As filed with the Securities and Exchange Commission on April 15, 2002
================================================================================
1933 Act File No. 333-
1940 Act File No. 811-
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-2
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[_] Pre-Effective Amendment No.
[_] Post-Effective Amendment No.
and
[X] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[_] Amendment No.
PIMCO Municipal Income Fund II
(Exact Name of Registrant as Specified in Declaration of Trust)
c/o PIMCO Funds Advisors LLC
1345 Avenue of the Americas
New York, New York 10105
(Address of Principal Executive Offices)
(Number, Street, City, State, Zip Code)
(212) 739-3502
(Registrant's Telephone Number, including Area Code)
Stephen J. Treadway
c/o PIMCO Funds Distributors LLC
2187 Atlantic Street
Stamford, Connecticut 06902
(Name and Address (Number, Street, City, State, Zip Code) of Agent for Service)
Copies of Communications to:
Joseph B. Kittredge, Jr., Esq. Thomas A. Hale
Ropes & Gray Skadden, Arps, Slate, Meagher & Flom LLP
One International Place 333 West Wacker Drive, Suite 2100
Boston, Massachusetts 02110 Chicago, IL 60606
Approximate Date of Proposed Public Offering:
As soon as practicable after the effective date of this Registration Statement
---------------------------
If any of the securities being registered on this form will be offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities Act of
1933, other than securities offered in connection with a dividend reinvestment
plan, check the following box. [_]
It is proposed that this filing will become effective (check appropriate
box)
[X] when declared effective pursuant to section 8(c)
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CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
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Proposed Maximum Proposed Maximum
Amount Being Offering Price Per Aggregate Amount of
Title of Securities Being Registered Registered Unit Offering Price/1/ Registration Fee
------------------------------------ ------------ ------------------ ---------------- -------------------
Common Shares, par value $0.00001 1,000 Shares $ 15.00 $ 15,000 $ 1.38
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/1/ Estimated solely for the purpose of calculating the registration fee.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant shall
file a further amendment which specifically states this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the Registration Statement shall become
effective on such dates as the Commission, acting pursuant to said Section 8(a),
may determine.
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The information in this Prospectus is not complete and may be changed. We may
not sell these securities until the registration statement filed with the
Securities and Exchange Commission is effective. This Prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
PRELIMINARY PROSPECTUS Subject to Completion _______________, 2002
Shares
LOGO
PIMCO MUNICIPAL INCOME FUND II
Common Shares
INVESTMENT OBJECTIVE. The Fund is a newly organized, diversified, closed-end
management investment company. The Fund's investment objective is to provide
current income exempt from federal income tax. In pursuing this objective, the
portfolio manager also seeks to preserve and enhance the value of the Fund's
holdings relative to the municipal bond market generally, using proprietary
analytical models that test and evaluate the sensitivity of those holdings to
changes in interest rates and yield relationships.
PORTFOLIO CONTENTS. Under normal market conditions, the Fund will invest its net
assets in a portfolio of municipal bonds the interest from which is exempt from
federal income taxes. Under normal market conditions, the Fund expects to be
fully invested (at least 90% of its total assets) in tax exempt municipal bonds.
The Fund will seek to avoid bonds generating interest potentially subjecting
individuals to the alternative minimum tax. The Fund will invest at least 80% of
its net assets in investment grade quality municipal bonds, including bonds that
are unrated but judged to be of investment grade quality by the Fund's portfolio
manager. The Fund may invest up to 20% of its net assets in municipal bonds that
are rated Ba/BB or B or that are unrated but judged to be of comparable quality
by the Fund's portfolio manager. The Fund cannot assure you that it will achieve
its investment objective.
NO PRIOR HISTORY. Because the Fund is newly organized, its common shares have no
history of public trading. Shares of closed-end investment companies frequently
trade at a discount from their net asset value and investors may lose money by
purchasing common shares in the initial public offering. The common shares have
been authorized for listing on the New York Stock Exchange, subject to notice of
issuance. The trading or "ticker" symbol of the common shares is expected to be
"____."
BEFORE BUYING ANY COMMON SHARES YOU SHOULD READ THE DISCUSSION OF THE MATERIAL
RISKS OF INVESTING IN THE FUND IN "RISKS" BEGINNING ON PAGE __. CERTAIN OF THESE
RISKS ARE SUMMARIZED IN "PROSPECTUS SUMMARY--SPECIAL RISK CONSIDERATIONS"
BEGINNING ON PAGE __.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
PRICE TO SALES PROCEEDS
PUBLIC LOAD TO FUND
Per Share $ 15.000 $ 0.675 $ 14.325
Total $ $ $
The Fund will pay organizational and offering expenses estimated at $ from
the proceeds of the offering. PIMCO Funds Advisors LLC has agreed to pay the
amount by which the aggregate of all of the Fund's organizational expenses and
all offering costs (other than the sales load) exceeds $0.03 per share.
The underwriters expect to deliver the common shares to purchasers on or
about , 2002.
[ ]
(continued from previous page)
The Fund intends to use leverage by issuing shares of preferred stock
representing approximately 38% of the Fund's capital immediately after their
issuance. The Fund also may add leverage to the portfolio by utilizing residual
interest municipal bonds and other derivative instruments. By using leverage,
the Fund will seek to obtain a higher return for holders of common shares than
if the Fund did not use leverage. Leveraging is a speculative technique and
there are special risks involved. There can be no assurance that a leveraging
strategy will be used or that it will be successful during any period in which
it is employed. See "Preferred shares and related leverage" and "Risks--Leverage
Risk."
You should read this Prospectus, which contains important information about the
Fund, before deciding whether to invest, and retain it for future reference. A
Statement of Additional Information, dated , 2002, containing additional
information about the Fund, has been filed with the Securities and Exchange
Commission and is incorporated by reference in its entirety into this
Prospectus, which means that it is part of the Prospectus for legal purposes.
You can review the table of contents of the Statement of Additional Information
on page ___ of this Prospectus. You may request a free copy of the Statement of
Additional Information by calling (877) 819-2224 or by writing to the Fund, or
obtain a copy (and other information regarding the Fund) from the Securities and
Exchange Commission's web site (http://www.sec.gov).
The Fund's common shares do not represent a deposit or obligation of, and are
not guaranteed or endorsed by, any bank or other insured depository institution,
and are not federally insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board or any other government agency.
The underwriters named in this Prospectus may purchase up to additional
common shares from the Fund under certain circumstances.
You should rely only on the information contained or incorporated by reference
in this Prospectus. The Fund has not, and the underwriters have not, authorized
anyone to provide you with different information. If anyone provides you with
different or inconsistent information, you should not rely on it. The Fund is
not, and the underwriters are not, making an offer of these securities in any
state where the offer is not permitted. You should not assume that the
information contained in this Prospectus is accurate as of any date other than
the date on the front of this Prospectus. The Fund's business, financial
condition, results of operations and prospects may have changed since that date.
Until , 2002 (25 days after the date of this Prospectus), all dealers that
buy, sell or trade the common shares, whether or not participating in this
offering, may be required to deliver a prospectus. This is in addition to the
dealers' obligation to deliver a prospectus when acting as underwriters and with
respect to their unsold allotments or subscriptions.
TABLE OF CONTENTS
Prospectus Summary ......................................................... 1
Summary of Fund expenses ................................................... 6
The Fund ................................................................... 8
Use of proceeds ............................................................ 8
The Fund's investments ..................................................... 8
Preferred shares and related leverage ...................................... 11
Risks ...................................................................... 13
How the Fund manages risk................................................... 16
Management of the Fund...................................................... 18
Net asset value............................................................. 19
Distributions............................................................... 20
Dividend reinvestment plan.................................................. 20
Description of shares....................................................... 21
Anti-takeover and other provisions in the Declaration of Trust.............. 23
Repurchase of Common Shares; conversion to open-end fund.................... 24
Tax matters................................................................. 24
Underwriting................................................................ 26
Shareholder servicing agent, custodian and transfer agent................... 27
Legal matters............................................................... 27
Table of contents for the statement of additional information............... 28
PROSPECTUS SUMMARY
This is only a summary. You should review the more detailed information
contained in this Prospectus and in the Statement of Additional Information.
THE FUND
PIMCO Municipal Income Fund II (the "Fund") is a newly organized, diversified,
closed-end management investment company. See "The Fund."
THE OFFERING
The Fund is offering common shares of beneficial interest, with a par value
of $0.00001 per share, at $15.00 per share through a group of underwriters (the
"Underwriters") led by . The common shares of beneficial interest are
called "Common Shares" in the rest of this Prospectus. You must purchase at
least 100 Common Shares. The Fund has given the Underwriters an option to
purchase up to additional Common Shares to cover orders in excess of
Common Shares. See "Underwriting." PIMCO Funds Advisors LLC (the "Manager"), the
Fund's investment manager, has agreed to pay the amount by which the aggregate
of all of the Fund's organizational expenses and all offering costs (other than
the sales load) exceeds $0.03 per Common Share.
INVESTMENT OBJECTIVE
The Fund's investment objective is to provide current income exempt from federal
income tax. In pursuing this objective, the portfolio manager also seeks to
preserve and enhance the value of the Fund's holdings relative to the municipal
bond market generally, using proprietary analytical models that test and
evaluate the sensitivity of those holdings to changes in interest rates and
yield relationships. Under normal market conditions, the Fund expects to be
fully invested (at least 90% of its total assets) in a portfolio of municipal
bonds the interest from which is exempt from federal income taxes. The Fund will
invest at least 80% of its net assets in municipal bonds that at the time of
investment are investment grade quality. Investment grade quality bonds are
bonds rated, at the time of investment, within the four highest grades (Baa or
BBB or better by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's
("S&P") or Fitch, Inc. ("Fitch")), or bonds that are unrated but judged to be of
comparable quality by the Fund's portfolio manager. The Fund may invest up to
20% of its net assets in municipal bonds that, at the time of investment, are
rated Ba/BB or B by Moody's, S&P or Fitch or that are unrated but judged to be
of comparable quality by the Fund's portfolio manager. Bonds of below investment
grade quality are regarded as having predominantly speculative characteristics
with respect to capacity to pay interest and repay principal, and are commonly
referred to as "junk bonds." Bonds in the lowest investment grade category may
also be considered to possess some speculative characteristics by certain rating
agencies. The Fund will seek to avoid bonds generating interest potentially
subjecting individuals to the alternative minimum tax.
The Fund may invest in "structured" notes, which are privately negotiated debt
obligations where the principal and/or interest is determined by reference to
the performance of a benchmark asset, market or interest rate, such as selected
securities, an index of securities or specified interest rates, or the
differential performance of two assets or markets, such as indices reflecting
taxable and tax-exempt bonds. The Fund currently intends that any use of
structured notes will be for the purpose of reducing the interest rate
sensitivity of the Fund's portfolio (and thereby decreasing the Fund's exposure
to interest rate risk) and, in any event, that the interest income on the notes
will normally be exempt from federal income tax.
The Fund cannot assure you that it will attain its investment objective. See
"The Fund's investments."
PROPOSED OFFERING OF PREFERRED SHARES AND OTHER FORMS OF LEVERAGE
Subject to market conditions, approximately one to three months after completion
of this offering, the Fund intends to offer preferred shares of beneficial
interest ("Preferred Shares") representing approximately 38% of the Fund's
capital after their issuance. The issuance of Preferred Shares will leverage
your investment in Common Shares. Leverage involves special risks. There is no
assurance that the Fund will issue Preferred Shares or that, if issued, the
Fund's leveraging strategy will be successful. The net proceeds the Fund obtains
from selling the Preferred Shares will be invested, in accordance with the
Fund's investment objective and policies, principally in long-term municipal
bonds, which generally will pay fixed rates of interest over the life of the
bond. The Preferred Shares will pay dividends based on short-term interest
rates, which will be reset frequently. So long as the rate of return, net of
applicable Fund expenses, on the long-term bonds and other instruments purchased
by the Fund exceeds Preferred Share dividend rates as reset periodically, the
investment of the proceeds of the Preferred Shares will generate more income
than will be needed to pay dividends on the Preferred Shares.
1
If so, the excess will be used to pay higher dividends to holders of Common
Shares ("Common Shareholders") than if the Fund were not so leveraged through
the issuance of Preferred Shares. The Fund also may add leverage to the
portfolio by utilizing residual interest municipal bonds ("RIBS") and other
derivative instruments. See "Risks--Leverage Risk." The Fund cannot assure you
that the issuance of Preferred Shares or the use of other forms of leverage will
result in a higher yield on your Common Shares. Once Preferred Shares are issued
and/or other forms of leverage are used, the net asset value and market price of
the Common Shares and the yield to Common Shareholders will be more volatile.
See "Preferred shares and related leverage," "Description of shares--Preferred
Shares" and "Risks--Leverage Risk."
INVESTMENT MANAGER
The Manager serves as the investment manager of the Fund. Subject to the
supervision of the Board of Trustees, the Manager is responsible for managing,
either directly or through others selected by it, the investment activities of
the Fund and the Fund's business affairs and other administrative matters. The
Manager will receive an annual fee, payable monthly, in a maximum amount equal
to 0.65% of the Fund's average daily net assets (including assets attributable
to any Preferred Shares that may be outstanding). The Manager has contractually
agreed to waive a portion of the management fees it is entitled to receive from
the Fund at the annual rate of 0.15% of the Fund's average daily net assets from
the commencement of operations through June 30, 2007 (i.e., roughly the first
five years of operations), and for a declining amount for an additional two
years of operations (through June 30, 2009). The Manager is located at 1345
Avenue of the Americas, New York, New York 10105. Organized in 2000 to succeed
certain businesses of a predecessor formed in 1987, the Manager provides
investment management and advisory services to several closed-end and open-end
investment company clients. As of December 31, 2001, the Manager had
approximately $80 billion in assets under management. Allianz Dresdner Asset
Management of America L.P. is the direct parent company of PIMCO Advisory
Services Holdings LLC, of which the Manager is a wholly-owned subsidiary. As of
December 31, 2001, Allianz Dresdner Asset Management of America L.P. and its
subsidiary partnerships, including Pacific Investment Management Company LLC
("PIMCO"), had approximately $320 billion in assets under management.
The Manager has retained its affiliate, PIMCO, as a sub-adviser to manage the
Fund's portfolio investments. See "--Portfolio Manager" below.
PORTFOLIO MANAGER
PIMCO will serve as the Fund's sub-adviser responsible for managing the Fund's
portfolio investments, and is sometimes referred to herein as the "portfolio
manager." Subject to the supervision of the Manager, PIMCO has full investment
discretion and makes all determinations with respect to the investment of the
Fund's assets.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California 92660.
Organized in 1971, PIMCO provides investment management and advisory services to
private accounts of institutional and individual clients and to mutual funds. As
of February 28, 2002, PIMCO had approximately $248 billion in assets under
management.
The Manager (and not the Fund) will pay a portion of the fees it receives to
PIMCO in return for PIMCO's services.
DISTRIBUTIONS
Commencing with the Fund's first dividend, the Fund intends to make regular
monthly cash distributions to you at a level rate based on the projected
performance of the Fund. The Fund's ability to maintain a level dividend rate
will depend on a number of factors, including dividends payable on the Preferred
Shares. As portfolio and market conditions change, the rate of dividends on the
Common Shares and the Fund's dividend policy could change. Over time, the Fund
will distribute substantially all of its net investment income (after it pays
accrued dividends on any outstanding Preferred Shares). In addition, at least
annually, the Fund intends to distribute to you your pro rata share of any
available net capital gain. Your initial distribution is expected to be declared
approximately 45 days, and paid approximately 60 to 90 days, from the completion
of this offering, depending on market conditions. Unless you elect to receive
distributions in cash, all of your distributions will be automatically
reinvested in additional Common Shares under the Fund's Dividend Reinvestment
Plan. See "Distributions" and "Dividend reinvestment plan."
LISTING
The Common Shares have been authorized for listing on the New York Stock
Exchange, subject to notice of issuance. The trading or "ticker" symbol of the
Common Shares is expected to be " ." See "Description of shares--Common Shares."
2
CUSTODIAN AND TRANSFER AGENT
State Street Bank and Trust Co. will serve as custodian of the Fund's assets.
PFPC Inc. will serve as the Fund's transfer and dividend disbursement agent. See
"Custodian and transfer agent."
MARKET PRICE OF SHARES
Shares of closed-end investment companies frequently trade at prices lower than
net asset value. Shares of closed-end investment companies like the Fund that
invest predominantly in investment grade municipal bonds have during some
periods traded at prices higher than net asset value and during other periods
traded at prices lower than net asset value. The Fund cannot assure you that
Common Shares will trade at a price higher than net asset value in the future.
Net asset value will be reduced immediately following the offering by the sales
load and the amount of organization and offering expenses paid by the Fund. See
"Use of proceeds." In addition to net asset value, market price may be affected
by such factors relating to the Fund and its portfolio holdings as dividend
levels (which are in turn affected by expenses), dividend stability, portfolio
credit quality and liquidity and call protection and market supply and demand.
See "Preferred shares and related leverage," "Risks," "Description of shares,"
and "Repurchase of Common Shares; conversion to open-end fund" in this
Prospectus, and the Statement of Additional Information under "Repurchase of
Common Shares; Conversion to Open-End Fund." The Common Shares are designed
primarily for long-term investors, and you should not view the Fund as a vehicle
for trading purposes.
SPECIAL RISK CONSIDERATIONS
NO OPERATING HISTORY
The Fund is a newly organized, diversified, closed-end management investment
company with no history of operations.
MARKET DISCOUNT RISK
Shares of closed-end management investment companies like the Fund frequently
trade at a discount from their net asset value.
INTEREST RATE RISK
Generally, when market interest rates fall, bond prices rise, and vice versa.
Interest rate risk is the risk that the municipal bonds in the Fund's portfolio
will decline in value because of increases in market interest rates. The prices
of longer-term bonds generally fluctuate more than prices of shorter-term bonds
as interest rates change. Because the Fund will invest primarily in long-term
bonds, the Common Share net asset value and market price per share will
fluctuate more in response to changes in market interest rates than if the Fund
invested primarily in short-term bonds. The Fund may utilize certain strategies,
including investments in "structured" notes, for the purpose of reducing the
interest rate sensitivity of the portfolio and decreasing the Fund's exposure to
interest rate risk, although there is no assurance that it will do so or that
such strategies will be successful. The Fund's use of leverage, as described
below, will tend to increase Common Share interest rate risk. See
"Risks--Interest Rate Risk" for additional information.
CREDIT RISK
Credit risk is the risk that one or more debt obligations in the Fund's
portfolio will decline in price, or fail to pay interest or principal when due,
because the issuer of the obligation experiences a decline in its financial
status. The Fund may invest up to 20% (measured at the time of investment) of
its net assets in municipal bonds that are rated Ba/BB or B or that are unrated
but judged to be of comparable quality by PIMCO. The prices of these lower grade
bonds are more sensitive to negative developments, such as a decline in the
issuer's revenues or a general economic downturn, than are the prices of higher
grade securities. Municipal bonds of below investment grade quality (commonly
referred to as "junk bonds") are predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal when due, and therefore
involve a greater risk of default. Municipal bonds in the lowest investment
grade category may also be considered to possess some speculative
characteristics by certain rating agencies.
MUNICIPAL BOND MARKET RISK
The amount of public information available about the municipal bonds in the
Fund's portfolio is generally less than that for corporate equities or bonds,
and the investment performance of the Fund may therefore be more dependent on
the analytical abilities of PIMCO than would be a stock fund or taxable bond
fund. The secondary market for municipal bonds, particularly below investment
grade bonds in which the Fund may invest, also tends to be less well-developed
and less liquid than many other securities markets, which may adversely affect
the Fund's ability to sell its bonds at attractive prices.
3
REINVESTMENT RISK
Income from the Fund's municipal bond portfolio will decline if and when the
Fund invests the proceeds from matured, traded or called bonds at market
interest rates that are below the portfolio's current earnings rate. A decline
in income could affect the Common Shares' market price or their overall return.
LEVERAGE RISK
The Fund's use of leverage through the issuance of Preferred Shares creates an
opportunity for increased Common Share net income, but also creates special
risks for Common Shareholders. There is no assurance that the Fund's leveraging
strategy will be successful. It is anticipated that dividends on Preferred
Shares will be based on short-term municipal bond rates of return (which would
be redetermined periodically, pursuant to an auction process), and that the Fund
will invest the net proceeds of the Preferred Shares offering principally in
long-term, typically fixed rate, municipal bonds. So long as the Fund's
municipal bond portfolio provides a higher rate of return (net of Fund expenses)
than the Preferred share dividend rate, as reset periodically, the leverage will
allow Common Shareholders to receive a higher current rate of return than if the
Fund were not leveraged. If, however, short-term tax-exempt interest rates rise
substantially after the issuance of the Preferred Shares, the Preferred Shares
dividend rate could approach or exceed the acquisition yield on long-term bonds
and other investments held by the Fund that were acquired during periods of
generally lower interest rates, reducing distribution yields and returns to
Common Shareholders. Investment by the Fund in RIBS and other derivative
instruments may increase the Fund's leverage and, during periods of rising
interest rates, may adversely affect the Fund's income, distributions and total
returns to Common Shareholders. See "The Fund's investments" for a discussion of
these instruments. Preferred Shares are expected to pay cumulative dividends,
which may tend to increase leverage risk. Leverage creates two major types of
risks for Common Shareholders:
- the likelihood of greater volatility of net asset value and market
price of Common Shares, because changes in the value of the Fund's municipal
bond portfolio (including securities bought with the proceeds of the
Preferred Shares offering) are borne entirely by the Common Shareholders; and
- the possibility either that Common Share income will fall if the
Preferred Share dividend rate rises, or that Common Share income will
fluctuate because the Preferred Share dividend rate varies.
Because the fees received by the Manager are based on the total net assets of
the Fund (including assets represented by Preferred Shares and any leverage
created thereby), the Manager has a financial incentive for the Fund to issue
Preferred Shares, which may create a conflict of interest between the Manager
and the holders of the Common Shares.
INFLATION RISK
Inflation risk is the risk that the value of assets or income from the Fund's
investments will be worth less in the future as inflation decreases the present
value of payments at future dates.
LIQUIDITY RISK
The Fund may invest up to 20% of its net assets in securities which are illiquid
at the time of investment, which means a security that cannot be sold within
seven days at a price which approximates fair value. Illiquid securities may
trade at a discount from comparable, more liquid investments, and may be subject
to wide fluctuations in market value. Also, the Fund may not be able to dispose
of illiquid securities when that would be beneficial at a favorable time or
price.
DERIVATIVES RISK
The Fund may utilize a variety of derivative instruments for investment or risk
management purposes, such as RIBS, structured notes, options contracts, futures
contracts, options on futures contracts, swap agreements, short sales and
delayed delivery and forward commitment transactions. Derivatives are subject to
a number of risks described elsewhere in this Prospectus, such as liquidity
risk, interest rate risk, credit risk, leverage risk and management risk. They
also involve the risk of mispricing or improper valuation, the risk of ambiguous
documentation, and the risk that changes in the value of a derivative may not
correlate perfectly with an underlying asset, interest rate or index. Suitable
derivative transactions may not be available in all circumstances and there can
be no assurance that the Fund will engage in these transactions to reduce
exposure to other risks when that would be beneficial.
MANAGEMENT RISK
The Fund is subject to management risk because it is an actively managed
investment portfolio. PIMCO and the individual portfolio manager will apply
investment techniques and risk analyses in making investment decisions for the
Fund, but there can be no guarantee that these will produce the desired results.
ANTI-TAKEOVER PROVISIONS
The Fund's Amended and Restated Agreement and Declaration of Trust (the
"Declaration") includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or convert the Fund to
open-end status. See
4
"Anti-takeover and other provisions in the Declaration of Trust." These
provisions in the Declaration could have the effect of depriving the Common
Shareholders of opportunities to sell their Common Shares at a premium over the
then current market price of the Common Shares.
TAX CONSIDERATIONS
The Fund's distributions of ordinary taxable income (including any net
short-term capital gain) will be taxable to shareholders as ordinary income, and
capital gain dividends will be subject to capital gains taxes. See "Tax
matters."
5
SUMMARY OF FUND EXPENSES
The following table assumes the issuance of Preferred Shares in an amount equal
to 38% of the Fund's capital (after their issuance), and shows Fund expenses as
a percentage of net assets attributable to Common Shares. Footnote 2 to the
table shows Fund expenses as a percentage of total net assets (attributable to
both Common and Preferred Shares).
Shareholder Transaction Expenses
Sales Load Paid by You (as a percentage of offering price) .......... 4.50%
Dividend Reinvestment Plan Fees ..................................... None(1)
Percentage of Net
Assets
Attributable to
Common Shares(2)
--------------------------------------------------------------------------------
Annual Expenses
Management Fees .......................................... 1.05%
Other Expenses ........................................... 0.32%
Total Annual Expenses .................................... 1.37%
Fee Waiver (Years 1-5) ................................... (0.24)%(3)
Net Annual Expenses (Years 1-5) .......................... 1.13%(3)
(1) You will pay brokerage charges if you direct the plan agent to sell your
Common Shares held in a dividend reinvestment account.
(2) The table presented in this footnote estimates what the Fund's annual
expenses would be stated as percentages of the Fund's total net assets
(rather than stated as percentages of the Fund's net assets attributable to
Common Shares, as presented above), and again assuming the issuance of
Preferred Shares in an amount equal to 38% of the Fund's capital (after
their issuance). In accordance with these assumptions, the Fund's expenses
would be estimated to be as follows:
Percentage of
Total Net Assets
--------------------------------------------------------------------------------
Annual Expenses
Management Fees ........................................... 0.65%
Other Expenses ............................................ 0.20%
Total Annual Expenses ..................................... 0.85%
Fees Waiver (Years 1-5) ...................................(0.15)%(3)
Net Annual Expenses (Years 1-5) ........................... 0.70%(3)
(3) The Manager has contractually agreed to waive a portion of the management
fees it is entitled to receive from the Fund at the annual rate of 0.15% of
the Fund's average daily net assets from the commencement of operations
through June 30, 2007 (i.e., roughly the first 5 years of Fund operations),
0.10% of average daily net assets in year 6 and 0.05% in year 7. The
Manager has not agreed to waive any portion of its fees and expenses beyond
June 30, 2009. Without the fee waiver, "Net Annual Expenses" would be
estimated to be 1.37% of average daily net assets attributable to Common
Shares and 0.85% of average total daily net assets (attributable to both
Common and Preferred Shares). The Manager has agreed to pay the amount by
which the aggregate of all of the Fund's organizational expenses and all
offering costs (other than the sales load) exceeds $0.03 per Common Share.
The purpose of the table above is to help you understand all fees and expenses
that you, as a Common Shareholder, would bear directly or indirectly. The Other
Expenses shown in the table and related footnotes are based on estimated amounts
for the Fund's first year of operations and assume that the Fund issues
approximately Common Shares. See "Management of the Fund" and "Dividend
reinvestment plan."
6
As required by relevant Securities and Exchange Commission regulations, the
following example illustrates the expenses (including the sales load of $45)
that you would pay on a $1,000 investment in Common Shares, assuming (a) total
net annual expenses of 1.13% of net assets attributable to Common Shares in
years 1 through 5, increasing to 1.37% in years 8, 9 and 10, and (b) a 5% annual
return(1):
1 Year 3 Years 5 Years 10 Years(2)
--------------------------------------------------------------------------------
$56 $79 $104 $188
THE EXAMPLE ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES.
ACTUAL EXPENSES MAY BE HIGHER OR LOWER THAN THOSE SHOWN.
(1) The example assumes that the estimated Other Expenses set forth in the
Annual Expenses table are accurate, that fees and expenses increase as
described in note 2 below, and that all dividends and distributions are
reinvested at net asset value. Actual expenses may be greater or less
than those assumed. Moreover, the Fund's actual rate of return may be
greater or less than the hypothetical 5% annual return shown in the
example.
(2) Assumes waiver of management fees at the annual rate of 0.10% of the
Fund's average daily net assets in year 6, 0.05% in year 7 and no
waiver in years 8, 9 and 10. The Manager has not agreed to waive any
portion of the management fees it is entitled to receive from the Fund
beyond June 30, 2009. See "Management of the Fund--Investment
Management Agreement."
7
THE FUND
The Fund is a recently organized, diversified, closed-end management investment
company registered under the Investment Company Act of 1940, as amended, and the
rules and regulations thereunder (the "1940 Act"). The Fund was organized as a
Massachusetts business trust on March 29, 2002 pursuant to the Declaration,
which is governed by the laws of The Commonwealth of Massachusetts. As a newly
organized entity, the Fund has no operating history. The Fund's principal office
is located at 1345 Avenue of the Americas, New York, New York 10105, and its
telephone number is (212) 739-3369.
USE OF PROCEEDS
The net proceeds of the offering of Common Shares will be approximately $
(or $ if the Underwriters exercise the over-allotment option in full)
after payment of the estimated organizational and offering costs. The Manager
has agreed to pay the amount by which the aggregate of all of the Fund's
organizational expenses and all offering costs (other than the sales load)
exceeds $0.03 per Common Share. The Fund will invest the net proceeds of the
offering in accordance with the Fund's investment objective and policies as
stated below. It is presently anticipated that the Fund will be able to invest
substantially all of the net proceeds in municipal bonds that meet its
investment objective and policies within three months after the completion of
the offering. Pending such investment, it is anticipated that the proceeds will
be invested in short-term, tax-exempt securities.
THE FUND'S INVESTMENTS
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide current income exempt from federal
income tax. In pursuing this objective, PIMCO also seeks to preserve and enhance
the value of the Fund's holdings relative to the municipal bond market
generally, using proprietary analytical models that test and evaluate the
sensitivity of those holdings to changes in interest rates and yield
relationships.
PIMCO may at times believe that bonds associated with a particular municipal
market sector (for example, electric utilities), issued by a particular
municipal issuer, or having particular structural characteristics, are
undervalued. PIMCO may purchase such a bond for the Fund's portfolio because it
represents a market sector or issuer that PIMCO considers undervalued, even if
the value of the particular bond appears to be consistent with the value of
similar bonds. Municipal bonds of particular types (e.g., hospital bonds,
industrial revenue bonds or bonds issued by a particular municipal issuer) may
be undervalued because there is a temporary excess of supply in that market
sector, or because of a general decline in the market price of municipal bonds
of the market sector for reasons that do not apply to the particular municipal
bonds that are considered undervalued. The Fund's investment in municipal bonds
may be based on PIMCO's belief that their yield and/or total return potential is
higher than that available on bonds bearing similar levels of interest rate
risk, credit risk and other forms of risk, or that their value relative to the
municipal bond market is less sensitive to these risks. The Fund attempts to
increase its portfolio value relative to the municipal bond market generally by
prudent selection of municipal bonds regardless of the direction the market may
move. Any capital appreciation realized by the Fund will generally result in the
distribution of taxable capital gains to Common Shareholders.
Under normal market conditions, the Fund will invest its net assets in a
portfolio of municipal bonds the interest from which is exempt from federal
income taxes. The Fund expects to be fully invested (at least 90% of its total
assets) in tax exempt municipal bonds.
Under normal market conditions, the Fund will invest at least 80% of its net
assets in municipal bonds which are of investment grade quality at the time of
investment, including bonds that are unrated but judged to be of investment
grade quality by PIMCO. Investment grade quality means that such bonds are
rated, at the time of investment, within the four highest grades (Baa or BBB or
better by Moody's, S&P or Fitch) or are unrated but judged to be of comparable
quality by PIMCO. The Fund may invest up to 20% of its net assets in municipal
bonds that are rated, at the time of investment, Ba/BB or B by Moody's, S&P or
Fitch or that are unrated but judged to be of comparable quality by PIMCO. Bonds
of below investment grade quality (Ba/BB or below) are commonly referred to as
"junk bonds." Bonds of below investment grade quality are regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. Bonds in the lowest investment grade category may
also be considered to possess some speculative characteristics by certain rating
agencies. The foregoing credit quality policies apply only at the time a
security is
8
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or PIMCO downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, PIMCO may consider such factors as PIMCO's assessment of the
credit quality of the issuer of such security, the price at which such security
could be sold and the rating, if any, assigned to such security by other rating
agencies. A general description of Moody's, S&P's and Fitch's ratings of
municipal bonds is set forth in Appendix A to the Statement of Additional
Information. The Fund may also invest up to 10% of its net assets in securities
of other open- or closed-end investment companies that invest primarily in
municipal bonds of the types in which the Fund may invest directly. As a
stockholder in an investment company, the Fund would bear its ratable share of
that investment company's expenses in addition to the Fund's own expenses. See
"--Other Investment Companies" below.
The Fund may purchase municipal bonds that are additionally secured by
insurance, bank credit agreements, or escrow accounts. The credit quality of
companies which provide such credit enhancements will affect the value of those
securities. Although the insurance feature reduces certain financial risks, the
premiums for insurance and the higher market price paid for insured obligations
may reduce the Fund's income. Insurance generally will be obtained from insurers
with a claims-paying ability rated Aaa by Moody's or AAA by S&P or Fitch. The
insurance feature does not guarantee the market value of the insured obligations
or the net asset value of the Common Shares.
Upon PIMCO's recommendation, temporarily or for defensive purposes and in order
to keep the Fund's cash fully invested, including the period during which the
net proceeds of this offering are being invested, the Fund may invest up to 100%
of its net assets in high quality, short-term investments, including
mortgage-backed and corporate debt securities, that may be either tax-exempt or
taxable. The Fund intends to invest in taxable short-term investments only in
the event that suitable tax-exempt short-term investments are not available at
reasonable prices and yields. Investment in taxable short-term investments would
result in a portion of your dividends being subject to federal income taxes. For
more information, see the Statement of Additional Information.
The Fund cannot change its investment objective without the approval of the
holders of a "majority of the outstanding" Common Shares and Preferred Shares
voting together as a single class, and of the holders of a "majority of the
outstanding" Preferred Shares voting as a separate class. A "majority of the
outstanding" shares (whether voting together as a single class or voting as a
separate class) means (i) 67% or more of such shares present at a meeting, if
the holders of more than 50% of those shares are present or represented by
proxy, or (ii) more than 50% of such shares, whichever is less. See "Description
of shares--Preferred Shares--Voting Rights" in this Prospectus and in the
Statement of Additional Information under "Description of Shares--Preferred
Shares--Voting Rights" for additional information with respect to the voting
rights of holders of Preferred Shares.
The Fund will seek to avoid bonds generating interest potentially subjecting
individuals to the federal alternative minimum tax. Nonetheless, the Fund may
not be successful in this regard and if you are, or as a result of an investment
in the Fund would become, subject to the federal alternative minimum tax, the
Fund may not be a suitable investment for you. Special alternative minimum tax
rules apply to corporate holders. In addition, capital gain dividends will be
subject to capital gains taxes. See "Tax matters."
The following provides additional information regarding the types of securities
and other instruments in which the Fund will ordinarily invest. A more detailed
discussion of these and other instruments and investment techniques that may be
used by the Fund is provided under "Investment Objective and Policies" in the
Statement of Additional Information.
MUNICIPAL BONDS
Municipal bonds are either general obligation or revenue bonds and typically are
issued to finance public projects (such as roads or public buildings), to pay
general operating expenses, or to refinance outstanding debt. General obligation
bonds are backed by the full faith and credit, or taxing authority, of the
issuer and may be repaid from any revenue source; revenue bonds may be repaid
only from the revenues of a specific facility or source. The Fund also may
purchase municipal bonds that represent lease obligations. These carry special
risks because the issuer of the bonds may not be obligated to appropriate money
annually to make payments under the lease. In order to reduce this risk, the
Fund will only purchase municipal bonds representing lease obligations where
PIMCO believes the issuer has a strong incentive to continue making
appropriations until maturity.
The municipal bonds in which the Fund will invest are generally issued by
states, cities or local authorities, or certain possessions and territories of
the United States (such as Puerto Rico or Guam), and pay interest that, in the
opinion of bond
9
counsel to the issuer (or on the basis of other authority believed by PIMCO to
be reliable), is exempt from federal income taxes.
The yields on municipal bonds depend on a variety of factors, including
prevailing interest rates and the condition of the general money market and the
municipal bond market, the size of a particular offering, the maturity of the
obligation and the rating of the issue. The market value of municipal bonds will
vary with changes in interest rate levels and as a result of changing
evaluations of the ability of their issuers to meet interest and principal
payments.
The Fund will invest primarily in municipal bonds with long-term maturities in
order to maintain a weighted average maturity of 15-30 years, but the weighted
average maturity of obligations held by the Fund may be shortened, depending on
market conditions.
WHEN ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS
The Fund may purchase securities which it is eligible to purchase on a
when-issued basis, may purchase and sell such securities for delayed delivery
and may make contracts to purchase such securities for a fixed price at a future
date beyond normal settlement time (forward commitments). When-issued
transactions, delayed delivery purchases and forward commitments involve a risk
of loss if the value of the securities declines prior to the settlement date.
The risk is in addition to the risk that the Fund's other assets will decline in
value. Therefore, these transactions may result in a form of leverage and
increase the Fund's overall investment exposure. Typically, no income accrues on
securities the Fund has committed to purchase prior to the time delivery of the
securities is made, although the Fund may earn income on securities it has
segregated to cover these positions.
STRUCTURED NOTES
The Fund may invest in "structured" notes, which are privately negotiated debt
obligations where the principal and/or interest is determined by reference to
the performance of a benchmark asset, market or interest rate, such as selected
securities, an index of securities or specified interest rates, or the
differential performance of two assets or markets, such as indices reflecting
taxable and tax-exempt bonds. Depending on the terms of the note, the Fund may
forgo all or part of the interest and principal that would be payable on a
comparable conventional note. The rate of return on structured notes may be
determined by applying a multiplier to the performance or differential
performance of the referenced index(es) or other asset(s). Application of a
multiplier involves leverage that will serve to magnify the potential for gain
and the risk of loss.
The Fund currently intends that any use of structured notes will be for the
purpose of reducing the interest rate sensitivity of the Fund's portfolio (and
thereby decreasing the Fund's exposure to interest rate risk) and, in any event,
that the interest income on the notes will normally be exempt from federal
income tax. The Fund will only invest in structured notes if it has received an
opinion of counsel for the issuer (or the advice of another authority believed
by PIMCO to be reliable) that the interest income on the notes will be exempt
from federal income tax. Like other sophisticated strategies, the Fund's use of
structured notes may not work as intended; for example, the change in value of
the structured notes may not match very closely the change in the value of bonds
that the structured notes were purchased to hedge.
VARIABLE AND FLOATING RATE SECURITIES
Variable and floating rate securities provide for a periodic adjustment in the
interest rate paid on the obligations. The Fund may invest in floating rate debt
instruments ("floaters") and engage in credit spread trades. While floaters
provide a certain degree of protection against rising interest rates, the Fund
will participate in any decline in interest rates as well. A credit spread trade
is an investment position relating to a difference in the prices or interest
rates of two bonds or other securities, where the value of the investment
position is determined by changes in the difference between such prices or
interest rates, as the case may be, of the respective securities.
RESIDUAL INTEREST MUNICIPAL BONDS (RIBS)
The Fund may also invest up to 10% of its total assets in RIBS, whose interest
rates bear an inverse relationship to the interest rate on another security or
the value of an index. An investment in RIBS typically will involve greater risk
than an investment in a fixed rate bond. Because increases in the interest rate
on the other security or index reduce the residual interest paid on a RIB, the
value of a RIB is generally more volatile than that of a fixed rate bond. RIBS
have interest rate adjustment formulas that generally reduce or, in the extreme,
eliminate the interest paid to the Fund when short-term interest rates rise, and
increase the interest paid to the Fund when short-term interest rates fall. RIBS
have varying degrees of liquidity that approximate the liquidity of the
underlying bond(s), and the market price for these securities is volatile. These
securities generally will underperform the market of fixed rate bonds in a
rising interest rate environment, but tend to
10
outperform the market of fixed rate bonds when interest rates decline or remain
relatively stable. Although volatile, RIBS typically offer the potential for
yields exceeding the yields available on fixed rate bonds with comparable credit
quality, coupon, call provisions and maturity. The Fund may also invest in RIBS
for the purpose of increasing the Fund's leverage as a more flexible alternative
to the issuance of Preferred Shares. Should short-term and long-term interest
rates rise, the combination of the Fund's investment in RIBS and its use of
other forms of leverage (including through the issuance of Preferred Shares or
the use of other derivative instruments) likely will adversely affect the Fund's
net asset value per share and income and distributions to shareholders. Trusts
in which RIBS may be held could be terminated, in which case the residual bond
holder would take possession of the underlying bond(s) on an unleveraged basis.
OTHER INVESTMENT COMPANIES
The Fund may invest up to 10% of its net assets in securities of other open- or
closed-end investment companies that invest primarily in municipal bonds of the
types in which the Fund may invest directly. The Fund may invest in other
investment companies either during periods when it has large amounts of
uninvested cash, such as the period shortly after the Fund receives the proceeds
of the offering of its Common Shares or Preferred Shares, during periods when
there is a shortage of attractive, high-yielding municipal bonds available in
the market, or when PIMCO believes share prices of other investment companies
offer attractive values. The Fund may invest in investment companies that are
advised by PIMCO or its affiliates to the extent permitted by applicable law
and/or pursuant to exemptive relief from the Securities and Exchange Commission.
As a stockholder in an investment company, the Fund will bear its ratable share
of that investment company's expenses, and would remain subject to payment of
the Fund's management fees and other expenses with respect to assets so
invested. Common Shareholders would therefore be subject to duplicative expenses
to the extent the Fund invests in other investment companies. PIMCO will take
expenses into account when evaluating the investment merits of an investment in
an investment company relative to available municipal bond investments. In
addition, the securities of other investment companies may also be leveraged and
will therefore be subject to the same leverage risks described herein. As
described in the section entitled "Risks," the net asset value and market value
of leveraged shares will be more volatile and the yield to shareholders will
tend to fluctuate more than the yield generated by unleveraged shares.
DERIVATIVES
The Fund may, but is not required to, use a variety of derivative instruments to
add leverage to the portfolio, for risk management purposes or as part of its
investment strategies. Generally, derivatives are financial contracts whose
value depends upon, or is derived from, the value of an underlying asset,
reference rate or index, and may relate to individual debt instruments, interest
rates and related indexes. Examples of derivative instruments that the Fund may
use include RIBS, structured notes, options contracts, futures contracts,
options on futures contracts, swap agreements, short sales and delayed delivery
and forward commitment transactions. The Fund's use of derivative instruments
involves risks different from, or possibly greater than, the risks associated
with investment directly in securities and other more traditional investments.
See "Risks--Derivatives Risk." Certain types of derivative instruments that the
Fund may utilize with some frequency are described elsewhere in this section,
including those described under "--Structured Notes" and "--Residual Interest
Municipal Bonds (RIBS)" above. Please see "Investment Objective and
Policies--Derivative Instruments" in the Statement of Additional Information for
additional information about these and other derivative instruments that the
Fund may use and the risks associated with such instruments. Income earned by
the Fund from many derivatives transactions will be treated as capital gain and,
if not offset by net realized capital loss, will be distributed to shareholders
in taxable distributions.
Please see "Investment Objective and Policies" in the Statement of Additional
Information for additional information regarding the investments of the Fund and
their related risks.
PREFERRED SHARES AND RELATED LEVERAGE
Subject to market conditions, approximately one to three months after the
completion of the offering of the Common Shares, the Fund intends to offer
Preferred Shares representing approximately 38% of the Fund's capital
immediately after the issuance of the Preferred Shares. The Preferred Shares
will have complete priority upon distribution of assets over the Common Shares.
The issuance of Preferred Shares will leverage the Common Shares. Leverage
involves special risks and there is no assurance that the Fund's leveraging
strategies will be successful. Although the timing and other terms of the
offering of the Preferred Shares will be determined by the Fund's Board of
Trustees, the Fund expects to invest the net proceeds of the Preferred Shares
principally in long-term municipal bonds. The Preferred Shares will pay
dividends based on short-term rates (which would be redetermined periodically by
an auction process). So long as the Fund's portfolio is invested in securities
that provide a higher rate of return than the dividend rate of the Preferred
Shares (after taking
11
expenses into consideration), the leverage will allow Common Shareholders to
receive a higher current rate of return than if the Fund were not leveraged.
Changes in the value of the Fund's municipal bond portfolio (including
investments bought with the proceeds of the Preferred Shares offering) will be
borne entirely by the Common Shareholders. If there is a net decrease (or
increase) in the value of the Fund's investment portfolio, the leverage will
decrease (or increase) the net asset value per Common Share to a greater extent
than if the Fund were not leveraged. During periods in which the Fund is using
leverage, the fees paid to the Manager will be higher than if the Fund did not
use leverage because the fees paid will be calculated on the basis of the Fund's
total net assets, including the proceeds from the issuance of Preferred Shares.
For tax purposes, the Fund is currently required to allocate net capital gain
and other taxable income, if any, between and among the Common Shares and any
series of Preferred Shares in proportion to total distributions paid to each
class for the taxable year in which the net capital gain or other taxable income
is realized. If net capital gain or other taxable income is allocated to
Preferred Shares (instead of solely tax-exempt income), the Fund will have to
pay higher total dividends to Preferred Shareholders or make dividend payments
intended to compensate Preferred Shareholders for the unanticipated
characterization of a portion of their dividends as taxable ("Gross-up
Dividends"). This would reduce any advantage of the Fund's leveraged structure
to Common Shareholders.
Under the 1940 Act, the Fund is not permitted to issue Preferred Shares unless
immediately after such issuance the value of the Fund's total net assets is at
least 200% of the liquidation value of the outstanding Preferred Shares plus the
aggregate amount of any senior securities of the Fund representing indebtedness
(i.e., such liquidation value plus the aggregate amount of senior securities
representing indebtedness may not exceed 50% of the Fund's total net assets). In
addition, the Fund is not permitted to declare any cash dividend or other
distribution on its Common Shares unless, at the time of such declaration, the
value of the Fund's total net assets satisfies the above-referenced 200%
coverage requirement. If Preferred Shares are issued, the Fund intends, to the
extent possible, to purchase or redeem Preferred Shares from time to time to the
extent necessary in order to maintain coverage of at least 200%. If the Fund has
Preferred Shares outstanding, two of the Fund's Trustees will be elected by the
holders of Preferred Shares, voting separately as a class. The remaining
Trustees of the Fund will be elected by holders of Common Shares and Preferred
Shares voting together as a single class. In the event the Fund failed to pay
dividends on Preferred Shares for two years, Preferred Shareholders would be
entitled to elect a majority of the Trustees of the Fund.
The Fund may be subject to certain restrictions imposed by guidelines of one or
more rating agencies that may issue ratings for Preferred Shares issued by the
Fund. These guidelines may impose asset coverage or portfolio composition
requirements that are more stringent than those imposed on the Fund by the 1940
Act. It is not anticipated that these covenants or guidelines will impede PIMCO
from managing the Fund's portfolio in accordance with the Fund's investment
objective and policies.
Assuming that the Preferred Shares will represent approximately 38% of the
Fund's capital and pay dividends at an annual average rate of %, the income
generated by the Fund's portfolio (net of expenses) would have to exceed % in
order to cover such dividend payments. Of course, these numbers are merely
estimates, used for illustration. Actual Preferred Share dividend rates will
vary frequently and may be significantly higher than the rate identified above.
The following table is furnished in response to requirements of the Securities
and Exchange Commission. It is designed to illustrate the effect of leverage on
Common Share total return, assuming investment portfolio total returns
(consisting of income and changes in the value of investments held in the Fund's
portfolio) of -10%, -5%, 0%, 5% and 10%. These assumed investment portfolio
returns are hypothetical figures and are not necessarily indicative of the
investment portfolio returns expected to be experienced by the Fund. The table
further assumes the issuance of Preferred Shares representing approximately 38%
of the Fund's total capital, a % yield on the Fund's investment portfolio, net
of expenses, and the Fund's currently projected annual Preferred Share dividend
rate of %. See "Risks."
Assumed Portfolio Total Return .... (10.00)% (5.00)% 0.00% 5.00% 10.00%
Common Share Total Return ......... ( )% ( )% ( )% % %
Common Share total return is composed of two elements--the Common Share
dividends paid by the Fund (the amount of which is largely determined by the net
investment income of the Fund after paying dividends on Preferred Shares) and
gains or losses on the value of the securities the Fund owns. As required by
Securities and Exchange Commission rules, the table assumes that the Fund is
more likely to suffer capital losses than to enjoy capital appreciation. For
example, to assume a total return of 0%, the Fund must assume that the
tax-exempt interest it receives on its municipal bond investments is entirely
offset by losses in the value of those investments.
12
OTHER FORMS OF LEVERAGE AND BORROWINGS
In addition to the issuance of Preferred Shares, the Fund may use a variety of
additional strategies to add leverage to the portfolio. These include the use of
RIBS and other derivative instruments. By adding additional leverage, these
strategies have the potential to increase returns to Common Shareholders, but
also involve additional risks. Additional leverage will increase the volatility
of the Fund's investment portfolio and could result in larger losses than if the
strategies were not used.
Under the 1940 Act, the Fund generally is not permitted to engage in borrowings
(including through the use of derivatives to the extent that these instruments
constitute senior securities) unless immediately after a borrowing the value of
the Fund's total assets less liabilities (other than the borrowing) is at least
300% of the principal amount of such borrowing (i.e., such principal amount may
not exceed 33 1/3% of the Fund's total assets). In addition, the Fund is not
permitted to declare any cash dividend or other distribution on Common Shares
unless, at the time of such declaration, the value of the Fund's total assets,
less liabilities other than borrowing, is at least 300% of such principal
amount. If the Fund borrows, it intends, to the extent possible, to prepay all
or a portion of the principal amount of the borrowing to the extent necessary in
order to maintain the required asset coverage. Failure to maintain certain asset
coverage requirements could result in an event of default and entitle Preferred
Shareholders to elect a majority of the Trustees of the Fund. Derivative
instruments used by the Fund will not constitute senior securities (and will not
be subject to the Fund's limitations on borrowings) to the extent that the Fund
segregates liquid assets at least equal in amount to its obligations under the
instruments, or enters into offsetting transactions or owns positions covering
its obligations. For instance, the Fund may cover its position in a forward
purchase commitment by segregating liquid assets in an amount sufficient to meet
the purchase price.
The Fund also may borrow money in order to repurchase its shares or as a
temporary measure for extraordinary or emergency purposes, including for the
payment of dividends or the settlement of securities transactions which
otherwise might require untimely dispositions of Fund securities.
RISKS
The net asset value of the Common Shares will fluctuate with and be affected by,
among other things, market discount risk, interest rate risk, credit risk,
municipal bond market risk, reinvestment risk, leverage risk, inflation risk,
liquidity risk, derivatives risk and management risk. An investment in Common
Shares will also be subject to the risk associated with the fact that the Fund
is newly organized. These risks are summarized below.
NEWLY ORGANIZED
The Fund is a newly organized, diversified, closed-end management investment
company and has no operating history.
MARKET DISCOUNT RISK
Shares of closed-end management investment companies frequently trade at a
discount from their net asset value.
INTEREST RATE RISK
Interest rate risk is the risk that bonds (and the Fund's net assets) will
decline in value because of changes in interest rates. Generally, municipal
bonds will decrease in value when interest rates rise and increase in value when
interest rates decline. This means that the net asset value of the Common Shares
will fluctuate with interest rate changes and the corresponding changes in the
value of the Fund's municipal bond holdings. The value of the longer-term bonds
in which the Fund generally invests normally fluctuates more in response to
changes in interest rates than does the value of shorter-term bonds. Because the
Fund will invest primarily in long-term bonds, the Common Share net asset value
and market price per share will fluctuate more in response to changes in market
interest rates than if the Fund invested primarily in shorter-term bonds. The
Fund's use of leverage, as described below, will tend to increase Common Share
interest rate risk. The Fund may invest up to 10% of its total assets in RIBS.
Compared to similar fixed rate municipal obligations, the value of RIBS will
fluctuate to a greater extent in response to changes in prevailing long-term
interest rates. Moreover, the income earned on RIBS will fluctuate in response
to changes in prevailing short-term interest rates. Thus, when RIBS are held by
the Fund, an increase in short- or long-term market interest rates will
adversely affect the income received from such bonds or the net asset value of
the Fund's shares. The Fund may utilize certain strategies, including
investments in structured notes, for the purpose of reducing the interest rate
sensitivity of the portfolio and decreasing the Fund's exposure to interest rate
risk, although there is no assurance that it will do so or that such strategies
will be successful. See "How the Fund manages risk--Hedging and Related
Strategies."
13
CREDIT RISK
The Fund could lose money if the issuer of a municipal bond, or the counterparty
to a derivatives contract or other obligation, is unable or unwilling to make
timely principal and/or interest payments, or to otherwise honor its
obligations. In general, lower rated municipal bonds carry a greater degree of
risk that the issuer will lose its ability to make interest and principal
payments, which could have a negative impact on the Fund's net asset value or
dividends. The Fund may invest up to 20% of its net assets in municipal bonds
that are rated Ba/BB or B by Moody's, S&P or Fitch or that are unrated but
judged to be of comparable quality by PIMCO. Bonds rated Ba/BB or B are regarded
as having predominantly speculative characteristics with respect to capacity to
pay interest and repay principal, and these bonds are commonly referred to as
"junk bonds." The prices of these lower grade bonds are more sensitive to
negative developments, such as a decline in the issuer's revenues or a general
economic downturn, than are the prices of higher grade securities. Municipal
bonds in the lowest investment grade category may also be considered to possess
some speculative characteristics by certain rating agencies.
MUNICIPAL BOND MARKET RISK
Investing in the municipal bond market involves certain risks. The amount of
public information available about the municipal bonds in the Fund's portfolio
is generally less than that for corporate equities or bonds, and the investment
performance of the Fund may therefore be more dependent on the analytical
abilities of PIMCO than would be a stock fund or taxable bond fund. The
secondary market for municipal bonds, particularly the below investment grade
bonds in which the Fund may invest, also tends to be less well-developed or
liquid than many other securities markets, which may adversely affect the Fund's
ability to sell its bonds at attractive prices.
The ability of municipal issuers to make timely payments of interest and
principal may be diminished during general economic downturns and as
governmental cost burdens are reallocated among federal, state and local
governments. In addition, laws enacted in the future by Congress or state
legislatures or referenda could extend the time for payment of principal and/or
interest, or impose other constraints on enforcement of such obligations, or on
the ability of municipal issuers to levy taxes. Issuers of municipal securities
might seek protection under the bankruptcy laws. In the event of bankruptcy of
such an issuer, the Fund could experience delays in collecting principal and
interest and the Fund may not, in all circumstances, be able to collect all
principal and interest to which it is entitled. To enforce its rights in the
event of a default in the payment of interest or repayment of principal, or
both, the Fund may take possession of, and manage, the assets securing the
issuer's obligations on such securities, which may increase the Fund's operating
expenses. Any income derived from the Fund's ownership or operation of such
assets may not be tax-exempt.
REINVESTMENT RISK
Reinvestment risk is the risk that income from the Fund's municipal bond
portfolio will decline if and when the Fund invests the proceeds from matured,
traded or called bonds at market interest rates that are below the portfolio's
current earnings rate. A decline in income could affect the Common Shares'
market price or their overall return.
LEVERAGE RISK
Leverage risk includes the risk associated with the issuance of the Preferred
Shares, if any, or the use of RIBs and other derivative instruments in order to
leverage the Fund's portfolio. There can be no assurance that the Fund's
leveraging strategies involving Preferred Shares or derivatives will be
successful. Once the Preferred Shares are issued or other forms of leverage are
used, the net asset value and market value of Common Shares will be more
volatile, and the yield and total return to Common Shareholders will tend to
fluctuate more in response to changes in interest rates and with changes in the
short-term dividend rates on the Preferred Shares. The Fund anticipates that the
Preferred Shares, at least initially, would likely pay cumulative dividends at
rates determined over relatively short-term periods (such as seven days), by
providing for the periodic redetermination of the dividend rate through an
auction or remarketing procedures. See "Description of shares--Preferred
Shares." The rates of return on long-term municipal bonds are typically,
although not always, higher than the rates of return on short-term municipal
bonds. If the dividend rate on the Preferred Shares approaches the net rate of
return on the Fund's investment portfolio, the benefit of leverage to Common
Shareholders would be reduced. If the dividend rate on the Preferred Shares
exceeds the net rate of return on the Fund's portfolio, the leverage will result
in a lower rate of return to Common Shareholders than if the Fund were not
leveraged. Because the longer-term bonds included in the Fund's portfolio will
typically pay fixed rates of interest while the dividend rate on the Preferred
Shares will be adjusted periodically, this could occur even when both long-term
and short-term interest rates rise. In addition, the Fund will pay (and Common
Shareholders will bear) any costs and expenses relating to the issuance and
ongoing maintenance of the Preferred Shares. Furthermore, if the Fund has net
capital gain or other taxable income that is allocated to Preferred Shares
(instead of solely tax-exempt income), the Fund may have to pay higher total
dividends or Gross-up Dividends to
14
Preferred Shareholders, which would reduce any advantage of the Fund's leveraged
structure to Common Shareholders without reducing the associated risk. See
"Preferred shares and related leverage." The Fund cannot assure you that it will
issue Preferred Shares or use other forms of leverage or, if used, that these
strategies will result in a higher yield or return to Common Shareholders.
Similarly, any decline in the net asset value of the Fund's investments will be
borne entirely by Common Shareholders. Therefore, if the market value of the
Fund's portfolio declines, any leverage will result in a greater decrease in net
asset value to Common Shareholders than if the Fund were not leveraged. Such
greater net asset value decrease will also tend to cause a greater decline in
the market price for the Common Shares. The Fund might be in danger of failing
to maintain the required 200% asset coverage or of losing its expected AAA/Aaa
ratings on the Preferred Shares or, in an extreme case, the Fund's current
investment income might not be sufficient to meet the dividend requirements on
the Preferred Shares. In order to counteract such an event, the Fund might need
to liquidate investments in order to fund a redemption of some or all of the
Preferred Shares. Liquidation at times of low municipal bond prices may result
in capital loss and may reduce returns to Common Shareholders.
While the Fund may from time to time consider reducing leverage in response to
actual or anticipated changes in interest rates in an effort to mitigate the
increased volatility of current income and net asset value associated with
leverage, there can be no assurance that the Fund will actually reduce leverage
in the future or that any reduction, if undertaken, will benefit the Common
Shareholders. Changes in the future direction of interest rates are very
difficult to predict accurately. If the Fund were to reduce leverage based on a
prediction about future changes to interest rates, and that prediction turned
out to be incorrect, the reduction in leverage would likely operate to reduce
the income and/or total returns to Common Shareholders relative to the
circumstance if the Fund had not reduced leverage. The Fund may decide that this
risk outweighs the likelihood of achieving the desired reduction to volatility
in income and Common Share price if the prediction were to turn out to be
correct, and determine not to reduce leverage as described above.
The Fund may invest in the securities of other investment companies. Such
securities may also be leveraged and will therefore be subject to the leverage
risks described above. Such additional leverage may in certain market conditions
serve to reduce the net asset value of the Fund's Common Shares and the returns
to Common Shareholders.
The Fund may also invest up to 10% of its total assets in RIBS and may also
invest in other derivative instruments, which may increase the Fund's leverage
and, during periods of rising short-term interest rates, may adversely affect
the Fund's net asset value per share and income and distributions to Common
Shareholders. See "Residual Interest Municipal Bonds (RIBS)" and "Derivatives"
under "The Fund's investments" and the Statement of Additional Information under
"Investment Objective and Policies--Derivative Instruments."
INFLATION RISK
Inflation risk is the risk that the value of assets or income from the Fund's
investments will be worth less in the future as inflation decreases the value of
money. As inflation increases, the real, or inflation-adjusted, value of the
Common Shares and distributions can decline, and the dividend payments on the
Fund's Preferred Shares, if any, or interest payments on Fund borrowings, if
any, may increase.
LIQUIDITY RISK
The Fund may invest up to 20% of its net assets in securities which are
illiquid at the time of investment. The term "illiquid securities" for this
purpose means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the value at which the Fund has
valued the securities. Illiquid securities may be subject to wide fluctuations
in market value. The Fund may be subject to significant delays in disposing of
illiquid securities. Accordingly, the Fund may be forced to sell these
securities at less than fair market value or may not be able to sell them when
PIMCO believes it is desirable to do so. Illiquid securities also may entail
registration expenses and other transaction costs that are higher than those for
liquid securities. Restricted securities, i.e., securities subject to legal or
contractual restrictions on resale, may be illiquid. However, some restricted
securities (such as securities issued pursuant to Rule 144A under the Securities
Act of 1933 and certain commercial paper) may be treated as liquid for these
purposes.
DERIVATIVES RISK
Derivatives are financial contracts whose value depends on, or is derived from,
the value of an underlying asset, reference rate or index (or relationship
between two indices). The Fund may invest in a variety of derivative
instruments, such as RIBS, structured notes, options contracts, futures
contracts, options on futures contracts, swap agreements, short sales and
delayed delivery and forward commitment transactions. The Fund may use
derivatives as a substitute for taking a position
15
in an underlying portfolio security or other asset and/or as part of a strategy
designed to reduce exposure to other risks, such as interest rate risk. The Fund
also may use derivatives to add leverage to the portfolio. The Fund's use of
derivative instruments involves risks different from, and possibly greater than,
the risks associated with investing directly in securities and other traditional
investments. Derivatives are subject to a number of risks described elsewhere in
this Prospectus, such as liquidity risk, interest rate risk, credit risk,
leveraging risk and management risk, and are also subject to the risk of
ambiguous documentation. They also involve the risk of mispricing or improper
valuation and the risk that changes in the value of the derivative may not
correlate perfectly with the underlying asset, rate or index. If the Fund
invests in a derivative instrument, it could lose more than the principal amount
invested. Also, suitable derivative transactions may not be available in all
circumstances and there can be no assurance that the Fund will engage in these
transactions to reduce exposure to other risks when that would be beneficial.
Income earned by the Fund from many derivatives transactions will be treated as
capital gain and, if not offset by net realized capital loss, will be
distributed to shareholders in taxable distributions.
MANAGEMENT RISK
The Fund is subject to management risk because it is an actively managed
investment portfolio. PIMCO and the individual portfolio manager will apply
investment techniques and risk analyses in making investment decisions for the
Fund, but there can be no guarantee that these will produce the desired results.
CERTAIN AFFILIATIONS
Certain broker-dealers may be considered to be affiliated persons of the Fund,
the Manager and/or PIMCO due to their possible affiliations with Allianz AG, the
ultimate parent of the Manager and PIMCO. Absent an exemption from the
Securities and Exchange Commission or other regulatory relief, the Fund is
generally precluded from effecting certain principal transactions with
affiliated brokers, and its ability to purchase securities being underwritten by
an affiliated broker or a syndicate including an affiliated broker, or to
utilize affiliated brokers for agency transactions, is subject to restrictions.
This could limit the Fund's ability to engage in securities transactions and
take advantage of market opportunities. In addition, unless and until the
underwriting syndicate is broken in connection with the initial public offering
of the Common Shares, the Fund will be precluded from effecting principal
transactions with brokers who are members of the syndicate.
HOW THE FUND MANAGES RISK
INVESTMENT LIMITATIONS
The Fund has adopted certain investment limitations designed to limit investment
risk and maintain portfolio diversification. These limitations (two of which are
listed below) are fundamental and may not be changed without the approval of the
holders of a majority of the outstanding Common Shares and, if issued, Preferred
Shares voting together as a single class, and the approval of the holders of a
majority of the Preferred Shares voting as a separate class. The Fund may not:
- Concentrate its investments in a particular "industry", as that term
is used in the 1940 Act and as interpreted, modified, or otherwise permitted
by regulatory authority having jurisdiction, from time to time; and
- With respect to 75% of the Fund's total assets, purchase the
securities of any issuer, except securities issued or guaranteed by the U.S.
government or any of its agencies or instrumentalities or securities of other
investment companies, if, as a result, (i) more than 5% of the Fund's total
assets would be invested in the securities of that issuer, or (ii) the Fund
would hold more than 10% of the outstanding voting securities of that issuer.
For the purpose of this restriction, each state and each separate political
subdivision, agency, authority or instrumentality of such state, each
multi-state agency or authority, and each obligor, if any, are treated as
separate issuers of municipal bonds.
The Fund would be deemed to "concentrate" its investments in a particular
industry if it invested more than 25% of its net assets in that industry. The
Fund's industry concentration policy does not preclude it from focusing
investments in issuers in a group of related industrial sectors (such as
different types of utilities).
The Fund may become subject to guidelines that are more limiting than the
investment restrictions set forth above and other restrictions set forth in the
Statement of Additional Information in order to obtain and maintain ratings from
Moody's, S&P and/or Fitch on the Preferred Shares that it intends to issue. The
Fund does not anticipate that such guidelines would have a material adverse
effect on the Fund's Common Shareholders or the Fund's ability to achieve its
investment objective. See "Investment
16
Objective and Policies" and "Investment Restrictions" in the Statement of
Additional Information for information about these guidelines and a complete
list of the fundamental investment policies of the Fund.
QUALITY OF INVESTMENTS
The Fund will invest at least 80% of its net assets in bonds of investment grade
quality at the time of investment. Investment grade quality means that such
bonds are rated by national rating agencies within the four highest grades (Baa
or BBB or better by Moody's, S&P or Fitch) or are unrated but judged to be of
comparable quality by PIMCO. Bonds in the lowest investment grade category may
be considered to possess some speculative characteristics by certain rating
agencies.
LIMITED ISSUANCE OF PREFERRED SHARES
Under the 1940 Act, the Fund could issue Preferred Shares having a total
liquidation value (original purchase price of the shares being liquidated plus
any accrued and unpaid dividends) of up to one-half of the value of the total
net assets of the Fund. To the extent that the Fund has outstanding any senior
securities representing indebtedness (such as through the use of derivative
instruments that constitute senior securities), the aggregate amount of such
senior securities will be added to the total liquidation value of any
outstanding Preferred Shares for purposes of this asset coverage requirement. If
the total liquidation value of the Preferred Shares plus the aggregate amount of
such other senior securities were ever more than one-half of the value of the
Fund's total net assets, the Fund would not be able to declare dividends on the
Common Shares until such liquidation value and/or aggregate amount of other
senior securities, as a percentage of the Fund's total assets, were reduced. The
Fund intends to issue Preferred Shares representing approximately 38% of the
Fund's total capital immediately after their issuance approximately one to three
months after the completion of the offering of the Common Shares. This higher
than required margin of net asset value provides a cushion against later
fluctuations in the value of the Fund's portfolio and will subject Common
Shareholders to less income and net asset value volatility than if the Fund were
more highly leveraged through Preferred Shares. It also gives the Fund
flexibility to utilize other forms of leverage in addition to Preferred Shares
from time to time in accordance with the 1940 Act asset coverage requirements
(such as RIBS and other derivatives) that may be more efficient or cost
effective sources of leverage than Preferred Shares under the circumstances. The
Fund intends to purchase or redeem Preferred Shares, if necessary, to keep the
liquidation value of the Preferred Shares plus the aggregate amount of other
senior securities representing indebtedness below one-half of the value of the
Fund's total net assets.
MANAGEMENT OF INVESTMENT PORTFOLIO AND CAPITAL STRUCTURE TO LIMIT LEVERAGE RISK
The Fund may take certain actions if short-term interest rates increase or
market conditions otherwise change (or the Fund anticipates such an increase or
change) and the Fund's leverage begins (or is expected) to adversely affect
Common Shareholders. In order to attempt to offset such a negative impact of
leverage on Common Shareholders, the Fund may shorten the average maturity or
duration of its investment portfolio (by investing in short-term, high quality
securities or implementing certain hedging strategies) or may extend the
maturity of outstanding Preferred Shares. The Fund also may attempt to reduce
leverage by redeeming or otherwise purchasing Preferred Shares or by reducing
any holdings in RIBS or other instruments that create leverage. As explained
above under "Risks--Leverage Risk," the success of any such attempt to limit
leverage risk depends on PIMCO's ability to accurately predict interest rate or
other market changes. Because of the difficulty of making such predictions, the
Fund may not be successful in managing its interest rate exposure in the manner
described above.
If market conditions suggest that additional leverage would be beneficial, the
Fund may sell previously unissued Preferred Shares or Preferred Shares that the
Fund previously issued but later repurchased, or utilize other forms of
leverage, such as RIBS and other derivative instruments.
HEDGING AND RELATED STRATEGIES
The Fund may use various investment strategies designed to limit the risk of
price fluctuations of its portfolio securities and to preserve capital. For
instance, the Fund may invest in structured notes for the purpose of reducing
the interest rate sensitivity of the Fund's portfolio and, thereby, decreasing
the Fund's exposure to interest rate risk. The Fund currently intends that the
income from structured notes will normally be exempt from federal income tax.
See "The Fund's investments--Structured Notes" in this Prospectus. Other hedging
strategies that the Fund may use include: financial futures contracts; short
sales; swap agreements or options thereon; options on financial futures; and
options based on either an index of municipal securities or taxable debt
securities whose prices, PIMCO believes, correlate with the prices of the Fund's
investments. Income earned by the Fund from many hedging activities will be
treated as capital gain and, if not offset by net realized capital loss, will be
distributed to shareholders in taxable distributions. If effectively used,
hedging strategies will offset in varying percentages losses incurred on the
Fund's investments due to adverse interest rate changes.
17
There is no assurance that these hedging strategies will be available at any
time or that PIMCO will determine to use them for the Fund or, if used, that the
strategies will be successful.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The Board of Trustees is responsible for the management of the Fund, including
supervision of the duties performed by the Manager and PIMCO. There are
currently six Trustees of the Fund, three of whom are currently treated by the
Fund as "interested persons" (as defined in the 1940 Act) and three of whom are
currently treated by the Fund as not "interested persons." The names and
business addresses of the Trustees and officers of the Fund and their principal
occupations and other affiliations during the past five years are set forth
under "Management of the Fund" in the Statement of Additional Information.
INVESTMENT MANAGER
The Manager serves as the investment manager of the Fund. Subject to the
supervision of the Board of Trustees, the Manager is responsible for managing,
either directly or through others selected by it, the investment activities of
the Fund and the Fund's business affairs and other administrative matters. The
Manager is located at 1345 Avenue of the Americas, New York, New York 10105.
Organized in 2000 to succeed certain businesses of a predecessor formed in 1987,
the Manager provides investment management and advisory services to several
closed-end and open-end investment company clients. As of December 31, 2001, the
Manager had approximately $80 billion in assets under management. Allianz
Dresdner Asset Management of America L.P. is the direct parent company of PIMCO
Advisory Services Holdings LLC, of which the Manager is a wholly-owned
subsidiary. As of December 31, 2001, Allianz Dresdner Asset Management of
America, L.P. and its subsidiary partnerships, including PIMCO, had
approximately $320 billion in assets under management.
The Manager has retained its affiliate, PIMCO, to manage the Fund's investments.
See "--Portfolio Manager" below. The Manager and PIMCO are each majority-owned
indirect subsidiaries of Allianz AG, a publicly traded German insurance and
financial services company.
PORTFOLIO MANAGER
PIMCO serves as the portfolio manager for the Fund. Subject to the supervision
of the Manager. PIMCO has full investment discretion and makes all
determinations with respect to the investment of the Fund's assets.
PIMCO is located at 840 Newport Center Drive, Newport Beach, California 92660.
Organized in 1971, PIMCO provides investment management and advisory services to
private accounts of institutional and individual clients and to mutual funds. As
of February 28, 2002, PIMCO had approximately $248 billion in assets under
management.
The Manager (and not the Fund) pays a portion of the fees it receives to PIMCO
in return for its services, at the maximum annual rate of 0.50% of the Fund's
average daily net assets (including assets attributable to any Preferred Shares
that may be outstanding). PIMCO has contractually agreed to waive a portion of
the advisory fee it is entitled to receive from the Manager such that PIMCO will
receive 0.26% of the Fund's average daily net assets from the commencement of
Fund operations through June 30, 2007 (i.e., roughly the first 5 years of Fund
operations), 0.40% of average daily net assets in year 6, 0.45% in year 7 and
0.50% in each year thereafter.
Bill Gross, a founder of PIMCO, serves as Managing Director and Chief Investment
Officer of PIMCO. In his role as Chief Investment Officer, he serves as the head
of the Investment Committee, which oversees setting investment policy decisions,
including duration positioning, yield curve management, sector rotation, credit
quality and overall portfolio composition, for all PIMCO portfolios and
strategies, including the Fund. The following individual at PIMCO has primary
responsibility for the day-to-day portfolio management of the Fund:
SINCE RECENT PROFESSIONAL EXPERIENCE
Mark V. McCray 2002 (Inception) Executive Vice President, PIMCO. Mr. McCray joined PIMCO as a
Portfolio Manager in 2000. Prior to that, he was a bond
trader from 1992-1999 at Goldman Sachs & Co. where he
was appointed Vice President in 1996 and named co-head
of municipal bond trading in 1997 with responsibility for
the firm's proprietary account and supervised municipal
bond traders.
18
Chris Dialynas, a Managing Director and senior member of PIMCO's investment
strategy group, oversees Mr. McCray regarding the management of the Fund.
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between the Manager and the Fund
(the "Investment Management Agreement"), the Fund has agreed to pay the Manager
an annual management fee payable on a monthly basis at the annual rate of 0.65%
of the Fund's average daily net assets (including net assets attributable to
Preferred Shares) for the services and facilities it provides.
In addition to the fees of the Manager, the Fund pays all other costs and
expenses of its operations, including compensation of its Trustees (other than
those affiliated with the Manager), custodial expenses, shareholder servicing
expenses, transfer agency and dividend disbursing expenses, legal fees, expenses
of independent auditors, expenses of repurchasing shares, expenses of issuing
any Preferred Shares, expenses of preparing, printing and distributing
prospectuses, shareholder reports, notices, proxy statements and reports to
governmental agencies, and taxes, if any.
The Manager has contractually agreed to waive a portion of the management fees
it is entitled to receive from the Fund in the amounts, and for the time
periods, set forth below (covering commencement of Fund operations through June
30, 2009):
Percentage Waived
(annual rate as a percentage of
Period Ending June 30, average daily net assets)(1)
---------------------- -----------------------------------
2003(2) ........................................................... 0.15%
2004 .............................................................. 0.15%
2005 .............................................................. 0.15%
2006 .............................................................. 0.15%
2007 .............................................................. 0.15%
2008 .............................................................. 0.10%
2009 .............................................................. 0.05%
__________________
(1) Including net assets attributable to Preferred Shares.
(2) From the commencement of the Fund's operations.
The Manager has not agreed to waive any portion of its fees beyond June 30,
2009.
Because the fees received by the Manager are based on the total net assets of
the Fund (including assets represented by Preferred Shares and any leverage
created thereby), the Manager has a financial incentive for the Fund to issue
Preferred Shares, which may create a conflict of interest between the Manager
and the holders of the Fund's Common Shares.
NET ASSET VALUE
The net asset value ("NAV") of the Fund equals the total value of the Fund's
portfolio investments and other assets, less any liabilities. For purposes of
calculating NAV, portfolio securities and other assets for which market quotes
are available are stated at market value. Market value is generally determined
on the basis of the last reported sales price, or if no sales are reported,
based on quotes obtained from a quotation reporting system, established market
makers, or pricing services. Certain securities or investments for which market
quotations are not readily available may be valued, pursuant to guidelines
established by the Board of Trustees, with reference to other securities or
indices. For instance, a pricing service may recommend a fair market value based
on prices of comparable municipal bonds. Short-term investments having a
maturity of 60 days or less are generally valued at amortized cost. Exchange
traded options, futures and options on futures are valued at the settlement
price determined by the exchange. Other securities for which market quotes are
not readily available are valued at fair value as determined in good faith by
the Board of Trustees or persons acting at their direction.
19
The NAV of the Fund will be determined as of the close of regular trading on the
New York Stock Exchange (normally 4:00 p.m., Eastern time) (the "NYSE Close") on
each day the New York Stock Exchange is open. Domestic debt securities are
normally priced using data reflecting the earlier closing of the principal
markets for those securities. Information that becomes known to the Fund or its
agent after the Fund's NAV has been calculated on a particular day will not be
used to retroactively adjust the price of a security or the Fund's NAV
determined earlier that day.
In unusual circumstances, instead of valuing securities in the usual manner, the
Fund may value securities at fair value as determined in good faith by the Board
of Trustees, generally based upon recommendations provided by PIMCO. Fair
valuation also may be required due to material events that occur after the close
of the relevant market but prior to the NYSE Close.
DISTRIBUTIONS
Commencing with the first dividend, the Fund intends to make regular monthly
cash distributions to Common Shareholders at a level rate based upon the
projected performance of the Fund. Distributions can only be made from net
investment income after paying any accrued dividends to Preferred Shareholders.
The Fund's ability to maintain a level dividend rate will depend on a number of
factors, including dividends payable on the Preferred Shares. The net income of
the Fund consists of all interest income accrued on portfolio assets less all
expenses of the Fund. Expenses of the Fund are accrued each day. Over time,
substantially all the net investment income of the Fund will be distributed. At
least annually, the Fund also intends to distribute to you your pro rata share
of any available net capital gain. Initial distributions to Common Shareholders
are expected to be declared approximately 45 days, and paid approximately 60 to
90 days, from the completion of this offering, depending on market conditions.
Although it does not now intend to do so, the Board of Trustees may change the
Fund's dividend policy and the amount or timing of the distributions, based on a
number of factors, including the amount of the Fund's undistributed net
investment income and historical and projected investment income and the amount
of the expenses and dividend rates on any outstanding Preferred Shares.
To permit the Fund to maintain a more stable monthly distribution, the Fund will
initially distribute less than the entire amount of net investment income earned
in a particular period. The undistributed net investment income would be
available to supplement future distributions. As a result, the distributions
paid by the Fund for any particular monthly period may be more or less than the
amount of net investment income actually earned by the Fund during the period.
Undistributed net investment income will be added to the Fund's net asset value
and, correspondingly, distributions from undistributed net investment income
will be deducted from the Fund's net asset value.
DIVIDEND REINVESTMENT PLAN
Pursuant to the Fund's Dividend Reinvestment Plan (the "Plan"), all Common
Shareholders whose shares are registered in their own names will have all
dividends, including any capital gain dividends, reinvested automatically in
additional Common Shares by PFPC Inc., as agent for the Common Shareholders (the
"Plan Agent"), unless the shareholder elects to receive cash. An election to
receive cash may be revoked or reinstated at the option of the shareholder. In
the case of record shareholders such as banks, brokers or other nominees that
hold Common Shares for others who are the beneficial owners, the Plan Agent will
administer the Plan on the basis of the number of Common Shares certified from
time to time by the record shareholder as representing the total amount
registered in such shareholder's name and held for the account of beneficial
owners who are to participate in the Plan. Shareholders whose shares are held in
the name of a bank, broker or nominee should contact the bank, broker or nominee
for details. Such shareholders may not be able to transfer their shares to
another bank or broker and continue to participate in the Plan. All
distributions to investors who elect not to participate in the Plan (or whose
broker or nominee elects not to participate on the investor's behalf), will be
paid in cash by check mailed, in the case of direct shareholders, to the record
holder by PFPC Inc., as the Fund's dividend disbursement agent.
Unless you (or your broker or nominee) elects not to participate in the Plan,
the number of Common Shares you will receive will be determined as follows:
(1) If Common Shares are trading at or above net asset value on the
payment date, the Fund will issue new shares at the greater of (i) the
net asset value per Common Share on the payment date or (ii) 95% of
the market price per Common Share on the payment date; or
(2) If Common Shares are trading below net asset value (minus estimated
brokerage commissions that would be incurred upon the purchase of
Common Shares on the open market) on the payment date, the Plan Agent
will receive the dividend or distribution in cash and will purchase
Common Shares in the open market, on the New
20
York Stock Exchange or elsewhere, for the participants' accounts. It
is possible that the market price for the Common Shares may increase
before the Plan Agent has completed its purchases. Therefore, the
average purchase price per share paid by the Plan Agent may exceed the
market price on the payment date, resulting in the purchase of fewer
shares than if the dividend or distribution had been paid in Common
Shares issued by the Fund. The Plan Agent will use all dividends and
distributions received in cash to purchase Common Shares in the open
market on or shortly after the payment date, but in no event later
than the ex-dividend date for the next distribution. Interest will not
be paid on any uninvested cash payments.
You may withdraw from the Plan at any time by giving written notice to the Plan
Agent. If you withdraw or the Plan is terminated, you will receive a certificate
for each whole share in your account under the Plan and you will receive a cash
payment for any fraction of a share in your account. If you wish, the Plan Agent
will sell your shares and send you the proceeds, minus brokerage commissions.
The Plan Agent maintains all shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. The Plan Agent will also furnish each person who
buys Common Shares with written instructions detailing the procedures for
electing not to participate in the Plan and to instead receive distributions in
cash. Common Shares in your account will be held by the Plan Agent in
non-certificated form. Any proxy you receive will include all Common Shares you
have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvested dividends and distributions are taxed in the same
manner as cash dividends and distributions.
The Fund and the Plan Agent reserve the right to amend or terminate the Plan.
There is no direct service charge to participants in the Plan; however, the Fund
reserves the right to amend the Plan to include a service charge payable by the
participants. Additional information about the Plan may be obtained from PFPC
Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809, telephone number
1-800-331-1710.
DESCRIPTION OF SHARES
COMMON SHARES
The Declaration authorizes the issuance of an unlimited number of Common Shares.
The Common Shares will be issued with a par value of $0.00001 per share. All
Common Shares have equal rights to the payment of dividends and the distribution
of assets upon liquidation. Common Shares will, when issued, be fully paid and,
subject to matters discussed in "Anti-takeover and other provisions in the
Declaration of Trust," non-assessable, and will have no pre-emptive or
conversion rights or rights to cumulative voting. Whenever Preferred Shares are
outstanding, Common Shareholders will not be entitled to receive any
distributions from the Fund unless all accrued dividends on Preferred Shares
have been paid, and unless asset coverage (as defined in the 1940 Act) with
respect to Preferred Shares would be at least 200% after giving effect to the
distributions. See "--Preferred Shares" below.
The Common Shares have been authorized for listing on the New York Stock
Exchange, subject to notice of issuance. The Fund intends to hold annual
meetings of shareholders so long as the Common Shares are listed on a national
securities exchange and such meetings are required as a condition to such
listing.
The Fund's net asset value per share generally increases when interest rates
decline, and decreases when interest rates rise, and these changes are likely to
be greater because the Fund intends to have a leveraged capital structure. Net
asset value will be reduced immediately following the offering by the amount of
the sales load and organization and offering expenses paid by the Fund. The
Manager has agreed to pay the amount by which the aggregate of all of the Fund's
organizational expenses and all offering costs (other than the sales load)
exceeds $0.03 per Common Share.
Unlike open-end funds, closed-end funds like the Fund do not continuously offer
shares and do not provide daily redemptions. Rather, if a shareholder determines
to buy additional Common Shares or sell shares already held, the shareholder may
do so by trading on the exchange through a broker or otherwise. Shares of
closed-end investment companies may frequently trade on an exchange at prices
lower than net asset value. Shares of closed-end investment companies like the
Fund that invest principally in investment grade municipal bonds have during
some periods traded at prices higher than net asset value and during other
periods have traded at prices lower than net asset value. The Fund's
21
Declaration limits the ability of the Fund to convert to open-end status. See
"Anti-takeover and other provisions in the Declaration of Trust."
Because the market value of the Common Shares may be influenced by such factors
as dividend levels (which are in turn affected by expenses), call protection,
dividend stability, portfolio credit quality, net asset value, relative demand
for and supply of such shares in the market, general market and economic
conditions, and other factors beyond the control of the Fund, the Fund cannot
assure you that the Common Shares will trade at a price equal to or higher than
net asset value in the future. The Common Shares are designed primarily for
long-term investors, and investors in the Common Shares should not view the Fund
as a vehicle for trading purposes. See "Preferred shares and related leverage"
and the Statement of Additional Information under "Repurchase of Common Shares;
Conversion to Open-End Fund."
PREFERRED SHARES
The Declaration authorizes the issuance of an unlimited number of Preferred
Shares. The Preferred Shares may be issued in one or more classes or series,
with such par value and rights as determined by the Board of Trustees, by action
of the Board of Trustees without the approval of the Common Shareholders.
The Fund's Board of Trustees has indicated its intention to authorize an
offering of Preferred Shares (representing approximately 38% of the Fund's
capital immediately after the time the Preferred Shares are issued)
approximately one to three months after completion of the offering of Common
Shares. Any such decision is subject to market conditions and to the Board's
continuing belief that leveraging the Fund's capital structure through the
issuance of Preferred Shares is likely to achieve the benefits to the Common
Shareholders described in this Prospectus. Although the terms of the Preferred
Shares will be determined by the Board of Trustees (subject to applicable law
and the Fund's Declaration) if and when it authorizes a Preferred Shares
offering, the Board has determined that the Preferred Shares, at least
initially, would likely pay cumulative dividends at rates determined over
relatively short-term periods (such as seven days), by providing for the
periodic redetermination of the dividend rate through an auction or remarketing
procedure. The Board of Trustees has indicated that the preference on
distribution, liquidation preference, voting rights and redemption provisions of
the Preferred Shares will likely be as stated below.
LIMITED ISSUANCE OF PREFERRED SHARES
Under the 1940 Act, the Fund could issue Preferred Shares with an aggregate
liquidation value of up to one-half of the value of the Fund's total net assets,
measured immediately after issuance of the Preferred Shares. "Liquidation value"
means the original purchase price of the shares being liquidated plus any
accrued and unpaid dividends. In addition, the Fund is not permitted to declare
any cash dividend or other distribution on its Common Shares unless the
liquidation value of the Preferred Shares is less than one-half of the value of
the Fund's total net assets (determined after deducting the amount of such
dividend or distribution) immediately after the distribution. The liquidation
value of the Preferred Shares is expected to be approximately 38% of the value
of the Fund's total net assets. The Fund intends to purchase or redeem Preferred
Shares, if necessary, to keep that fraction below one-half.
DISTRIBUTION PREFERENCE
The Preferred Shares have complete priority over the Common Shares as to
distribution of assets.
LIQUIDATION PREFERENCE
In the event of any voluntary or involuntary liquidation, dissolution or winding
up of the affairs of the Fund, holders of Preferred Shares will be entitled to
receive a preferential liquidating distribution (expected to equal the original
purchase price per share plus accumulated and unpaid dividends thereon, whether
or not earned or declared) before any distribution of assets is made to holders
of Common Shares.
VOTING RIGHTS
Preferred Shares are required to be voting shares. Except as otherwise provided
in the Declaration or the Fund's Bylaws or otherwise required by applicable law,
holders of Preferred Shares will vote together with Common Shareholders as a
single class.
Holders of Preferred Shares, voting as a separate class, will also be entitled
to elect two of the Fund's Trustees. The remaining Trustees will be elected by
Common Shareholders and holders of Preferred Shares, voting together as a single
class. In the unlikely event that two full years of accrued dividends are unpaid
on the Preferred Shares, the holders of all outstanding Preferred Shares, voting
as a separate class, will be entitled to elect a majority of the Fund's Trustees
until all dividends in arrears have been paid or declared and set apart for
payment.
22
REDEMPTION, PURCHASE AND SALE OF PREFERRED SHARES
The terms of the Preferred Shares may provide that they are redeemable at
certain times, in whole or in part, at the original purchase price per share
plus accumulated dividends. The terms also may state that the Fund may tender
for or purchase Preferred Shares and resell any shares so tendered. Any
redemption or purchase of Preferred Shares by the Fund will reduce the leverage
applicable to Common Shares, while any resale of Preferred Shares by the Fund
will increase such leverage. See "Preferred shares and related leverage."
The discussion above describes the Board of Trustees' present intention with
respect to a possible offering of Preferred Shares. If the Board of Trustees
determines to authorize such an offering, the terms of the Preferred Shares may
be the same as, or different from, the terms described above, subject to
applicable law and the Fund's Declaration and Bylaws.
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
The Declaration includes provisions that could limit the ability of other
entities or persons to acquire control of the Fund or to convert the Fund to
open-end status. The Fund's Trustees are divided into three classes. At each
annual meeting of shareholders, the term of one class will expire and each
Trustee elected to that class will hold office for a term of three years. The
classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the outstanding
shares of the classes or series of shares entitled to vote for the election of
such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining
Trustees.
As described below, the Declaration grants special approval rights with respect
to certain matters to members of the Board who qualify as "Continuing Trustees,"
which term means a Trustee who either (i) has been a member of the Board for a
period of at least thirty-six months (or since the commencement of the Fund's
operations, if less than thirty-six months) or (ii) was nominated to serve as a
member of the Board of Trustees by a majority of the Continuing Trustees then
members of the Board.
The Declaration requires the affirmative vote or consent of at least
seventy-five percent (75%) of the Board of Trustees and holders of at least
seventy-five percent (75%) of the Fund's shares (including Common and Preferred
Shares) to authorize certain Fund transactions not in the ordinary course of
business, including a merger or consolidation, or a sale or transfer of Fund
assets, unless the transaction is authorized by both a majority of the Trustees
and seventy-five percent (75%) of the Continuing Trustees (in which case no
shareholder authorization would be required by the Declaration, but may be
required in certain cases under the 1940 Act). The Declaration also requires the
affirmative vote or consent of holders of at least seventy-five percent (75%) of
each class of the Fund's shares entitled to vote on the matter to authorize a
conversion of the Fund from a closed-end to an open-end investment company,
unless the conversion is authorized by both a majority of the Trustees and
seventy-five percent (75%) of the Continuing Trustees (in which case
shareholders would have only the minimum voting rights required by the 1940 Act
with respect to the conversion). Also, the Declaration provides that the Fund
may be terminated at any time by vote or consent of at least seventy-five
percent (75%) of the Fund's shares or, alternatively, by vote or consent of both
a majority of the Trustees and seventy-five percent (75%) of the Continuing
Trustees. See "Anti-Takeover and Other Provisions in the Declaration of Trust"
in the Statement of Additional Information for a more detailed summary of these
provisions.
The Trustees may from time to time grant other voting rights to shareholders
with respect to these and other matters in the Fund's Bylaws.
The overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control by a third party. They
provide, however, the advantage of potentially requiring persons seeking control
of the Fund to negotiate with its management regarding the price to be paid and
facilitating the continuity of the Fund's investment objective and policies. The
provisions of the Declaration described above could have the effect of depriving
the Common Shareholders of opportunities to sell their Common Shares at a
premium over the then current market price of the Common Shares by discouraging
a third party from seeking to obtain control of the Fund in a tender offer or
similar transaction. The Board of Trustees of the Fund has considered the
foregoing anti-takeover provisions and concluded that they are in the best
interests of the Fund and its Common Shareholders.
The foregoing is intended only as a summary and is qualified in its entirety by
reference to the full text of the Declaration and the Fund's Bylaws, both of
which are on file with the Securities and Exchange Commission.
Under Massachusetts law, shareholders could, in certain circumstances, be held
personally liable for the obligations of the Fund. However, the Declaration
contains an express disclaimer of shareholder liability for debts or obligations
of the Fund and requires that notice of such limited liability be given in each
agreement, obligation or instrument entered into or
23
executed by the Fund or the Trustees. The Declaration further provides for
indemnification out of the assets and property of the Fund for all loss and
expense of any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the Fund would be
unable to meet its obligations. The Fund believes that the likelihood of such
circumstances is remote.
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders will
not have the right to cause the Fund to redeem their shares. Instead, the Common
Shares will trade in the open market at a price that will be a function of
several factors, including dividend levels (which are in turn affected by
expenses), net asset value, call protection, dividend stability, portfolio
credit quality, relative demand for and supply of such shares in the market,
general market and economic conditions and other factors. Shares of a closed-end
investment company may frequently trade at prices lower than net asset value.
The Fund's Board of Trustees regularly monitors the relationship between the
market price and net asset value of the Common Shares. If the Common Shares were
to trade at a substantial discount to net asset value for an extended period of
time, the Board may consider the repurchase of its Common Shares on the open
market or in private transactions, the making of a tender offer for such shares,
or the conversion of the Fund to an open-end investment company. The Fund cannot
assure you that its Board of Trustees will decide to take or propose any of
these actions, or that share repurchases or tender offers will actually reduce
market discount.
If the Fund converted to an open-end company, it would be required to redeem all
Preferred Shares then outstanding (requiring in turn that it liquidate a portion
of its investment portfolio), and the Common Shares would no longer be listed on
the New York Stock Exchange. In contrast to a closed-end investment company,
shareholders of an open-end investment company may require the company to redeem
their shares at any time (except in certain circumstances as authorized by or
under the 1940 Act) at their net asset value, less any redemption charge that is
in effect at the time of redemption.
Before deciding whether to take any action to convert the Fund to an open-end
investment company, the Board would consider all relevant factors, including the
extent and duration of the discount, the liquidity of the Fund's portfolio, the
impact of any action that might be taken on the Fund or its shareholders, and
market considerations. Based on these considerations, even if the Fund's shares
should trade at a discount, the Board of Trustees may determine that, in the
interest of the Fund and its shareholders, no action should be taken. See the
Statement of Additional Information under "Repurchase of Common Shares;
Conversion to Open-End Fund" for a further discussion of possible action to
reduce or eliminate such discount to net asset value.
TAX MATTERS
FEDERAL INCOME TAX MATTERS
The following federal income tax discussion is based on the advice of Ropes &
Gray, counsel to the Fund, and reflects provisions of the Internal Revenue Code
of 1986, as amended (the "Code"), existing Treasury regulations, rulings
published by the Internal Revenue Service (the "Service"), and other applicable
authority, as of the date of this Prospectus. These authorities are subject to
change by legislative or administrative action, possibly with retroactive
effect. The following discussion is only a summary of some of the important tax
considerations generally applicable to investments in the Fund. For more
detailed information regarding tax considerations, see the Statement of
Additional Information. There may be other tax considerations applicable to
particular investors. In addition, income earned through an investment in the
Fund may be subject to state and local taxes.
The Fund intends to qualify each year for taxation as a regulated investment
company eligible for treatment under the provisions of Subchapter M of the Code.
If the Fund so qualifies and satisfies certain distribution requirements, the
Fund will not be subject to federal income tax on income distributed in a timely
manner to its shareholders in the form of dividends or capital gain
distributions.
To satisfy the distribution requirement applicable to regulated investment
companies, amounts paid as dividends by the Fund to its shareholders, including
holders of its Preferred Shares, must qualify for the dividends-paid deduction.
In certain circumstances, the Service could take the position that dividends
paid on the Preferred Shares constitute preferential dividends under Section
562(c) of the Code, and thus do not qualify for the dividends-paid deduction.
24
If at any time when Preferred Shares are outstanding the Fund does not meet
applicable asset coverage requirements, it will be required to suspend
distributions to Common Shareholders until the requisite asset coverage is
restored. Any such suspension may cause the Fund to pay a 4% federal excise tax
(imposed on regulated investment companies that fail to distribute for a given
calendar year, generally, at least 98% of their net investment income and
capital gain net income) and income tax on undistributed income or gains, and
may, in certain circumstances, prevent the Fund from qualifying for treatment as
a regulated investment company. The Fund may redeem Preferred Shares in an
effort to comply with the distribution requirement applicable to regulated
investment companies and to avoid income and excise taxes.
The Fund primarily invests in municipal bonds issued by states, cities and local
authorities and certain possessions and territories of the United States (such
as Puerto Rico or Guam) or in municipal bonds the income on which is, in the
opinion of bond counsel to the issuer (or on the basis of other authority
believed by PIMCO to be reliable), otherwise exempt from federal income taxes.
Thus, substantially all of the Fund's dividends to you will qualify as
"exempt-interest dividends," which are not generally subject to federal income
tax. An investment in the Fund may result in liability for federal alternative
minimum tax for both individual and corporate shareholders. The Fund will seek
to avoid portfolio investments that pay interest that is taxable to individuals
under the federal alternative minimum tax. Nonetheless, the Fund may not be
successful in this regard and if you are, or as a result of an investment in the
Fund would become, subject to the federal alternative minimum tax, the Fund may
not be a suitable investment for you.
As described above in the section entitled "Preferred shares and related
leverage," the terms of the Preferred Shares require, in certain circumstances,
that the Fund distribute Gross-up Dividends to holders of the Preferred Shares.
It is anticipated that the allocation rules described in the noted section will,
in a number of circumstances, require the Fund to distribute such Gross-up
Dividends. Such Gross-up Dividends would reduce the amount available for
distribution to Common Shareholders.
The Fund may at times buy tax-exempt investments at a discount from the price at
which they were originally issued, especially during periods of rising interest
rates. For federal income tax purposes, some or all of any market discount that
is other than de minimis will be included in the Fund's ordinary income and will
be taxable to shareholders as such when it is distributed.
The Fund's investments in certain debt obligations may cause the Fund to
recognize taxable income in excess of the cash generated by such obligations.
Thus, the Fund could be required at times to liquidate other investments in
order to satisfy its distribution requirements.
For federal income tax purposes, distributions of investment income other than
exempt interest dividends are taxable as ordinary income. Generally, gains
realized by the Fund on the sale or exchange of investments will be taxable to
its shareholders, even though the income from such investments generally will be
tax-exempt. Whether distributions of capital gains are taxed as ordinary income
or capital gains is determined by how long the Fund owned the investments that
generated such capital gains, rather than how long a shareholder has owned his
or her shares. Taxable distributions are taxable to shareholders even if they
are paid from income or gains earned by the Fund before a shareholder's
investment (and thus were included in the price the shareholder paid).
Distributions of gains from the sale of investments that the Fund owned for more
than one year will be taxable as capital gains. Distributions of gains from the
sale of investments that the Fund owned for one year or less will be taxable as
ordinary income. Distributions are taxable whether shareholders receive them in
cash or reinvest them in additional shares through the Dividend Reinvestment
Plan.
Any gain resulting from the sale or exchange of Fund shares will generally also
be subject to tax. In addition, the exemption from federal income tax for
exempt-interest dividends does not necessarily result in exemption for such
dividends under the income or other tax laws of any state or local taxing
authority.
The backup withholding tax rate is 30% for amounts paid during 2002 and 2003 if
the Fund is required to apply backup withholding to taxable distributions
payable to a shareholder. Please see "Tax Matters" in the Statement of
Additional Information for additional information about the backup withholding
tax rates for subsequent years.
This section relates only to federal income tax consequences of investing in the
Fund; the consequences under other tax laws may differ. You should consult your
tax advisor as to the possible application of state and local income tax laws to
Fund dividends and capital distributions. Please see "Tax Matters" in the
Statement of Additional Information for additional information regarding the tax
aspects of investing in the Fund.
25
UNDERWRITING
The underwriters named below (the "Underwriters"), acting through
, as their representatives (the "Representatives"), have
severally agreed, subject to the terms and conditions of the Underwriting
Agreement with the Fund and the Manager, to purchase from the Fund the number of
Common Shares set forth opposite their respective names. The Underwriters are
committed to purchase and pay for all of such Common Shares (other than those
covered by the over-allotment option described below) if any are purchased.
NUMBER OF
UNDERWRITER COMMON SHARES
Total
The Fund has granted to the Underwriters an option, exercisable for 45 days from
the date of this Prospectus, to purchase up to an additional Common Shares
to cover over-allotments, if any, at the initial offering price. The
Underwriters may exercise such option solely for the purpose of covering
Underwriting over-allotments incurred in the sale of the Common Shares offered
hereby. To the extent that the Underwriters exercise this option, each of the
Underwriters will have a firm commitment, subject to certain conditions, to
purchase an additional number of Common Shares proportionate to such
Underwriter's initial commitment.
The Fund has agreed to pay a commission to the Underwriters in the amount of up
to $ per Common Share ( % of the public offering price per Common Share).
The Representatives have advised the Fund that the Underwriters may pay up to
$ per Common Share from such commission to selected dealers who sell the
Common Shares and that such dealers may reallow a concession of up to $ per
Common Share to certain other dealers who sell shares. Investors must pay for
any Common Shares purchased on or before , 2002.
Prior to this offering, there has been no public or private market for the
Common Shares or any other securities of the Fund. Consequently, the offering
price for the Common Shares was determined by negotiation among the Fund, the
Manager and the Representatives. There can be no assurance, however, that the
price at which Common Shares sell after this offering will not be lower than the
price at which they are sold by the Underwriters or that an active trading
market in the Common Shares will develop and continue after this offering. The
minimum investment requirement is 100 Common Shares.
The Fund and the Manager have agreed to indemnify the several Underwriters for
or to contribute to the losses arising out of certain liabilities, including
liabilities under the Securities Act of 1933, as amended.
The Fund has agreed not to offer, sell or register with the Securities and
Exchange Commission any equity securities of the Fund, other than issuances of
Common Shares, including pursuant to the Fund's Dividend Reinvestment Plan, and
issuances in connection with any offering of Preferred Shares, each as
contemplated in this Prospectus, for a period of 180 days after the date of the
Underwriting Agreement without the prior written consent of the Representatives.
The Representatives have informed the Fund that the Underwriters do not intend
to confirm any sales to any accounts over which they exercise discretionary
authority.
In connection with this offering, the Underwriters may purchase and sell Common
Shares in the open market. These transactions may include over-allotment and
stabilizing transactions and purchases to cover syndicate short positions
created in connection with this offering. Stabilizing transactions consist of
certain bids or purchases for the purpose of preventing or retarding a decline
in the market price of the Common Shares and syndicate short positions involve
the sale by the Underwriters of a greater number of Common Shares than they are
required to purchase from the Fund in this offering. The Underwriters also may
impose a penalty bid, whereby selling concessions allowed to syndicate members
or other broker-dealers in respect of the Common Shares sold in this offering
for their account, may be reclaimed by the syndicate if such Common Shares are
repurchased by the syndicate in stabilizing or covering transactions. These
activities may stabilize, maintain or otherwise affect the market price of the
Common Shares, which may be higher than the price that might otherwise prevail
in the open market; and these activities, if commenced, may be discontinued at
any time without notice. These transactions may be effected on the New York
Stock Exchange or otherwise.
The Fund anticipates that the Representatives and certain other Underwriters may
from time to time act as brokers and dealers in connection with the execution of
its portfolio transactions after they have ceased to be Underwriters and,
subject to certain restrictions, may act as such brokers while they are
Underwriters.
As described below under "Shareholder servicing agent, custodian and transfer
agent," will provide shareholder services to the Fund pursuant to a
shareholder servicing agreement with the Manager. may pay as
sales commission to Underwriters that meet certain minimum sales thresholds
during this offering or in combination with other contemporaneous offerings a
portion of the Shareholder Servicing Fee (as defined below). The Underwriters
have informed the Fund that the Underwriters undertake that, to the extent that
a portion of the Shareholder Servicing Fee is so paid as sales commission, the
amount of the sales load and the amounts so paid to such Underwriters will not
exceed any sales charge limits under the rules of the National Association of
Securities Dealers, Inc.
26
SHAREHOLDER SERVICING AGENT, CUSTODIAN AND TRANSFER AGENT
The Manager (and not the Fund) has agreed to pay from its own assets to
a shareholder servicing fee (the "Shareholder Servicing
Fee") at an annual rate equal to 0.10% of the Fund's total Managed Assets
pursuant to a shareholder servicing agreement between the Manager and
(the "Shareholder Servicing Agreement"). "Managed Assets,"
for these purposes, means the total assets of the Fund (including any assets
attributable to any Preferred Shares that may be outstanding) minus the sum of
accrued liabilities (other than debt representing financial leverage).
Pursuant to the Shareholder Servicing Agreement, will: (i) undertake
to make public information pertaining to the Fund on an ongoing basis and to
communicate to investors and prospective investors the Fund's features and
benefits (including periodic seminars or conference calls, responses to
questions from current or prospective shareholders and specific shareholder
contact where appropriate); (ii) make available to investors and prospective
investors market price, net asset value, yield and other information regarding
the Fund, if reasonably obtainable, for the purpose of maintaining the
visibility of the Fund in the investor community; (iii) at the request of the
Manager, provide certain economic research and statistical information and
reports, if reasonably obtainable, on behalf of the Fund, and consult with
representatives and Trustees of the Fund in connection therewith, which
information and reports shall include: (a) statistical and financial market
information with respect to the Fund's market performance and (b) comparative
information regarding the Fund and other closed-end management investment
companies with respect to (1) the net asset value of their respective shares,
(2) the respective market performance of the Fund and such other companies, (3)
other relevant performance indicators; and (iv) at the request of the Manager,
provide information to and consult with the Board of Trustees with respect to
applicable modifications to dividend policies or capital structure,
repositioning or restructuring of the Fund, conversion of the Fund to an
open-end investment company, liquidation or merger; provided, however, that
under the terms of the Shareholder Servicing Agreement, is not
obligated to render any opinions, valuations or recommendations of any kind or
to perform any such similar services. Under the terms of the Shareholder
Servicing Agreement, is relieved from liability to the Manager for
any act or omission in the course of its performances under the Shareholder
Servicing Agreement in the absence of gross negligence or willful misconduct.
The Shareholder Servicing Agreement will continue for an initial term of two
years and thereafter for successive one-year periods unless terminated by either
party upon 60 days written notice.
The custodian of the assets of the Fund is State Street Bank and Trust Co., 225
Franklin Street, Boston, Massachusetts 02110. The Custodian performs custodial
and fund accounting services.
PFPC Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as the
Fund's transfer agent, registrar, dividend disbursement agent and shareholder
servicing agent, as well as agent for the Fund's Dividend Reinvestment Plan.
LEGAL MATTERS
Certain legal matters in connection with the Common Shares will be passed upon
for the Fund by Ropes & Gray, Boston, Massachusetts, and for the Underwriters by
Skadden, Arps, Slate, Meagher & Flom (Illinois), Chicago, Illinois, and its
affiliated entities.
27
TABLE OF CONTENTS FOR THE
STATEMENT OF ADDITIONAL INFORMATION
Use of Proceeds.............................................................. 3
Investment Objective and Policies............................................ 3
Investment Restrictions......................................................27
Management of the Fund.......................................................29
Investment Manager and Portfolio Manager.....................................39
Portfolio Transactions.......................................................44
Distributions................................................................46
Description of Shares........................................................46
Anti-Takeover and Other Provisions in the Declaration of Trust...............49
Repurchase of Common Shares; Conversion to Open-End Fund.....................52
Tax Matters..................................................................53
Performance Related and Comparative Information..............................59
Custodian, Transfer Agent and Dividend Disbursement Agent....................60
Independent Accountants......................................................60
Counsel......................................................................60
Registration Statement.......................................................61
Report of Independent Accountants............................................62
Financial Statements.........................................................63
Appendix A--Description of Securities Ratings ............................. A-1
Appendix B--Performance Related and Comparative and Other Information ..... B-1
28
LOGO
The information in this Statement of Additional Information is not
complete and may be changed. We may not sell these securities until the
registration statement filed with the Securities and Exchange Commission is
effective. This Statement of Additional Information is not an offer to sell
these securities and it is not soliciting an offer to buy these securities in
any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION--DATED [ ], 2002
PIMCO MUNICIPAL INCOME FUND II
STATEMENT OF ADDITIONAL INFORMATION
[__________], 2002
PIMCO Municipal Income Fund II (the "Fund") is a newly organized,
diversified closed-end management investment company.
This Statement of Additional Information relating to common shares of
the Fund ("Common Shares") is not a prospectus, and should be read in
conjunction with the Fund's prospectus relating thereto dated [__________], 2002
(the "Prospectus"). This Statement of Additional Information does not include
all information that a prospective investor should consider before purchasing
Common Shares, and investors should obtain and read the Prospectus prior to
purchasing such shares. A copy of the Prospectus may be obtained without charge
by calling (877) 819-2224. You may also obtain a copy of the Prospectus on the
web site (http://www.sec.gov) of the Securities and Exchange Commission ("SEC").
------------------
Capitalized terms used but not defined in this Statement of Additional
Information have the meanings ascribed to them in the Prospectus.
1
TABLE OF CONTENTS
USE OF PROCEEDS............................................................3
INVESTMENT OBJECTIVE AND POLICIES..........................................3
INVESTMENT RESTRICTIONS...................................................27
MANAGEMENT OF THE FUND....................................................29
INVESTMENT MANAGER AND PORTFOLIO MANAGER..................................39
PORTFOLIO TRANSACTIONS....................................................44
DISTRIBUTIONS.............................................................46
DESCRIPTION OF SHARES.....................................................46
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST............49
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND..................52
TAX MATTERS...............................................................53
PERFORMANCE RELATED AND COMPARATIVE INFORMATION...........................59
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT.................60
INDEPENDENT ACCOUNTANTS...................................................60
COUNSEL...................................................................60
REGISTRATION STATEMENT....................................................61
REPORT OF INDEPENDENT ACCOUNTANTS.........................................62
FINANCIAL STATEMENTS......................................................63
APPENDIX A - Description of Securities Ratings...........................A-1
APPENDIX B - Performance Related and Comparative and Other Information...B-1
This Statement of Additional Information is dated [__________], 2002.
2
USE OF PROCEEDS
The net proceeds of the offering of Common Shares of the Fund will be
approximately $[__________] (or $[__________] if the Underwriters exercise the
over-allotment option in full) after payment of organization and offering costs.
On behalf of the Fund, PIMCO Funds Advisors LLC (the "Manager"), the
Fund's investment manager, has agreed to pay the amount by which the aggregate
of all of the Fund's organizational expenses and all offering costs (other than
the sales load) exceeds $0.03 per Common Share.
Pending investment in Municipal Bonds (as hereinafter defined) that
meet the Fund's investment objective and policies, the net proceeds of the
offering will be invested in high quality, short-term tax-exempt money market
securities or in high quality Municipal Bonds with relatively low price
volatility (such as pre-refunded and intermediate-term bonds), to the extent
such securities are available. If necessary to invest fully the net proceeds of
the offering immediately, the Fund may also purchase, as temporary investments,
short-term taxable investments of the type described below under "Investment
Objective and Policies--Short-Term Investments/Temporary Defensive Strategies,"
the income on which is subject to regular federal income tax.
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and general investment policies of the Fund
are described in the Prospectus. Additional information concerning the
characteristics of certain of the Fund's investments is set forth below.
MUNICIPAL BONDS
Under normal market conditions, the Fund will invest its net assets in
a portfolio of municipal bonds the interest from which, in the opinion of bond
counsel to the issuer (or on the basis of other authority believed by the Fund's
portfolio manager to be reliable), is exempt from federal income taxes
("Municipal Bonds"). Under normal market conditions, the Fund expects to be
fully invested (at least 90% of its total assets) in Municipal Bonds.
Municipal Bonds share the attributes of debt/fixed income securities in
general, but are generally issued by states, municipalities and other political
subdivisions, agencies, authorities and instrumentalities of states and
multi-state agencies or authorities. The Municipal Bonds that the Fund may
purchase include general obligation bonds and limited obligation bonds (or
revenue bonds), including industrial development bonds issued pursuant to former
federal tax law. General obligation bonds are obligations involving the credit
of an issuer possessing taxing power and are payable from such issuer's general
revenues and not from any particular source. Limited obligation bonds are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source. Tax-exempt private activity bonds and industrial
development bonds generally
3
are also revenue bonds and thus are not payable from the issuer's general
revenues. The credit and quality of private activity bonds and industrial
development bonds are usually related to the credit of the corporate user of the
facilities. Payment of interest on and repayment of principal of such bonds is
the responsibility of the corporate user (and/or any guarantor).
The Fund will invest at least 80% of its net assets in Municipal Bonds
that at the time of investment are investment grade quality. Investment grade
quality bonds are bonds rated within the four highest grades (Baa or BBB or
better by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's ("S&P")
or Fitch, Inc. ("Fitch")) or bonds that are unrated but judged to be of
comparable quality by the Fund's portfolio manager, Pacific Investment
Management Company LLC ("PIMCO"). The Fund may invest up to 20% of its net
assets in Municipal Bonds that, at the time of investment, are rated Ba/BB or B
by Moody's, S&P or Fitch or unrated but judged to be of comparable quality by
PIMCO. Bonds of below investment grade quality (Ba/BB or below) are commonly
referred to as "junk bonds." For a description of the risks associated with
lower quality securities, see "High Yield Securities ('Junk Bonds')" below.
The Fund will primarily invest in Municipal Bonds with long-term
maturities in order to maintain a weighted average maturity of 15-30 years, but
the average weighted maturity of obligations held by the Fund may be shortened,
depending on market conditions. As a result, the Fund's portfolio at any given
time may include both long-term and intermediate-term Municipal Bonds. Moreover,
during temporary or defensive periods (e.g., times when PIMCO believes that
temporary imbalances of supply and demand or other temporary dislocations in the
tax-exempt bond market adversely affect the price at which long-term or
intermediate-term Municipal Bonds are available), and in order to keep the
Fund's cash fully invested, including the period during which the net proceeds
of the offering are being invested, the Fund may invest any percentage of its
net assets in short-term investments, including high quality, short-term
securities that may be either tax-exempt or taxable and up to 10% of its net
assets in securities of open- or closed-end investment companies that invest
primarily in Municipal Bonds of the type in which the Fund may invest directly.
The Fund intends to invest in taxable short-term investments only in the event
that suitable tax-exempt short-term investments are not available at reasonable
prices and yields. See "Tax Matters" for information relating to the allocation
of taxable income between and among Common Shares and any series of the Fund's
preferred shares (called "Preferred Shares" herein), if any. Tax-exempt
short-term investments include various obligations issued by state and local
governmental issuers, such as tax-exempt notes (bond anticipation notes, tax
anticipation notes and revenue anticipation notes or other such Municipal Bonds
maturing in three years or less from the date of issuance) and municipal
commercial paper. The Fund will invest only in taxable short-term investments
that are U.S. government securities or securities rated within the four highest
grade by Moody's, S&P or Fitch, and which mature within one year from the date
of purchase or carry a variable or floating rate of interest. See Appendix A for
a general description of Moody's, S&P's and Fitch's ratings of securities in
such categories. Taxable short-term investments of the Fund may include
certificates of deposit issued by U.S. banks with assets of at least $1 billion,
or commercial paper or corporate notes, bonds or debentures with a remaining
maturity of one year or less, or repurchase agreements. See "--Short-Term
Investments/Temporary Defensive Strategies." To the extent the Fund invests in
taxable investments, the Fund will not at such times be in a position to achieve
its investment objective.
4
Also included within the general category of Municipal Bonds in which
the Fund may invest are participations in lease obligations or installment
purchase contract obligations of municipal authorities or entities ("Municipal
Lease Obligations"). Although a Municipal Lease Obligation does not constitute a
general obligation of the municipality for which the municipality's taxing power
is pledged, a Municipal Lease Obligation is ordinarily backed by the
municipality's covenant to budget for, appropriate and make the payments due
under the Municipal Lease Obligation. However, certain Municipal Lease
Obligations contain "non-appropriation" clauses that provide that the
municipality has no obligation to make lease or installment purchase payments in
future years unless money is appropriated for such purpose on a yearly basis. In
the case of a "non-appropriation" lease, the Fund's ability to recover under the
lease in the event of non-appropriation or default will be limited solely to the
repossession of the leased property, without recourse to the general credit of
the lessee, and disposition or releasing of the property might prove difficult.
There have been challenges to the legality of lease financing in numerous
states, and, from time to time, certain municipalities have considered not
appropriating money for lease payments. In deciding whether to purchase a
Municipal Lease Obligation, PIMCO will assess the financial condition of the
borrower, the merits of the project, the level of public support for the
project, and the legislative history of lease financing in the state. These
securities may be less readily marketable than other Municipal Bonds. The Fund
may also purchase unrated lease obligations if determined by PIMCO to be of
comparable quality to rated securities in which the Fund is permitted to invest.
The Fund may seek to enhance its yield through the purchase of private
placements. These securities are sold through private negotiations, usually to
institutions or mutual funds, and may have resale restrictions. Their yields are
usually higher than comparable public securities to compensate the investor for
their limited marketability. The Fund may invest up to 20% of its net assets in
securities which are illiquid at the time of investment, including unmarketable
private placements.
Some longer-term Municipal Bonds give the investor the right to "put"
or sell the security at par (face value) within a specified number of days
following the investor's request--usually one to seven days. This demand feature
enhances a security's liquidity by shortening its effective maturity and enables
it to trade at a price equal to or very close to par. If a demand feature
terminates prior to being exercised, the Fund would hold the longer-term
security, which could experience substantially more volatility.
The Fund may invest in Municipal Bonds with credit enhancements such as
letters of credit, municipal bond insurance and Standby Bond Purchase Agreements
("SBPAs"). Letters of credit are issued by a third party, usually a bank, to
enhance liquidity and ensure repayment of principal and any accrued interest if
the underlying Municipal Bond should default. Municipal bond insurance, which is
usually purchased by the bond issuer from a private, non-governmental insurance
company, provides an unconditional and irrevocable guarantee that the insured
bond's principal and interest will be paid when due. Insurance does not
guarantee the price of the bond or the share price of the Fund. The credit
rating of an insured bond reflects the credit rating of the insurer, based on
its claims-paying ability. The obligation of a municipal bond insurance company
to pay a claim extends over the life of each insured bond. Although defaults on
insured Municipal Bonds have been low to date and municipal bond insurers have
ordinarily met their claims, there is no assurance this will continue. A
higher-than-expected default rate could strain
5
the insurer's loss reserves and adversely affect its ability to pay claims to
bondholders. The number of municipal bond insurers is relatively small, and not
all of them have the highest rating. An SBPA is a liquidity facility provided to
pay the purchase price of bonds that cannot be re-marketed. The obligation of
the liquidity provider (usually a bank) is only to advance funds to purchase
tendered bonds that cannot be remarketed and does not cover principal or
interest under any other circumstances. The liquidity provider's obligations
under the SBPA are usually subject to numerous conditions, including the
continued creditworthiness of the underlying borrower.
The Fund also may invest in participation interests. Participation
interests are various types of securities created by converting fixed rate bonds
into short-term, variable rate certificates. These securities have been
developed in the secondary market to meet the demand for short-term, tax-exempt
securities. The Fund will invest only in securities deemed tax-exempt by a
nationally recognized bond counsel, but there is no guarantee the interest will
be exempt.
The Fund may also invest up to 10% of its total assets in residual
interest Municipal Bonds, which may involve leverage and related risks.
See "--Residual Interest Municipal Bonds (RIBS)" below.
The Fund may purchase custodial receipts representing the right to
receive either the principal amount or the periodic interest payments or both
with respect to specific underlying Municipal Bonds. In a typical custodial
receipt arrangement, an issuer or third party owner of Municipal Bonds deposits
the bonds with a custodian in exchange for two classes of custodial receipts.
The two classes have different characteristics, but, in each case, payments on
the two classes are based on payments received on the underlying Municipal
Bonds. In no event will the aggregate interest paid with respect to the two
classes exceed the interest paid by the underlying Municipal Bond. Custodial
receipts are sold in private placements. The value of a custodial receipt may
fluctuate more than the value of a Municipal Bond of comparable quality and
maturity.
Municipal Bonds are subject to credit and market risk. Generally,
prices of higher quality issues tend to fluctuate less with changes in market
interest rates than prices of lower quality issues and prices of longer maturity
issues tend to fluctuate more than prices of shorter maturity issues.
The Fund may purchase and sell portfolio investments to take advantage
of changes or anticipated changes in yield relationships, markets or economic
conditions. The Fund may also sell Municipal Bonds due to changes in PIMCO's
evaluation of the issuer. The secondary market for Municipal Bonds typically has
been less liquid than that for taxable debt/fixed income securities, and this
may affect the Fund's ability to sell particular Municipal Bonds at then-current
market prices, especially in periods when other investors are attempting to sell
the same securities.
Prices and yields on Municipal Bonds are dependent on a variety of
factors, including general money-market conditions, the financial condition of
the issuer, general conditions of the Municipal Bond market, the size of a
particular offering, the maturity of the obligation and the rating of the issue.
A number of these factors, including the ratings of particular issues, are
6
subject to change from time to time. Information about the financial condition
of an issuer of Municipal Bonds may not be as extensive as that made available
by corporations whose securities are publicly traded.
Obligations of issuers of Municipal Bonds are subject to the provisions
of bankruptcy, insolvency and other laws, such as the Federal Bankruptcy Reform
Act of 1978, affecting the rights and remedies of creditors. Congress or state
legislatures may seek to extend the time for payment of principal or interest,
or both, or to impose other constraints upon enforcement of such obligations.
There is also the possibility that as a result of litigation or other
conditions, the power or ability of issuers to meet their obligations for the
payment of interest and principal on their Municipal Bonds may be materially
affected or their obligations may be found to be invalid or unenforceable. Such
litigation or conditions may from time to time have the effect of introducing
uncertainties in the market for Municipal Bonds or certain segments thereof, or
of materially affecting the credit risk with respect to particular bonds.
Adverse economic, business, legal or political developments might affect all or
a substantial portion of the Fund's Municipal Bonds in the same manner. The Fund
will be particularly subject to these risks to the extent that it focuses its
investments in a particular state or region.
RESIDUAL INTEREST MUNICIPAL BONDS (RIBS)
The Fund may also invest up to 10% of its total assets in residual
interest Municipal Bonds ("RIBS") whose interest rates bear an inverse
relationship to the interest rate on another security or the value of an index.
RIBS are created by dividing the income stream provided by the underlying bonds
to create two securities, one short-term and one long-term. The interest rate on
the short-term component is reset by an index or auction process normally every
seven to 35 days. After income is paid on the short-term securities at current
rates, the residual income from the underlying bond(s) goes to the long-term
securities. Therefore, rising short-term interest rates result in lower income
for the longer-term portion, and vice versa. The longer-term bonds can be very
volatile and may be less liquid than other Municipal Bonds of comparable
maturity. An investment in RIBS typically will involve greater risk than an
investment in a fixed rate bond. Because increases in the interest rate on the
other security or index reduce the residual interest paid on a RIB, the value of
a RIB is generally more volatile than that of a fixed rate bond. RIBS have
interest rate adjustment formulas that generally reduce or, in the extreme,
eliminate the interest paid to the Fund when short-term interest rates rise, and
increase the interest paid to the Fund when short-term interest rates fall. RIBS
have varying degrees of liquidity that approximate the liquidity of the
underlying bond(s), and the market price for these securities is volatile. These
securities generally will underperform the market of fixed rate bonds in a
rising interest rate environment, but tend to outperform the market of fixed
rate bonds when interest rates decline or remain relatively stable. Although
volatile, RIBS typically offer the potential for yields exceeding the yields
available on fixed rate bonds with comparable credit quality, coupon, call
provisions and maturity. The Fund may also invest in RIBS for the purpose of
increasing the Fund's leverage as a more flexible alternative to the issuance of
Preferred Shares. Should short-term and long-term interest rates rise, the
combination of the Fund's investment in RIBS and its use of other forms of
leverage (including through the issuance of Preferred Shares or the use of other
derivative instruments) likely will adversely affect the Fund's net asset value
per share and income, distributions and total returns to shareholders.
7
Trusts in which RIBS may be held could be terminated, in which case the residual
bond holder would take possession of the underlying bond(s) on an unleveraged
basis.
SHORT-TERM INVESTMENTS / TEMPORARY DEFENSIVE STRATEGIES
Upon PIMCO's recommendation, temporarily or for defensive purposes and
in order to keep the Fund's cash fully invested, including the period during
which the net proceeds of the offering are being invested, the Fund may invest
up to 100% of its net assets in short-term investments including high quality,
short-term securities that may be either tax-exempt or taxable. The Fund intends
to invest in taxable short-term investments only in the event that suitable
tax-exempt short-term investments are not available at reasonable prices and
yields. To the extent the Fund invests in taxable short-term investments, the
Fund will not at such times be in a position to achieve its investment objective
of providing current income exempt from federal income tax.
Short-Term Taxable Fixed Income Securities
------------------------------------------
Short-term taxable fixed income investments are defined to include,
without limitation, the following:
(1) U.S. government securities, including bills, notes and
bonds differing as to maturity and rates of interest that are either
issued or guaranteed by the U.S. Treasury or by U.S. government
agencies or instrumentalities. U.S. government agency securities
include, without limitation, securities issued by (a) the Federal
Housing Administration, Farmers Home Administration, Export-Import Bank
of the United States, Small Business Administration, and the Government
National Mortgage Association, whose securities are supported by the
full faith and credit of the United States; (b) the Federal Home Loan
Banks, Federal Intermediate Credit Banks, and the Tennessee Valley
Authority, whose securities are supported by the right of the agency to
borrow from the U.S. Treasury; (c) the Federal National Mortgage
Association, whose securities are supported by the discretionary
authority of the U.S. government to purchase certain obligations of the
agency or instrumentality; and (d) the Student Loan Marketing
Association, whose securities are supported only by its credit. While
the U.S. government provides financial support to such U.S.
government-sponsored agencies or instrumentalities, no assurance can be
given that it always will do so since it is not so obligated by law.
The U.S. government, its agencies, and instrumentalities do not
guarantee the market value of their securities. Consequently, the value
of such securities may fluctuate.
(2) Certificates of deposit issued against funds deposited in
a bank or a savings and loan association. Such certificates are for a
definite period of time, earn a specified rate of return, and are
normally negotiable. The issuer of a certificate of deposit agrees to
pay the amount deposited plus interest to the bearer of the certificate
on the date specified thereon. Certificates of deposit purchased by the
Fund may not be fully insured.
(3) Repurchase agreements, which involve purchases of debt
securities. A repurchase agreement is a contractual agreement whereby
the seller of securities (e.g., U.S. government securities) agrees to
repurchase the same security at a specified price on
8
a future date agreed upon by the parties. The agreed-upon repurchase
price determines the yield during the Fund's holding period. Repurchase
agreements are considered to be loans collateralized by the underlying
security that is the subject of the repurchase contract. Income
generated from transactions in repurchase agreements will be taxable.
The Fund will only enter into repurchase agreements with registered
securities dealers or domestic banks that PIMCO believes present
minimal credit risk. The risk to the Fund is limited to the ability of
the issuer to pay the agreed-upon repurchase price on the delivery
date; however, although the value of the underlying collateral at the
time the transaction is entered into always equals or exceeds the
agreed-upon repurchase price, if the value of the collateral declines
there is a risk of loss of both principal and interest. In the event of
default, the collateral may be sold but the Fund might incur a loss if
the value of the collateral declines, and might incur disposition costs
or experience delays in connection with liquidating the collateral. In
addition, if bankruptcy proceedings are commenced with respect to the
seller of the security, realization upon the collateral by the Fund may
be delayed or limited. PIMCO will monitor the value of the collateral
at the time the transaction is entered into and at all times subsequent
during the term of the repurchase agreement in an effort to determine
that such value always equals or exceeds the agreed-upon repurchase
price.
(4) Commercial paper, which consists of short-term unsecured
promissory notes, including variable rate master demand notes issued by
corporations to finance their current operations. Master demand notes
are direct lending arrangements between the Fund and a corporation.
There is no secondary market for such notes. However, they are
redeemable by the Fund at any time. PIMCO will consider the financial
condition of the corporation (e.g., earning power, cash flow, and other
liquidity ratios) and will continuously monitor the corporation's
ability to meet all of its financial obligations, because the Fund's
liquidity might be impaired if the corporation were unable to pay
principal and interest on demand. Investments in commercial paper will
be limited to commercial paper rated investment grade by a major rating
agency, or unrated but determined by PIMCO to be of comparable quality,
and which mature within one year of the date of purchase or carry a
variable or floating rate of interest.
Short-Term Tax-Exempt Fixed Income Securities
---------------------------------------------
Short-term tax-exempt fixed-income securities are securities that are
exempt from regular federal income tax and mature within three years or less
from the date of issuance. Short-term tax-exempt fixed income securities are
defined to include, without limitation, the following:
Bond Anticipation Notes ("BANs") are usually general obligations of
state and local governmental issuers that are sold to obtain interim financing
for projects that will eventually be funded through the sale of long-term debt
obligations or bonds. The ability of an issuer to meet its obligations on its
BANs is primarily dependent on the issuer's access to the long-term Municipal
Bond market and the likelihood that the proceeds of such bond sales will be used
to pay the principal and interest on the BANs.
Tax Anticipation Notes ("TANs") are issued by state and local
governments to finance the current operations of such governments. Repayment is
generally to be derived from specific
9
future tax revenues. TANs are usually general obligations of the issuer. A
weakness in an issuer's capacity to raise taxes due to, among other things, a
decline in its tax base or a rise in delinquencies, could adversely affect the
issuer's ability to meet its obligations on outstanding TANs.
Revenue Anticipation Notes ("RANs") are issued by governments or
governmental bodies with the expectation that future revenues from a designated
source will be used to repay the notes. In general, they also constitute general
obligations of the issuer. A decline in the receipt of projected revenues, such
as anticipated revenues from another level of government, could adversely affect
an issuer's ability to meet its obligations on outstanding RANs. In addition,
the possibility that the revenues would, when received, be used to meet other
obligations could affect the ability of the issuer to pay the principal and
interest on RANs.
Construction Loan Notes are issued to provide construction financing
for specific projects. Frequently, these notes are redeemed with funds obtained
from the Federal Housing Administration.
Bank Notes are notes issued by local government bodies and agencies,
such as those described above to commercial banks as evidence of borrowings. The
purposes for which the notes are issued are varied but they are frequently
issued to meet short-term working capital or capital-project needs. These notes
may have risks similar to the risks associated with TANs and RANs.
Tax-Exempt Commercial Paper ("Municipal Paper") represents very
short-term unsecured, negotiable promissory notes issued by states,
municipalities and their agencies. Payment of principal and interest on issues
of Municipal Paper may be made from various sources, to the extent the funds are
available therefrom. Maturities of Municipal Paper generally will be shorter
than the maturities of TANs, BANs or RANs. There is a limited secondary market
for issues of Municipal Paper.
Certain Municipal Bonds may carry variable or floating rates of
interest whereby the rate of interest is not fixed but varies with changes in
specified market rates or indices, such as a bank prime rate or a tax-exempt
money market index.
While the various types of notes described above as a group currently
represent the major portion of the tax-exempt note market, other types of notes
are or may become available in the marketplace and the Fund may invest in such
other types of notes to the extent permitted under its investment objective,
policies and limitations. Such notes may be issued for different purposes and
may be secured differently from those mentioned above.
HIGH YIELD SECURITIES ("JUNK BONDS")
The Fund may invest up to 20% of its net assets in Municipal Bonds
that, at the time of investment, are rated Ba/BB or B by Moody's, S&P or Fitch
or unrated but judged to be of comparable quality by PIMCO. Bonds of below
investment grade quality (Ba/BB or below) are commonly referred to as "high
yield securities" or "junk bonds." Issuers of bonds rated Ba/BB or B are
regarded as having current capacity to make principal and interest payments but
are
10
subject to business, financial or economic conditions which could adversely
affect such payment capacity. Municipal bonds rated Baa or BBB are considered
"investment grade" securities, although such bonds may be considered to possess
some speculative characteristics. Municipal Bonds rated AAA in which the Fund
may invest may have been so rated on the basis of the existence of insurance
guaranteeing the timely payment, when due, of all principal and interest.
High yield securities are regarded as predominantly speculative with
respect to the issuer's continuing ability to meet principal and interest
payments and, therefore, carry greater price volatility and principal and income
risk, including the possibility of issuer default and bankruptcy and increased
market price volatility.
High yield securities may be more susceptible to real or perceived
adverse economic and competitive industry conditions than investment grade
securities. A projection of an economic downturn or of a period of rising
interest rates, for example, could cause a decline in high yield security prices
because the advent of a recession could lessen the ability of an issuer to make
principal and interest payments on its debt securities. If an issuer of high
yield securities defaults, in addition to risking payment of all or a portion of
interest and principal, the Fund may incur additional expenses to seek recovery.
In the case of high yield securities structured as zero-coupon, their market
prices are affected to a greater extent by interest rate changes, and therefore
tend to be more volatile than securities which pay interest periodically and in
cash. PIMCO seeks to reduce these risks through diversification, credit analysis
and attention to current developments and trends in both the economy and
financial markets.
The secondary market on which high yield securities are traded may be
less liquid than the market for higher grade securities. Less liquidity in the
secondary trading market could adversely affect the price at which the Fund
could sell a high yield security, and could adversely affect the daily net asset
value of the shares. Adverse publicity and investor perceptions, whether or not
based on fundamental analysis, may decrease the values and liquidity of high
yield securities, especially in a thinly traded market. When secondary markets
for high yield securities are less liquid than the market for higher grade
securities, it may be more difficult to value the securities because such
valuation may require more research, and elements of judgment may play a greater
role in the valuation because there is less reliable, objective data available.
During periods of thin trading in these markets, the spread between bid and
asked prices is likely to increase significantly and the Fund may have greater
difficulty selling its portfolio securities. The Fund will be more dependent on
PIMCO's research and analysis when investing in high yield securities. PIMCO
seeks to minimize the risks of investing in all securities through
diversification, in-depth credit analysis and attention to current developments
in interest rates and market conditions.
A general description of Moody's, S&P's and Fitch's ratings of
Municipal Bonds is set forth in Appendix A hereto. The ratings of Moody's, S&P
and Fitch represent their opinions as to the quality of the Municipal Bonds they
rate. It should be emphasized, however, that ratings are general and are not
absolute standards of quality. Consequently, Municipal Bonds with the same
maturity, coupon and rating may have different yields while obligations with the
same maturity and coupon with different ratings may have the same yield. For
these reasons, the use of credit ratings as the sole method of evaluating high
yield securities can involve certain risks. For example, credit ratings evaluate
the safety of principal and interest payments, not the market
11
value risk of high yield securities. Also, credit rating agencies may fail to
change credit ratings in a timely fashion to reflect events since the security
was last rated. PIMCO does not rely solely on credit ratings when selecting
securities for the Fund, and develops its own independent analysis of issuer
credit quality.
The Fund's credit quality policies apply only at the time a security is
purchased, and the Fund is not required to dispose of a security in the event
that a rating agency or PIMCO downgrades its assessment of the credit
characteristics of a particular issue. In determining whether to retain or sell
such a security, PIMCO may consider such factors as PIMCO's assessment of the
credit quality of the issuer of such security, the price at which such security
could be sold and the rating, if any, assigned to such security by other rating
agencies. However, analysis of the creditworthiness of issuers of high yield
securities may be more complex than for issuers of higher quality debt
securities.
MUNICIPAL WARRANTS
The Fund may invest in municipal warrants, which are essentially call
options on Municipal Bonds. In exchange for a premium, they give the purchaser
the right, but not the obligation, to purchase a Municipal Bond in the future.
The Fund might purchase a warrant to lock in forward supply in an environment
where the current issuance of bonds is sharply reduced. Like options, warrants
may expire worthless and they may have reduced liquidity.
MORTGAGE-BACKED SECURITIES
The Fund may invest in mortgage-backed securities. Mortgage-backed
securities in which the Fund may invest include fixed and adjustable rate
mortgage pass-through securities and other securities that directly or
indirectly represent a participation in, or are secured by and payable from,
mortgage loans on real property.
The value of mortgage-backed securities may be particularly sensitive
to changes in prevailing interest rates. Early repayment of principal on some
mortgage-backed securities may expose the Fund to a lower rate of return upon
reinvestment of principal. When interest rates rise, the value of a
mortgage-backed security generally will decline; however, when interest rates
are declining, the value of mortgage-backed securities with prepayment features
may not increase as much as other fixed income securities without such
prepayment features. The rate of prepayments on underlying mortgages will affect
the price and volatility of a mortgage-backed security, and may shorten or
extend the effective maturity of the security beyond what was anticipated at the
time of purchase. If unanticipated rates of prepayment on underlying mortgages
increase the effective maturity of a mortgage-related security, the volatility
of the security can be expected to increase. The value of these securities may
fluctuate in response to the market's perception of the creditworthiness of the
issuers. Additionally, although mortgages and mortgage-backed securities are
generally supported by some form of government or private guarantee and/or
insurance, there is no assurance that private guarantors or insurers will meet
their obligations.
12
VARIABLE AND FLOATING RATE SECURITIES
Variable and floating rate securities provide for a periodic adjustment
in the interest rate paid on the obligations. The terms of such obligations must
provide that interest rates are adjusted periodically based upon an interest
rate adjustment index as provided in the respective obligations. The adjustment
intervals may be regular, and range from daily up to annually, or may be event
based, such as based on a change in the prime rate.
The Fund may invest in floating rate debt instruments ("floaters") and
engage in credit spread trades. The interest rate on a floater is a variable
rate that is tied to another interest rate, such as a municipal bond index or
Treasury bill rate. The interest rate on a floater resets periodically,
typically every six months. While, because of the interest rate reset feature,
floaters provide the Fund with a certain degree of protection against rising
interest rates, the Fund will participate in any declines in interest rates as
well. A credit spread trade is an investment position relating to a difference
in the prices or interest rates of two bonds or other securities, where the
value of the investment position is determined by movements in the difference
between the prices or interest rates, as the case may be, of the respective
securities or currencies.
The Fund may also invest in inverse floating rate debt instruments
("inverse floaters"). The interest rate on an inverse floater resets in the
opposite direction from the market rate of interest to which the inverse floater
is indexed. An inverse floating rate security may exhibit greater price
volatility than a fixed rate obligation of similar credit quality.
STRUCTURED NOTES AND OTHER HYBRID INSTRUMENTS
The Fund may invest in "structured" notes, which are privately
negotiated debt obligations where the principal and/or interest is determined by
reference to the performance of a benchmark asset, market or interest rate, such
as selected securities, an index of securities or specified interest rates, or
the differential performance of two assets or markets, such as indices
reflecting taxable and tax-exempt bonds. Depending on the terms of the note, the
Fund may forgo all or part of the interest and principal that would be payable
on a comparable conventional note. The rate of return on structured notes may be
determined by applying a multiplier to the performance or differential
performance of the referenced index(es) or other asset(s). Application of a
multiplier involves leverage that will serve to magnify the potential for gain
and the risk of loss. The Fund currently intends that any use of structured
notes will be for the purpose of reducing the interest rate sensitivity of the
Fund's portfolio (and, thereby, decreasing the Fund's exposure to interest rate
risk) and, in any event, that the interest income on the notes will normally be
exempt from federal income tax. Like other sophisticated strategies, the Fund's
use of structured notes may not work as intended; for example, the change in the
value of the structured notes may not match very closely the change in the value
of bonds that the structured notes were purchased to hedge.
The Fund may invest in other types of "hybrid" instruments that combine
the characteristics of securities, futures, and options. For example, the
principal amount or interest rate of a hybrid could be tied (positively or
negatively) to the price of some securities index or another interest rate (each
a "benchmark"). The interest rate or (unlike most debt obligations) the
principal amount payable at maturity of a hybrid security may be increased or
decreased,
13
depending on changes in the value of the benchmark. Hybrids can be
used as an efficient means of pursuing a variety of investment goals, including
duration management and increased total return. Hybrids may not bear interest or
pay dividends. The value of a hybrid or its interest rate may be a multiple of a
benchmark and, as a result, may be leveraged and move (up or down) more steeply
and rapidly than the benchmark. These benchmarks may be sensitive to economic
and political events that cannot be readily foreseen by the purchaser of a
hybrid. Under certain conditions, the redemption value of a hybrid could be
zero. Thus, an investment in a hybrid may entail significant market risks that
are not associated with a similar investment in a traditional, U.S.
dollar-denominated bond that has a fixed principal amount and pays a fixed rate
or floating rate of interest. The purchase of hybrids also exposes the Fund to
the credit risk of the issuer of the hybrids. These risks may cause significant
fluctuations in the net asset value of the Fund.
Certain issuers of structured products, such as hybrid instruments, may
be deemed to be investment companies as defined in the 1940 Act. As a result,
the Fund's investments in these products may be subject to limits applicable to
investments in investment companies and may be subject to restrictions contained
in the 1940 Act.
MUNICIPAL MARKET DATA RATE LOCKS
The Fund may purchase and sell Municipal Market Data Rate Locks ("MMD
Rate Locks"). An MMD Rate Lock permits the Fund to lock in a specified municipal
interest rate for a portion of its portfolio to preserve a return on a
particular investment or a portion of its portfolio as a duration management
technique or to protect against any increase in the price of securities to be
purchased at a later date. The Fund will ordinarily use these transactions as a
hedge or for duration or risk management although it is permitted to enter into
them to enhance income or gain. An MMD Rate Lock is a contract between the Fund
and an MMD Rate Lock provider pursuant to which the parties agree to make
payments to each other on a notional amount, contingent upon whether the
Municipal Market Data AAA General Obligation Scale is above or below a specified
level on the expiration date of the contract. For example, if the Fund buys an
MMD Rate Lock and the Municipal Market Data AAA General Obligation Scale is
below the specified level on the expiration date, the counterparty to the
contract will make a payment to the Fund equal to the specified level minus the
actual level, multiplied by the notional amount of the contract. If the
Municipal Market Data AAA General Obligation Scale is above the specified level
on the expiration date, the Fund will make a payment to the counterparty equal
to the actual level minus the specified level, multiplied by the notional amount
of the contract. In entering into MMD Rate Locks, there is a risk that municipal
yields will move in the direction opposite of the direction anticipated by the
Fund.
BORROWING
The Fund may borrow money to the extent permitted under the 1940 Act,
as interpreted, modified or otherwise permitted by regulatory authority having
jurisdiction from time to time. The Fund may from time to time borrow money to
add leverage to the portfolio. The Fund may also borrow money for temporary
administrative purposes.
Under the 1940 Act, the Fund generally is not permitted to engage in
borrowings unless immediately after a borrowing the value of the Fund's total
assets less liabilities (other than the
14
borrowing) is at least 300% of the principal amount of such borrowing (i.e.,
such principal amount may not exceed 33 1/3% of the Fund's total assets). In
addition, the Fund is not permitted to declare any cash dividend or other
distribution on Common Shares unless, at the time of such declaration, the
value of the Fund's total assets, less liabilities other than borrowing, is at
least 300% of such principal amount. If the Fund borrows, it intends, to the
extent possible, to prepay all or a portion of the principal amount of the
borrowing to the extent necessary in order to maintain the required asset
coverage. Failure to maintain certain asset coverage requirements could result
in an event of default and entitle holders of Preferred Shares ("Preferred
Shareholders") to elect a majority of the Trustees of the Fund.
As described elsewhere in this section, the Fund also may enter into
certain transactions, including RIBS and other derivative instruments that can
constitute a form of borrowing or financing transaction by the Fund. The Fund
may enter into these transactions in order to add leverage to the portfolio. The
Fund may (but is not required to) cover its commitment under these instruments
by the segregation of assets determined to be liquid by PIMCO in accordance with
procedures adopted by the Trustees, equal in value to the amount of the Fund's
commitment, or by entering into offsetting transactions or owning positions
covering its obligations. In that case, the instruments will not be considered
"senior securities" under the 1940 Act for purposes of the asset coverage
requirements otherwise applicable to borrowings by the Fund or the Fund's
issuance of Preferred Shares. Borrowing will tend to exaggerate the effect on
net asset value of any increase or decrease in the market value of the Fund's
portfolio. Money borrowed will be subject to interest costs that may or may not
be recovered by appreciation of the securities purchased. The Fund also may be
required to maintain minimum average balances in connection with such borrowing
or to pay a commitment or other fee to maintain a line of credit; either of
these requirements would increase the cost of borrowing over the stated interest
rate.
DERIVATIVE INSTRUMENTS
In pursuing its investment objective, the Fund may purchase and sell
(write) both put options and call options on securities, swap agreements, and
securities indexes, and enter into interest rate and index futures contracts and
purchase and sell options on such futures contracts ("futures options") to add
leverage to the portfolio, for hedging purposes or as part of its overall
investment strategy. The Fund also may enter into swap agreements with respect
to interest rates, securities indexes and other assets and measures of risk or
return. If other types of financial instruments, including other types of
options, futures contracts, or futures options are traded in the future, the
Fund may also use those instruments, provided that the Trustees determine that
their use is consistent with the Fund's investment objective.
The value of some derivative instruments in which the Fund may invest
may be particularly sensitive to changes in prevailing interest rates, and, like
the other investments of the Fund, the ability of the Fund to successfully
utilize these instruments may depend in part upon the ability of PIMCO to
forecast interest rates and other economic factors correctly. If PIMCO
incorrectly forecasts such factors and has taken positions in derivative
instruments contrary to prevailing market trends, the Fund could be exposed to
the risk of loss.
15
The Fund might not employ any of the strategies described below, and no
assurance can be given that any strategy used will succeed. If PIMCO incorrectly
forecasts interest rates, market values or other economic factors in utilizing a
derivatives strategy for the Fund, the Fund might have been in a better position
if it had not entered into the transaction at all. Also, suitable derivative
transactions may not be available in all circumstances. The use of these
strategies involves certain special risks, including a possible imperfect
correlation, or even no correlation, between price movements of derivative
instruments and price movements of related investments. While some strategies
involving derivative instruments can reduce the risk of loss, they can also
reduce the opportunity for gain or even result in losses by offsetting favorable
price movements in related investments or otherwise, due to the possible
inability of the Fund to purchase or sell a portfolio security at a time that
otherwise would be favorable or the possible need to sell a portfolio security
at a disadvantageous time because the Fund is required to maintain asset
coverage or offsetting positions in connection with transactions in derivative
instruments, and the possible inability of the Fund to close out or to liquidate
its derivatives positions. Income earned by the Fund from many derivative
strategies will be treated as capital gain and, if not offset by net realized
capital loss, will be distributed to shareholders in taxable distributions.
Options on Securities, Swap Agreements and Indexes. The Fund may
purchase and sell both put and call options on securities, swap agreements or
indexes in standardized contracts traded on domestic or other securities
exchanges, boards of trade, or similar entities, or quoted on NASDAQ or on an
over-the-counter market, and agreements, sometimes called cash puts, which may
accompany the purchase of a new issue of debt obligations from a dealer.
An option on a security (or an index) is a contract that gives the
holder of the option, in return for a premium, the right to buy from (in the
case of a call) or sell to (in the case of a put) the writer of the option the
security underlying the option (or the cash value of the index) at a specified
exercise price at any time during the term of the option. The writer of an
option on a security has the obligation upon exercise of the option to deliver
the underlying security upon payment of the exercise price or to pay the
exercise price upon delivery of the underlying security. Upon exercise, the
writer of an option on an index is obligated to pay the difference between the
cash value of the index and the exercise price multiplied by the specified
multiplier for the index option. (An index is designed to reflect features of a
particular securities market, a specific group of financial instruments or
securities, or certain economic indicators.)
The Fund will write call options and put options only if they are
"covered." In the case of a call option on a security, the option is "covered"
if the Fund owns the security underlying the call or has an absolute and
immediate right to acquire that security without additional cash consideration
(or, if additional cash consideration is required, cash or other assets
determined to be liquid by PIMCO in accordance with procedures established by
the Board of Trustees, in such amount are segregated by its custodian) upon
conversion or exchange of other securities held by the Fund. For a call option
on an index, the option is covered if the Fund maintains with its custodian
assets determined to be liquid by PIMCO in accordance with procedures
established by the Board of Trustees, in an amount equal to the contract value
of the index. A call option is also covered if the Fund holds a call on the same
security or index as the call written where the exercise price of the call held
is (i) equal to or less than the exercise price of the call written, or (ii)
greater than the exercise price of the call written, provided the difference is
maintained by the
16
Fund in segregated assets determined to be liquid by PIMCO in accordance with
procedures established by the Board of Trustees. A put option on a security or
an index is "covered" if the Fund segregates assets determined to be liquid by
PIMCO in accordance with procedures established by the Board of Trustees equal
to the exercise price. A put option is also covered if the Fund holds a put on
the same security or index as the put written where the exercise price of the
put held is (i) equal to or greater than the exercise price of the put written,
or (ii) less than the exercise price of the put written, provided the
difference is maintained by the Fund in segregated assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees.
If an option written by the Fund expires unexercised, the Fund realizes
a capital gain equal to the premium received at the time the option was written.
If an option purchased by the Fund expires unexercised, the Fund realizes a
capital loss equal to the premium paid. Prior to the earlier of exercise or
expiration, an exchange-traded option may be closed out by an offsetting
purchase or sale of an option of the same series (type, exchange, underlying
security or index, exercise price, and expiration). There can be no assurance,
however, that a closing purchase or sale transaction can be effected when the
Fund desires.
The Fund may sell put or call options it has previously purchased,
which could result in a net gain or loss depending on whether the amount
realized on the sale is more or less than the premium and other transaction
costs paid on the put or call option which is sold. Prior to exercise or
expiration, an option may be closed out by an offsetting purchase or sale of an
option of the same series. The Fund will realize a capital gain from a closing
purchase transaction if the cost of the closing option is less than the premium
received from writing the option, or, if it is more, the Fund will realize a
capital loss. If the premium received from a closing sale transaction is more
than the premium paid to purchase the option, the Fund will realize a capital
gain or, if it is less, the Fund will realize a capital loss. The principal
factors affecting the market value of a put or a call option include supply and
demand, interest rates, the current market price of the underlying security or
index in relation to the exercise price of the option, the volatility of the
underlying security or index, and the time remaining until the expiration date.
The premium paid for a put or call option purchased by the Fund is an
asset of the Fund. The premium received for an option written by the Fund is
recorded as a deferred credit. The value of an option purchased or written is
marked to market daily and is valued at the closing price on the exchange on
which it is traded or, if not traded on an exchange or no closing price is
available, at the mean between the last bid and asked prices.
The Fund may write covered straddles consisting of a combination of a
call and a put written on the same underlying security. A straddle will be
covered when sufficient assets are deposited to meet the Fund's immediate
obligations. The Fund may use the same liquid assets to cover both the call and
put options where the exercise price of the call and put are the same, or the
exercise price of the call is higher than that of the put. In such cases, the
Fund will also segregate liquid assets equivalent to the amount, if any, by
which the put is "in the money."
Risks Associated with Options on Securities and Indexes. There are
several risks associated with transactions in options on securities and on
indexes. For example, there are
17
significant differences between the securities and options markets that could
result in an imperfect correlation between these markets, causing a given
transaction not to achieve its objectives. A decision as to whether, when and
how to use options involves the exercise of skill and judgment, and even a
well-conceived transaction may be unsuccessful to some degree because of market
behavior or unexpected events.
During the option period, the covered call writer has, in return for
the premium on the option, given up the opportunity to profit from a price
increase in the underlying security above the exercise price, but, as long as
its obligation as a writer continues, has retained the risk of loss should the
price of the underlying security decline. The writer of an option has no control
over the time when it may be required to fulfill its obligation as a writer of
the option. Once an option writer has received an exercise notice, it cannot
effect a closing purchase transaction in order to terminate its obligation under
the option and must deliver the underlying security at the exercise price. If a
put or call option purchased by the Fund is not sold when it has remaining
value, and if the market price of the underlying security remains equal to or
greater than the exercise price (in the case of a put), or remains less than or
equal to the exercise price (in the case of a call), the Fund will lose its
entire investment in the option. Also, where a put or call option on a
particular security is purchased to hedge against price movements in a related
security, the price of the put or call option may move more or less than the
price of the related security.
There can be no assurance that a liquid market will exist when the Fund
seeks to close out an option position. If the Fund were unable to close out an
option that it had purchased on a security, it would have to exercise the option
in order to realize any profit or the option may expire worthless. If the Fund
were unable to close out a covered call option that it had written on a
security, it would not be able to sell the underlying security unless the option
expired without exercise. As the writer of a covered call option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by the Fund, the Fund
would not be able to close out the option. If restrictions on exercise were
imposed, the Fund might be unable to exercise an option it has purchased. Except
to the extent that a call option on an index written by the Fund is covered by
an option on the same index purchased by the Fund, movements in the index may
result in a loss to the Fund; however, such losses may be mitigated by changes
in the value of the Fund's securities during the period the option was
outstanding.
Futures Contracts and Options on Futures Contracts. The Fund may invest
in interest rate futures contracts and options thereon ("futures options"). The
Fund may also purchase and sell futures contracts on Municipal Bonds and U.S.
government and agency securities, as well as purchase put and call options on
such futures contracts.
A securities or interest rate futures contract provides for the future
sale by one party and purchase by another party of a specified quantity of the
security or financial instrument representative of interest rate fluctuations at
a specified price and time. A futures contract on an index is an agreement
pursuant to which two parties agree to take or make delivery of an amount of
cash equal to the difference between the value of the index at the close of the
last trading day
18
of the contract and the price at which the index contract was originally
written. Although the value of an index might be a function of the value of
certain specified securities, physical delivery of these securities is not
always made. A public market exists in futures contracts covering a number of
indexes as well as financial instruments, including, without limitation: U.S.
Treasury bonds; U.S. Treasury notes; three-month U.S. Treasury bills; 90-day
commercial paper; bank certificates of deposit; and the Bond Buyer 40 Bond
Index. It is expected that other futures contracts will be developed and traded
in the future.
The Fund may purchase and write call and put futures options. Futures
options possess many of the same characteristics as options on securities and
indexes (discussed above). A futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
To comply with applicable rules of the Commodity Futures Trading
Commission ("CFTC") under which the Fund avoids being deemed a "commodity pool"
or a "commodity pool operator," the Fund intends generally to limit its use of
futures contracts and futures options to "bona fide hedging" transactions, as
such term is defined in applicable regulations, interpretations and practice.
For example, the Fund might use futures contracts to hedge against anticipated
changes in interest rates that might adversely affect either the value of the
Fund's Municipal Bonds or the price of the bonds that the Fund intends to
purchase. The Fund's hedging activities may include sales of futures contracts
as an offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to reduce
the Fund's exposure to interest rate fluctuations, the Fund may be able to hedge
its exposure more effectively and perhaps at a lower cost by using futures
contracts and futures options.
The Fund will only enter into futures contracts and futures options
that are standardized and traded on a U.S. or other exchange, board of trade, or
similar entity, or quoted on an automated quotation system. The Fund may also
enter into OTC options on futures contracts.
When a purchase or sale of a futures contract is made by the Fund, the
Fund is required to deposit with its custodian (or broker, if legally permitted)
a specified amount of assets determined to be liquid by PIMCO in accordance with
procedures established by the Board of Trustees ("initial margin"). The margin
required for a futures contract is set by the exchange on which the contract is
traded and may be modified during the term of the contract. The initial margin
is in the nature of a performance bond or good faith deposit on the futures
contract that is returned to the Fund upon termination of the contract, assuming
all contractual obligations have been satisfied. The Fund expects to earn
taxable interest income on its initial margin deposits. A futures contract held
by the Fund is valued daily at the official settlement price of the exchange on
which it is traded. Each day the Fund pays or receives cash, called "variation
margin," equal to the daily change in value of the futures contract. This
process is known as "marking to market." Variation margin does not represent a
borrowing or loan by the Fund but is instead a settlement between the Fund and
the broker of the amount one would owe the other if the futures
19
contract expired. In computing daily net asset value, the Fund will mark to
market its open futures positions.
The Fund is also required to deposit and maintain margin with respect
to put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Fund.
Although some futures contracts call for making or taking delivery of
the underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts
(involving the same exchange, underlying security or index, and delivery month).
If an offsetting purchase price is less than the original sale price, the Fund
realizes a capital gain, or if it is more, the Fund realizes a capital loss.
Conversely, if an offsetting sale price is more than the original purchase
price, the Fund realizes a capital gain, or if it is less, the Fund realizes a
capital loss. The transaction costs must also be included in these calculations.
The Fund may write covered straddles consisting of a call and a put
written on the same underlying futures contract. A straddle will be covered when
sufficient assets are deposited to meet the Fund's immediate obligations. The
Fund may use the same liquid assets to cover both the call and put options where
the exercise price of the call and put are the same, or the exercise price of
the call is higher than that of the put. In such cases, the Fund will also
segregate liquid assets equivalent to the amount, if any, by which the put is
"in the money."
Limitations on Use of Futures and Futures Options. As noted above, the
Fund generally intends to enter into positions in futures contracts and related
options only for "bona fide hedging" purposes. With respect to positions in
futures and related options that do not constitute bona fide hedging positions,
the Fund will not enter into a futures contract or futures option contract if,
immediately thereafter, the aggregate initial margin deposits relating to such
positions plus premiums paid by it for open futures option positions, less the
amount by which any such options are "in-the-money," would exceed 5% of the
Fund's liquidation value, after taking into account unrealized profits and
unrealized losses on any such contracts into which the Fund has entered. A call
option is "in-the-money" if the value of the futures contract that is the
subject of the option exceeds the exercise price. A put option is "in-the-money"
if the exercise price exceeds the value of the futures contract that is the
subject of the option.
When purchasing a futures contract, the Fund will maintain with its
custodian (and mark-to-market on a daily basis) assets determined to be liquid
by PIMCO in accordance with procedures established by the Board of Trustees,
that, when added to the amounts deposited with a futures commission merchant as
margin, are equal to the market value of the futures contract. Alternatively,
the Fund may "cover" its position by purchasing a put option on the same futures
contract with a strike price as high or higher than the price of the contract
held by the Fund.
When selling a futures contract, the Fund will maintain with its
custodian (and mark-to-market on a daily basis) assets determined to be liquid
by PIMCO in accordance with procedures established by the Board of Trustees,
that are equal to the market value of the instruments
20
underlying the contract. Alternatively, the Fund may "cover" its position by
owning the instruments underlying the contract (or, in the case of an index
futures contract, a portfolio with a volatility substantially similar to that
of the index on which the futures contract is based), or by holding a call
option permitting the Fund to purchase the same futures contract at a price no
higher than the price of the contract written by the Fund (or at a higher price
if the difference is maintained in liquid assets with the Fund's custodian).
When selling a call option on a futures contract, the Fund will
maintain with its custodian (and mark-to-market on a daily basis) assets
determined to be liquid by PIMCO in accordance with procedures established by
the Board of Trustees, that, when added to the amounts deposited with a futures
commission merchant as margin, equal the total market value of the futures
contract underlying the call option. Alternatively, the Fund may cover its
position by entering into a long position in the same futures contract at a
price no higher than the strike price of the call option, by owning the
instruments underlying the futures contract, or by holding a separate call
option permitting the Fund to purchase the same futures contract at a price not
higher than the strike price of the call option sold by the Fund.
When selling a put option on a futures contract, the Fund will maintain
with its custodian (and mark-to-market on a daily basis) assets determined to be
liquid by PIMCO in accordance with procedures established by the Board of
Trustees, that equal the purchase price of the futures contract, less any margin
on deposit. Alternatively, the Fund may cover the position either by entering
into a short position in the same futures contract, or by owning a separate put
option permitting it to sell the same futures contract so long as the strike
price of the purchased put option is the same or higher than the strike price of
the put option sold by the Fund.
To the extent that securities with maturities greater than one year are
used to segregate assets to cover the Fund's obligations under futures contracts
and related options, such use will not eliminate the leverage risk arising from
such use, which may tend to exaggerate the effect on net asset value of any
increase or decrease in the market value of the Fund's portfolio, and may
require liquidation of portfolio positions when it is not advantageous to do so.
The requirements for qualification as a regulated investment company
also may limit the extent to which the Fund may enter into futures, futures
options or forward contracts. See "Tax Matters."
Risks Associated with Futures and Futures Options. There are several
risks associated with the use of futures contracts and futures options as
hedging techniques. A purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract. There can be no
guarantee that there will be a correlation between price movements in the
hedging vehicle and in the Fund securities being hedged. In addition, there are
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objectives. The degree of imperfection of correlation depends
on circumstances such as variations in speculative market demand for futures and
futures options on securities, including technical influences in futures trading
and futures options, and differences between the financial instruments being
hedged and the instruments underlying the standard contracts available for
trading in such respects as interest
21
rate levels, maturities, and creditworthiness of issuers. A decision as to
whether, when and how to hedge involves the exercise of skill and judgment, and
even a well-conceived hedge may be unsuccessful to some degree because of
market behavior or unexpected interest rate trends.
Futures contracts on U.S. government securities historically have
reacted to an increase or decrease in interest rates in a manner similar to that
in which the underlying U.S. government securities reacted. To the extent,
however, that the Fund enters into such futures contracts, the value of such
futures will not vary in direct proportion to the value of the Fund's holdings
of Municipal Bonds. Thus, the anticipated spread between the price of the
futures contract and the hedged security may be distorted due to differences in
the nature of the markets. The spread also may be distorted by differences in
initial and variation margin requirements, the liquidity of such markets and the
participation of speculators in such markets.
Futures exchanges may limit the amount of fluctuation permitted in
certain futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of the
current trading session. Once the daily limit has been reached in a futures
contract subject to the limit, no more trades may be made on that day at a price
beyond that limit. The daily limit governs only price movements during a
particular trading day and therefore does not limit potential losses because the
limit may work to prevent the liquidation of unfavorable positions. For example,
futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses.
There can be no assurance that a liquid market will exist at a time
when the Fund seeks to close out a futures contract or a futures option
position, and the Fund would remain obligated to meet margin requirements until
the position is closed. In addition, many of the contracts discussed above are
relatively new instruments without a significant trading history. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist.
Swap Agreements. The Fund may enter into swap agreements with respect
to interest rates, indexes of securities and other assets or measures of risk or
return. The Fund may also enter into options on swap agreements ("swaptions").
These transactions are entered into in an attempt to obtain a particular return
when it is considered desirable to do so, possibly at a lower cost to the Fund
than if the Fund had invested directly in an instrument that yielded that
desired return. Swap agreements are two-party contracts entered into primarily
by institutional investors for periods ranging from a few weeks to more than one
year. In a standard "swap" transaction, two parties agree to exchange the
returns (or differentials in rates of return) earned or realized on particular
predetermined investments or instruments, which may be adjusted for an interest
factor. The gross returns to be exchanged or "swapped" between the parties are
generally calculated with respect to a "notional amount," i.e., the return on or
increase in value of a particular dollar amount invested at a particular
interest rate or in a "basket" of securities representing a particular index.
Forms of swap agreements include interest rate caps, under which, in return for
a premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap"; interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall
22
below a specified rate, or "floor"; and interest rate collars, under which a
party sells a cap and purchases a floor or vice versa in an attempt to protect
itself against interest rate movements exceeding given minimum or maximum
levels. A swaption is a contract that gives a counterparty the right (but not
the obligation) to enter into a new swap agreement or to shorten, extend,
cancel or otherwise modify an existing swap agreement, at some designated
future time on specified terms. The Fund may write (sell) and purchase put and
call swaptions.
Most swap agreements entered into by the Fund would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, the
Fund's current obligations (or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received under the agreement based on
the relative values of the positions held by each party to the agreement (the
"net amount"). The Fund's current obligations under a swap agreement will be
accrued daily (offset against any amounts owed to the Fund). The Fund may use
swap agreements to add leverage to the portfolio. The Fund may (but is not
required to) cover any accrued but unpaid net amounts owed to a swap
counterparty through the segregation of assets determined to be liquid by PIMCO
in accordance with procedures established by the Board of Trustees. Obligations
under swap agreements so covered will not be construed to be "senior securities"
for purposes of the Fund's investment restriction concerning senior securities
and borrowings.
Whether the Fund's use of swap agreements or swaptions will be
successful in furthering its investment objective will depend on PIMCO's ability
to predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Because they are two-party contracts and
because they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Fund bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. The Fund will enter into
swap agreements only with counterparties that meet certain standards of
creditworthiness. The swaps market is a relatively new market and is largely
unregulated. It is possible that developments in the swaps market, including
potential government regulation, could adversely affect the Fund's ability to
terminate existing swap agreements or to realize amounts to be received under
such agreements.
Depending on the terms of the particular option agreement, the Fund
will generally incur a greater degree of risk when it writes a swaption than it
will incur when it purchases a swaption. When the Fund purchases a swaption, it
risks losing only the amount of the premium it has paid should it decide to let
the option expire unexercised. However, when the Fund writes a swaption, upon
exercise of the option the Fund will become obligated according to the terms of
the underlying agreement.
Certain swap agreements are exempt from most provisions of the
Commodity Exchange Act ("CEA") and, therefore, are not regulated as futures or
commodity option transactions under the CEA.
23
SHORT SALES
The Fund may make short sales of securities as part of its overall
portfolio management strategy and to offset potential declines in long positions
in securities in the Fund's portfolio. A short sale is a transaction in which
the Fund sells a security it does not own in anticipation that the market price
of that security will decline. Although short sale transactions are not
currently available with respect to Municipal Bonds, the Fund may engage in
short sales on taxable bonds and on futures contracts with respect to Municipal
Bonds and taxable bonds.
When the Fund makes a short sale on a security, it must borrow the
security sold short and deliver it to the broker-dealer through which it made
the short sale as collateral for its obligation to deliver the security upon
conclusion of the sale. The Fund may have to pay a fee to borrow particular
securities and is often obligated to pay over any accrued interest and dividends
on such borrowed securities.
If the price of the security sold short increases between the time of
the short sale and the time the Fund replaces the borrowed security, the Fund
will incur a loss; conversely, if the price declines, the Fund will realize a
capital gain. Any gain will be decreased, and any loss increased, by the
transaction costs described above. The successful use of short selling may be
adversely affected by imperfect correlation between movements in the price of
the security sold short and the securities being hedged.
To the extent that the Fund engages in short sales, it will provide
collateral to the broker-dealer. A short sale is "against the box" to the extent
that the Fund contemporaneously owns, or has the right to obtain at no added
cost, securities identical to those sold short. The Fund may also engage in
so-called "naked" short sales (i.e., short sales that are not "against the
box"), in which case the Fund's losses could theoretically be unlimited, in
cases where the Fund is unable for whatever reason to close out its short
position. The Fund has the flexibility to engage in short selling to the extent
permitted by the 1940 Act and rules and interpretations thereunder.
ILLIQUID SECURITIES
The Fund may invest up to 20% of its net assets in securities which
are illiquid at the time of investment. The term "illiquid securities" for this
purpose means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Fund has
valued the securities. Illiquid securities are considered to include, among
other things, written over-the-counter options, securities or other liquid
assets being used as cover for such options, repurchase agreements with
maturities in excess of seven days, certain loan participation interests, fixed
time deposits which are not subject to prepayment or provide for withdrawal
penalties upon prepayment (other than overnight deposits), and other securities
whose disposition is restricted under the federal securities laws (other than
securities issued pursuant to Rule 144A under the 1933 Act and certain
commercial paper that PIMCO has determined to be liquid under procedures
approved by the Board of Trustees).
Illiquid securities may include privately placed securities, which are
sold directly to a small number of investors, usually institutions. Unlike
public offerings, such securities are not
24
registered under the federal securities laws. Although certain of these
securities may be readily sold, others may be illiquid, and their sale may
involve substantial delays and additional costs.
PORTFOLIO TRADING AND TURNOVER RATE
Portfolio trading may be undertaken to accomplish the investment
objective of the Fund in relation to actual and anticipated movements in
interest rates. In addition, a security may be sold and another of comparable
quality purchased at approximately the same time to take advantage of what PIMCO
believes to be a temporary price disparity between the two securities. Temporary
price disparities between two comparable securities may result from supply and
demand imbalances where, for example, a temporary oversupply of certain bonds
may cause a temporarily low price for such bonds, as compared with other bonds
of like quality and characteristics. The Fund may also engage in short-term
trading consistent with its investment objective. Securities may be sold in
anticipation of a market decline (a rise in interest rates) or purchased in
anticipation of a market rise (a decline in interest rates) and later sold, or
to recognize a gain.
A change in the securities held by the Fund is known as "portfolio
turnover." PIMCO manages the Fund without regard generally to restrictions on
portfolio turnover. The use of certain derivative instruments with relatively
short maturities may tend to exaggerate the portfolio turnover rate for the
Fund. Trading in debt obligations does not generally involve the payment of
brokerage commissions, but does involve indirect transaction costs. The use of
futures contracts may involve the payment of commissions to futures commission
merchants. High portfolio turnover (e.g., greater than 100%) involves
correspondingly greater expenses to the Fund, including brokerage commissions or
dealer mark-ups and other transaction costs on the sale of securities and
reinvestments in other securities. The higher the rate of portfolio turnover of
the Fund, the higher these transaction costs borne by the Fund generally will
be. Transactions in the Fund's portfolio securities may result in realization of
taxable capital gains (including short-term capital gains which are generally
taxed to shareholders at ordinary income tax rates). The trading costs and tax
effects associated with portfolio turnover may adversely affect the Fund's
performance.
The portfolio turnover rate of the Fund is calculated by dividing (a)
the lesser of purchases or sales of portfolio securities for the particular
fiscal year by (b) the monthly average of the value of the portfolio securities
owned by the Fund during the particular fiscal year. In calculating the rate of
portfolio turnover, there is excluded from both (a) and (b) all securities,
including options, whose maturities or expiration dates at the time of
acquisition were one year or less.
OTHER INVESTMENT COMPANIES
The Fund may invest up to 10% of its net assets in securities of
open- or closed-end investment companies that invest primarily in Municipal
Bonds of the types in which the Fund may invest directly. The Fund may invest in
other investment companies either during periods when it has large amounts of
uninvested cash, such as the period shortly after the Fund receives the proceeds
of the offering of its Common Shares or Preferred Shares, during periods when
there is a shortage of attractive, high-yielding Municipal Bonds available in
the market, or when
25
PIMCO believes share prices of other investment companies offer attractive
values. The Fund may invest in investment companies that are advised by PIMCO or
its affiliates to the extent permitted by applicable law and/or pursuant to
exemptive relief from the SEC. As a stockholder in an investment company, the
Fund will bear its ratable share of that investment company's expenses and would
remain subject to payment of the Fund's management fees with respect to assets
so invested. Holders of Common Shares ("Common Shareholders") would therefore be
subject to duplicative expenses to the extent the Fund invests in other
investment companies. PIMCO will take expenses into account when evaluating the
investment merits of an investment in an investment company relative to
available Municipal Bond investments. In addition, the securities of other
investment companies may also be leveraged and will therefore be subject to the
same leverage risks described in the Prospectus and herein. As described in the
Fund's Prospectus in the section entitled "Risks--Leverage Risk," the net asset
value and market value of leveraged shares will be more volatile and the yield
to shareholders will tend to fluctuate more than the yield generated by
unleveraged shares.
WHEN-ISSUED, DELAYED DELIVERY AND FORWARD COMMITMENT TRANSACTIONS
The Fund may purchase or sell securities on a when-issued, delayed
delivery, or forward commitment basis. Typically, no income accrues on
securities the Fund has committed to purchase prior to the time delivery of the
securities is made, although the Fund may earn income on securities it has
segregated.
When purchasing a security on a when-issued, delayed delivery, or
forward commitment basis, the Fund assumes the rights and risks of ownership of
the security, including the risk of price and yield fluctuations, and takes such
fluctuations into account when determining its net asset value. Because the Fund
is not required to pay for the security until the delivery date, these risks are
in addition to the risks associated with the Fund's other investments. If the
Fund remains substantially fully invested at a time when when-issued, delayed
delivery, or forward commitment purchases are outstanding, the purchases may
result in a form of leverage.
When the Fund has sold a security on a when-issued, delayed delivery,
or forward commitment basis, the Fund does not participate in future gains or
losses with respect to the security. If the other party to a transaction fails
to deliver or pay for the securities, the Fund could miss a favorable price or
yield opportunity or could suffer a loss. The Fund may dispose of or renegotiate
a transaction after it is entered into, and may sell when-issued, delayed
delivery or forward commitment securities before they are delivered, which may
result in a capital gain or loss. There is no percentage limitation on the
extent to which the Fund may purchase or sell securities on a when-issued,
delayed delivery, or forward commitment basis.
ZERO-COUPON BONDS AND STEP-UPS
Zero-coupon securities are debt obligations that do not entitle the
holder to any periodic payments of interest either for the entire life of the
obligation or for an initial period after the issuance of the obligations. Like
zero-coupon bonds, "step-up" bonds pay no interest initially but eventually
begin to pay a coupon rate prior to maturity, which rate may increase at stated
intervals during the life of the security. Each of these instruments is
typically issued and traded at a deep discount from its face amount. The amount
of the discount varies depending on such
26
factors as the time remaining until maturity of the securities, prevailing
interest rates, the liquidity of the security and the perceived credit quality
of the issuer. The market prices of zero-coupon bonds and step-ups generally are
more volatile than the market prices of debt instruments that pay interest
currently and in cash and are likely to respond to changes in interest rates to
a greater degree than do other types of securities having similar maturities and
credit quality. In order to satisfy a requirement for qualification as a
"regulated investment company" under the Internal Revenue Code of 1986, as
amended (the "Code"), an investment company, such as the Fund, must distribute
each year at least 90% of its net investment income, including the original
issue discount accrued on zero-coupon bonds and step-ups. Because the Fund will
not on a current basis receive cash payments from the issuer of these securities
in respect of any accrued original issue discount, in some years the Fund may
have to distribute cash obtained from selling other portfolio holdings of the
Fund. In some circumstances, such sales might be necessary in order to satisfy
cash distribution requirements even though investment considerations might
otherwise make it undesirable for the Fund to sell securities at such time.
Under many market conditions, investments in zero-coupon bonds and step-ups may
be illiquid, making it difficult for the Fund to dispose of them or determine
their current value.
INVESTMENT RESTRICTIONS
FUNDAMENTAL INVESTMENT RESTRICTIONS
Except as described below, the Fund, as a fundamental policy, may not,
without the approval of the holders of a majority of the outstanding Common
Shares and, if issued, Preferred Shares voting together as a single class, and
of the holders of a majority of the outstanding Preferred Shares voting as a
separate class:
(1) Concentrate its investments in a particular "industry," as
that term is used in the Investment Company Act of 1940, as amended,
and as interpreted, modified, or otherwise permitted by regulatory
authority having jurisdiction, from time to time.
(2) With respect to 75% of the Fund's total assets, purchase
the securities of any issuer, except securities issued or guaranteed by
the U.S. government or any of its agencies or instrumentalities or
securities issued by other investment companies, if, as a result, (i)
more than 5% of the Fund's total assets would be invested in the
securities of that issuer, or (ii) the Fund would hold more than 10% of
the outstanding voting securities of that issuer. For the purpose of
this restriction, each state and each separate political subdivision,
agency, authority or instrumentality of such state, each multi-state
agency or authority, and each obligor, if any, are treated as separate
issuers of Municipal Bonds.
(3) Purchase or sell real estate, although it may purchase
securities (including Municipal Bonds) secured by real estate or
interests therein, or securities issued by companies which invest in
real estate, or interests therein.
(4) Purchase or sell commodities or commodities contracts or
oil, gas or mineral programs. This restriction shall not prohibit the
Fund, subject to restrictions described in
27
the Prospectus and elsewhere in this Statement of Additional
Information, from purchasing, selling or entering into futures
contracts, options on futures contracts, forward contracts, or any
interest rate, securities-related or other hedging instrument,
including swap agreements and other derivative instruments, subject to
compliance with any applicable provisions of the federal securities or
commodities laws.
(5) Borrow money or issue any senior security, except to the
extent permitted under the Investment Company Act of 1940, as amended,
and as interpreted, modified, or otherwise permitted by regulatory
authority having jurisdiction, from time to time.
(6) Make loans, except to the extent permitted under the
Investment Company Act of 1940, as amended, and as interpreted,
modified, or otherwise permitted by regulatory authority having
jurisdiction, from time to time.
(7) Act as an underwriter of securities of other issuers,
except to the extent that in connection with the disposition of
portfolio securities, it may be deemed to be an underwriter under the
federal securities laws.
(8) Make an investment if, at the time of such investment, the
Fund has invested less than 80% of its "assets" (as that term is
defined in Rule 35d-1 under the Investment Company Act of 1940, as
amended) in investments the income from which is, in the opinion of
bond counsel to the issuer (or on the basis of other authority believed
by the Fund's portfolio manager to be reliable), exempt from federal
income tax (not including, for these purposes, the federal alternative
minimum tax).
For purposes of the foregoing and "Description of Shares--Preferred
Shares--Voting Rights" below, "majority of the outstanding," when used with
respect to particular shares of the Fund (whether voting together as a single
class or voting as separate classes), means (i) 67% or more of such shares
present at a meeting, if the holders of more than 50% of such shares are present
or represented by proxy, or (ii) more than 50% of such shares, whichever is
less.
Unless otherwise indicated, all limitations applicable to the Fund's
investments (as stated above and elsewhere in this Statement of Additional
Information) apply only at the time a transaction is entered into. Any
subsequent change in a rating assigned by any rating service to a security (or,
if unrated, deemed by PIMCO to be of comparable quality), or change in the
percentage of the Fund's total assets invested in certain securities or other
instruments, or change in the average maturity or duration of the Fund's
investment portfolio, resulting from market fluctuations or other changes in the
Fund's total assets, will not require the Fund to dispose of an investment until
PIMCO determines that it is practicable to sell or close out the investment
without undue market or tax consequences to the Fund. In the event that rating
agencies assign different ratings to the same security, PIMCO will determine
which rating it believes best reflects the security's quality and risk at that
time, which may be the higher of the several assigned ratings.
Under the 1940 Act, a "senior security" does not include any promissory
note or evidence of indebtedness where such loan is for temporary purposes only
and in an amount not exceeding 5% of the value of the total assets of the issuer
at the time the loan is made. A loan is presumed
28
to be for temporary purposes if it is repaid within sixty days and is not
extended or renewed.
The Fund would be deemed to "concentrate" in a particular industry if
it invested more than 25% of its net assets in that industry. The Fund's
industry concentration policy does not preclude it from focusing investments in
issuers in a group of related industrial sectors (such as different types of
utilities).
To the extent the Fund covers its commitment under a derivative
instrument by the segregation of assets determined by PIMCO to be liquid in
accordance with procedures adopted by the Trustees, equal in value to the amount
of the Fund's commitment, such instrument will not be considered a "senior
security" for purposes of the asset coverage requirements otherwise applicable
to borrowings by the Fund or the Fund's issuance of Preferred Shares.
The Fund interprets its policies with respect to borrowing and lending
to permit such activities as may be lawful for the Fund, to the full extent
permitted by the 1940 Act or by exemption from the provisions therefrom pursuant
to exemptive order of the SEC.
The Fund intends to apply for ratings for its Preferred Shares from
Moody's, S&P and/or Fitch. In order to obtain and maintain the required ratings,
the Fund may be required to comply with investment quality, diversification and
other guidelines established by Moody's, S&P and/or Fitch. Such guidelines will
likely be more restrictive than the restrictions set forth above. The Fund does
not anticipate that such guidelines would have a material adverse effect on
Common Shareholders or its ability to achieve its investment objective. The Fund
presently anticipates that any Preferred Shares that it intends to issue would
be initially given the highest ratings by Moody's ("Aaa"), S&P ("AAA") and/or
Fitch ("AAA"), but no assurance can be given that such ratings will be obtained.
No minimum rating is required for the issuance of Preferred Shares by the Fund.
Moody's, S&P and Fitch receive fees in connection with their ratings issuances.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The business of the Fund is managed under the direction of the Fund's
Board of Trustees. Subject to the provisions of the Fund's Amended and Restated
Agreement and Declaration of Trust (the "Declaration"), its Bylaws and
Massachusetts law, the Trustees have all powers necessary and convenient to
carry out this responsibility, including the election and removal of the Fund's
officers.
The Trustees and officers of the Fund, their ages, the position they
hold with the Fund, their term of office and length of time served, a
description of their principal occupations during the past five years, the
number of portfolios in the fund complex that the Trustee oversees and any other
directorships held by the Trustee are listed in the two tables immediately
following. Except as shown, each Trustee's and officer's principal occupation
and business experience for the last five years has been with the employer(s)
indicated, although in some cases the Trustee may have held different positions
with such employer(s). Unless otherwise indicated, the
29
business address of the persons listed below is c/o PIMCO Funds Advisors LLC,
1345 Avenue of the Americas, New York, New York 10105.
INDEPENDENT TRUSTEES
--------------------
(1) (2) (3) (4) (5) (6)
Number of
Term of Portfolios
Office and in Fund Other
Position(s) Length of Complex Directorships
Name, Address Held Time Principal Occupation(s) Overseen by Held by
and Age with Fund Served During the Past 5 Years Trustee Trustee
Paul Belica Trustee Since Trustee, Fixed Income [6 - number Dreyfus Tax
Age 80 inception SHares, PIMCO Corporate used in Exempt Bond
([_____], Income Fund, PIMCO Municipal FISH SAI; Fund, Inc.,
2002). Income Fund, PIMCO add this Dreyfus New
California Municipal Income round of York State Tax
Fund and PIMCO New York additional Exempt Bond
Municipal Income Fund; funds] Fund, Inc.,
Manager, Stratigos Fund, Student Loan
L.L.C., Whistler Fund, Finance
L.L.C., Xanthus Fund, L.L.C. Corporation,
and Wynstone Fund, L.L.C.; Education
Former Advisor, Salomon Loans, Inc.
Smith Barney Inc.; Director,
Senior Vice President and
Managing Director, Smith
Barney, Harris Upham and
Co.; Director and Treasurer,
Isabela Home Inc., Isabela
Housing Company Inc., and
Isabela Nursing Home Inc.;
Executive Director, New York
State Housing Finance
Agency, New York State
Medical Care Facilities
Finance Agency, New York
State Municipal Bond Bank
Agency, New York State
Project Finance Agency and
Chairman, State of New York
Mortgage Agency; President,
Paul Belica and Company,
Inc., a financial advisory
business; Project Manager,
Walsh Construction Company;
Member, Ministry of Foreign
Affairs of Czechoslovakia in
Prague and Czechoslovak
Embassy in Vienna.
30
(1) (2) (3) (4) (5) (6)
Number of
Term of Portfolios
Office and in Fund Other
Position(s) Length of Complex Directorships
Name, Address Held Time Principal Occupation(s) Overseen Held by
and Age with Fund Served During the Past 5 Years by Trustee Trustee
Robert E. Connor Trustee Since Trustee, Fixed Income [7 - number None.
Age 68 inception SHares, PIMCO Corporate used in
([_____], Income Fund, PIMCO Municipal FISH SAI;
2002). Income Fund, PIMCO add this
California Municipal Income round of
Fund and PIMCO New York additional
Municipal Income Fund; funds]
Director, Municipal
Advantage Fund, Inc.;
Corporate Affairs
Consultant; Formerly, Senior
Vice President, Corporate
Office, Salomon Smith Barney
Inc.
R. Peter Sullivan III Trustee Since Managing Partner, Wagner Stott 3 [None.]
Age 60 inception Mercator LLC.
([____], 2002)
Interested Trustees*
-------------------
(1) (2) (3) (4) (5) (6)
Number of
Term of Portfolios
Office and in Fund Other
Position(s) Length of Complex Directorships
Name, Address Held Time Principal Occupation(s) Overseen by Held by
and Age with Fund Served During the Past 5 Years Trustee Trustee
Stephen J. Treadway Chairman, Since Managing Director, PIMCO [ ] [None.]
2187 Atlantic Street President, inception Funds Advisors LLC; Managing
Stamford, CT 06902 Trustee ([_____], Director and Chief Executive
Age 55 2002). Officer, PIMCO Funds
Distributors LLC ("PFD");
Trustee, President and Chief
Executive Officer, PIMCO
Funds: Multi-Manager Series;
Chairman, Fixed Income
SHares; Trustee, Chairman
and President, OCC Cash
Reserves, Inc., OCC
Accumulation Trust, PIMCO
Corporate Income Fund, PIMCO
Municipal Income Fund, PIMCO
California Municipal Income
Fund and PIMCO New York
Municipal Income Fund;
Chairman, Municipal
Advantage Fund, Inc.;
President, The Emerging
Markets Income Fund, Inc.,
The Emerging Markets Income
Fund II, Inc., The
31
(1) (2) (3) (4) (5) (6)
Number of
Term of Portfolios
Office and in Fund Other
Position(s) Length of Complex Directorships
Name, Address Held Time Principal Occupation(s) Overseen by Held by
and Age with Fund Served During the Past 5 Years Trustee Trustee
Emerging
Markets Floating Rate Fund,
Inc., Global Partners Income
Fund, Inc., Municipal
Partners Fund, Inc. and
Municipal Partners Fund II,
Inc. Formerly, Trustee,
President and Chief
Executive Officer of Cash
Accumulation Trust;
Chairman, The Central
European Value Fund, Inc.;
Executive Vice President,
Smith Barney Inc.
Hans W. Kertess Trustee Since inception Managing Director, Dain Rauscher [4 plus this [None.]
Age 62 Inc.; Trustee, PIMCO Corporate round of
([_____], Income Fund, PIMCO Municipal additional
2002). Income Fund, PIMCO California funds]
Municipal Income Fund and
PIMCO New York Municipal
Income Fund. Formerly, Managing
Director, Salomon Brothers.
John J. Dalessandro II Trustee Since President and Director, J.J. [4 plus this [None.]
Age 65 inception Dalessandro II Ltd., registered round of
([_____], broker-dealer and member of the additional
2002). New York Stock Exchange; funds]
Trustee, PIMCO Corporate Income
Fund, PIMCO Municipal Income
Fund, PIMCO California Municipal
Income Fund and PIMCO New
York Municipal Income Fund.
-----------------
* These Trustees are treated by the Fund as "interested persons" (as
defined in Section 2(a)(19) of the 1940 Act) of the Fund, the Manager, PIMCO or
one or more of the Underwriters. Mr. Treadway is an "interested person" because
of his affiliation with the Manager. Mr. Kertess is currently treated as an
"interested person" because of his association with Dain Rauscher Inc., a
broker-dealer that has within the last 6 months executed portfolio transactions
for the PIMCO Funds. Mr. Kertess retired from Dain Rauscher Inc. effective
January 1, 2002, and he and Dain Rauscher Inc. are in the process of finalizing
arrangements under which he would be expected to serve as a consultant and
independent contractor to Dain Rauscher Inc. It is expected that he will no
longer be treated as "interested person" of the Fund upon such arrangements
being made final. Mr. Dalessandro is treated as an "interested person" because
of his affiliation with J.J. Dalessandro II Ltd. The Fund does not, however,
concede that Mr. Dalessandro is in fact an "interested person" because it is
not clear whether his firm has executed portfolio transactions for the PIMCO
Funds.
In accordance with the Fund's staggered board (see "Anti-Takeover and
Other Provisions in the Declaration of Trust"), the Common Shareholders of the
Fund will elect Trustees to fill the
32
vacancies of Trustees whose terms expire at each annual meeting of Common
Shareholders, unless any Preferred Shares are outstanding, in which event
Preferred Shareholders, voting as a separate class, will elect two Trustees and
the remaining Trustee shall be elected by Common Shareholders and Preferred
Shareholders, voting together as a single class. Preferred Shareholders will be
entitled to elect a majority of the Fund's Trustees under certain circumstances.
Officers
--------
(1) (2) (3) (4) (5) (6)
Number of
Term of Portfolios
Office and in Fund Other
Position(s) Length of Complex Directorships
Name, Address Held Time Principal Occupation(s) Overseen by Held by
and Age with Fund Served During the Past 5 Years Trustee Trustee
Stephen J. Treadway See See previous See previous table. See See previous
2187 Atlantic Street previous table. previous table.
Stamford, CT 06902 table. table.
Age 55
Newton B. Schott, Jr. Vice Since Managing Director, Chief N/A N/A
2187 Atlantic Street President, inception Administrative Officer,
Stamford, CT 06902 Secretary ([_____], Secretary and General
Age 59 2002). Counsel, PFD; Managing
Director, Chief Legal Officer
and Secretary, PIMCO Funds
Advisors LLC; President,
Municipal Advantage Fund,
Inc.; Vice President and
Secretary, PIMCO Funds:
Multi-Manager Series, PIMCO
Corporate Income Fund, PIMCO
Municipal Income Fund, PIMCO
California Municipal Income
Fund, PIMCO New York
Municipal Income Fund;
Executive Vice President,
The Emerging Markets
Income Fund, Inc., The
Emerging Markets Income
Fund II, Inc., The Emerging
Markets Floating Rate Fund,
Inc., Global Partners Income
Fund, Inc., Municipal
Partners Fund, Inc. and
Municipal Partners Fund II,
Inc.; Secretary, Fixed
Income SHares. Formerly,
Vice President and Clerk,
PIMCO Advisors Funds and
Cash Accumulation Trust.
Brian S. Shlissel Treasurer; Since Senior Vice President, N/A N/A
Age 37 Principal inception PIMCO Funds Advisors LLC;
Financial ([_____], Executive Vice President
and 2002). and Treasurer, OCC Cash
Accounting Reserves, Inc. and OCC
Officer Accumulation Trust;
President, Chief
Executive Officer and
33
(1) (2) (3) (4) (5) (6)
Number of
Term of Portfolios
Office and in Fund Other
Position(s) Length of Complex Directorships
Name, Address Held Time Principal Occupation(s) Overseen by Held by
and Age with Fund Served During the Past 5 Years Trustee Trustee
Treasurer, Fixed Income
Shares; Treasurer,
Municipal Advantage Fund
Inc.; Treasurer and
Principal Financial and
Accounting Officer,
PIMCO Corporate Income
Fund, PIMCO Municipal
Income Fund, PIMCO
California Municipal
Income Fund and PIMCO
New York Municipal
Income Fund. Formerly,
Vice President, Mitchell
Hutchins Asset
Management Inc.
Mark V. McCray Vice Since Executive Vice President, N/A N/A
840 Newport Center Drive President inception PIMCO; Vice President, PIMCO
Newport Beach, CA 92660 ([_____], Corporate Income Fund.
Age 34 2002). Formerly, Vice President and
co-head of municipal bond
trading, Goldman Sachs & Co.
Michael B. Zuckerman Assistant Since Vice President, Allianz N/A N/A
Age 36 Secretary inception Dresdner Asset Management
([_____], of America L.P.; Secretary,
2002). Municipal Advantage Fund,
Inc., OCC Accumulation Trust
and OCC Cash Reserves, Inc.;
Assistant Secretary, Fixed
Income SHares, PIMCO
Corporate Income Fund, PIMCO
Municipal Income Fund, PIMCO
California Municipal Income
Fund and PIMCO New York
Municipal Income Fund.
Formerly, Associate, Dechert
Price and Rhoads; Associate
Counsel, Metropolitan Life
Insurance Company.
For interested Trustees and officers, positions held with affiliated
persons or principal underwriters of the Fund are listed in the following table:
(1) (2)
Name Positions Held with Affiliated Persons or Principal
Underwriters of the Fund
Stephen J. Treadway [TO BE ADDED]
34
Hans W. Kertess [TO BE ADDED]
John J. Dalessandro II [TO BE ADDED]
Newton B. Schott, Jr. [TO BE ADDED]
Brian S. Shlissel [TO BE ADDED]
Mark V. McCray [TO BE ADDED]
Michael B. Zuckerman [TO BE ADDED]
Committees of the Board of Trustees
Audit & Oversight Committee
---------------------------
Provides oversight with respect to the internal and external accounting
and auditing procedures of the Fund and, among other things, considers the
selection of independent public accountants for the Fund and the scope of the
audit, approves all significant services proposed to be performed by those
accountants on behalf of the Fund, and considers other services provided by
those accountants to the Fund, the Manager and PIMCO and the possible effect
of those services on the independence of those accountants. Messrs. Belica,
Connor and Kertess serve on this committee.
Nominating Committee
--------------------
Recommends qualified candidates to the Board in the event that a
position is vacated or created. Considers nominees recommended by the
shareholders. [Add description of procedures to be followed by shareholders in
submitting recommendations]. Messrs. Belica and Connor serve on this
committee.
Valuation Committee
-------------------
Reviews procedures for the valuation of securities and periodically
reviews information from the Manager and PIMCO regarding fair value and
liquidity determination made pursuant to the Board-approved procedures, and
makes related recommendations to the full Board and assists the full Board in
resolving particular valuation matters. Messrs. Belica, Connor and Treadway
serve on this committee.
Securities Ownership
For each Trustee, the following table discloses the dollar range of
equity securities beneficially owned by the Trustee in the Fund and, on an
aggregate basis, in any registered
35
investment companies overseen by the Trustee within the Fund's family of
investment companies as of December 31, 2001:
(1) (2) (3)
Aggregate Dollar Range of Equity Securities
Dollar Range of in All Registered Investment Companies
Equity Securities Overseen by Trustee in Family of
Name of Trustee in the Fund Investment Companies
Stephen J. Treadway None. [_____]
Hans W. Kertess None. [_____]
John J. Dalessandro II None. [_____]
Paul Belica None. [_____]
Robert E. Connor None. [_____]
R. Peter Sullivan III None. [_____]
For independent Trustees and their immediate family members, the
following table provides information regarding each class of securities owned
beneficially in an investment adviser or principal underwriter of the Fund, or a
person (other than a registered investment company) directly or indirectly
controlling, controlled by, or under common control with an investment adviser
or principal underwriter of the Fund as of December 31, 2001:
(1) (2) (3) (4) (5) (6)
Name of
Owners and
Relationships Value of
Name of Trustee to Trustee Company Title of Class Securities Percent of Class
Paul Belica N/A N/A N/A N/A N/A
Robert E. Connor N/A N/A N/A N/A N/A
R. Peter Sullivan III N/A N/A N/A N/A N/A
As of [__________], 2002, the Fund's officers and Trustees as a group
owned less than 1% of the outstanding Common Shares.
As of [__________], 2002, the following persons owned of record the
number of Common Shares noted below, representing the indicated percentage of
the Fund's outstanding shares as of such date.
36
Percentage of the Fund's
outstanding shares
Number of as of [__________], 2002
Common Shares ----
------
Shareholder
-----------
PIMCO Funds Advisors LLC [6,981] 100%
1345 Avenue of the Americas
New York, New York 10105
Compensation
Messrs. Belica, Connor, Dalessandro, Kertess and Treadway also serve as
Trustees of PIMCO California Municipal Income Fund, PIMCO New York Municipal
Income Fund, PIMCO Municipal Income Fund, PIMCO California Municipal Income Fund
II and PIMCO New York Municipal Income Fund II (together, the "Municipal Funds")
and PIMCO Corporate Income Fund, six closed-end funds for which the Manager
serves as investment manager and PIMCO serves as portfolio manager. Mr. Sullivan
also serves as Trustee of PIMCO California Municipal Income Fund II and PIMCO
New York Municipal Income Fund II. In addition to the Municipal Funds and PIMCO
Corporate Income Fund, Mr. Belica is a director or trustee, as the case may be,
of one open-end investment company (comprising two separate investment
portfolios) advised by the Manager; Mr. Connor is a director or trustee, as the
case may be, of one open-end investment company (comprising two separate
investment portfolios) and one closed-end investment company advised by the
Manager; and Mr. Treadway is a director or trustee, as the case may be, of four
open-end investment companies (which have multiple series) and seven closed-end
investment companies advised by the Manager or its affiliates. None of the
"independent" Trustees has ever been a director, officer, or employee of, or a
consultant to, the Manager, PIMCO, any one or more of the Underwriters or any
one or more affiliates of any of the foregoing. As indicated above, certain of
the officers and Trustees of the Fund are affiliated with the Manager and/or
PIMCO.
The Municipal Funds, PIMCO Corporate Income Fund and the Fund
(together, the "PIMCO Closed-End Funds") have the same Board of Trustees and are
expected to hold joint meetings of their Boards of Trustees whenever possible.
Each Trustee, other than any Trustee who is a director, officer, partner or
employee of the Manager, PIMCO or any entity controlling, controlled by or under
common control with the Manager or PIMCO, receives $14,000 for each joint
meeting for the first four joint meetings in each year and $7,000 for each
additional joint meeting in such year if the meetings are attended in person.
Trustees receive $3,500 per joint meeting if the meetings are attended
telephonically. Members of the Audit Oversight Committee will receive $3,500
per joint meeting of the PIMCO Closed-End Funds' Audit Oversight Committees if
the meeting takes place on a day other than the day of a regularly scheduled
Board meeting. Trustees will also be reimbursed for meeting-related expenses.
37
The PIMCO Closed-End Funds will allocate the Trustees' compensation and
other costs of their joint meetings pro rata based on each PIMCO Closed-End
Fund's net assets, including assets attributable to any preferred shares.
It is estimated that the Trustees will receive the amounts set forth in
the following table from the Fund for its fiscal year ending March 31, 2003. For
the calendar year ended December 31, 2000, the Trustees received the
compensation set forth in the following table for serving as trustees of other
funds in the "Fund Complex." Each officer and Trustee who is a director,
officer, partner or employee of the Manager, PIMCO or any entity controlling,
controlled by or under common control with the Manager or PIMCO serves without
any compensation from the Fund.
(1) (2) (3)
Aggregate Compensation from Fund Total Compensation from Fund and Fund Complex
for the Fiscal Year Ending Paid to Trustees for the Calendar Year Ending
Name of Person, Position March 31, 2003* December 31, 2001**
Paul Belica $0 $26,000
Robert E. Connor $0 $36,500
Hans W. Kertess $0 $6,000
John J. Dalessandro II $0 $13,500
R. Peter Sullivan III $0 $0
-----------------
* Since the Fund has not completed its first full fiscal year,
compensation is estimated based upon future payments to be made by the Fund
during the current fiscal year and upon estimated relative net assets of the
PIMCO Closed-End Funds. The estimate is for the fiscal year ending March 31,
2003.
** In addition to the PIMCO Closed-End Funds, during the year ended
December 31, 2001, Mr. Belica served as a Trustee of one open-end investment
company (comprising two separate investment portfolios) advised by the Manager,
and Mr. Connor served as a director or Trustee of one open-end investment
company (comprising two separate investment portfolios) and one closed-end
investment company advised by the Manager. These investment companies are
considered to be in the same "Fund Complex" as the Fund.
The Fund has no employees. Its officers are compensated by the Manager
and/or PIMCO.
CODES OF ETHICS
The Fund, the Manager and PIMCO have each adopted a separate code of
ethics governing personal trading activities of, as applicable, all Trustees and
officers of the Fund, and directors, officers and employees of the Manager and
PIMCO, who, in connection with their regular functions, play a role in the
recommendation of any purchase or sale of a security by the Fund or obtain
information pertaining to such purchase or sale or who have the power to
influence the management or policies of the Fund, the Manager or PIMCO, as
applicable. Such
38
persons are prohibited from effecting certain transactions, allowed to effect
certain exempt transactions (including with respect to securities that may be
purchased or held by the Fund), and are required to preclear certain security
transactions with the applicable compliance officer or his designee and to
report certain transactions on a regular basis. The Fund, the Manager and PIMCO
have each developed procedures for administration of their respective codes.
Text-only versions of the codes of ethics can be viewed online or downloaded
from the EDGAR Database on the SEC's internet web site at www.sec.gov. You may
also review and copy those documents by visiting the SEC's Public Reference Room
in Washington, DC. Information on the operation of the Public Reference Room may
be obtained by calling the SEC at 202-942-8090. In addition, copies of the codes
of ethics may be obtained, after mailing the appropriate duplicating fee, by
writing to the SEC's Public Reference Section, 450 5th Street, N.W., Washington,
DC 20549-0102 or by e-mail request at publicinfo@sec.gov.
------------------
INVESTMENT MANAGER AND PORTFOLIO MANAGER
INVESTMENT MANAGER
The Manager serves as investment manager to the Fund pursuant to an
investment management agreement (the "Investment Management Agreement") between
it and the Fund. The Manager, a Delaware limited liability company organized in
2000, is wholly-owned by PIMCO Advisory Services Holdings LLC, a wholly-owned
subsidiary of Allianz Dresdner Asset Management of America L.P. ("ADAM of
America", formerly PIMCO Advisors, L.P.). ADAM of America was organized as a
limited partnership under Delaware law in 1987. ADAM of America's sole general
partner is Allianz Paclife Partners LLC. Allianz Paclife Partners LLC is a
Delaware limited liability company with two members, ADAM U.S. Holding LLC, a
Delaware limited liability company, and Pacific Asset Management LLC, a Delaware
limited liability company. ADAM U.S. Holdings LLC is a wholly-owned subsidiary
of Allianz Dresdner Asset Management of America LLC, a wholly-owned subsidiary
of Allianz of America, Inc., which is a wholly-owned subsidiary of Allianz AG.
Pacific Asset Management LLC is a wholly-owned subsidiary of Pacific Life
Insurance Company, which is a wholly-owned subsidiary of Pacific Mutual Holding
Company. Pacific Mutual Holding Company is a Newport Beach, California-based
insurance holding company. Pacific Life Insurance Company's address is 700
Newport Center Drive, Newport Beach, California.
The general partner of ADAM of America has substantially delegated its
management and control of ADAM of America to an Executive Committee. The
Executive Committee of ADAM of America is comprised of Udo Frank, William S.
Thompson, Jr. and Marcus Riess.
The Manager is located at 1345 Avenue of the Americas, New York, New
York 10105. As of December 31, 2001, the Manager had approximately $80 billion
in assets under management. As of December 31, 2001, ADAM of America and its
subsidiary partnerships had approximately $320 billion in assets under
management.
Allianz of America has entered into a put/call arrangement for the
possible disposition of Pacific Life's indirect interest in the Manager. The put
option held by Pacific Life will allow it to require Allianz of America, on the
last business day of each calendar quarter following May 5,
39
2000, to purchase at a formula-based price all units of the Manager owned
directly or indirectly by Pacific Life. The call option held by Allianz of
America will allow it, beginning January 31, 2003 or upon a change in control of
Pacific Life, to require Pacific Life to sell or cause to be sold to Allianz of
America, at the same formula-based price, all units of the Manager owned
directly or indirectly by Pacific Life.
As of the date of this Statement of Additional Information, significant
institutional shareholders of Allianz AG currently include Munchener
Ruckversicherungs-Gesellschaft AG ("Munich Re") and HypoVereinsbank. Allianz AG
in turn owns more than 95% of Dresdner Bank AG. Credit Lyonnais, Munich Re and
HypoVereinsbank, as well as certain broker-dealers that might be controlled by
or affiliated with these entities or Dresdner Bank AG, such as DB Alex. Brown
LLC and Dresdner Klienwort Benson North America LLC (collectively, the
"Affiliated Brokers"), may be considered to be affiliated persons of the Manager
and PIMCO. Absent an SEC exemption or other relief, the Fund generally is
precluded from effecting principal transactions with the Affiliated Brokers, and
its ability to purchase securities being underwritten by an Affiliated Broker or
a syndicate including an Affiliated Broker is subject to restrictions.
Similarly, the Fund's ability to utilize the Affiliated Brokers for agency
transactions is subject to the restrictions of Rule 17e-1 under the 1940 Act.
PIMCO does not believe that the restrictions on transactions with the Affiliated
Brokers described above will materially adversely affect its ability to provide
services to the Fund, the Fund's ability to take advantage of market
opportunities, or the Fund's overall performance.
Allianz AG's address is Koniginstrasse 28, D-80802, Munich, Germany.
Pacific Life's address is 700 Newport Center Drive, Newport Beach, CA 92660.
The Manager, subject to the supervision of the Board of Trustees, is
responsible for managing, either directly or through others selected by the
Manager, the investments of the Fund. The Manager also furnishes to the Board of
Trustees periodic reports on the investment performance of the Fund. As more
fully discussed below, the Manager has retained PIMCO, its affiliate, to serve
as the Fund's portfolio manager.
Under the terms of the Investment Management Agreement, subject to such
policies as the Trustees of the Fund may determine, the Manager, at its expense,
will furnish continuously an investment program for the Fund and will make
investment decisions on behalf of the Fund and place all orders for the purchase
and sale of portfolio securities subject always to the Fund's investment
objective, policies and restrictions; provided that, so long as PIMCO serves as
the portfolio manager for the Fund, the Manager's obligation under the
Investment Management Agreement with respect to the Fund is, subject always to
the control of the Trustees, to determine and review with PIMCO the investment
policies of the Fund.
Subject to the control of the Trustees, the Manager also manages,
supervises and conducts the other affairs and business of the Fund, furnishes
office space and equipment, provides bookkeeping and certain clerical services
(excluding determination of the net asset value of the Fund, shareholder
accounting services and the accounting services for the Fund) and pays all
salaries, fees and expenses of officers and Trustees of the Fund who are
affiliated with the Manager. As indicated under "Portfolio
Transactions--Brokerage and Research Services," the Fund's portfolio
transactions may be placed with broker-dealers which furnish the Manager
40
and PIMCO, without cost, certain research, statistical and quotation services of
value to them or their respective affiliates in advising the Fund or their other
clients. In so doing, the Fund may incur greater brokerage commissions and other
transactions costs than it might otherwise pay.
Pursuant to the Investment Management Agreement, the Fund has agreed to
pay the Manager an annual management fee, payable on a monthly basis, at the
annual rate of 0.65% of the Fund's average daily net assets (including net
assets attributable to Preferred Shares) for the services and facilities it
provides. All fees and expenses are accrued daily and deducted before payment of
dividends to investors.
From the commencement of the Fund's operations through June 30, 2009,
the Manager has contractually agreed to waive a portion of the management fees
it is entitled to receive from the Fund in the amounts, and for the time
periods, set forth below:
Percentage Waived Percentage Waived
(annual rate as a (annual rate as a
Period Ending percentage of average Period Ending percentage of average
June 30 daily net assets) /1/ June 30 daily net assets) /1/
---------------- -------------------------------- ----------------- ---------------------------------
2003 /2/............ 0.15% 2007............... 0.15%
2004................ 0.15% 2008............... 0.10%
2005................ 0.15% 2009............... 0.05%
2006................ 0.15%
-------------------
/1/ Including net assets attributable to Preferred Shares.
/2/ From the commencement of the Fund's operations.
The Manager has not agreed to waive any portion of its fees beyond June
30, 2009.
Except as otherwise described in the Prospectus, the Fund pays, in
addition to the investment management fee described above, all expenses not
assumed by the Manager, including, without limitation, fees and expenses of
Trustees who are not "interested persons" of the Manager or the Fund, interest
charges, taxes, brokerage commissions, expenses of issue of shares, fees and
expenses of registering and qualifying the Fund and its classes of shares for
distribution under federal and state laws and regulations, charges of
custodians, auditing and legal expenses, expenses of determining net asset value
of the Fund, reports to shareholders, expenses of meetings of shareholders,
expenses of printing and mailing prospectuses, proxy statements and proxies to
existing shareholders, and its proportionate share of insurance premiums and
professional association dues or assessments. The Fund is also responsible for
such nonrecurring expenses as may arise, including litigation in which the Fund
may be a party, and other expenses as determined by the Trustees. The Fund may
have an obligation to indemnify its officers and Trustees with respect to such
litigation.
PORTFOLIO MANAGER
PIMCO serves as portfolio manager for the Fund pursuant to a portfolio
management agreement (the "Portfolio Management Agreement") between PIMCO and
the Manager. Under the Portfolio Management Agreement, subject always to the
control of the Trustees and the
41
supervision of the Manager, PIMCO's obligation is to furnish continuously an
investment program for the Fund, to make investment decisions on behalf of the
Fund and to place all orders for the purchase and sale of portfolio securities
and all other investments for the Fund.
Under the Portfolio Management Agreement, the Manager pays a portion of
the fees it receives from the Fund to PIMCO in return for PIMCO's services, at
the maximum annual rate of 0.50% of the Fund's average daily net assets
(including assets attributable to any Preferred Shares that may be outstanding).
PIMCO has contractually agreed to waive a portion of the fee it is entitled to
receive from the Manager such that PIMCO will receive 0.26% of the Fund's
average daily net assets from the commencement of Fund operations through June
30, 2007 (i.e., roughly the first 5 years of Fund operations), 0.40% of
average daily net assets in year 6, 0.45% in year 7 and 0.50% in each year
thereafter.
Originally organized in 1971, reorganized as a Delaware general
partnership in 1994 and reorganized as a Delaware limited liability company in
2000, PIMCO provides investment management and advisory services to private
accounts of institutional and individual clients and to mutual funds. The
membership interests of PIMCO as of January 1, 2002, were held 91% by ADAM of
America and 9% by the managing directors of PIMCO. As of February 28, 2002,
PIMCO had approximately $248 billion in assets under management. PIMCO is
located at 840 Newport Center Drive, Newport Beach, California 92660.
Certain Terms of the Investment Management Agreement and Portfolio
Management Agreement. The Investment Management Agreement and the Portfolio
Management Agreement were each approved by the Trustees of the Fund (including
all of the Trustees who are not "interested persons" of the Manager or PIMCO).
The Investment Management Agreement and Portfolio Management Agreement will each
continue in force with respect to the Fund for two years from their respective
dates, and from year to year thereafter, but only so long as their continuance
is approved at least annually by (i) vote, cast in person at a meeting called
for that purpose, of a majority of those Trustees who are not "interested
persons" of the Manager, PIMCO or the Fund, and by (ii) the majority vote of
either the full Board of Trustees or the vote of a majority of the outstanding
shares of all classes of the Fund. Each of the Investment Management Agreement
and Portfolio Management Agreement automatically terminates on assignment. The
Investment Management Agreement may be terminated on not less than 60 days'
notice by the Manager to the Fund or by the Fund to the Manager. The Portfolio
Management Agreement may be terminated on not less than 60 days' notice by the
Manager to PIMCO or by PIMCO to the Manager, or by the Fund at any time by
notice to the Manager and PIMCO.
The Investment Management Agreement and the Portfolio Management
Agreement each provide that the Manager or PIMCO, as applicable, shall not be
subject to any liability in connection with the performance of its services
thereunder in the absence of willful misfeasance, bad faith, gross negligence or
reckless disregard of its obligations and duties.
Basis for Approval of the Investment Management Agreement and Portfolio
Management Agreement. In determining to approve the Investment Management
Agreement and the Portfolio Management Agreement, the Trustees met with the
relevant investment advisory personnel from the Manager and PIMCO and considered
information relating to the
42
education, experience and number of investment professionals and other personnel
who would provide services under the applicable agreement. See "Management of
the Fund" in the Prospectus and this Statement of Additional Information. The
Trustees also took into account the time and attention to be devoted by senior
management to the Fund and the other funds in the complex. The Trustees
evaluated the level of skill required to manage the Fund and concluded that the
human resources to be available at the Manager and PIMCO were appropriate to
fulfill effectively the duties of the Manager and PIMCO on behalf of the Fund
under the applicable agreement. The Trustees also considered the business
reputation of the Manager and PIMCO, their financial resources and professional
liability insurance coverage and concluded that they would be able to meet any
reasonably foreseeable obligations under the applicable agreement.
The Trustees received information concerning the investment philosophy
and investment process to be applied by PIMCO in managing the Fund. In this
connection, the Trustees considered PIMCO's in-house research capabilities as
well as other resources available to PIMCO's personnel, including research
services available to PIMCO as a result of securities transactions effected for
the Fund and other investment advisory clients. The Trustees concluded that
PIMCO's investment process, research capabilities and philosophy were well
suited to the Fund, given the Fund's investment objective and policies.
The Trustees considered the scope of the services provided by the
Manager and PIMCO to the Fund under the Investment Management Agreement and
Portfolio Management Agreement, respectively, relative to services provided by
third parties to other mutual funds. The Trustees noted that the Manager's and
PIMCO's standard of care was comparable to that found in most investment company
advisory agreements. See "--Certain Terms of the Investment Management Agreement
and the Portfolio Management Agreement" above. The Trustees concluded that the
scope of the Manager's and PIMCO's services to be provided to the Fund was
consistent with the Fund's operational requirements, including, in addition to
its investment objective, compliance with the Fund's investment restrictions,
tax and reporting requirements and related shareholder services.
The Trustees considered the quality of the services to be provided by
the Manager and PIMCO to the Fund. The Trustees also evaluated the procedures of
the Manager and PIMCO designed to fulfill the their fiduciary duty to the Fund
with respect to possible conflicts of interest, including their codes of ethics
(regulating the personal trading of their officers and employees) (see
"Management of the Fund--Code of Ethics" above), the procedures by which PIMCO
allocates trades among its various investment advisory clients, the integrity of
the systems in place to ensure compliance with the foregoing and the record of
PIMCO in these matters. The Trustees also received information concerning
standards of the Manager and PIMCO with respect to the execution of portfolio
transactions. See "Portfolio Transactions" below.
In approving the agreements, the Trustees also gave substantial
consideration to the fees payable under the agreements. The Trustees reviewed
information [supplied by third parties] concerning fees paid to investment
advisers of similar municipal bond funds. The Trustees also considered the fees
of the Fund as a percentage of assets at different asset levels and possible
economies of scale to the Manager. The Trustees evaluated the Manager's
profitability with
43
respect to the Fund, concluding that such profitability was not inconsistent
with levels of profitability that had been determined by courts not to be
"excessive." In evaluating the Fund's advisory fees, the Trustees also took into
account the complexity of investment management for the Fund relative to other
types of funds. The Trustees concluded that, generally, municipal bond funds
require greater intensity of research and trading acumen than more diversified
funds.
PORTFOLIO TRANSACTIONS
INVESTMENT DECISIONS AND PORTFOLIO TRANSACTIONS
Investment decisions for the Fund and for the other investment advisory
clients of the Manager and PIMCO are made with a view to achieving their
respective investment objective. Investment decisions are the product of many
factors in addition to basic suitability for the particular client involved
(including the Fund). Some securities considered for investments by the Fund may
also be appropriate for other clients served by the Manager and PIMCO. Thus, a
particular security may be bought or sold for certain clients even though it
could have been bought or sold for other clients at the same time. If a purchase
or sale of securities consistent with the investment policies of the Fund and
one or more of these clients served by the Manager or PIMCO is considered at or
about the same time, transactions in such securities will be allocated among the
Fund and clients in a manner deemed fair and reasonable by the Manager or PIMCO,
as applicable. The Manager or PIMCO may aggregate orders for the Fund with
simultaneous transactions entered into on behalf of its other clients so long as
price and transaction expenses are averaged either for that transaction or for
the day. Likewise, a particular security may be bought for one or more clients
when one or more clients are selling the security. In some instances, one client
may sell a particular security to another client. It also sometimes happens that
two or more clients simultaneously purchase or sell the same security, in which
event each day's transactions in such security are, insofar as possible,
averaged as to price and allocated between such clients in a manner which the
Manager or PIMCO believes is equitable to each and in accordance with the amount
being purchased or sold by each. There may be circumstances when purchases or
sales of portfolio securities for one or more clients will have an adverse
effect on other clients.
BROKERAGE AND RESEARCH SERVICES
There is generally no stated commission in the case of debt securities,
which are traded in the over-the-counter markets, but the price paid by the Fund
usually includes an undisclosed dealer commission or mark-up. In underwritten
offerings, the price paid by the Fund includes a disclosed, fixed commission or
discount retained by the underwriter or dealer. Transactions on U.S. stock
exchanges and other agency transactions involve the payment by the Fund of
negotiated brokerage commissions. Such commissions vary among different brokers.
Also, a particular broker may charge different commissions according to such
factors as the difficulty and size of the transaction.
Subject to the supervision of the Manager, PIMCO places all orders for
the purchase and sale of portfolio securities, options, futures contracts and
other instruments for the Fund and buys and sells such securities, options,
futures and other instruments for the Fund through a substantial
44
number of brokers and dealers. In so doing, PIMCO uses its best efforts to
obtain for the Fund the most favorable price and execution available, except to
the extent it may be permitted to pay higher brokerage commissions as described
below. In seeking the most favorable price and execution, PIMCO, having in mind
the Fund's best interests, considers all factors it deems relevant, including,
by way of illustration, price, the size of the transaction, the nature of the
market for the security, the amount of the commission, the timing of the
transaction taking into account market prices and trends, the reputation,
experience and financial stability of the broker-dealer involved and the quality
of service rendered by the broker-dealer in other transactions.
Subject to the supervision of the Manager, PIMCO places orders for the
purchase and sale of portfolio investments for the Fund's account with brokers
or dealers selected by it in its discretion. In effecting purchases and sales of
portfolio securities for the account of the Fund, PIMCO will seek the best price
and execution of the Fund's orders. In doing so, the Fund may pay higher
commission rates than the lowest available when PIMCO believes it is reasonable
to do so in light of the value of the brokerage and research services provided
by the broker effecting the transaction, as discussed below.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research services from broker-dealers which execute portfolio
transactions for the clients of such advisers. Consistent with this practice,
PIMCO may receive research services from many broker-dealers with which PIMCO
places the Fund's portfolio transactions. PIMCO may also receive research or
research credits from brokers which are generated from underwriting commissions
when purchasing new issues of debt securities or other assets for the Fund.
These services, which in some cases may also be purchased for cash, include such
matters as general economic and security market reviews, industry and company
reviews, evaluations of securities and recommendations as to the purchase and
sale of securities. Some of these services are of value to PIMCO in advising
various of its clients (including the Fund), although not all of these services
are necessarily useful and of value in managing the Fund. Neither the management
fee paid by the Fund to the Manager nor the portfolio management fee paid by the
Manager to PIMCO is reduced because PIMCO and its affiliates receive such
services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934,
PIMCO may cause the Fund to pay a broker-dealer which provides "brokerage and
research services" (as defined in such Act) to PIMCO an amount of disclosed
commission for effecting a securities transaction for the Fund in excess of the
commission which another broker-dealer would have charged for effecting that
transaction.
The Fund may use broker-dealers that are affiliates (or affiliates of
affiliates) of the Fund, the Manager and/or PIMCO, subject to certain
restrictions discussed above under "Investment Manager and Portfolio
Manager--Investment Advisor."
References to PIMCO in this section would apply equally to the Manager
if the Manager were to assume portfolio management responsibilities for the Fund
and place orders for the purchase and sale of the Fund's portfolio investments.
45
DISTRIBUTIONS
As described in the Fund's Prospectus, initial distributions to Common
Shareholders are expected to be declared approximately 45 days, and paid
approximately 60 to 90 days, from the completion of the offering of the Common
Shares, depending on market conditions. To permit the Fund to maintain a more
stable monthly distribution, the Fund will initially (prior to its first
distribution), and may from time to time thereafter, distribute less than the
entire amount of net investment income earned in a particular period. Such
undistributed net investment income would be available to supplement future
distributions, including distributions that might otherwise have been reduced by
a decrease in the Fund's monthly net income due to fluctuations in investment
income or expenses, or due to an increase in the dividend rate on the Fund's
outstanding Preferred Shares. As a result, the distributions paid by the Fund
for any particular period may be more or less than the amount of net investment
income actually earned by the Fund during such period. Undistributed net
investment income will be added to the Fund's net asset value and,
correspondingly, distributions from undistributed net investment income will be
deducted from the Fund's net asset value.
For tax purposes, the Fund is currently required to allocate net
capital gain and other taxable income, if any, between and among Common Shares
and any series of Preferred Shares in proportion to total distributions paid to
each class for the year in which such net capital gain or other taxable income
is realized. For information relating to the impact of the issuance of Preferred
Shares on the distributions made by the Fund to Common Shareholders, see the
Fund's Prospectus under "Preferred Shares and Related Leverage."
While any Preferred Shares are outstanding, the Fund may not declare
any cash dividend or other distribution on its Common Shares unless at the time
of such declaration (1) all accumulated dividends on the Preferred Shares have
been paid and (2) the net asset value of the Fund's portfolio (determined after
deducting the amount of such dividend or other distribution) is at least 200% of
the liquidation value of any outstanding Preferred Shares. This latter
limitation on the Fund's ability to make distributions on its Common Shares
could cause the Fund to incur income and excise tax and, under certain
circumstances, impair the ability of the Fund to maintain its qualification for
taxation as a regulated investment company. See "Tax Matters."
DESCRIPTION OF SHARES
COMMON SHARES
The Fund's Declaration authorizes the issuance of an unlimited number
of Common Shares. The Common Shares will be issued with a par value of $0.00001
per share. All Common Shares of the Fund have equal rights as to the payment of
dividends and the distribution of assets upon liquidation of the Fund. Common
Shares will, when issued, be fully paid and, subject to matters discussed in
"Anti-Takeover and Other Provisions in the Declaration of Trust--Shareholder
Liability" below, non-assessable, and will have no pre-emptive or conversion
rights or rights to cumulative voting. At any time when the Fund's Preferred
Shares are outstanding, Common Shareholders will not be entitled to receive any
distributions from the
46
Fund unless all accrued dividends on Preferred Shares have been paid, and unless
asset coverage (as defined in the 1940 Act) with respect to Preferred Shares
would be at least 200% after giving effect to such distributions. See
"--Preferred Shares" below.
The Common Shares have been authorized for listing on the New York
Stock Exchange, subject to notice of issuance. The Fund intends to hold annual
meetings of shareholders so long as the Common Shares are listed on a national
securities exchange and such meetings are required as a condition to such
listing.
Shares of closed-end investment companies may frequently trade at
prices lower than net asset value. Shares of closed-end investment companies
like the Fund that invest predominantly in investment grade Municipal Bonds have
during some periods traded at prices higher than net asset value and during
other periods traded at prices lower than net asset value. There can be no
assurance that Common Shares or shares of other municipal funds will trade at a
price higher than net asset value in the future. Net asset value will be reduced
immediately following the offering of Common Shares after payment of the sales
load and organization and offering expenses. Net asset value generally increases
when interest rates decline, and decreases when interest rates rise, and these
changes are likely to be greater in the case of a fund, such as the Fund, having
a leveraged capital structure. Whether investors will realize gains or losses
upon the sale of Common Shares will not depend upon the Fund's net asset value
but will depend entirely upon whether the market price of the Common Shares at
the time of sale is above or below the original purchase price for the shares.
Since the market price of the Fund's Common Shares will be determined by factors
beyond the control of the Fund, the Fund cannot predict whether the Common
Shares will trade at, below, or above net asset value or at, below or above the
initial public offering price. Accordingly, the Common Shares are designed
primarily for long-term investors, and investors in the Common Shares should not
view the Fund as a vehicle for trading purposes. See "Repurchase of Common
Shares; Conversion to Open-End Fund" and the Fund's Prospectus under "Preferred
Shares and Related Leverage" and "The Fund's Investments--Municipal Bonds."
PREFERRED SHARES
The Declaration authorizes the issuance of an unlimited number of
Preferred Shares. The Preferred Shares may be issued in one or more classes or
series, with such par value and rights as determined by the Board of Trustees of
the Fund, by action of the Board of Trustees without the approval of the Common
Shareholders.
The Fund's Board of Trustees has indicated its intention to authorize
an offering of Preferred Shares (representing approximately 38% of the Fund's
capital immediately after the time the Preferred Shares are issued) within
approximately one to three months after completion of the offering of Common
Shares, subject to market conditions and to the Board's continuing belief that
leveraging the Fund's capital structure through the issuance of Preferred Shares
is likely to achieve the benefits to the Common Shareholders described in the
Prospectus and this Statement of Additional Information. Although the terms of
the Preferred Shares, including their dividend rate, voting rights, liquidation
preference and redemption provisions, will be determined by the Board of
Trustees (subject to applicable law and the Declaration) if and when it
authorizes a Preferred Shares offering, the Board has stated that the initial
series of Preferred
47
Shares would likely pay cumulative dividends at relatively short-term periods
(such as 7 days); by providing for the periodic redetermination of the dividend
rate through an auction or remarketing procedure. The liquidation preference,
preference on distribution, voting rights and redemption provisions of the
Preferred Shares are expected to be as stated below.
Limited Issuance of Preferred Shares. Under the 1940 Act, the Fund
could issue Preferred Shares with an aggregate liquidation value of up to
one-half of the value of the Fund's total net assets, measured immediately after
issuance of the Preferred Shares. "Liquidation value" means the original
purchase price of the shares being liquidated plus any accrued and unpaid
dividends. In addition, the Fund is not permitted to declare any cash dividend
or other distribution on its Common Shares unless the liquidation value of the
Preferred Shares is less than one-half of the value of the Fund's total net
assets (determined after deducting the amount of such dividend or distribution)
immediately after the distribution. To the extent that the Fund has outstanding
any senior securities representing indebtedness (such as through the use of
derivative instruments that constitute senior securities), the aggregate amount
of such senior securities will be added to the total liquidation value of any
outstanding Preferred Shares for purposes of these asset coverage requirements.
The liquidation value of the Preferred Shares is expected to be approximately
38% of the value of the Fund's total net assets. The Fund intends to purchase or
redeem Preferred Shares, if necessary, to keep the liquidation value of the
Preferred Shares plus the aggregate amount of other senior securities
representing indebtedness at or below one-half of the value of the Fund's total
net assets.
Distribution Preference. The Preferred Shares will have complete
priority over the Common Shares as to distribution of assets.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the affairs of the Fund, Preferred
Shareholders will be entitled to receive a preferential liquidating distribution
(expected to equal the original purchase price per share plus accumulated and
unpaid dividends thereon, whether or not earned or declared) before any
distribution of assets is made to holders of Common Shares. After payment of the
full amount of the liquidating distribution to which they are entitled,
Preferred Shareholders will not be entitled to any further participation in any
distribution of assets by the Fund. A consolidation or merger of the Fund with
or into any Massachusetts business trust or corporation or a sale of all or
substantially all of the assets of the Fund shall not be deemed to be a
liquidation, dissolution or winding up of the Fund.
Voting Rights. In connection with any issuance of Preferred Shares, the
Fund must comply with Section 18(i) of the 1940 Act which requires, among other
things, that Preferred Shares be voting shares. Except as otherwise provided in
the Declaration or the Fund's Bylaws or otherwise required by applicable law,
Preferred Shareholders will vote together with Common Shareholders as a single
class.
In connection with the election of the Fund's Trustees, Preferred
Shareholders, voting as a separate class, will also be entitled to elect two of
the Fund's Trustees, and the remaining Trustees shall be elected by Common
Shareholders and Preferred Shareholders, voting together as a single class. In
addition, if at any time dividends on the Fund's outstanding Preferred Shares
shall be unpaid in an amount equal to two full years' dividends thereon, the
holders of all
48
outstanding Preferred Shares, voting as a separate class, will be entitled to
elect a majority of the Fund's Trustees until all dividends in arrears have been
paid or declared and set apart for payment.
The affirmative vote of the holders of a majority of the outstanding
Preferred Shares, voting as a separate class, shall be required to approve any
action requiring a vote of security holders under Section 13(a) of the 1940 Act
including, among other things, changes in the Fund's investment objective, the
conversion of the Fund from a closed-end to an open-end company, or changes in
the investment restrictions described as fundamental policies under "Investment
Restrictions." The class or series vote of Preferred Shareholders described
above shall in each case be in addition to any separate vote of the requisite
percentage of Common Shares and Preferred Shares necessary to authorize the
action in question.
The foregoing voting provisions will not apply with respect to the
Fund's Preferred Shares if, at or prior to the time when a vote is required,
such shares shall have been (1) redeemed or (2) called for redemption and
sufficient funds shall have been deposited in trust to effect such redemption.
Redemption, Purchase and Sale of Preferred Shares by the Fund. The
terms of the Preferred Shares may provide that they are redeemable at certain
times, in whole or in part, at the original purchase price per share plus
accumulated dividends, that the Fund may tender for or purchase Preferred Shares
and that the Fund may subsequently resell any shares so tendered for or
purchased. Any redemption or purchase of Preferred Shares by the Fund will
reduce the leverage applicable to Common Shares, while any resale of shares by
the Fund will increase such leverage.
The discussion above describes the Fund's Board of Trustees' present
intention with respect to a possible offering of Preferred Shares. If the Board
of Trustees determines to authorize such an offering, the terms of the Preferred
Shares may be the same as, or different from, the terms described above, subject
to applicable law and the Declaration.
ANTI-TAKEOVER AND OTHER PROVISIONS IN THE DECLARATION OF TRUST
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Fund.
However, the Declaration contains an express disclaimer of shareholder liability
for acts or obligations of the Fund and requires that notice of such disclaimer
be given in each agreement, obligation or instrument entered into or executed by
the Fund or the Trustees. The Declaration also provides for indemnification out
of the Fund's property for all loss and expense of any shareholder held
personally liable on account of being or having been a shareholder. Thus, the
risk of a shareholder incurring financial loss on account of shareholder
liability is limited to circumstances in which such disclaimer is inoperative or
the Fund is unable to meet its obligations, and thus should be considered
remote.
49
ANTI-TAKEOVER PROVISIONS
As described below, the Declaration includes provisions that could have
the effect of limiting the ability of other entities or persons to acquire
control of the Fund or to change the composition of its Board of Trustees, and
could have the effect of depriving shareholders of opportunities to sell their
shares at a premium over prevailing market prices by discouraging a third party
from seeking to obtain control of the Fund.
The Fund's Trustees are divided into three classes (Class I, Class II
and Class III), having initial terms of one, two and three years, respectively.
At each annual meeting of shareholders, the term of one class will expire and
each Trustee elected to that class will hold office for a term of three years.
The classification of the Board of Trustees in this manner could delay for an
additional year the replacement of a majority of the Board of Trustees. In
addition, the Declaration provides that a Trustee may be removed only for cause
and only (i) by action of at least seventy-five percent (75%) of the outstanding
shares of the classes or series of shares entitled to vote for the election of
such Trustee, or (ii) by at least seventy-five percent (75%) of the remaining
Trustees.
Except as provided in the next paragraph, the affirmative vote or
consent of at least seventy-five percent (75%) of the Board of Trustees and at
least seventy-five percent (75%) of the shares of the Fund outstanding and
entitled to vote thereon are required to authorize any of the following
transactions (each a "Material Transaction"): (1) a merger, consolidation or
share exchange of the Fund or any series or class of shares of the Fund with or
into any other person or company, or of any such person or company with or into
the Fund or any such series or class of shares; (2) the issuance or transfer by
the Fund or any series or class of shares (in one or a series of transactions in
any twelve-month period) of any securities of the Fund or such series or class
to any other person or entity for cash, securities or other property (or
combination thereof) having an aggregate fair market value of $1,000,000 or
more, excluding sales of securities of the Fund or such series or class in
connection with a public offering, issuances of securities of the Fund or such
series or class pursuant to a dividend reinvestment plan adopted by the Fund and
issuances of securities of the Fund or such series or class upon the exercise of
any stock subscription rights distributed by the Fund; or (3) a sale, lease,
exchange, mortgage, pledge, transfer or other disposition by the Fund or any
series or class of shares (in one or a series of transactions in any
twelve-month period) to or with any person of any assets of the Fund or such
series or class having an aggregate fair market value of $1,000,000 or more,
except for transactions in securities effected by the Fund or such series or
class in the ordinary course of its business. The same affirmative votes are
required with respect to any shareholder proposal as to specific investment
decisions made or to be made with respect to the Fund's assets or the assets of
any series or class of shares of the Fund.
Notwithstanding the approval requirements specified in the preceding
paragraph, the Declaration requires no vote or consent of the Fund's
shareholders to authorize a Material Transaction if the transaction is approved
by a vote of both a majority of the Board of Trustees and seventy-five percent
(75%) of the Continuing Trustees (as defined below), so long as all other
conditions and requirements, if any, provided for in the Fund's Bylaws and
applicable law (including any shareholder voting rights under the 1940 Act) have
been satisfied.
50
In addition, the Declaration provides that the Fund may be terminated
at any time by vote or consent of at least seventy-five percent (75%) of the
Fund's shares or, alternatively, by vote or consent of both a majority of the
Board of Trustees and seventy-five percent (75%) of the Continuing Trustees (as
defined below).
In certain circumstances, the Declaration also imposes shareholder
voting requirements that are more demanding than those required under the 1940
Act in order to authorize a conversion of the Fund from a closed-end to an
open-end investment company. See "Repurchase of Common Shares; Conversion to
Open-End Fund" below.
As noted, the voting provisions described above could have the effect
of depriving Common Shareholders of an opportunity to sell their Common Shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund in a tender offer or similar transaction.
In the view of the Fund's Board of Trustees, however, these provisions offer
several possible advantages, including: (1) requiring persons seeking control of
the Fund to negotiate with its management regarding the price to be paid for the
amount of Common Shares required to obtain control; (2) promoting continuity and
stability; and (3) enhancing the Fund's ability to pursue long-term strategies
that are consistent with its investment objective and management policies. The
Board of Trustees has determined that the voting requirements described above,
which are generally greater than the minimum requirements under the 1940 Act,
are in the best interests of the Fund's Common Shareholders generally.
A "Continuing Trustee," as used in the discussion above, is any member
of the Fund's Board of Trustees who either (i) has been a member of the Board
for a period of at least thirty-six months (or since the commencement of the
Fund's operations, if less than thirty-six months) or (ii) was nominated to
serve as a member of the Board of Trustees by a majority of the Continuing
Trustees then members of the Board.
The foregoing is intended only as a summary and is qualified in its
entirety by reference to the full text of the Declaration and the Fund's Bylaws,
both of which have been filed as exhibits to the Fund's registration statement
on file with the SEC.
LIABILITY OF TRUSTEES
The Declaration provides that the obligations of the Fund are not
binding upon the Trustees of the Fund individually, but only upon the assets and
property of the Fund, and that the Trustees shall not be liable for errors of
judgment or mistakes of fact or law. Nothing in the Declaration, however,
protects a Trustee against any liability to which he would otherwise be subject
by reason of willful misfeasance, bad faith, gross negligence or reckless
disregard of the duties involved in the conduct of his office.
51
REPURCHASE OF COMMON SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its
shareholders will not have the right to cause the Fund to redeem their shares.
Instead, the Fund's Common Shares will trade in the open market at a price that
will be a function of several factors, including dividend levels (which are in
turn affected by expenses), net asset value, call protection, price, dividend
stability, relative demand for and supply of such shares in the market, general
market and economic conditions and other factors. Shares of a closed-end
investment company may frequently trade at prices lower than net asset value.
The Fund's Board of Trustees regularly monitors the relationship between the
market price and net asset value of the Common Shares. If the Common Shares were
to trade at a substantial discount to net asset value for an extended period of
time, the Board may consider the repurchase of its Common Shares on the open
market or in private transactions, or the making of a tender offer for such
shares. There can be no assurance, however, that the Board of Trustees will
decide to take or propose any of these actions, or that share repurchases or
tender offers, if undertaken, will reduce market discount. The Fund has no
present intention to repurchase its Common Shares and would do so only in the
circumstances described in this section.
Notwithstanding the foregoing, at any time when the Fund's Preferred
Shares are outstanding, the Fund may not purchase, redeem or otherwise acquire
any of its Common Shares unless (1) all accrued dividends on Preferred Shares
have been paid and (2) at the time of such purchase, redemption or acquisition,
the net asset value of the Fund's portfolio (determined after deducting the
acquisition price of the Common Shares) is at least 200% of the liquidation
value of the outstanding Preferred Shares (expected to equal the original
purchase price per share plus any accrued and unpaid dividends thereon).
Subject to its investment limitations, the Fund may borrow to finance
the repurchase of shares or to make a tender offer. Interest on any borrowings
to finance share repurchase transactions or the accumulation of cash by the Fund
in anticipation of share repurchases or tenders will reduce the Fund's net
income. Any share repurchase, tender offer or borrowing that might be approved
by the Board of Trustees would have to comply with the Securities Exchange Act
of 1934, as amended, and the 1940 Act and the rules and regulations thereunder.
The Fund's Board of Trustees may also from time to time consider
submitting to the holders of the shares of beneficial interest of the Fund a
proposal to convert the Fund to an open-end investment company. In determining
whether to exercise its sole discretion to submit this issue to shareholders,
the Board of Trustees would consider all factors then relevant, including the
relationship of the market price of the Common Shares to net asset value, the
extent to which the Fund's capital structure is leveraged and the possibility of
re-leveraging, the spread, if any, between the yields on securities in the
Fund's portfolio and interest and dividend charges on Preferred Shares issued by
the Fund and general market and economic conditions.
The Declaration requires the affirmative vote or consent of holders of
at least seventy-five percent (75%) of each class of the Fund's shares entitled
to vote on the matter to authorize a conversion of the Fund from a closed-end to
an open-end investment company, unless the conversion is authorized by both a
majority of the Board of Trustees and seventy-five percent (75%) of the
Continuing Trustees (as defined above under "Anti-Takeover and Other Provisions
52
in the Declaration of Trust--Anti-Takeover Provisions"). This seventy-five
percent (75%) shareholder approval requirement is higher than is required under
the 1940 Act. In the event that a conversion is approved by the Trustees and the
Continuing Trustees as described above, the minimum shareholder vote required
under the 1940 Act would be necessary to authorize the conversion. Currently,
the 1940 Act would require approval of the holders of a "majority of the
outstanding" Common Shares and, if issued, Preferred Shares voting together as a
single class, and the holders of a "majority of the outstanding" Preferred
Shares voting as a separate class, in order to authorize a conversion.
If the Fund converted to an open-end company, it would be required to
redeem all Preferred Shares then outstanding (requiring in turn that it
liquidate a portion of its investment portfolio), and the Fund's Common Shares
likely would no longer be listed on the New York Stock Exchange. Shareholders of
an open-end investment company may require the company to redeem their shares on
any business day (except in certain circumstances as authorized by or under the
1940 Act) at their net asset value, less such redemption charge, if any, as
might be in effect at the time of redemption. In order to avoid maintaining
large cash positions or liquidating favorable investments to meet redemptions,
open-end companies typically engage in a continuous offering of their shares.
Open-end companies are thus subject to periodic asset in-flows and out-flows
that can complicate portfolio management.
The repurchase by the Fund of its shares at prices below net asset
value will result in an increase in the net asset value of those shares that
remain outstanding. However, there can be no assurance that share repurchases or
tenders at or below net asset value will result in the Fund's shares trading at
a price equal to their net asset value. Nevertheless, the fact that the Fund's
shares may be the subject of repurchase or tender offers at net asset value from
time to time, or that the Fund may be converted to an open-end company, may
reduce any spread between market price and net asset value that might otherwise
exist.
In addition, a purchase by the Fund of its Common Shares will decrease
the Fund's total assets. This would likely have the effect of increasing the
Fund's expense ratio. Any purchase by the Fund of its Common Shares at a time
when Preferred Shares are outstanding will increase the leverage applicable to
the outstanding Common Shares then remaining. See the Fund's Prospectus under
"Risks--Leverage Risk."
Before deciding whether to take any action if the Fund's Common Shares
trade below net asset value, the Board of Trustees would consider all relevant
factors, including the extent and duration of the discount, the liquidity of the
Fund's portfolio, the impact of any action that might be taken on the Fund or
its shareholders and market considerations. Based on these considerations, even
if the Fund's shares should trade at a discount, the Board of Trustees may
determine that, in the interest of the Fund and its shareholders, no action
should be taken.
TAX MATTERS
Taxation of the Fund. The Fund intends to qualify each year as a
regulated investment company under Subchapter M of the Code. In order to qualify
for the special tax treatment
53
accorded regulated investment companies and their shareholders, the Fund must,
among other things:
(a) derive at least 90% of its gross income from dividends, interest,
payments with respect to certain securities loans, and gains from the
sale of stock, securities or foreign currencies, or other income
(including but not limited to gains from options, futures, or forward
contracts) derived with respect to its business of investing in such
stock, securities, or currencies;
(b) distribute with respect to each taxable year at least 90% of the
sum of its taxable net investment income, its net tax-exempt income,
and the excess, if any, of net short-term capital gains over net
long-term capital losses for such year; and
(c) diversify its holdings so that, at the end of each quarter of the
Fund's taxable year, (i) at least 50% of the market value of the Fund's
total assets is represented by cash and cash items, U.S. government
securities, securities of other regulated investment companies, and
other securities limited in respect of any one issuer to a value not
greater than 5% of the value of the Fund's total assets and not more
than 10% of the outstanding voting securities of such issuer, and (ii)
not more than 25% of the value of the Fund's total assets is invested
in the securities (other than those of the U.S. government or other
regulated investment companies) of any one issuer or of two or more
issuers which the Fund controls and which are engaged in the same,
similar, or related trades or businesses.
If the Fund qualifies as a regulated investment company that is accorded special
tax treatment, the Fund will not be subject to federal income tax on income
distributed in a timely manner to its shareholders in the form of dividends
(including Capital Gain Dividends, as defined below).
If the Fund failed to qualify as a regulated investment company
accorded special tax treatment in any taxable year, the Fund would be subject to
tax on its taxable income at corporate rates, and all distributions from
earnings and profits, including any distributions of net tax-exempt income and
net long-term capital gains, would be taxable to shareholders as ordinary
income. Such distributions generally would be eligible for the dividends
received deduction in the case of corporate shareholders. In addition, the Fund
could be required to recognize unrealized gains, pay substantial taxes and
interest and make substantial distributions before requalifying as a regulated
investment company that is accorded special tax treatment.
The Fund intends to distribute at least annually to its shareholders
all or substantially all of its net tax-exempt interest and any investment
company taxable income, and may distribute its net capital gain. The Fund may
also retain for investment its net capital gain. If the Fund does retain any net
capital gain or any investment company taxable income, it will be subject to tax
at regular corporate rates on the amount retained. If the Fund retains any net
capital gain, it may designate the retained amount as undistributed capital
gains in a notice to its shareholders who, if subject to federal income tax on
long-term capital gains, (i) will be required to include in income for federal
income tax purposes, as long-term capital gain, their share of such
undistributed amount, and (ii) will be entitled to credit their proportionate
shares of the tax paid by the Fund on such undistributed amount against their
federal income tax liabilities, if any, and to claim refunds to the extent the
credit exceeds such liabilities. For federal income tax purposes, the tax basis
of
54
shares owned by a shareholder of the Fund will be increased by an amount
equal under current law to the difference between the amount of undistributed
capital gains included in the shareholder's gross income and the tax deemed paid
by the shareholder under clause (ii) of the preceding sentence.
Treasury regulations permit a regulated investment company, in
determining its investment company taxable income and net capital gain, to elect
to treat all or part of any net capital loss, any net long-term capital loss or
any net foreign currency loss incurred after October 31 as if it had been
incurred in the succeeding year.
If the Fund fails to distribute in a calendar year at least an amount
equal to the sum of 98% of its ordinary income for such year and 98% of its
capital gain net income for the one-year period ending October 31 of such year,
plus any retained amount from the prior year, the Fund will be subject to a 4%
excise tax on the undistributed amounts. For these purposes, the Fund will be
treated as having distributed any amount for which it is subject to income tax.
A dividend paid to shareholders in January of a year generally is deemed to have
been paid by the Fund on December 31 of the preceding year, if the dividend was
declared and payable to shareholders of record on a date in October, November or
December of that preceding year. The Fund intends generally to make
distributions sufficient to avoid imposition of the 4% excise tax.
Fund Distributions. Distributions from the Fund (other than
exempt-interest dividends, as discussed below) will be taxable to shareholders
as ordinary income to the extent derived from investment income and net
short-term capital gains. Distributions of net capital gains (that is, the
excess of net gains from the sale of capital assets held more than one year over
net losses from the sale of capital assets held for not more than one year)
properly designated as capital gain dividends ("Capital Gain Dividends") will be
taxable to shareholders as long-term gain, regardless of how long a shareholder
has held the shares in the Fund.
The Fund's expenses attributable to earning tax-exempt income do not
reduce its current earnings and profits; therefore, distributions in excess of
the sum of the Fund's net tax-exempt and taxable income may be treated as
taxable dividends to the extent of the Fund's remaining earnings and profits
(which provides the measure of the Fund's dividend-paying capacity for tax
purposes). Distributions in excess of the sum of the Fund's net tax-exempt and
taxable income could occur, for example, if the Fund's book income exceeded the
sum of its net tax-exempt and taxable income. Differences in the Fund's book
income and its net tax-exempt and taxable income may arise from certain of the
Fund's hedging and investment activities. See "--Hedging Transactions" below.
Exempt-interest dividends. The Fund will be qualified to pay
exempt-interest dividends to its shareholders only if, at the close of each
quarter of the Fund's taxable year, at least 50% of the total value of the
Fund's total assets consists of obligations the interest on which is exempt from
federal income tax under Code Section 103(a). Distributions that the Fund
properly designates as exempt-interest dividends are treated as interest
excludable from shareholders' gross income for federal income tax purposes but
may be taxable for federal alternative minimum tax purposes and for state and
local purposes. Because the Fund intends to qualify to pay exempt-interest
dividends, the Fund may be limited in its ability to enter into taxable
55
transactions involving forward commitments, repurchase agreements, financial
futures and options contracts on financial futures, tax-exempt bond indices and
other assets.
The receipt of exempt-interest dividends may affect the portion, if
any, of a person's Social Security and Railroad Retirement benefits that will be
includable in gross income subject to federal income tax. Up to 85% of Social
Security and Railroad Retirement benefits may be included in gross income in
cases where the recipient's combined income, consisting of adjusted gross income
(with certain adjustments), tax-exempt interest income and one-half of any
Social Security and Railroad Retirement benefits, exceeds an adjusted base
amount ($34,000 for a single individual and $44,000 for individuals filing a
joint return). Shareholders receiving Social Security or Railroad Retirement
benefits should consult their tax advisers.
Under the Code, the interest on certain "private activity bonds" issued
after August 7, 1986 is treated as a preference item and is (after reduction by
applicable expenses) included in federal alternative minimum taxable income. The
Fund will furnish to shareholders annually a report indicating the percentage of
Fund income treated as a preference item for federal alternative minimum tax
("AMT") purposes. In addition, for corporations, alternative minimum taxable
income is increased by a percentage of the excess of an alternative measure of
income that includes interest on all tax-exempt securities over the amount
otherwise determined to be alternative minimum taxable income. Accordingly, the
portion of the Fund's dividends that would otherwise be tax-exempt to the
shareholders may cause an investor to be subject to the AMT or may increase the
tax liability of an investor who is subject to such tax. As described above, the
portfolio manager will normally avoid investments in bonds potentially
subjecting individuals to the AMT, which generally includes private activity
bonds.
Legislation has been introduced in recent years that would reinstate a
deductible tax (the "Environmental Tax") imposed through tax years beginning
before 1996 at a rate of 0.12% on a corporation's alternative minimum taxable
income (computed without regard to the AMT net operating loss deduction) in
excess of $2 million. If the Environmental Tax is reinstated, exempt-interest
dividends that are included in a corporate shareholder's alternative minimum
taxable income may subject corporate shareholders of the Fund to the
Environmental Tax.
The Fund designates distributions made to the share classes as
consisting of a portion of each type of income distributed by the Fund. The
portion of each type of income deemed received by each class of shareholders is
equal to the portion of total Fund distributions received by such class. Thus,
the Fund will designate dividends paid as exempt-interest dividends in a manner
that allocates such dividends between and among the holders of Common Shares and
any series of the Preferred Shares in proportion to the total dividends paid to
each class during or with respect to the taxable year, or otherwise as required
by applicable law. Long-term capital gain distributions and other income subject
to regular federal income tax will similarly be allocated between and among the
two (or more) classes.
Dividends (including Capital Gain Dividends) will be taxable as
described above whether received in cash or in shares. A shareholder whose
distributions are reinvested in shares will be treated as having received a
dividend equal to the fair market value of the new shares issued to the
shareholder, or the amount of cash allocated to the shareholder for the purchase
of shares on its behalf.
56
Part or all of the interest on indebtedness, if any, incurred or
continued by a shareholder to purchase or carry shares of the Fund paying
exempt-interest dividends is not deductible. The portion of interest that is not
deductible is equal to the total interest paid or accrued on the indebtedness,
multiplied by the percentage of the Fund's total distributions (not including
distributions from net long-term capital gains) paid to the shareholder that are
exempt-interest dividends. Under rules used by the Internal Revenue Service (the
"Service") to determine when borrowed funds are considered used for the purpose
of purchasing or carrying particular assets, the purchase of shares may be
considered to have been made with borrowed funds even though such funds are not
directly traceable to the purchase of shares.
Under a published position of the Service, a shareholder's interest
deduction generally will not be disallowed if the average adjusted basis of the
shareholder's tax-exempt obligations (including shares of preferred stock) does
not exceed two percent of the average adjusted basis of the shareholder's trade
or business assets (in the case of most corporations) or portfolio investments
(in the case of individuals). Legislation has been introduced in recent years
that would further limit or repeal this two-percent de minimis exception, thus
reducing the total after-tax yield of a shareholder.
In general, exempt-interest dividends, if any, attributable to interest
received on certain private activity obligations and certain industrial
development bonds will not be tax-exempt to any shareholders who are
"substantial users," within the meaning of Section 147(a) of the Code, of the
facilities financed by such obligations or bonds or who are "related persons" of
such substantial users.
The Fund will inform investors within 60 days of the Fund's fiscal
year-end of the percentage of its income distributions designated as tax-exempt.
The percentage is applied uniformly to all distributions made during the year.
The percentage of income designated as tax-exempt for any particular
distribution may be substantially different from the percentage of the Fund's
income that was tax-exempt during the period covered by the distribution.
Hedging Transactions. If the Fund engages in hedging transactions,
including hedging transactions in options, futures contracts, and straddles, or
other similar transactions, it will be subject to special tax rules (including
constructive sale, mark-to-market, straddle, wash sale, and short sale rules),
the effect of which may be to accelerate income to the Fund, defer losses to the
Fund, cause adjustments in the holding periods of the Fund's securities, convert
long-term capital gains into short-term capital gains or convert short-term
capital losses into long-term capital losses. These rules could therefore affect
the amount, timing and character of distributions to shareholders. Income earned
as a result of the Fund's hedging activities will not be eligible to be treated
as exempt-interest dividends when distributed to shareholders. The Fund will
endeavor to make any available elections pertaining to such transactions in a
manner believed to be in the best interests of the Fund.
Certain of the Fund's hedging activities are likely to produce a
difference between its book income and the sum of its net tax-exempt and taxable
income. If the Fund's book income exceeds its net tax-exempt income, the
distribution (if any) of such excess will be treated as (i) a taxable dividend
to the extent of the Fund's remaining earnings and profits (including earnings
and profits arising from tax-exempt income), (ii) thereafter as a return of
capital to the extent of
57
the recipient's basis in the shares, and (iii) thereafter as gain from the sale
or exchange of a capital asset. If the Fund's book income is less than its
taxable income, the Fund could be required to make distributions exceeding book
income to qualify as a regulated investment company that is accorded special tax
treatment.
Return of Capital Distributions. If the Fund makes a distribution to a
shareholder in excess of the Fund's current and accumulated earnings and profits
in any taxable year, the excess distribution will be treated as a return of
capital to the extent of his tax basis in his shares, and thereafter as capital
gain. A return of capital is not taxable, but it reduces a shareholder's tax
basis in his shares, thus reducing any loss or increasing any gain on a
subsequent taxable disposition by the shareholder of his shares.
Dividends and distributions on the Fund's shares are generally subject
to federal income tax as described herein to the extent they do not exceed the
Fund's realized income and gains, even though such dividends and distributions
may economically represent a return of a particular shareholder's investment.
Such distributions are likely to occur in respect of shares purchased at a time
when the Fund's net asset value reflects gains that are either unrealized, or
realized but not distributed. Such realized gains may be required to be
distributed even when the Fund's net asset value also reflects unrealized
losses. Distributions are taxable to a shareholder even if they are paid from
income or gains earned by the Fund prior to the shareholder's investment (and
thus included in the price paid by the shareholders).
Securities Issued or Purchased at a Discount. The Fund's investment in
securities issued at a discount and certain other obligations will (and
investments in securities purchased at a discount may) require the Fund to
accrue and distribute income not yet received. In order to generate sufficient
cash to make the requisite distributions, the Fund may be required to sell
securities in its portfolio that it otherwise would have continued to hold.
Capital Loss Carryover. Distributions from capital gains are generally
made after applying any available capital loss carryovers.
Sale or Redemption of Shares. The sale, exchange or redemption of Fund
shares may give rise to a gain or loss. In general, any gain or loss realized
upon a taxable disposition of shares will be treated as long-term capital gain
or loss if the shares have been held for more than 12 months. Otherwise the gain
or loss on the taxable disposition of Fund shares will be treated as short-term
capital gain or loss. However, if a shareholder sells shares at a loss within
six months of purchase, any loss will be disallowed for federal income tax
purposes to the extent of any exempt-interest dividends received on such shares.
In addition, any loss realized upon a taxable disposition of shares held for six
months or less but not disallowed as provided in the preceding sentence will be
treated as long-term, rather than short-term, to the extent of any long-term
capital gain distributions received by the shareholder with respect to the
shares. All or a portion of any loss realized upon a taxable disposition of Fund
shares will be disallowed if other shares of the Fund are purchased within 30
days before or after the disposition. In such a case, the basis of the newly
purchased shares will be adjusted to reflect the disallowed loss.
From time to time the Fund may make a tender offer for its Common
Shares. It is expected that the terms of any such offer will require a tendering
shareholder to tender all
58
Common Shares and dispose of all Preferred Shares, held, or considered under
certain attribution rules of the Code to be held, by such shareholder.
Shareholders who tender all Common Shares and dispose of all Preferred Shares
held, or considered to be held, by them will be treated as having sold their
shares and generally will realize a capital gain or loss. If a shareholder
tenders fewer than all of its Common Shares, or retains a substantial portion of
its Preferred Shares, such shareholder may be treated as having received a
taxable dividend upon the tender of its Common Shares. In such a case, there is
a remote risk that non-tendering shareholders will be treated as having received
taxable distributions from the Fund. Likewise, if the Fund redeems some but not
all of the Preferred Shares held by a Preferred Shareholder and such shareholder
is treated as having received a taxable dividend upon such redemption, there is
a remote risk that Common Shareholders and non-redeeming Preferred Shareholders
will be treated as having received taxable distributions from the Fund. To the
extent that the Fund recognizes net gains on the liquidation of portfolio
securities to meet such tenders of Common Shares, the Fund will be required to
make taxable distributions to its shareholders, which may in turn require the
Fund to make additional distributions to its Preferred Shareholders, if any.
Backup Withholding. The Fund generally is required to withhold and
remit to the U.S. Treasury a percentage of the taxable dividends and other
distributions paid to any individual shareholder who fails to properly furnish
the Fund with a correct taxpayer identification number (TIN), who has
under-reported dividend or interest income, or who fails to certify to the Fund
that he or she is not subject to such withholding. The backup withholding tax
rate is (i) 30% for amounts paid during 2002 and 2003, (ii) 29% for amounts paid
during 2004 and 2005, and (iii) 28% for amounts paid during 2006 through 2010.
The backup withholding rate will be 31% for amounts paid after December 31,
2010, unless Congress enacts tax legislation providing otherwise.
In order for a foreign investor to qualify for exemption from the
back-up withholding tax rates under income tax treaties, the foreign investor
must comply with special certification and filing requirements. Foreign
investors in the Fund should consult their tax advisers in this regard.
General. The federal income tax discussion set forth above is for
general information only. Prospective investors should consult their tax
advisers regarding the specific federal tax consequences of purchasing, holding,
and disposing of shares of the Fund, as well as the effects of state, local and
foreign tax law and any proposed tax law changes.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may be a suitable investment for a shareholder who is thinking
of adding bond investments to his portfolio to balance the appreciated stocks
that the shareholder is holding. Although the Fund currently intends to avoid
investments generating income potentially subjecting individuals to the federal
alternative minimum tax, it may not be successful in doing so. Therefore, Common
Shares may not be a suitable investment for investors who are subject to the
federal alternative minimum tax or who would become subject to such tax by
purchasing Common Shares. The suitability of an investment in Common Shares will
depend upon a comparison of the after-tax yield likely to be provided from the
Fund with that from comparable
59
tax-exempt investments (including those not subject to the alternative minimum
tax), and from comparable fully taxable investments, in light of each such
investor's tax position.
The Fund may quote certain performance-related information and may
compare certain aspects of its portfolio and structure to other substantially
similar closed-end funds as categorized by Lipper, Inc. ("Lipper"), Morningstar
Inc. or other independent services. Comparison of the Fund to an alternative
investment should be made with consideration of differences in features and
expected performance. The Fund may obtain data from sources or reporting
services, such as Bloomberg Financial ("Bloomberg") and Lipper, that the Fund
believes to be generally accurate.
The Fund, in its advertisements, may refer to pending legislation from
time to time and the possible impact of such legislation on investors,
investment strategy and related matters. This would include any tax proposals
and their effect on marginal tax rates and tax-equivalent yields. At any time in
the future, yields and total return may be higher or lower than past yields and
there can be no assurance that any historical results will continue.
Past performance is not indicative of future results. At the time
Common Shareholders sell their shares, they may be worth more or less than their
original investment.
See Appendix B for additional performance related and comparative
and other information.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSEMENT AGENT
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, serves as custodian for assets of the Fund. The custodian
performs custodial and fund accounting services.
PFPC Inc., 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as
the transfer agent, registrar, dividend disbursement agent and shareholder
servicing agent for the Common Shares, as well as agent for the Dividend
Reinvestment Plan relating to the Common Shares.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New
York 10036, serves as independent accountants for the Fund.
PricewaterhouseCoopers LLP provides audit services, tax return preparation and
assistance and consultation in connection with review of SEC filings to the
Fund.
COUNSEL
Ropes & Gray, One International Place, Boston, Massachusetts 02110,
passes upon certain legal matters in connection with shares offered by the Fund,
and also acts as counsel to the Fund.
60
REGISTRATION STATEMENT
A Registration Statement on Form N-2, including any amendments thereto,
relating to the shares of the Fund offered hereby, has been filed by the Fund
with the Securities and Exchange Commission (the "SEC"), Washington, D.C. The
Fund's Prospectus and this Statement of Additional Information do not contain
all of the information set forth in the Registration Statement, including any
exhibits and schedules thereto. For further information with respect to the Fund
and the shares offered or to be offered hereby, reference is made to the Fund's
Registration Statement. Statements contained in the Fund's Prospectus and this
Statement of Additional Information as to the contents of any contract or other
document referred to are not necessarily complete and in each instance reference
is made to the copy of such contract or other document filed as an exhibit to
the Registration Statement, each such statement being qualified in all respects
by such reference. Copies of the Registration Statement may be inspected without
charge at the SEC's principal office in Washington, D.C., and copies of all or
any part thereof may be obtained from the SEC upon the payment of certain fees
prescribed by the SEC.
61
REPORT OF INDEPENDENT ACCOUNTANTS
[TO BE PROVIDED]
62
FINANCIAL STATEMENTS
PIMCO Municipal Income Fund II
STATEMENT OF ASSETS AND LIABILITIES
[__________], 2002
[TO BE PROVIDED]
STATEMENT OF OPERATIONS
ONE DAY ENDED [__________], 2002
[TO BE PROVIDED]
63
APPENDIX A
DESCRIPTION OF SECURITIES RATINGS
The Fund's investments may range in quality from securities rated in
the lowest category to securities rated in the highest category (as rated by
Moody's, S&P or Fitch or, if unrated, determined by PIMCO to be of comparable
quality). The percentage of the Fund's assets invested in securities in a
particular rating category will vary. The following terms are generally used to
describe the credit quality of debt securities:
High Quality Debt Securities are those rated in one of the two highest
rating categories (the highest category for commercial paper) or, if unrated,
deemed comparable by PIMCO.
Investment Grade Debt Securities are those rated in one of the four
highest rating categories or, if unrated, deemed comparable by PIMCO.
Below Investment Grade, High Yield Securities (the "Junk Bonds") are
those rated lower than Baa by Moody's, BBB by S&P and BBB by Fitch and
comparable securities. They are deemed predominately speculative with respect to
the issuer's ability to repay principal and interest.
Following is a description of Moody's, S&P's and Fitch's rating
categories applicable to debt securities.
MOODY'S INVESTORS SERVICE, INC.
CORPORATE AND MUNICIPAL BOND RATINGS
Aaa: Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present that
make the long-term risks appear somewhat larger than with Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present that suggest a susceptibility to impairment sometime in the future.
A-1
Baa: Bonds which are rated Baa are considered as medium-grade
obligations (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of a
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca: Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's bond ratings, where specified, are applicable to financial
contracts, senior bank obligations and insurance company senior policyholder and
claims obligations with an original maturity in excess of one year. Obligations
relying upon support mechanisms such as letter-of-credit and bonds of indemnity
are excluded unless explicitly rated. Obligations of a branch of a bank are
considered to be domiciled in the country in which the branch is located.
Unless noted as an exception, Moody's rating on a bank's ability to
repay senior obligations extends only to branches located in countries which
carry a Moody's Sovereign Rating for Bank Deposits. Such branch obligations are
rated at the lower of the bank's rating or Moody's Sovereign Rating for the Bank
Deposits for the country in which the branch is located. When the currency in
which an obligation is denominated is not the same as the currency of the
country in which the obligation is domiciled, Moody's ratings do not incorporate
an opinion as to whether payment of the obligation will be affected by the
actions of the government controlling the currency of denomination. In addition,
risk associated with bilateral conflicts between an investor's home country and
either the issuer's home country or the country where an issuer branch is
located are not incorporated into Moody's ratings.
Moody's makes no representation that rated bank obligations or
insurance company obligations are exempt from registration under the U.S.
Securities Act of 1933 or issued in conformity with any other applicable law or
regulation. Nor does Moody's represent any specific bank or insurance company
obligation is legally enforceable or a valid senior obligation of a rated
issuer.
A-2
Moody's applies numerical modifiers, 1, 2, and 3 in each generic rating
classified from Aa through Caa in its corporate bond rating system. The modifier
1 indicates that the security ranks in the higher end of its generic rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates that the issue ranks in the lower end of its generic rating category.
CORPORATE SHORT-TERM DEBT RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers
to repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment ability of rated issuers:
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in earnings
coverage of fixed financial charges and high internal cash generation; and
well-established access to a range of financial markets and assured sources of
alternate liquidity.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a
strong ability for repayment of senior short-term debt obligations. This will
normally be evidenced by many of the characteristics cited above but to a lesser
degree. Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
PRIME-3: Issuers rated Prime-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime
rating categories.
STANDARD & POOR'S RATINGS SERVICES
ISSUE CREDIT RATING DEFINITIONS
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program
(including ratings on medium term note programs and commercial
A-3
paper programs). It takes into consideration the creditworthiness of guarantors,
insurers, or other forms of credit enhancement on the obligation and takes into
account the currency in which the obligation is denominated. The issue credit
rating is not a recommendation to purchase, sell, or hold a financial
obligation, inasmuch as it does not comment as to market price or suitability
for a particular investor.
Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short term in the
relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days -- including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition to
the usual long-term rating. Medium-term notes are assigned long-term ratings.
Issue credit ratings are based, in varying degrees, on the following
considerations: likelihood of payment -- capacity and willingness of the obligor
to meet its financial commitment on an obligation in accordance with the terms
of the obligation; nature of and provisions of the obligation; protection
afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy
and other laws affecting creditors' rights.
The issue rating definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above. (Such differentiation applies when an entity has
both senior and subordinated obligations, secured and unsecured obligations, or
operating company and holding company obligations.) Accordingly, in the case of
junior debt, the rating may not conform exactly with the category definition.
CORPORATE AND MUNICIPAL BOND RATINGS
Investment Grade
AAA: An obligation rated AAA has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is extremely strong.
AA: An obligation rated AA differs from the highest rated obligations
only in small degree. The obligor's capacity to meet its financial commitment on
the obligation is very strong.
A-4
A: An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB: An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
Speculative Grade
Obligations rated BB, B, CCC, CC, and C are regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. BB indicates the least degree of speculation and C
the highest. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major exposures
to adverse conditions.
BB: An obligation rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B: An obligation rated B is more vulnerable to nonpayment than
obligations rated BB, but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC: An obligation rated CCC is currently vulnerable to nonpayment, and
is dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC: An obligation rated CC is currently highly vulnerable to
nonpayment.
C: A subordinated debt or preferred stock obligation rated C is
CURRENTLY HIGHLY VULNERABLE to nonpayment. The C rating may be used to cover a
situation where a bankruptcy petition has been filed or similar action taken,
but payments on this obligation are being continued. A C also will be assigned
to a preferred stock issue in arrears on dividends or sinking fund payments, but
that is currently paying.
CI: The rating CI is reserved for income bonds on which no interest is
being paid.
D: An obligation rated D is in payment default. The D rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such
A-5
grace period. The D rating also will be used upon the filing of a bankruptcy
petition or the taking of a similar action if payments on an obligation are
jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
Provisional ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon failure of, such completion. The
investor should exercise his own judgment with respect to such likelihood and
risk.
r: This symbol is attached to the ratings of instruments with
significant noncredit risks. It highlights risks to principal or volatility of
expected returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk -- such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
The absence of an "r" symbol should not be taken as an indication that
an obligation will exhibit no volatility or variability in total return.
N.R.: This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that Standard & Poor's
does not rate a particular obligation as a matter of policy.
Debt obligations of issuers outside the United States and its
territories are rated on the same basis as domestic corporate and municipal
issues. The ratings measure the creditworthiness of the obligor but do not take
into account currency exchange and related uncertainties.
COMMERCIAL PAPER RATING DEFINITIONS
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into several categories, ranging from A for
the highest quality obligations to D for the lowest. These categories are as
follows:
A-1: A short-term obligation rated A-1 is rated in the highest category
by Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-6
A-2: A short-term obligation rated A-2 is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
A-3: A short-term obligation rated A-3 exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
B: A short-term obligation rated B is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C: A short-term obligation rated C is currently vulnerable to
nonpayment and is dependent upon favorable business, financial, and economic
conditions for the obligor to meet its financial commitment on the obligation.
D: A short-term obligation rated D is in payment default. The D rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The D rating
also will be used upon the filing of a bankruptcy petition or the taking of a
similar action if payments on an obligation are jeopardized.
A commercial paper rating is not a recommendation to purchase, sell or
hold a security inasmuch as it does not comment as to market price or
suitability for a particular investor. The ratings are based on current
information furnished to Standard & Poor's by the issuer or obtained from other
sources it considers reliable. Standard & Poor's does not perform an audit in
connection with any rating and may, on occasion, rely on unaudited financial
information. The ratings may be changed, suspended, or withdrawn as a result of
changes in or unavailability of such information.
FITCH, INC.
A brief description of the applicable Fitch, Inc. ("Fitch") ratings
symbols and meanings (as published by Fitch) follows:
LONG-TERM CREDIT RATINGS
Investment Grade
AAA: Highest credit quality. 'AAA' ratings denote the lowest
expectation of credit risk. They are assigned only in case of exceptionally
strong capacity for timely payment of financial commitments. This capacity is
highly unlikely to be adversely affected by foreseeable events.
A-7
AA: Very high credit quality. 'AA' ratings denote a very low
expectation of credit risk. They indicate very strong capacity for timely
payment of financial commitments. This capacity is not significantly
vulnerable to foreseeable events.
A: High credit quality. `A' ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered
strong. This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher ratings.
BBB: Good credit quality. `BBB' ratings indicate that there is currently
a low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
Speculative Grade
BB: Speculative. 'BB' ratings indicate that there is a possibility of
credit risk developing, particularly as the result of adverse economic change
over time; however, business or financial alternatives may be available to
allow financial commitments to be met. Securities rated in this category are
not investment grade.
B: Highly speculative. `B' ratings indicate that significant credit
risk is present, but a limited margin of safety remains. Financial commitments
are currently being met; however, capacity for continued payment is contingent
upon a sustained, favorable business and economic environment.
CCC, CC, C: High default risk. Default is a real possibility. Capacity
for meeting financial commitments is solely reliant upon sustained, favorable
business or economic developments. A `CC' rating indicates that default of some
kind appears probable. `C' ratings signal imminent default.
DDD, DD, D: Default. The ratings of obligations in this category are
based on their prospects for achieving partial or full recovery in a
reorganization or liquidation of the obligor. While expected recovery values are
highly speculative and cannot be estimated with any precision, the following
serve as general guidelines. `DDD' obligations have the highest potential for
recovery, around 90%-100% of outstanding amounts and accrued interest. `DD'
indicates potential recoveries in the range of 50%-90%, and `D' the lowest
recovery potential, i.e., below 50%. Entities rated in this category have
defaulted on some or all of their obligations. Entities rated `DDD' have the
highest prospect for resumption of performance or continued operation with or
without a formal reorganization process. Entities rated `DD' and `D' are
generally undergoing a formal reorganization or liquidation process; those rated
`DD' are likely to satisfy a higher portion of their outstanding obligations,
while entities rated `D' have a poor prospect for repaying all obligations.
A-8
SHORT-TERM CREDIT RATINGS
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
F1: Highest credit quality. Indicates the strongest capacity for
timely payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2: Good credit quality. A satisfactory capacity for timely payment
of financial commitments, but the margin of safety is not as great as in the
case of the higher ratings.
F3: Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
B: Speculative. Minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
C: High default risk. Default is a real possibility. Capacity for
meeting financial commitments is solely reliant upon a sustained, favorable
business and economic environment.
D: Default. Denotes actual or imminent payment default.
"+" or "-" may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the `AAA' long-term
rating category, to categories below `CCC', or to short-term ratings other than
`F1'.
`NR' indicates that Fitch does not rate the issuer or issue in
question.
`Withdrawn': A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
`Rating Watch': Ratings are placed on RatingWatch to notify investors
that there is a reasonable probability of a rating change and the likely
direction of such change. These are designated as "Positive", indicating a
potential upgrade, "Negative", for a potential downgrade, or "Evolving", if
ratings may be raised, lowered or maintained. Rating Watch is typically resolved
over a relatively short period.
A Rating Outlook indicates the direction a rating is likely to move
over a one to two year period. Outlooks may be positive, stable, or negative. A
positive or negative Rating Outlook does not imply a rating change is
inevitable. Similarly, companies whose outlooks are `stable' could be downgraded
before an outlook moves to positive or negative if circumstances warrant such an
action. Occasionally, Fitch may be unable to identify the fundamental trend. In
these cases, the Rating Outlook may be described as evolving.
A-9
APPENDIX B
PERFORMANCE RELATED AND COMPARATIVE AND OTHER INFORMATION
From time to time, the Fund, the Manager and/or PIMCO may report to
shareholders or to the public in advertisements concerning the performance of
the Manager and/or PIMCO as adviser to clients other than the Fund, or on the
comparative performance or standing of the Manager and/or PIMCO in relation to
other money managers. The Manager and/or PIMCO also may provide current or
prospective private account clients, in connection with standardized performance
information for the Fund, performance information for the Fund gross of fees and
expenses for the purpose of assisting such clients in evaluating similar
performance information provided by other investment managers or institutions.
Comparative information may be complied or provided by independent ratings
services or by news organizations. Any performance information, whether related
to the Fund, the Manager or PIMCO, should be considered in light of the Fund's
investment objective and policies, characteristics and quality of the Fund, and
the market conditions during the time period indicated, and should not be
considered to be representative of what may be achieved in the future.
Performance information for the Fund may be compared to various unmanaged
indexes.
[ADDITIONAL INFORMATION TO BE PROVIDED]
B-1
PART C - OTHER INFORMATION
Item 24: Financial Statements and Exhibits
1. Financial Statements:
Registrant has not conducted any business as of the date of this
filing, other than in connection with its organization. Financial
Statements indicating that the Registrant has met the net worth
requirements of Section 14(a) of the 1940 Act will be filed by pre-
effective amendment to this Registration Statement.
2. Exhibits:
a. Agreement and Declaration of Trust dated March 29, 2002, filed herewith.
b. Bylaws of Registrant dated March 29, 2002, filed herewith.
c. None.
d.1 Article III (Shares) and Article V (Shareholders' Voting Powers and
Meetings) of the Agreement and Declaration of Trust, filed herewith.
d.2 Article 10 (Shareholders' Voting Powers and Meetings) of the Bylaws of
Registrant, filed herewith.
d.3 Form of Share Certificate of the Common Shares.*
e. Terms and Conditions of Dividend Reinvestment Plan.*
f. None.
g.1 Form of Investment Management Agreement between Registrant and PIMCO Funds
Advisors LLC.*
g.2 Form of Portfolio Management Agreement between PIMCO Funds Advisors LLC
and Pacific Investment Management Company LLC.*
h.1 Form of Underwriting Agreement.*
h.2 Form of Master Selected Dealer Agreement.*
h.3 Form of Master Agreement Among Underwriters.*
i. None.
j. Form of Custodian Agreement between Registrant and State Street Bank &
Trust Co.*
k.1 Form of Transfer Agency Services Agreement between Registrant and
PFPC Inc.*
C-1
k.2 Form of Organizational and Offering Expenses Reimbursement Agreement
between Registrant and PIMCO Funds Advisors LLC.*
k.3 Form of Fee Waiver Agreement between Registrant and PIMCO Funds Advisors
LLC.*
k.4 Form of Fee Waiver Agreement between PIMCO Funds Advisors LLC and Pacific
Investment Management Company LLC.*
l. Opinion and consent of Ropes & Gray.*
m. None.
n. Consent of Registrant's independent accountants.*
o. None.
p. Subscription Agreement of PIMCO Funds Advisors LLC dated ________, 2002.*
q. None.
r.1 Code of Ethics of Registrant dated ________, 2002.*
r.2. Code of Ethics of PIMCO Funds Advisors LLC.*
r.3 Code of Ethics of Pacific Investment Management Company LLC.*
--------------------------
* To be filed by amendment.
C-2
Item 25: Marketing Arrangements
To be filed by amendment.
Item 26: Other Expenses of Issuance and Distribution
Securities and Exchange Commission Fees *
National Association of Securities Dealers, Inc. Fees *
Printing and engraving expenses *
Legal fees *
New York Stock Exchange listing fees *
Accounting expenses *
Miscellaneous expenses *
----
Total *
* To be completed by amendment. Expenses may be reduced pursuant to an
expected contractual arrangement of PIMCO Funds Advisors LLC to pay the
amount by which the aggregate of all the Fund's organizational expenses
and all offering costs (other than the sales load) exceed $0.03 per
share.
Item 27: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 28: Number of Holders of Securities
At April 15, 2002
Number of
Title of Class Record Holders
-------------- --------------
Common Shares, par value $0.00001 0
Item 29: Indemnification
Reference is made to Article VIII, Sections 1 through 4, of the
Registrant's Agreement and Declaration of Trust, which is incorporated by
reference herein.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to trustees, officers and
controlling persons of the Registrant by the Registrant pursuant to the Trust's
Agreement and Declaration of Trust, its Bylaws or otherwise, the Registrant is
aware that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Act and, therefore,
is unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by trustees, officers or controlling persons of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
trustees, officers or controlling persons in connection with the securities
being registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
C-3
Item 30: Business and Other Connections of Investment Adviser
Descriptions of the business of PIMCO Funds Advisors LLC, the
Registrant's investment manager, and Pacific Investment Management Company LLC,
the Registrant's portfolio manager, are set forth under the captions "Investment
Manager" and "Portfolio Manager" under "Management of the Fund" in both the
prospectus and Statement of Additional Information forming part of this
Registration Statement. The following sets forth business and other connections
of each director and executive officer (and persons performing similar
functions) of PIMCO Funds Advisors LLC and Pacific Investment Management Company
LLC.
PIMCO Funds Advisors LLC
1345 Avenue of the Americas
New York, NY 10105
Name Position with Advisor Other Connections
---------------- -------------------------- ------------------------------
Larry Altadonna Vice President
Andrew Bocko Senior Vice President and Senior Vice President,
Director of IT PIMCO Funds Advisors LLC,
Allianz Dresdner Asset
Management U.S. Equities LLC,
PIMCO Funds Advisors LLC
Tim Clark Managing Director
Cindy Columbo Vice President
Patrick Coyne Vice President
Udo Frank Vice President
Derek Hayes Senior Vice President
Steve Jobe Senior Vice President
Alan Kwan Vice President
John C. Maney Executive Vice President Chief Financial Officer,
and Chief Financial PIMCO Funds Advisors LLC,
Officer Allianz Dresdner Asset
Management U.S. Equities LLC,
Cadence Capital Management,
NFJ Investment Group, OCE
Distributors LLC, OpCap
Advisors LLC, Oppenheimer
Capital LLC, Pacific
Investment Management Company
LLC, PIMCO Allianz Advisors
LLC, PIMCO Funds Avisors,
PIMCO CD Distributors LLC,
PIMCO Equity Advisors LLC,
PIMCO Equity Partners LLC,
PIMCO Funds Advertising Agency
Inc., PIMCO Funds Distributors
LLC, Allianz Private Client
Services LLC, StocksPLUS
Management Inc. and Value
Advisors LLC
Vinh T. Nguyen Vice President and Vice President and Controller,
Controller PIMCO Funds Advisors LLC,
Allianz Dresdner Asset
Management U.S. Equities LLC,
Cadence Capital Management,
NFJ Investment Group, OCE
Distributors LLC, OpCap
Advisors LLC, Oppenheimer
Capital LLC, Pacific
Investment Management Company
LLC, PIMCO Allianz Advisors
LLC, PIMCO Funds Avisors,
PIMCO CD Distributors LLC,
PIMCO Equity Advisors LLC,
C-4
PIMCO Equity Partners LLC,
PIMCO Funds Advertising Agency
Inc., PIMCO Funds Distributors
LLC, Allianz Private Client
Services LLC, StocksPLUS
Management Inc. and Value
Advisors LLC
Francis C. Poli Executive Vice President, Chief Legal and Compliance
Chief Legal Officer, Officer, PIMCO Funds Advisors
Director of Compliance LLC, Allianz Dresdner Asset
and Assistant Secretary Management U.S. Equities LLC,
Allianz Hedge Fund Partners
L.P., Allianz Private Client
Services LLC, Cadence Capital
Management, NFJ Investment
Group, OCC Distributors LLC,
OpCap Advisors LLC,
Oppenheimer Capital LLC, PIMCO
Advisory Services Holdings
LLC, PIMCO Allianz Advisors
LLC, PIMCO Funds Advsisors
LLC, PIMCO CD Distributors
LLC, PIMCO Equity Advisors LLC
Bob Rokose Vice President and
Assistant Controller
Newton B. Schott, Jr. Managing Director,
Chief Legal Officer - MMS
Funds and Secretary
Brian S. Shlissel Senior Vice President
Stewart A. Smith Vice President and Secretary, PIMCO Funds
Assistant Secretary Advisors LLC, Allianz Dresdner
Asset Management U.S. Equities
LLC, Alianz Hedge Fund
Partners L.P., Allianz Private
Client Services LLC, Cadence
Capital Management, NFJ
Investment Group, PIMCO
Advisory Services Holding LLC,
PIMCO Allianz Advisors, PIMCO
Funds Advisors LLC, PIMCO CD
Distributors and PIMCO Equity
Advisors LLC, Assistant
Secretary, Oppenheimer Capital
LLC, OpCap Advisors and OCC
Distributors LLC
Stephen J. Treadway Managing Director and Chairman, President and Chief
Chief Executive Officer Executive Officer, PIMCO
Funds Advertising Agency
Inc.; Managing Director and
Chief Executive Officer,
PIMCO Funds Distributors LLC,
PIMCO Allianz Advisors LLC,
Allianz Private Client
Services LLC, Managing
Director, Allianz Asset
Management of America LLC
James G. Ward Executive Vice President Executive Vice President
and Director of Human Allianz Asset Management of
Resources America LLC, Director of Human
Resources, Allianz Asset
Management U.S. Equities LLC,
PIMCO Funds Distributors LLC
Michael B. Zuckerman Vice President
C-5
Pacific Investment Management Company LLC
("PIMCO")
840 Newport Center Drive, Suite 300
Newport Beach, CA 92660
Name Business and Other Connections
----------------------------- --------------------------------------------------
Arnold, Tammie J. Executive Vice President, PIMCO
Benz, William R. II Managing Director, Executive Committee Member,
PIMCO
Bhansali, Vineer Executive Vice President, PIMCO
Brynjolfsson, John B. Executive Vice President, PIMCO
Burns, R. Wesley Managing Director, PIMCO; President and Trustee of
PIMCO Funds and PIMCO Variable Insurance Trust;
President and Director of PIMCO Commercial
Mortgage Securities Trust, Inc.; Director, PIMCO
Funds: Global Investors Series plc and PIMCO
Global Advisors (Ireland) Limited
Cupps, Wendy W. Executive Vice President, PIMCO
Dialynas, Chris P. Managing Director, PIMCO
El-Erian, Mohamed A. Managing Director, PIMCO
Gross, William H. Managing Director and Executive Committee Member,
PIMCO; Director and Vice President, StocksPLUS
Management, Inc.; Senior Vice President of PIMCO
Funds and PIMCO Variable Insurance Trust
Hague, John L. Managing Director, PIMCO
Hally, Gordon C. Executive Vice President, PIMCO
Hamalainen, Pasi M. Managing Director, PIMCO
Harris, Brent R. Managing Director and Executive Committee Member,
PIMCO; Director and Vice President, StocksPLUS
Management, Inc.; Trustee and Chairman of PIMCO
Funds and PIMCO Variable Insurance Trust; Director
and Chairman, PIMCO Commercial Mortgage Securities
Trust, Inc.; Managing Director, PIMCO Specialty
Markets LLC
Hinman, David C. Executive Vice President, PIMCO
Hodge, Douglas M. Executive Vice President, PIMCO; Director,
PIMCO JAPAN LTD
Holden, Brent L. Managing Director, PIMCO
Isberg, Margaret E. Managing Director, PIMCO; Senior Vice President of
PIMCO Funds
Keller, James M. Executive Vice President, PIMCO
Kennedy, Raymond G. Executive Vice President, PIMCO
Loftus, John S. Managing Director, PIMCO; Senior Vice President of
PIMCO Funds; Vice President and Assistant
Secretary, StocksPLUS Management, Inc.
Mariappa, Sudesh N. Executive Vice President, PIMCO
C-6
Mather, Scott A. Executive Vice President, PIMCO; Senior Vice
President, PIMCO Commercial Mortgage Securities
Trust, Inc.
McCray, Mark V. Executive Vice President, PIMCO
McCulley, Paul A. Managing Director, PIMCO
McDevitt, Joseph E. Executive Vice President, PIMCO; Director and
Chief Executive Officer, PIMCO Europe Ltd
Meiling, Dean S. Managing Director, PIMCO
Monsan, Kristen S. Executive Vice President, PIMCO
Muzzy, James F. Managing Director, PIMCO; Director and Vice
President, StocksPLUS Management, Inc.; Senior
Vice President, PIMCO Variable Insurance Trust;
Vice President of PIMCO Funds; Director, PIMCO
Europe Ltd., PIMCO JAPAN LTD., PIMCO Asia Pte
Ltd., PIMCO Australia Pty Ltd.
Otterbein, Thomas J. Executive Vice President, PIMCO
Phansalkar, Mohan V. Executive Vice President, Secretary and Chief
Legal Officer, PIMCO; Vice President and
Secretary, StocksPLUS Management, Inc.
Podlich, William F. Managing Director, PIMCO
Powers, William C. Managing Director and Executive Committee Member,
PIMCO; Senior Vice President, PIMCO Commercial
Mortgage Securities Trust, Inc.
Schmider, Ernest L. Managing Director, PIMCO
Simon, W. Scott Executive Vice President, PIMCO
Thomas, Lee R. Managing Director, PIMCO
Thompson, William S. Managing Director and Executive Committee Member,
PIMCO; Director and President, StocksPLUS
Management, Inc.; Senior Vice President of PIMCO
Variable Insurance Trust; Vice President of PIMCO
Funds and PIMCO Commercial Mortgage Securities
Trust, Inc.
Trosky, Benjamin L. Managing Director, PIMCO; Senior Vice President,
PIMCO Commercial Mortgage Securities Trust, Inc.
Weil, Richard M. Chief Operating Officer and Executive Vice
President, PIMCO
Wood, George H. Executive Vice President, PIMCO
Wyman, Charles C. Executive Vice President, PIMCO
C-7
Item 31: Location of Accounts and Records
The account books and other documents required to be maintained by the
Registrant pursuant to Section 31(a) of the Investment Company Act of 1940 and
the Rules thereunder will be maintained at the offices of State Street Bank &
Trust Co., 225 Franklin Street, Boston, MA 02110 and/or PFPC Inc., 400 Bellevue
Parkway, Wilmington, Delaware 19809.
Item 32: Management Services
Not applicable.
Item 33: Undertakings
1. Registrant undertakes to suspend the offering of its Common Shares
until it amends the prospectus filed herewith if (1) subsequent to the effective
date of its registration statement, the net asset value declines more than 10
percent from its net asset value as of the effective date of the registration
statement, or (2) the net asset value increases to an amount greater than its
net proceeds as stated in the prospectus.
2. Not applicable.
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
a. For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and
contained in the form of prospectus filed by the Registrant under Rule
497(h) under the Securities Act of 1933 shall be deemed to be part of this
registration statement as of the time it was declared effective; and
b. For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of the securities at that
time shall be deemed to be the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or other means
designed to ensure equally prompt delivery, within two business days of receipt
of a written or oral request, any Statement of Additional Information.
Notice
A copy of the Agreement and Declaration of Trust of PIMCO Municipal Income
Fund II (the "Fund"), together with all amendments thereto, is on file with the
Secretary of State of The Commonwealth of Massachusetts, and notice is hereby
given that this instrument is executed on behalf of the Fund by any officer of
the Fund as an officer and not individually and that the obligations of or
arising out of this instrument are not binding upon any of the Trustees of the
Fund or shareholders of the Fund individually, but are binding only upon the
assets and property of the Fund.
C-8
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of New York, and the State of New York on the
15th day of April, 2002.
PIMCO Municipal Income Fund II
/s/ Stephen J. Treadway
By: _________________________________
Stephen J. Treadway,
President
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
Name Capacity Date
---- -------- ----
/s/ Stephen J. Treadway Trustee and President April 15, 2002
_________________________________
Stephen J. Treadway
/s/ Brian S. Shlissel Treasurer and Principal April 15, 2002
_________________________________ Financial and Accounting
Brian S. Shlissel Officer
INDEX TO EXHIBITS
Exhibit Exhibit Name
------- ------------
a. Agreement and Declaration of Trust dated March 29, 2002.
b. Bylaws of Registrant dated March 29, 2002.