The Trust’s portfolio is divided into five different asset segments: common stocks of closed-end investment companies (“closed-end funds”), high-yielding common stocks/American Depositary Receipts (“ADRs”), master limited partnerships (“MLPs”), real estate investment trusts (“REITs”) and stocks of companies created to hold investments in operating companies or their cash flows (“Royalty Trusts”). The selection methodology for each asset segment is as follows.
The security selection process begins by identifying an initial universe of North American-traded stocks in the Zacks Investment Research, Inc. database. From this initial universe, the Trust portfolio is compiled using the following five quantitative strategies:
Closed-End Fund Segment
The closed-end fund portion of the portfolio is reduced to 15 stocks based on the following pre-set quantitative investment criteria:
- Eliminate those closed-end funds that are not trading at a discount or have less than $150 million in assets under management.
- Eliminate those closed-end funds that have a dividend yield equal to zero.
- Eliminate those closed-end funds with less than $1 million in liquidity, where liquidity is defined as price times average three-month trading volume.
- Rank the remaining stocks based on descending dividend yield and select the best 15 closed-end funds for inclusion in the Trust.
- Weight these 15 stocks based on dividend yield to make up approximately 10% of the Trust’s assets.
Common Stock/ADR Segment
The Common Stock/ADR portion of the portfolio is reduced to 40 securities based on the following pre-set quantitative investment criteria:
- Rank the securities in this asset segment by descending market capitalization and eliminate those securities not among the largest 1,000.
- Eliminate those securities with a payout ratio of greater than 80%.
- From the remaining universe, eliminate those securities with a share price less than $10.00 and less than $2 million in liquidity, where liquidity is defined as price times average three-month trading volume.
- Rank the remaining securities based on descending dividend yield and select the best 40 securities for inclusion in the Trust.
- Weight these 40 stocks based on dividend yield to make up approximately 30% of the Trust’s assets.
The MLP portion of the portfolio is reduced to 15 stocks based on the following pre-set quantitative investment criteria:
- Eliminate those MLPs with a share price less than $10.00 and less than $3 million in liquidity, where liquidity is defined as price times average three-month trading volume.
- Rank the remaining stocks based on proportional short interest and eliminate the 10% with the largest amount of short interest.
- Rank the remaining stocks based on descending dividend yield and select the best 15 stocks for inclusion in the Trust.
- Weight these 15 stocks based on dividend yield to make up approximately 17.5% of the Trust’s assets.
The REIT portion of the portfolio is reduced to 20 stocks based on the following pre-set quantitative investment criteria:
- Eliminate those REITs with a share price less than $10.00 and less than $5 million in liquidity, where liquidity is defined as price times average three-month trading volume.
- Rank the remaining stocks based on proportional short interest and eliminate the 10% with the largest amount of short interest.
- Rank the remaining stocks based on descending dividend yield and select the best 20 stocks for inclusion in the Trust.
- Weight these 20 stocks based on dividend yield to make up approximately 20% of the Trust’s assets.
Royalty Trust Segment
The Royalty Trust portion of the portfolio is reduced to 10 stocks based on the following preset quantitative investment criteria:
- Eliminate those Royalty Trusts with a share price less than $10.00 and less than $3 million in liquidity, where liquidity is defined as price times average three-month trading volume.
- Rank the remaining stocks based on descending dividend yield and select the best 10 stocks for inclusion in the Trust.
- Weight these 10 stocks based on liquidity to make up approximately 22.5% of the Trust’s assets.
Final Portfolio Construction
The five asset segments are combined to form the final portfolio. A final liquidity check is performed to ensure investability and portfolio capacity. Any stock that has a liquidity value – defined as price times average three-month daily trading volume – less than the estimated investment may be removed from the Trust. The removed security will be replaced with the next highest ranked security from the same asset segment. In the event that a stock is selected which may not be treated as a corporation for U.S. tax purposes, that stock will be removed and the next stock in the list will be selected for inclusion in the portfolio.
Zacks & Company
Zacks & Company is a Chicago-based firm with over 25 years of experience in providing institutional and individual investors with the analytical tools and financial information necessary to the success of their investment process. The Trust will pay Zacks Investment Research, Inc. an annual licensing fee for the use of its intellectual property.
Risks and Other Considerations
As with all investments, you may lose some or all of your investment in the Trust. No assurance can be given that the Trust’s investment objective will be achieved. The Trust also might not perform as well as you expect. This can happen for reasons such as these:
- Securities prices can be volatile. The value of your investment may fall over time. Market value fluctuates in response to various factors. These can include stock market movements, purchases or sales of securities by the Trust, government policies, litigation, and changes in interest rates, inflation, the financial condition of the securities’ issuer or even perceptions of the issuer. Units of the Trust are not deposits of any bank and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
- Due to the current state of the economy, the value of the securities held by the Trust may be subject to steep declines or increased volatility due to changes in performance or perception of the issuers. In the last year, economic activity has declined across all sectors of the economy, and the United States is experiencing increased unemployment. The current economic crisis has affected the global economy with European and Asian markets also suffering historic losses. Extraordinary steps have been taken by the governments of several leading economic countries to combat the economic crisis; however, the impact of these measures is not yet known and cannot be predicted.
- The Trust invests in stocks issued by small-capitalization and mid-capitalization companies. These stocks customarily involve more investment risk than stocks of larger capitalization companies. Small-capitalization and mid-capitalization companies may have limited product lines, markets or financial resources and may be more vulnerable to adverse general market or economic developments.
- Share prices or dividend rates on the securities in the Trust may decline during the life of the Trust. There is no guarantee that the issuers of the securities will declare dividends in the future and, if declared, whether they will remain at current levels or increase over time.
- The Trust invests in ADRs, U.S.-listed foreign securities and foreign securities listed on a foreign exchange. The Trust’s investment in ADRs and foreign securities presents additional risk. ADRs are issued by a bank or trust company to evidence ownership of underlying securities issued by foreign corporations. Securities of foreign issuers present risks beyond those of domestic securities. More specifically, foreign risk is the risk that foreign stocks will be more volatile than U.S. stocks due to such factors as adverse economic, currency, political, social or regulatory developments in a country, including government seizure of assets, excessive taxation, limitations on the use or transfer of assets, the lack of liquidity or regulatory controls with respect to certain industries or differing legal and/or accounting standards. The Trust invests in companies located in countries with emerging markets. These markets are generally more volatile than in countries with more mature economies.
- Certain closed-end funds held by the Trust invest in securities issued by entities located in emerging markets. Emerging markets are generally defined as countries with low per capita income in the initial stages of their industrialization cycles. The markets of emerging markets countries are generally more volatile than the markets of developed countries with more mature economies.
- The Trust may invest in companies that are considered to be passive foreign investment companies (“PFICs”). In general, PFICs are certain non-U.S. corporations that receive at least 75% of their annual gross income from passive sources (such as interest, dividends, certain rents and royalties or capital gains) or that hold at least 50% of their assets in investments producing such passive income. As a result of an investment in PFICs, the Trust could be subject to U.S. federal income tax and additional interest charges on gains and certain distributions with respect to those equity interests, even if all the income or gain is distributed to its unitholders in a timely manner. The Trust will not be able to pass through to its unitholders any credit or deduction for such taxes.
- The Trust includes closed-end funds. Closed-end funds are actively managed investment companies that invest in various types of securities. Closed-end funds issue shares of common stock that are traded on a securities exchange. Closed-end funds are subject to various risks, including management’s ability to meet the closed-end fund’s investment objective and to manage the closed-end fund’s portfolio during periods of market turmoil and as investors’ perceptions regarding closed-end funds or their underlying investments change. Closed-end funds are not redeemable at the option of the shareholder and they may trade in the market at a discount to their net asset value. Closed-end funds may also employ the use of leverage which increases risk and volatility. Recent instability in the auction rate preferred shares market may affect the volatility of certain closed-end funds, especially those that use leverage or plan to use leverage.
- The value of the fixed-income securities in the closed-end funds will generally fall if interest rates, in general, rise. Typically, fixed-income securities with longer periods before maturity are more sensitive to interest rate changes.
- A closed-end fund or an issuer of securities held by a closed-end fund may be unwilling or unable to make principal payments and/or to declare distributions in the future, may call a security before its stated maturity, or may reduce the level of distributions declared. This may result in a reduction in the value of your units.
- The financial condition of a closed-end fund or an issuer of securities held by a closed-end fund may worsen or its credit ratings may drop, resulting in a reduction in the value of your units. This may occur at any point in time, including during the primary offering period.
- Certain closed-end funds held by the Trust invest in bonds that are rated below investment-grade and are considered to be “junk” securities. Below investment-grade obligations are considered to be speculative and are subject to greater market and credit risks, and accordingly, the risk of nonpayment or default is higher than with investment-grade securities. In addition, such securities may be more sensitive to interest rate changes and more likely to receive early returns of principal.
- Certain closed-end funds held by the Trust may invest in bonds that are rated as investment-grade by only one rating agency. As a result, such split-rated securities may have more speculative characteristics and are subject to a greater risk of default than securities rated as investment-grade by both Moody’s and Standard & Poor’s.
- Current economic conditions may lead to limited liquidity and greater volatility. The markets for fixed-income securities, such as those held by the closed-end funds, have experienced periods of illiquidity and volatility since the latter half of 2007. General market uncertainty and consequent repricing risk have led to market imbalances of sellers and buyers, which in turn have resulted in significant valuation uncertainties in a variety of fixed-income securities. These conditions resulted, and in many cases continue to result in, greater volatility, less liquidity, widening credit spreads and a lack of price transparency, with many debt securities remaining illiquid and of uncertain value. These market conditions may make valuation of some of the securities held by the closed-end fund uncertain and/or result in sudden and significant valuation increases or declines in its holdings.
- The Trust and certain closed-end funds held by the Trust invest in REITs. REITs may concentrate their investments in specific geographic areas or in specific property types, such as, hotels, shopping malls, residential complexes and office buildings. The value of the REITs and other real estate securities and the ability of such securities to distribute income may be adversely affected by several factors, including: rising interest rates; changes in the global and local economic climate and real estate conditions; perceptions of prospective tenants of the safety, convenience and attractiveness of the properties; the ability of the owner to provide adequate management, maintenance and insurance; increased competition from new properties; the impact of present or future environmental legislation and compliance with environmental laws; changes in real estate taxes and other operating expenses; adverse changes in governmental rules and fiscal policies; adverse changes in zoning laws; declines in the value of real estate; the downturn in the subprime mortgage lending market in the United States; and other factors beyond the control of the issuer of the security.
- The Trust invests in units of Royalty Trusts. The Trust’s investment in Royalty Trust units involves risks which may differ from an investment in common stock of a corporation. Royalty Trust units represent an equal fractional beneficial interest in such trust and often include provisions in their organization documents that limit their liability to unitholders. As a result, ownership of Royalty Trusts may not provide unitholders with the statutory rights normally associated with ownership of shares of a corporation. In addition, Royalty Trusts generally do not guarantee minimum distributions or even a return of capital and are subject to the risk that tax changes or recharacterizations will substantially affect the tax consequences of owning such trusts. On June 22, 2007, the Canadian Senate passed into law the Tax Fairness Plan, which included a tax on distributions paid by the Royalty Trusts. For those Royalty Trusts that began public trading after October 31, 2006, the application of the distribution tax commenced in 2007. For Royalty Trusts that began public trading before November 1, 2006, the distribution tax will apply beginning in 2011. The distribution tax could have a material impact on the current market value of all income trusts, and consequently, could impact the value of units of the Trust. Royalty Trusts are often subject to the risks associated with other energyrelated companies including the possibility of wide fluctuations of energy prices.
- The Trust invests in MLPs. MLPs are limited partnerships or limited liability companies that are taxed as partnerships and whose interests (limited partnership units or limited liability company units) are traded on securities exchanges like shares of common stock. Currently, most MLPs operate in the energy, natural resources or real estate sectors. Investments in MLP interests are subject to the risks generally applicable to companies in the energy and natural resources sectors, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk.
- The Trust includes securities issued by companies in the energy sector. Companies in the energy sector are subject to volatile fluctuations in price and supply of energy fuels, and can be impacted by international politics and conflicts, including the war in Iraq and hostilities in the Middle East, terrorist attacks, the success of exploration projects, reduced demand as a result of increases in energy efficiency and energy conservation, natural disasters, clean-up and litigation costs associated with environmental damage and extensive regulation.
- The Sponsor does not actively manage the portfolio. The Trust will generally hold, and may continue to buy, the same securities even though a security’s outlook, market value or yield may have changed.
- Inflation may lead to a decrease in the value of assets or income from investments.
- Please note that the Sponsor may be engaged as a service provider to certain closed-end funds held by the Trust and therefore certain fees paid by the Trust to such closed-end funds will be paid to the Sponsor for it services to such closed-end funds.
- In addition to the expenses of the units of the Trust, the Trust is subject to various expenses of the closed-end fund.