credits to shareholders, but may not be able to claim a credit or deduction with respect to the withholding tax for
the foreign tax treated as having been paid by them.
Income
Effectively Connected with a U.S. Trade or Business. If the income from the Fund is effectively connected with a U.S. trade
or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends and any gains realized
upon the sale of Shares of the Fund will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic
corporations and require the filing of a nonresident U.S. income tax return.
U.S.
Estate Tax. Transfers by gift of Shares of the Fund by a foreign shareholder who is a nonresident alien individual will not
be subject to U.S. federal gift tax. An individual who, at the time of death, is a non-U.S. shareholder will nevertheless be subject
to U.S. federal estate tax with respect to Fund Shares at the graduated rates applicable to U.S. citizens and residents, unless
a treaty exemption applies. If a treaty exemption is available, a decedent’s estate may nonetheless need to file a U.S.
estate tax return to claim the exemption in order to obtain a U.S. federal transfer certificate, which permits the decedent’s
property to be transferred without federal estate tax liability. The transfer certificate will identify the property (i.e., Fund
Shares) as to which the U.S. federal estate tax lien has been released. In the absence of a treaty, there is a $13,000 statutory
estate tax credit (equivalent to U.S. situs assets with a value of $60,000). For estates with U.S. situs assets of not more than
$60,000, an affidavit from an appropriate individual that states that the decedent’s U.S. situs assets are below this threshold
amount may be sufficient to transfer the Fund Shares.
U.S.
Tax Certification Rules. Special U.S. tax certification requirements may apply to non-U.S. shareholders both to avoid U.S.
backup withholding imposed at a rate of 24% and to obtain the benefits of any treaty between the United States and the shareholder’s
country of residence. In general, if you are a non-U.S. shareholder, you must provide a Form W-8 BEN (or other applicable Form
W-8) to establish that you are not a U.S. person, to claim that you are the beneficial owner of the income and, if applicable,
to claim a reduced rate of, or exemption from, withholding as a resident of a country with which the United States has an income
tax treaty. A Form W-8 BEN provided without a U.S. taxpayer identification number will remain in effect for a period beginning
on the date signed and ending on the last day of the third succeeding calendar year unless an earlier change of circumstances
makes the information on the form incorrect. Certain payees and payments are exempt from backup withholding.
The
tax consequences to a non-U.S. shareholder entitled to claim the benefits of an applicable tax treaty may be different from those
described herein. Non-U.S. shareholders are urged to consult their own tax advisors with respect to the particular tax consequences
to them of an investment in the Fund, including the applicability of foreign tax.
Foreign
Account Tax Compliance Act (“FATCA”). Under FATCA, a 30% withholding tax is imposed on income dividends paid by
the Fund to certain foreign entities, referred to as foreign financial institutions (“FFI”) or non-financial foreign
entities (“NFFE”). After December 31, 2018, FATCA withholding also would have applied to certain capital gain distributions,
return of capital distributions and the proceeds arising from the sale of Fund Shares; however, based on proposed regulations
issued by the IRS, which can be relied upon currently, such withholding is no longer required unless final regulations provide
otherwise (which is not expected). The FATCA withholding tax generally can be avoided: (a) by an FFI, if it reports certain direct
and indirect ownership of foreign financial accounts held by U.S. persons with the FFI and (b) by an NFFE, if it: (i) certifies
that it has no substantial U.S. persons as owners or (ii) if it does have such owners, reporting information relating to them.
The U.S. Treasury has negotiated intergovernmental agreements (“IGA”) with certain countries and is in various stages
of negotiations with a number of other foreign countries with respect to one or more alternative approaches to implement FATCA;
an entity in one of those countries may be required to comply with the terms of an IGA instead of U.S. Treasury regulations.
An
FFI can avoid FATCA withholding if it is deemed compliant or by becoming a “participating FFI,” which requires the
FFI to enter into a U.S. tax compliance agreement with the IRS under section 1471(b) of the Code (“FFI agreement”)
under which it agrees to verify, report and disclose certain of its U.S. accountholders and meet certain other specified requirements.
The FFI will either report the specified information about the U.S. accounts to the IRS, or, to the government of the FFI’s
country of residence (pursuant to the terms and conditions of applicable law and an applicable IGA entered into between the United
States and the FFI’s country of residence), which will, in turn, report the specified information to the IRS. An FFI that
is resident in a country that has entered into an IGA with the U.S. to implement FATCA will be exempt from FATCA withholding provided
that the FFI shareholder and the applicable foreign government comply with the terms of such agreement.
An
NFFE that is the beneficial owner of a payment from the Fund can avoid the FATCA withholding tax generally by certifying that
it does not have any substantial U.S. owners or by providing the name, address and taxpayer identification number of each substantial
U.S. owner. The NFFE will report the information to the applicable withholding agent, which will, in turn, report information
to the IRS.
Such
foreign shareholders also may fall into certain exempt, excepted or deemed compliant categories as established by U.S. Treasury
regulations, IGAs, and other guidance regarding FATCA. An FFI or NFFE that invests in the Fund will need to provide documentation
properly certifying the entity’s status under FATCA in order to avoid FATCA withholding. Non-U.S. investors should consult
their own tax advisors regarding the impact of these requirements on their investment in the Fund. The requirements imposed by
FATCA are different from, and in addition to, the U.S. tax certification rules to avoid backup withholding described above. Shareholders
are urged to consult their tax advisors regarding the application of these requirements to their own situation.
Effect
of Future Legislation; Local Tax Considerations
The
foregoing general discussion of U.S. federal income tax consequences is based on the Code and the regulations issued thereunder
as in effect on the date of this SAI. Future legislative or administrative changes, including provisions of current law that sunset
and thereafter no longer apply, or court decisions may significantly change the conclusions expressed herein, and any such changes
or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation
of ordinary income, qualified dividend income and capital gain dividends may differ from the rules for U.S. federal income taxation
described above. Distributions may also be subject to additional state, local and foreign taxes depending on each shareholder’s
particular situation. Non-U.S. shareholders may be subject to U.S. tax rules that differ significantly from those summarized above.
Shareholders are urged to consult their tax advisors as to the consequences of these and other state and local tax rules affecting
investment in the Fund.
OTHER
INFORMATION
Shareholder
inquiries may be made by writing to the Trust, c/o Virtus ETF Advisers LLC, 1540 Broadway, New York, New York 10036.
FINANCIAL
STATEMENTS
The
audited financial statements of the Fund, including the financial highlights pertaining thereto, and the report of PricewaterhouseCoopers
LLP, in the Fund’s annual report to shareholders for the fiscal year ended October 31, 2019, are incorporated herein by
reference and made a part of this SAI.